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Slide 1: UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K/A Amendment No. 2 (Mark One) ¥ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Ñscal year ended December 31, 2003 or n TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Ñle number: 1-12079 Calpine Corporation (A Delaware Corporation) I.R.S. Employer IdentiÑcation No. 77-0212977 50 West San Fernando Street San Jose, California 95113 Telephone: (408) 995-5115 Securities registered pursuant to Section 12(b) of the Act: Calpine Corporation Common Stock, $.001 Par Value Registered on the New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has Ñled all reports required to be Ñled 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 Ñle such reports), and (2) has been subject to such Ñling requirements for the past 90 days. Yes ¥ No n Indicate by check mark if disclosure of delinquent Ñlers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in deÑnitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. n Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Rule 12b-2 of the Securities Exchange Act). Yes ¥ No n Aggregate market value of the common equity held by non-aÇliates of the registrant as of June 30, 2003, the last business day of the registrant's most recently completed second Ñscal quarter: approximately $2.5 billion. Common stock outstanding as of March 19, 2004: 415,736,644 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the documents listed below have been incorporated by reference into the indicated parts of this report, as speciÑed in the responses to the item numbers involved. (1) Designated portions of the Proxy Statement relating to the 2004 Annual Meeting of Shareholders ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Part III (Items 10, 11, 12, 13 and 14)
Slide 2: FORM 10-K/A ANNUAL REPORT For the Year Ended December 31, 2003 TABLE OF CONTENTS Page Item Item Item Item Item Item Item Item Item Item 1. 2. 3. 4. 5. 6. 7. 7A. 8. 9. PART I Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Legal Proceedings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Submission of Matters to a Vote of Security HoldersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PART II Market for Registrant's Common Equity and Related Stockholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏ Selected Financial Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financial Statements and Supplementary Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in and Disagreements With Accountants on Accounting and Financial Disclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Controls and Procedures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ PART III Directors and Executive OÇcers of the Registrant ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Executive CompensationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Security Ownership of Certain BeneÑcial Owners and Management ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Certain Relationships and Related Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Principal Accounting Fees and Services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2 42 46 52 52 55 59 108 108 109 109 110 110 110 111 111 112 125 F-1 Item 9A. Item Item Item Item Item 10. 11. 12. 13. 14. PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Signatures and Power of AttorneyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Index to Consolidated Financial Statements and Other Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1
Slide 3: EXPLANATORY NOTE This Amendment No. 2 to the Annual Report on Form 10-K for Calpine Corporation (""Calpine'') for the Ñscal year ended December 31, 2003, as Ñled with the Securities and Exchange Commission (""SEC'') on March 25, 2004, is being Ñled in connection with the SEC's review of Calpine's registration statement on Form S-3, relating to the resale of 4.75% contingent convertible senior notes sold by Calpine on November 17, 2003 and January 9, 2004, and 1934 Exchange Act Filings incorporated by reference thereto. We Ñled Amendment No. 1 on September 13, 2004, at which time the SEC had not completed the review of our oil and gas related disclosures. This Amendment No. 2 is Ñled to revise or expand certain oil and gas related disclosures. There were no changes to the Consolidated Financial Statements as a result of Amendment No. 2. Amendment No. 2 does provide, however, revised or expanded disclosure in Part I: Item 1 ""Business'' and Item 2 ""Properties''; Part II: Item 8 ""Financial Statements and Supplementary Data''; and Part IV: Item 15 ""Exhibits, Financial Statement Schedules and Reports on Form 8-K.'' PART I Item 1. Business In addition to historical information, this report contains forward-looking statements. Such statements include those concerning Calpine Corporation's (""the Company's'') expected Ñnancial performance and its strategic and operational plans, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties that could cause actual results to diÅer materially from the forward-looking statements such as, but 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 produce reduced demand for power, (v) systemic economic slowdowns, which can adversely aÅect consumption of power by businesses and consumers, (vi) commercial operations of new plants that may be delayed or prevented because of various development and construction risks, such as a failure to obtain the necessary permits to operate, failure of third-party contractors to perform their contractual obligations or failure to obtain project Ñnancing on acceptable terms, (vii) cost estimates are preliminary and actual costs may be higher than estimated, (viii) a competitor's development of lower-cost power plants or of a lower cost means of operating a Öeet of power plants, (ix) risks associated with marketing and selling power from power plants in the evolving energy market, (x) the successful exploitation of an oil or gas resource that ultimately depends upon the geology of the 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) our estimates of oil and gas reserves may not be accurate, (xii) the eÅects on the Company's business resulting from reduced liquidity in the trading and power generation industry, (xiii) the Company's ability to access the capital markets on attractive terms or at all, (xiv) sources and uses of cash are estimates based on current expectations; actual sources may be lower and actual uses may be higher than estimated, (xv) the direct or indirect eÅects on the Company's business of a lowering of its credit rating (or actions it may take in response to changing credit rating criteria) including increased collateral requirements, refusal by the Company's current or potential counterparties to enter into transactions with it and its inability to obtain credit or capital in desired amounts or on favorable terms, (xvi) possible future claims, litigation and enforcement actions pertaining to the foregoing, (xvii) eÅects of the application of regulations, including changes in regulations or the interpretation thereof; or (xviii) other risks as identiÑed herein. Current information set forth in this Ñling has been updated to March 24, 2004, and Calpine undertakes no duty to further update this information. All other information in this Ñling is presented as of the speciÑc date noted and has not been updated since that time. We Ñle annual, quarterly and periodic reports, proxy statements and other information with the SEC. You may obtain and copy any document we Ñle 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 We 2
Slide 4: Ñle annual, quarterly and periodic reports, proxy statements and other information with the SEC. You may obtain and copy any document we Ñle 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 oÇce 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 Ñle electronically with the SEC. Our SEC Ñlings 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 Ñled 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 Ñlings, 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 speciÑcally requested and you pay our fee for duplication and delivery. OVERVIEW We are a San Jose, California based power company engaged in the development, construction, ownership and operation of power generation facilities and the sale of electricity predominantly in the United States, but also in Canada and the United Kingdom. We were established as a corporation in 1984. We focus on two eÇcient and clean types of power generation technologies, natural gas-Ñred combustion turbine and geothermal. We currently lease and operate a signiÑcant Öeet of geothermal power plants at The Geysers, and have increased our operating portfolio of clean burning natural gas power plants by 17,201 megawatts (""MW'') over the past three years. We have a proven track record in the development of new power facilities and may make acquisitions as opportunities arise. We also have in place an experienced gas production and management team to give us a broad range of fuel sourcing options, and we own over 800 billion cubic feet equivalent (""Bcfe'') of net proved natural gas reserves located in Alberta, Canada as well as in the Sacramento Basin, Rockies and Gulf Coast regions of the United States. Additionally, we own a 25% interest in Calpine Natural Gas Trust, which has proved reserves of approximately 72 Bcfe (18 Bcfe net to Calpine's equity interest). We are currently (in March 2004) capable of producing, net to Calpine's interest, approximately 207 million cubic feet equivalent (""MMcfe'') of natural gas per day, and Calpine Natural Gas Trust's (""CNG Trust'') total production, net of royalties, is currently approximately 35 MMcfe (approximately 9 MMcfe net to Calpine's interest) of natural gas per day. Currently, we own interests in 87 power plants having a net capacity of 22,206 MW. We also have 12 gasÑred projects and 1 project expansion currently under construction collectively having a net capacity of 7,685 MW. The completion of the new projects currently under construction would give us interests in 99 power plants located in 22 states, 3 Canadian provinces and the United Kingdom, and we will own net capacity of 29,891 MW. Of this total generating capacity, 97% will be attributable to gas-Ñred facilities and 3% will be attributable to geothermal facilities. Calpine Energy Services, L.P. (""CES'') provides the trading and risk management services needed to schedule power sales and to ensure fuel is delivered to the power plants on time to meet delivery requirements and to manage and optimize the value of our physical power generation and gas production assets. Complementing CES's activities, we have recently reorganized our marketing and sales organization to better meet the needs of our growing list of wholesale and large retail customers. We focus our sales activities on load serving entities such as local utilities, municipalities and cooperatives, as well as on large-scale end users such as industrial and commercial companies. See a further discussion of our marketing and sales organization in ""Strategy'' below. As a general goal, we seek to have 65% of our available capacity sold under long-term contracts or hedged by our risk management group. Currently we have 52% of our available capacity sold or hedged for 2004. 3
Slide 5: We continue to strengthen our system operations management and information technology capabilities to enhance the economic performance of our portfolio of assets in our major markets and to provide loadfollowing and other ancillary services to our customers. These operational optimization systems, combined with our sales, marketing and risk management capabilities, enable us to add value to traditional commodity products in ways that not all competitors can match. Our construction organization has assembled an experienced team of construction management professionals to ensure that our projects are built using our standard design speciÑcations reÖecting our exacting operational standards. We have established relationships with leading equipment manufacturers for gas turbine generators, steam turbine generators and heat recovery steam generators and other key equipment. We will continue to leverage these capabilities and relationships to ensure that our power plants are completed on time and are the best built and lowest cost energy facilities possible. With a vision of enhancing the performance of our modern portfolio of gas-Ñred power plants and lowering our replacement parts maintenance costs, we have fostered the development of our wholly owned subsidiary, Power Systems Manufacturing (""PSM''), to design and manufacture high performance combustion system and turbine blade parts. PSM manufactures new vanes, blades, combustors and other replacement parts for the industrial gas turbine industry. It oÅers a wide range of Low Emissions Combustion systems and advanced airfoils designed to be transparently compatible for retroÑtting or replacing existing combustion systems or components operating in General Electric and Siemens Westinghouse turbines. In 2003 we expanded our energy services capabilities with the acquisition of Netherlands-based Thomassen Turbine Systems (""TTS''). TTS complements Calpine's broad array of energy services by selling combustion turbine component parts and repair services worldwide. We established Calpine Power Services (""CPS'') to oÅer the unique skills that we have honed in building and operating our own power plants to third party customers. We are now selling, and have received contracts for, various engineering, procurement, construction management, plant commissioning, operations, and maintenance services through CPS. As we build the nation's most modern and eÇcient portfolio of gas-Ñred generation assets and establish our low-cost position, our integrated operations and skill sets have allowed us to weather a multi-year downturn in the North American energy industry. We have demonstrated the Öexibility to adapt to fundamental market changes. SpeciÑcally, we responded to the market downturn by reducing capital expenditures, selling or monetizing various gas, power, and contractual assets, restructuring our equipment procurement obligations, and reorganizing to reÖect our transition from a development focused company to an operations focused company. These eÅorts have allowed us to cut costs and raise capital while positioning ourselves to continue our quest to be the power company in North America with the largest market capitalization. See Note 25 of the Notes to Consolidated Financial Statements for Operating Segments Disclosures. THE MARKET The electric power industry represents one of the largest industries in the United States and impacts nearly every aspect of our economy, with an estimated end-user market of nearly $260 billion of electricity sales in 2003 based on information published by the Energy Information Administration of the Department of Energy (""EIA''). Historically, the power generation industry has been largely characterized by electric utility monopolies producing electricity from old, ineÇcient, polluting, high-cost generating facilities selling to a captive customer base. However, industry trends and regulatory initiatives have transformed some markets into more competitive grounds where load-serving entities and end-users may purchase electricity from a variety of suppliers, including independent power producers, power marketers, regulated public utilities and others. For the past decade, the power industry has been deregulated at the wholesale level allowing generators to sell directly to the load serving entities, such as public utilities, municipalities and electric cooperatives. Although industry trends and regulatory initiatives aimed at further deregulation have slowed, the power industry continues to transform into a more competitive market. 4
Slide 6: The North American Electric Reliability Council (""NERC'') estimates that in the United States, peak (summer) electric demand in 2003 totaled approximately 720,000 MW, while summer generating capacity in 2003 totaled approximately 912,000 MW, creating a peak summer reserve margin of 192,000 MW, or 26.7%. Historically, utility reserve margins have been targeted to be 15% above peak demand to provide for load forecasting errors, scheduled and unscheduled plant outages and local area grid protection. Some regions have margins well in excess of the 15% target range, while other regions remain short of ideal reserve margins. The estimated 192,000 MW of reserve margin in 2003 compares to an estimated 120,000 MW in 2002. The increase is due in large part to the start-up of new low-cost, clean-burning, gas-Ñred power plants. The United States market consists of regional electric markets not all of which are eÅectively interconnected, so reserve margins vary from region to region. Even though most new power plants are fueled by natural gas, the majority of power generated in the U.S. is still produced by coal and nuclear power plants. The EIA has estimated that approximately 51% of the electricity generated in the U.S. is fueled by coal, 20% by nuclear sources, 17% by natural gas, 7% by hydro, and 5% from fuel oil and other sources. As regulations continue to evolve, many of the current coal plants will likely be faced with installing a signiÑcant amount of costly emission control devices. This activity could cause some of the oldest and dirtiest coal plants to be retired, thereby allowing a greater proportion of power to be produced by cleaner natural gas-Ñred generation. Due primarily to the completion of gas-Ñred combustion turbine projects, we have seen power supplies increase and higher reserve margins in the last two years accompanied by a decrease in liquidity in the energy trading markets, and a general lessening of enthusiasm for investing in energy companies. In 2003 while electricity prices generally increased, the cost of natural gas grew at an even greater rate, further depressing spark spreads (the margin between the value of the electricity sold and the cost of fuel to generate that electricity) from the low levels in 2002. Based on strength in residential and commercial demand, overall consumption of electricity was estimated to have grown by approximately 2.9% in 2004 through February compared to the same period in 2003, according to Edison Electric Institute (""EEI'') published data. The growth rate for calendar year 2003 was 1.8%. The growth rate in supply is diminishing with many developers canceling, or delaying completion of their projects as a result of current market conditions. The supply and demand balance in the natural gas industry continues to be strained with gas prices rising to over $6.40 per million btu (""MMbtu'') in the Ñrst quarter of 2004, compared to an average of approximately $5.50 per MMbtu in 2003 and $3 per MMbtu in 2002. In addition, capital market participants are slowly making progress in restructuring their portfolios, thereby stabilizing Ñnancial pressures on the industry. Overall, we expect the market to continue these trends and work through the current oversupply of power in several regions within the next few years. As the supplydemand picture improves, we expect to see spark spreads improve and capital markets regain their interest in helping to repower America with clean, highly eÇcient energy technologies. STRATEGY Our vision is to become North America's largest power company and ultimately become a major worldwide power company. In achieving our corporate strategic objectives, the number one priority for our company is maintaining the highest level of integrity in all of our endeavors. We have posted on our website (www.calpine.com Ghttp://www.calpine.comH) our Code of Conduct applicable to all employees, including our principal executive oÇcer, principal Ñnancial oÇcer and principal accounting oÇcer. We intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding any amendments to or waivers from the Code of Conduct by posting such information on our website at www.calpine.com. Our timeline to achieve our strategic objectives is Öexible and will be guided by our view of market fundamentals. When necessary, we will slow or delay our growth activities in order to ensure that our Ñnancial health is secure and our investment opportunities meet our long-term rate of return requirements. 5
Slide 7: Near-Term Objectives Our ability to adapt as needed to market dynamics has led us to develop a set of near-term strategic objectives that will guide our activities until market fundamentals improve. These include: ‚ Continue to focus on our liquidity position as our second highest priority after integrity; ‚ Complete our 2004 reÑnancing program, which includes Calpine Generating Company, LLC (""CalGen'') (see ""Recent Developments'' for more information), the remaining outstanding 4% Convertible Senior Notes Due 2006, and the Remarketable Term Income Deferrable Equity Securities (""HIGH TIDES''); ‚ Complete our current construction program and start construction of new projects in strategic locations only when Ñnancing is available and attractive returns are expected; ‚ Continue to lower operating and overhead costs per megawatt hour produced and improve operating performance with an increasingly eÇcient power plant Öeet; and ‚ Utilize our marketing and sales capabilities to selectively increase our power contract portfolio. Longer-Term Objectives We plan on realizing our strategy by (1) achieving the lowest-cost position in the industry by applying our fully integrated areas of expertise to the cost-eÅective development, construction, Ñnancing, fueling, and operation of the most modern and eÇcient power generation facilities and by achieving economies of scale in general, administrative and other support costs, and (2) enhancing the value of the power we generate in the marketplace (a) by operating our plants as a system, (b) by selling directly to load-serving entities and, to the extent allowable, to industrial customers, in each of the markets in which we participate, (c) by oÅering loadfollowing and other ancillary services to our customers, and (d) by providing eÅective marketing, risk management and asset optimization activities through our CES and marketing and sales organizations. Our ""system approach'' refers to our ability to cluster our standardized, highly eÇcient power generation assets within a given energy market and to sell the energy from that system of power plants, rather than using ""unit speciÑc'' marketing contracts. The clustering of standardized power generation assets allows for signiÑcant economies of scale to be achieved. SpeciÑcally, construction costs, supply chain activities such as inventory and warehousing costs, labor, and fuel procurement costs can all be reduced with this approach. The choice to focus on highly eÇcient and clean technologies reduces our fuel costs, a major expense when operating power plants. Furthermore, our lower-than-market heat rate (high eÇciency advantage) provides us a competitive advantage in times of rising fuel prices, and our systems approach to fuel purchases reduces imbalance charges when a plant is forced out of service. Finally, utilizing our system approach in a sales contract allows us to provide power to a customer from whichever plant in the system is most economical at a given period of time. In addition, the operation of plants can be coordinated when increasing or decreasing power output throughout the day to enhance overall system eÇciency, thereby enhancing the heat rate advantage already enjoyed by the plants. In total, this approach lays a foundation for a sustainable competitive cost advantage in operating our plants. The integration of gas production, hedging, optimization and marketing activities achieves additional cost reductions while simultaneously enhancing revenues. Our Öeet of natural gas burning power plants requires a large amount of gas to operate. Our fuel strategy is to produce from our own gas reserves enough fuel to provide a natural hedge against gas price volatility, while providing a secure and reliable source of fuel and lowering our fuel costs over time. The ownership of gas provides our CES risk management organization with additional Öexibility when structuring Ñxed price transactions with our customers. Recent trends conÑrm that both buyers and sellers of power beneÑt from signing long-term power contracts and avoiding the severe volatility often seen with power prices. The trend towards signing long-term contracts is creating opportunities for companies, such as ours, that own power plants and gas reserves to negotiate directly with buyers (end users and load serving entities) that need power, thereby skipping the trading middlemen, many of whom have now exited the market. 6
Slide 8: Our marketing and sales organization is dedicated to serving wholesale and industrial customers with reliable, cost-eÅective electricity and a full range of services. The organization oÅers customers: (1) wholesale bulk energy; (2) Ñrm supply energy; (3) fully dispatchable energy; (4) full service requirements energy; (5) renewable energy; (6) energy scheduling services; (7) engineering, construction, operations and maintenance services; and (8) critical reliability energy services. Our physical, Ñnancial and intellectual assets and our generating facilities that are pooled into unique energy centers in key markets, enable us to create customizable energy solutions for our customers. For example, our wholesale energy products deliver power when, where and in the capacity our customers need. Our power marketing experience gives us the know-how to structure innovative deals that meet our customers' particular requirements. Our highly tailored, yet understandable energy contracts help customers oÅset pricing risk and other variables. Our ""Virtual Power Plant'' projects provide customers with an energy resource that is reliable and Öexible. They give customers all of the advantages of owning and operating their own plants without many of the risks, by gaining access to a portfolio of highly eÇcient generation assets and by implementing our IT solutions to allow power to be dispatched as needed. Marketing and Sales is pursuing 21,000 MW of active opportunities with 135 customers across the United States. This customer base includes municipalities, cooperatives, investor owned utilities, industrial customers and commercial customers across the United States. Our Ñnancing strategy includes an objective to achieve and maintain an investment grade credit and bond rating from the major rating agencies within the next several years. We intend to employ various approaches for extending or reÑnancing existing credit facilities and for Ñnancing new plants, with a goal of retaining maximum system operating Öexibility. The availability of capital at attractive terms will be a key requirement to enable us to develop and construct new plants. We have adjusted to recent market conditions by taking near-term actions focused on liquidity. We have been very successful throughout 2003 and early 2004 at selling certain less strategically important assets, monetizing several contracts, establishing a Canadian natural gas trust to raise funds based on selling to the trust certain of our oil and gas assets, buying back our debt, issuing convertible and non-convertible senior notes, and raising capital with non-recourse project Ñnancing. COMPETITION We are engaged in several diÅerent types of business activities each of which has its own competitive environment. To better understand the competitive landscape we face, it is helpful to look at Ñve diÅerent groupings of business activities. Development and Construction. In this activity, we face competition from independent power producers (""IPPs''), non-regulated subsidiaries of utilities, and increasingly from regulated utilities and large end-users of electricity. Furthermore, the regulatory and community pressures against locating a power plant at a speciÑc site can often be substantial, causing months or years of delays. Similarly, the construction process is highly competitive as there are only a few primary suppliers of key gas turbine, steam turbine and heat recovery steam generator equipment used in a state of the art gas turbine power plant. Additionally, we have seen periods of strong competition with respect to securing the best construction personnel and contractors. Power Plant Operations. The competitive landscape faced by our power plant operations organization consists of a patchwork of highly competitive and highly regulated market environments. This patchwork has been caused by an uneven transition to deregulated markets across the various states and provinces of North America. For example, in markets where there is open competition, our merchant capacity (that which has not been sold under a long-term contract) competes directly on a real time basis with all other sources of electricity such as nuclear, coal, oil, gas-Ñred, and renewable units owned by others. However, there are other markets where the local incumbent utility still predominantly uses its own supply to meet its own demand before dispatching competitively provided power. Each of these markets oÅers a unique and challenging competitive environment. Asset Acquisition and Divestiture. The recent downturn in the electricity industry has prompted many companies to sell assets to improve their Ñnancial positions. In addition, the postponement of plans for construction of new power plants is also creating a competitive market for the sale of excess equipment. Although there is a strong buyers market at the moment, relatively few assets are changing hands due to the gap between sellers' and buyers' price expectations. 7
Slide 9: Gas Production and Operations. Gas production is a signiÑcant component of our operations and an area that we would like to expand when market conditions are attractive. However, this market is also highly competitive and is populated by numerous participants including majors, large independents and smaller ""wild cat'' type exploration companies. Recently, the competition in this sector has increased due to a fundamental shift in the supply and demand balance for gas in North America. This shift has driven gas prices higher and has led to increased production activities and development of alternative supply options such as LNG or coal gasiÑcation. In the near-term, however, we expect that the market to Ñnd and produce natural gas will remain highly competitive. Power Marketing and Sales. Power marketing and sales generally includes all those activities associated with identifying customers, negotiating, and selling energy and service contracts to load-serving entities and large scale industrial and retail end-users. SpeciÑcally, there has been a trend for trading companies that served a ""middle man'' role to exit the industry for Ñnancial and business model reasons. Instead, power generators are increasingly selling long-term power directly to load serving entities (utilities, municipalities, cooperatives) and large scale end-users, thereby reducing the high levels of price volatility witnessed in the industry since 2001. RECENT DEVELOPMENTS Financing. On January 9, 2004, one of the initial purchasers of the 43/4% Contingent Convertible Senior Notes Due 2023 exercised in full its option to purchase an additional $250.0 million of these notes. The notes are convertible into cash and into shares of Calpine common stock upon the occurrence of certain contingencies at an initial conversion price of $6.50 per share, which represents a 38% premium over the New York Stock Exchange closing price of $4.71 per share on November 6, 2003, the date the notes were originally priced. Upon conversion of the notes, we will deliver par value in cash and any additional value in Calpine shares. On January 15, 2004, we completed the sale of our 50-percent undivided interest in the 545-megawatt Lost Pines 1 Power Project to GenTex Power Corporation, an aÇliate of the Lower Colorado River Authority (""LCRA''). Under the terms of the agreement, we received a cash payment of $146.8 million and recorded a gain before taxes of $35.5 million in January 2004. In addition, CES entered into a tolling agreement with LCRA to purchase 250 megawatts of electricity through December 31, 2004. At December 31, 2003, we classiÑed our undivided interest in the Lost Pines facility as ""held for sale'' and reclassiÑed all earnings to discontinued operations (see Note 10 of the Notes to Consolidated Financial Statements). In January 2004 CES concluded a settlement with the Commodity Futures Trading Commission (""CFTC'') related to the CFTC's Ñnding of inaccurate reporting of certain natural gas trading information by one former CES employee during 2001 and 2002. Neither Calpine nor CES beneÑted from the trader's conduct. Under the terms of the agreement, CES paid a civil monetary penalty in the amount of $1.5 million without admitting or denying the Ñndings in the CFTC's order. Subsequent to December 31, 2003, we repurchased approximately $177.0 million in principal amount of our outstanding 4% Convertible Senior Notes Due 2006 (""2006 Convertible Senior Notes'') that can be put to us in exchange for approximately $176.0 million in cash. Additionally, on February 9, 2004, we made a cash tender oÅer, which expired on March 9, 2004, for all of the 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. Currently, 2006 Convertible Senior Notes in the aggregate principal amount of $73.7 million remain outstanding. On February 2, 2004, a class action complaint was Ñled in the United States District Court for the Southern District of New York against CES and others. The complaint alleges unlawful manipulation of natural gas futures and options contracts traded on NYMEX during the period January 21, 2000 through December 31, 2002. The causes of action alleged are fraudulent concealment and violations of the Commodity Exchange Act, and CES anticipates Ñling a motion to dismiss the complaint. This complaint was Ñled as a 8
Slide 10: related action to another consolidated class action complaint involving numerous other defendants. The court has not granted class action certiÑcation for any of the matters at this time. On February 18, 2004, one of our wholly owned subsidiaries closed on the sale of natural gas properties to Calpine Natural Gas Trust (""CNG Trust''). We received consideration of Cdn$40.5 million (US$30.9 million). We hold 25% of the outstanding trust units of CNG Trust and account for the investment using the equity method. On February 18, 2004, we entered into an agreement to purchase the Brazos Valley Power Plant in Fort Bend County, Texas, for approximately $175.0 million in cash, subject to certain adjustments. We expect to acquire the 570-megawatt, natural gas-Ñred facility with the net proceeds from the sale of Lost Pines 1 and cash on hand. The special purpose companies that own Brazos Valley are indirectly owned by the consortium of banks that had provided construction Ñnancing for the power plant and had taken possession of the plant from the original developer in 2003. Upon completion of the transaction, Brazos Valley will become part of the collateral package for the Calpine Construction Finance Company, L.P. (""CCFC I'') First Priority Secured Institutional Term Loans Due 2009 and Second Priority Senior Secured Floating Rate Notes Due 2011. On February 20, 2004, we completed a $250.0 million, non-recourse project Ñnancing for the 600megawatt Rocky Mountain Energy Center. A consortium of banks Ñnanced the construction of the plant at a rate of LIBOR plus 250 basis points. Upon commercial operation of the Rocky Mountain Energy Center in the summer of 2004, the banks will provide a three-year term-loan facility. On March 23, 2004, our wholly owned subsidiary CalGen, formerly Calpine Construction Finance Company II, LLC (""CCFC II''), completed its oÅering of secured term loans and secured notes. As expected, we realized net total proceeds from the oÅerings (after payment of transaction fees and expenses, including the fee payable to Morgan Stanley in connection with an index hedge) in the approximate amount of $2.3 billion. The oÅerings included: Amount Description Interest Rate $235.0 $640.0 $680.0 $150.0 $600.0 $100.0 million million million million million million First Priority Secured Floating Rate Notes Due 2009 Second Priority Secured Floating Rate Notes Due 2010 Third Priority Secured Floating Rate Notes Due 2011 Third Priority Secured Notes Due 2011 First Priority Secured Term Loans due 2009 Second Priority Secured Term Loans due 2010 LIBOR LIBOR LIBOR 11.50% LIBOR LIBOR plus 375 basis points plus 575 basis points plus 900 basis points plus 375 basis points(1) plus 575 basis points(2) (1) We may also elect a Base Rate plus 275 basis points. (2) We may also elect a Base Rate plus 475 basis points. The secured term loans and secured notes described above in each case are secured, through a combination of pledges of the equity interests in CalGen and its Ñrst tier subsidiary, CalGen Expansion Company, liens on the assets of CalGen's power generating facilities (other than its Goldendale facility) and related assets located throughout the United States. The lenders' recourse is limited to such security, and none of the indebtedness is guaranteed by Calpine. Net proceeds from the oÅerings were used to reÑnance 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 reÑnancing. Concurrently with this reÑnancing, we amended and restated the CCFC II credit facility (as amended and restated, the ""CalGen revolving credit facility'') to reduce the commitments under the facility to $200.0 million and extend its maturity to March 2007. Interest under the CalGen revolving facility equals LIBOR plus 350 basis points (or, at our election, the Base Rate plus 250 basis points). Outstanding indebtedness and letters of credit at December 31, 2003, and at the reÑnancing date, under the CCFC II credit facility totaled approximately $2.3 billion and 2.4 billion, respectively. See ""Ì Summary of Key Activities'' for 2003 developments. 9
Slide 11: DESCRIPTION OF POWER GENERATION FACILITIES 1 1 1 1 NPCC 3 1 MA PP 1 2 W ECC 39 MAIN 1 3 1 SPP 1 2 ECAR 1 3 1 4 NYPOOL NEPOOL 1 MAAC 2 1 1 2 1 3 10 1 1 ERCOT 1 1 2 2 1 1 UK SERC 1 1 FRCC 10
Slide 12: At March 24, 2004, we had ownership or lease interests in 87 operating power generation facilities representing 22,206 megawatts of net capacity. Of these projects, 68 are gas-Ñred power plants with a net capacity of 21,356 megawatts, and 19 are geothermal power generation facilities with a net capacity of 850 megawatts. We also have 12 gas-Ñred projects and 1 project expansion currently under construction with a net capacity of 7,685 megawatts. We expect to complete construction of advanced development projects. The timing of the completion of these projects will be based on market fundamentals and when our return on investment criteria are expected to be met, and Ñnancing is available on attractive terms. Each of the power generation facilities currently in operation produces electricity for sale to a utility, other third-party end user, or to an intermediary such as a trading company. Thermal energy produced by the gas-Ñred cogeneration facilities is sold to industrial and governmental users. The gas-Ñred and geothermal power generation projects in which we have an interest produce electricity and thermal energy that are sold pursuant to short-term and long-term power sales agreements or into the spot market. Revenue from a power sales agreement often consists of either or both of the following components: energy payments and capacity payments. Energy payments are based on a power plant's net electrical output, and payment rates are typically either at Ñxed rates or indexed to fuel costs. Capacity payments are based on a power plant's net electrical output and/or its available capacity. Energy payments are earned for each kilowatt-hour of energy delivered, while capacity payments, under certain circumstances, are earned whether or not any electricity is scheduled by the customer and delivered. Upon completion of our projects under construction, we will provide operating and maintenance services for 97 of the 99 power plants in which we have an interest. Such services include the operation of power plants, geothermal steam Ñelds, wells and well pumps, gas Ñelds, gathering systems and gas pipelines. We also supervise maintenance, materials purchasing and inventory control, manage cash Öow, train staÅ and prepare operating and maintenance manuals for each power generation facility that we operate. As a facility develops an operating history, we analyze its operation and may modify or upgrade equipment or adjust operating procedures or maintenance measures to enhance the facility's reliability or proÑtability. These services are sometimes performed for third parties under the terms of an operating and maintenance agreement pursuant to which we are generally reimbursed for certain costs, paid an annual operating fee and may also be paid an incentive fee based on the performance of the facility. The fees payable to us may be subordinated to any lease payments or debt service obligations of Ñnancing for the project. In order to provide fuel for the gas-Ñred power generation facilities in which we have an interest, natural gas reserves are acquired or natural gas is purchased from third parties under supply agreements. We manage a gas-Ñred power facility's fuel supply so that we protect the plant's spark spread. We currently hold interests in geothermal leaseholds in Lake and Sonoma Counties in northern California (""The Geysers'') that produce steam that is supplied to geothermal power generation facilities owned by us for use in producing electricity. In late 2003 we began to inject waste water from the City of Santa Rosa Recharge Project into our geothermal reservoirs. We expect this recharge project to extend the useful life and enhance the performance of The Geysers geothermal resources and power plants. Certain power generation facilities in which we have an interest have been Ñnanced primarily with project Ñnancing that is structured to be serviced out of the cash Öows derived from the sale of electricity and thermal energy produced by such facilities and provides that the obligations to pay interest and principal on the loans are secured almost solely by the capital stock or partnership interests, physical assets, contracts and/or cash Öow attributable to the entities that own the facilities. The lenders under non-recourse project Ñnancing generally have no recourse for repayment against us or any of our assets or the assets of any other entity other than foreclosure on pledges of stock or partnership interests and the assets attributable to the entities that own the facilities. Our plan historically has been to reÑnance project-speciÑc construction Ñnancing with long-term capital market Ñnancing after construction projects enter commercial operation. Substantially all of the power generation facilities in which we have an interest are located on sites which we own or are leased on a long-term basis. See Item 2. ""Properties.'' 11
Slide 13: Set forth below is certain information regarding our operating power plants and plants under construction as of March 24, 2004. Megawatts Number of Plants Baseload Capacity With Peaking Capacity Calpine Net Interest Baseload Calpine Net Interest with Peaking In operation Geothermal power plants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gas-Ñred power plantsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Under construction New facilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expansion projectÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operating Power Plants Country, US State or Can. Province Baseload Capacity (MW) 19 68 12 Ì 99 850 18,941 6,057 438 26,286 850 23,347 7,028 657 31,882 850 17,104 6,057 438 24,449 850 21,356 7,028 657 29,891 Power Plant With Peaking Capacity (MW) Calpine Interest Percentage Calpine Net Interest Baseload (MW) Calpine Net Interest With Peaking (MW) Total 2003 Generation MWh(1) Geothermal Power Plants Sonoma County (12 plants)ÏÏÏÏÏ Lake County (2 plants) ÏÏÏÏÏÏÏÏ Calistoga ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sonoma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ West Ford FlatÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Bear CanyonÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Aidlin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Geothermal Power Plants (19)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gas-Fired Power Plants Saltend Energy Centre ÏÏÏÏÏÏÏÏÏ Acadia Energy Center ÏÏÏÏÏÏÏÏÏÏ Oneta Energy CenterÏÏÏÏÏÏÏÏÏÏÏ Freestone Energy CenterÏÏÏÏÏÏÏÏ Broad River Energy Center ÏÏÏÏÏ Delta Energy Center ÏÏÏÏÏÏÏÏÏÏÏ Baytown Energy Center ÏÏÏÏÏÏÏÏ Morgan Energy Center ÏÏÏÏÏÏÏÏÏ Pasadena Power Plant ÏÏÏÏÏÏÏÏÏÏ Magic Valley Generating Station Decatur Energy Center ÏÏÏÏÏÏÏÏÏ Hermiston Power Project ÏÏÏÏÏÏÏ Channel Energy CenterÏÏÏÏÏÏÏÏÏ Aries Power Project ÏÏÏÏÏÏÏÏÏÏÏÏ South Point Energy CenterÏÏÏÏÏÏ Los Medanos Energy Center ÏÏÏÏ Sutter Energy Center ÏÏÏÏÏÏÏÏÏÏ CA CA CA CA CA CA CA 512.0 145.0 73.0 53.0 27.0 20.0 20.0 850.0 512.0 145.0 73.0 53.0 27.0 20.0 20.0 850.0 1,200.0 1,160.0 994.0 1,022.0 840.0 882.0 830.0 852.0 787.0 751.0 838.0 642.0 574.0 591.0 530.0 566.0 543.0 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 512.0 145.0 73.0 53.0 27.0 20.0 20.0 850.0 512.0 145.0 73.0 53.0 27.0 20.0 20.0 850.0 1,200.0 580.0 994.0 1,022.0 840.0 882.0 830.0 852.0 787.0 751.0 838.0 642.0 574.0 295.5 530.0 566.0 543.0 4,022,608 1,202,592 615,960 350,317 237,225 157,028 146,448 6,732,178 9,095,929 2,259,944 611,992 4,930,706 206,078 5,440,349 5,045,069 95,457 4,080,123 2,683,274 429,220 2,615,001 3,144,479 791,065 2,944,368 3,344,159 3,234,514 UK LA OK TX SC CA TX AL TX TX AL OR TX MO AZ CA CA 1,200.0 1,080.0 994.0 1,022.0 Ì 799.0 742.0 722.0 751.0 700.0 692.0 546.0 527.0 516.0 520.0 497.0 535.0 100.0% 50.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 50.0% 100.0% 100.0% 100.0% 1,200.0 540.0 994.0 1,022.0 Ì 799.0 742.0 722.0 751.0 700.0 692.0 546.0 527.0 258.0 520.0 497.0 535.0 12
Slide 14: Power Plant Country, US State or Can. Province Baseload Capacity (MW) With Peaking Capacity (MW) Calpine Interest Percentage Calpine Net Interest Baseload (MW) Calpine Net Interest With Peaking (MW) Total 2003 Generation MWh(1) Lost Pines 1 Power Project(2)ÏÏÏ Ontelaunee Energy Center ÏÏÏÏÏÏ Westbrook Energy CenterÏÏÏÏÏÏÏ Corpus Christi Energy Center ÏÏÏ Hidalgo Energy Center ÏÏÏÏÏÏÏÏÏ Carville Energy Center ÏÏÏÏÏÏÏÏÏ Texas City Power PlantÏÏÏÏÏÏÏÏÏ RockGen Energy Center ÏÏÏÏÏÏÏÏ Deer Park Energy Center, Phases 1 and 1a ÏÏÏÏÏÏÏÏÏÏÏÏÏ Clear Lake Power Plant ÏÏÏÏÏÏÏÏ Zion Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏ Santa Rosa Energy Center ÏÏÏÏÏÏ Blue Spruce Energy Center ÏÏÏÏÏ Calgary Energy Centre ÏÏÏÏÏÏÏÏÏ Rumford Power Plant ÏÏÏÏÏÏÏÏÏÏ Hog Bayou Energy Center ÏÏÏÏÏÏ Tiverton Power PlantÏÏÏÏÏÏÏÏÏÏÏ Gordonsville Power Plant(3) ÏÏÏÏ Island Cogeneration ÏÏÏÏÏÏÏÏÏÏÏÏ Pine BluÅ Energy Center ÏÏÏÏÏÏÏ Los Esteros Critical Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Morris Power Plant ÏÏÏÏÏÏÏÏÏÏÏÏ Dighton Power Plant ÏÏÏÏÏÏÏÏÏÏÏ Androscoggin Energy Center ÏÏÏÏ Auburndale Power Plant ÏÏÏÏÏÏÏÏ Grays Ferry Power PlantÏÏÏÏÏÏÏÏ Gilroy Peaking Energy Center ÏÏÏ Gilroy Power Plant ÏÏÏÏÏÏÏÏÏÏÏÏ Pryor Power Plant ÏÏÏÏÏÏÏÏÏÏÏÏÏ Sumas Power Plant ÏÏÏÏÏÏÏÏÏÏÏÏ Parlin Power Plant ÏÏÏÏÏÏÏÏÏÏÏÏÏ Auburndale Peaking Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ King City Power Plant ÏÏÏÏÏÏÏÏÏ Kennedy International Airport Power Plant (""KIAC'') ÏÏÏÏÏÏ Bethpage Power Plant ÏÏÏÏÏÏÏÏÏÏ Bethpage Peaking Energy Center Pittsburg Power Plant ÏÏÏÏÏÏÏÏÏÏ Newark Power Plant ÏÏÏÏÏÏÏÏÏÏÏ Greenleaf 1 Power Plant ÏÏÏÏÏÏÏÏ Greenleaf 2 Power Plant ÏÏÏÏÏÏÏÏ Whitby CogenerationÏÏÏÏÏÏÏÏÏÏÏ King City Peaking Energy Center TX PA ME TX TX LA TX WI TX TX IL FL CO AB ME AL RI VA BC AR CA IL MA ME FL PA CA CA OK WA NJ FL CA NY NY NY CA NJ CA CA ON CA Ì 561.0 528.0 414.0 502.0 455.0 465.0 Ì 354.0 335.0 Ì 250.0 Ì 250.0 237.0 246.6 240.0 Ì 230.0 213.3 Ì 155.0 162.0 160.0 143.0 143.0 Ì 112.0 109.0 120.0 89.0 Ì 103.0 95.0 52.0 Ì 64.0 47.0 50.0 50.0 50.0 Ì Ì 584.0 528.0 537.0 502.0 531.0 471.0 460.0 362.0 412.0 513.0 250.0 300.0 300.0 251.0 246.6 240.0 Ì 230.0 213.3 180.0 177.5 168.0 160.0 153.0 148.0 135.0 131.0 124.0 122.0 118.0 115.0 115.0 105.0 53.7 48.0 71.0 58.0 50.0 50.0 50.0 45.0 0.0% 100.0% 100.0% 100.0% 78.5% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 30.0% 100.0% 100.0% 100.0% 0.0% 30.0% 100.0% 100.0% 86.0% 100.0% 32.3% 30.0% 40.0% 100.0% 100.0% 80.0% 0.1% 80.0% 100.0% 40.0% 100.0% 100.0% 100.0% 100.0% 80.0% 100.0% 100.0% 15.0% 100.0% Ì 561.0 528.0 414.0 394.1 455.0 465.0 Ì 354.0 335.0 Ì 250.0 Ì 75.0 237.0 246.6 240.0 Ì 69.0 213.3 Ì 134.0 162.0 51.7 42.9 57.2 Ì 112.0 87.2 0.1 71.2 Ì 41.2 95.0 52.0 Ì 64.0 37.6 50.0 50.0 7.5 Ì Ì 584.0 528.0 537.0 394.1 531.0 471.0 460.0 362.0 412.0 513.0 250.0 300.0 90.0 251.0 246.6 240.0 Ì 69.0 213.3 180.0 146.4 168.0 51.7 45.9 59.2 135.0 131.0 99.2 0.1 94.4 115.0 46.0 105.0 53.7 48.0 71.0 46.4 50.0 50.0 7.5 45.0 3,101,574 863,253 3,307,527 1,854,208 1,743,360 1,697,994 2,446,410 223,977 1,823,311 1,918,603 74,781 22,706 290,410 731,449 1,547,533 122,762 1,689,698 155,402 1,487,028 1,503,735 164,251 484,971 449,781 796,172 1,094,795 765,609 69,338 184,603 331,035 943,343 84,825 36,067 928,484 581,122 423,104 97,005 239,991 376,911 388,939 363,320 344,648 17,436 13
Slide 15: Power Plant Country, US State or Can. Province Baseload Capacity (MW) With Peaking Capacity (MW) Calpine Interest Percentage Calpine Net Interest Baseload (MW) Calpine Net Interest With Peaking (MW) Total 2003 Generation MWh(1) Yuba City Energy Center ÏÏÏÏÏÏÏ Feather River Energy Center ÏÏÏÏ Creed Energy CenterÏÏÏÏÏÏÏÏÏÏÏ Lambie Energy Center ÏÏÏÏÏÏÏÏÏ Wolfskill Energy Center ÏÏÏÏÏÏÏÏ Goose Haven Energy Center ÏÏÏÏ Riverview Energy Center ÏÏÏÏÏÏÏ Stony Brook Power Plant ÏÏÏÏÏÏÏ Watsonville Power Plant ÏÏÏÏÏÏÏÏ Agnews Power Plant ÏÏÏÏÏÏÏÏÏÏÏ Philadelphia Water Project ÏÏÏÏÏÏ Total Gas-Fired Power Plants (68) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Operating Power Plants (87) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Projects including plants with operating leases ÏÏÏ Equity (Unconsolidated) Projects CA CA CA CA CA CA CA NY CA CA PA Ì Ì Ì Ì Ì Ì Ì 36.0 29.0 26.5 22.0 18,941.4 19,791.4 17,722.4 2,069.0 45.0 45.0 45.0 45.0 45.0 45.0 45.0 40.0 30.0 28.6 23.0 23,346.7 24,196.7 21,965.7 2,231.0 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 66.4% Ì Ì Ì Ì Ì Ì Ì 36.0 29.0 26.5 14.6 17,103.7 17,953.7 17,039.2 914.5 45.0 45.0 45.0 45.0 45.0 45.0 45.0 40.0 30.0 28.6 15.3 21,355.9 22,205.9 21,211.9 994.0 19,078 15,745 14,266 14,140 16,820 13,524 15,693 346,971 211,755 219,153 Ì 87,610,343 94,342,521 (1) Generation MWh is shown here as 100% of each plant's gross generation in megawatt hours (""MWh''). (2) This facility is presented here only to state the facility's generation in MWh for 2003. This facility was sold in January 2004. See Note 10 of the Notes to Consolidated Financial Statements for more information regarding the sale of this facility. (3) This facility is presented here only to state the facility's generation in MWh through November 26, 2003, the date it was sold. See Note 7 of the Notes to Consolidated Financial Statements for more information regarding the sale of this facility. 14
Slide 16: Projects Under Construction (All gas-Ñred) Country, US State or Can. Province Baseload Capacity (MW) With Peaking Capacity (MW) Calpine Interest Percentage Calpine Net Interest Baseload (MW) Calpine Net Interest With Peaking (MW) Power Plant Projects Under Construction Deer Park Energy Center* Hillabee Energy CenterÏÏÏÏ Pastoria Energy Center ÏÏÏÏ Fremont Energy Center ÏÏÏ Columbia Energy Center ÏÏ Riverside Energy Center ÏÏÏ Metcalf Energy Center ÏÏÏÏ Osprey Energy Center ÏÏÏÏÏ Washington Parish Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Otay Mesa Energy Center Rocky Mountain Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Goldendale Energy Center Fox Energy Center ÏÏÏÏÏÏÏ Total Projects Under Construction ÏÏÏÏÏÏÏÏÏ * Expansion project. TX AL CA OH SC WI CA FL LA CA CO WA WI 438.0 710.0 759.0 550.0 464.0 518.0 556.0 530.0 509.0 510.0 479.0 237.0 235.0 6,495.0 657.0 770.0 769.0 700.0 641.0 602.0 602.0 609.0 565.0 593.0 601.0 271.0 305.0 7,685 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 438.0 710.0 759.0 550.0 464.0 518.0 556.0 530.0 509.0 510.0 479.0 237.0 235.0 6,495.0 657.0 770.0 769.0 700.0 641.0 602.0 602.0 609.0 565.0 593.0 601.0 271.0 305.0 7,685.0 ACQUISITIONS OF POWER PROJECTS AND PROJECTS UNDER CONSTRUCTION We have extensive experience in the development and acquisition of power generation projects. We have historically focused principally on the development and acquisition of interests in gas-Ñred and geothermal power projects, although we may also consider projects that utilize other power generation technologies. We have signiÑcant expertise in a variety of power generation technologies and have substantial capabilities in each aspect of the development and acquisition process, including design, engineering, procurement, construction management, fuel and resource acquisition and management, power marketing, Ñnancing and operations. As indicated in the Strategy Section, our development and acquisition activities have been greatly scaled back, for the indeÑnite future, to focus on liquidity and operational priorities. Acquisitions We may consider the acquisition of an interest in operating projects as well as projects under development where we would assume responsibility for completing the development of the project. In the acquisition of power generation facilities, we generally seek to acquire 100% ownership of facilities that oÅer us attractive opportunities for earnings growth, and that permit us to assume sole responsibility for the operation and maintenance of the facility. In evaluating and selecting a project for acquisition, we consider a variety of factors, including the type of power generation technology utilized, the location of the project, the terms of any existing power or thermal energy sales agreements, gas supply and transportation agreements and wheeling agreements, the quantity and quality of any geothermal or other natural resource involved, and the actual condition of the physical plant. In addition, we assess the past performance of an operating project and prepare Ñnancial projections to determine the proÑtability of the project. Acquisition activity is dependent on the 15
Slide 17: availability of Ñnancing on attractive terms and the expectation of returns that meet our long-term requirements. Although our preference is to own 100% of the power plants we acquire or develop, there are situations when we take less than 100% ownership. Reasons why we may take less than a 100% interest in a power plant may include, but are not limited to: (a) our acquisitions of other independent power producers such as Cogeneration Corporation of America in 1999 and SkyGen Energy LLC in 2000 in which minority interest projects were included in the portfolio of assets owned by the acquired entities (Grays Ferry Power Plant (40% now owned by Calpine) and Androscoggin Energy Center (32.3% now owned by Calpine), respectively); (b) opportunities to co-invest with non-regulated subsidiaries of regulated electric utilities, which under PURPA are restricted to 50% ownership of cogeneration qualifying facilities; and (c) opportunities to invest in merchant power projects with partners who bring marketing, funding, permitting or other resources that add value to a project, for example, Acadia Energy Center in Louisiana (50% owned by Calpine and 50% owned by Cleco Midstream Resources, an aÇliate of Cleco Corporation). None of our equity investment projects have nominal carrying values as a result of material recurring losses. Further, there is no history of impairment in any of these investments. Projects Under Construction The development and construction of power generation projects involves numerous elements, including evaluating and selecting development opportunities, designing and engineering the project, obtaining power sales agreements in some cases, acquiring necessary land rights, permits and fuel resources, obtaining Ñnancing, procuring equipment and managing construction. We intend to focus on completing projects already in construction and starting new projects only when Ñnancing is available and attractive returns are expected. Deer Park Energy Center. In March 2001 we announced plans to build, own and operate a 1,019megawatt, natural gas-Ñred energy center in Deer Park, Texas. The Deer Park Energy Center supplies steam to Shell Chemical Company, and electric power generated at the facility is sold on the wholesale market. Construction began in mid-2001. The Ñrst and second phases of the project entered commercial operation in June 2003 and the Ñnal phase is expected to begin commercial operation in June 2004. Hillabee Energy Center. On February 24, 2000, we announced plans to build, own and operate the Hillabee Energy Center, a 770-megawatt, natural gas-Ñred cogeneration facility in Tallapoosa County, Alabama. Construction began in mid-2001, and we expect commercial operation of the facility will commence in spring 2006. Pastoria Energy Center. In April 2001 we acquired the rights to develop the 769-megawatt Pastoria Energy Center, a combined-cycle project planned for Kern County, California. Construction began in mid2001, and commercial operation is scheduled to begin in the fall of 2004 for phase one and in mid-2005 for phase two. Fremont Energy Center. On May 23, 2000, we announced plans to build, own and operate the Fremont Energy Center, a 700-megawatt natural gas-Ñred electricity generating facility to be located near Fremont, Ohio. Commercial operation is expected to commence in the summer of 2006. Columbia Energy Center. On September 25, 2001, we announced plans to construct the new 641megawatt Columbia Energy Center, a natural gas-Ñred cogeneration facility located on property leased from Voridian (formerly Eastman Chemical Company) in Calhoun County, S.C. The facility will sell electricity to the wholesale power market and will supply thermal energy to Voridian. Commercial operation is expected to commence in the spring of 2004. Riverside Energy Center. On December 18, 2002, we announced that construction of the Riverside Energy Center, a 602-megawatt natural gas-Ñred electricity generating facility had begun in Beloit, Wisconsin. We anticipate commercial operation of the facility to begin in the summer of 2004. Metcalf Energy Center. On April 30, 1999, we submitted an Application for CertiÑcation with the California Energy Commission (""CEC'') to build, own and operate the Metcalf Energy Center, a 602-mega16
Slide 18: watt natural gas-Ñred electricity generating facility located in San Jose, California. The CEC permit was approved on September 21, 2001. Construction of the facility began in June 2002, and commercial operation is anticipated to commence in the summer of 2005. Osprey Energy Center. On January 11, 2000, we announced plans to build, own and operate the Osprey Energy Center, a 609-megawatt, natural gas-Ñred cogeneration energy center near the city of Auburndale, Florida. Construction commenced in the fall 2001 and commercial operation of the facility is scheduled to begin in the spring of 2004. Upon commercial operation, the Osprey Energy Center will supply electric power to Tampa, Florida-based Seminole Electric Cooperative, Inc. for a period of 16 years. Washington Parish Energy Center. On January 26, 2001, we announced the acquisition of the development rights from Cogentrix, an independent power company based in North Carolina, for the 565megawatt Washington Parish Energy Center, located near Bogalusa, Louisiana. We are managing construction of the facility, which began in January 2001, and will operate the facility when it enters commercial operation, which is anticipated to be in the summer of 2006. Otay Mesa Energy Center. On July 10, 2001, we acquired Otay Mesa Generating Company, LLC and the associated development rights including a license from the California Energy Commission. The 593megawatt facility is located in southern San Diego County, California. Construction began in 2001. In October 2003 we signed a term sheet setting forth the principal terms and conditions for a ten-year, 570megawatt power sales agreement with San Diego Gas & Electric (""SDG&E''). Under the Ñnal agreement, we will supply electricity to SDG&E from the Otay Mesa Energy Center. Power deliveries are scheduled to begin in 2007. Rocky Mountain Energy Center. In August 2002 we commenced construction of the 601-megawatt, natural gas-Ñred Rocky Mountain Energy Center in Weld County, Colorado. We will sell the output of the facility to Public Service Co. of Colorado under the terms of a ten-year tolling agreement. Commercial operation of the facility is expected to commence in the summer of 2004. Goldendale Energy Center. In April 2001 we acquired the rights to develop a 271-megawatt combinedcycle energy center located in Goldendale, Washington. Construction of the Goldendale Energy Center began in the summer of 2001 and commercial operation is expected to commence in the summer of 2004. Energy generated by the facility will be sold directly into the Northwest Power Pool. Fox Energy Center. In 2003 we acquired the fully permitted 305-megawatt Fox Energy Center in Kaukauna, Wisconsin, which will be used to fulÑll an existing contract with Wisconsin Public Service. Commercial operation is expected to begin in the summer of 2005. OIL AND GAS PROPERTIES In 1997 we began an equity gas strategy to diversify the gas sources for our natural gas-Ñred power plants by purchasing Montis Niger, Inc., a gas production and pipeline company operating primarily in the Sacramento Basin in northern California. We currently supply the majority of the fuel requirements for the Greenleaf 1 and 2 Power Plants from these reserves. In October 1999, we purchased Sheridan Energy, Inc. (""Sheridan''), a natural gas exploration and production company operating in northern California and the Gulf Coast region. The Sheridan acquisition provided the initial management team and operational infrastructure to evaluate and acquire oil and gas reserves to keep pace with our growth in gas-Ñred power plants. In December 1999, we added Vintage Petroleum, Inc.'s interest in the Rio Vista Gas Unit and related areas, representing primarily natural gas reserves located in the Sacramento Basin in northern California. Sheridan was merged into Calpine in April 2000 and Calpine Natural Gas L.P. (""CNGLP'') was established to manage our oil and gas properties in the U.S. Additionally, we own a 25% interest in CNG Trust, which has proved reserves of approximately 72 Bcfe (18 Bcfe, net to Calpine's equity interest). We are currently (in March 2004) capable of producing, net to Calpine's interest, approximately 207 MMcfe of natural gas per day, and CNG Trust's total production, net of royalties, is currently approximately 35 MMcfe (approximately 9 MMcfe net to Calpine's interest) of natural gas per day. 17
Slide 19: The focus of the equity gas program has been on acquisitions in strategic markets where we are developing low-cost natural gas supplies and proprietary pipeline systems in support of our natural gas-Ñred power plants. In conjunction with these eÅorts we acquired various gas assets and gas companies in 2001 and 2000. See Note 6 of the Notes to Consolidated Financial Statements for more information regarding the 2001 acquisitions. In 2002 and 2003 certain non-strategic divestments were completed to further focus operations on gas production and to enhance liquidity. These divestments are discussed in detail under Note 10 of the Notes to Consolidated Financial Statements. As a result of our oil and gas acquisition, divestment and drilling program activity, equity equivalent net production from continuing operations averaged approximately 260 MMcfe/day for the year ended December 31, 2003, enough to fuel approximately 2,300 megawatts of our power plant Öeet, assuming an average capacity factor of 70%. MARKETING, HEDGING, OPTIMIZATION, AND TRADING ACTIVITIES Most of the electric power generated by our plants is transferred to our marketing and risk management unit, CES, which sells it to load-serving entities (e.g., utilities) industrial and large retail end users, and to other third parties (e.g., power trading and marketing companies). Because a suÇciently liquid market does not exist for electricity Ñnancial instruments (typically, exchange and over-the-counter traded contracts that net settle rather than entail physical delivery) at most of the locations where we sell power, CES also enters into incremental physical purchase and sale transactions as part of its hedging, balancing, and optimization activities. The hedging, balancing, and optimization activities that we engage in are directly related to exposures that arise from our ownership and operation of power plants and gas reserves and are designed to protect or enhance our ""spark spread'' (the diÅerence between our fuel cost and the revenue we receive for our electric generation). In many of these transactions CES purchases and resells power and gas in contracts with third parties. We utilize derivatives, which are deÑned in Statement of Financial Accounting Standards (""SFAS'') No. 133, ""Accounting for Derivative Instruments and Hedging Activities'' to include many physical commodity contracts and commodity Ñnancial instruments such as exchange-traded swaps and forward contracts, to optimize the returns that we are able to achieve from our power and gas assets. From time to time we have entered into contracts considered energy trading contracts under Emerging Issues Task Force (""EITF'') Issue No. 02-3, ""Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities.'' However, our risk managers have low capital at risk and value at risk limits for energy trading, and our risk management policy limits, at any given time, our net sales of power to our generation capacity and limits our net purchases of gas to our fuel consumption requirements on a total portfolio basis. This model is markedly diÅerent from that of companies that engage in signiÑcant commodity trading operations that are unrelated to underlying physical assets. Derivative commodity instruments are accounted for under the requirements of SFAS No. 133. The EITF reached a consensus under EITF Issue No. 02-3 that gains and losses on derivative instruments within the scope of SFAS No. 133 should be shown net in the income statement if the derivative instruments are held for trading purposes. In addition we present on a net basis certain types of hedging, balancing and optimization revenues and costs of revenue under 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 DeÑned 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''), which we adopted prospectively on October 1, 2003. See Item 7. ""Management's Discussion and Analysis Ì Impact of Recent Accounting Pronouncements'' and Note 2 to the Consolidated Financial Statements for a discussion of the eÅects of adopting this standard. 18
Slide 20: Following is a discussion of the types of electricity and gas hedging, balancing, optimization, and trading activities in which we engage. Electricity Transactions ‚ Electricity hedging transactions are entered into to reduce potential volatility in future results. An example of an electricity hedging transaction would be one in which we sell power at a Ñxed rate to allow us to predict the future revenues from our portfolio of generating plants. Hedging is a dynamic process; from time to time we adjust the extent to which our portfolio is hedged. An example of an electricity hedge adjusting transaction would be the purchase of power in the market to reduce the extent to which we had previously hedged our generation portfolio through Ñxed price power sales. To illustrate, suppose we had elected to hedge 65% of our portfolio of generation capacity for the following six months but then believed that prices for electricity were going to steadily move up during that same period. We might buy electricity on the open market to reduce our hedged position to, say, 50%. If electricity prices, do in fact increase, we might then sell electricity again to increase our hedged position back to the 65% level and generate additional margin. ‚ Electricity balancing activities are typically short-term in nature and are done to make sure that sales commitments to deliver power are fulÑlled. An example of an electricity balancing transaction would be where one of our generating plants has an unscheduled outage so we buy replacement power to deliver to a customer to meet our sales commitment. ‚ Electricity optimization activity, also generally short-term in nature, is done to maximize our proÑt potential by executing the most proÑtable alternatives in the power markets. An example of an electricity optimization transaction would be fulÑlling a power sales contract with power purchases from third parties instead of generating power when the market price for power is below the cost of generation. In all cases, optimization activity is associated with the operating Öexibility in our systems of power plants, natural gas assets, and gas and power contracts. That Öexibility provides us with alternatives to most proÑtably manage our portfolio. ‚ Electricity trading activities are done with the purpose of proÑting from movement in commodity prices or to transact business with customers in market areas where we do not have generating assets. An example of an electricity trading contract would be where we buy and sell electricity, typically with trading company counterparties, solely to proÑt from electricity price movements. We have engaged in limited activity of this type to date in terms of earnings impact. All such activity is done by CES, mostly through short-term contracts. Another example of an electricity trading contract would be one in which we transact with customers in market areas where we do not have generating assets, generally to develop market experience and customer relations in areas where we expect to have generation assets in the future. We have done a small number of such transactions to date. Natural Gas Transactions ‚ Gas hedging transactions are also entered into to reduce potential volatility in future results. An example of a gas hedging transaction would be where we purchase gas at a Ñxed rate to allow us to predict the future costs of fuel for our generating plants or conversely where we enter into a Ñnancial forward contract to essentially swap Öoating rate (indexed) gas for Ñxed price gas. Similar to electricity hedging, gas hedging is a dynamic process, and from time to time we adjust the extent to which our portfolio is hedged. To illustrate, suppose we had elected to hedge 65% of our gas requirements for our generation capacity for the next six months through Ñxed price gas purchases but then believed that prices for gas were going to steadily decline during that same period. We might sell Ñxed price gas on the open market to reduce our hedged gas position to 50%. If gas prices do in fact decrease, we might then buy Ñxed price gas again to increase our hedged position back to the 65% level and increase our margins. ‚ Gas balancing activities are typically short-term in nature and are done to ensure that purchase commitments for gas are adjusted for changes in production schedules. An example of a gas balancing 19
Slide 21: transaction would be where one of our generating plants has an unscheduled outage so we sell the gas that we had purchased for that plant to a third party. ‚ Gas optimization activities are also generally short-term in nature and are done to maximize our proÑt potential by executing the most proÑtable alternatives in the gas markets. An example of gas optimization is selling our gas supply, not generating power, and fulÑlling power sales contracts with power purchases from third parties, instead of generating power when market gas prices spike relative to our gas supply cost. ‚ Gas trading activities are done with the purpose of proÑting from movement in commodity prices. An example of gas trading contracts would be where we buy and sell gas, typically with a trading company counterparty, solely to proÑt from gas price movements or where we transact with customers in market areas where we do not have fuel consumption requirements. We have engaged in a limited level of this type of activity to date. All such activity is done by CES, mostly through short-term contracts. In some instances economic hedges may not be designated as hedges for accounting purposes. The accounting treatment of our various risk management and trading activities is governed by SFAS No. 133, EITF Issue No. 02-3, as discussed above, and EITF Issue No. 03-11 which we adopted on October 1, 2003, and is discussed further in Note 2 of the Notes to Consolidated Financial Statements. An example of an economic hedge that is not a hedge for accounting purposes would be a long-term Ñxed price electric sales contract that economically hedges us against the risk of falling electric prices, but which for accounting purposes is exempted from derivative accounting under SFAS No. 133 as a normal sale. For a further discussion of our derivative accounting methodology, see Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operation Ì Application of Critical Accounting Policies.'' GOVERNMENT REGULATION We are subject to complex and stringent energy, environmental and other governmental laws and regulations at the federal, state and local levels in connection with the development, ownership and operation of our energy generation facilities. Federal laws and regulations govern transactions by electric and gas utility companies, the types of fuel which may be utilized by an electricity generating plant, the type of energy which may be produced by such a plant, the ownership of a plant, and access to and service on the transmission grid. In most instances, public utilities that serve retail customers are subject to rate regulation by the state's related utility regulatory commission. A state utility regulatory commission is often primarily responsible for determining whether a public utility may recover the costs of wholesale electricity purchases or other supplyrelated activity through retail rates that the public utility may charge its customers. The state utility regulatory commission may, from time to time, impose restrictions or limitations on the manner in which a public utility may transact with wholesale power sellers, such as independent power producers. Under certain circumstances where speciÑc exemptions are otherwise unavailable, state utility regulatory commissions may have broad jurisdiction over non-utility electric power plants. Energy producing projects also are subject to federal, state and local laws and administrative regulations which govern the emissions and other substances produced, discharged or disposed of by a plant and the geographical location, zoning, land use and operation of a plant. Applicable federal environmental laws typically have both state and local enforcement and implementation provisions. These environmental laws and regulations generally require that a wide variety of permits and other approvals be obtained before the commencement of construction or operation of an energy producing facility and that the facility then operate in compliance with such permits and approvals. Federal Energy Regulation PURPA The enactment of the Public Utility Regulatory Policies Act of 1978, as amended (""PURPA''), and the adoption of regulations thereunder by the Federal Energy Regulatory Commission (""FERC'') provided incentives for the development of cogeneration facilities and small power production facilities (those utilizing renewable fuels and having a capacity of less than 80 megawatts). 20
Slide 22: A domestic electricity generating project must be a Qualifying Facility (""QF'') under FERC regulations in order to take advantage of certain rate and regulatory incentives provided by PURPA. PURPA exempts owners of QFs from the Public Utility Holding Company Act of 1935, as amended (""PUHCA''), and exempts QFs from most provisions of the Federal Power Act (""FPA'') and, except under certain limited circumstances, state laws concerning rate or Ñnancial regulation. These exemptions are important to us and our competitors. We believe that each of the electricity-generating projects in which we own an interest and which operates as a QF power producer meets or will meet the requirements under PURPA necessary for QF status. In some cases our projects have temporarily been rendered incapable of meeting such requirements (due, for example, to the loss of a thermal host) and we have sought waivers of the applicable QF requirements from FERC. In the past FERC has been willing to issue such waivers (which typically are for a one-or two-year period) where it can be shown that the project is expected to be able to meet the applicable QF requirements at the end of the waiver period; however, we cannot provide assurance that such waivers will in every case be granted. PURPA provides two primary beneÑts to QFs. First, QFs generally are relieved of compliance with extensive federal and state regulations that control the Ñnancial structure of an electricity generating plant and the prices and terms on which electricity may be sold by the plant. Second, FERC's regulations promulgated under PURPA require that electric utilities purchase electricity generated by QFs at a price based on the purchasing utility's avoided cost, and that the utility sell back-up power to the QF on a non-discriminatory basis. The term ""avoided cost'' is deÑned as the incremental cost to an electric utility of electric energy or capacity, or both, which, but for the purchase from QFs, such utility would generate for itself or purchase from another source. FERC regulations also permit QFs and utilities to negotiate agreements for utility purchases of power at rates lower than the utilities' avoided costs. While public utilities are not explicitly required by PURPA to enter into long-term power sales agreements, PURPA helped to create a regulatory environment in which it has been common for long-term agreements to be negotiated. In order to be a QF, a cogeneration facility must produce not only electricity, but also useful thermal energy for use in an industrial or commercial process for heating or cooling applications in certain proportions to the facility's total energy output, and must meet certain energy eÇciency standards. A geothermal facility may qualify as a QF if it produces less than 80 megawatts of electricity. Finally, a QF (including a geothermal QF or other qualifying small power producer) must not be controlled or more than 50% owned by one or more electric utilities or by most electric utility holding companies, or one or more subsidiaries of such a utility or holding company or any combination thereof. We endeavor to develop our projects, monitor compliance by the projects with applicable regulations and choose our customers in a manner which minimizes the risks of any project losing its QF status. Certain factors necessary to maintain QF status are, however, subject to the risk of events outside our control. For example, loss of a thermal energy customer or failure of a thermal energy customer to take required amounts of thermal energy from a cogeneration facility that is a QF could cause the facility to fail requirements regarding the level of useful thermal energy output. Upon the occurrence of such an event, we would seek to replace the thermal energy customer or Ñnd another use for the thermal energy which meets PURPA's requirements, but no assurance can be given that this would be possible. If one of the facilities in which we have an interest should lose its status as a QF, the project would no longer be entitled to the exemptions from PUHCA and the FPA. This could also trigger certain rights of termination under the facility's power sales agreement, could subject the facility to rate regulation as a public utility under the FPA and state law and could result in us inadvertently becoming an electric utility holding company by owning more than 10% of the voting securities of, or controlling, a facility that would no longer be exempt from PUHCA. This could cause all of our remaining projects to lose their qualifying status, because QFs may not be controlled or more than 50% owned by such electric utility holding companies. Loss of QF status may also trigger defaults under covenants to maintain QF status in the projects power sales agreements, steam sales agreements and Ñnancing agreements and result in termination, penalties or acceleration of indebtedness under such agreements such that loss of status may be on a retroactive or a prospective basis. 21
Slide 23: Under the Energy Policy Act of 1992, if a facility can be qualiÑed as an Exempt Wholesale Generator (""EWG''), meaning that all of its output is sold for resale rather than to end users, it will be exempt from PUHCA even if it does not qualify as a QF. Therefore, another response to the loss or potential loss of QF status would be to apply to have the project qualiÑed as an EWG. However, assuming this changed status would be permissible under the terms of the applicable power sales agreement, rate approval from FERC would be required. In addition, the facility would be required to cease selling electricity to any retail customers (such as the thermal energy customer) to retain its EWG status and could become subject to state regulation of sales of thermal energy. See Public Utility Holding Company Regulation. Currently, Congress is considering proposed legislation that would repeal PUHCA and amend PURPA by limiting its mandatory purchase obligation to existing contracts, in those regions of the country that are found to have competitive energy markets. In light of the circumstances in California, the PaciÑc Gas and Electric Company (""PG&E'') bankruptcy and the Enron bankruptcy, among other events in recent years, there are a number of federal legislative and regulatory initiatives that could result in changes in how the energy markets are regulated. We do not know whether these legislative and regulatory initiatives will be adopted or, if adopted, what form they may take. We cannot provide assurance that any legislation or regulation ultimately adopted would not adversely aÅect our existing domestic projects. Public Utility Holding Company Regulation Under PUHCA, any corporation, partnership or other legal entity which owns or controls 10% or more of the outstanding voting securities of a public utility company, or a company which is a holding company for a public utility company, is subject to registration with the Securities and Exchange Commission (""SEC'') and regulation under PUHCA, unless eligible for an exemption. A holding company of a public utility company that is subject to registration is required by PUHCA to limit its utility operations to a single integrated utility system and to divest any other operations not functionally related to the operation of that utility system. Approval by the SEC is required for nearly all important Ñnancial and business dealings of a registered holding company. Under PURPA, most QFs are not public utility companies under PUHCA. The Energy Policy Act of 1992, among other things, amends PUHCA to allow EWGs, under certain circumstances, to own and operate non-QF electric generating facilities without subjecting those producers to registration or regulation under PUHCA. The eÅect of such amendments has been to enhance the development of non-QFs which do not have to meet the fuel, production and ownership requirements of PURPA. We believe that these amendments beneÑt us by expanding our ability to own and operate facilities that do not qualify for QF status. However, they have also resulted in increased competition by allowing utilities and their aÇliates to develop such facilities which are not subject to the constraints of PUHCA. Federal Natural Gas Transportation Regulation We have an ownership interest in 80 gas-Ñred power plants in operation or under construction. The cost of natural gas is ordinarily the largest expense of a gas-Ñred project and is critical to the project's economics. The risks associated with using natural gas can include the need to arrange gathering, processing, extraction, blending, and storage, as well as transportation of the gas from great distances, including obtaining removal, export and import authority if the gas is transported from Canada; the possibility of interruption of the gas supply or transportation (depending on the quality of the gas reserves purchased or dedicated to the project, the Ñnancial and operating strength of the gas supplier, whether Ñrm or non-Ñrm transportation is purchased and the operations of the gas pipeline); and obligations to take a minimum quantity of gas and pay for it (i.e., take-and-pay obligations). Pursuant to the Natural Gas Act, FERC has jurisdiction over the transportation and storage of natural gas in interstate commerce. With respect to most transactions that do not involve the construction of pipeline facilities, regulatory authorization can be obtained on a self-implementing basis. However, interstate pipeline rates and terms and conditions for such services are subject to continuing FERC oversight. 22
Slide 24: Federal Power Act Regulation Under the FPA, FERC is authorized to regulate the transmission of electric energy and the sale of electric energy at wholesale in interstate commerce. Unless otherwise exempt, any person that owns or operates facilities used for such purposes is considered a public utility subject to FERC jurisdiction. FERC regulation under the FPA includes approval of the disposition of utility property, authorization of the issuance of securities by public utilities, regulation of the rates, terms and conditions for the transmission or sale of electric energy at wholesale in interstate commerce, the regulation of interlocking directorates, a uniform system of accounts and reporting requirements for public utilities. FERC regulations implementing PURPA provide that a QF is exempt from regulation under the foregoing provisions of the FPA. An EWG is not exempt from the FPA and therefore an EWG that makes sales of electric energy at wholesale in interstate commerce is subject to FERC regulation as a public utility. However, many of the regulations which customarily apply to traditional public utilities have been waived or relaxed for power marketers, EWGs and other non-traditional public utilities that lack market power. EWGs are regularly granted authorization to charge market-based rates, blanket authority to issue securities, and waivers of certain FERC requirements pertaining to accounts, reports and interlocking directorates. Such action is intended to implement FERC's policy to foster a more competitive wholesale power market. Many of the generating projects in which we own an interest are operated as QFs and are therefore exempt from FERC regulation under the FPA. However, several of our generating projects are or will be EWGs subject to FERC jurisdiction under the FPA. Several of our aÇliates have been granted authority to engage in sales at market-based rates and to issue securities, and have also been granted the customary waivers of FERC regulations available to non-traditional public utilities; however, we cannot assure that such authorities or waivers will be granted in the future to other aÇliates. Federal Open Access Electric Transmission Regulation In the summer of 1996 FERC issued Orders Nos. 888 and 889 ordering the ""functional unbundling'' of transmission and generation assets by the transmission owning utilities subject to its jurisdiction. Under Order No. 888, the jurisdictional transmission owning utilities, and many non-jurisdictional transmission owners, were required to adopt the pro forma open access transmission tariÅ establishing terms of non-discriminatory transmission service, including generator interconnection service. Order No. 889 required transmission-owning utilities to publish information concerning the availability of transmission capacity and make such transmission capacity available on a non-discriminatory basis. In addition, these orders established the operational requirements of Independent System Operators (""ISO''), which are entities that have been given authority to operate the transmission assets of certain jurisdictional utilities. The interpretation and application of the requirements of Orders Nos. 888 and 889 continues to be reÑned through subsequent administrative proceedings at FERC. These orders have been subject to review, and have been aÇrmed, by the courts. In December 1999 FERC issued Order No. 2000, which requires jurisdictional transmission-owning utilities to enter into agreements with ISOs to operate their transmission systems or join a Regional Transmission Organization (""RTO''), which would likewise control the transmission facilities in a certain region. Order No. 2000 sets forth the basic governance terms for RTOs. To date, compliance by the transmission-owning utilities has been uneven and has met with political resistance on the part of the state governments and the state public utilities commissions in some regions of the country. The impact on our business of the implementation of Order No. 2000 and the development of RTOs cannot be predicted. In addition to its eÅorts in Order Nos. 888, 889, and 2000 and in creating RTOs, FERC has attempted to further reÑne and clarify the rights and obligations of owners and users of the interstate transmission grid in its Standard Market Design (""SMD'') and Interconnection rule-making proceedings. FERC's intention under the SMD proceedings is to establish a set of standard rules, which could be adopted in the form of a revised tariÅ by transmission-owning utilities, addressing the manner in which transmission capacity would be allocated, how generation would be dispatched given transmission constraints, the coordination of transmission upgrades and the allocation of costs associated therewith, among other transmission-related issues. The SMD rule-making proceeding is pending currently. The timing of FERC's issuance of a Ñnal order in this proceeding 23
Slide 25: is uncertain and has been delayed due to political resistance on the part of the state governments and the state public utilities commissions in some regions in the country. The impact on our business due to the issuance of a Ñnal order in this proceeding is uncertain and cannot be predicted at this time. On July 24, 2003, FERC issued Order No. 2003 which is the Ñnal rule in the Interconnection rulemaking proceeding. Order No. 2003 establishes uniform procedures for generator interconnection to the transmission grid, including the allocation of some of the costs associated with transmission system upgrades and special facilities required to interconnect the generator to the grid. Pursuant to Order No. 2003, transmission owners have been directed to make compliance Ñlings with the FERC to implement the requirements of the order. The purpose of Order No. 2003 is to provide greater certainty and reduce costs associated with the interconnection of new generation facilities to the transmission grid. Western Energy Markets There was signiÑcant price volatility in both wholesale electricity and gas markets in the Western United States for much of calendar year 2000 and extending through the second quarter of 2001. Due to a number of factors, including drier than expected weather, which led to lower than normal hydro-electric capacity in California and the Northwestern United States, inadequate natural gas pipeline and electric generation capacity to meet higher than anticipated energy demand in the region, the inability of the California utilities to manage their exposure to such price volatility due to regulatory and Ñnancial constraints, and evolving market structures in California, prices for electricity and natural gas were much higher than anticipated. A number of federal and state investigations and proceedings were commenced to address the crisis. There are currently a number of proceedings pending at FERC which were initiated as a direct result of the price volatility in the energy markets in the Western United States during this period. Many of these proceedings were initiated by buyers of wholesale electricity seeking refunds for purchases made during this period or the reduction of price terms in contracts entered into at this time. We have been a party to some of these proceedings. See Item 1. ""Business Ì Risk Factors Ì California Power Market'' and Item 3. ""Legal Proceedings.'' As part of certain proceedings, and as a result of its own investigations, FERC has ordered the implementation of certain measures for wholesale electricity markets in California and the Western United States, including, the implementation of price caps on the day ahead or real-time prices for electricity through September 30, 2002, and a continuing obligation of electricity generators to oÅer uncommitted generation capacity to the California Independent System Operator. FERC is continuing to investigate the causes of the price volatility in the Western United States during this period. It is uncertain at this time when these proceedings and investigations at FERC will conclude or what will be the Ñnal resolution thereof. See ""Ì Risk Factors Ì California Power Market'' below. Other federal and state governmental entities have and continue to conduct various investigations into the causes of the price volatility in the energy markets in the Western United States during this time. It is uncertain at this time when these investigations will conclude or what the results may be. The impact on our business of the results of the investigations cannot be predicted at this time. State Regulation State public utility commissions (""PUCs'') have historically had broad authority to regulate both the rates charged by, and the Ñnancial activities of, electric utilities operating in their states and to promulgate regulation for implementation of PURPA. Since a power sales agreement becomes a part of a utility's cost structure (generally reÖected in its retail rates), power sales agreements with independent electricity producers, such as EWGs, are potentially under the regulatory purview of PUCs and in particular the process by which the utility has entered into the power sales agreements. If a PUC has approved the process by which a utility secures its power supply, a PUC is generally inclined to pass through the expense associated with a power purchase agreement with an independent power producer to the utility's retail customers. However, a regulatory commission under certain circumstances may disallow the full reimbursement to a utility for the cost to purchase power from a QF or an EWG. In addition, retail sales of electricity or thermal energy by an independent power producer may be subject to PUC regulation depending on state law. Independent power 24
Slide 26: producers which are not QFs under PURPA, or EWGs pursuant to the Energy Policy Act of 1992, are considered to be public utilities in many states and are subject to broad regulation by a PUC, ranging from requirement of certiÑcate of public convenience and necessity to regulation of organizational, accounting, Ñnancial and other corporate matters. States may assert jurisdiction over the siting and construction of electricity generating facilities including QFs and EWGs and, with the exception of QFs, over the issuance of securities and the sale or other transfer of assets by these facilities. State PUCs also have jurisdiction over the transportation of natural gas by local distribution companies (""LDCs''). Each state's regulatory laws are somewhat diÅerent; however, all generally require the LDC to obtain approval from the PUC for the construction of facilities and transportation services if the LDCs generally applicable tariÅs do not cover the proposed transaction. LDC rates are usually subject to continuing PUC oversight. We own and operate numerous midstream assets in a number of states where we have plants and/or oil and gas production. Regulation of Canadian Gas The Canadian natural gas industry is subject to extensive regulation by federal and provincial authorities. At the federal level, a party exporting gas from Canada must obtain an export license from the National Energy Board (""NEB''). The NEB also regulates Canadian pipeline transportation rates and the construction of pipeline facilities. Gas producers also must obtain a removal permit or license from each provincial authority before natural gas may be removed from the province, and provincial authorities regulate intraprovincial pipeline and gathering systems. In addition, a party importing natural gas into the United States Ñrst must obtain an import authorization from the U.S. Department of Energy. Environmental Regulations The exploration for and development of geothermal resources, oil, gas liquids and natural gas, and the construction and operation of wells, Ñelds, pipelines, various other mid-stream facilities and equipment, and power projects, are subject to extensive federal, state and local laws and regulations adopted for the protection of the environment and to regulate land use. The laws and regulations applicable to us primarily involve the discharge of emissions into the water and air and the use of water, but can also include wetlands preservation, endangered species, hazardous materials handling and disposal, waste disposal and noise regulations. These laws and regulations in many cases require a lengthy and complex process of obtaining licenses, permits and approvals from federal, state and local agencies. Noncompliance with environmental laws and regulations can result in the imposition of civil or criminal Ñnes or penalties. In some instances, environmental laws also may impose clean-up or other remedial obligations in the event of a release of pollutants or contaminants into the environment. The following federal laws are among the more signiÑcant environmental laws as they apply to us. In most cases, analogous state laws also exist that may impose similar, and in some cases more stringent, requirements on us as those discussed below. Clean Air Act The Federal Clean Air Act of 1970 (""the Clean Air Act'') provides for the regulation, largely through state implementation of federal requirements, of emissions of air pollutants from certain facilities and operations. As originally enacted, the Clean Air Act sets guidelines for emissions standards for major pollutants (i.e., sulfur dioxide and nitrogen oxide) from newly built sources. In late 1990, Congress passed the Clean Air Act Amendments (""the 1990 Amendments''). The 1990 Amendments attempt to reduce emissions from existing sources, particularly previously exempted older power plants. We believe that all of our operating plants and relevant oil and gas related facilities are in compliance with federal performance standards mandated under the Clean Air Act and the 1990 Amendments. 25
Slide 27: Clean Water Act The Federal Clean Water Act (the ""Clean Water Act'') establishes rules regulating the discharge of pollutants into waters of the United States. We are required to obtain wastewater and storm water discharge permits for wastewater and runoÅ, respectively, from certain of our facilities. We believe that, with respect to our geothermal and oil and gas operations, we are exempt from newly promulgated federal storm water requirements. We are required to maintain a spill prevention control and countermeasure plan with respect to certain of our oil and gas facilities. We believe that we are in material compliance with applicable discharge requirements of the Clean Water Act. Oil Pollution Act of 1990 The Oil Pollution Act of 1990 (""OPA'') applies to our oÅshore facilities in the U.S. Gulf of Mexico regulating oil pollution prevention measures and Ñnancial responsibility requirements. We believe that we are in material compliance with applicable OPA requirements. Safe Drinking Water Act Part C of the Safe Water Drinking Act (""SWDA'') mandates the underground injection control (""UIC'') program. The UIC regulates the disposal of wastes by means of deep well injection. Deep well injection is a common method of disposing of saltwater, produced water and other oil and gas wastes. We believe that we are in material compliance with applicable UIC requirements of the SWDA. Resource Conservation and Recovery Act The Resource Conservation and Recovery Act (""RCRA'') regulates the generation, treatment, storage, handling, transportation and disposal of solid and hazardous waste. We believe that we are exempt from solid waste requirements under RCRA. However, particularly with respect to our solid waste disposal practices at the power generation facilities and steam Ñelds located at The Geysers, we are subject to certain solid waste requirements under applicable California laws. Based on the exploration and production exception, many oil and gas wastes are exempt from hazardous wastes regulation under RCRA. For those wastes generated in association with the exploration and production of oil and gas which are classiÑed as hazardous wastes, we undertake to comply with the RCRA requirements for identiÑcation and disposal. Various state environmental and safety laws also regulate the oil and gas industry. We believe that our operations are in material compliance with RCRA and all such laws. Comprehensive Environmental Response, Compensation, and Liability Act The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (""CERCLA'' or ""Superfund''), requires cleanup of sites from which there has been a release or threatened release of hazardous substances and authorizes the United States Environmental Protection Agency to take any necessary response action at Superfund sites, including ordering potentially responsible parties (""PRPs'') liable for the release to take or pay for such actions. PRPs are broadly deÑned under CERCLA to include past and present owners and operators of, as well as generators of wastes sent to, a site. As of the present time, we are not subject to liability for any Superfund matters. However, we generate certain wastes, including hazardous wastes, and send certain of our wastes to third party waste disposal sites. As a result, there can be no assurance that we will not incur liability under CERCLA in the future. Canadian Environmental, Health and Safety Regulations Our Canadian power projects and oil and gas operations are also subject to extensive federal, provincial and local laws and regulations adopted for the protection of the environment and to regulate land use. We believe that we are in material compliance with all applicable requirements under Canadian law related to same. 26
Slide 28: Regulation of U.S. Gas The U.S. natural gas industry is subject to extensive regulation by federal, state and local authorities. Calpine holds onshore and oÅshore federal leases involving the U.S. Dept. of Interior (Bureau of Land Management, Bureau of Indian AÅairs and the Minerals Management Service). At the federal level, various federal rules, regulations and procedures apply, including those issued by the U.S. Dept. of Interior as noted above, and the U.S. Dept. of Transportation (U.S. Coast Guard and OÇce of Pipeline Safety). At the state and local level, various agencies and commissions regulate drilling, production and midstream activities. Calpine has state and private oil and gas leases covering developed and undeveloped properties located in Arkansas, California, Colorado, Kansas, Louisiana, Mississippi, Missouri, Montana, New Mexico, Oklahoma, Texas and Wyoming. These federal, state and local authorities have various permitting, licensing and bonding requirements. Varied remedies are available for enforcement of these federal, state and local rules, regulations and procedures, including Ñnes, penalties, revocation of permits and licenses, actions aÅecting the value of leases, wells or other assets, and suspension of production. As a result, there can be no assurance that we will not incur liability for Ñnes and penalties or otherwise subject Calpine to the various remedies as are available to these federal, state and local authorities. However, we believe that we are currently in material compliance with these federal, state and local rules, regulations and procedures. RISK FACTORS Capital Resources We have substantial indebtedness that we may be unable to service and that restricts our activities. We have substantial debt that we incurred to Ñnance the acquisition and development of power generation facilities. As of December 31, 2003, our total consolidated funded debt was $17.7 billion, our total consolidated assets were $27.3 billion and our stockholders' equity was $4.6 billion. Whether we will be able to meet our debt service obligations and repay, extend, or reÑnance our outstanding indebtedness will be dependent primarily upon the operational performance of our power generation facilities and of our oil and gas properties, movements in electric and natural gas prices over time, and our marketing and risk management activities. This high level of indebtedness has important consequences, including: ‚ limiting our ability to borrow additional amounts for working capital, capital expenditures, debt service requirements, execution of our growth strategy, or other purposes; ‚ limiting our ability to use operating cash Öow in other areas of our business because we must dedicate a substantial portion of these funds to service the debt; ‚ increasing our vulnerability to general adverse economic and industry conditions; ‚ limiting our ability to capitalize on business opportunities and to react to competitive pressures and adverse changes in government regulation; ‚ limiting our ability or increasing the costs to reÑnance indebtedness; and ‚ limiting our ability to enter into marketing, hedging, optimization and trading transactions by reducing the number of counterparties with whom we can transact as well as the volume of those transactions. The operating and Ñnancial restrictions and covenants in certain of our existing debt agreements limit or prohibit our ability to: ‚ incur indebtedness; ‚ make prepayments on or purchase indebtedness in whole or in part; ‚ pay dividends; ‚ make investments; ‚ lease properties; 27
Slide 29: ‚ engage in transactions with aÇliates; ‚ create liens; ‚ consolidate or merge with another entity, or allow one of our subsidiaries to do so; ‚ sell assets; and ‚ acquire facilities or other businesses. Also, if our ownership changes, the indentures governing certain of our senior notes may require us to make an oÅer to purchase those senior notes. We cannot assure that we will have the Ñnancial resources necessary to purchase those senior notes in this event. If we are unable to comply with the terms of our indentures and other debt agreements, or if we fail to generate suÇcient cash Öow from operations, or to reÑnance our debt as described below, we may be required to reÑnance all or a portion of our senior notes and other debt or to obtain additional Ñnancing. However, we may be unable to reÑnance or obtain additional Ñnancing because of our high levels of debt and the debt incurrence restrictions under our indentures and other debt agreements. If cash Öow is insuÇcient and reÑnancing or additional Ñnancing is unavailable, we may be forced to default on our senior notes and other debt obligations. In the event of a default under the terms of any of our indebtedness, the debt holders may accelerate the maturity of our obligations, which could cause defaults under our other obligations. In addition, our unsecured senior notes and our other senior unsecured debt are eÅectively subordinated to all of our secured indebtedness to the extent of the value of the assets securing such indebtedness. Our secured indebtedness includes our $3.7 billion second-priority senior secured term loans and notes. The term loans and notes are secured by a second-priority lien on, among other things, substantially all of the assets owned directly by Calpine Corporation, including natural gas and power plant assets and the equity in all of the subsidiaries directly owned by Calpine Corporation. We also have a $500.0 million working capital facility that is secured by a Ñrst-priority lien on the same assets that secure our $3.7 billion second-priority senior secured term loans and notes. The noteholders' recourse on our $800.0 million CCFC I institutional term loans and secured notes is limited to the assets and contracts associated with the seven natural gas-Ñred electric generating facilities owned by CCFC I and its subsidiaries (as adjusted for approved dispositions and acquisitions, such as the completed sale of Lost Pines Power Project and the pending acquisition of the Brazos Valley Power Plant). The lenders' recourse on our $2.5 billion CalGen, formerly CCFC II secured revolving construction Ñnancing facility was limited to the assets and contracts associated with the 14 natural gas-Ñred electric generating facilities owned by subsidiaries of CalGen. The secured institutional term loans and secured notes issued by CalGen, that in March 2004 reÑnanced the $2.5 billion CalGen facility, are secured, through a combination of direct and indirect stock pledges and asset liens, by CalGen's 14 power generating facilities and related assets located throughout the United States, and the lenders' recourse is limited to such security. We have additional non-recourse project Ñnancings, secured in each case by the assets of the project being Ñnanced. We must reÑnance our debt maturing in 2004 and 2005. Since the latter half of 2001, there has been a signiÑcant 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 surplus of electric generating capacity. These factors have continued through 2003 and 2004, during which contracting credit markets and decreased spark spreads have adversely impacted our liquidity and earnings. While we have been able to access the capital and bank credit markets, it has been on signiÑcantly diÅerent terms than in the past. We recognize that terms of Ñnancing 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. As discussed above, in March 2004 we reÑnanced our CCFC II construction facility that had been scheduled to mature in November 2004. We are subject to a holders' put on December 26, 2004, which may require us to repurchase all or a portion of the aggregate principal amount of 4% Convertible Senior Notes Due 2006 (the ""2006 Convertible Senior Notes'') then outstanding with our choice of cash, stock or a combination thereof. On February 9, 2004, we made a cash tender oÅer, which expired on March 9, 2004, for all of the outstanding 2006 28
Slide 30: Convertible Senior Notes at a price of par plus accrued interest. See ""Business Ì Recent Developments'' for more information regarding this tender oÅer. 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 Ñve consecutive trading days after the applicable Ñnal failed remarketing termination date. We have $224.7 million in aggregate principal amount of 81/4% Senior Notes Due 2005 and $148.1 million aggregate principal amount of notes issued in connection with the monetization of a power contract with California Department of Water Resources (""DWR'') which will mature in 2005. In addition to the debt instruments discussed above, we have approximately $349.1 million and $133.9 million of miscellaneous debt and capital lease obligations that are maturing or for which scheduled principal payments will be made in 2004 and 2005, respectively. We cannot assure you that our business will generate suÇcient cash Öow from operations or that future borrowings will be available to us in an amount suÇcient to enable us to pay our indebtedness when due, or to fund our other liquidity needs. We may need to reÑnance all or a portion of our indebtedness, on or before maturity. While we believe we will be successful in reÑnancing all of our debt on or before maturity, we cannot assure you that we will be able to do so. We may be unable to secure additional Ñnancing in the future. Each power generation facility that we acquire or develop will require substantial capital investment. Our ability to arrange Ñnancing (including any extension or reÑnancing) and the cost of the Ñnancing are dependent upon numerous factors. Access to capital (including any extension or reÑnancing) for participants in the energy sector, including for us, has been signiÑcantly restricted since late 2001. Other factors include: ‚ general economic and capital market conditions; ‚ conditions in energy markets; ‚ regulatory developments; ‚ credit availability from banks or other lenders for us and our industry peers, as well as the economy in general; ‚ investor conÑdence in the industry and in us; ‚ the continued success of our current power generation facilities; and ‚ provisions of tax and securities laws that are conducive to raising capital. We have Ñnanced our existing power generation facilities using a variety of leveraged Ñnancing structures, consisting of senior secured and unsecured indebtedness, construction Ñnancing, project Ñnancing, revolving credit facilities, term loans and lease obligations. As of December 31, 2003, we had approximately $17.7 billion of total consolidated funded debt, consisting of $4.3 billion of secured construction/project Ñnancing, $0.2 billion of capital lease obligations, $9.4 billion in senior notes, $1.3 billion in convertible senior notes, $0.2 billion in preferred interests, $1.2 billion of trust preferred securities and $1.1 billion of secured and unsecured notes payable and borrowings under lines of credit. Each project Ñnancing and lease obligation is structured to be fully paid out of cash Öow provided by the facility or facilities Ñnanced or leased. In the event of a default under a Ñnancing agreement which we do not cure, the lenders or lessors would generally have rights to the facility and any related assets. In the event of foreclosure after a default, we might not retain any interest in the facility. While we intend to utilize non-recourse or lease Ñnancing when appropriate, market conditions and other factors may prevent similar Ñnancing for future facilities. It is possible that we may be unable to obtain the Ñnancing required to develop our power generation facilities on terms satisfactory to us. We have from time to time guaranteed certain obligations of our subsidiaries and other aÇliates. Our lenders or lessors may also seek to have us guarantee the indebtedness for future facilities. Guarantees render 29
Slide 31: our general corporate funds vulnerable in the event of a default by the facility or related subsidiary. Additionally, certain of our indentures may restrict our ability to guarantee future debt, which could adversely aÅect our ability to fund new facilities. Our indentures do not limit the ability of our subsidiaries to incur nonrecourse or lease Ñnancing for investment in new facilities. Our credit ratings have been downgraded and could be downgraded further. On July 17, 2003, Standard & Poor's placed our corporate rating (currently rated at B), our senior unsecured debt rating (currently at CCC°), our preferred stock rating (currently at CCC), our bank loan rating (currently at B), and our second priority senior secured debt rating (currently at B) under review for possible downgrade. On July 23, 2003, Fitch, Inc. downgraded our long-term senior unsecured debt rating from B° to B¿ (with a stable outlook), our preferred stock rating from B¿ to CCC (with a stable outlook), and initiated coverage of our senior secured debt rating at BB¿ (with a stable outlook). On October 20, 2003, Moody's downgraded the rating of our long-term senior unsecured debt from B1 to Caa1 (with a stable outlook) and our senior implied rating from Ba3 to B2 (with a stable outlook). The ratings on our senior unsecured debt, senior unsecured convertible debt and convertible preferred securities were also lowered (with a stable outlook) from B1 to Caa1, from B1 to Caa1 and from B2 to Caa3, respectively. Many other issuers in the power generation sector have also been downgraded by one or more of the ratings agencies during this period. Such downgrades can have a negative impact on our liquidity by reducing attractive Ñnancing opportunities and increasing the amount of collateral required by trading counterparties. We cannot assure you that Moody's, Fitch and Standard & Poor's will not further downgrade our credit ratings in the future. If our credit rating is downgraded, we could be required to, among other things, pay additional interest under our credit agreements, or provide additional guarantees, collateral, letters of credit or cash for credit support obligations, and it could increase our cost of capital, make our eÅorts to raise capital more diÇcult and have an adverse impact on our subsidiaries' and our business, Ñnancial condition and results of operations. Our ability to repay our debt depends upon the performance of our subsidiaries. Almost all of our operations are conducted through our subsidiaries and other aÇliates. As a result, we depend almost entirely upon their earnings and cash Öow to service our indebtedness, including our ability to pay the interest and principal of our senior notes. The Ñnancing agreements of certain of our subsidiaries and other aÇliates generally restrict their ability to pay dividends, make distributions, or otherwise transfer funds to us prior to the payment of their other obligations, including their outstanding debt, operating expenses, lease payments and reserves. Our subsidiaries and other aÇliates are separate and distinct legal entities and, except in limited circumstances, have no obligation to pay any amounts due on our senior notes or our $500.0 million secured working capital credit facility and do not guarantee the payment of interest on or principal of such debt. The right of the holders of such debt to receive any assets of any of our subsidiaries or other aÇliates upon our liquidation or reorganization will be subordinated to the claims of any subsidiaries' or other aÇliates' creditors (including trade creditors and holders of debt issued by our subsidiaries or aÇliates). As of December 31, 2003, our subsidiaries had $4.3 billion of secured construction/project Ñnancing. We may utilize project Ñnancing when appropriate in the future, and this Ñnancing will be eÅectively senior to our secured and unsecured debt. The senior note indentures and our senior secured credit facilities impose limitations on our ability and the ability of our subsidiaries to incur additional indebtedness. However, the senior note indentures do not limit the amount of construction/project Ñnancing that our subsidiaries may incur to Ñnance the acquisition and development of new power generation facilities. The senior secured credit facilities do impose limitations on certain types of non-recourse Ñnancings. 30
Slide 32: Operations Revenue may be reduced signiÑcantly upon expiration or termination of our power sales agreements. Some of the electricity we generate from our existing portfolio is sold under long-term power sales agreements that expire at various times. We also sell power under short to intermediate (1 to 5 year) contracts. When the terms of each of these various power sales agreements expire, it is possible that the price paid to us for the generation of electricity under subsequent arrangements may be reduced signiÑcantly. Use of derivatives can create volatility in earnings and may require signiÑcant cash collateral. During 2003 we recognized $26.4 million in mark-to-market losses on electric power and natural gas derivatives. Additionally, we recognized as a cumulative eÅect of a change in accounting principle, an after-tax gain of approximately $181.9 million 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'' on October 1, 2003. Please see Item 7 Ì ""Management's Discussion and Analysis of Financial Condition and Results of Operation Ì Impact of Recent Accounting Pronouncements'' for a detailed discussion of the accounting requirements relating to electric power and natural gas derivatives. In addition, Generally Accepted Accounting Principles (""GAAP'') treatment of derivatives in general, and particularly in our industry, continues to evolve. We may enter into other transactions in future periods that require us to mark various derivatives to market through earnings. The nature of the transactions that we enter into and the volatility of natural gas and electric power prices will determine the volatility of earnings that we may experience related to these transactions. As a result, in part, of the fallout from Enron's declaration of bankruptcy on December 2, 2001, companies using derivatives have become more sensitive to the inherent risks of such transactions. Consequently, many companies, including us, are requiring cash collateral for certain derivative transactions in excess of what was previously required. As of December 31, 2003, we had $188.0 million in margin deposits with counterparties, net of deposits posted by counterparties with us, and had posted $14.5 million of letters of credit, compared to $25.2 million and $106.1 million, respectively, at December 31, 2002. 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. We may be unable to obtain an adequate supply of natural gas in the future. To date, our fuel acquisition strategy has included various combinations of our own gas reserves, gas prepayment contracts, short-, medium- and long-term supply contracts and gas hedging transactions. In our gas supply arrangements, we attempt to match the fuel cost with the fuel component included in the facility's power sales agreements in order to minimize a project's exposure to fuel price risk. In addition, the focus of CES is to manage the ""spark spread'' for our portfolio of generating plants Ì the spread between the cost of fuel and electricity revenues Ì and we actively enter into hedging transactions to lock in gas costs and spark spreads. We believe that there will be adequate supplies of natural gas available at reasonable prices for each of our facilities when current gas supply agreements expire. However, gas supplies may not be available for the full term of the facilities' power sales agreements, and gas prices may increase signiÑcantly. Additionally, our credit ratings may inhibit our ability to procure gas supplies from third parties. If gas is not available, or if gas prices increase above the level that can be recovered in electricity prices, there could be a negative impact on our results of operations or Ñnancial condition. Our power project development and acquisition activities may not be successful. The development of power generation facilities is subject to substantial risks. In connection with the development of a power generation facility, we must generally obtain: ‚ necessary power generation equipment; ‚ governmental permits and approvals; ‚ fuel supply and transportation agreements; ‚ suÇcient equity capital and debt Ñnancing; 31
Slide 33: ‚ electrical transmission agreements; ‚ water supply and wastewater discharge agreements; and ‚ site agreements and construction contracts. We may be unsuccessful in accomplishing any of these matters or in doing so on a timely basis. In addition, project development is subject to various environmental, engineering and construction risks relating to cost-overruns, delays and performance. Although we may attempt to minimize the Ñnancial risks in the development of a project by securing a favorable power sales agreement, obtaining all required governmental permits and approvals, and arranging adequate Ñnancing prior to the commencement of construction, the development of a power project may require us to expend signiÑcant sums for preliminary engineering, permitting, legal and other expenses before we can determine whether a project is feasible, economically attractive or Ñnanceable. If we are unable to complete the development of a facility, we might not be able to recover our investment in the project. The process for obtaining initial environmental, siting and other governmental permits and approvals is complicated and lengthy, often taking more than one year, and is subject to signiÑcant uncertainties. We cannot assure you that we will be successful in the development of power generation facilities in the future or that we will be able to successfully complete construction of our facilities currently in development, nor can we assure you that any of these facilities will be proÑtable or have value equal to the investment in them even if they do achieve commercial operation. We have grown substantially in recent years partly as a result of acquisitions of interests in power generation facilities, geothermal steam Ñelds and natural gas reserves and facilities. The integration and consolidation of our acquisitions with our existing business requires substantial management, Ñnancial and other resources and, ultimately, our acquisitions may not be successfully integrated. In addition, as we transition from a development company to an operating company, we are not likely to continue to grow at historical rates due to reduced acquisition activities in the near future. Thus, we have also substantially curtailed our development eÅorts in response to our reduced liquidity. Although the domestic power industry is continuing to undergo consolidation and may oÅer acquisition opportunities at favorable prices, we believe that we are likely to confront signiÑcant competition for those opportunities and, due to the constriction in the availability of capital resources for acquisitions and other expansion, to the extent that any opportunities are identiÑed, we may be unable to eÅect any acquisitions. Similarly, to the extent we seek to divest assets, we may not be able to do so at attractive prices. Our projects under construction may not commence operation as scheduled. The commencement of operation of a newly constructed power generation facility involves many risks, including: ‚ start-up problems; ‚ the breakdown or failure of equipment or processes; and ‚ performance below expected levels of output or eÇciency. New plants have no operating history and may employ recently developed and technologically complex equipment. Insurance (including a layer of insurance provided by a captive insurance subsidiary) is maintained to protect against certain risks, warranties are generally obtained for limited periods relating to the construction of each project and its equipment in varying degrees, and contractors and equipment suppliers are obligated to meet certain performance levels. The insurance, warranties or performance guarantees, however, may not be adequate to cover lost revenues or increased expenses. As a result, a project may be unable to fund principal and interest payments under its Ñnancing obligations and may operate at a loss. A default under such a Ñnancing obligation, unless cured, could result in our losing our interest in a power generation facility. In certain situations, power sales agreements (""PSAs'') entered into with a utility early in the development phase of a project may enable the utility to terminate the PSA or to retain security posted as liquidated damages under the PSA. Currently, six of our 12 projects under construction are party to PSAs containing such provisions and could be materially aÅected if these provisions were triggered. The six projects 32
Slide 34: are our Freeport, Valladolid, Mankato, Bethpage, Fox and Otay Mesa facilities. The situations that could allow a utility to terminate a PSA or retain posted security as liquidated damages include: ‚ the cessation or abandonment of the development, construction, maintenance or operation of the facility; ‚ failure of the facility to achieve construction milestones by agreed upon deadlines, subject to extensions due to force majeure events; ‚ failure of the facility to achieve commercial operation by agreed upon deadlines, subject to extensions due to force majeure events; ‚ failure of the facility to have achieved certain output minimums; ‚ failure by the facility to make any of the payments owing to the utility under the PSA or to establish, maintain, restore, extend the term of, or increase the posted security if required by the PSA; ‚ a material breach of a representation or warranty or failure by the facility to observe, comply with or perform any other material obligation under the PSA; ‚ failure of the facility to obtain material permits and regulatory approvals by agreed upon deadlines; or ‚ the liquidation, dissolution, insolvency or bankruptcy of the facility. Our power generation facilities may not operate as planned. Upon completion of our projects currently under construction, we will operate 97 of the 99 power plants in which we will have an interest. The continued operation of power generation facilities, including, upon completion of construction, the facilities owned directly by Calpine, involves many risks, including the breakdown or failure of power generation equipment, transmission lines, pipelines or other equipment or processes, and performance below expected levels of output or eÇciency. Although from time to time our power generation facilities have experienced equipment breakdowns or failures, these breakdowns or failures have not had a signiÑcant eÅect on the operation of the facilities or on our results of operations. For calendar year 2003, our gas-Ñred and geothermal power generation facilities operated at an average availability of approximately 91% and 97%, respectively. Although our facilities contain various redundancies and back-up mechanisms, a breakdown or failure may prevent the aÅected facility from performing under applicable power sales agreements. In addition, although insurance is maintained to protect against operating risks, the proceeds of insurance may not be adequate to cover lost revenues or increased expenses. As a result, we could be unable to service principal and interest payments under our Ñnancing obligations which could result in losing our interest in one or more power generation facility. We cannot assure you that our estimates of oil and gas reserves are accurate. Estimates of proved oil and gas reserves and the future net cash Öows attributable to those reserves are prepared by independent petroleum and geological engineers. There are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves and cash Öows attributable to such reserves, including factors beyond our control and that of our engineers. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. The accuracy of an estimate of quantities of reserves, or of cash Öows attributable to such reserves, is a function of the available data, assumptions regarding future oil and gas prices and expenditures for future development and exploitation activities, and of engineering and geological interpretation and judgment. Additionally, reserves and future cash Öows may be subject to material downward or upward revisions, based upon production history, development and exploration activities and prices of oil and gas. Actual future production, revenue, taxes, development expenditures, operating expenses, underlying information, quantities of recoverable reserves and the value of cash Öows from such reserves may vary signiÑcantly from the assumptions and underlying information set forth herein. In addition, diÅerent reserve engineers may make diÅerent estimates of reserves and cash Öows based on the same available data. Our geothermal energy reserves may be inadequate for our operations. The development and operation of geothermal energy resources are subject to substantial risks and uncertainties similar to those experienced 33
Slide 35: in the development of oil and gas resources. The successful exploitation of a geothermal energy resource ultimately depends upon: ‚ the heat content of the extractable steam or Öuids; ‚ the geology of the reservoir; ‚ the total amount of recoverable reserves; ‚ operating expenses relating to the extraction of steam or Öuids; ‚ price levels relating to the extraction of steam or Öuids or power generated; and ‚ capital expenditure requirements relating primarily to the drilling of new wells. In connection with each geothermal power plant, we estimate the productivity of the geothermal resource and the expected decline in productivity. The productivity of a geothermal resource may decline more than anticipated, resulting in insuÇcient reserves being available for sustained generation of the electrical power capacity desired. An incorrect estimate by us or an unexpected decline in productivity could, if material, adversely aÅect our results of operations or Ñnancial condition. Geothermal reservoirs are highly complex. As a result, there exist numerous uncertainties in determining the extent of the reservoirs and the quantity and productivity of the steam reserves. Reservoir engineering is an inexact process of estimating underground accumulations of steam or fluids that cannot be measured in any precise way, and depends significantly on the quantity and accuracy of available data. As a result, the estimates of other reservoir specialists may differ materially from ours. Estimates of reserves are generally revised over time on the basis of the results of drilling, testing and production that occur after the original estimate was prepared. We cannot assure you that we will be able to successfully manage the development and operation of our geothermal reservoirs or that we will accurately estimate the quantity or productivity of our steam reserves. Market We depend on our electricity and thermal energy customers. Our systems of power generation facilities rely on one or more power sales agreements with one or more utilities or other customers for a substantial portion of our revenue. While electricity is a fungible commodity and the loss of any one customer could be mitigated by selling our power into the market, some of our contracts contain pricing provisions more favorable than those that could be obtained currently in the market. The loss of any of our contracts with such favorable pricing provisions would negatively aÅect our margins. In addition, sales of electricity to one customer during 2003, DWR, comprised approximately 14% of our total revenue that year. After aggregating our power sales agreements by speciÑc counterparty, DWR is currently the only signiÑcant customer based on revenues within our portfolio of existing power sales agreements. Additionally, all of our contracts with DWR contain termination provisions consistent with those standard in the industry. For further information on our revenues and receivables from DWR, see Note 21 of the Notes to Consolidated Financial Statements. The loss of signiÑcant power sales agreements with DWR or an adverse change in DWR's ability to pay for power delivered under our contracts could have a negative eÅect on our results of operations. In addition, any material failure by any customer to fulÑll its obligations under a power sales agreement could have a negative eÅect on the cash Öow available to us and on our results of operations. Competition could adversely aÅect our performance. The power generation industry is characterized by intense competition, and we encounter competition from utilities, industrial companies and other independent power producers. In recent years, there has been increasing competition among generators in an eÅort to obtain power sales agreements, and this competition has contributed to a reduction in electricity prices in certain markets. In addition, many states are implementing or considering regulatory initiatives designed to increase competition in the domestic power industry. In California, the California Public Utilities Commission (""CPUC'') issued decisions that provide for direct access for all customers as of April 1, 1998; however, the CPUC suspended direct access in California eÅective September 20, 2001, due to the problems that arose in California's newly deregulated markets. As a result, uncertainty exists as to the future course for direct access in California in the aftermath of the energy crisis in that state. In Texas, legislation phased in a deregulated power market, which commenced on January 1, 2001. This competition has put pressure on electric utilities to 34
Slide 36: lower their costs, including the cost of purchased electricity, and increasing competition in the supply of electricity in the future will increase this pressure. Our international investments may face uncertainties. We have investments in oil and natural gas resources and power projects in Canada in development and in operation, an investment in an energy service business in the Netherlands, an investment in a power generation facility in development in Mexico, and an investment in a power generation facility in the U.K. that is in operation, and we may pursue additional international investments in the future subject to the limitations on our expansion plans due to current capital market constraints. International investments are subject to unique risks and uncertainties relating to the political, social and economic structures of the countries in which we invest. Risks speciÑcally related to investments in non-United States projects may include: ‚ Öuctuations in currency valuation; ‚ currency inconvertibility; ‚ expropriation and conÑscatory taxation; ‚ increased regulation; and ‚ approval requirements and governmental policies limiting returns to foreign investors. California Power Market The unresolved issues arising from the California power market, where 42 of our 99 power plants are located, could adversely aÅect our performance. The volatility in the California power market from mid2000 through mid-2001 has produced signiÑcant unanticipated results. We may be required to make refund payments to the CalPX and CAISO as a result of the 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 eÅective period of October 2, 2000, to June 19, 2001, for sales made into those markets. On December 12, 2002, the Administrative Law Judge issued a CertiÑcation of Proposed Finding on California Refund Liability (""December 12 CertiÑcation'') making an initial determination of refund liability. On March 26, 2003, FERC also issued an order adopting many of the ALJ's Ñndings set forth in the December 12 CertiÑcation (the ""March 26 Order''). In addition, as a result of certain Ñndings by the FERC staÅ 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 modiÑed by substituting a gas proxy price based upon gas prices in the producing areas plus the tariÅ transportation rate for the California gas price indices previously adopted in the refund proceeding. We believe, based on information that we have analyzed to date, that any refund liability that may be attributable to us will increase modestly, from approximately $6.2 million to at least $8.4 million, after taking the appropriate set-oÅs for outstanding receivables owed by the CalPX and CAISO to Calpine. We have fully reserved the amount of refund liability that by our current analysis would potentially be owed under the refund calculation clariÑcation in the March 26 order. We note that, in March 2004, CAISO transmitted new tentative price data as part of the process of further reÑning the refund calculation. We have not completed our analysis of this new tentative price data (which has not been approved by FERC and is subject to change), but it is possible that the revised price data will result in an increase in the refund liability that may be attributable to us. The Ñnal 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 Ñnal refund liability. Thus, the impact on our business is uncertain at this time. We have been issued a show cause order in connection with the FERC investigation into western markets regarding the CalPX and CAISO tariffs and may be found liable for payments thereunder. On February 13, 2002, FERC initiated an investigation of potential manipulation of electric and natural gas prices in the western 35
Slide 37: 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 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 OÇce 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 tariÅ prohibitions. No individual market participant was identiÑed. We believe that we did not violate the CAISO and CalPX tariÅ prohibitions referred to by FERC in this order; however, we are unable to predict at this time the Ñnal outcome of this proceeding or its impact on Calpine. The energy payments made to us under our QF contracts with PG&E may be retroactively adjusted downward as a result of the CPUC proceeding regarding QF contract pricing for past periods. Our 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 CalPX zonal day-ahead clearing price (""CalPX Price'') from summer 2000 until January 19, 2001, when the CalPX ceased operating a day-ahead market. The CPUC has conducted proceedings (R.99-11-022) to determine whether the CalPX Price was the appropriate price for the energy component upon which to base payments to QFs which had elected the CalPX-based pricing option. The CPUC at one point issued a proposed decision to the eÅect that the CalPX Price was the appropriate price for energy payments under the California Public Utility Code but tabled it, and a Ñnal decision has not been issued to date. Therefore, it is possible that the CPUC could order a payment adjustment based on a diÅerent energy price determination. We believe that the CalPX Price was the appropriate price for energy payments but there can be no assurance that this will be the outcome of the CPUC proceedings. The availability payments made to us under our Geysers' Reliability Must Run contracts have been challenged by certain buyers as having been not just and reasonable. California Independent System Operator, California Electricity Oversight Board, Public Utilities Commission of the State of California, PaciÑc Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison (collectively referred to as the ""Buyers Coalition'') Ñled 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 speciÑc generation unit to provide energy and ancillary services when called upon to do so by the ISO to meet 36
Slide 38: local transmission reliability needs or to manage transmission constraints. The Buyers Coalition has asked FERC to Ñnd that the availability payments under these RMR Contracts are not just and reasonable. Geysers Power Company, LLC Ñled 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. Government Regulation We are subject to complex government regulation which could adversely aÅect our operations. Our activities are subject to complex and stringent energy, environmental and other governmental laws and regulations. The construction and operation of power generation facilities and oil and gas exploration and production require numerous permits, approvals and certiÑcates from appropriate foreign, federal, state and local governmental agencies, as well as compliance with environmental protection legislation and other regulations. While we believe that we have obtained the requisite approvals and permits for our existing operations and that our business is operated in accordance with applicable laws, we remain subject to a varied and complex body of laws and regulations that both public oÇcials and private individuals may seek to enforce. Existing laws and regulations may be revised or reinterpreted, or new laws and regulations may become applicable to us that may have a negative eÅect on our business and results of operations. We may be unable to obtain all necessary licenses, permits, approvals and certiÑcates for proposed projects, and completed facilities may not comply with all applicable permit conditions, statutes or regulations. In addition, regulatory compliance for the construction of new facilities is a costly and time-consuming process. Intricate and changing environmental and other regulatory requirements may necessitate substantial expenditures to obtain permits. If a project is unable to function as planned due to changing requirements or local opposition, it may create expensive delays or signiÑcant loss of value in a project. Environmental regulations have had and will continue to have an impact on our cost of doing business and our investment decisions. For example, the existing market-based cap-and-trade emissions allowance system in Texas requires operators to either reduce nitrogen oxide (""NOx'') emissions or purchase additional NOx allowances in the marketplace. Rather than purchase additional allowances, we have chosen to install additional NOx emission controls as part of a $31 million steam capacity upgrade at our Texas City facility and to retroÑt our Clear Lake, Texas facility with similar technology at a cost of approximately $17 million. These new emission control systems will allow us to meet our thermal customers' needs while reducing the need to purchase allowances for our facilities in Texas. Our operations are potentially subject to the provisions of various energy laws and regulations, including PURPA, PUHCA, the FPA, and state and local regulations. PUHCA provides for the extensive regulation of public utility holding companies and their subsidiaries. PURPA provides QFs (as deÑned under PURPA) and owners of QFs exemptions from certain federal and state regulations, including rate and Ñnancial regulations. The FPA regulates wholesale sales of power, as well as electric transmission in interstate commerce. Under current federal law, we are not subject to regulation as a holding company under PUHCA, and will not be subject to such regulation as long as the plants in which we have an interest (1) qualify as QFs, (2) are subject to another exemption or waiver or (3) qualify as an EWG under the Energy Policy Act of 1992. In order to be a QF, a facility must be not more than 50% owned by one or more electric utility companies or electric utility holding companies. Generally, any geothermal power facility which produces up to 80 megawatts of electricity and meets PURPA ownership requirements is considered a QF. In addition, a QF that is a cogeneration facility, such as the plants in which we currently have interests, must produce electricity as well as thermal energy for use in an industrial or commercial process in speciÑed minimum proportions. The QF also must meet certain minimum energy eÇciency standards. If any of the plants in which we have an interest lose their QF status or if amendments to PURPA are enacted that substantially reduce the beneÑts currently aÅorded QFs, we could become a public utility holding company, which could subject us to signiÑcant federal, state and local regulation, including rate regulation. If we become a holding company, which could be deemed to occur prospectively or retroactively to the date that any of our plants loses its QF status, all of our other power plants could lose QF status because, under FERC 37
Slide 39: regulations, a QF cannot be owned by an electric utility or electric utility holding company. In addition, a loss of QF status could, depending on the particular power purchase agreement, allow the power purchaser to cease taking and paying for electricity or to seek refunds of past amounts paid and thus could cause the loss of some or all contract revenues or otherwise impair the value of a project. If a power purchaser were to cease taking and paying for electricity or seek to obtain refunds of past amounts paid, there can be no assurance that the costs incurred in connection with the project could be recovered through sales to other purchasers. Such events could adversely aÅect our ability to service our indebtedness. See ""Item 1 Ì Business Ì Government Regulation Ì Federal Energy Regulation Ì Federal Power Act Regulation.'' A cogeneration QF could lose its QF status if it does not continue to meet FERC's operating and eÇciency requirements. Such possible loss of QF status could occur, for example, if the QF's steam host, typically an industrial facility, fails for operating, permit or economic reasons to use suÇcient quantities of the QF's steam output. We cannot assure you that any of our steam hosts will continue to take and use suÇcient quantities of their respective QF's steam output. Currently, Congress is considering proposed legislation that would repeal PUHCA, and would amend PURPA by limiting its mandatory purchase obligation to existing contracts in those regions of the country that are found to have competitive energy markets. In light of the circumstances in California, the PG&E bankruptcy and the Enron Corp. (""Enron'') bankruptcy, among other events in recent years, there are a number of federal legislative and regulatory initiatives that could result in changes in how the energy markets are regulated. We do not know whether this legislation or regulatory initiatives will be adopted or, if adopted, what form they may take. We cannot provide assurance that any legislation or regulation ultimately adopted would not adversely aÅect our existing domestic projects. In addition, many states are implementing or considering regulatory initiatives designed to increase competition in the domestic power generation industry and increase access to electric utilities' transmission and distribution systems for independent power producers and electricity consumers. However, in light of the circumstances in the California power markets and the bankruptcies of both PG&E and Enron, the pace and direction of further deregulation at the state level in many jurisdictions is uncertain. See ""California Power Market'' risk factors. Other Risk Factors We depend on our management and employees. Our success is largely dependent on the skills, experience and eÅorts of our people. While we believe that we have excellent depth throughout all levels of management and in all key skill levels of our employees, the loss of the services of one or more members of our senior management or of numerous employees with critical skills could have a negative eÅect on our business, Ñnancial conditions and results of operations and future growth. We have employment agreements with certain of our key employees, including our Chief Executive OÇcer and Chief Financial OÇcer. Seismic disturbances could damage our projects. Areas where we operate and are developing many of our geothermal and gas-Ñred projects are subject to frequent low-level seismic disturbances. More signiÑcant seismic disturbances are possible. Our existing power generation facilities are built to withstand relatively signiÑcant levels of seismic disturbances, and we believe we maintain adequate insurance protection. However, earthquake, property damage or business interruption insurance may be inadequate to cover all potential losses sustained in the event of serious seismic disturbances. Additionally, insurance for these risks may not continue to be available to us on commercially reasonable terms. Our results are subject to quarterly and seasonal Öuctuations. Our quarterly operating results have Öuctuated in the past and may continue to do so in the future as a result of a number of factors, including without limitation: ‚ seasonal variations in energy prices; ‚ variations in levels of production; 38
Slide 40: ‚ the timing and size of acquisitions; and ‚ the completion of development projects. Additionally, because we receive the majority of capacity payments under some of our power sales agreements during the months of May through October, our revenues and results of operations are, to some extent, seasonal. The ultimate outcome of the legal proceedings relating to our activities cannot be predicted. Any adverse determination could have a material adverse eÅect on our Ñnancial condition and results of operations. We are party to various litigation matters arising out of the normal course of business, the more signiÑcant of which are summarized in ""Item 3. Legal Proceedings.'' These matters include securities class action lawsuits, such as Hawaii Structural Ironworkers Pension Fund v. Calpine et al., which relates to our April 2002 equity oÅering and also named the underwriters of that oÅering as defendants. 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, these matters may potentially be material to our Ñnancial condition and results of operations. The price of our common stock is volatile. The market price for our common stock has been volatile in the past, and several factors could cause the price to Öuctuate substantially in the future. These factors include without limitation: ‚ general conditions in our industry, the power markets in which we participate, or the worldwide economy; ‚ announcements of developments related to our business or sector; ‚ Öuctuations in our results of operations; ‚ our debt to equity ratios and other leverage ratios; ‚ eÅects of signiÑcant events relating to the energy sector in general; ‚ sales of substantial amounts of our securities into the marketplace; ‚ an outbreak of war or hostilities; ‚ a shortfall in revenues or earnings compared to securities analysts' expectations; ‚ changes in analysts' recommendations or projections; and ‚ announcements of new acquisitions or development projects by us. The market price of our common stock may Öuctuate signiÑcantly in the future, and these Öuctuations may be unrelated to our performance. General market price declines or market volatility in the future could adversely aÅect the price of our common stock, and the current market price may not be indicative of future market prices. EMPLOYEES As of December 31, 2003, we employed 3,418 people, of whom 62 (domestic and international) were represented by collective bargaining agreements. We have never experienced a work stoppage or strike, and we consider relations with our employees to be good. Although we are an asset-based company, we are successful because of the talents, intelligence, resourcefulness and energy level of our employees. As discussed in our strategy section, our employee knowledge base enables us to optimize the value and proÑtability of our electricity production and prudently manage the risks inherent in our business. 39
Slide 41: SUMMARY OF KEY ACTIVITIES Finance New Issuances by Calpine Corporation and certain of its wholly owned subsidiaries: Date Amount Description 2/13/03 6/13/03 Cdn $153.3 million (US $100.9 million) $802.2 million Closed a secondary oÅering for the Calpine Power Income Fund Power Contract Financing, L.L.C., completed an oÅering of $339.9 million aggregate principal amount of 5.2% Senior Secured Notes Due 2006 and $462.3 million aggregate principal amount of 6.256% Senior Secured Notes Due 2010 Completed an oÅering of a $750.0 million Öoating rate term loan, $500.0 of million Second Priority Senior Secured Floating Rate Notes Due 2007, $1.15 billion aggregate principal amount of 8.5% Second Priority Senior Secured Notes Due 2010, and $900.0 million aggregate principal amount of 8.75% Second Priority Senior Secured Notes Due 2013 Completed a $300.0 million two-year working capital revolver and a $200.0 million four-year term loan Entered into a cash collateralized letter of credit facility for up to $200.0 million CCFC I and CCFC Finance Corp. completed an oÅering of $385.0 million aggregate principal amount of First Priority Floating Rate Secured Institutional Term Loans Due 2009, as well as $365.0 million aggregate principal amount of Second Priority Secured Floating Rate Notes Due 2011 Completed non-recourse project Ñnancing for Riverside Energy Center CCFC I and CCFC Finance Corp. completed an oÅering of an additional $50.0 million aggregate principal amount of Second Priority Senior Secured Floating Rate Notes Due 2011 Gilroy Energy Center, LLC, completed an oÅering of 4% Senior Secured Notes Due 2011 Calpine Power Income Fund obtained an extendible revolving term credit facility Completed initial public oÅering of Calpine Natural Gas Trust Completed a non-recourse term loan for Blue Spruce Energy Center Completed oÅering of 43/4% Contingent Convertible Senior Notes Due 2023 Completed oÅering of 97/8% Second Priority Senior Secured Notes OÅering Due 2011 Description 7/16/03 $3.3 billion 7/16/03 7/16/03 8/14/03 $500.0 million $200.0 million $750.0 million 8/25/03 9/25/03 $230.0 million $50.0 million 9/30/03 10/6/03 10/15/03 11/7/03 11/17/03 11/18/03 $301.7 million $120.0 million Cdn $184.5 million (US $139.4 million) $140.0 million $650.0 million $400.0 million Repurchases/Repayments: Date Amount 7/03 7/03 7/03 8/03 $949.6 million $555.5 million $50.0 million $880.1 million Repaid facility Repaid Repaid Repaid outstanding balance under our $1.0 billion secured term credit outstanding balance on certain of our revolving credit facilities the outstanding balance on our California peaker Ñnancing the outstanding balance on our CCFC I project Ñnancing 40
Slide 42: Date Amount Description 6/03-12/03 9/03-10/03 Other: Date $1.9 billion $182.5 million Repurchased various debt securities Exchanged debt securities and HIGH TIDES for common stock in privately negotiated transactions Description 1/7/03 1/21/03 1/27/03 2/26/03 3/17/03 4/29/03 5/9/03 5/12/03 5/15/03 6/2/03 7/17/03 7/23/03 8/7/03 9/3/03 9/30/03 10/20/03 10/23/03 11/26/03 12/2/03 12/4/03 Entered into renegotiated power purchase and sales agreements with PG&E and DWR Entered into a 16-year power purchase and sale agreement with Long Island Power Authority Entered into a 3-year power purchase agreement with Nevada Power Company, a subsidiary of Sierra PaciÑc Resources Federal Energy Regulatory Commission approved a Reliability Must-Run Settlement Agreement Entered into a long-term power sales agreement with Southern California Edison Completed sale of a preferred interest in a subsidiary that leases and operates King City Power Plant for $82.0 million Entered into a two-year agreement to provide up to 300 megawatts of power to Brazos Electric Power Cooperative, Inc. Completed the contract monetization and restructuring of our interest in Acadia Energy Center Completed $82.8 million monetization of an existing power sales agreement with the Bonneville Power Administration Standard & Poor's downgraded the corporate credit rating to B from BB Standard & Poor's placed our corporate rating (currently rated at B), senior unsecured debt rating (currently at CCC°), preferred stock rating (currently at CCC), bank loan rating (currently at B) and second priority senior secured debt rating (currently at B) under review for possible downgrade Fitch, Inc. downgraded the rating on long-term senior unsecured debt from B° to B- (with a stable outlook) and preferred stock rating from B- to CCC (with a stable outlook), and initiated coverage of our senior secured debt rating at BB- (with a stable outlook) Bankruptcy court approved Ñnal settlement with Enron resulting in our recording other revenue of $67.3 million Completed sale of a 70-percent interest in Auburndale Power Plant to Pomifer Power Funding, LLC, a subsidiary of ArcLight Energy Partners Fund 1, L.P., for $88.0 million Received funding on a third party preferred equity investment in GEC Holdings, LLC Moody's downgraded the rating on long-term senior unsecured debt from B1 to Caa1 (with a stable outlook) and senior implied rating from Ba3 to B2 (with a stable outlook). The ratings on senior unsecured debt, senior unsecured convertible debt and convertible preferred securities were also lowered (with a stable outlook) from B1 to Caa1, from B1 to Caa1 and from B2 to Caa3, respectively Entered into a 2-year agreement to supply electricity to Reliant Energy Electric Solutions, LLC Completed sale of unconsolidated investment in Gordonsville Power Plant for $36.2 million cash payment Entered into a one-year agreement to provide up to 155 megawatts of power to Utility Choice Electric Completed monetization of PG&E note receivable for $133.4 million 41
Slide 43: Power Plant Development and Construction Date Project Description 1/03 1/03 1/03 3/03 3/03 4/03 4/03 5/03 6/03 6/03 6/03 6/03 6/03 6/03 6/03 Goose Haven Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lambie Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Creed Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Los Esteros Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Wolfskill Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Blue Spruce Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calgary Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Riverview Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Carville Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Santa Rosa Energy Center ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oneta Energy Center, Phase II ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deer Park Energy Center, Phases I and IAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Decatur Energy Center, Phase I ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Morgan Energy Center, Units 2 and 3 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Zion Energy Center Expansion, Unit 3 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Commercial Operation Operation Operation Operation Operation Operation Operation Operation Operation Operation Operation Operation Operation Operation Operation Turbine Restructuring Program Date of Announcement Reduction in Capital Spending Earnings EÅect 2/11/03 $3.4 billion ÏÏÏÏÏÏÏÏÏ Pre-tax charge of approximately $207.4 million in the quarter ended December 31, 2002 Annual Meeting of Stockholders on May 28, 2003 Stockholders' Voting Results ‚ Election of JeÅrey E. Garten, George J. Stathakis and John O. Wilson as Class I Directors for a threeyear term expiring 2006 ‚ Proposal that the Board of Directors be requested to redeem the stockholders right plan unless such plan is approved by a majority vote of the stockholders to be held as soon as may be practicable Ì approved ‚ Proposal that the Board of Directors take the necessary steps to declassify the Board of Directors for the purpose of establishing elections for directors Ì approved ‚ RatiÑcation of the appointment of PricewaterhouseCoopers LLP as independent accountants for the Ñscal year ending December 31, 2003 The three-year terms of Class II and Class III Directors continued after the Annual Meeting and will expire in 2004 and 2005, respectively. The Class II Directors are Ann B. Curtis, Kenneth T. Derr and Gerald Greenwald. The Class III Directors are Susan C. Schwab, Susan Wang and Peter Cartwright. See Item 1. ""Business Ì Recent Developments'' for 2004 developments. Item 2. Properties Our principal executive oÇce located in San Jose, California is held under leases that expire through 2008, and we also lease oÇces, with leases expiring through 2013, in Dublin and Folsom, California; Houston and Pasadena, Texas; Boston, Massachusetts; Washington, D.C.; Calgary, Alberta; and Jupiter, Florida. We hold additional leases for other satellite oÇces. 42
Slide 44: We either lease or own the land upon which our power-generating facilities are built. We believe that our properties are adequate for our current operations. A description of our power-generating facilities is included under Item 1. ""Business.'' We have leasehold interests in 107 leases comprising 21,888 acres of federal, state and private geothermal resource lands in The Geysers area in northern California. In the Glass Mountain and Medicine Lake areas in northern California, we hold leasehold interests in 41 leases comprising approximately 46,519 acres of federal geothermal resource lands. In general, under these leases, we have the exclusive right to drill for, produce and sell geothermal resources from these properties and the right to use the surface for all related purposes. Each lease requires the payment of annual rent until commercial quantities of geothermal resources are established. After such time, the leases require the payment of minimum advance royalties or other payments until production commences, at which time production royalties are payable. Such royalties and other payments are payable to landowners, state and federal agencies and others, and vary widely as to the particular lease. The leases are generally for initial terms varying from 10 to 20 years or for so long as geothermal resources are produced and sold. Certain of the leases contain drilling or other exploratory work requirements. In certain cases, if a requirement is not fulÑlled, the lease may be terminated and in other cases additional payments may be required. We believe that our leases are valid and that we have complied with all the requirements and conditions material to the continued eÅectiveness of the leases. A number of our leases for undeveloped properties may expire in any given year. Before leases expire, we perform geological evaluations in an eÅort to determine the resource potential of the underlying properties. We can make no assurance that we will decide to renew any expiring leases. Based on independent petroleum engineering reports of Netherland, Sewell & Associates Inc., and Gilbert Laustsen Jung Associates Ltd., as of December 31, 2003, utilizing year end product prices and costs held constant, our proved oil, natural gas, and natural gas liquids (""NGLs'') reserve volumes, in millions of barrels (""MMBbls'') and billions of cubic feet (""Bcf'') are as follows: As of December 31, 2003 Oil and NGLs (MMBbls) Gas (Bcf) United States Proved developed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proved undeveloped ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Canada Proved developed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proved undeveloped ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Proved developed ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proved undeveloped ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1.9 1.5 3.4 6.8 0.7 7.5 8.7 2.2 10.9(1) 369 186 555 176 25 201 545 211 756 (1) 10.9 MMBbls of oil is equivalent to 65.4 Bcf of gas using a conversion factor of six thousand cubic feet of gas to one barrel of crude oil and natural gas liquids. On an equivalent basis, proved reserves at year-end totaled 821 Bcfe. Proved oil and natural gas reserves are the estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Estimated future 43
Slide 45: development costs associated with proved producing and non-producing plus proved undeveloped reserves as of December 31, 2003, totaled approximately $222 million. No estimates of total, proved net oil or gas reserves were Ñled with or included in reports to any other federal authority or agency (other than the Securities and Exchange Commission) since January 1, 2003. The following table sets forth our interest in undeveloped acreage, developed acreage and productive wells in which we own a working interest as of December 31, 2003. Gross represents the total number of acres or wells in which we own a working interest. Net represents our proportionate working interest resulting from our ownership in the gross acres or wells. Productive wells are wells in which we have a working interest and are capable of producing oil or natural gas. Undeveloped Acres Gross Net Developed Acres Gross Net Productive Wells Gross Net United States Arkansas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ California ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Colorado ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Kansas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LouisianaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MississippiÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Missouri ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Montana ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ New Mexico ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ OÅshoreÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oklahoma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Texas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ WyomingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total United States ÏÏÏÏÏÏÏÏÏ Canada Alberta ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ British Columbia ÏÏÏÏÏÏÏÏÏÏÏÏÏ Saskatchewan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Total ÏÏÏÏÏÏÏÏÏÏÏ 160 17,999 9,704 118,488 1,421 4,257 35,008 43,290 Ì 2,625 492 54,081 50,750 338,275 834,332 298,955 158 1,133,445 1,471,720 80 17,482 9,302 107,933 507 857 31,651 30,259 Ì 2,625 92 26,378 39,649 266,815 567,958 69,520 13 637,491 904,306 3,521 48,334 10,854 Ì 10,356 12,653 43 960 13,017 21,260 13,007 96,678 600 231,283 847,269 16,826 394 864,489 1,095,772 1,399 37,617 5,944 Ì 1,955 3,102 43 240 9,924 16,141 4,475 48,524 2 129,366 375,195 4,322 70 379,587 508,953 32 278 83 Ì 27 13 Ì 2 90 34 43 601 Ì 1,203 1,851 Ì Ì 1,851 3,054 15 231 82 Ì 5 3 Ì 1 64 24 12 299 Ì 736 459 Ì Ì 459 1,195 The following table shows our interest in undeveloped acreage as of December 31, 2003 which is subject to expiration in 2004, 2005 and 2006. 2004 Gross Net Gross 2005 Net Gross 2006 Net Thereafter Gross Net United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Total ÏÏÏÏÏÏÏÏÏ 181,577 100,922 282,499 162,537 70,729 233,266 10,807 242,982 253,789 9,528 190,065 199,593 21,841 129,631 151,472 20,714 119,838 140,552 124,050 659,910 783,960 74,036 256,859 330,895 The following table sets forth the number of gross exploratory and gross development wells drilled in which we participated during the last three Ñscal years. The number of wells drilled refers to the number of wells commenced at any time during the respective Ñscal year. Productive wells are either producing wells or 44
Slide 46: wells capable of commercial production. At December 31, 2003, we were in the process of drilling 2 wells (net 2) in the US and 3 wells (net 1) in Canada. Exploratory Productive Dry Total Development Productive Dry Total 2003 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Canada ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 17 1 18 Ì 1 1 5 2 7 8 2 10 6 1 7 2 Ì 2 25 3 28 6 2 8 7 2 9 20 158 178 41 87 128 66 186 252 5 3 8 4 8 12 12 26 38 25 161 186 45 95 140 78 212 290 The following table sets forth, for each of the last three Ñscal years, the number of net exploratory and net development wells, drilled by us based on our proportionate working interest in such wells: Exploratory Productive Dry Total Development Productive Dry Total 2003 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CanadaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CanadaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CanadaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 14.0 0.3 14.3 Ì 0.5 0.5 2.2 1.6 3.8 4.5 0.7 5.2 3.9 0.5 4.4 1.0 Ì 1.0 18.5 1.0 19.5 3.9 1.0 4.9 3.2 1.6 4.8 18.5 42.5 61.0 36.4 38.9 75.3 58.9 97.2 156.1 3.4 1.0 4.4 2.8 4.2 7.0 7.4 19.7 27.1 21.9 43.5 65.4 39.2 43.1 82.3 66.3 116.9 183.2 45
Slide 47: The following table shows our annual average wellhead sales prices and average production costs. The average sales prices with hedges include realized gains and losses for derivative contracts we enter into with non-aÇliates to manage price risk related to our sales volumes. 2003 With Hedges 2002 2001 2003 Without Hedges 2002 2001 UNITED STATES Sales price Natural gas (per Mcf)(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and condensate (per barrel)ÏÏÏÏÏÏÏÏÏÏ Natural gas liquids (per barrel) ÏÏÏÏÏÏÏÏÏÏ Lease operating cost (per Mcfe)(2) ÏÏÏÏÏÏÏÏ Production taxes (per Mcfe) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Production cost (per Mcfe)(3) ÏÏÏÏÏÏÏ CANADA Sales price Natural gas (per Mcf) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and condensate (per barrel)ÏÏÏÏÏÏÏÏÏÏ Natural gas liquids (per barrel) ÏÏÏÏÏÏÏÏÏÏ Lease operating cost (per Mcfe)(2) ÏÏÏÏÏÏÏÏ Production taxes (per Mcfe) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Production cost (per Mcfe) ÏÏÏÏÏÏÏÏÏÏ TOTAL Sales price Natural gas (per Mcf) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and condensate (per barrel)ÏÏÏÏÏÏÏÏÏÏ Natural gas liquids (per barrel) ÏÏÏÏÏÏÏÏÏÏ Lease operating cost (per Mcfe)(2) ÏÏÏÏÏÏÏÏ Production taxes (per Mcfe) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Production cost (per Mcfe) ÏÏÏÏÏÏÏÏÏÏ (1) Thousand cubic feet. $ 5.30 $29.64 $18.42 $ 0.74 $ 0.08 $ 0.82 $ 3.14 $21.58 $13.35 $ 0.60 $ 0.06 $ 0.66 $ 4.90 $23.30 $15.67 $ 0.57 $ 0.07 $ 0.64 $ 5.30 $29.64 $18.42 $ 0.74 $ 0.08 $ 0.82 $ 3.06 $21.58 $13.35 $ 0.60 $ 0.06 $ 0.66 $ 4.81 $23.30 $15.67 $ 0.57 $ 0.07 $ 0.64 $ 4.81 $26.01 $26.31 $ 0.89 $Ì $ 0.89 $ 2.44 $21.95 $18.48 $ 0.61 $Ì $ 0.61 $ 3.17 $20.49 $20.96 $ 0.42 $Ì $ 0.42 $ 4.81 $28.72 $26.31 $ 0.89 $Ì $ 0.89 $ 2.44 $22.29 $18.48 $ 0.61 $Ì $ 0.61 $ 3.25 $20.16 $20.96 $ 0.42 $Ì $ 0.42 $ 5.13 $27.46 $26.10 $ 0.80 $ 0.05 $ 0.85 $ 2.76 $21.90 $18.35 $ 0.60 $ 0.03 $ 0.63 $ 3.76 $20.69 $20.90 $ 0.47 $ 0.02 $ 0.49 $ 5.13 $29.08 $26.10 $ 0.80 $ 0.05 $ 0.85 $ 2.72 $22.20 $18.35 $ 0.60 $ 0.03 $ 0.63 $ 3.78 $20.38 $20.90 $ 0.47 $ 0.02 $ 0.49 (2) Includes lifting costs, treating and transportation and workover costs. (3) Thousand cubic feet equivalent. Item 3. Legal Proceedings We are party to various litigation matters arising out of the normal course of business, the more signiÑcant 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 Ñnancial statements. Securities Class Action Lawsuits. Since March 11, 2002, fourteen shareholder lawsuits have been Ñled against Calpine and certain of its oÇcers in the United States District Court, Northern District of California. The actions captioned Weisz v. Calpine Corp., et al., Ñled March 11, 2002, and Labyrinth Technologies, Inc. v. Calpine Corp., et al., Ñled 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., Ñled April 18, 2002, is a purported class action on behalf of purchasers of Calpine stock between February 6, 2001 and December 13, 46
Slide 48: 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 Ñled between March 18, 2002 and April 23, 2002. The complaints in these eleven actions are virtually identical Ì they are Ñled by three law Ñrms, in conjunction with other law Ñrms 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 Ñnancial 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 unspeciÑed amount of damages, in addition to other forms of relief. In addition, a Ñfteenth securities class action, Ser v. Calpine, et al., was Ñled 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 Ñnancial condition. This action names Calpine, certain of its oÇcers and directors, and the underwriters of the 2011 Notes oÅering as defendants, and seeks an unspeciÑed amount of damages, in addition to other forms of relief. All Ñfteen of these securities class action lawsuits were consolidated in the U.S. District Court for the Northern District Court of California. The plaintiÅs Ñled a Ñrst 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, the plaintiÅs Ñled 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 Ñled 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 plaintiÅs to Ñle a third amended complaint, which they 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 plaintiÅ's Section 11 claim was barred by the applicable one-year statute of limitations. On February 5, 2004, the judge denied our motion to dismiss but has asked the parties to be prepared to Ñle summary judgment motions to address the statute of limitations issue. Our answer to the third amended complaint has been Ñled. 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 Ñled on March 11, 2003, against Calpine, its directors and certain investment banks in the California Superior Court, San Diego County. The underlying allegations in the Hawaii Structural Ironworkers Pension Fund action (""Hawaii action'') are substantially the 47
Slide 49: 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 oÅering. The Hawaii action alleges that the Registration Statement and Prospectus Ñled by Calpine which became eÅective on April 24, 2002, contained false and misleading statements regarding Calpine's Ñnancial 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 Ñnancial results, announced on March 3, 2003, to support its allegations. The Hawaii action seeks an unspeciÑed amount of damages, in addition to other forms of relief. We removed the Hawaii action to federal court in April 2003 and Ñled a motion to transfer the case for consolidation with the other securities class action lawsuits in the U.S. District Court Northern District Court of California in May 2003. The plaintiÅ sought to have the action remanded to state court, and on August 27, 2003, the U.S. District Court for the Southern District of California granted plaintiÅ's motion to remand the action to state court. In early October 2003 plaintiÅ 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 Ñled 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 the plaintiÅ's standing. The court found that the plaintiÅ had not shown that it had purchased Calpine' stock ""traceable'' to the April 2002 equity oÅering. The court overruled our motion to dismiss on all other grounds. We have requested oral argument on these other issues which oral argument is currently scheduled for March 2004. We consider this lawsuit to be without merit and intend to continue 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'') Ñled a class action lawsuit in the Northern District Court 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 Ñlings and statements made by Calpine during the class period were materially false and misleading, and that the defendants failed to fulÑll their Ñduciary obligations as Ñduciaries of the 401(k) Plan by allowing the 401(k) Plan to invest in Calpine common stock. The Phelps action seeks an unspeciÑed amount of damages, in addition to other forms of relief. In May 2003 Lennette Poor-Herena, another participant in the 401(k) Plan, Ñled a substantially similar class action lawsuit as the Phelps action also in the Northern District of California. PlaintiÅs' 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, plaintiÅ James Phelps Ñled a consolidated ERISA complaint naming Calpine and numerous individual current and former Calpine Board members and employees as defendants. Calpine's response to the amended complaint is due March 22, 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 Ñled a derivative lawsuit on behalf of Calpine against its directors and one of its senior oÇcers. This lawsuit is captioned Johnson v. Cartwright, et al. and is pending in the California Superior Court, Santa Clara County. 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 oÇcer defendant. In December 2002 the court dismissed the complaint with respect to certain of the director defendants for lack of personal jurisdiction, though the plaintiÅ may appeal this ruling. In early February 2003 the plaintiÅ Ñled an amended complaint. In March 2003 Calpine and the individual defendants Ñled 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 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 Ñled a derivative suit in the United States District Court for the Northern District California on behalf of Calpine against its directors, captioned Gordon v. Cartwright, et al. similar to Johnson v. Cartwright. Motions have been Ñled to dismiss the action against certain of the director defendants on the grounds of lack of personal jurisdiction, as well as to dismiss 48
Slide 50: the complaint in total on other grounds. In February 2003 plaintiÅ 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, the plaintiÅ Ñled papers with the court voluntarily agreeing to dismiss without prejudice the claims he had against three of the outside directors. 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 the Superior Court of the State of California for the County of Alameda 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 oÅ $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 Ñled by InterGen North America, L.P. (""InterGen'') against Anne M. Sholtz, the owner of ACE, and EonXchange, another Sholtz-controlled entity, which Ñled for bankruptcy protection on May 6, 2002. InterGen alleges it suÅered 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 Ñling 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 Ñled 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, Ñled 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 Ñling of bankruptcy and therefore should be avoided and preserved for the beneÑt of the bankruptcy estate. On August 28, 2003, Calpine Ñled its answer denying that the $7 million is an avoidable preference. Discovery is currently ongoing. Calpine believes that it has valid defenses to this claim and will vigorously defend against this complaint. On January 26, 2004, Calpine Ñled a Motion for Partial Summary Judgment asserting that the Bankruptcy Court did not properly consolidate Anne Sholtz into the bankruptcy estate of EonXchange. If the motion is granted, at least $2.9 million of the $7 million that the Trustee is seeking to recover from Calpine could not be avoided as a preferential transfer. We believe we have adequately reserved for the possible loss, if any, it may ultimately incur as a result of this matter. International Paper Company v. Androscoggin Energy LLC. In October 2000 International Paper Company (""IP'') Ñled a complaint in the Federal 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, eÅective May 8, 1998, of one of AELLC's Ñxed-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 Ñled a counterclaim against IP that has been referred to arbitration. AELLC may commence the arbitration counterclaim after discovery has progressed further. On November 7, 2002, the court issued an opinion on the parties' cross motions for summary judgment Ñnding 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 signiÑcant 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-oÅ 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 49
Slide 51: 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 oÅset 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 reÑling the claims as breach of contract claims in a separate lawsuit. On June 30, 2003, AELLC Ñled a motion to reconsider the order dismissing AELLC's Amended Counterclaim. 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 suÇcient questions of fact remain to deny IP summary judgment on the measure of damages as IP did not suÇciently 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 Ñled a pretrial order with the Court. The case appears likely scheduled for trial in the second 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. PaciÑc Gas and Electric Company v. Calpine Corporation, et al. On July 22, 2003, PaciÑc Gas and Electric Company (""PG&E'') Ñled 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 the 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 Ñrst 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 tariÅed transportation rates and to make restitution for any proÑts 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-aÇliated 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 Ñled its answer and a motion to dismiss. LGS has also made similar Ñlings. 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. Although Calpine has denied the allegations in the Complaint and believes this Complaint to be without merit, 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 eÅective immediately and the eÅectiveness 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 Ñling of the Settlement Agreement. On February 6, 2004, the Settlement Agreement was Ñled with the CPUC. Parties have the opportunity to submit comments and reply comments on the Settlement Agreement and then the matter shall be before the CPUC for its consideration. 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'') Ñled suit against Calpine and certain of its aÇliates in the U.S. 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 proÑts from Oneta plant and that Calpine's actions have reduced the proÑts from Oneta plant thereby undermining Panda's 50
Slide 52: 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. 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 Ñled a counterclaim against Panda Energy International, Inc. (and PLC II, LLC) based on a guaranty, and have also Ñled a motion to dismiss as to the causes of action alleging federal and state securities laws violations. 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 Ñled 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 Ñled to federal court for pretrial proceedings with other cases in which we are not named as a defendant. We consider the allegations to be without merit, and Ñled a motion to dismiss on August 28, 2003. The court granted the motion, and plaintiÅs 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 the Superior Court of the State of California for the County of Alameda. 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. We anticipate Ñling a timely motion for dismissal of this action as well. McClintock et al. v. Vikram Budhraja, et al. California Department of Water Resources Case. On May 1, 2002, California State Senator Tom McClintock and others Ñled a complaint against Vikram Budhraja, a consultant to the California Department of Water Resources (""DWR''), DWR itself, and more than twenty-nine energy providers and other interested parties, including Calpine. The complaint alleged that the long term power contracts that DWR entered into with these energy providers, including Calpine, were rendered void because Budhraja, who negotiated the contracts on behalf of DWR, allegedly had an undisclosed Ñnancial interest in the contracts due to his connection with one of the energy providers, Edison International. Among other things, the complaint sought an injunction prohibiting further performance of the long term contracts and restitution of any funds paid to energy providers by the State of California under the contracts. The action had been stayed by order of the Court since August 26, 2002, pending resolution of an earlier Ñled state court action involving the same parties and subject matter captioned Carboneau v. State of California in which we are not a defendant. We considered the allegations in this lawsuit to be without merit and Ñled a motion for dismissal with prejudice on November 26, 2003, which was granted. No appeal was Ñled and therefore the case has been concluded in its entirety. Nevada Power Company and Sierra PaciÑc Power Company v. Calpine Energy Services, L.P. before the FERC, Ñled on December 4, 2001. Nevada Section 206 Complaint. On December 4, 2001, Nevada Power Company (""NPC'') and Sierra PaciÑc Power Company (""SPPC'') Ñled 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 plaintiÅs appealed to the FERC and their request for rehearing was denied. The FERC decision is therefore Ñnal, and the matter is pending on appeal before the United States Court of Appeals for the Ninth Circuit. Calpine Canada Natural Gas Partnership v. Enron Canada Corp. On February 6, 2002, Calpine Canada Natural Gas Partnership (""Calpine Canada'') Ñled a complaint in the Alberta Court of Queens 51
Slide 53: 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 Ñled a complaint against Calpine in the U.S. District Court, 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 unspeciÑed amount in excess of $75,000. On July 28, 2003, Calpine Ñled 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. The plaintiÅs have Ñled a motion for reconsideration of the decision, and the plaintiÅs may also ultimately appeal. 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 legal actions proceedings, and state and regulatory investigations relating to our business. These actions and proceedings are described in detail elsewhere in this report. See Item 1. ""Business Ì Risk Factors Ì California Power Market.'' 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 eÅect on our Ñnancial position or results of operations. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Our common stock is traded on the New York Stock Exchange under the symbol ""CPN.'' Public trading of the common stock commenced on September 20, 1996. Prior to that, there was no public market for the common stock. The following table sets forth, for the periods indicated, the high and low sale price per share of the common stock on The New York Stock Exchange. High Low 2003 First QuarterÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 First QuarterÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 52 $ 4.42 7.25 8.03 5.25 $17.28 13.55 7.29 4.69 $2.51 3.33 4.76 3.28 $6.15 5.30 2.36 1.55
Slide 54: As of March 19, 2004, there were approximately 2,169 holders of record of our common stock. On March 19, 2004, the last sale price reported on the New York Stock Exchange for our common stock was $5.14 per share. We have not declared any cash dividends on the common stock during the past two Ñscal years. We do not anticipate paying any cash dividends on the common stock in the foreseeable future because we intend to retain our earnings to Ñnance the expansion of our business, to repay debt, and for general corporate purposes. In addition, our ability to pay cash dividends is restricted under certain of our indentures and our other debt agreements. Future cash dividends, if any, will be at the discretion of our board of directors and will depend upon, among other things, our future operations and earnings, capital requirements, general Ñnancial condition, contractual restrictions and such other factors as the board of directors may deem relevant. Convertible Senior Notes 4% Convertible Senior Notes Due 2006. On December 26, 2001, we completed a private placement of $1.0 billion aggregate principal amount of our 4% Convertible Senior Notes Due 2006 (""2006 Convertible Senior Notes''). The initial purchaser of the 2006 Convertible Senior Notes was Deutsche Bank Alex. Brown Inc. Deutsche Bank exercised its option to acquire an additional $200.0 million aggregate principal amount of the 2006 Convertible Senior Notes by purchasing an additional $100.0 million aggregate principal amount of the 2006 Convertible Senior Notes on each of December 31, 2001, and January 3, 2002. The oÅering price of the 2006 Convertible Senior Notes was 100% of the principal amount, less an aggregate underwriting discount of $30.0 million. Each sale of the 2006 Convertible Senior Notes to Deutsche Bank was exempt from registration in reliance on Section 4(2) under the Securities Act of 1933, as amended, as a transaction not involving a public oÅering. The 2006 Convertible Senior Notes were re-oÅered by Deutsche Bank to qualiÑed institutional buyers in reliance on Rule 144A under the Securities Act. We subsequently Ñled with the SEC a registration statement with respect to resales of the 2006 Convertible Senior Notes, which was declared eÅective by the SEC on June 21, 2002. The 2006 Convertible Senior Notes are convertible into shares of our common stock at a conversion price of $18.07 per share which represents a 13.0% premium over the New York Stock Exchange closing price of $15.99 per share on December 26, 2001. The conversion price is subject to adjustment in certain circumstances. We have reserved 66,408,411 shares of our authorized common stock for issuance upon conversion of the 2006 Convertible Senior Notes, which are convertible at any time on or before the close of business on the day that is two business days prior to the maturity date, December 26, 2006, unless we have previously repurchased the 2006 Convertible Senior Notes. Holders of the 2006 Convertible Senior Notes have the right to require us to repurchase their notes on at par plus accrued interest December 26, 2004. We may choose to pay the repurchase price in cash or shares of common stock, or a combination thereof. As of December 31, 2003, we had repurchased $539.9 million of principal amount of the 2006 Convertible Senior Notes in open market and privately negotiated transactions, leaving an outstanding balance of $660.1 million. Subsequent to December 31, 2003, we repurchased approximately $177.0 million in principal amount of our outstanding 2006 Convertible Senior Notes that can be put to us in exchange for approximately $176.0 million in cash. Additionally, on February 9, 2004, we made a cash tender oÅer, which expired on March 9, 2004, for all of the 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. Currently, 2006 Convertible Senior Notes in the aggregate principal amount of $73.7 million remain outstanding. 43/4% Contingent Convertible Senior Notes Due 2023. On November 17, 2003, we completed the issuance of $650 million aggregate principal amount of our 43/4% Contingent Convertible Senior Notes Due 2023 (""2023 Convertible Notes''). The initial purchasers of the 2023 Convertible Notes were Deutsche Bank Securities Inc., Credit Lyonnais Securities (USA) Inc., Harris Nesbitt Corp. and Williams Capital Group LP (the ""initial purchasers''). One of the initial purchasers, Deutsche Bank Securities Inc., exercised its option to acquire an additional $250.0 million aggregate principal amount of the 2023 Convertible Notes on January 9, 2004. The oÅering price of the 2023 Convertible Notes was 100% of the principal amount of the 2023 53
Slide 55: Convertible Senior Notes, less an aggregate underwriting discount of $24.75 million. Each sale of the 2023 Convertible Notes to an initial purchaser was exempt from registration in reliance on Section 4(2) under the Securities Act of 1933, as amended, as a transaction not involving a public oÅering. The 2023 Convertible Notes were oÅered by each initial purchaser to qualiÑed institutional buyers in reliance on Rule 144A under the Securities Act. Upon the occurrence of certain contingencies, the 2023 Convertible Notes are convertible, at the option of holder, into cash and shares of our common stock at an initial conversion price of $6.50 per share, which represents a 38% premium over The New York Stock Exchange closing price of $4.71 per share on November 6, 2003. The number of shares of our common stock a holder ultimately receives upon conversion is determined by a formula based on the closing price of our common stock on The New York Stock Exchange over a period of Ñve consecutive trading days during a speciÑed period. We have initially reserved 69,230,000 shares of our authorized common stock for issuance upon conversion of the 2023 Convertible Notes, and have undertaken to reserve additional shares as may be necessary to satisfy our obligation to deliver shares upon conversion if our stock price increases such that the numbers of shares reserved is inadequate. Upon conversion of the 2023 Convertible Notes, we will deliver par value in cash and any additional value in shares of our common stock. The 2023 Contingent Notes will mature on November 15, 2023. We may redeem some or all of the notes at any time on or after November 22, 2009, at a redemption price, payable in cash, of 100% of the principal amount of the notes, plus accrued and unpaid interest and additional interest, if any, up to but not including the date of redemption. Holders have the right to require us to repurchase all or a portion of the 2023 Convertible Notes on November 22, 2009, 2013 and 2018, at 100% of their principal amount plus any accrued and unpaid interest. We have the right to repurchase the 2023 Convertible Senior Notes with cash, shares of our common stock, or a combination of cash and our common stock. 54
Slide 56: Item 6. Selected Financial Data Selected Consolidated Financial Data 2003 Years Ended December 31, 2002 2001 2000 (In thousands, except earnings per share) 1999 Statement of Operations data: Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Discontinued operations, net of tax ÏÏÏÏÏÏÏÏ Cumulative eÅect of a change in accounting principleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per common share: Income before discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Discontinued operations, net of tax ÏÏÏÏÏÏ Cumulative eÅect of a change in accounting principle, net of tax ÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common share: Income before discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Discontinued operations, net of tax provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of a change in accounting principle, net of tax ÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance Sheet data: Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term debt and capital lease obligations Long-term debt and capital lease obligations Company-obligated mandatorily redeemable convertible preferred securities of subsidiary trusts(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,919,539 $ 7,391,861 $ 6,714,929 $ 2,374,695 $ 888,328 $ 109,753 $ (8,674) 180,943 53,690 64,928 Ì $ 582,966 39,490 1,036 $ 332,754 36,330 Ì $ 89,000 17,650 Ì $ 282,022 $ 118,618 $ 623,492 $ 369,084 $ 106,650 $ 0.28 $ (0.02) 0.46 0.15 0.18 Ì $ 1.92 0.13 Ì $ 1.18 0.13 Ì $ 0.39 0.08 Ì $ 0.72 $ 0.33 $ 2.05 $ 1.31 $ 0.47 $ 0.28 (0.02) 0.45 $ 0.15 0.18 Ì $ 1.69 0.11 Ì $ 1.07 0.11 Ì $ 0.38 0.07 Ì $ 0.71 $ 0.33 $ 1.80 $ 1.18 $ 0.45 $27,303,932 349,128 17,328,181 $23,226,992 1,651,448 12,462,290 $21,937,227 903,307 12,490,175 $10,610,232 64,525 5,018,044 $4,400,902 47,470 2,214,921 $ Ì $ 1,123,969 $ 1,122,924 $ 1,122,390 $ 270,713 (1) Included in long-term debt as of December 31, 2003. See Note 11 of the Notes to Consolidated Financial Statements for more information. 55
Slide 57: Reconciliation of GAAP cash provided from operating activities to EBITDA, as adjusted(1): 2003 Years Ended December 31, 2002 2001 2000 (In thousands) 1999 Cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏÏÏ Less: Changes in operating assets and liabilities, excluding the eÅects of acquisitions(2) ÏÏÏÏÏÏÏÏ Less: Additional adjustments to reconcile net income to net cash provided by operating activities, net(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ GAAP net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from unconsolidated investments in power projects and oil and gas properties ÏÏÏÏÏÏÏÏÏÏÏÏ Distributions from unconsolidated investments in power projects and oil and gas propertiesÏÏÏÏÏÏÏ Adjusted net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 /3 of operating lease expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Distributions on trust preferred securitiesÏÏÏÏÏÏÏÏÏ Provision (beneÑt) for income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation, depletion and amortization expenseÏÏ Interest expense, provision for income taxes and depreciation from discontinued operations ÏÏÏÏÏÏ EBITDA, as adjusted(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 290,559 (609,840) $1,068,466 480,193 $ 423,569 (359,640) $ 875,751 277,696 $314,361 8,213 618,377 282,022 (76,703) 141,627 346,946 726,103 37,357 46,610 (134) 608,182 3,390 $1,768,454 469,655 118,618 (16,552) 14,117 116,183 413,690 37,007 62,632 (14,945) 474,225 92,544 $1,181,336 159,717 623,492 (16,946) 5,983 612,529 196,622 33,173 62,412 297,614 319,884 90,601 $1,612,835 228,971 369,084 (28,796) 29,979 370,267 81,890 21,154 45,076 231,419 199,763 74,163 $1,023,732 199,498 106,650 (36,593) 43,318 113,375 96,932 11,198 2,565 61,523 112,665 35,093 $433,351 (1) This non-GAAP measure is presented not as a measure of operating results, but rather as a measure of our ability to service debt and to raise additional funds. It should not be construed as an alternative to either (i) income from operations or (ii) cash Öows from operating activities. It is deÑned as net income less income from unconsolidated investments, plus cash received from unconsolidated investments, plus provision for tax, plus interest expense(including distributions on trust preferred securities and one-third of operating lease expense, which is management's estimate of the component of operating lease expense that constitutes interest expense,) plus depreciation, depletion and amortization. The interest, tax and depreciation and amortization components of discontinued operations are added back in calculating EBITDA, as adjusted. For the year ended December 31, 2003 EBITDA, as adjusted, includes a $180.9 million (net of tax) gain from the cumulative eÅect of a change in accounting principle and a $278.6 million gain from the repurchase of debt, oÅset by approximately $273.0 million of certain charges, consisting primarily of foreign currency transaction losses, equipment cancellation and impairment costs, certain mark-tomarket activity, and minority interest expense, some of which required, or will require cash settlement. EBITDA, as adjusted for the year ended December 31, 2002 includes a non-cash equipment cancellation charge of $404.7 million, a $118.0 million gain on the repurchase of debt, and approximately $55.0 million of certain charges, some of which required, or will require cash settlement. (2) See the Consolidated Statements of Cash Flows for further detail of these items. 56
Slide 58: Selected Operating Information 2003 Years Ended December 31, 2002 2001 2000 1999 (Dollars in thousands, except production and pricing data) Power Plants(1): Electricity and steam (""E&S'') revenues: Energy ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capacity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thermal and other ÏÏÏÏÏÏÏÏÏ SubtotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Spread on sales of purchased power(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted E&S revenues ÏÏÏÏÏÏ Megawatt hours produced ÏÏÏÏÏ All-in electricity price per megawatt hour generated ÏÏÏ $ 3,361,095 844,195 490,454 $ 4,695,744 24,118 $ 4,719,862 82,423,422 $ 57.26 $ 2,273,524 781,127 167,551 $ 3,222,202 527,546 $ 3,749,748 72,767,280 $ 51.53 $ 1,701,533 525,174 158,617 $ 2,385,324 345,834 $ 2,731,158 42,393,726 $ 64.42 $ 1,220,684 376,085 99,297 $ 1,696,066 11,262 $ 1,707,328 22,749,588 $ 75.05 $ 452,909 252,565 54,851 760,325 2,476 $ $ 762,801 14,802,709 51.53 $ (1) From continuing operations only. Discontinued operations are excluded. (2) From hedging, balancing and optimization activities related to our generating assets. Set forth above is certain selected operating information for our power plants and, through May 1999 for our geothermal steam Ñelds at The Geysers, for which results are consolidated in our statements of operations. Electricity revenue is composed of Ñxed 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, including our geothermal steam Ñeld revenues prior to our acquisition of the PG&E geothermal power plants at The Geysers on May 7, 1999. 57
Slide 59: Set forth below is a table summarizing the dollar amounts and percentages of our total revenue for the years ended December 31, 2003, 2002, and 2001, 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): 2003 Year Ended December 31, 2002 2001 Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased power for hedging and optimization(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sale of purchased gas for hedging and optimization ÏÏÏÏ As a percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total cost of revenue (""COR'')ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased power expense for hedging and optimization(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of total COR ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased gas expense for hedging and optimization ÏÏÏ As a percentage of total COR ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $8,919,539 2,714,187 30.4% 1,320,902 14.8% 8,082,838 2,690,069 33.3% 1,279,568 15.8% $7,391,861 3,145,991 42.6% 870,466 11.8% 6,385,208 2,618,445 41.0% 821,065 12.9% $6,714,929 3,332,412 49.6% 526,517 7.8% 5,491,800 2,986,578 54.4% 492,587 9.0% (1) On October 1, 2003, we adopted on a prospective basis EITF Issue No. 03-11 and netted purchases of power 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 signiÑcant levels of these sales and costs of revenue items include: (a) signiÑcant levels of hedging, balancing and optimization activities by our 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 StaÅ Accounting Bulletin (""SAB'') No. 101, ""Revenue Recognition in Financial Statements,'' and Emerging Issues Task Force (""EITF'') Issue No. 99-19, ""Reporting Revenue Gross as a Principal versus Net as an Agent,'' under which we show most of our hedging contracts on a gross basis (as opposed to netting sales and cost of revenue); and (d) rules in eÅect throughout 2001 and 2002 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 adoption of EITF Issue No. 03-11 on October 1, 2003. This gross basis presentation increased revenues but not gross proÑt. The table below details the Ñnancial extent of our transactions with NEPOOL for all Ñnancial 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. Nine Months Ended September 30, 2003 Year Ended December 31, 2002 2001 (In thousands) Sales to NEPOOL from power we generated ÏÏÏÏÏÏÏ Sales to NEPOOL from hedging and other activity ÏÏ Total sales to NEPOOL ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total purchases from NEPOOL ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $258,945 117,345 $376,290 $310,025 $294,634 106,861 $401,495 $360,113 $285,706 165,416 $451,122 $413,875 (The statement of operations data information and the balance sheet data information contained in the Selected Financial Data is derived from the audited Consolidated Financial Statements of Calpine Corpora- 58
Slide 60: tion and Subsidiaries. See the Notes to the Consolidated Financial Statements and Item 7. ""Management's Discussion and Analysis of Financial Condition Ì Results of Operation'' for additional information.) Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 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 eÇcient 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 oÅer 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: ‚ preserving and enhancing our liquidity while spark spreads (the diÅerential between power revenues and fuel costs) are depressed, ‚ selectively adding new load-serving entities and power users to our satisÑed customer list as we increase our power contract portfolio, and ‚ continuing to add value through prudent risk management and optimization activities. Since the latter half of 2001, there has been a signiÑcant 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 Ñnancing 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. We have recently completed the reÑnancing of Calpine Generating Company (""CalGen,'' formerly CCFC II) revolving construction facility indebtedness of approximately $2.3 billion as further discussed in Note 27 of the Notes to Consolidated Financial Statements. Remaining debt maturities are relatively modest in 2004 and 2005 as shown in Note 17 of the Notes to Consolidated Financial Statements. Set forth below are the Results of Operations for the years ending December 31, 2003, 2002, and 2001. Results of Operations Year Ended December 31, 2003, Compared to Year Ended December 31, 2002 (in millions, except for unit pricing information, percentages and MW volumes). Revenue 2003 2002 $ Change % Change Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $8,919.5 $7,391.9 $1,527.6 20.7% 59
Slide 61: The increase in total revenue is explained by category below. 2003 2002 $ Change % Change Electricity and steam revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased power for hedging and optimization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total electric generation and marketing revenue $4,695.7 2,714.2 $7,409.9 $3,222.2 3,146.0 $6,368.2 $1,473.5 (431.8) $1,041.7 45.7% (13.7)% 16.4% Electricity and steam revenue increased as we completed construction and brought into operation 5 new baseload power plants, 7 new peaker facilities and 3 project expansions in 2003. Average megawatts in operation of our consolidated plants increased by 40% to 20,092 MW while generation increased by 13%. The increase in generation lagged behind the increase in average MW in operation as our baseload capacity factor dropped to 53% in 2003 from 65% in 2002 primarily due to the increased occurrence of unattractive oÅ-peak market spark spreads in certain areas reÖecting oversupply conditions which are expected to gradually work oÅ over the next several years (this caused us to cycle oÅ certain of our merchant plants without contracts in oÅpeak hours) and to a lesser extent due to unscheduled outages caused by equipment problems at certain of our plants in the Ñrst half of 2003. Average realized electricity prices, before the eÅects of hedging, balancing and optimization, increased to $56.97/MWh in 2003 from $44.28/MWh in 2002. Sales of purchased power for hedging and optimization decreased during 2003, due primarily to adoption of EITF Issue No. 03-11 and lower realized prices on term power hedges. 2003 2002 $ Change % Change Oil and gas salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased gas for hedging and optimizationÏÏ Total oil and gas production and marketing revenue $ 107.7 1,320.9 $1,428.6 $120.9 870.5 $991.4 $(13.2) 450.4 $437.2 (10.9)% 51.7% 44.1% Oil and gas sales are net of internal consumption, which is eliminated in consolidation. Internal consumption increased by $228.7 to $409.1 in 2003. Before intercompany eliminations, oil and gas sales increased by $215.4 to $516.7 in 2003 from $301.3 in 2002 due primarily to 76% higher average realized natural gas pricing in 2003. Sales of purchased gas for hedging and optimization increased during 2003 due to higher prices for natural gas. 2003 2002 $ Change % Change Realized gain on power and gas transactions, net ÏÏÏÏÏÏÏ Unrealized loss on power and gas transactions, net ÏÏÏÏÏ Mark-to-market activities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 24.3 (50.7) $(26.4) $26.1 (4.6) $21.5 $ (1.8) (46.1) $(47.9) (6.9)% (1,002.2)% (222.8)% Realized revenue on power and gas mark-to-market activity represents the portion of mark-to-market contracts actually settled. Mark-to-market activities, which are shown on a net basis, results 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 ineÅective portion of cash Öow hedges. The decrease in mark-to-market activities revenue in 2003 is due primarily to a $27.3 reduction in value of option contracts associated with a spark spread 60
Slide 62: protection arrangement for the CCFC I Ñnancing and a decline in the value of a long-term spark spread option contract accounted for on a mark-to-market basis under SFAS No. 133. 2003 2002 $ Change % Change Other revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $107.5 $10.8 $96.7 895.4% Other revenue increased during 2003 primarily due to a $67.3 reduction in liability in connection with our settlement with Enron, primarily related to the termination of commodity contracts following the Enron bankruptcy. We also realized $23.6 of revenue from Thomassen Turbine Systems (""TTS''), which we acquired in February 2003. Power Systems Mfg., LLC (""PSM'') revenues increased $6.2 in 2003 as compared to 2002. Cost of Revenue 2003 2002 $ Change % Change Total cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $8,082.8 $6,385.2 $1,697.6 26.6% The increase in total cost of revenue is explained by category below. 2003 2002 $ Change % Change Plant operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Royalty expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased power expense for hedging and optimization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total electrical generation and marketing expense $ 679.0 24.9 2,690.1 $3,394.0 $ 506.0 17.6 2,618.4 $3,142.0 $173.0 7.3 71.7 $252.0 34.2% 41.5% 2.7% 8.0% Plant operating expense increased due to 5 new baseload power plants, 7 new peaker facilities and 3 expansion projects completed during 2003. Additionally, we experienced higher transmission expenses and higher maintenance expense as several newer plants underwent their Ñrst scheduled hot gas path overhauls which generally Ñrst occur after a plant has been in operation for three years. Royalty expense increased primarily due to the accrual of $5.3 in 2003 vs. $0 in 2002 for payments to the previous owner of the Texas City and Clear Lake Power Plants based on a percentage of gross revenues at these two natural gas-Ñred plants. Additionally, royalties increased by $2.0 due to an increase in electric revenues at The Geysers geothermal plants, where we pay royalties to geothermal property owners, mostly as a percentage of geothermal electricity revenues. Approximately 78% of the royalty expense for 2003 is attributable to such geothermal royalties. The increase in purchased power expense for hedging and optimization was due primarily to increased spot market costs to purchase power for hedging and optimization activities partially oÅset by the adoption of EITF Issue No. 03-11. 2003 2002 $ Change % Change Oil and gas production expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and gas exploration expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and gas operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased gas expense for hedging and optimization Total oil and gas operating and marketing expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 86.9 19.3 $ 84.4 13.1 97.5 821.1 $918.6 $ 2.5 6.2 8.7 458.5 3.0% 47.3% 8.9% 55.8% 50.9% 106.2 1,279.6 $1,385.8 $467.2 Oil and gas production expense increased primarily due to higher production taxes and higher gas treating and transportation costs, which were primarily the result of higher oil and gas prices plus an increase in operating cost and an increase in the average Canadian dollar foreign exchange rate in 2003. 61
Slide 63: Oil and gas exploration expense increased primarily as a result of $9.5 in dry hole drilling expenses in 2003 compared to $5.0 in 2002. Purchased gas expense for hedging and optimization increased during 2003 due to higher prices for gas in 2003. 2003 2002 $ Change % Change Fuel expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,564.7 $1,752.9 $811.8 46.3% Fuel expense increased in 2003, due to a 15% increase in gas-Ñred megawatt hours generated and 33% higher prices excluding the eÅects of hedging, balancing and optimization. This was partially oÅset by an increased value of internally produced gas, which is eliminated in consolidation. 2003 2002 $ Change % Change Depreciation, depletion and amortization expenseÏÏÏÏÏÏ $583.9 $453.4 $130.5 28.8% Depreciation, depletion and amortization expense increased in 2003 primarily due to additional power facilities in consolidated operations subsequent to 2002. Additionally, in 2003 we incurred $18.2 in accelerated depletion expense for oil and gas impairment charges compared to $6.0 in 2002. 2003 2002 $ Change % Change Operating lease expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $112.1 $111.0 $1.1 1.0% Operating lease expense was Öat as the number of operating leases did not change in 2003 as compared to 2002. 2003 2002 $ Change % Change Other cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $42.3 $7.3 $35.0 479.5% Approximately half of this increase is due to $17.3 of TTS expense. TTS was acquired in February 2003 so there is no comparable expense in the prior period. Additionally, PSM expense increased $9.0 in 2003 as compared to 2002 due primarily to an increase in sales. (Income)/Expenses 2003 2002 $ Change % Change (Income) from unconsolidated investments in power projects and oil and gas properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(76.7) $(16.6) $60.1 362.0% The increase in income is primarily due to a $52.8 gain recognized on the termination of the tolling agreement with Aquila Merchant Services, Inc. (""AMS'') on the Acadia Energy Center (see Note 7 of the Notes to Consolidated Financial Statements). Additionally, we realized a pre-tax gain of $7.1 from the sale of our interest in the Gordonsville Energy Center to Dominion Virginia Power. 2003 2002 $ Change % Change Equipment cancellation and impairment cost ÏÏÏÏÏÏÏÏÏÏ $64.4 $404.7 $(340.3) (84.1)% In 2003 the pre-tax equipment cancellation and impairment charge was primarily a result of cancellation costs related to three turbines and three heat recovery steam generators and impairment charges related to four turbines. The pre-tax charge of $404.7 in 2002 was the result of turbine and other equipment order cancellation charges and related write-oÅs as a result of our scale-back in construction and development activities. For further information, see Note 4 of the Notes to Consolidated Financial Statements. 2003 2002 $ Change % Change Long-term service agreement cancellation charges ÏÏÏÏÏÏÏÏ $16.4 $Ì $16.4 100.0% Of the $16.4 in charges incurred in 2003, $14.1 occurred as a result of the cancellation of long-term service agreements with General Electric related to our Rumford, Tiverton and Westbrook facilities. The other $2.3 occurred as a result of the cancellation of long-term service agreements with Siemens-Westinghouse Power Corporation related to our Sutter, South Point, Hermiston and Ontelaunee facilities. 62
Slide 64: 2003 2002 $ Change % Change Project development expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 21.8 $ 67.0 $(45.2) (67.5)% Project development expense decreased as we placed certain existing development projects on hold and scaled back new development activity. Additionally, write-oÅs of terminated and suspended development projects decreased to $3.7 in 2003 from $34.8 in 2002. 2003 2002 $ Change % Change Sales, general and administrative expense ÏÏÏÏÏÏÏÏÏÏÏÏ $265.7 $229.0 $36.7 16.0% Sales, general and administrative expense increased due to $16.1 of stock-based compensation expense associated with our adoption of SFAS No. 123, ""Accounting for Stock-Based Compensation,'' eÅective January 1, 2003, on a prospective basis. $7.1 of the increase is attributable to the acquisition of TTS in February 2003. Other causes of the increase include an increase of $7.3 in insurance costs and an increase in write-oÅ of excess oÇce space of $6.2. Sales, general and administrative expense expressed per MWh of generation increased to $3.22/MWh in 2003 from $3.15/MWh in 2002, due to a lower average capacity factor in 2003. 2003 2002 $ Change % Change Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $726.1 $413.7 $312.4 75.5% Interest expense increased primarily due to the new plants entering commercial operations (at which point capitalization of interest expense ceases). Interest capitalized decreased from $575.5 for the year ended December 31, 2002, to $444.5 for the year ended December 31, 2003. 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, to a lesser extent, as a result of suspension of certain of our development projects and suspension of capitalization of interest thereon. The remaining increase relates to an increase in average indebtedness, 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 FIN 46-R prospectively on October 1, 2003. See Note 2 of the Notes to Consolidated Financial Statements for a discussion of our adoption of FIN 46-R. 2003 2002 $ Change % Change Distributions on trust preferred securitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $46.6 $62.6 $(16.0) 25.6% As a result of the deconsolidation of the three Calpine Capital Trusts upon adoption of FIN 46-R as of October 1, 2003, the distributions paid on the Trust Preferred Securities during the fourth quarter of 2003 were no longer recorded on our books and were replaced by interest expense on our debt to the Calpine Capital Trusts, thus explaining the decrease in distributions on trust preferred securities in 2003. 2003 2002 $ Change % Change Interest (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(39.7) $(43.1) $3.4 (7.9)% The decrease is primarily due to lower cash balances and lower interest rates in 2003. 2003 2002 $ Change % Change Minority interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $27.3 $2.7 $24.6 911.1% The increase is primarily due to an increase of $24.4 of minority interest expense associated with the Calpine Power Income Fund (""CPIF''), which had an initial public oÅering in August 2002. During 2003, as a result of a secondary oÅering of Calpine's interests in CPIF, Calpine decreased its ownership interests in February 2003 to 30%, thus increasing minority interest expense. Additionally, prior to fourth quarter of 2003, we presented minority interest expense on CPIF net of taxes, but we reclassed $13.4 of tax beneÑt from 63
Slide 65: minority interest expense to tax expense in the fourth quarter of 2003, thus increasing minority interest expense by that amount. 2003 2002 $ Change % Change (Income) from repurchase of various issuances of debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(278.6) $(118.0) $(160.6) 136.1% The 2003 pre-tax gain of $278.6 was recorded in connection with the repurchase of various issuances of debt at a discount. In 2002 the primary contribution was a gain of $114.8 from the receipt of Senior Notes, which were trading at a discount to face value, as partial consideration for British Columbia asset sales. 2003 2002 $ Change % Change Other (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(46.1) $(34.2) $(11.9) 34.8% Other income during 2003 is comprised primarily of gains of $62.2 on the sale of oil and gas assets to Calpine Natural Gas Trust and $57.0 from the termination of a power contract at our RockGen Energy Center. This income was oÅset primarily by $33.3 of foreign exchange transaction losses and $12.5 of letter of credit fees. The foreign exchange transaction losses recognized into income were mainly due to a strong Canadian dollar during 2003. In 2002 the primary contribution to other income was a $41.5 gain on the termination of a power sales agreement. 2003 2002 $ Change % Change (BeneÑt) for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(0.1) $(14.9) $14.8 (99.3)% During 2003 the eÅective tax rate increased to (0.1)% from (38.6)% from 2002. This eÅective rate variance is due to the inclusion of signiÑcant permanent items in the calculation of the eÅective rate, which are Ñxed in amount and have a signiÑcant eÅect on the eÅective tax rates as such items become more material to net income. 2003 2002 $ Change % Change Discontinued operations, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(8.7) $64.9 $(73.6) (113.4)% The 2003 discontinued operations activity included the eÅects of an agreement to sell 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, reÖecting the soft market for data centers for the foreseeable future. The sale of the Lost Pines 1 Energy Center closed in January 2004. The 2002 discontinued operations activity included the Lost Pines 1 Energy Center, Alvin South Field oil and gas assets, our specialty data center engineering business, and the DePere Energy Center, as well as the Drakes Bay Field, British Columbia and Medicine River oil and gas assets. With the exception of the Lost Pines 1 Energy Center, Alvin South Field oil and gas assets and our specialty data center engineering business, the sales of these assets were completed by December 31, 2002; therefore, their results are not included in the 2003 activity. For more information about discontinued operations, see Note 10 of the Notes to Consolidated Financial Statements. 2003 2002 $ Change % Change Cumulative eÅect of a change in accounting principle, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $180.9 $Ì $180.9 100.0% The gain from the cumulative eÅect of a change in accounting principle includes three items: (1) a gain of $181.9, net of tax eÅect, 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;'' (2) a loss of $1.5 associated with the adoption of FIN 46-R and the deconsolidation of the three Calpine Capital Trusts which issued the HIGH TIDES. The loss of $1.5 represents the reversal of a gain, net of tax eÅect, recognized prior to the adoption of FIN 46-R on our repurchase of $37.5 of the value of HIGH TIDES by issuing Calpine Corporation common stock valued at $35.0; and (3) a gain of $0.5, net of tax eÅect, from the adoption of SFAS No. 143 ""Accounting for Asset Retirement Obligations.'' 64
Slide 66: Net Income 2003 2002 $ Change % Change Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $282.0 $118.6 $163.4 137.8% Our growing portfolio of operating power generation facilities contributed to a 13% increase in electric generation production for the year ended December 31, 2003, compared to the same period in 2002. Electric generation and marketing revenue increased 16.4% for the year ended December 31, 2003, as electricity and steam revenue increased by $1,473.5 or 45.7%, as a result of the higher production and higher electricity prices. This was partially oÅset by a decline in sales of purchased power for hedging and optimization. Operating results for the year ended December 31, 2003, reÖect a decrease in average spark spreads per megawatt-hour compared with the same period in 2002. While we experienced an increase in realized electricity prices in 2003, this was more than oÅset by higher fuel expense. At the same time, higher realized oil and gas pricing resulted in an increase in oil and gas production margins compared to the prior period. In 2003 we recorded other revenue of $67.3 in connection with our settlement with Enron, primarily related to the termination of commodity contracts following the Enron bankruptcy. Plant operating expense, interest expense and depreciation were higher due to the additional plants in operation. 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, and gross proÑt for the year ended December 31, 2003, decreased approximately 16.9%, compared to the same period in 2002. During 2003 overall Ñnancial results signiÑcantly beneÑted from $278.6 of net pre-tax gains recorded in connection with the repurchase of various issuances of debt and preferred securities at a discount, and a gain of $52.8 from the termination of the AMS power contract at the Acadia Energy Center, a gain of $57.0 from the termination of a power contract at the RockGen Energy Center, a gain of $62.2 from the sale of oil and gas assets to the Calpine Natural Gas Trust and an after-tax gain of $180.9 due to the cumulative eÅect of changes in accounting principle. Year Ended December 31, 2002, Compared to Year Ended December 31, 2001 (in millions, except for unit pricing information, percentages and MW volumes). Revenue 2002 2001 $ Change % Change Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $7,391.9 $6,714.9 $677.0 10.1% The increase in total revenue is explained by category below. 2002 2001 $ Change % Change Electricity and steam revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased power for hedging and optimization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total electric generation and marketing revenue ÏÏ $3,222.2 3,146.0 $6,368.2 $2,385.3 3,332.4 $5,717.7 $ 836.9 (186.4) $ 650.5 35.1% (5.6)% 11.4% Electricity and steam revenue increased as we completed construction and brought into operation 11 new baseload power plants, 7 new peaker facilities and 3 project expansions in 2002. Average megawatts in operation of our consolidated plants increased by 84% to 14,346 MW while generation increased by 72%. The increase in generation lagged behind the increase in average MW in operation as our baseload capacity factor dropped to 65% in 2002 from 70% in 2001 primarily because of the increased impact of unattractive oÅ peak market spark spreads in certain areas, which caused us to cycle oÅ certain of our merchants plants without contracts in oÅ peak hours. The overall increase in generation was partially oÅset by lower average pricing, which dropped 21% as average realized electricity prices, before the eÅects of hedging, balancing and optimization, declined to $44.28/MWh in 2002 from $56.27/MWh in 2001. 65
Slide 67: Sales of purchased power for hedging and optimization decreased during 2002, due to lower power prices and increased industry-wide credit restrictions on risk management activities in 2002. 2002 2001 $ Change % Change Oil and gas sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased gas for hedging and optimization ÏÏÏ Total oil and gas production and marketing revenue $120.9 870.5 $991.4 $286.2 526.5 $812.7 $(165.3) 344.0 $ 178.7 (57.8)% 65.3% 22.0% Oil and gas sales are net of internal consumption, which increased by $60.3 to $180.4 in 2002. Internal consumption is eliminated in consolidation. Additionally oil and gas sales were reduced by reclassiÑcation of $76.5 in 2002 and $136.4 in 2001 to discontinued operations for assets sold. Before inter-company eliminations and reclassiÑcations to discontinued operations, oil and gas sales decreased by $164.9 due primarily to 31% lower average realized natural gas pricing in 2002. Sales of purchased gas for hedging and optimization increased during 2002 as we brought into operation new generation and the related level of physical gas optimization and balancing activity increased to support the new generation. 2002 2001 $ Change % Change Realized gain on power and gas transactions, net ÏÏÏÏÏÏÏ Unrealized gain (loss) on power and gas transactions, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mark-to-market activities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $26.1 (4.6) $21.5 $ 29.1 122.6 $151.7 $ (3.0) (127.2) (10.3)% (103.8)% (85.8)% $(130.2) Realized revenue on power and gas trading and other mark-to-market activity represents the portion of contracts actually settled. In the year ended December 31, 2001, we recognized a net unrealized mark-to-market gain of $68.5 from power contracts in a market area where we did not have generation assets and approximately $66 of gains from various other power and gas transactions. The shift from unrealized mark-to-market gain in 2001 to unrealized loss in 2002 reÖects increased industry-wide credit and liquidity restrictions on risk management and trading activities, which caused us to greatly curtail trading activities so that our available capacity could be concentrated on hedging activities associated with our existing physical power and gas assets. Also, in 2002 we established liquidity reserves of approximately $6.7 against unrealized mark-to-market revenue to take into account reduced liquidity and the resulting increase in bid/ask spreads in the energy industry. 2002 2001 $ Change % Change Other revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $10.8 $32.7 $(21.9) (67.0)% The decrease in 2002 is due primarily to one-time license fee revenue of $10.6 recognized in 2001 by our wholly owned subsidiary PSM and due to $5.9 in commissioning services in 2001 related to an unconsolidated construction project. Cost of Revenue 2002 2001 $ Change % Change Total cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6,385.2 $5,491.8 $893.4 16.3% 66
Slide 68: The increase in total cost of revenue is explained by category below. 2002 2001 $ Change % Change Plant operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Royalty expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased power expense for hedging and optimization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total electrical generation and marketing expense $ 506.0 17.6 2,618.4 $3,142.0 $ 324.0 27.5 2,986.6 $3,338.1 $ 182.0 (9.9) (368.2) $(196.1) 56.2% (36.0)% (12.3)% (5.9)% Plant operating expense increased due to 11 new baseload power plants, 7 new peaker facilities and 3 expansion projects completed during 2002, but, expressed per MWh of generation, it decreased from $7.64/MWh to $6.95/MWh as economies of scale were realized due to the increase in the average size of our plants. Royalty expense decreased due to a decrease in revenue at The Geysers geothermal plants due to lower electricity prices. The decrease in purchased power expense for hedging and optimization was caused by lower power prices and by increased industry-wide credit restrictions on risk management activities in 2002. 2002 2001 $ Change % Change Oil and gas production expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and gas exploration expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Oil and gas operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased gas expense for hedging and optimization ÏÏÏ Total oil and gas operating and marketing expense $ 84.4 13.1 97.5 821.1 $918.6 $ 76.9 13.6 90.5 492.6 $583.1 $ 7.5 (0.5) 7.0 328.5 9.8% (3.7)% 7.7% 66.7% 57.5% $335.5 Oil and gas production expense increased primarily due to increases in gas treating and transportation costs coupled with higher lifting costs due to a 1% increase in equivalent volumes and due to inÖation. Oil and gas exploration expense increased as we incurred $5.0 in dry hole drilling expenses in 2002 compared to $3.6 in 2001. Purchased gas expense for hedging and optimization increased during 2002 as we brought into operation new generation and the related level of physical gas optimization and balancing activity increased to support the new generation. 2002 2001 $ Change % Change Fuel expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,752.9 $1,150.8 $602.1 52.3% Fuel expense increased in 2002 due to an 85% increase in gas-Ñred megawatt hours generated which was partially oÅset by signiÑcantly lower gas prices, increased usage of internally produced gas and an improved average heat rate of our generation portfolio in 2002. 2002 2001 $ Change % Change Depreciation, depletion and amortization expenseÏÏÏÏÏÏ $453.4 $309.4 $144.0 46.5% Depreciation, depletion and amortization expense increased primarily due to additional power facilities in consolidated operations during 2002 as compared to 2001. 2002 2001 $ Change % Change Operating lease expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $111.0 $99.5 $11.5 11.6% 67
Slide 69: Operating lease expense increased due to the RockGen, Aidlin and South Point sale/leaseback transactions entered into during 2001. 2002 2001 $ Change % Change Other cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $7.3 $10.9 $(3.6) (33.0)% The decrease is primarily due to $4.1 less expense at PSM, as combustion parts sales to third parties decreased in 2002. (Income)/Expense 2002 2001 $ Change % Change (Income) from unconsolidated investments in power projects and oil and gas properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(16.6) $(16.9) $0.3 (1.8)% The modest decrease is primarily due to approximately $14.6 earned from our investment in the Acadia facility, which commenced operations in August 2002, being oÅset by $4.0 less revenue from our investment in Lockport, which we sold in the Ñrst quarter of 2002, losses at Androscoggin and Grays Ferry in 2002 due to lower spark spreads, and a $6.7 decrease in interest income from loans to power projects resulting from the extinguishment of a note from the Delta Energy Center, LLC after we acquired the remaining 50% interest in November 2001. 2002 2001 $ Change % Change Equipment cancellation impairment cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $404.7 $Ì $404.7 Ì% The pre-tax charge of $404.7 in the year ended December 31, 2002, was a result of turbine and other equipment order cancellation charges and related write-oÅs as a result of our revised construction and development program. For further information, see Note 4 of the Notes to Consolidated Financial Statements. 2002 2001 $ Change % Change Project development expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $67.0 $35.9 $31.1 86.6% Project development expense increased primarily because we expensed $34.8 of previously capitalized costs due to the cancellation or indeÑnite suspension of certain development projects. Additionally, we stopped capitalizing costs on certain development projects placed on hold. 2002 2001 $ Change % Change Sales, general and administrative expense ÏÏÏÏÏÏÏÏÏÏÏÏ $229.0 $150.5 $78.5 52.2% The increase was attributable to continued growth in personnel and associated overhead costs necessary to support the overall growth in our operations. In addition we incurred $13.7 of severance costs and the writeoÅ of excess oÇce space due to the reduction of our work force during 2002. Sales, general and administrative expense expressed per MWh of generation decreased to $3.15/MWh in 2002 from $3.55/MWh in 2001. 2002 2001 $ Change % Change Merger expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $Ì $41.6 $(41.6) Ì% The merger expense of $41.6 in the year ended December 31, 2001, was a result of the pooling-ofinterests transaction with Encal Energy Ltd. that closed on April 19, 2001. 2002 2001 $ Change % Change Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $413.7 $196.6 $217.1 110.4% Interest expense increased primarily due to the issuance of the 4% Convertible Senior Notes Due 2006 and additional senior notes issued in the second half of 2001 and due to the new plants entering commercial operations (at which point capitalization of interest expense ceases). Interest capitalized increased from $498.7 for the year ended December 31, 2001, to $575.5 for the year ended December 31, 2002, due to a larger construction portfolio during most of 2002. 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, 68
Slide 70: to a lesser extent, as a result of suspension of certain of our development projects and suspension of capitalization of interest thereon. 2002 2001 $ Change % Change Interest (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(43.1) 2002 $(72.4) 2001 $29.3 $ Change (40.5)% % Change The decrease in interest income is due primarily to lower cash balances and lower interest rates in 2002. (Income) from the repurchase of various issuances of debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(118.0) $(11.9) $(106.1) 891.6% In 2002 the primary contribution was the recognition of $114.8 of net pre-tax gain from the receipt of Senior Notes, which were trading at a discount to face value, as partial consideration for British Columbia asset sales. In 2001 the $11.9 represents the net pre-tax gain on extinguishment of debt from repurchasing $122.0 aggregate principal amount of our Zero Coupon Convertible Debentures Due 2021 at a discount. 2002 2001 $ Change % Change Other (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(34.2) $(41.8) $(7.6) 18.2% In 2002 the primary contribution to other income was a $41.5 gain on the termination of a power sales agreement. In 2001 other income resulted from contract settlements and gains from the sales of certain assets. 2002 2001 $ Change % Change Provision (beneÑt) for income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(14.9) $297.6 $(312.5) (105)% The decrease is primarily due to the signiÑcant decrease in income from continuing operations from 2001 to 2002. In 2002 the income tax beneÑt was caused by a full year of permanent tax items arising out of our cross border Ñnancings in 2001. See Note 18 of the Notes to Consolidated Financial Statements for further discussions. 2002 2001 $ Change % Change Discontinued operations, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $64.9 $39.5 $25.4 64.3% The increase in 2002 results reÖects approximately $56.5 of gains relating to the sale of oil and gas assets and the DePere Energy Center, partially oÅset by lower earnings from these discontinued operations as they did not contribute to earnings for the full year in 2002 and due to higher gas prices in 2001. See Note 10 of the Notes to Consolidated Financial Statements for further discussion. 2002 2001 $ Change % Change Cumulative eÅect of a change in accounting principle, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $Ì $1.0 $(1.0) Ì% In 2001 the $1.0 of additional income (net of tax of $0.7), is due to the adoption of SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities.'' Net Income Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 2001 $ Change % Change $118.6 $623.5 $(504.9) (81.0)% The decrease in net income reÖects a $216.5 decrease in gross proÑt resulting primarily from lower spark spreads per MWh, which more than oÅset the positive eÅects of the increase in generation volume. In 2002 generation did not increase in line with new average capacity coming on line (lower base load capacity factor) and spark spread margins did not keep pace with the additional operating and depreciation costs associated with the new capacity. It also reÖects $130.2 lower mark-to-market revenue in 2002. Additionally, we recorded $404.7 in turbine cancellation and impairment charges in 2002, and interest expense increased by $217.1 as more plants entered commercial operations and interest ceased being capitalized on them at that time. Finally, we experienced $78.5 higher general and administrative expense in 2002 due to the dramatic growth in our operations. These factors were mitigated by a $312.5 reduction in income tax expense and a $114.8 net pre-tax gain from receipt of senior notes in consideration for an asset sale discussed above. 69
Slide 71: 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 Ñnancing. We have utilized this cash to fund our operations, service or prepay debt obligations, fund acquisitions, develop and construct power generation facilities, Ñnance 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 to fund the completion of our current construction portfolio, for reÑnancing and for general corporate purposes. In May and June 2003 our $950 million in secured working capital revolving credit facilities matured and were extended, ultimately to July 16, 2003. On July 16, 2003, we closed a $3.3 billion term loan and secondpriority senior secured notes oÅering (the ""July 2003 oÅerings''), entered into agreements for a new $500 million working capital facility which is composed of a Ñrst-priority senior secured two-year, $300 million working capital revolver and a Ñrst-priority senior secured four-year, $200 million term loan and repaid the outstanding balance on the revolving credit facilities. We also repaid the $949.6 million in funded borrowings outstanding under our $1.0 billion secured term credit facility which was to mature in May 2004 with proceeds of the July 2003 oÅerings. We have also repurchased nearly $1.5 billion aggregate principal amount of our outstanding senior notes and HIGH TIDES in 2003 and 2004 primarily with proceeds of the July 2003 oÅerings and also through equity swaps. In November 2003 our $1.0 billion secured revolving construction Ñnancing facility through CCFC I was scheduled to mature. On August 14, 2003, CCFC I and another of our wholly owned subsidiaries, CCFC Finance Corp., closed on a $750.0 million institutional term loan and secured notes oÅering. On September 25, 2003, CCFC I and CCFC Finance Corp. closed on a $50.0 million secured notes oÅering, which represented an add-on to the secured notes oÅering completed on August 14, 2003. Net proceeds from these oÅerings were used to reÑnance the majority of the $880.1 million outstanding at the date the facility was repaid. The remainder of that facility was repaid from cash proceeds from the July 2003 oÅerings. In November 2004 our $2.5 billion secured revolving construction Ñnancing facility through our wholly owned subsidiary CCFC II (renamed ""CalGen'') was scheduled to mature, requiring us to reÑnance 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 its oÅering of secured institutional term loans and secured notes, which reÑnanced the CalGen facility. We realized total proceeds from the oÅering in the amount of $2.4 billion, before transaction costs and fees. See Item 1. ""Business Ì Recent Developments'' for more information regarding this oÅering. The holders of our 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 eÅect such a 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 $1,126.3 million of the outstanding principal amount of 2006 Convertible Senior Notes, primarily with proceeds of the July 2003 oÅerings and through equity swaps and with the proceeds of our 2023 Convertible Notes oÅering, and the February 9, 2004, tender oÅer, in which we initiated a cash tender oÅer 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 oÅer, which expired on March 9, 2004, for which we paid a total of $412.8 million, which included accrued interest of $3.4 million. Currently, 2006 Convertible Senior Notes in the aggregate principal amount of $73.7 million remain outstanding. On November 6, 2003, we priced our separate oÅerings of 2023 Convertible Notes and Second Priority Senior Secured Notes. The latter oÅering was for $400.0 million of 9.875% Second Priority Senior Secured 70
Slide 72: Notes Due 2011, oÅered at 98.01% of par. This oÅering closed on November 18, 2003. We used the net proceeds from this oÅering to purchase outstanding senior notes. The other oÅering consisted of $650.0 million of 4.75% Contingent Convertible Senior Notes Due 2023, which included the exercise of $50.0 million of an option to purchase additional 2023 Convertible Notes granted to one of the initial purchasers. The 2023 Convertible Notes are convertible into cash and shares of Calpine common stock at an initial conversion price of $6.50 per share, which represents a 38% premium on the November 6, 2003 New York Stock Exchange closing price of $4.71 per Calpine common share. This oÅering closed on November 14, 2003. Net proceeds from this oÅering are being used to repurchase our outstanding 2006 Convertible Senior Notes. In addition, on January 9, 2004, we received funding on an additional $250.0 million aggregate principal amount of the 2023 Convertible Notes pursuant to the exercise in full by one of the initial purchasers of its remaining option to purchase additional 2023 Convertible Notes, the net proceeds of which will be used to repurchase our outstanding 2006 Convertible Senior Notes pursuant to the tender oÅer described above. 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 Ñve consecutive trading days after the applicable Ñnal failed remarketing termination date. While a failed remarketing of our HIGH TIDES would not have a material eÅect on our liquidity position, it would impact our calculation of diluted earnings per share and increase our interest expense. We expect to have suÇcient liquidity from cash Öow from operations, borrowings available under lines of credit, access to sale/leaseback and project Ñnancing markets, sale or monetization of certain assets and cash balances to satisfy all obligations under our outstanding indebtedness, and to fund anticipated capital expenditures and working capital requirements for the next twelve months. Factors that could aÅect our liquidity and capital resources are also discussed in Item 1. ""Business Ì Risk Factors.'' Cash Flow Activities Ì The following table summarizes our cash Öow activities for the periods indicated: 2003 Years Ended December 31, 2002 (In thousands) 2001 Beginning cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by: Operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅect of exchange rates changes on cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net increase (decrease) in cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ending cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 579,486 $ 1,594,144 1,068,466 (3,837,827) 1,757,396 (2,693) (1,014,658) $ 579,486 $ 664,722 290,559 (2,515,365) 2,623,986 13,140 412,320 $ 991,806 423,569 (7,240,655) 7,750,177 (3,669) 929,422 $ 1,594,144 Operating activities for the year ended December 31, 2003, provided net cash of $290.6 million, compared to $1,068.5 million for the same period in 2002. The decrease in operating cash Öow between periods is primarily due to the working capital funding requirements. During the year ended December 31, 2003, operating assets and liabilities used approximately $609.8 million, as compared to having provided $480.2 million in the same period last year. The growth in short term assets such as margin deposits and accounts receivable accounted for the majority of this diÅerence. At December 31, 2003, we had posted $188.0 million in net margin deposits as compared to $25.2 million at the end of 2002. The increase in such 71
Slide 73: deposits, which serve as collateral for certain of our commodity transactions that are ""out-of-the-money'' on a mark-to-market basis, is reÖective of movements in commodity prices and a higher mix of margin deposits posted relative to letters of credit (during 2003 the dollar value of letters of credit that we posted as collateral for commodity transactions decreased $91.6 million). In 2003 the increase in the posting of margin deposits constituted a use of funds of $162.8 million, which compares to a $320.3 million source of operating cash Öow in 2002 as a result of the decrease in margin deposits during that year. The decrease in margin deposits in 2002 was primarily the result of increased gas prices, which allowed us to post less collateral on certain of our gas contracts. Accounts receivable grew by $221.2 million in 2003 from year-end 2002, representing a use of funds. Although average spark spreads were lower in 2003 than in 2002, higher electricity prices and increased electrical generation resulted in higher revenues, and consequently, higher receivables balances. However, in 2002 accounts receivable decreased by $229.2 million from year-end 2001, representing a source of funds as we collected from escrow approximately $222.3 million in 2002 for the PG&E past due pre-petition receivables that were sold to a third party in December 2001. Also, in 2003 we received $105.5 million from the Acadia joint venture, following the termination of the power purchase agreement with Aquila Merchant Services, Inc. and the restructuring of our interest in the joint venture, which is included in distributions from unconsolidated investments. See Note 7 of the Notes to Consolidated Financial Statements for further discussion. Investing activities for the year ended December 31, 2003, consumed net cash of $2,515.4 million, as compared to $3,837.8 million in the same period of 2002. In both periods capital expenditures represent the majority of investing cash outÖows. The decrease between periods is due to the completion of construction on several facilities during 2002 and 2003, and due to our revised capital expenditure program, which reduced capital investments in 2003. Additionally, investing activities for 2003 include a use of $766.8 million for restricted cash, of which approximately $553.3 million is expected to be used to repay outstanding indebtedness within the next year. Financing activities for the year ended December 31, 2003, provided net cash $2,624.0 million, compared to $1,757.4 million in the prior year. Current year cash inÖows are primarily the result of several Ñnancing transactions, including $3.9 billion from the issuance of senior notes, $802.2 million from the Power Contract Financing, L.L.C. (""PCF'') Ñnancing transaction, $785.5 million from the reÑnancing of our CCFC I credit facility, $301.7 million from the issuance of secured notes by our wholly owned subsidiary Gilroy Energy Center (""GEC'') LLC, $159.7 million from secondary trust unit oÅerings from our Canadian Income Trust, $82.8 million from the monetization of one of our power sales agreements, $82.0 million, $88.0 million, and $74.0 million, respectively, from the sales of preferred interests in the cash Öows of our King City, Auburndale, and GEC Holdings, LLC facilities and additional borrowings under our revolvers. This was partially oÅset by Ñnancing costs and $5.0 billion in debt repayments and repurchases. We expect that the signiÑcant Ñnancing transactions will allow us to continue to retire short term debt and will also enable us to make further repurchases of other long term securities. In the same period of 2002 Ñnancing inÖows were comprised of $751.8 million from the issuance of common stock, and $2.3 billion in debt Ñnancing, partially oÅset by the use of $869.7 million used to repay our Zero Coupon Convertible Debentures Due 2021, in addition to the repayment of $412.7 million of other indebtedness. Letter of Credit Facilities Ì At December 31, 2003 and 2002, we had approximately $410.8 million and $685.6 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, $272.1 million and $573.9 million, respectively, were in aggregate issued under the cash collateralized letter of credit facility and the corporate revolving credit facility at December 31, 2003 and 2002, respectively. CES Margin Deposits and Other Credit Support Ì As of December 31, 2003 and 2002, CES had deposited net amounts of $188.0 million and $25.2 million, respectively, in cash as margin deposits with third parties and had letters of credit outstanding of $14.5 million and $106.1 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 72
Slide 74: 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 diÇcult to predict future developments and the amount of credit support that we may need to provide as part of our business operations. Working Capital Ì At December 31, 2002, we had a negative working capital balance of approximately $1.4 billion due primarily to the classiÑcation as a current liability of the outstanding CCFC I construction revolving credit facility balance of $970.1 million, which was successfully reÑnanced in August 2003. Revised Capital Expenditure Program Ì Following a comprehensive review of our power plant development program, we announced in January 2002 the adoption of a revised capital expenditure program which contemplated the completion of 27 power projects (representing 15,200 MW) then under construction. 22 of these facilities have subsequently achieved full or partial commercial operation as of December 31, 2003. Construction of advanced stage development projects is expected to proceed only when there is an established market need for additional generating resources at prices that will allow us to meet our investment criteria, and when capital may again become available to us on attractive terms. Further, our entire development and construction program is Öexible and subject to continuing review and revision based upon such criteria. On March 12, 2002, we announced a new turbine program that reduced previously forecasted capital spending by approximately $1.2 billion in 2002 and $1.8 billion in 2003. The revision includes adjusted timing of turbine delivery and related payment schedules and also cancellation of some orders. As a result of these turbine cancellations and other equipment cancellations, we recorded a pre-tax charge of $168.5 million in the Ñrst quarter of 2002. On February 11, 2003, we announced a signiÑcant restructuring of its turbine agreements (see Note 4 of the Notes to Consolidated Financial Statements), which enables us to cancel up to 131 steam and gas turbines. We recorded a pre-tax charge of $207.4 million in the quarter ending December 31, 2002, in connection with fees paid to vendors to restructure these contracts. To date, 60 of these turbines have been canceled, leaving the disposition of 71 turbines still to be determined. In July 2003 we completed a restructuring of our existing agreements for 20 gas and 2 steam turbines. The new agreement provides for later payment dates, which are in line with our construction program. The table in Note 24 of the Notes to Consolidated Financial Statements sets forth future turbine payments for construction and development projects, as well as for unassigned turbines. It includes previously delivered turbines, payments and delivery year for the remaining 5 turbines to be delivered as well as payment required for the potential cancellation costs of the remaining 71 gas and steam turbines. The table in Note 24 of the Notes to Consolidated Financial Statements does not include payments that would result if we were to release for manufacturing any of these remaining 71 turbines. See Note 24 of the Notes to Consolidated Financial Statements for more information regarding turbine restructuring agreements. In 2003 the pre-tax equipment cancellation and impairment charge was primarily a result of the cancellation costs related to three turbines and three heat recovery steam generators totaling $31.8 million, impairment charges related to four turbines totaling $27.4 million and storage and suspension costs for unassigned equipment. Uses and Sources of Funding Ì Our estimated uses of funds for 2004 are as follows: cash interest of $1.2 billion, committed capital expenditures of $0.3 billion, discretionary capital expenditures of $0.3 billion, turbine costs of $0.2 billion, maintenance capital of $0.4 billion, principal payments on operating leases and debt of $0.8 billion and working capital and other miscellaneous uses of $0.2 billion. These outÖows will be funded primarily through cash on hand (cash and cash equivalents, the current portion of restricted cash and funds escrowed for the repurchase of outstanding debt and borrowing capacity under our various credit facilities) of $2.3 billion, estimated EBITDA, as adjusted of $1.7 billion and $0.4 billion of proceeds from Ñnancing transactions. Actual costs for the projected use of funds identiÑed above, and net proceeds from the projected sources of funds identiÑed above could vary from those estimates, potentially in material respects. In addition, the timing is diÇcult to predict and we may not be able to complete the Ñnancings or we may be able to complete them only on less favorable terms than currently anticipated. The above reÖects the reÑnancing of 73
Slide 75: the CCFC II revolving construction Ñnancing facility, expiring in 2004, which occurred on March 23, 2004. Factors that could aÅect the accuracy of these estimates include the factors identiÑed at the beginning of this section and under ""Risk Factors'' in Item 1. ""Business.'' Capital Availability Ì 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 signiÑcantly diÅerent terms than in the past. In particular, our senior working capital facility and term loan Ñnancings and the majority of our debt securities oÅered and sold in this period, have been secured by certain of our assets and equity interests. While we believe we will be successful in reÑnancing all debt before maturity, the terms of Ñnancing 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 diÇcult to predict and are outside of our control. At the beginning of 2003, Calpine launched a liquidity-enhancing and reÑnancing program, which resulted in us closing approximately $8.6 billion of transactions such as contract monetizations, sales of nonstrategic assets, reÑnancings, and new corporate and project Ñnancings. To date, we have completed in excess of $2.7 billion of liquidity-enhancing transactions, exceeding our original $2.3 billion goal. Over the past several months (in 2003, unless otherwise noted), we: ‚ Completed the $250 million, non-recourse project Ñnancing facility to fund the construction of our 600-megawatt Rocky Mountain Energy Center (February 2004). ‚ Closed the $133 million monetization of a PG&E note receivable; and ‚ Received $36 million for the sale of our 50% interest in the 240-megawatt Gordonsville power plant. Over the past twelve months, we completed over $8 billion of capital market transactions and successfully reÑnanced $6.6 billion of current maturities. We: ‚ Completed $3.8 billion of term loan and secured notes oÅerings Ì the largest high-yield Ñnancing in the capital markets in seven years; ‚ CalGen completed its oÅering of secured institutional term loans and secured notes, totaling $2.4 billion before transaction costs and fees (March 2004); ‚ Raised an additional $400.0 million through an add-on oÅering of our secured notes; ‚ Completed the $800.0 million CCFC I loan reÑnancing with a secured note and term loan issuance; and ‚ Issued $900.0 million of 43/4% Contingent Convertible Senior Notes Due 2023 to reÑnance the 2006 Convertible Senior Notes that can be put to Calpine in December 2004 ($250 million of the $900 million issued in 2004). Calpine used proceeds from these oÅerings to reÑnance the following: ‚ The $1 billion working capital revolver that matured in May 2003; ‚ The $1 billion CCFC I facility that was scheduled to mature in November 2003; ‚ The $1 billion in term loans under our senior working capital facility that were scheduled to mature in May 2004; ‚ The majority of the $1.2 billion 2006 Convertible Senior Notes, that can be put to Calpine in December 2004. At December 31, 2003, we had repurchased $539.9 million of these Notes. Subsequent to December 31, 2003, we repurchased approximately $177.0 million in principal amount of the 2006 Convertible Senior Notes in exchange for approximately $176.0 million in cash. Additionally, on February 9, 2004, we made a cash tender oÅer, which expired on March 9, 2004, for all of the outstanding 2006 Convertible Senior Notes at a price of par plus accrued interest. On 74
Slide 76: 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. Currently, 2006 Convertible Senior Notes in the aggregate principal amount of $73.7 million remain outstanding, and ‚ The $2.5 billion CCFC II facility that was scheduled to mature in November 2004. In 2003 with the remaining proceeds from the oÅerings, we repurchased $2,035.9 million of the principal amount of our outstanding debt and preferred securities in exchange for $1,575.4 million in cash and 30 million shares of Calpine common stock valued at approximately $158.1 million. As a result, in 2003 we realized a net pre-tax gain on the repurchase of securities of $278.6 million, while reducing indebtedness by approximately $460.5 million. Asset Sales Ì As a result of the signiÑcant 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 primarily to strengthen our balance sheet through repayment of debt. Set forth below are the completed asset disposals: On October 1, 2003, we sold select oil and gas properties located in Oklahoma to Loto Energy, LLC for approximately $1.2 million. As a result of the sale, we recognized a pre-tax gain of $0.3 million. On October 15, 2003, we sold select oil and natural gas properties located throughout the province of Alberta, Canada to Calpine Natural Gas Trust, owned 25% indirectly by Calpine, for net proceeds of $153.6 million. The assets represent approximately 83 billion cubic feet of natural gas equivalent net proved reserves, of which approximately 27 percent were crude oil and natural gas liquids. The properties included 74,916 net developed acres and 41,462 net undeveloped acres, with approximately 175 net producing wells. On November 20, 2003, we completed the sale of our 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, we recognized a pre-tax loss of $0.2 million. On November 26, 2003, we completed the sale of our 50 percent interest in the Gordonsville Power Plant. Under the terms of the transaction, we received $36.2 million in cash. We recorded a pre-tax gain of $7.1 million on the sale. We believe that our completion of the Ñnancing and liquidity transactions described above in diÇcult conditions aÅecting 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 signiÑcantly 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. Credit Considerations Ì On July 17, 2003, Standard & Poor's placed our corporate rating (currently rated at B), our senior unsecured debt rating (currently at CCC°), our preferred stock rating (currently at CCC), our bank loan rating (currently at B), and our second priority senior secured debt rating (currently at B) under review for possible downgrade. On July 23, 2003, Fitch, Inc. downgraded our long-term senior unsecured debt rating from B° to B¿ (with a stable outlook), our preferred stock rating from B¿ to CCC (with a stable outlook), and initiated coverage of our senior secured debt rating at BB¿ (with a stable outlook). On October 20, 2003, Moody's downgraded the rating of our long-term senior unsecured debt from B1 to Caa1 (with a stable outlook) and our senior implied rating from Ba3 to B2 (with a stable outlook). The ratings on our senior unsecured debt, senior unsecured convertible debt and convertible preferred securities were also lowered (with a stable outlook) from B1 to Caa1, from B1 to Caa1 and from B2 to Caa3, respectively. The Moody's downgrade did not impact our credit agreements, and we continue to conduct our business with our usual creditworthy counterparties. Many other issuers in the power generation sector have also been downgraded by one or more of the ratings agencies during this period. Such downgrades can have a negative impact on our liquidity by reducing attractive Ñnancing opportunities and increasing the amount of collateral required by trading counterparties. 75
Slide 77: Performance Indicators Ì We believe the following factors are important in assessing our ability to continue to fund our growth in the capital markets: (a) our debt-to-capital ratio; (b) various interest coverage ratios; (c) our credit and debt ratings by the rating agencies; (d) the trading prices of our senior notes in the capital markets; (e) the price of our common stock on The New York Stock Exchange; (f) our anticipated capital requirements over the coming quarters and years; (g) the proÑtability of our operations; (h) the nonGAAP Ñnancial measures and other performance metrics discussed in ""Performance Metrics'' below; (i) our cash balances and remaining capacity under existing revolving credit construction and general purpose credit facilities; (j) compliance with covenants in existing debt facilities; (k) progress in raising new or replacement capital; and (l) the stability of future contractual cash Öows. OÅ-Balance Sheet Commitments Ì In accordance with SFAS No. 13 and SFAS No. 98, ""Accounting for Leases'' our operating leases are not reÖected on our balance sheet. All counterparties in these transactions are third parties that are unrelated to us. The sale/leaseback transactions utilize special-purpose entities formed by the equity investors with the sole purpose of owning a power generation facility. Some of our operating leases contain customary restrictions on dividends, additional debt and further encumbrances similar to those typically found in project Ñnance debt instruments. We guarantee $1.7 billion of the total future minimum lease payments of our consolidated subsidiaries related to our operating leases. We have no ownership or other interest in any of these special-purpose entities. See Note 24 of the Notes to Consolidated Financial Statements for the future minimum lease payments under our power plant operating leases. 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 reÖected on our balance sheet (see Note 7 of the Notes to Consolidated Financial Statements). At December 31, 2003, investee debt was approximately $455.9 million. Based on our pro rata ownership share of each of the investments, our share would be approximately $145.0 million. However, all such debt is non-recourse to us. For the Aries Power Plant construction debt, Aquila Inc. and Calpine provided support arrangements until construction was completed to cover any cost overruns. See Note 7 of the Notes to Consolidated Financial Statements for additional information on our equity method investments in power projects and oil and gas properties. Commercial Commitments Ì Our primary commercial obligations as of December 31, 2003, are as follows (in thousands): Amounts of Commitment Expiration Per Period Commercial Commitments 2004 2005 2006 2007 2008 Thereafter Total Amounts Committed Guarantee of subsidiary debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 27,194 Standby letters of credit 320,580 Surety bondsÏÏÏÏÏÏÏÏÏÏ 34,273 Guarantee of subsidiary operating lease payments ÏÏÏÏÏÏÏÏÏÏÏ 96,688 Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $478,735 $ 17,531 $ 15,128 75,756 10,666 Ì Ì $171,621 3,401 Ì $2,099,553 400 Ì $ 658,876 Ì 36,207 $2,989,903 410,803 70,480 83,169 $176,456 81,772 $107,566 82,487 $257,509 115,604 $2,215,557 1,277,760 $1,972,843 1,737,480 $5,208,666 Our commercial commitments primarily include guarantee of subsidiary debt, standby letters of credit and surety bonds to third parties and guarantee of subsidiary operating lease payments. The debt guarantees consist of parent guarantees for the Ñnance subsidiaries and project Ñnancing for the Broad River Energy Center and the Pasadena Power Plant. The debt guarantees and operating lease payments are also included in the contractual obligations table above. We also issue guarantees for normal course of business activities. The King City operating lease commitment is supported by collateral debt securities that mature serially in 76
Slide 78: amounts equal to a portion of the semi-annual lease payment. See ""Financial Market Risks Ì Collateral Debt Securities'' for more information. We have guaranteed the principal payment of $2.4 billion and $2.7 billion, respectively, of senior notes as of December 31, 2003 and 2002, for two wholly owned Ñnance subsidiaries of Calpine, Calpine Canada Energy Finance ULC and Calpine Canada Energy Finance II ULC. As of December 31, 2003, we have guaranteed $291.6 million and $289.1 million, respectively, of project Ñnancing for the Broad River Energy Center and Pasadena Power Plant and $301.0 million and $388.9 million, respectively, as of December 31, 2002, for these power plants. As of December 31, 2003 and 2002, we have also guaranteed $35.6 million and $38.0 million, respectively, of other miscellaneous debt. All of the guaranteed debt is recorded on our Consolidated Balance Sheet. Contractual Obligations Ì Our contractual obligations as of December 31, 2003, are as follows (in thousands): 2004 Other long-term liabilities reÖected on the Consolidated Balance Sheet ÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 130,593 Total operating lease obligations(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 291,764 Debt: Unsecured Senior Notes(3) ÏÏÏÏ $ Second Priority Senior Secured Notes(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ First Priority Senior Secured Notes(3)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Senior Notes ÏÏÏÏÏÏÏÏÏ Convertible Senior Notes Due 2006 and 2023(3)(5) ÏÏÏÏÏÏÏ Notes payable and borrowings under lines of credit(2)(4) ÏÏ Notes payable to Calpine Capital Trusts(3)ÏÏÏÏÏÏÏÏÏÏÏ Preferred interests(2) ÏÏÏÏÏÏÏÏÏ Capital lease obligation(2) ÏÏÏÏÏ Construction/project Ñnancing(2)(6) ÏÏÏÏÏÏÏÏÏÏÏÏ 2005 2006 2007 2008 Thereafter Total $ 11,619 $ 11,565 $ 3,918 $ 3,519 $ 60,248 $ 221,462 $ 274,672 $ 260,564 $ 260,045 $ 257,570 $ 2,650,772 $ 3,995,387 Ì 12,500 2,000 14,500 Ì 247,425 Ì 11,220 4,008 65,108 $ 224,679 12,500 2,000 239,179 Ì 175,297 Ì 18,712 4,407 61,285 $ 498,880 $ 381,188 12,500 2,000 395,688 660,059 179,791 Ì 17,679 5,499 65,460 $1,324,176 $ 380,240 1,209,375 193,500 1,783,115 Ì 134,963 Ì 16,231 5,980 237,351 $2,177,640 $2,384,529 Ì Ì 2,384,529 Ì 97,806 Ì 18,073 8,369 80,024 $2,588,801 $ 2,124,583 2,442,159 Ì 4,566,742 650,000 160,197 1,153,500 161,717 169,486 3,751,524 $10,613,166 $ 5,495,219 3,689,034 199,500 9,383,753 1,310,059 995,479 1,153,500 243,632 197,749 4,260,752 $17,544,924 Total debt(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 342,261 Purchase obligations: Turbine commitments ÏÏÏÏÏÏÏÏÏ $ 100,186 $ 18,641 $ 2,516 $ Ì$ Ì$ Ì $ 121,343 Commodity purchase obligations(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,145,714 624,664 561,546 502,903 508,546 2,629,699 5,973,072 Land leasesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,489 5,886 6,039 6,179 6,320 384,720 413,633 Long-term service agreements ÏÏ 111,173 59,491 85,807 133,531 104,830 934,653 1,429,485 Costs to complete construction projects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 856,953 430,886 231,014 25,141 Ì Ì 1,543,994 Other purchase obligations ÏÏÏÏÏ 19,790 20,134 19,596 19,430 18,934 372,106 469,990 Total purchase obligations(7) $2,238,305 $1,159,702 $ 906,518 $ 687,184 $ 638,630 $ 4,321,178 $ 9,951,517 (1) The amounts presented here include contracts for the purchase, transportation, or storage of commodities accounted for as executory contracts and therefore not recognized as liabilities on our Consolidated Balance Sheet. See Financial Market Risks for a discussion of our commodity derivative contracts recorded at fair value on our Consolidated Balance Sheet. 77
Slide 79: (2) Structured as an obligation(s) of certain subsidiaries of Calpine Corporation without recourse to Calpine Corporation. However, default on these instruments could potentially trigger cross-default provisions in Calpine's recourse Ñnancings. (3) An obligation of or with recourse to Calpine Corporation. (4) The note payable totaling $132.4 million associated with the sale of the PG&E note receivable to a third party, is excluded from notes payable and borrowings under lines of credit for this purpose as it is a noncash liability. If the $132.4 million is summed with the $995.5 (total notes payable and borrowings under lines of credit) million from the table above, the total notes payable and borrowings under lines of credit would be $1,127.9 million, which agrees to the Consolidated Balance Sheet sum of the current and longterm notes payable and borrowings under lines of credit balances on the Consolidated Balance Sheet. See Note 8 of the Notes to Consolidated Financial Statements for more information concerning this note. Total debt of $17,544.9 million from the table above summed with the $132.4 million totals $17,677.3 million, which agrees to the total debt amount in Note 17 of the Notes to Consolidated Financial Statements. (5) See Note 27 of the Notes to Consolidated Financial Statements for information regarding our repurchases of our 2006 Convertible Senior Notes that occurred subsequent to December 31, 2003. (6) Included in the total are guaranteed amounts of $291.6 million and $289.1 million, respectively, of project Ñnancing for the Broad River Energy Center and Pasadena Power Plant. See Note 27 of the Notes to Consolidated Financial Statements for information regarding CalGen's completed oÅering of secured institutional term loans and secured notes, which reÑnanced the CalGen facility. As a result of this reÑnancing, the $2.2 billion balance outstanding at December 31, 2003 on the reÑnanced CalGen revolving construction Ñnancing facility is shown in the table in the thereafter column. (7) The amounts included above for purchase obligations include the minimum requirements under contract. Agreements that we can cancel without signiÑcant cancellation fees are excluded. (8) Included in the total are future minimum payments for power plant operating leases, oÇce and equipment leases and two tolling agreements with Acadia Energy Center accounted for as leases (See Note 24 of the Notes to Consolidated Financial Statements for more information). We also enter into derivative Ñnancial instruments to manage our exposure to commodity price Öuctuations and to optimize the returns that we are able to achieve from our power and gas assets. See ""Financial Market Risks'' in this report and refer to Note 22 of the Notes to Consolidated Financial Statements for additional information regarding derivative Ñnancial instruments. Debt securities repurchased by Calpine during 2003 totaled $1,853.4 million in aggregate outstanding principal amount at a repurchase price of $1,575.3 million plus accrued interest. We recorded a pre-tax gain on these transactions in the amount of $278.1 million, which was $256.9 million, net of write-oÅs of $18.9 million of unamortized deferred Ñnancing costs and $2.3 million of unamortized premiums or discounts. 78
Slide 80: The following table summarizes the total debt securities repurchased during the year ended December 31, 2003 (in millions): Debt Security Principal Amount Amount Repurchased 2006 Convertible Senior Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 81/4% Senior Notes Due 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 101/2% Senior Notes Due 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 75/8% Senior Notes Due 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 83/4% Senior Notes Due 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 77/8% Senior Notes Due 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 81/2% Senior Notes Due 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 83/8% Senior Notes Due 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 73/4% Senior Notes Due 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 85/8% Senior Notes Due 2010 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 81/2% Senior Notes Due 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 87/8% Senior Notes Due 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 474.9 25.0 5.2 35.3 48.9 74.8 48.3 59.2 97.2 210.4 648.4 125.8 $1,853.4 $ 458.8 24.5 5.1 32.5 45.0 58.3 42.3 46.6 75.9 170.7 521.3 94.3 $1,575.3 Debt securities, exchanged for 23.5 million shares of Calpine common stock in privately negotiated transactions during 2003, totaled $145.0 million in aggregate outstanding principal amount plus accrued interest. We recorded a pre-tax gain on these transactions in the amount of $20.2 million, net of write-oÅs of unamortized deferred Ñnancing costs and the unamortized premiums or discounts. Additionally, during 2003, we exchanged 6.5 million shares of Calpine common stock in privately negotiated transactions for approximately $37.5 million par value of HIGH TIDES I. These repurchased HIGH TIDES I are reÖected on the balance sheet as an asset, versus being netted against the balance outstanding, due to the deconsolidation of the Calpine Capital Trusts, which issued the HIGH TIDES, upon the adoption of FIN 46-R. The following table summarizes the total debt securities and HIGH TIDES I exchanged for common stock during the year ended December 31, 2003 (in millions): Debt Securities and HIGH TIDES Principal Amount Common Stock Issued 2006 Convertible Senior Notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 81/2% Senior Notes Due 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 81/2% Senior Notes Due 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ HIGH TIDES I ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 65.0 55.0 25.0 37.5 $182.5 12.0 8.1 3.4 6.5 30.0 Our senior notes indentures and our credit facilities contain Ñnancial and other restrictive covenants that limit or prohibit our ability to incur indebtedness, make prepayments on or purchase indebtedness in whole or in part, pay dividends, make investments, lease properties, engage in transactions with aÇliates, create liens, consolidate or merge with another entity or allow one of our subsidiaries to do so, sell assets, and acquire facilities or other businesses. We are currently in compliance with all of such Ñnancial and other restrictive covenants; however, any failure to comply could give holders of debt under the relevant instrument the right to accelerate the maturity of all debt outstanding thereunder if the default was not cured or waived. In addition, holders of debt under other instruments typically would have cross-acceleration provisions, which would permit them also to elect to accelerate the maturity of their debt if another debt instrument was accelerated upon the occurrence of such an uncured event of default. See Note 24 of the Notes to Consolidated Financial Statements for information regarding the restructuring of certain turbine agreements. 79
Slide 81: 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 $60.8 million outstanding as of December 31, 2003. The debt is non-recourse to Calpine Corporation (the ""AELLC Non-Recourse Financing''). On December 31, 2003, our investment balance was $11.8 million and our notes receivable balance due from AELLC was $13.3 million. On and after August 8, 2003, AELLC received letters from the lenders claiming that certain events of default have occurred under the credit agreement for the AELLC Non-Recourse Financing, including, among other things, that the project has been and remains in default under its debt 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''), Ñled a complaint against AELLC in October 2000, which is discussed in Note 24 of the Notes to Consolidated Condensed Financial Statements. IP's complaint has been a complicating factor in converting the construction debt to long term Ñnancing. As a result of these events, we have reviewed our investment and notes receivable balances and believe that the assets are not impaired. We further believe that AELLC will be able to convert the construction loan to a term loan. We also own a 50% interest in the unconsolidated equity method investee Merchant Energy Partners Pleasant Hill, LLC (""Aries''). Currently, we are Ñnalizing the purchase of the 50% interest in Aries that is held by Aquila, Inc. Following the purchase, we will have a 100% interest in Aries. Aries owns the 591-MW Aries Power Project located in Pleasant Hill, Missouri, and is in default on its construction debt of $190.0 million as of December 31, 2003, that was due on June 26, 2003. Due to this payment default, the partners were required to contribute their proportionate share of $75 million in additional equity. During the second quarter of 2003, we drew down $37.5 million under our working capital revolver to fund our equity contribution. In conjunction with the Aquila, Inc. buyout negotiations, we are in negotiation with the lenders on a term loan for the project. The project is technically in default of its debt agreement until the new term loan is completed. We believe that the project will be able to obtain long-term project Ñnancing at commercially reasonable terms. As a result of this event, we have reviewed our $58.2 million investment in the Aries project and believe that the investment is not impaired. We are a party to a Letter of Credit and Reimbursement Agreement dated as of December 19, 2000, with Credit Suisse First Boston (""CSFB''), pursuant to which CSFB issued a letter of credit with a maximum face amount of $78.3 million for our account. CSFB previously advised us that CSFB believed that we may have failed to comply with certain covenants under the Letter of Credit and Reimbursement Agreement related to our ability to incur indebtedness and grant liens. We disputed the purported non-compliance. This dispute with CSFB has now been resolved and we are in the process of completing an amendment to the Letter of Credit and Reimbursement Agreement. On May 15, 2003, our wholly owned indirect subsidiary, Calpine Northbrook Energy Marketing, LLC (""CNEM''), completed an oÅering of $82.8 million secured by an existing power sales agreement with the Bonneville Power Administration (""BPA''). CNEM borrowed $82.8 million secured by the BPA contract, a spot market power purchase agreement, a Ñxed price swap agreement and the equity interest in CNEM. CNEM was established as an entity with its existence separate from Calpine and our other subsidiaries, and the $82.8 million loan is recourse only to CNEM's assets and the equity interest in CNEM and is not guaranteed by us. CNEM was determined to be a VIE in which we were the primary beneÑciary. Accordingly, the entity's assets and liabilities were consolidated into our accounts as of June 30, 2003. Pursuant to the applicable transaction agreements, each of CNEM and its parent, CNEM Holdings, LLC, has been established as an entity with its existence separate from Calpine and our other subsidiaries. In accordance with FIN 46 we consolidate these entities. See Note 2 of the Notes to Consolidated Financial Statements for more information on FIN 46. The above mentioned power sales agreement with BPA has been acquired by CNEM from CES and the spot market power purchase agreement with a third party and the swap agreement have been entered into by CNEM and, together with the $82.8 million loan, are assets and liabilities of CNEM, separate from the assets and liabilities of Calpine and our other subsidiaries. The only signiÑcant asset of CNEM Holdings, LLC is its equity interest in CNEM. The proceeds of the $82.8 million loan were primarily used by CNEM to purchase the power sales agreement with BPA. 80
Slide 82: The following table sets forth selected Ñnancial information of CNEM at December 31, 2003 (in thousands): CNEM Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenue(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $106,904 82,397 1,827 184 5,921 (2,870) (1) CNEM's contracts are derivatives and are recorded on a net mark-to-market basis on our Ñnancial statements under SFAS No. 133, notwithstanding that economically they are fully hedged. See Note 11 of the Notes to Consolidated Financial Statements for further information. On June 13, 2003, Power Contract Financing, L.L.C. (""PCF''), a wholly owned stand-alone subsidiary of CES, completed an oÅering of two tranches of Senior Secured Notes due 2006 and 2010 (collectively called the ""PCF Notes''), totaling $802.2 million. To facilitate the transaction, we formed PCF as an entity with its existence separate from Calpine and our other subsidiaries, with assets and liabilities consisting of cash, the transferred power purchase and sales contracts and the PCF Notes. PCF was determined to be a VIE in which we were the primary beneÑciary. Accordingly, the entity's assets and liabilities were consolidated into our accounts as of June 30, 2003. Pursuant to the applicable transaction agreements, PCF has been established as an entity with its existence separate from Calpine and our other subsidiaries. In accordance with FIN 46 we consolidate this entity. See Note 2 of the Notes to Consolidated Financial Statements for more information on FIN 46. The above mentioned power sales and power purchase agreements, which have been acquired by PCF from CES, and the PCF Notes are assets and liabilities of PCF, separate from the assets and liabilities of Calpine and our other subsidiaries. The proceeds of the Senior Secured Notes were primarily used by PCF to purchase the power sales and power purchase agreements. The following table sets forth selected Ñnancial information of PCF at December 31, 2003 (in thousands): PCF Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,046,213 1,150,625 180,896 165,043 39,396 (15,022) See Note 11 of the Notes to Consolidated Financial Statements for further information. On September 30, 2003, Gilroy Energy Center, LLC (""GEC''), a wholly owned subsidiary of our indirect subsidiary GEC Holdings, LLC, completed an oÅering of $301.7 million of 4% Senior Secured Notes Due 2011 (see Note 16 of the Notes to Consolidated Financial Statements for more information on this secured Ñnancing). In connection with this secured notes borrowing, we received funding on a third party preferred equity investment in GEC Holdings, LLC totaling $74.0 million. This preferred interest meets the criteria of a mandatorily redeemable Ñnancial instrument and has been classiÑed as debt under the guidance of SFAS No. 150, due to certain preferential distributions to the third party. The preferential distributions are due bi-annually beginning in March 2004 through September 2011 and total approximately $113.3 million over the eight-year period. As of December 31, 2003, there was $74.0 million outstanding under the preferred interest. The eÅective interest rate, after amortization of deferred Ñnancing charges, was 11.3% per annum at December 31, 2003. 81
Slide 83: Pursuant to the applicable transaction agreements, GEC has been established as an entity with its existence separate from Calpine and our other subsidiaries. We consolidate these entities. The long-term power sales agreement with the State of California Department of Water Resources has been acquired by GEC by means of a series of capital contributions by CES and certain of its aÇliates and is an asset of GEC, and the Senior Secured Notes and preferred interest are liabilities of GEC, separate from the assets and liabilities of Calpine and our other subsidiaries. Aside from seven peaker power plants owned directly and the power sales agreement, GEC's assets include cash and a 100% equity interest in each of Creed Energy Center, LLC (""Creed'') and Goose Haven Energy Center, LLC (""Goose Haven'') each of which is a wholly owned subsidiary of GEC. Each of Creed and Goose Haven has been established as an entity with its existence separate from Calpine and our other subsidiaries of the Company. GEC consolidates these entities. Creed and Goose Haven each have assets consisting of various power plants and other assets. The following table sets forth selected Ñnancial information of GEC at December 31, 2003 (in thousands): GEC Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ See Note 8 of the Notes to Consolidated Financial Statements for further information. $662,811 333,404 109,831 59,569 37,277 8,172 On April 29, 2003, we sold a preferred interest in a subsidiary that leases and operates the 115-MW King City Power Plant to GE Structured Finance for $82.0 million. The preferred interest holder will receive approximately 60% of future cash Öow distributions based on current projections. We will continue to provide O&M services. As of December 31, 2003, there was $82.0 million outstanding under the preferred interest. The eÅective interest rate, after amortization of deferred Ñnancing charges, was 12.8% per annum at December 31, 2003. Pursuant to the applicable transaction agreements, each of Calpine King City Cogen LLC, Calpine Securities Company, L.P., a parent company of Calpine King City Cogen LLC, and Calpine King City, LLC, an indirect parent company of Calpine Securities Company, L.P., has been established as an entity with its existence separate from Calpine and our other subsidiaries. We consolidate these entities. The following table sets forth certain Ñnancial information relating to these three entities as of December 31, 2003 (in thousands): Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $157,598 $ 60,785 On December 4, 2003, we announced that we had sold to a group of institutional investors our right to receive payments from PG&E under the Agreement between PG&E and Calpine Gilroy Cogen, L.P. (""Gilroy''), a California Limited Partnership (PG&E Log No. 08C002) For Termination and Buy-Out of Standard OÅer 4 Power Purchase Agreement, executed by PG&E on July 1, 1999 (the ""Gilroy Receivable'') under the Gilroy notes receivable from PG&E for $133.4 million in cash. Because the transaction did not satisfy the criteria for sales treatment under SFAS No. 140, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities Ì a Replacement of FASB Statement No. 125,'' it is reÖected in the Consolidated Financial Statements as a secured Ñnancing, with a note payable of $132.4 million. The receivable balance and note payable balance are both reduced as PG&E makes payments to the buyer of the Gilroy Receivable. The $25.1 million diÅerence between the $157.5 million book value of the Gilroy Receivable at the transaction date and the cash received will be recognized as additional interest expense over the repayment term. We will continue to book interest income over the repayment term and interest expense will be accreted on the amortizing note payable balance. Pursuant to the applicable transaction agreements, each of Gilroy and Calpine Gilroy 1, Inc., the general partner of Gilroy, has been established as an entity with its existence separate from Calpine and our other 82
Slide 84: subsidiaries. We consolidate these entities. The following table sets forth the assets and liabilities of Gilroy as of December 31, 2003 (in thousands): Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital Spending Ì Development and Construction Construction and development costs in process consisted of the following at December 31, 2003 (dollars in thousands): # of Projects CIP(2) Equipment Included in CIP Project Development Costs Unassigned Equipment $468,624 $134,170 Projects in active construction ÏÏ Projects in advanced development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Projects in suspended development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Projects in early development ÏÏ Other capital projects ÏÏÏÏÏÏÏÏÏ Unassigned equipment ÏÏÏÏÏÏÏÏ Total construction and development costs ÏÏÏÏÏÏÏÏ 14(1) 12 5 3 NA NA $4,538,093 711,779 466,350 Ì 45,910 Ì $5,762,132 $1,572,708 599,512 204,873 Ì Ì Ì $2,377,093 $ Ì 122,248 8,753 8,952 Ì Ì $ Ì Ì Ì Ì Ì 71,361 $139,953 $71,361 (1) 12 gas-Ñred projects and 2 project expansions. Includes expansion of the Morgan Energy Center, which entered commercial operation in January 2004. (2) Construction in Progress (""CIP''). Projects in Active Construction Ì The 14 projects in active construction are estimated to come on line from January 2004 to June 2007. These projects will bring on line approximately 6,742 MW of base load (8,004 MW base load with peaking capacity). Interest and other costs related to the construction activities necessary to bring these projects to their intended use are being capitalized. At December 31, 2003, the estimated funding requirements to complete these projects, net of expected project Ñnancing proceeds, is approximately $1.2 billion. We plan to spend $0.6 billion, $0.4 billion, and $0.2 billion in 2004, 2005, and 2006, respectively, net of project Ñnancing. Projects in Advanced Development Ì There are 12 projects in advanced development. These projects will bring on line approximately 5,709 MW of base load (6,835 MW base load 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 substantially complete but construction will not commence until a power purchase agreement and Ñnancing are obtained. The estimated cost to complete the 12 projects in advanced development is approximately $3.7 billion. Our current plan is to project Ñnance these costs as power purchase agreements are arranged. Suspended Development Projects Ì 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 indicating that it is again highly probable that the costs will be recovered through future operations. As is true for all projects, the suspended projects are reviewed for impairment whenever there is an indication of potential reduction in a project's fair value. Further, 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. These projects 83
Slide 85: would bring on line approximately 2,569 MW of base load (3,029 MW base load with peaking capacity). The estimated cost to complete these projects is approximately $1.5 billion. Projects in Early Development Ì 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 signiÑcant project milestones are achieved. Until then, all costs, including interest costs, are expensed. The projects in early development with capitalized costs relate to 3 projects and include geothermal drilling costs and equipment purchases. Other Capital Projects Ì 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 Ì As of December 31, 2003, we had made progress payments on 4 turbines, 1 heat recovery steam generator, and other equipment with an aggregate carrying value of $71.4 million. This unassigned equipment is classiÑed on the balance sheet as other assets, because it is not assigned to speciÑc 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 Ì 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 Impairment or Disposal of Long-Lived Assets.'' We review our unassigned equipment for potential impairment based on probability-weighted alternatives of utilizing it for future projects versus selling it. Utilizing this methodology, we do not believe that the equipment not committed to sale is impaired. However, during year ended December 31, 2003, we recorded approximately $27.4 million in losses in connection with the sale of four turbines, and we may incur further losses should we decide to sell more unassigned equipment in the future. 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 fulÑll 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 84
Slide 86: 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 proÑtably, the baseload capacity factor will reÖect that decision as well as both scheduled and unscheduled outages due to maintenance and repair requirements. ‚ Average heat rate for gas-Ñred Öeet of power plants expressed in Btu's of fuel consumed per KWh generated. We calculate the average heat rate for our gas-Ñred 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 eÇciency, 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 electricity 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-Ñred 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 intercompany ""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 diÅerence 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 baseload 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. For comparison purposes we also include POX per actual MWh. The table below shows the operating performance metrics discussed above. 2003 Years Ended December 31, 2002 2001 (In thousands) Operating Performance Metrics; Total deliveries of power: MWh generated ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ HBO and trading MWh sold ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MWh delivered ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average availability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 85 82,423 74,837 157,260 91% 72,767 75,740 148,507 92% 42,394 54,810 97,204 93%
Slide 87: 2003 Years Ended December 31, 2002 2001 (In thousands) Average baseload capacity factor: Average total MW in operation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Average MW of pure peakersÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average baseload MW in operationÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Hours in the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Potential baseload generation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Actual total generation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Actual pure peakers' generation ÏÏÏÏÏÏÏÏÏÏÏÏ Actual baseload generation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average baseload capacity factor ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average heat rate for gas-Ñred power plants (excluding peakers) (Btu's/KWh): Not steam adjusted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Steam adjustedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average all-in realized electric price: Electricity and steam revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Spread on sales of purchased power for hedging and optimizationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted electricity and steam revenue (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MWh generated (in thousands)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average all-in realized electric price per MWh ÏÏÏÏ Average cost of natural gas: Cost of oil and natural gas burned by power plants (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fuel cost elimination ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjusted fuel expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Million Btu's (""MMBtu'') of fuel consumed by generating plants (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average cost of natural gas per MMBtuÏÏÏÏÏÏÏÏÏÏ MWh generated (in thousands)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Average cost of adjusted fuel expense per MWhÏÏÏ 20,092 2,672 17,420 8,760 152,599 82,423 1,077 81,346 53% 14,346 1,708 12,638 8,760 110,709 72,767 979 71,788 65% 7,805 976 6,829 8,760 59,822 42,394 542 41,852 70% 8,007 7,253 $4,695,744 24,118 $4,719,862 82,423 $ 57.26 7,928 7,239 $3,222,202 527,546 $3,749,748 72,767 $ 51.53 8,203 7,398 $2,385,324 345,834 $2,731,158 42,394 $ 64.42 $2,523,408 374,298 $2,897,706 560,508 5.17 82,423 $ 35.16 $1,703,499 180,375 $1,883,874 511,354 3.68 72,767 $ 25.89 $1,116,857 99,854 $1,216,711 288,549 4.22 42,394 $ 28.70 $ $ $ 86
Slide 88: 2003 Years Ended December 31, 2002 2001 (In thousands) Average spark spread: Adjusted electricity and steam revenue (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Adjusted fuel expense (in thousands) ÏÏÏÏÏÏÏ $4,719,862 2,897,706 $3,749,748 1,883,874 $1,865,874 72,767 $ 25.64 $ 57,116 $1,922,990 $ 26.43 $2,731,158 1,216,711 $1,514,447 42,394 $ 35.72 $ 199,196 $1,713,643 $ 40.42 Spark spread (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,822,156 MWh generated (in thousands)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 82,423 Average spark spread per MWhÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 22.11 Add: Equity gas contribution(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 202,454 Spark spread with equity gas beneÑts (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,024,610 Average spark spread with equity gas beneÑts per MWhÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 24.56 Average plant operating expense (""POX'') per normalized MWh (for comparison purposes we also include POX per actual MWh): Average total consolidated MW in operations ÏÏÏÏÏ 20,092 Hours per year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,760 Total potential MWhÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 176,006 Normalized MWh (at 70% capacity factor)ÏÏÏÏÏÏÏ 123,204 Plant operating expense (POX)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 679,031 POX per normalized MWh ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5.51 POX per actual MWhÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8.24 (1) Equity gas contribution margin: 14,346 8,760 125,671 87,970 $ 505,971 $ 5.75 $ 6.95 7,805 8,760 68,372 47,860 $ 324,029 $ 6.77 $ 7.64 Years Ended December 31, 2003 2002 2001 (In thousands) Oil and gas sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Add: Fuel cost eliminated in consolidation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subtotal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Oil and gas operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Depletion, depreciation and amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity gas contribution margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MWh generated (in thousands) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity gas contribution margin per MWh ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $107,662 374,298 $481,960 106,244 173,262 $202,454 82,423 $ 2.46 $120,930 180,375 $301,305 97,499 146,690 $ 57,116 72,767 $ 0.78 $286,241 99,854 $386,095 90,492 96,407 $199,196 42,394 $ 4.70 87
Slide 89: The table below provides additional detail of total mark-to-market activity. For the years ended December 31, 2003, 2002 and 2001, mark-to-market activity, net consisted of (dollars in thousands): Years Ended December 31, 2003 2002 2001 (In thousands) Mark-to-market activity, net Realized: Power activity ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total realized power activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gas activity ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total realized gas activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total realized activity: ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total realized activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized: Power activity ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total unrealized power activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gas activity ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total unrealized gas activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Unrealized activity: ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total unrealized activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 52,559 $ 12,175 Ì Ì (26,059) Ì $ 26,500 $ (2,166) Ì Ì $ (2,166) $ 50,393 Ì (26,059) $ 24,334 $ 12,175 $ 13,915 Ì Ì $ 13,915 $ 26,090 Ì Ì $ 26,090 $ 9,926 Ì Ì 9,926 $ $ 19,219 Ì Ì $ 19,219 $ 29,145 Ì Ì $ 29,145 $(55,450) $ 12,974 $ 96,402 (5,001) (4,934) 1,866 (1,243) Ì Ì $(61,694) $ 7,768 3,153 Ì $ 8,040 $ 98,268 $ 30,113 (5,788) Ì $ 24,325 $(14,792) 2,147 Ì $(12,645) $ 10,921 $(47,682) $ (1,818) $126,515 (1,848) (2,787) (3,922) (1,243) Ì Ì $(50,773) $ (4,605) $122,593 88
Slide 90: Years Ended December 31, 2003 2002 2001 (In thousands) Total mark-to-market activity: ""Trading Activity'' as deÑned in EITF No. 02-03 ÏÏÏÏÏÏ IneÅectiveness related to cash Öow hedges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other mark-to-market activity(1)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total mark-to-market activity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 2,711 $ 24,272 (1,848) (2,787) (27,302) Ì $ 21,485 $155,660 (3,922) Ì $151,738 $(26,439) (1) Activity related to our assets but does not qualify for hedge accounting. Strategy For a discussion of our strategy and management's outlook, see ""Item 1 Ì Business Ì Strategy.'' Financial Market Risks As we are primarily focused on generation of electricity using gas-Ñred 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 Öuctuation in these and (to a lesser extent) other commodities, we enter into derivative commodity instruments as discussed in Item 6. ""Business Ì Marketing, Hedging, Optimization and Trading Activities.'' The change in fair value of outstanding commodity derivative instruments from January 1, 2003, through December 31, 2003, is summarized in the table below (in thousands): Fair value of contracts outstanding at January 1, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gains recognized or otherwise settled during the period(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in fair value attributable to changes in valuation techniques and assumptions(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in fair value attributable to new contracts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in fair value attributable to price movementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Terminated derivatives(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fair value of contracts outstanding at December 31, 2003(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 150,627 (153,673) (12,673) 60,752 87,666 (56,158) $ 76,541 (1) Consists of (a) recognized gains from commodity cash Öow hedges of $129.4 million, (represents realized value of cash Öow hedge activity of $(38.5) million as disclosed in Note 22 of the Notes to Consolidated Financial Statements, net of terminated derivatives of $(167.9) million) and (b) $24.3 million realized gain on mark-to-market activity, which is reported in the Consolidated Statements of Operations under mark-to-market activities, net. (2) Relates to changes in the valuation technique used by Calpine to extrapolate price curves beyond periods where external price quotes are observable. See discussion of the change in valuation technique under the ""Fair Value of Energy Marketing and Risk Management Contracts and Derivatives'' subsection to the critical accounting policies. (3) Includes the value of derivatives terminated or settled before their scheduled maturity. (4) Net commodity derivative assets reported in Note 22 of the Notes to Consolidated Financial Statements included in this Ñling. 89
Slide 91: The fair value of outstanding derivative commodity instruments at December 31, 2003, 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 quotedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prices provided by other external sources ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prices based on models and other valuation methods ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 52,180 (13,062) Ì $ 39,118 $16,724 40,485 1,017 $58,226 $ Ì 6,382 1,110 $ Ì (21,792) (6,503) $68,904 12,013 (4,376) $76,541 $7,492 $(28,295) 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. See Critical Accounting Policies for a discussion of valuation estimates used where external prices are unavailable. The counterparty credit quality associated with the fair value of outstanding derivative commodity instruments at December 31, 2003, and the period during which the instruments will mature are summarized in the table below (in thousands): Credit Quality (based on Standard & Poor's Ratings as of January 7, 2004) 2004 2005-2006 2007-2008 After 2008 Total Investment gradeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Non-investment grade ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ No external ratings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total fair value ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,767 39,044 (5,693) $39,118 $46,770 12,019 (563) $58,226 $8,412 (633) (287) $7,492 $(27,788) (507) Ì $(28,295) $33,161 49,923 (6,543) $76,541 The fair value of outstanding derivative commodity instruments and the fair value that would be expected after a ten percent adverse price change are shown in the table below (in thousands): Fair Value Fair Value After 10% Adverse Price Change At December 31, 2003: Electricity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Natural gas ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(6,085) 82,626 $76,541 $(157,116) 9,505 $(147,611) Derivative commodity instruments included in the table are those included in Note 22 of the Notes to Consolidated 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 eÅect of increased power prices versus our derivative forward commitments. Conversely, the fair value of the natural gas derivatives after a 10% adverse price change reÖects a general decline in gas prices versus our derivative forward commitments. Derivative commodity instruments oÅset the price risk exposure of our physical assets. None of the oÅsetting 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 90
Slide 92: 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 eÅects of discounting expected future cash Öows. The primary factors aÅecting 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 decreased 70% from December 31, 2002, to December 31, 2003, while the total volume of open power derivative positions decreased 12% 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 reÖected 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 December 31, 2003, the majority of the balance in accumulated OCI represented the unrealized net loss associated with commodity cash Öow 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 year ended December 31, 2003, have reÖected this. See Note 22 of the Notes to Consolidated Financial Statements for additional information on derivative activity. Collateral Debt Securities Ì The King City operating lease commitment is supported by collateral debt securities that mature serially in amounts equal to a portion of the semi-annual lease payment. We have the ability and intent to hold these securities to maturity, and as a result, we do not expect a sudden change in market interest rates to have a material eÅect on the value of the securities at the maturity date. The securities are recorded at an amortized cost of $82.6 million at December 31, 2003. See Note 3 of the Notes to Consolidated Financial Statements. The following tables present our diÅerent classes of collateral debt securities by expected maturity date and fair market value as of December 31, 2003 (dollars in thousands): Weighted Average Interest Rate 2004 2005 2006 2007 2008 Thereafter Total Corporate Debt Securities ÏÏÏÏÏ U.S. Treasury NotesÏÏÏÏÏÏÏÏÏÏ U.S. Treasury Securities (non-interest bearing) ÏÏÏÏÏÏ TotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.3% 6.5% Ì $6,050 $7,825 Ì 1,975 Ì $6,050 Ì $9,800 $ Ì$ Ì Ì$ Ì Ì Ì 9,050 $ Ì Ì 87,100 $ 13,875 1,975 114,950 $130,800 9,700 $9,700 9,100 $9,100 $9,050 $87,100 Fair Market Value Corporate Debt Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. Treasury NotesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ U.S. Treasury Securities (non-interest bearing) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14,475 2,130 81,775 $98,380 Interest Rate Swaps Ì From time to time, we use interest rate swap agreements to mitigate our exposure to interest rate Öuctuations associated with certain of our debt instruments. We do not use interest rate swap 91
Slide 93: agreements for speculative or trading purposes. The following tables summarize the fair market values of our existing interest rate swap agreements as of December 31, 2003 (dollars in thousands): Variable to Fixed Swaps Maturity Date Notional Principal Amount Weighted Average Interest Rate (Pay) Weighted Average Interest Rate (Receive) Fair Market Value 2007 2007 2007 2011 2012 2014 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 38,000 38,333 38,667 43,013 111,384 59,331 $328,728 3.8% 3.8% 3.8% 6.9% 6.5% 6.7% 5.6% 3-month 3-month 3-month 3-month 3-month 3-month US$LIBOR US$LIBOR US$LIBOR US$LIBOR US$LIBOR US$LIBOR $ (564) (569) (574) (5,838) (15,192) (7,893) Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fixed to Variable Swaps Maturity Date $(30,630) Notional Principal Amount Weighted Average Interest Rate (Pay) Weighted Average Interest Rate (Receive) Fair Market Value 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2011 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $100,000 100,000 200,000 $400,000 6-month US$LIBOR 6-month US$LIBOR 6-month US$LIBOR 8.5% 8.5% 8.5% 8.5% $ (7,193) (5,369) (11,179) $(23,741) The fair value of outstanding interest rate swaps and the fair value that would be expected after a one percent (100 basis points) adverse interest rate change are shown in the table below (in thousands): Variable to Fixed Swaps Fair Value After a 1.0% (100 basis points) Adverse Interest Rate Change $(44,249) Fair Value as of December 31, 2003 $(30,630) Fixed to Variable Swaps Fair Value as of December 31, 2003 $(23,741) Fair Value After a 1.0% (100 basis points) Adverse Interest Rate Change $(46,905) Currency Exposure Ì 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 December 31, 2003, the impact to our pre-tax 92
Slide 94: earnings that would be expected after a 10% adverse change in exchange rates is shown in the table below (in thousands): Currency Exposure Impact to Pre-Tax Net Income GBP-Euro ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $C-$USÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $C-$Euro ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ (22,831) (5,002) (1,546) SigniÑcant changes in exchange rates will also impact our Cumulative Translation Adjustment (""CTA'') balance when translating the Ñnancial statements of our foreign operations from their respective functional currencies into our reporting currency, the U.S. dollar. During 2003, our CTA increased by approximately $200 million primarily due to a weakening of the U.S. dollar of approximately 18% and 10% against the Canadian dollar and Great British Pound, respectively. Debt Financing Ì Because of the signiÑcant capital requirements within our industry, debt Ñnancing is often needed to fund our growth. Certain debt instruments may aÅect us adversely because of changes in market conditions. We have used two primary forms of debt which are subject to market risk: (1) Variable rate construction/project Ñnancing and (2) Other variable-rate instruments. SigniÑcant LIBOR increases could have a negative impact on our future interest expense. Our variable-rate construction/project Ñnancing is primarily through CCFC II (renamed CalGen). Borrowings under this credit agreement are used exclusively to fund the construction of our power plants. Other variable-rate instruments consist primarily of our revolving credit and term loan facilities, which are used for general corporate purposes. Both our variablerate construction/project Ñnancing and other variable-rate instruments are indexed to base rates, generally LIBOR, as shown below. 93
Slide 95: The following table summarizes our variable-rate debt exposed to interest rate risk as of December 31, 2003. All fair market values are shown net of applicable premium or discount, if any (dollars in thousands): Total Variable-rate Debt Outstanding at 12/31/2003 2004 2005 2006 2007 2008 Thereafter 3-month US$LIBOR weighted average interest rate basis(4) First Priority Senior Secured Term Loan B Notes Due 2007ÏÏÏÏÏÏÏÏÏÏÏ $ 2,000 $ 2,000 $ 2,000 $ 193,500 $ Total of 3-Month US$LIBOR rate debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1-month US$LIBOR weighted average interest rate basis(4) Riverside Energy Center Project Ñnancing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thomassen revolving line of credit ÏÏÏÏ Calpine Construction Finance Company II, LLC (CCFC II) ÏÏÏÏÏ Total of 1-Month US$LIBOR rate debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other (1)(4) First Priority Secured Institutional Term Loan Due 2009 (CCFC I) ÏÏÏ Second Priority Senior Secured Floating Rate Notes Due 2011 (CCFC I) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total of variable rate debt as deÑned at (1) below ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2)(4) Second Priority Senior Secured Term Loan B Notes Due 2007ÏÏÏÏÏÏÏÏÏÏÏ Total of variable rate debt as deÑned at (2) below ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (3)(4) Second Priority Senior Secured Floating Rate Notes Due 2007 ÏÏÏÏÏ Blue Spruce Energy Center Project Ñnancing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total of variable rate debt as deÑned at (3) below ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2,000 2,000 2,000 193,500 Ì Ì $ Ì Ì $ 199,500 199,500 Ì 609 Ì 609 Ì Ì Ì Ì Ì Ì Ì Ì- 165,347 Ì Ì 165,347 Ì Ì Ì Ì Ì Ì 2,200,358 2,200,358 165,347 609 2,200,358 2,366,314 3,208 3,208 3,208 3,208 3,208 365,351 381,391 Ì 3,208 Ì 3,208 Ì 3,208 Ì 3,208 Ì 3,208 407,598 772,949 407,598 788,989 7,500 7,500 7,500 7,500 7,500 7,500 725,625 725,625 Ì Ì Ì Ì 748,125 748,125 5,000 Ì 5,000 5,000 Ì 5,000 5,000 Ì 5,000 483,750 Ì 483,750 Ì Ì Ì Ì 140,000 140,000 498,750 140,000 638,750 Total variable-rate construction/project Ñnancing and other variable-rate instruments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $18,317 $17,708 $17,708 $1,571,430 $3,208 $3,113,307 $4,741,678 (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 EÅective 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. 94
Slide 96: Construction/Project Financing Facilities Ì In November 2004 the $2.5 billion secured construction Ñnancing revolving facility for our wholly owned subsidiary CCFC II (or CalGen) was scheduled to mature. On March 23, 2004, CalGen completed its oÅering of secured institutional term loans and secured notes, which reÑnanced the CalGen facility. We realized total proceeds from the oÅering in the amount of $2.4 billion, before transaction costs and fees. See Item 1. ""Business Ì Recent Developments'' for more information regarding this oÅering. On August 14, 2003, our wholly owned subsidiaries, CCFC I and CCFC Finance Corp., closed their $750 million institutional term loans and secured notes oÅerings, proceeds from which were utilized to repay the majority of CCFC I's indebtedness which would have matured in the fourth quarter of 2003. The oÅering included $385 million of First Priority Secured Institutional Term Loans Due 2009 oÅered at 98% of par and priced at LIBOR plus 600 basis points, with a LIBOR Öoor of 150 basis points, and $365 million of Second Priority Senior Secured Floating Rate Notes Due 2011 oÅered at 98.01% of par and priced at LIBOR plus 850 basis points, with a LIBOR Öoor of 125 basis points. S&P has assigned a B corporate credit rating to CCFC I. S&P also assigned a B° rating (with a negative outlook) to the First Priority Secured Institutional Term Loans Due 2009 and a B¿ rating (with a negative outlook) to the Second Priority Secured Floating Rate Notes Due 2011. The noteholders' recourse is limited to seven of CCFC I's natural gas-Ñred electric generating facilities (as adjusted for approved dispositions and acquisitions, such as the completed sale of Lost Pines Power Project and the pending acquisition of the Brazos Valley Power Plant) located in various power markets in the United States, and related assets and contracts. See Note 14 of the Notes to Consolidated Financial Statements for more information. On September 25, 2003, our wholly owned subsidiaries, CCFC I and CCFC Finance Corp., closed on a $50 million add-on Ñnancing to the $385 million secured notes oÅering completed on August 14, 2003. See Note 14 of the Notes to Consolidated Financial Statements for more information. Revolving credit and term loan facilities Ì On July 16, 2003, we closed our $3.3 billion term loan and second-priority senior secured notes oÅering (the ""July 2003 oÅerings''). The term loan and senior notes are secured by substantially all of the assets owned directly by Calpine Corporation, including natural gas and power plant assets and the stock of Calpine Energy Services and other subsidiaries. The July 2003 oÅerings were comprised of two tranches of Öoating rate term loans and senior notes and two tranches of Ñxed rate securities. The Öoating rate term loans and senior notes included a $750 million, four-year term loan and $500 million of Second-Priority Senior Secured Floating Rate Notes Due 2007. The Ñxed rate securities included $1.15 billion of 8.5% Second Priority Senior Secured Notes Due 2010 and $900 million of 8.75% Second Priority Senior Secured Notes Due 2013. See Notes 11 and 16 of the Notes to Consolidated Financial Statements for more information. Concurrent with the July 2003 oÅerings, on July 16, 2003, we entered into agreements for a new $500 million working capital facility. The new Ñrst-priority senior secured facility consists of a two-year, $300 million working capital revolver and a four-year, $200 million term loan that together provide up to $500 million in combined cash borrowing and letter of credit capacity. The new facility replaced our prior working capital facilities and is secured by a Ñrst-priority lien on the same assets that collateralize the July 2003 oÅerings described above. See Notes 11 and 16 of the Notes to Consolidated Financial Statements for more information. Application of Critical Accounting Policies Our Ñnancial statements reÖect the selection and application of accounting policies which require management to make signiÑcant estimates and judgments. See Note 2 of the Notes to Consolidated Financial Statements, ""Summary of SigniÑcant Accounting Policies.'' We believe that the following reÖect the more critical accounting policies that currently aÅect our Ñnancial condition and results of operations. Fair Value of Energy Marketing and Risk Management Contracts and Derivatives GAAP requires us to account for certain derivative contracts at fair value. Accounting for derivatives at fair value requires us to make estimates about future prices during periods for which price quotes are not 95
Slide 97: available from sources external to us. As a result, we are required to rely on internally developed price estimates when external price quotes are unavailable. Our estimates regarding future prices involve a level of uncertainty, and prices actually realized in the future could diÅer from our estimates. We derive our 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. We perform 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. We adopted this approach December 31, 2003, for purposes of valuing our commodity derivative instruments. This valuation technique diÅers from our historical approach. Historically we had extrapolated forward price curves by extrapolating liquid and observable market prices into future periods based on observed year-over-year spreads. While our historical approach was reasonable, we believe the new approach is superior because it incorporates expectations about long-range market fundamentals into the extrapolation. The change did not aÅect the valuation of the majority of our commodity derivative instruments because of the relative short tenor of those instruments and the fact that the liquid and observable curves under both valuation techniques are the same. The eÅect of the change on our longer dated derivative commodity instruments resulted in a $12.7 million reduction in the value of our derivative assets, $(13.1) million of which was recognized as a charge to mark-to-market income and $0.4 million of which was recognized as a gain in other comprehensive income. Credit Reserves In estimating the fair value of our derivatives, we must take into account the credit risk that our counterparties will not have the Ñnancial wherewithal to honor their contract commitments. In establishing credit risk reserves we take into account historical default rate data published by the rating agencies based on the credit rating of each counterparty where we have realization exposure, as well as other published data and information. Liquidity Reserves We value our forward positions at the mid-market price, or the price in the middle of the bid-ask spread. This creates a risk that the value reported by us as the fair value of our derivative positions will not represent the realizable value or probable loss exposure of our derivative positions if we are unable to liquidate those positions at the mid-market price. Adjusting for this liquidity risk states our derivative assets and liabilities at their most probable value. We use a two-step quantitative and qualitative analysis to determine our liquidity reserve. In the Ñrst step we quantitatively derive an initial liquidity reserve assessment applying the following assumptions in calculating the initial liquidity reserve assessment: (1) where we have the capability to cover physical positions with our own assets, we assume no liquidity reserve is necessary because we will not have to cross the bid-ask spread in covering the position; (2) we record no reserve against our hedge positions because a high likelihood exists that we will hold our hedge positions to maturity or cover them with our own assets; and (3) where reserves are necessary, we base the reserves on the spreads observed using broker quotes as a starting point. Using these assumptions, we calculate the net notional volume exposure at each location by commodity and multiply the result by one half of the bid-ask spread. The second step involves a qualitative analysis where the initial assessment may be adjusted for qualitative factors such as liquidity spreads observed through recent trading activity, strategies for liquidating open positions, and imprecision in or unavailability of broker quotes due to market illiquidity. Using this quantitative and qualitative information, we estimate the amount of probable liquidity risk exposure to us and we record this estimate as a liquidity reserve. 96
Slide 98: Presentation of Revenue Under EITF No. 03-11 During 2003 the Emerging Issues Task Force (""the Task Force'') discussed EITF Issue No. 03-11. In EITF Issue No. 02-3 the Task Force reached a consensus that companies should present all gains and losses on derivative instruments held for trading purposes net in the income statement, whether or not settled physically. EITF Issue No. 03-11 addresses income statement classiÑcation of derivative instruments held for other than trading purposes. At the July 31, 2003, EITF meeting, the Task Force reached a consensus that determining whether realized gains and losses on derivative contracts not ""held for trading purposes'' should be reported on a net or gross basis is a matter of judgment that depends on the relevant facts and circumstances. The Task Force ratiÑed this consensus at its August 13, 2003, meeting, and it is eÅective beginning October 1, 2003. The Task Force did not prescribe speciÑc eÅective date or transition guidance for this Issue. We determined that under the provisions of EITF Issue No. 03-11, transactions which are not physically settled should be reported net for purposes of the Consolidated Statements of Operations. Accordingly, transactions with either of the following characteristics are presented net in our Ñnancial 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 our power schedulers net the physical Öow of the power purchase against the physical Öow of the power sale (""book out'' the physical power Öows) as a matter of scheduling convenience to eliminate the need to schedule actual power deliveries. These book out transactions may occur with the same counterparty or between diÅerent counterparties where we have equal but oÅsetting physical purchase and delivery commitments. Based on guidance in EITF Topic No. D-1 ""Implications and Implementation of an EITF Consensus'' and because EITF Issue No. 03-11 is silent with respect to transition provisions, we have adopted EITF No. 03-11 on a prospective basis eÅective October 1, 2003. While adoption of EITF No. 03-11 had no eÅect on our gross proÑt or net income, it reduced our 2003 sales of purchased power for hedging and optimization and purchased power expense for hedging and optimization by approximately $256.6 million. Accounting for Long-Lived Assets Plant Useful Lives Property, plant and equipment is stated at cost. The cost of renewals and betterments that extend the useful life of property, plant and equipment are also capitalized. Depreciation is recorded utilizing the straightline method over the estimated original composite useful life, generally 35 years for baseload power plants and 40 years for peaking facilities, exclusive of the estimated salvage value, typically 10%. Impairment of Long-Lived Assets, Including Intangibles We evaluate long-lived assets, such as property, plant and equipment, equity method investments, patents, and speciÑcally identiÑable intangibles, when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors which could trigger an impairment include signiÑcant underperformance relative to historical or projected future operating results; signiÑcant changes in the manner of our use of the acquired assets or the strategy for our overall business; and signiÑcant negative industry or economic trends. Certain of our generating assets are located in regions with depressed demands and market spark spreads. Our forecasts assume that spark spreads will increase in future years in these regions as the supply and demand relationships improve. The determination of whether an impairment has occurred is based on an estimate of undiscounted cash Öows attributable to the assets, as compared to the carrying value of the assets. The signiÑcant assumptions that we use in our undiscounted future cash Öow estimates include the future supply and demand relationships for electricity and natural gas, and the expected pricing for those commodities and the resultant spark spreads in the various regions where we generate. If an impairment has occurred, the amount of the impairment loss recognized would be determined by estimating the fair value of the assets and recording a loss if the fair value was less than the book value. For equity method investments and assets identiÑed as held for sale, the book value is compared to the estimated fair value to determine if an impairment loss is required. For equity method investments, we would record a loss when the decline in value is other than temporary. 97
Slide 99: Our assessment regarding the existence of impairment factors is based on market conditions, operational performance and legal factors of our businesses. Our review of factors present and the resulting appropriate carrying value of our intangibles, and other long-lived assets are subject to judgments and estimates that management is required to make. Future events could cause us to conclude that impairment indicators exist and that our intangibles, and other long-lived assets might be impaired. Turbine Impairment Charges A signiÑcant portion of our overall cost of constructing a power plant is the cost of the gas turbinegenerators (GTGs), steam turbine-generators (STGs) and related equipment (collectively the ""turbines''). The turbines are ordered primarily from three large manufacturers under long-term, build to order contracts. Payments are generally made over a two to four year period for each turbine. The turbine prepayments are included as a component of construction-in-progress if the turbines are assigned to speciÑc projects probable of being built, and interest is capitalized on such costs. Turbines assigned to speciÑc projects are not evaluated for impairment separately from the project as a whole. Prepayments for turbines that are not assigned to speciÑc projects that are probable of being built are carried in other assets, and interest is not capitalized on such costs. Additionally, our commitments relating to future turbine payments are discussed in Note 24 of the Notes to Consolidated Financial Statements. To the extent that there are more turbines on order than are allocated to speciÑc construction projects, we determine the probability that new projects will be initiated to utilize the turbines or that the turbines will be resold to third parties. The completion of in progress projects and the initiation of new projects are dependent on our overall liquidity and the availability of funds for capital expenditures. In assessing the impairment of turbines, we must determine both the realizability of the progress payments to date that have been capitalized, as well as the probability that at future decision dates, we will cancel the turbines, forfeiting the prepayment and incurring the cancellation payment, or will proceed and pay the remaining progress payments in accordance with the original payment schedule. We apply SFAS No. 5, ""Accounting for Contingencies'' to evaluate potential future cancellation obligations. We apply SFAS No. 144, ""Accounting for the Impairment or Disposal of Long-Lived Assets'' to evaluate turbine progress payments made to date and the carrying value of delivered turbines not assigned to projects. At the reporting date, if we believe that it is probable that we will elect the cancellation provisions relating to future decision dates, then the expected future termination payment is also expensed. Oil and Gas Property Valuations Successful EÅorts Method of Accounting. We follow the successful eÅorts method of accounting for oil and natural gas activities. Under the successful eÅorts method, lease acquisition costs and all development costs are capitalized. Exploratory drilling costs are capitalized until the results are determined. If proved reserves are not discovered, the exploratory drilling costs are expensed. Other exploratory costs are expensed as incurred. Interest costs related to Ñnancing major oil and gas projects in progress are capitalized until the projects are evaluated, or until the projects are substantially complete and ready for their intended use if the projects are evaluated as successful. The successful eÅorts method of accounting relies on management's judgment in the designation of wells as either exploratory or developmental, which determines the proper accounting treatment of costs incurred. During 2003 we drilled 186 (net 65.4) development wells and 28 (net 19.5) exploratory wells, of which 178 (net 61.0) development and 18 (net 14.3) exploration were successful. Our operational results may be signiÑcantly impacted if we decide to drill in a new exploratory area, which will result in increased seismic costs and potentially increased dry hole costs if the wells are determined to be not successful. Successful EÅorts Method of Accounting v. Full Cost Method of Accounting. Under the successful eÅorts method, unsuccessful exploration well cost, geological and geophysical costs, delay rentals, and general and administrative expenses directly allocable to acquisition, exploration, and development activities are 98
Slide 100: charged to exploration expense as incurred; whereas, under the full cost method these costs are capitalized and amortized over the life of the reserves. A signiÑcant sale would have to occur before a gain or loss would be recognized under the full cost method but, when an entire cost center (generally a Ñeld) is sold under successful eÅorts method, a gain or loss is recognized. For impairment evaluation purposes, successful eÅorts requires that individual assets are grouped for impairment purposes at the lowest level for which there are identiÑable cash Öows, which are generally on a Ñeld-by-Ñeld basis. Under full cost impairment review, all properties in the depreciation, depletion and amortization pools are assessed against a ceiling based on discounted cash Öows, with certain adjustments. Though successful eÅorts and full cost methods are both acceptable under GAAP, historically successful eÅorts is used by most major companies due to such method being more reÖective of current operating results due to expensing of certain exploration activities. Impairment of Oil and Gas Properties. We review our oil and gas properties periodically to determine if impairment of such properties is necessary. Property impairments may occur if a Ñeld discovers lower than anticipated reserves or if commodity prices fall below a level that signiÑcantly aÅects anticipated future cash Öows on the property. Proved oil and gas property values are reviewed when circumstances suggest the need for such a review and, if required, the proved properties are written down to their estimated fair value. Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, with any such impairment charged to expense in the current period. During 2003 we recorded approximately $18 million primarily in proved property impairments. Oil and Gas Reserves. The process of estimating quantities of proved developed and proved undeveloped crude oil and natural gas reserves is very complex, requiring signiÑcant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. Estimates of economically recoverable oil and gas reserves and future net cash Öows depend upon a number of variable factors and assumptions, such as historical production from the area compared with production from other producing areas, the assumed eÅect of governmental regulations, operating and workover costs, severance taxes and development costs, all of which may vary considerably from actual results. Any signiÑcant variance in the assumptions could materially aÅect the estimated quantity and value of the reserves, which could aÅect the carrying value of our oil and gas properties and/or the rate of depletion of such properties. We based our estimates of proved developed and proved undeveloped reserves as of December 31, 2003, on estimates made by Netherland, Sewell & Associates, Inc. for reserves in the United States; and Gilbert Laustsen Jung Associates Ltd. for reserves in Canada, both independent petroleum consultants. Capitalized Interest We capitalize interest using two methods: (1) capitalized interest on funds borrowed for speciÑc construction projects and (2) capitalized interest on general corporate funds. For capitalization of interest on speciÑc funds, we capitalize the interest cost incurred related to debt entered into for speciÑc projects under construction or in the advanced stage of development. The methodology for capitalizing interest on general funds, consistent with paragraphs 13 and 14 of SFAS No. 34, ""Capitalization of Interest Cost,'' begins with a determination of the borrowings applicable to our qualifying assets. The basis of this approach is the assumption that the portion of the interest costs that are capitalized on expenditures during an asset's acquisition period could have been avoided if the expenditures had not been made. This methodology takes the view that if funds are not required for construction then they would have been used to pay oÅ other debt. We use our best judgment in determining which borrowings represent the cost of Ñnancing the acquisition of the assets. The primary debt instruments included in the rate calculation of interest incurred on general corporate funds are our Senior Notes, our term loan facilities and our secured working capital revolving credit facility. The interest rate is derived by dividing the total interest cost by the average borrowings. This weighted average interest rate is applied to our average qualifying assets. See Note 4 of the Notes to Consolidated Financial Statements for additional information about the capitalization of interest expense. 99
Slide 101: Accounting for Income Taxes To arrive at our worldwide income tax provision signiÑcant judgment is required. In the ordinary course of a global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of the treatment of capital assets, Ñnancing transactions, multistate taxation of operations and segregation of foreign and domestic income and expense to avoid double taxation. Although we believe that our estimates are reasonable, no assurance can be given that the Ñnal tax outcome of these matters will not be diÅerent than that which is reÖected in our historical income tax provisions and accruals. Such diÅerences could have a material impact on our income tax provision and net income in the period in which such determination is made. We record a valuation allowance to reduce our deferred tax assets to the amount of future tax beneÑt that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, there is no assurance that the valuation allowance would not need to be increased to cover additional deferred tax assets that may not be realizable. Any increase in the valuation allowance could have a material adverse impact on our income tax provision and net income in the period in which such determination is made. We provide for United States income taxes on the earnings of foreign subsidiaries unless they are considered permanently invested outside the United States. At December 31, 2003, we had no cumulative undistributed earnings of foreign subsidiaries. Our eÅective income tax rates were (0.1)%, (38.6)% and 33.8% in Ñscal 2003, 2002 and 2001, respectively. The eÅective tax rate in all periods is the result of proÑts Calpine Corporation and its subsidiaries earned in various tax jurisdictions, both foreign and domestic, that apply a broad range of income tax rates. The provision for income taxes diÅers from the tax computed at the federal statutory income tax rate due primarily to state taxes and earnings considered as permanently reinvested in foreign operations and the eÅect of the treatment by foreign jurisdictions of cross border Ñnancings. Future eÅective tax rates could be adversely aÅected if earnings are lower than anticipated in countries where we have lower statutory rates, if unfavorable changes in tax laws and regulations occur, or if we experience future adverse determinations by taxing authorities after any related litigation. For calendar year 2003 the state tax rate increased over prior years due to a one-time adjustment increasing our deferred state taxes and receiving no beneÑt for foreign losses in our state tax Ñlings. Our foreign taxes at rates other than statutory include the beneÑt of cross border Ñnancings as well as withholding taxes and foreign valuation allowance. Additionally, our 2003 eÅective rate was adversely impacted by the recognition of undistributed foreign income (Subpart F) in our U.S. tax return. Under SFAS No. 109, ""Accounting for Income Taxes,'' deferred tax assets and liabilities are determined based on diÅerences between the Ñnancial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that will be in eÅect when the diÅerences are expected to reverse. SFAS No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, we have provided a valuation allowance against certain deferred tax assets. The valuation allowance was based on the historical earnings patterns within individual tax jurisdictions that make it uncertain that we will have suÇcient income in the appropriate jurisdictions to realize the full value of the assets. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. At December 31, 2003, we had credit carryforwards, resulting in a $8.1 million tax beneÑt, which originated from acceleration of deductions on capital assets. We expect to utilize all of the credit carryforwards. We also had federal and state net operating loss carryforwards of $364.8 million, which expire between 2004 and 2023. The federal and state net operating loss carryforwards available are subject to limitations on annual usage. In addition, we had loss carryforwards in certain foreign subsidiaries, resulting in a tax beneÑt of $113.3 million, the majority of which expire by 2008. It is expected that they will be fully utilized before expiring. The deferred tax asset for the federal and state losses, foreign losses, and other prepaid taxes has been oÅset by a valuation allowance of $19.3 million. 100
Slide 102: Variable Interest Entities and Primary BeneÑciary In determining whether an entity is a variable interest entity (""VIE'') and whether or not we are the Primary BeneÑciary, we use signiÑcant judgment regarding the adequacy of an entity's equity relative to maximum expected losses, amounts and timing of estimated cash Öows, discount rates and the probability of achieving a speciÑc expected future cash Öow outcome for various cash Öow scenarios. Due to the long-term nature of our investment in a VIE and its underlying assets, our estimates of the probability-weighted future expected cash Öow outcomes are complex and subjective, and are based, in part, on our assessment of future commodity prices based on long-term supply and demand forecasts for electricity and natural gas, operational performance of the underlying assets, legal and regulatory factors aÅecting our industry, long-term interest rates and our current credit proÑle and cost of capital. As a result of applying the complex guidance outlined in FIN 46-R, we may be required to consolidate assets we do not legally own and liabilities that we are not legally obligated to satisfy. Also, future changes in a VIE's legal or capital structure may cause us to reassess whether or not we are the Primary BeneÑciary and may result in our consolidation or deconsolidation of that entity. SigniÑcant judgment was required in making our assessment of whether or not a VIE was a special purpose entity (""SPE'') for purposes of applying FIN 46-R as of October 1, 2003. Entities that meet the deÑnition 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 deÑnitional 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, operational process 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 deÑnition of an SPE, our assessment was primarily based on the degree to which a VIE aligned with the deÑnition of a business. Based on this assessment, we determined that three VIEs, Calpine Capital Trusts I, II and III, were SPEs and subject to FIN 46-R as of October 1, 2003. Consequently as discussed in Notes 2 and 11 of the Notes to Consolidated Financial Statements, we deconsolidated these entities. Initial Adoption of New Accounting Standards in 2003 SFAS No. 123 Ì ""Accounting for Stock-Based Compensation'' and SFAS No. 148 ""Accounting for Stock-Based Compensation Ì Transition and Disclosure'' Prior to 2003 we accounted for qualiÑed stock compensation under APB Opinion No. 25, ""Accounting for Stock Issued to Employees'' (""APB 25''). Under APB 25, we were required to recognize stock compensation as expense only to the extent that there is a diÅerence in value between the market price of the stock being oÅered to employees and the price those employees must pay to acquire the stock. The expense measurement methodology provided by APB 25 is commonly referred to as the ""intrinsic value based method.'' To date, our stock compensation program has been based primarily on stock options whose exercise prices are equal to the market price of Calpine stock on the date of the stock option grant; consequently, under APB 25 we had historically incurred minimal stock compensation expense. On January 1, 2003, we 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 Ì 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 APB 25 could only do so on a prospective basis; no adoption or transition provisions were established to allow for a restatement of prior period Ñnancial statements. SFAS No. 148 provides two additional transition options to report the change in accounting principle Ì the modiÑed 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 Ñnancial statements about the method of accounting for stock-based employee compensation and the eÅect of the method used on reported results. We elected to adopt the provisions of SFAS No. 123 on a prospective 101
Slide 103: basis; consequently, we are 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 our Ñnancial statements. Under SFAS No. 123, the fair value of a stock option or its equivalent is estimated on the date of grant by using an option-pricing model, such as the Black-Scholes model or a binomial model. The option-pricing model selected should take into account, as of the stock option's grant date, the exercise price and expected life of the stock option, the current price of the underlying stock and its expected volatility, expected dividends on the stock, and the risk-free interest rate for the expected term of the stock option. The fair value calculated by this model is then recognized as compensation expense over the period in which the related employee services are rendered. Unless speciÑcally deÑned within the provisions of the stock option granted, the service period is presumed to begin on the grant date and end when the stock option is fully vested. Depending on the vesting structure of the stock option and other variables that are built into the option-pricing model, the fair value of the stock option is recognized over the service period using either a straight-line method (the single option approach) or a more conservative, accelerated method (the multiple option approach). For consistency, we have chosen the multiple option approach, which we have used historically for pro-forma disclosure purposes. The multiple option approach views one four-year option grant as four separate sub-grants, each representing 25% of the total number of stock options granted. The Ñrst subgrant vests over one year, the second sub-grant vests over two years, the third sub-grant vests over three years, and the fourth sub-grant vests over four years. Under this scenario, over 50% of the total fair value of the stock option grant is recognized during the Ñrst year of the vesting period, and nearly 80% of the total fair value of the stock option grant is recognized by the end of the second year of the vesting period. By contrast, if we were to apply the single option approach, only 25% and 50% of the total fair value of the stock option grant would be recognized as compensation expense by the end of the Ñrst and second years of the vesting period, respectively. We have selected the Black-Scholes model, primarily because it is the most commonly recognized options-pricing model among U.S.-based corporations. Nonetheless, we believe this model tends to overstate the true fair value of our employee stock options in that our options cannot be freely traded, have vesting requirements, and are subject to blackout periods during which, even if vested, they cannot be traded. We will monitor valuation trends and techniques as more companies adopt SFAS No. 123 and as additional guidance is provided by FASB and review our choices as appropriate in the future. The key assumption in our BlackScholes model is the expected life of the stock option, because it is this Ñgure that drives our expected volatility calculation, as well as our risk-free interest rate. The expected life of the option relies on two factors Ì the option's vesting period and the expected term that an employee holds the option once it has vested. There is no single method described by SFAS No. 123 for predicting future events such as how long an employee holds on to an option or what the expected volatility of a company's stock price will be; the facts and circumstances are unique to diÅerent companies and depend on factors such as historical employee stock option exercise patterns, signiÑcant changes in the market place that could create a material impact on a company's stock price in the future, and changes in a company's stock-based compensation structure. We base our expected option terms on historical employee exercise patterns. We have segregated our employees into four diÅerent categories based on the fact that diÅerent groups of employees within our company have exhibited diÅerent stock exercise patterns in the past, usually based on employee rank and income levels. Therefore, we have concluded that we will perform separate Black-Scholes calculations for four employee groups Ì executive oÇcers, senior vice presidents, vice presidents, and all other employees. We compute our expected stock price volatility based on our stock's historical movements. For each employee group, we measure the volatility of our stock over a period that equals the expected term of the option. In the case of our executive oÇcers, this means we measure our stock price volatility dating back to our public inception in 1996, because these employees are expected to hold their options for over 7 years after the options have fully vested. In the case of other employees, volatility is only measured dating back 4 years. In the short run, this causes other employees to generate a higher volatility Ñgure than the other company employee groups because our stock price has Öuctuated signiÑcantly in the past four years. As of December 31, 2003, the volatility for our employee groups ranged from 70%-113%. 102
Slide 104: See Note 2 of the Notes to Consolidated Financial Statements for additional information related to the January 1, 2003, adoption of SFAS Nos. 123 and 148 and the pro-forma impact that they would have had on our net income for the years ended December 31, 2003, 2002 and 2001. SFAS No. 143 Ì ""Accounting for Asset Retirement Obligations'' In June 2001 FASB issued SFAS No. 143 ""Accounting for Asset Retirement Obligations.'' SFAS No. 143 applies to Ñscal years beginning after June 15, 2002 and amends SFAS No. 19, ""Financial Accounting and Reporting by Oil and Gas Producing Companies.'' This standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the assets and requires that a liability for an asset retirement obligation be recognized when incurred, recorded at fair value and classiÑed as a liability in the balance sheet. When the liability is initially recorded, the entity will capitalize the cost and increase the carrying value of the related long-lived asset. Asset retirement obligations represent future liabilities, and, as a result, accretion expense will be accrued on this liability until the obligation is satisÑed. At the same time, the capitalized cost will be depreciated over the estimated useful life of the related asset. At the settlement date, the entity will settle the obligation for its recorded amount or recognize a gain or loss upon settlement. We adopted the new rules on asset retirement obligations on January 1, 2003. As required by the new rules, we recorded liabilities equal to the present value of expected future asset retirement obligations at January 1, 2003. We identiÑed obligations related to operating gas-Ñred power plants, geothermal power plants and oil and gas properties. The liabilities are partially oÅset by increases in net assets recorded as if the provisions of SFAS No. 143 had been in eÅect at the date the obligation was incurred, which for power plants is generally the start of construction and typically building up during construction until commercial operations for the facility is achieved. For oil and gas properties the date the obligation is incurred is generally the start of drilling of a well or the start of construction of a facility and typically building up until completion of drilling of a well or completion of construction of a facility. FIN 45 Ì ""Guarantors Accounting and Disclosure for Guarantees, Including Indirect Guarantees of Indebtedness of Others'' In November 2002 FASB issued Interpretation No. 45, ""Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others'' (""FIN 45''). FIN 45 elaborates on the existing disclosure requirements for most guarantees. FIN 45 also clariÑes that at the time a company issues a guarantee, it must recognize an initial liability for the fair value of the obligation it assumes under that guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that speciÑed triggering events or conditions occur. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modiÑed after December 31, 2002. The disclosure requirements for FIN 45 are eÅective for Ñnancial statements of interim or annual periods ending after December 15, 2002, and have been incorporated into our December 31, 2003, disclosures of guarantees in the Notes to Consolidated Financial Statements. Adoption of this Interpretation did not have a material impact on our Consolidated Financial Statements. See ""Commercial Commitments'' in the Liquidity and Capital Resources section and Note 24 of the Notes to Consolidated Financial Statements for the disclosures. FIN 46 Ì ""Consolidation of Variable Interest Entities, An Interpretation of ARB 51'' See ""Variable Interest Entities (""VIE'') and Primary BeneÑciary'' above for a discussion of the judgment involved in FIN 46. Derivatives Implementation Group Issue No. C20 In June 2003 FASB issued 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.'' DIG Issue No. C20 superseded DIG Issue No. C11 103
Slide 105: ""Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception,'' and speciÑed additional circumstances in which a price adjustment feature in a derivative contract would not be an impediment to qualifying for the normal purchases and normal sales scope exception under SFAS No. 133. DIG Issue No. C20 is eÅective as of the Ñrst day of the Ñscal quarter beginning after July 10, 2003, (i.e. October 1, 2003, for us) with early application permitted. In conjunction with initially applying the implementation guidance, DIG Issue No. C20 requires the recognition of a special transition adjustment for certain contracts containing a price adjustment feature based on a broad market index for which the normal purchases and normal sales scope exception had been previously elected. In those circumstances, the derivative contract should be recognized at fair value as of the date of the initial application with a corresponding adjustment of net income as the cumulative eÅect of a change in accounting principle. It should then be applied prospectively for all existing contracts as of the eÅective date and for all future transactions. Two of our power sales contracts, which meet the deÑnition of a derivative and for which we previously elected the normal purchases and normal sales scope exception, use a CPI or similar index to escalate the Operations and Maintenance (""O&M'') charges. Adoption of DIG Issue No. C20 required us to recognize a special transition accounting adjustment for the estimated future economic beneÑts of these contracts. We based the transition adjustment on the nature and extent of the key price adjustment features in the contracts and estimated future market conditions on the date of adoption, such as the forward price of power and natural gas and the expected rate of inÖation. We will realize the actual future economic beneÑts of these contracts over the remaining lives of these contracts which extend through 2013 and 2023 as actual power deliveries occur, although DIG Issue No. C20 required us to account for the estimated future economic beneÑts currently. We will amortize the corresponding asset recorded upon adoption of DIG Issue No. C20 through a charge to earnings in future periods. Accordingly on October 1, 2003, the date we adopted DIG Issue No. C20, we recorded other current assets and other assets of approximately $33.5 million and 259.9 million, respectively, and a cumulative eÅect of a change in accounting principle of approximately $181.9 million, net of $111.5 million of tax. For all periods subsequent to October 1, 2003, we will account for the contracts as normal purchases and sales under the provisions of DIG Issue No. C20. EITF Issue No. 01-08 Ì ""Determining Whether an Arrangement Contains a Lease'' In May 2003 the EITF reached consensus in EITF Issue No. 01-08, ""Determining Whether an Arrangement Contains a Lease,'' to clarify the requirements of identifying whether an arrangement should be accounted for as a lease at its inception. The guidance in the consensus is designed to broaden the scope of arrangements, such as power purchase agreements, accounted for as leases. EITF Issue No. 01-08 requires both parties to an arrangement to determine whether a service contract or similar arrangement is, or includes, a lease within the scope of SFAS No. 13, ""Accounting for Leases.'' The consensus is being applied prospectively to arrangements agreed to, modiÑed, or acquired in business combinations on or after July 1, 2003. Prior to adopting EITF Issue No. 01-08, we had accounted for certain contractual arrangements as leases under existing industry practices, and the adoption of EITF Issue No. 01-08 did not materially change accounting for previous arrangements that had been accounted for as leases prior to the adoption of EITF Issue No. 01-08. Currently the income to us under these arrangements is immaterial; however, we may, in the future, structure additional power purchase agreements as leases. For income statement presentation purposes, income from arrangements accounted for as leases is classiÑed within electricity and steam revenue in our consolidated statements of operations. Impact of Recent Accounting Pronouncements SFAS No. 133 Ì ""Accounting for Derivative Instruments and Hedging Activities'' FASB in recent years has issued numerous new accounting standards that have already taken eÅect or will soon impact us. In Note 2 of our Notes to Consolidated Financial Statements we invite your attention to a discussion of several new standards, emerging issues and interpretations under the section entitled ""New Accounting Pronouncements.'' 104
Slide 106: Below is a detailed discussion of how we apply SFAS No. 133 since this accounting standard has a profound impact on how we account for our energy contracts and transactions. On January 1, 2001, we adopted SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities,'' as amended by SFAS No. 137, ""Accounting for Derivative Instruments and Hedging Activities Ì Deferral of the EÅective Date of FASB Statement No. 133 Ì an Amendment of FASB Statement No. 133,'' and SFAS No. 138, ""Accounting for Certain Derivative Instruments and Certain Hedging Activities Ì an Amendment of FASB Statement No. 133.'' We currently hold six classes of derivative instruments that are impacted by the new pronouncement Ì foreign currency swaps, interest rate swaps, forward interest rate agreements, commodity Ñnancial instruments, commodity contracts, and physical options. Consistent with the requirements of SFAS No. 133, we evaluate all of our contracts to determine whether or not they qualify as derivatives under the accounting pronouncement. For a given contract, there are typically three steps we use to determine its proper accounting treatment. First, based on the terms and conditions of the contract, as well as the applicable guidelines established by SFAS No. 133, we identify the contract as being either a derivative or non-derivative contract. Second, if the contract is not a derivative, we further identify its speciÑc classiÑcation (e.g. whether or not it qualiÑes as a lease) and apply the appropriate non-derivative accounting treatment. Alternatively, if the contract does qualify as a derivative under the guidance of SFAS No. 133, we evaluate whether or not it qualiÑes for the ""normal'' purchases and sales exception (as described below). If the contract qualiÑes for the exception, we apply the traditional accrual accounting treatment. Finally, if the contract qualiÑes as a derivative and does not qualify for the ""normal'' purchases and sales exception, we apply the accounting treatment required by SFAS No. 133, which is outlined below in further detail. The diagram below illustrates the process we use for the purposes of identifying the classiÑcation and subsequent accounting treatment of our contracts: Types of Contract Accounting Transactions New Contract Is it a Lease? No Yes Is it Exempt (Normal Purchases and Sales Contracts?) No Is it a Highly Effective Hedge? Designate as Fair Value, Cash Flow or Foreign Exchange Hedge Is it a Derivative? Yes Yes No Yes No Mark-to-Market Through Income Statement Lease Accounting Accrual Accounting Hedge Accounting Classification Flow Chart 105
Slide 107: As an independent power producer primarily focused on generation of electricity using gas-Ñred turbines, our natural physical commodity position is ""short'' fuel (i.e., natural gas consumer) and ""long'' power capacity (i.e., electricity seller). Additionally, we also have a natural ""long'' crude position due to our petroleum reserves. To manage forward exposure to price Öuctuation, we execute commodity derivative contracts as deÑned by SFAS No. 133. As we apply SFAS No. 133, derivatives can receive one of four treatments depending on associated circumstances: 1. exemption from SFAS No. 133 accounting treatment if these contracts qualify as ""normal'' purchases and sales contracts; 2. fair value hedges; 3. cash Öow hedges; or 4. undesignated derivatives. Normal Purchases and Sales Normal purchases and sales, as deÑned by paragraph 10b. of SFAS No. 133 and amended by SFAS No. 138, are exempt from SFAS No. 133 accounting treatment. As a result, these contracts are not required to be recorded on the balance sheet at their fair values and any Öuctuations in these values are not required to be reported within earnings. Probability of physical delivery from our generation plants, in the case of electricity sales, and to our generation plants, in the case of natural gas contracts, is required over the life of the contract within reasonable tolerances. On June 27, 2001, FASB cleared SFAS No. 133 Implementation Issue No. C15 dealing with a proposed electric industry normal purchases and sales exception for capacity sales transactions (""The Eligibility of Option Contracts in Electricity for the Normal Purchases and Normal Sales Exception''). On December 19, 2001, FASB revised the criteria for qualifying for the ""normal'' exception. As a result of Issue No. C15, as revised, certain power purchase and/or sale agreements that are structured as capacity sales contracts are now eligible to qualify for the normal purchases and sales exception. Because we are ""long'' power capacity, we often enter into capacity sales contracts as a means to recover the costs incurred from maintaining and operating our power plants as well as the costs directly associated with the generation and sale of electricity to our customers. Under Issue No. C15, a capacity sales contract qualiÑes for the normal purchases and sales exception subject to certain conditions. A majority of our capacity sales contracts qualify for the normal purchases and sales exception. Cash Flow Hedges and Fair Value Hedges Within the energy industry, cash Öow and fair value hedge transactions typically use the same types of standard transactions (i.e., oÅered for purchase/sale in over-the-counter markets or commodity exchanges). Fair Value Hedges As further deÑned in SFAS No. 133, fair value hedge transactions hedge the exposure to changes in the fair value of either all or a speciÑc portion of a recognized asset or liability or of an unrecognized Ñrm commitment. The accounting treatment for fair value hedges requires reporting both the changes in fair values of a hedged item (the underlying risk) and the hedging instrument (the derivative designated to oÅset the underlying risk) on both the balance sheet and the income statement. On that basis, when a Ñrm commitment is associated with a hedge instrument that attains 100% eÅectiveness (under the eÅectiveness criteria outlined in SFAS No. 133), there is no net earnings impact because the earnings caused by the changes in fair value of the hedged item will move in an equal, but opposite, amount as the earnings caused by the changes in fair value of the hedging instrument. In other words, the earnings volatility caused by the underlying risk factor will be neutralized because of the hedge. For example, if we want to manage the price risk (i.e. the risk that market electric rates will rise, making a Ñxed price contract less valuable) associated with all or a portion of a Ñxed price power sale that has been identiÑed as a ""normal'' transaction (as described above), we might create a fair value hedge by purchasing Ñxed price power. From that date and time forward until delivery, the change in fair value of the hedged item and hedge instrument will be reported in earnings with asset/liability oÅsets on the balance sheet. If there is 100% eÅectiveness, there is no net earnings impact. If there is less than 100% eÅectiveness, the fair value change of the hedged item (the underlying risk) and the hedging instrument (the derivative) will likely be diÅerent and the ""ineÅectiveness'' will result in a net earnings impact. 106
Slide 108: Cash Flow Hedges As further deÑned in SFAS No. 133, cash Öow hedge transactions hedge the exposure to variability in expected future cash Öows (i.e., in our case, the price variability of forecasted purchases of gas and sales of power, as well as interest rate and foreign exchange rate exposure). In the case of cash Öow hedges, the hedged item (the underlying risk) is generally unrecognized (i.e., not recorded on the balance sheet prior to delivery), and any changes in this fair value, therefore, will not be recorded within earnings. Conceptually, if a cash Öow hedge is eÅective, this means that a variable, such as movement in power prices, has been eÅectively Ñxed, so that any Öuctuations will have no net result on either cash Öows or earnings. Therefore, if the changes in fair value of the hedged item are not recorded in earnings, then the changes in fair value of the hedging instrument (the derivative) must also be excluded from the income statement, or else a one-sided net impact on earnings will be reported, despite the fact that the establishment of the eÅective hedge results in no net economic impact. To prevent such a scenario from occurring, SFAS No. 133 requires that the fair value of a derivative instrument designated as a cash Öow hedge be recorded as an asset or liability on the balance sheet, but with the oÅset reported as part of other comprehensive income (""OCI''), to the extent that the hedge is eÅective. Similar to fair value hedges, any ineÅectiveness portion will be reÖected in earnings. The diagram below illustrates the process used to account for derivatives designated as cash Öow hedges: Accounting for Cash Flow Hedges Derivative Change in Fair Value Hedged Item Other Comprehensive Income Offsetting Gain or Loss Attributable to Risk Being Hedged Ineffectiveness Earnings (Interest Expense, Cost of Revenue, or Revenue) Certain contracts could either qualify for exemption from SFAS No. 133 accounting as normal purchases or sales or be designated as eÅective hedges. Our marketing and sales and fuels groups generally transact with load serving entities and other end-users of electricity and with fuel suppliers, respectively, in physical contracts where delivery is expected. These transactions are structured as normal purchases and sales, when possible, and if the normal exception is not allowed, we seek to structure the transactions as cash Öow hedges. Conversely, our CES risk management desks generally transact in over-the-counter or exchange traded contracts, in hedging transactions. These transactions are designated as hedges when possible, notwithstanding the fact that some might qualify as normal purchases or sales. 107
Slide 109: Undesignated Derivatives The fair values and changes in fair values of undesignated derivatives are recorded in earnings, with the corresponding oÅsets recorded as derivative assets or liabilities on the balance sheet. We have the following types of undesignated transactions: ‚ transactions are executed at a location where we do not have an associated natural long (generation capacity) or short (fuel consumption requirements) position of suÇcient quantity for the entire term of the transaction (e.g., power sales where we do not own generating assets or intend to acquire transmission rights for delivery from other assets for any portion of the contract term), and ‚ transactions executed with the intent to proÑt from short-term price movements, and ‚ discontinuance (de-designation) of hedge treatment prospectively consistent with paragraphs 25 and 32 of SFAS No. 133. In circumstances where we believe the hedge relationship is no longer necessary, we will remove the hedge designation and close out the hedge positions by entering into an equal and oÅsetting derivative position. Prospectively, the two derivative positions should generally have no net earnings impact because the changes in their fair values are oÅsetting. Accumulated Other Comprehensive Income Accumulated other comprehensive income (""AOCI'') includes the following components: (i) unrealized pre-tax gains/losses, net of reclassiÑcation-to-earnings adjustments, from eÅective cash Öow hedges as designated pursuant to SFAS No. 133, (see Note 22 of the Notes to Consolidated Financial Statements); (ii) unrealized pre-tax gains/losses that result from the translation of foreign subsidiaries' balance sheets from the foreign functional currency to our consolidated reporting currency (US $); (iii) other comprehensive income from equity method investees; and (iv) the taxes associated with the unrealized gains/losses from items (i) and (iii). See Note 20 of the Notes to Consolidated Financial Statements for further information. One result of our adoption on January 1, 2001, of SFAS No. 133 has been volatility in the AOCI component of Stockholders' Equity on the balance sheet. As explained in Notes 20 and 22 of the Notes to Consolidated Financial Statements, our AOCI balances are primarily related to our cash Öow hedging and currency translation activity. The quarterly balances for 2003 in AOCI related to cash Öow hedging activity are summarized in the table below (in thousands). December 31 Quarter Ended September 30 June 30 March 31 AOCI balances related to cash Öow hedging ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $(130,419) $(129,387) $(162,762) $(193,265) Note that the amounts above represent AOCI from cash Öow hedging activity only. For further information on other components of our total AOCI balance at December 31, 2003, see Note 20 of the Notes to Consolidated Financial Statements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information required hereunder is set forth under ""Management's Discussion and Analysis of Financial Condition and Results of Operation Ì Financial Market Risks.'' Item 8. Financial Statements and Supplementary Data The information required hereunder is set forth under ""Reports of Independent Auditors,'' ""Consolidated Balance Sheets,'' ""Consolidated Statements of Operations,'' ""Consolidated Statements of Stockholders' Equity,'' ""Consolidated Statements of Cash Flows,'' and ""Notes to Consolidated Financial Statements'' included in the Consolidated Financial Statements that are a part of this report. Other Ñnancial information and schedules are included in the Consolidated Financial Statements that are a part of this report. 108
Slide 110: Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure On April 10, 2003, we and our former auditors, Deloitte & Touche LLP (""Deloitte''), ceased our client auditor relationship. On that date, the following events occurred: (1) Deloitte notiÑed the Chairman of the Audit Committee of our Board of Directors that Deloitte resigned its audit relationship with us. (2) Our Audit Committee and Board of Directors determined to no longer utilize the audit services of Deloitte and approved the appointment of PricewaterhouseCoopers LLP to serve as our independent public accountants for the Ñscal year ended December 31, 2003. Deloitte has not included, in any report on our Ñnancial statements, an adverse opinion or a disclaimer of opinion, or a qualiÑcation or modiÑcation as to uncertainty, audit scope, or accounting principles with respect to our Ñnancial statements. During our prior Ñscal year ended December 31, 2002, and the subsequent interim period through April 10, 2003, (i) other than described in the paragraph immediately following this paragraph, there were no disagreements between us and Deloitte on any matter of accounting principles or practices, Ñnancial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to Deloitte's satisfaction, would have caused Deloitte to make reference to the subject matter of the disagreement in connection with its reports of our Ñnancial statements, and (ii) there were no ""reportable events'' (as that term is deÑned in Item 304(a)(1)(v) of Regulation S-K). We had a disagreement with Deloitte, which was satisfactorily resolved, related to the interpretation of certain provisions of power sales agreements associated with two power plants for which we had utilized saleleaseback transactions. We had previously accounted for these sale-leaseback transactions as qualifying for operating lease accounting treatment. Deloitte concluded that the provisions of the power sales agreements precluded operating lease accounting treatment. Our Audit Committee and Board of Directors discussed the subject matter of the disagreement with Deloitte. We recorded adjustments related to these matters in the 2000 and 2001 consolidated Ñnancial statements and adjusted the previously announced unaudited Ñnancial statements for 2002. We have authorized Deloitte to respond fully to the inquiries of PricewaterhouseCoopers LLP concerning the subject matter of the foregoing disagreement. During our two most recent Ñscal years, and the subsequent interim period through April 10, 2003, neither we nor anyone on our behalf consulted PricewaterhouseCoopers LLP regarding the application of accounting principles to a speciÑed transaction, either completed or proposed, regarding the type of audit opinion that might be rendered on our Ñnancial statements or regarding ""disagreements'' (as that term is deÑned in Item 304(a)(1)(iv) of Regulation S-K, including the disagreements noted herein) or any ""reportable events'' (as that term is deÑned in Item 304(a)(1)(v) of Regulation S-K). Item 9A. Controls and Procedures In connection with the audit of the Company's Ñnancial statements for the Ñscal year ended December 31, 2003, its independent registered public accounting Ñrm reviewed the Company's information systems control framework and identiÑed to the Company certain signiÑcant deÑciencies in the design of such systems. These design deÑciencies 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 deÑciencies constituted a material weakness in its internal control over Ñnancial reporting, and the Company has performed substantial analytical and post-closing procedures as a result of these design deÑciencies. Based on the Company's compensating controls and testing, it has concluded that these design deÑciencies did not result in any material errors in its Ñnancial statements. 109
Slide 111: Additionally, the Company has completed the process of correcting these design deÑciencies by taking the following steps: ‚ 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 ‚ system access rights for Ñnancial system software updates have been re-deÑned and restricted to segregate incompatible activities and allow user activities to be monitored. The Company continues to test the eÅectiveness of these changes. Other than correcting the material control weakness identiÑed above, there were no other changes in the Company's internal controls over Ñnancial reporting identiÑed in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that have materially aÅected, or are reasonably likely to materially aÅect, the Company's internal controls over Ñnancial reporting. Our Chief Executive OÇcer and Chief Financial OÇcer supervised the evaluation of the Company's disclosure controls and procedures (as deÑned in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of December 31, 2003, and based on such evaluation concluded that, despite the material weakness described above, the Company's disclosure controls and procedures overall were eÅective 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 III Item 10. Directors and Executive OÇcers of the Registrant Incorporated by reference to Proxy Statement relating to the 2004 Annual Meeting of Stockholders to be Ñled. Item 11. Executive Compensation Incorporated by reference to Proxy Statement relating to the 2004 Annual Meeting of Stockholders to be Ñled. Item 12. Security Ownership of Certain BeneÑcial Owners and Management Incorporated by reference to Proxy Statement relating to the 2004 Annual Meeting of Stockholders to be Ñled. 110
Slide 112: Equity Compensation Plan Information The following table provides certain information, as of December 31, 2003, concerning certain compensation plans under which our equity securities are authorized for issuance. Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants, and Rights Weighted Average Exercise Price of Outstanding Options, Warrants and Rights Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities ReÖected in Column(a)) Plan Category Equity compensation plans approved by security holders Calpine Corporation 1992 Stock Incentive Plan(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏ Encal Energy Ltd. Stock Option Plan(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calpine Corporation 1996 Stock Incentive Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Calpine Corporation 2000 Employee Stock Purchase Plan ÏÏÏÏÏÏÏÏÏÏÏ Equity compensation plans not approved by security holders ÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,996,798 126,219 28,715,414 $ 0.784 34.693 9.427 Ì Ì 5,816,080 4,405,560 Ì 33,838,431 Ì $ 8.245 Ì 10,221,640 (1) The Calpine Corporation 1992 Stock Incentive Plan was approved in 1992 by the Company's sole security holder at the time, Electrowatt Ltd. (2) In connection with the merger with Encal Energy Ltd., which closed in 2001, we assumed the Encal Energy Fifth Amended and Restated Stock Option Plan. 126,219 shares of our common stock are subject to issuance upon exercise of options granted pursuant to this plan at a weighted average exercise price of $34.693. Other than the shares reserved for future issuance upon the exercise of these options, there are no securities available for future issuance under this Plan. Item 13. Certain Relationships and Related Transactions Incorporated by reference to Proxy Statement relating to the 2004 Annual Meeting of Stockholders to be Ñled. Item 14. Principal Accounting Fees and Services Incorporated by reference to Proxy Statement relating to the 2004 Annual Meeting of Stockholders to be Ñled. 111
Slide 113: PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)-1. Financial Statements and Other Information The following items appear in Appendix F of this report: Reports of Independent Auditors Consolidated Balance Sheets, December 31, 2003 and 2002 Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002, and 2001 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2003, 2002, and 2001 Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002, and 2001 Notes to Consolidated Financial Statements for the Years Ended December 31, 2003, 2002, and 2001 (a)-2. Financial Statement Schedules Schedule II Ì Valuation and Qualifying Accounts (b) Reports on Form 8-K The registrant Ñled the following reports on Form 8-K during the quarter ended December 31, 2003: Date of Report Date Filed or Furnished Item Reported 10/1/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10/3/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10/6/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10/15/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 10/21/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12/31/02 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/5/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/6/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/6/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/11/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/17/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/20/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11/26/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12/4/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 12/15/03 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (c) Exhibits 10/1/03 10/8/03 10/8/03 10/16/03 10/22/03 10/23/03 11/6/03 11/6/03 11/7/03 11/12/03 11/17/03 11/20/03 11/26/03 12/5/03 12/15/03 5 5 5 5 5 5,7 12 5 5 5 5 5 5 5 5 The following exhibits are Ñled herewith unless otherwise indicated: Exhibit Number Description 3.1.1 3.1.2 4.1.1 4.1.2 Amended and Restated CertiÑcate of Incorporation of Calpine Corporation, as amended through June 2, 2004.(a) Amended and Restated By-laws of Calpine Corporation.(b) 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.(c) First Supplemental Indenture dated as of August 1, 2000, between the Company and U.S. Bank (as successor trustee to Fleet National Bank), as Trustee.(d) 112
Slide 114: Exhibit Number Description 4.2.1 4.2.2 4.2.3 4.3.1 4.3.2 4.3.3 4.4.1 4.4.2 4.5.1 4.5.2 4.6.1 4.6.2 4.7.1 4.7.2 4.7.3 4.8.1 4.8.2 4.8.3 4.8.4 4.9 4.10 4.11 4.12 4.13.1 Indenture dated as of July 8, 1997, between the Company and The Bank of New York, as Trustee, including form of Notes.(e) Supplemental Indenture dated as of September 10, 1997, between the Company and The Bank of New York, as Trustee.(f) Second Supplemental Indenture dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(d) Indenture dated as of March 31, 1998, between the Company and The Bank of New York, as Trustee, including form of Notes.(g) Supplemental Indenture dated as of July 24, 1998, between the Company and The Bank of New York, as Trustee.(g) Second Supplemental Indenture dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(d) Indenture dated as of March 29, 1999, between the Company and The Bank of New York, as Trustee, including form of Notes.(h) First Supplemental Indenture dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(d) Indenture dated as of March 29, 1999, between the Company and The Bank of New York, as Trustee, including form of Notes.(h) First Supplemental Indenture dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(d) Indenture dated as of August 10, 2000, between the Company and Wilmington Trust Company, as Trustee.(i) First Supplemental Indenture dated as of September 28, 2000, between the Company and Wilmington Trust Company, as Trustee.(d) Amended and Restated Indenture dated as of October 16, 2001, between Calpine Canada Energy Finance ULC and Wilmington Trust Company, as Trustee.(j) Guarantee Agreement dated as of April 25, 2001, between the Company and Wilmington Trust Company, as Trustee.(k) First Amendment, dated as of October 16, 2001, to Guarantee Agreement dated as of April 25, 2001, between the Company and Wilmington Trust Company, as Trustee.(j) Indenture dated as of October 18, 2001, between Calpine Canada Energy Finance II ULC and Wilmington Trust Company, as Trustee.(j) First Supplemental Indenture, dated as of October 18, 2001, between Calpine Canada Energy Finance II ULC and Wilmington Trust Company, as Trustee.(j) Guarantee Agreement dated as of October 18, 2001, between the Company and Wilmington Trust Company, as Trustee.(j) First Amendment, dated as of October 18, 2001, to Guarantee Agreement dated as of October 18, 2001, between the Company and Wilmington Trust Company, as Trustee.(j) Indenture, dated as of June 13, 2003, between Power Contract Financing, L.L.C. and Wilmington Trust Company, as Trustee, Accounts Agent, Paying Agent and Registrar, including form of Notes.(l) Indenture, dated as of July 16, 2003, between the Company and Wilmington Trust Company, as Trustee, including form of Notes.(l) Indenture, dated as of July 16, 2003, between the Company and Wilmington Trust Company, as Trustee, including form of Notes.(l) Indenture, dated as of July 16, 2003, between the Company and Wilmington Trust Company, as Trustee, including form of Notes.(l) Indenture, dated as of August 14, 2003, among Calpine Construction Finance Company, L.P., CCFC Finance Corp., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, and Wilmington Trust Company, as Trustee, including form of Notes.(m) 113
Slide 115: Exhibit Number Description 4.13.2 4.13.3 4.13.4 4.14 4.15 4.16.1 4.16.2 4.17 4.18 4.19 4.20 4.21 4.21.1 4.21.2 4.21.3 4.21.4 4.21.5 4.21.6 4.21.7 4.23 4.22.1 Supplemental Indenture, dated as of September 18, 2003, among Calpine Construction Finance Company, L.P., CCFC Finance Corp., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, and Wilmington Trust Company, as Trustee.(m) Second Supplemental Indenture, dated as of January 14, 2004, among Calpine Construction Finance Company, L.P., CCFC Finance Corp., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, and Wilmington Trust Company, as Trustee.(n) Third Supplemental Indenture, dated as of March 5, 2004, among Calpine Construction Finance Company, L.P., CCFC Finance Corp., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, and Wilmington Trust Company, as Trustee.(n) Indenture, dated as of September 30, 2003, among Gilroy Energy Center, LLC, each of Creed Energy Center, LLC and Goose Haven Energy Center, as Guarantors, and Wilmington Trust Company, as Trustee and Collateral Agent, including form of Notes.(m) Indenture, dated as of November 18, 2003, between the Company and Wilmington Trust Company, as Trustee, including form of Notes.(n) Amended and Restated Indenture, dated as of March 12, 2004, between the Company and Wilmington Trust Company, including form of Notes.(n) Registration Rights Agreement, dated as of November 14, 2003, between the Company and Deutsche Bank Securities, Inc., as Representative of the Initial Purchasers.(n) Amended and Restated Rights Agreement, dated as of September 19, 2001, between Calpine Corporation and Equiserve Trust Company, N.A., as Rights Agent.(o) First Priority Indenture, dated as of March 23, 2004, among Calpine Generating Company, LLC, CalGen Finance Corp. and Wilmington Trust FSB, as Trustee, including form of Notes.(n) Second Priority Indenture, dated as of March 23, 2004, among Calpine Generating Company, LLC, CalGen Finance Corp. and Wilmington Trust FSB, as Trustee, including form of Notes.(n) Third Priority Indenture, dated as of March 23, 2004, among Calpine Generating Company, LLC, CalGen Finance Corp. and Wilmington Trust FSB, as Trustee, including form of Notes.(n) HIGH TIDES I. CertiÑcate of Trust of Calpine Capital Trust, a Delaware statutory trust, dated September 29, 1999.(p) Corrected CertiÑcate of CertiÑcate of Trust of Calpine Capital Trust, a Delaware statutory trust, Ñled October 4, 1999.(p) Declaration of Trust of Calpine Capital Trust, dated as of October 4, 1999, among Calpine Corporation, as Depositor, The Bank of New York (Delaware), as Delaware Trustee, The Bank of New York, as Property Trustee, and the Administrative Trustees named therein.(p) Indenture, dated as of November 2, 1999, between Calpine Corporation and The Bank of New York, as Trustee, including form of Debenture.(p) Remarketing Agreement, dated November 2, 1999, among Calpine Corporation, Calpine Capital Trust, The Bank of New York, as Tender Agent, and Credit Suisse First Boston Corporation, as Remarketing Agent.(p) Amended and Restated Declaration of Trust of Calpine Capital Trust, dated as of November 2, 1999, among Calpine Corporation, as Depositor and Debenture Issuer, The Bank of New York (Delaware), as Delaware Trustee, and The Bank of New York, as Property Trustee, and the Administrative Trustees named therein, including form of Preferred Security and form of Common Security.(p) Preferred Securities Guarantee Agreement, dated as of November 2, 1999, between Calpine Corporation and The Bank of New York, as Guarantee Trustee.(p) HIGH TIDES II. CertiÑcate of Trust of Calpine Capital Trust II, a Delaware statutory trust, Ñled January 25, 2000.(q) 114
Slide 116: Exhibit Number Description 4.22.2 4.22.3 4.22.4 4.22.5 4.22.6 4.22.7 4.23 4.23.1 4.23.2 4.23.3 4.23.4 4.23.5 4.23.6 4.23.7 4.23.8 4.24 4.24.1 4.24.2 4.24.3 Declaration of Trust of Calpine Capital Trust II, dated as of January 24, 2000, among Calpine Corporation, as Depositor and Debenture Issuer, The Bank of New York (Delaware), as Delaware Trustee, The Bank of New York, as Property Trustee, and the Administrative Trustees named therein.(q) Indenture, dated as of January 31, 2000, between Calpine Corporation and The Bank of New York, as Trustee, including form of Debenture.(q) Remarketing Agreement, dated as of January 31, 2000, among Calpine Corporation, Calpine Capital Trust II, The Bank of New York, as Tender Agent, and Credit Suisse First Boston Corporation, as Remarketing Agent.(q) Registration Rights Agreement, dated January 31, 2000, among Calpine Corporation, Calpine Capital Trust II, Credit Suisse First Boston Corporation and ING Barings LLC.(q) Amended and Restated Declaration of Trust of Calpine Capital Trust II, dated as of January 31, 2000, among Calpine Corporation, as Depositor and Debenture Issuer, The Bank of New York (Delaware), as Delaware Trustee, The Bank of New York, as Property Trustee, and the Administrative Trustees named therein, including form of Preferred Security and form of Common Security.(q) Preferred Securities Guarantee Agreement, dated as of January 31, 2000, between Calpine Corporation and The Bank of New York, as Guarantee Trustee.(q) HIGH TIDES III. Amended and Restated CertiÑcate of Trust of Calpine Capital Trust III, a Delaware statutory trust, Ñled July 19, 2000.(r) Declaration of Trust of Calpine Capital Trust III dated June 28, 2000, among the Company, as Depositor and Debenture Issuer, The Bank of New York (Delaware), as Delaware Trustee, The Bank of New York, as Property Trustee and the Administrative Trustees named therein.(r) Amendment No. 1 to the Declaration of Trust of Calpine Capital Trust III dated July 19, 2000, among the Company, as Depositor and Debenture Issuer, Wilmington Trust Company, as Delaware Trustee, Wilmington Trust Company, as Property Trustee, and the Administrative Trustees named therein.(r) Indenture dated as of August 9, 2000, between the Company and Wilmington Trust Company, as Trustee.(r) Remarketing Agreement dated as of August 9, 2000, among the Company, Calpine Capital Trust III, Wilmington Trust Company, as Tender Agent, and Credit Suisse First Boston Corporation, as Remarketing Agent.(r) Registration Rights Agreement dated as August 9, 2000, between the Company, Calpine Capital Trust III, Credit Suisse First Boston Corporation, ING Barings LLC and CIBC World Markets Corp.(r) Amended and Restated Declaration of Trust of Calpine Capital Trust III dated as of August 9, 2000, the Company, as Depositor and Debenture Issuer, Wilmington Trust Company, as Delaware Trustee, Wilmington Trust Company, as Property Trustee, and the Administrative Trustees named therein, including the form of Preferred Security and form of Common Security.(r) Preferred Securities Guarantee Agreement dated as of August 9, 2000, between the Company, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.(r) PASS THROUGH CERTIFICATES (TIVERTON AND RUMFORD). Pass Through Trust Agreement dated as of December 19, 2000, among Tiverton Power Associates Limited Partnership, Rumford Power Associates Limited Partnership and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including the form of CertiÑcate.(d) Participation Agreement dated as of December 19, 2000, among the Company, Tiverton Power Associates Limited Partnership, Rumford Power Associates Limited Partnership, PMCC Calpine New England Investment LLC, PMCC Calpine NEIM LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee.(d) Appendix A Ì DeÑnitions and Rules of Interpretation.(d) 115
Slide 117: Exhibit Number Description 4.24.4 4.24.5 4.24.6 4.25 4.25.1 4.25.2 4.25.3 4.25.4 4.25.5 4.25.6 4.25.7 Indenture of Trust, Mortgage and Security Agreement, dated as of December 19, 2000, between PMCC Calpine New England Investment LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, including the forms of Lessor Notes.(s) Calpine Guaranty and Payment Agreement (Tiverton) dated as of December 19, 2000, by Calpine, as Guarantor, to PMCC Calpine New England Investment LLC, PMCC Calpine NEIM LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(d) Calpine Guaranty and Payment Agreement (Rumford) dated as of December 19, 2000, by Calpine, as Guarantor, to PMCC Calpine New England Investment LLC, PMCC Calpine NEIM LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(d) PASS THROUGH CERTIFICATES (SOUTH POINT, BROAD RIVER AND ROCKGEN). Pass Through Trust Agreement A dated as of October 18, 2001, among South Point Energy Center, LLC, Broad River Energy LLC, RockGen Energy LLC and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including the form of 8.400% Pass Through CertiÑcate, Series A.(b) Pass Through Trust Agreement B dated as of October 18, 2001, among South Point Energy Center, LLC, Broad River Energy LLC, RockGen Energy LLC and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including the form of 9.825% Pass Through CertiÑcate, Series B.(b) Participation Agreement (SP-1) dated as of October 18, 2001, among the Company, South Point Energy Center, LLC, South Point OL-1, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-1, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (SP-2) dated as of October 18, 2001, among the Company, South Point Energy Center, LLC, South Point OL-2, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-2, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (SP-3) dated as of October 18, 2001, among the Company, South Point Energy Center, LLC, South Point OL-3, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-3, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (SP-4) dated as of October 18, 2001, among the Company, South Point Energy Center, LLC, South Point OL-4, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-4, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (BR-1) dated as of October 18, 2001, among the Company, Broad River Energy LLC, Broad River OL-1, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-1, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) 116
Slide 118: Exhibit Number Description 4.25.8 4.25.9 4.25.10 4.25.11 4.25.12 4.25.13 4.25.14 4.25.15 4.25.16 4.25.17 Participation Agreement (BR-2) dated as of October 18, 2001, among the Company, Broad River Energy LLC, Broad River OL-2, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-2, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (BR-3) dated as of October 18, 2001, among the Company, Broad River Energy LLC, Broad River OL-3, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-3, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (BR-4) dated as of October 18, 2001, among the Company, Broad River Energy LLC, Broad River OL-4, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-4, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (RG-1) dated as of October 18, 2001, among the Company, RockGen Energy LLC, RockGen OL-1, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-1, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (RG-2) dated as of October 18, 2001, among the Company, RockGen Energy LLC, RockGen OL-2, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-2, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (RG-3) dated as of October 18, 2001, among the Company, RockGen Energy LLC, RockGen OL-3, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-3, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Participation Agreement (RG-4) dated as of October 18, 2001, among the Company, RockGen Energy LLC, RockGen OL-4, LLC, Wells Fargo Bank Northwest, National Association, as Lessor Manager, SBR OP-4, LLC, State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, National Association, as Pass Through Trustee, including Appendix A Ì DeÑnitions and Rules of Interpretation.(b) Indenture of Trust, Deed of Trust, Assignment of Rents and Leases, Security Agreement and Financing Statement, dated as of October 18, 2001, between South Point OL-1, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of South Point Lessor Notes.(b) Indenture of Trust, Deed of Trust, Assignment of Rents and Leases, Security Agreement and Financing Statement, dated as of October 18, 2001, between South Point OL-2, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of South Point Lessor Notes.(b) Indenture of Trust, Deed of Trust, Assignment of Rents and Leases, Security Agreement and Financing Statement, dated as of October 18, 2001, between South Point OL-3, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of South Point Lessor Notes.(b) 117
Slide 119: Exhibit Number Description 4.25.18 4.25.19 4.25.20 4.25.21 4.25.22 4.25.23 4.25.24 4.25.25 4.25.26 4.25.27 4.25.28 4.25.29 4.25.30 Indenture of Trust, Deed of Trust, Assignment of Rents and Leases, Security Agreement and Financing Statement, dated as of October 18, 2001, between South Point OL-4, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of South Point Lessor Notes.(b) Indenture of Trust, Mortgage, Security Agreement and Fixture Filing, dated as of October 18, 2001, between Broad River OL-1, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, Mortgagee and Account Bank, including the form of Broad River Lessor Notes.(b) Indenture of Trust, Mortgage, Security Agreement and Fixture Filing, dated as of October 18, 2001, between Broad River OL-2, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, Mortgagee and Account Bank, including the form of Broad River Lessor Notes.(b) Indenture of Trust, Mortgage, Security Agreement and Fixture Filing, dated as of October 18, 2001, between Broad River OL-3, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, Mortgagee and Account Bank, including the form of Broad River Lessor Notes.(b) Indenture of Trust, Mortgage, Security Agreement and Fixture Filing, dated as of October 18, 2001, between Broad River OL-4, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee, Mortgagee and Account Bank, including the form of Broad River Lessor Notes.(b) Indenture of Trust, Mortgage and Security Agreement, dated as of October 18, 2001, between RockGen OL-1, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of RockGen Lessor Notes.(b) Indenture of Trust, Mortgage and Security Agreement, dated as of October 18, 2001, between RockGen OL-2, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of RockGen Lessor Notes.(b) Indenture of Trust, Mortgage and Security Agreement, dated as of October 18, 2001, between RockGen OL-3, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of RockGen Lessor Notes.(b) Indenture of Trust, Mortgage and Security Agreement, dated as of October 18, 2001, between RockGen OL-4, LLC and State Street Bank and Trust Company of Connecticut, National Association, as Indenture Trustee and Account Bank, including the form of RockGen Lessor Notes.(b) Calpine Guaranty and Payment Agreement (South Point SP-1) dated as of October 18, 2001, by Calpine, as Guarantor, to South Point OL-1, LLC, SBR OP-1, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (South Point SP-2) dated as of October 18, 2001, by Calpine, as Guarantor, to South Point OL-2, LLC, SBR OP-2, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (South Point SP-3) dated as of October 18, 2001, by Calpine, as Guarantor, to South Point OL-3, LLC, SBR OP-3, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (South Point SP-4) dated as of October 18, 2001, by Calpine, as Guarantor, to South Point OL-4, LLC, SBR OP-4, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) 118
Slide 120: Exhibit Number Description 4.25.31 4.25.32 4.25.33 4.25.34 4.25.35 4.25.36 4.25.37 4.25.38 10.1 10.1.1.1 10.1.1.2 10.1.2.1 10.1.2.2 Calpine Guaranty and Payment Agreement (Broad River BR-1) dated as of October 18, 2001, by Calpine, as Guarantor, to Broad River OL-1, LLC, SBR OP-1, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (Broad River BR-2) dated as of October 18, 2001, by Calpine, as Guarantor, to Broad River OL-2, LLC, SBR OP-2, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (Broad River BR-3) dated as of October 18, 2001, by Calpine, as Guarantor, to Broad River OL-3, LLC, SBR OP-3, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (Broad River BR-4) dated as of October 18, 2001, by Calpine, as Guarantor, to Broad River OL-4, LLC, SBR OP-4, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (RockGen RG-1) dated as of October 18, 2001, by Calpine, as Guarantor, to RockGen OL-1, LLC, SBR OP-1, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (RockGen RG-2) dated as of October 18, 2001, by Calpine, as Guarantor, to RockGen OL-2, LLC, SBR OP-2, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (RockGen RG-3) dated as of October 18, 2001, by Calpine, as Guarantor, to RockGen OL-3, LLC, SBR OP-3, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Calpine Guaranty and Payment Agreement (RockGen RG-4) dated as of October 18, 2001, by Calpine, as Guarantor, to RockGen OL-4, LLC, SBR OP-4, LLC, State Street Bank and Trust Company of Connecticut, as Indenture Trustee, and State Street Bank and Trust Company of Connecticut, as Pass Through Trustee.(b) Financing Agreements. Calpine Construction Finance Company Financing Agreement (""CCFC II''), dated as of October 16, 2000.(d)(s) Amended and Restated Credit Agreement, dated as of March 23, 2004, among Calpine Generating Company, LLC, the Guarantors named therein, the Lenders named therein, The Bank of Nova Scotia, as Administrative Agent, LC Bank, Lead Arranger and Sole Bookrunner, Bayerische Landesbank Cayman Islands Branch, as Arranger and Co-Syndication Agent, Credit Lyonnais New York Branch, as Arranger and Co-Syndication Agent, ING Capital LLC, as Arranger and Co-Syndication Agent, Toronto-Dominion (Texas) Inc., as Arranger and CoSyndication Agent, and Union Bank of California, N.A., as Arranger and Co-Syndication Agent.(n) Amended and Restated Credit Agreement, dated as of July 16, 2003 (""Amended and Restated Credit Agreement''), among the Company, the Lenders named therein, The Bank of Nova Scotia, as Administrative Agent, Funding Agent, Lead Arranger and Bookrunner, Bayerische Landesbank, Cayman Islands Branch, as Lead Arranger, as Co-Bookrunner and Documentation Agent, and ING Capital LLC and Toronto Dominion (Texas) Inc., as Lead Arrangers, CoBookrunners and Syndication Agents.(l) First Amendment to Amended and Restated Credit Agreement, dated as of August 7, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(l) 119
Slide 121: Exhibit Number Description 10.1.2.3 10.1.2.4 10.1.2.5 10.1.2.6 10.1.2.7 10.1.2.8 10.1.2.9 10.1.3 10.1.4 10.1.5 10.1.6 10.1.7.1 10.1.7.2 10.1.8.1 10.1.8.2 10.1.9 10.1.10.1 10.1.10.2 Amendment and Waiver to Amended and Restated Credit Agreement, dated as of August 28, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(m) Letter Agreement regarding Technical Correction to Amendment and Waiver to Amended and Restated Credit Agreement, dated as of September 5, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(m) Third Amendment to Amended and Restated Credit Agreement, dated as of November 6, 2003, among the Company, each of Quintana Minerals (USA) Inc., JOQ Canada, Inc., and Quintana Canada Holdings, LLC, as a Guarantor, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(m) Fourth Amendment and Waiver to Amended and Restated Credit Agreement, dated as of November 19, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(n) Fifth Amendment and Waiver to Amended and Restated Credit Agreement, dated as of December 30, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(n) Technical Correction to Fifth Amendment and Waiver to Amended and Restated Credit Agreement, dated as of December 31, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(n) Waiver to Amended and Restated Credit Agreement, dated as of March 5, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent and Funding Agent.(n) Letter of Credit Agreement, dated as of July 16, 2003, among the Company, the Lenders named therein, and The Bank of Nova Scotia, as Administrative Agent.(l) Guarantee and Collateral Agreement, dated as of July 16, 2003, made by Calpine Corporation, JOQ Canada, Inc., Quintana Minerals (USA) Inc., and Quintana Canada Holdings LLC, in favor of The Bank of New York, as Collateral Trustee.(l) First Amendment Pledge Agreement, dated as of July 16, 2003, made by JOQ Canada, Inc., Quintana Minerals (USA) Inc., and Quintana Canada Holdings LLC in favor of The Bank of New York, as Collateral Trustee.(l) First Amendment Assignment and Security Agreement, dated as of July 16, 2003, made by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(l) Second Amendment Pledge Agreement (Stock Interests), dated as of July 16, 2003, made by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(l) Amendment No. 1 to the Second Amendment Pledge Agreement (Stock Interests), dated as of November 18, 2003, made by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(n) Second Amendment Pledge Agreement (Membership Interests), dated as of July 16, 2003, made by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(l) Amendment No. 1 to the Second Amendment Pledge Agreement (Membership Interests), dated as of November 18, 2003, made by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(n) First Amendment Note Pledge Agreement, dated as of July 16, 2003, made by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(l) Collateral Trust Agreement, dated as of July 16, 2003, among Calpine Corporation, JOQ Canada, Inc., Quintana Minerals (USA) Inc., Quintana Canada Holdings LLC, Wilmington Trust Company, as Trustee, The Bank of Nova Scotia, as Agent, Goldman Sachs Credit Partners L.P., as Administrative Agent, and The Bank of New York, as Collateral Trustee.(l) First Amendment to the Collateral Trust Agreement, dated as of November 18, 2003, among Calpine Corporation, JOQ Canada, Inc., Quintana Minerals (USA) Inc., Quintana Canada Holdings LLC, Wilmington Trust Company, as Trustee, The Bank of Nova Scotia, as Agent, Goldman Sachs Credit Partners L.P., as Administrative Agent, and The Bank of New York, as Collateral Trustee.(n) 120
Slide 122: Exhibit Number Description 10.1.11 10.1.12 10.1.13 10.1.14 10.1.15 10.1.16 10.1.17 10.1.18 10.1.19 10.1.20 10.1.21 10.1.22 10.1.23 10.1.24 10.1.25 10.2 10.2.1 Form of Amended and Restated Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Multistate), dated as of July 16, 2003, from Calpine Corporation to Messrs. Denis O'Meara and James Trimble, as Trustees, and The Bank of New York, as Collateral Trustee.(l) Form of Amended and Restated Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Multistate), dated as of July 16, 2003, from Calpine Corporation to Messrs. Kemp Leonard and John Quick, as Trustees, and The Bank of New York, as Collateral Trustee.(l) Form of Amended and Restated Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (Colorado), dated as of July 16, 2003, from Calpine Corporation to Messrs. Kemp Leonard and John Quick, as Trustees, and The Bank of New York, as Collateral Trustee.(l) Form of Amended and Restated Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (New Mexico), dated as of July 16, 2003, from Calpine Corporation to Messrs. Kemp Leonard and John Quick, as Trustees, and The Bank of New York, as Collateral Trustee.(l) Form of Amended and Restated Mortgage, Assignment, Security Agreement and Financing Statement (Louisiana), dated as of July 16, 2003, from Calpine Corporation to The Bank of New York, as Collateral Trustee.(l) Form of Amended and Restated Deed of Trust with Power of Sale, Assignment of Production, Security Agreement, Financing Statement and Fixture Filings (California), dated as of July 16, 2003, from Calpine Corporation to Chicago Title Insurance Company, as Trustee, and The Bank of New York, as Collateral Trustee.(l) Form of Deed to Secure Debt, Assignment of Rents and Security Agreement (Georgia), dated as of July 16, 2003, from Calpine Corporation to The Bank of New York, as Collateral Trustee.(l) Form of Mortgage, Assignment of Rents and Security Agreement (Florida), dated as of July 16, 2003, from Calpine Corporation to The Bank of New York, as Collateral Trustee.(l) Form of Deed of Trust, Assignment of Rents and Security Agreement and Fixture Filing (Texas), dated as of July 16, 2003, from Calpine Corporation to Malcolm S. Morris, as Trustee, in favor of The Bank of New York, as Collateral Trustee.(l) Form of Deed of Trust, Assignment of Rents and Security Agreement (Washington), dated as of July 16, 2003, from Calpine Corporation to Chicago Title Insurance Company, in favor of The Bank of New York, as Collateral Trustee.(l) Form of Deed of Trust, Assignment of Rents, and Security Agreement (California), dated as of July 16, 2003, from Calpine Corporation to Chicago Title Insurance Company, in favor of The Bank of New York, as Collateral Trustee.(l) Form of Mortgage, Collateral Assignment of Leases and Rents, Security Agreement and Financing Statement (Louisiana), dated as of July 16, 2003, from Calpine Corporation to The Bank of New York, as Collateral Trustee.(l) Amended and Restated Hazardous Materials Undertaking and Indemnity (Multistate), dated as of July 16, 2003, by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(l) Amended and Restated Hazardous Materials Undertaking and Indemnity (California), dated as of July 16, 2003, by Calpine Corporation in favor of The Bank of New York, as Collateral Trustee.(l) Designated Asset Sale Proceeds Account Control Agreement, dated as of July 16, 2003, among Calpine Corporation, Union Bank of California, N.A., and The Bank of New York, as Collateral Agent.(n) Term Loan Agreements. Credit Agreement, dated as of July 16, 2003, among the Company, the Lenders named therein, Goldman Sachs Credit Partners L.P., as Sole Lead Arranger, Sole Bookrunner and Administrative Agent, The Bank of Nova Scotia, as Arranger and Syndication Agent, TD Securities (USA) Inc., ING (U.S.) Capital LLC and Landesbank Hessen-Thuringen, as Co-Arrangers, and Credit Lyonnais New York Branch and Union Bank of California, N.A., as Managing Agents.(l) 121
Slide 123: Exhibit Number Description 10.2.2.1 10.2.2.2 10.2.2.3 10.2.2.4 10.2.3 10.2.4 10.3 10.3.1 10.3.2 10.3.3 10.3.4 10.3.5 10.3.6 10.3.7 10.3.8 10.3.9 10.3.10 10.3.11 Credit and Guarantee Agreement, dated as of August 14, 2003, among Calpine Construction Finance Company, L.P., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, the Lenders named therein, and Goldman Sachs Credit Partners L.P., as Administrative Agent and Sole Lead Arranger.(m) Amendment No. 1 to the Credit and Guarantee Agreement, dated as of September 12, 2003, among Calpine Construction Finance Company, L.P., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, the Lenders named therein, and Goldman Sachs Credit Partners L.P., as Administrative Agent and Sole Lead Arranger.(m) Amendment No. 2 to the Credit and Guarantee Agreement, dated as of January 13, 2004, among Calpine Construction Finance Company, L.P., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, the Lenders named therein, and Goldman Sachs Credit Partners L.P., as Administrative Agent and Sole Lead Arranger.(n) Amendment No. 3 to the Credit and Guarantee Agreement, dated as of March 5, 2004, among Calpine Construction Finance Company, L.P., each of Calpine Hermiston, LLC, CPN Hermiston, LLC and Hermiston Power Partnership, as Guarantors, the Lenders named therein, and Goldman Sachs Credit Partners L.P., as Administrative Agent and Sole Lead Arranger.(n) Credit and Guarantee Agreement, dated as of March 23, 2004, among Calpine Generating Company, LLC, the Guarantors named therein, the Lenders named therein, Morgan Stanley Senior Funding, Inc., as Administrative Agent, and Morgan Stanley Senior Funding, Inc., as Sole Lead Arranger and Sole Bookrunner.(n) Credit and Guarantee Agreement, dated as of March 23, 2004, among Calpine Generating Company, LLC, the Guarantors named therein, the Lenders named therein, Morgan Stanley Senior Funding, Inc., as Administrative Agent, and Morgan Stanley Senior Funding, Inc., as Sole Lead Arranger and Sole Bookrunner.(n) Management Contracts or Compensatory Plans or Arrangements. Calpine Corporation 1996 Stock Incentive Plan and forms of agreements there under.(n)(t) Employment Agreement, dated as of January 1, 2000, between Calpine Corporation and Mr. Peter Cartwright.(q)(t) Employment Agreement, dated as of January 1, 2000, between Calpine Corporation and Ms. Ann B. Curtis.(b)(t) Employment Agreement, dated as of January 1, 2000, between Calpine Corporation and Mr. Ron A. Walter.(b)(t) Employment Agreement, dated as of January 1, 2000, between Calpine Corporation and Mr. Robert D. Kelly.(b)(t) Employment Agreement, dated as of January 1, 2000, between Calpine Corporation and Mr. Thomas R. Mason.(b)(t) Consulting Contract, dated as of January 1, 2004, between Calpine Corporation and Mr. George J. Stathakis.(n)(t) Calpine Corporation Annual Management Incentive Plan.(u)(t) $500,000 Promissory Note Secured by Deed of Trust made by Thomas R. Mason and Debra J. Mason in favor of Calpine Corporation.(u)(t) 2000 Employee Stock Purchase Plan (v)(t) Form of IndemniÑcation Agreement for directors and oÇcers.(w)(t) 122
Slide 124: Exhibit Number Description 10.3.12 10.4 10.4.1 12.1 21.1 23.1 23.2 23.3 23.4 24.1 31.1 31.2 32.1 99.1 99.2 Form of IndemniÑcation Agreement for directors and oÇcers.(b)(t) Power Purchase and Sale Agreements. Power Purchase and Sale Agreements with the State of California Department of Water Resources comprising Amended and Restated Cover Sheet and Master Power Purchase and Sale Agreement, dated as of April 22, 2002 and eÅective as of May 1, 2004, between Calpine Energy Services, L.P. and the State of California Department of Water Resources together with Amended and Restated ConÑrmation (""Calpine 1''), Amended and Restated ConÑrmation (""Calpine 2''), Amended and Restated ConÑrmation (""Calpine 3'') and Amended and Restated ConÑrmation (""Calpine 4''), each dated as of April 22, 2002, and eÅective as of May 1, 2002, between Calpine Energy Services, L.P., and the State of California Department of Water Resources.(x) Statement on Computation of Ratio of Earnings to Fixed Charges.(n) Subsidiaries of the Company.(n) Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.(*) Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm.(*) Consent of Netherland, Sewell & Associates, Inc., independent engineer.(*) Consent of Gilbert Laustsen Jung Associates, Ltd., independent engineer.(*) Power of Attorney of OÇcers and Directors of Calpine Corporation (set forth on the signature pages of this report).(*) CertiÑcation of the Chairman, President and Chief Executive OÇcer 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.(*) CertiÑcation of the Executive Vice President and Chief Financial OÇcer 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.(*) CertiÑcation of Chief Executive OÇcer and Chief Financial OÇcer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(*) Acadia Power Partners, LLC and Subsidiary, Consolidated Financial Statements, December 31, 2003, 2002 and 2001.(*) Consent of PricewaterhouseCoopers LLP, Independent Accountants.(*) (*) Filed herewith. (a) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated June 30, 2004, Ñled with the SEC on August 9, 2004. (b) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K dated December 31, 2001, Ñled with the SEC on March 29, 2002. (c) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration Statement No. 333-06259) Ñled with the SEC on June 19, 1996. (d) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, Ñled with the SEC on March 15, 2001. (e) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated June 30, 1997, Ñled with the SEC on August 14, 1997. (f) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration Statement No. 333-41261) Ñled with the SEC on November 28, 1997. (g) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration Statement No. 333-61047) Ñled with the SEC on August 10, 1998. (h) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3/A (Registration Statement No. 333-72583) Ñled with the SEC on March 8, 1999. (i) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3 (Registration No. 333-76880) Ñled with the SEC on January 17, 2002. 123
Slide 125: (j) Incorporated by reference to Calpine Corporation's Current Report on Form 8-K dated October 16, 2001, Ñled with the SEC on November 13, 2001. (k) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3/A (Registration No. 333-57338) Ñled with the SEC on April 19, 2001. (l) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated June 30, 2003, Ñled with the SEC on August 14, 2003. (m) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated September 30, 2003, Ñled with the SEC on November 13, 2003. (n) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K dated December 31, 2003, Ñled with the SEC on March 25, 2004. (o) Incorporated by reference to Calpine Corporation's Registration Statement on Form 8-A/A (Registration No. 001-12079) Ñled with the SEC on September 28, 2001. (p) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3/A (Registration Statement No. 333-87427) Ñled with the SEC on October 26, 1999. (q) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 1999, Ñled with the SEC on February 29, 2000. (r) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3 (Registration Statement No. 333-47068) Ñled with the SEC on September 29, 2000. (s) Approximately 71 pages of this exhibit have been omitted pursuant to a request for conÑdential treatment. The omitted language has been Ñled separately with the SEC. (t) Management contract or compensatory plan or arrangement. (u) Incorporated by reference to Calpine Corporation's Current Report on Form 8-K dated March 30, 2000, Ñled with the SEC on April 3, 2000. (v) Incorporated by reference to Calpine Corporation's DeÑnitive Proxy Statement on Schedule 14A dated April 13, 2000, Ñled with the SEC on April 13, 2000. (w) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-1/A (Registration Statement No. 333-07497) Ñled with the SEC on August 22, 1996. (x) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K/A dated December 31, 2003, Ñled with the SEC on September 13, 2004. 124
Slide 126: SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 OÇcer Date: September 22, 2004 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENT: That the undersigned oÇcers and directors of Calpine Corporation do hereby constitute and appoint Peter Cartwright and Ann B. Curtis, and each of them, the lawful attorney and agent or attorneys and agents with power and authority to do any and all acts and things and to execute any and all instruments which said attorneys and agents, or either of them, determine may be necessary or advisable or required to enable Calpine Corporation to comply with the Securities and Exchange Act of 1934, as amended, and any rules or regulations or requirements of the Securities and Exchange Commission in connection with this Form 10-K Annual Report. Without limiting the generality of the foregoing power and authority, the powers granted include the power and authority to sign the names of the undersigned oÇcers and directors in the capacities indicated below to this Form 10-K/A Annual Report or amendments or supplements thereto, and each of the undersigned hereby ratiÑes and conÑrms all that said attorneys and agents, or either of them, shall do or cause to be done by virtue hereof. This Power of Attorney may be signed in several counterparts. IN WITNESS WHEREOF, each of the undersigned has executed this Power of Attorney as of the date indicated opposite the name. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ PETER CARTWRIGHT Peter Cartwright ANN B. CURTIS Ann B. Curtis ROBERT D. KELLY Robert D. Kelly Chairman, President, Chief Executive and Director (Principal Executive OÇcer) Executive Vice President, Vice Chairman and Director Executive Vice President and Chief Financial OÇcer (Principal Financial OÇcer) Senior Vice President and Corporate Controller (Principal Accounting OÇcer) 125 September 22, 2004 September 22, 2004 September 22, 2004 September 22, 2004 /s/ /s/ /s/ CHARLES B. CLARK, JR. Charles B. Clark, Jr.
Slide 127: Signature Title Date * Kenneth T. Derr * JeÅrey E. Garten Director September 22, 2004 September 22, 2004 Director Director Gerald Greenwald * Susan C. Schwab * George J. Stathakis * Susan Wang * John O. Wilson *By: /s/ ANN B. CURTIS Ann B. Curtis Attorney-in-Fact Director September 22, 2004 September 22, 2004 September 22, 2004 September 22, 2004 September 22, 2004 Director Director Director 126
Slide 128: CALPINE CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 Reports of Independent Registered Public Accounting Firms ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Balance Sheets December 31, 2003 and 2002ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002, and 2001 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2003, 2002, and 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002, and 2001 Notes to Consolidated Financial Statements for the Years Ended December 31, 2003, 2002, and 2001 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ F-2 F-4 F-6 F-8 F-9 F-11 F-1
Slide 129: REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors And Stockholders of Calpine Corporation: In our opinion, the accompanying consolidated Ñnancial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the Ñnancial position of Calpine Corporation and its subsidiaries (the ""Company'') at December 31, 2003, and the results of their operations and their cash Öows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the Ñnancial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated Ñnancial statements. These Ñnancial statements and Ñnancial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these Ñnancial statements and Ñnancial statement schedule based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements, assessing the accounting principles used and signiÑcant estimates made by management, and evaluating the overall Ñnancial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The Ñnancial statements of the Company as of December 31, 2002 and for the two years then ended were audited by other auditors whose report dated March 10, 2003, except as to paragraph two of note 10 as to which the date is October 21, 2003, and except as to paragraph six and eight of note 10 as to which the date is March 22, 2004, expressed an unqualiÑed opinion on those statements and included emphasis paragraphs relating to the adoption of new accounting standards and the reclassiÑcation of certain discontinued operations. As discussed in Note 2 to the consolidated Ñnancial statements, the Company changed the manner in which they account for asset retirement costs and stock based compensation as of January 1, 2003, changed the manner in which they account for certain Ñnancial instruments with characteristics of both liabilities and equity, eÅective July 1, 2003, changed the manner in which they report gains and losses on certain derivative instruments not held for trading purposes and account for certain derivative contracts with a price adjustment feature, eÅective October 1, 2003 and adopted certain provisions of Financial Accounting Standards Board Interpretation No. 46, ""Consolidation of Variable Interest Entities Ì an interpretation of ARB 51 (revised December 2003),'' as of December 31, 2003. /S/ PRICEWATERHOUSECOOPERS LLP Los Angeles, California March 23, 2004 F-2
Slide 130: REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Calpine Corporation: We have audited the consolidated balance sheet of Calpine Corporation and subsidiaries (the ""Company'') as of December 31, 2002 and the related consolidated statements of operations, stockholders' equity, and cash Öows for the years ended December 31, 2002 and 2001. Our audits also included the 2002 and 2001 consolidated Ñnancial statement schedules listed in the Index at Item 15(a)-2. These Ñnancial statements and Ñnancial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these Ñnancial statements and Ñnancial statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the Ñnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements. An audit also includes assessing the accounting principles used and signiÑcant estimates made by management, as well as evaluating the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits, such consolidated Ñnancial statements present fairly, in all material respects, the consolidated Ñnancial position of Calpine Corporation and subsidiaries as of December 31, 2002, and the consolidated results of their operations and their cash Öows for the years ended 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 2002 and 2001 consolidated Ñnancial statement schedules, when considered in relation to the basic consolidated Ñnancial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 2 of the Notes to the Consolidated Financial Statements, in 2002, the Company adopted new accounting standards to account for the impairment of long-lived assets, discontinued operations, gains and losses on debt extinguishments and certain derivative contracts. Additionally, in 2002, the Company changed its method of reporting gains and losses associated with energy trading contracts from the gross to the net method and retroactively reclassiÑed the consolidated statement of operations for 2001. In 2001, as discussed in Note 2 of the Notes to the Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 133, ""Accounting for Derivative Instruments and Hedging Activities,'' as amended, and certain interpretations issued by the Derivative Implementation Group of the Financial Accounting Standards Board. As discussed in Note 10 of the Notes to the Consolidated Financial Statements, in June 2003, the Company approved the divestiture of its specialty data center engineering business; in November 2003, the Company completed the divestiture of certain oil and gas assets; and in December 2003, the Company committed to the divestiture of its Ñfty percent ownership interest in a power project. /s/ DELOITTE & TOUCHE LLP San Jose, California March 10, 2003 (October 21, 2003 as to paragraph two of Note 10 and March 22, 2004 as to paragraphs six and eight of Note 10) F-3
Slide 131: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2003 and 2002 2003 2002 (In thousands, except share and per share amounts) ASSETS Current assets: Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts receivable, net of allowance of $7,614 and $5,955 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Margin deposits and other prepaid expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ InventoriesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current derivative assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current assets held for saleÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes receivable, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Project development costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investments in power projects and oil and gas properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred Ñnancing costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prepaid lease, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property, plant and equipment, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Goodwill, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other intangible assets, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term derivative assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term assets held for sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 991,806 988,947 385,348 139,654 383,788 496,967 651 89,593 3,476,754 575,027 213,629 139,953 472,749 400,732 414,058 20,081,052 45,160 89,924 673,979 112,148 608,767 $ 579,486 745,312 152,413 105,872 176,716 330,244 2,669 143,318 2,236,030 9,203 195,398 116,795 421,402 185,026 301,603 18,730,847 29,165 93,066 496,028 127,363 285,066 $27,303,932 $23,226,992 F-4
Slide 132: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS Ì (Continued) December 31, 2003 and 2002 2003 2002 (In thousands, except share and per share amounts) LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued payroll and related expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued interest payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income taxes payableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes payable and borrowings under lines of credit, current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred interests, current portionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital lease obligation, current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Construction/project Ñnancing, current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior notes, current portionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current derivative liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current liabilities held for sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total current liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Term loan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes payable and borrowings under lines of credit, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes payable to Calpine Capital TrustsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Preferred interests, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital lease obligation, net of current portionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Construction/project Ñnancing, net of current portionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Convertible Senior Notes Due 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Convertible Senior Notes Due 2023 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Senior notes, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred income taxes, net of current portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred lease incentive ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term derivative liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term liabilities held for sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commitments and contingencies (see Note 24) Company-obligated mandatorily redeemable convertible preferred securities of subsidiary trusts Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stockholders' equity: Preferred stock, $.001 par value per share; authorized 10,000,000 shares; none issued and outstanding in 2003 and one share in 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock, $.001 par value per share; authorized 1,000,000,000 shares; issued and outstanding 415,010,125 shares in 2003 and 380,816,132 shares in 2002 ÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated other comprehensive income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities and stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 938,644 96,693 321,176 18,026 254,292 11,220 4,008 65,108 14,500 456,688 Ì 335,048 2,515,403 Ì 873,572 1,153,500 232,412 193,741 4,195,644 660,059 650,000 9,369,253 1,310,335 50,228 116,001 692,088 161 259,390 22,271,787 Ì 410,892 $ 1,237,261 47,978 189,336 3,640 340,703 Ì 3,454 1,307,291 Ì 189,356 1,962 301,097 3,622,078 949,565 8,249 Ì Ì 197,653 3,212,022 1,200,000 Ì 6,894,801 1,068,782 53,732 154,969 528,400 19 175,636 18,065,906 1,123,969 185,203 Ì 415 2,995,735 1,568,509 56,594 4,621,253 $27,303,932 Ì 381 2,802,503 1,286,487 (237,457) 3,851,914 $23,226,992 The accompanying notes are an integral part of these consolidated Ñnancial statements. F-5
Slide 133: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 2003 2002 2001 (In thousands, except per share amounts) Revenue: Electric generation and marketing revenue Electricity and steam revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased power for hedging and optimization ÏÏÏÏÏ Total electric generation and marketing revenue ÏÏÏÏÏÏÏÏÏ Oil and gas production and marketing revenue Oil and gas sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales of purchased gas for hedging and optimization ÏÏÏÏÏÏÏ Total oil and gas production and marketing revenue ÏÏÏÏÏÏ Mark-to-market activities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of revenue: Electric generation and marketing expense Plant operating expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Royalty expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased power expense for hedging and optimization ÏÏÏÏÏ Total electric generation and marketing expense ÏÏÏÏÏÏÏÏÏ Oil and gas operating and marketing expense Oil and gas operating expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchased gas expense for hedging and optimization ÏÏÏÏÏÏÏ Total oil and gas operating and marketing expense ÏÏÏÏÏÏÏ Fuel expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation, depletion and amortization expense ÏÏÏÏÏÏÏÏÏÏÏÏ Operating lease expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Income) from unconsolidated investments in power projects and oil and gas propertiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equipment cancellation and impairment cost ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term service agreement cancellation charge ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Project development expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Sales, general and administrative expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Merger expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,695,744 2,714,187 7,409,931 107,662 1,320,902 1,428,564 (26,439) 107,483 8,919,539 $3,222,202 3,145,991 6,368,193 120,930 870,466 991,396 21,485 10,787 7,391,861 $2,385,324 3,332,412 5,717,736 286,241 526,517 812,758 151,738 32,697 6,714,929 679,031 24,932 2,690,069 3,394,032 106,244 1,279,568 1,385,812 2,564,742 583,912 112,070 42,270 8,082,838 836,701 (76,703) 64,384 16,355 21,804 265,653 Ì 505,971 17,615 2,618,445 3,142,031 97,499 821,065 918,564 1,752,901 453,411 111,022 7,279 6,385,208 1,006,653 (16,552) 404,737 Ì 66,981 229,011 Ì 324,029 27,493 2,986,578 3,338,100 90,492 492,587 583,079 1,150,786 309,373 99,519 10,943 5,491,800 1,223,129 (16,946) Ì Ì 35,879 150,453 41,627 F-6
Slide 134: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Ì (Continued) For the Years Ended December 31, 2003 2002 2001 (In thousands, except per share amounts) Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Distributions on trust preferred securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest (income)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interest expense (income)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Income) from repurchase of various issuances of debt ÏÏÏÏÏÏÏÏÏ Other (income) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before provision (beneÑt) for income taxes ÏÏÏÏÏÏÏÏÏÏ Provision (beneÑt) for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Discontinued operations, net of tax (beneÑt) provision of $(5,819), $42,884 and $37,899ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of a change in accounting principle, net of tax provision of $110,913, $ Ì, and $699 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Basic earnings per common share: Weighted average shares of common stock outstanding ÏÏÏÏÏÏÏ Income before discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Discontinued operations, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of a change in accounting principle, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per common share: Weighted average shares of common stock outstanding before dilutive eÅect of certain convertible securities ÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before dilutive eÅect of certain convertible securities, discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dilutive eÅect of certain convertible securities(1)ÏÏÏÏÏÏÏÏÏÏÏÏ Income before discontinued operations and cumulative eÅect of a change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Discontinued operations, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of a change in accounting principle, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 545,208 726,103 46,610 (39,716) 27,330 (278,612) (46,126) 109,619 (134) 109,753 (8,674) 180,943 $ 282,022 390,772 $ $ $ $ 0.28 $ (0.02) $ 0.46 0.72 $ $ 322,476 413,690 62,632 (43,087) 2,716 (118,020) (34,200) 38,745 (14,945) 53,690 64,928 Ì $ 118,618 354,822 0.15 0.18 Ì 0.33 $ $ $ $ 1,012,116 196,621 62,412 (72,448) (1,344) (11,919) (41,786) 880,580 297,614 582,966 39,490 1,036 $ 623,492 303,522 1.92 0.13 Ì 2.05 396,219 362,533 317,919 $ $ $ $ $ $ 0.28 Ì $ $ 0.15 Ì 0.15 0.18 Ì 0.33 $ $ $ $ $ $ 1.83 (0.14) 1.69 0.11 Ì 1.80 0.28 $ (0.02) $ 0.45 0.71 $ $ (1) See Note 23 of the Notes to Consolidated Financial Statements for further information. The accompanying notes are an integral part of these consolidated Ñnancial statements. F-7
Slide 135: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 2003, 2002, and 2001 Accumulated Other Total Retained Comprehensive Stockholders' Earnings Income (Loss) Equity (In thousands, except share amounts) Common Stock Additional Paid-In Capital Comprehensive Income Balance, January 1, 2001 ÏÏÏÏÏÏ Issuance of 6,833,497 shares of common stock, net of issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏ Issuance of 151,176 shares of common stock for acquisitions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax beneÑt from stock options exercised and other ÏÏÏÏÏÏÏ Comprehensive income: Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other comprehensive loss ÏÏÏÏ Total comprehensive income Balance, December 31, 2001 ÏÏÏ Issuance of 73,757,381 shares of common stock, net of issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏ Tax beneÑt from stock options exercised and other ÏÏÏÏÏÏÏ Comprehensive income: Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other comprehensive income Total comprehensive income Balance, December 31, 2002 ÏÏÏ Issuance of 34,194,063 shares of common stock, net of issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏ Tax beneÑt from stock options exercised and other ÏÏÏÏÏÏÏ Stock compensation expense Comprehensive income: Net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other comprehensive income Total comprehensive income Balance, December 31, 2003 ÏÏÏ $300 $1,896,987 $ 544,377 $(25,363) $2,416,301 7 72,459 Ì Ì 72,466 Ì Ì Ì Ì 307 7,500 63,887 Ì Ì 2,040,833 Ì Ì 623,492 Ì 1,167,869 Ì Ì Ì (215,517) Ì (240,880) 7,500 63,887 623,492 (215,517) Ì 2,968,129 $623,492 (215,517) $407,975 74 Ì Ì Ì 381 751,721 9,949 Ì Ì 2,802,503 118,618 Ì 1,286,487 Ì 751,795 9,949 Ì 3,423 118,618 3,423 $118,618 3,423 $122,041 (237,457) 3,851,914 34 Ì Ì Ì Ì $415 175,063 2,097 16,072 Ì Ì $2,995,735 Ì Ì Ì 282,022 Ì $1,568,509 Ì Ì Ì Ì 294,051 Ì $ 56,594 175,097 2,097 16,072 282,022 294,051 Ì $4,621,253 $282,022 294,051 $576,073 The accompanying notes are an integral part of these consolidated Ñnancial statements. F-8
Slide 136: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2003, 2002, and 2001 2003 2002 (In thousands) 2001 Cash Öows from operating activities: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortization(1) ÏÏÏÏÏÏÏÏÏÏÏ Equipment cancellation and asset impairment cost ÏÏÏÏÏÏ Development cost write oÅ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred income taxes, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gain on sale of assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign currency transaction loss (gain)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative change in accounting principle ÏÏÏÏÏÏÏÏÏÏÏÏ Gain on retirement of debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in net derivative liability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from unconsolidated investments in power projects and oil and gas properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Distributions from unconsolidated investments in power projects and oil and gas properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock compensation expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in operating assets and liabilities, net of eÅects of acquisitions: Accounts receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other current assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts payable and accrued expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏ Cash Öows from investing activities: Purchases of property, plant and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Disposals of property, plant and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Acquisitions, net of cash acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from sale leasebacks ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advances to joint ventures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Project development costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from derivatives not designated as hedges ÏÏÏÏÏÏ (Increase) decrease in restricted cash ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (Increase) decrease in notes receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash used in investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 282,022 $ 118,618 $ 623,492 735,341 53,058 3,400 150,323 (65,351) 33,346 (180,943) (278,612) 27,330 59,490 (76,704) 141,627 16,072 542,176 404,737 56,427 23,206 (97,377) (986) Ì (118,020) 2,716 (340,851) (16,490) 14,117 Ì 364,056 Ì Ì 82,410 (38,258) 2,930 Ì (9,600) 1,345 (239,716) (9,433) 5,983 Ì (221,243) (160,672) (143,654) (111,901) 27,630 290,559 (1,886,013) 206,804 (6,818) Ì (54,024) (35,778) 42,342 (766,841) (21,135) 6,098 (2,515,365) 229,187 405,515 (305,908) (48,804) 200,203 1,068,466 (4,036,254) 400,349 Ì Ì (68,088) (105,182) 26,091 (73,848) 8,926 10,179 (3,837,827) (230,400) (527,296) (120,310) 449,369 68,997 423,569 (5,832,874) 49,120 (1,608,840) 517,081 (177,917) (147,520) 29,145 (45,642) (40,273) 17,065 (7,240,655) F-9
Slide 137: CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Ì (Continued) 2003 2002 (In thousands) 2001 Cash Öows from Ñnancing activities: Proceeds from issuance of Zero-Coupon Convertible Debentures Due 2021 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repurchase of Zero-Coupon Convertible Debentures Due 2021 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Borrowings from notes payable and lines of creditÏÏÏÏÏÏÏÏÏ Repayments of notes payable and lines of credit ÏÏÏÏÏÏÏÏÏÏ Borrowings from project Ñnancing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of project Ñnancing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from issuance of Convertible Senior Notes ÏÏÏÏÏÏ Repurchases of Convertible Senior Notes Due 2006 ÏÏÏÏÏÏÏ Repurchases of senior notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from issuance of senior notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from issuance of common stockÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from income trust oÅerings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financing costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by Ñnancing activities ÏÏÏÏÏÏÏÏÏÏ EÅect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents ÏÏÏÏÏÏÏ Cash and cash equivalents, beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents, end of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash paid during the period for: Interest, net of amounts capitalized ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 1,672,871 (1,769,072) 1,548,601 (1,638,519) 650,000 (455,447) (1,139,812) 3,892,040 15,951 159,727 (323,167) 10,813 2,623,986 13,140 412,320 579,486 $ $ $ 991,806 462,714 18,415 $ $ $ Ì (869,736) 1,348,798 (126,404) 725,111 (286,293) 100,000 Ì Ì Ì 751,795 169,677 (42,783) (12,769) 1,757,396 (2,693) (1,014,658) 1,594,144 579,486 325,334 15,451 1,000,000 (110,100) 148,863 (962,873) 3,869,391 (1,712,292) 1,100,000 Ì (106,300) 4,596,039 72,465 Ì (144,746) (270) 7,750,177 (3,669) 929,422 664,722 $ 1,594,144 $ $ 42,883 271,973 (1) Includes depreciation and amortization that is also recorded in sales, general and administrative expense and interest expense. Schedule of non cash investing and Ñnancing activities: ‚ 2003 issuance of 30 million shares of common stock in exchange for $182.5 million of debt, convertible debt and preferred securities ‚ 2002 non-cash consideration of $88.4 million in tendered Company debt received upon the sale of its British Columbia oil and gas properties ‚ 2001 equity investment in a power project for $17.5 million note receivable The accompanying notes are an integral part of these consolidated Ñnancial statements. F-10
Slide 138: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 2003, 2002, and 2001 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 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-Ñred power generation and cogeneration facilities, gas Ñelds, gathering systems and gas pipelines, geothermal steam Ñelds 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, power facilities. In the United Kingdom, the Company owns and operates a gas-Ñred 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-Ñred 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 SigniÑcant Accounting Policies Principles of Consolidation Ì The accompanying consolidated Ñnancial statements as of December 31, 2002, and for the three years ended December 31, 2003, include accounts of the Company and its wholly owned and majority-owned subsidiaries. The consolidated Ñnancial statements as of December 31, 2003, include the accounts of the Company and its majority-owned subsidiaries that are not considered Variable Interest Entities (""VIE'') and all special purpose VIEs for which the Company is the Primary BeneÑciary. Certain less-than-majority-owned subsidiaries are accounted for using the equity method. For equity method investments, the Company's share of income is calculated according to the Company's equity ownership or according to the terms of the appropriate partnership agreement (see Note 7). All intercompany accounts and transactions are eliminated in consolidation. ReclassiÑcations Ì Certain prior years amounts in the Consolidated Financial Statements have been reclassiÑed to conform to the 2003 presentation. Taxes on net current derivative assets and liabilities were reclassiÑed out of Deferred income taxes, net to Other current liabilities. Use of Estimates in Preparation of Financial Statements Ì The preparation of Ñnancial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that aÅect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the Ñnancial statements and the reported amounts of revenue and expense during the reporting period. Actual results could diÅer from those estimates. The most signiÑcant estimates with regard to these Ñnancial 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 beneÑciary determination for our 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. Operational data (including, but not limited to, megawatts (""MW''), megawatt hours (""MWh''), billions cubic feet equivalent (""Bcfe'') and thousand barrels (""MBbl''), throughout this Form-10K is unaudited. Foreign Currency Translation Ì Through its international operations, the Company owns 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 accordance with SFAS No. 52, ""Foreign Currency Translation,'' (""SFAS F-11
Slide 139: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) No. 52'' the Company translates the Ñnancial statements of its foreign subsidiaries from their respective functional currencies into the U.S. dollar, which represents the Company's reporting currency. Assets and liabilities held by the foreign subsidiaries are translated into U.S. dollars using exchange rates in eÅect at the balance sheet date. Certain long-term assets (such as the investment in a subsidiary company) as well as equity accounts are translated into U.S. dollars using historical exchange rates at the date the speciÑc transaction occurred which created the asset or equity balance (such as the date of the initial investment in the subsidiary). Income and expense accounts are translated into U.S. dollars using average exchange rates during the reporting period. All translation gains and losses that result from translating the Ñnancial statements of the Company's foreign subsidiaries from their respective functional currencies into the U.S. dollar reporting currency are recognized within the Cumulative Translation Adjustment (""CTA'') account, which is a component of Other Comprehensive Income (""OCI'') within Stockholders' Equity. In certain cases, the Company and its foreign subsidiary entities hold monetary assets and/or liabilities that are not denominated in the functional currencies referred to above. In such instances, the Company applies the provisions of SFAS No. 52 to account for the monthly re-measurement gains and losses of these assets and liabilities into the functional currencies for each entity. For foreign currency transactions designated as economic hedges of a net investment in a foreign entity and for intercompany foreign currency transactions which are of a long-term investment nature, the Company records the re-measurement gains and losses through the CTA account, in accordance with Paragraph 20 of SFAS No. 52. All other foreign currency transactions that do not qualify for the Paragraph 20 exclusion are re-measured at the end of each month into the proper functional currency, and the gains and losses resulting from such remeasurement are recorded within net income, in accordance with Paragraph 15 of SFAS No. 52. For the years ended December 31, 2003, 2002 and 2001, the Company recognized foreign currency transaction losses of $33.3 million, $1.0 million and $2.9 million, respectively. Subsequent to December 31, 2003, the Company was exposed to signiÑcant favorable exchange rate movements between the Euro and the Great British Pound (""GBP''). Included in the Company's portfolio of Senior Notes payable (as disclosed in Note 16) are its 83/8% Senior Notes Due 2008, which are denominated in Euros and were issued by a subsidiary with a functional currency of GBP. Subsequent to December 31, 2003, the Euro weakened considerably against the GBP, and the Company recognized re-measurement gains on these Senior Notes of approximately $11.3 million. Fair Value of Financial Instruments Ì The carrying value of accounts receivable, marketable securities, accounts and other payables approximate their respective fair values due to their short maturities. See Note 16 for disclosures regarding the fair value of the senior notes. Cash and Cash Equivalents Ì The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The carrying amount of these instruments approximates fair value because of their short maturity. The Company has certain project debt agreements which establish working capital accounts which limit the use of certain cash balances to the operations of the respective plants. At December 31, 2003 and 2002, $342.5 million and $189.0 million, respectively, of the cash and cash equivalents balance was subject to such project debt agreements. Accounts Receivable and Accounts Payable Ì Accounts receivable and payable represent amounts due from customers and owed to vendors. These balances also include settled but unpaid amounts relating to hedging, balancing, optimization and trading activities of Calpine Energy Services, L.P. (""CES''). Some of these receivables and payables with individual counterparties are subject to master netting agreements whereby the Company legally has a right of oÅset and the Company settles the balances net. However, for F-12
Slide 140: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) balance sheet presentation purposes and to be consistent with the way the Company presents the majority of amounts related to hedging, balancing and optimization activities in its statements of operations under StaÅ Accounting Bulletin (""SAB'') No. 101 ""Revenue Recognition in Financial Statements,'' as amended by SAB No. 104 ""Revenue Recognition'' (collectively ""SAB No. 101''), and EITF Issue No. 99-19 ""Reporting Revenue Gross as a Principal Versus Net as an Agent,'' the Company presents its receivables and payables on a gross basis. Inventories Ì The Company's inventories primarily include spare parts, work-in-process and stored gas. Operating supplies are valued at the lower of cost or market. Cost for large replacement parts estimated to be used within one year is determined using the speciÑc identiÑcation method. For the remaining supplies and spare parts, cost is generally determined using the weighted average cost method. Stored gas is valued at the lower of weighted average cost or market. Work-in-process represents the value of manufactured goods during the manufacturing process. The inventory balance at December 31, 2003, was $139.7 million. This balance is comprised of $90.3 million of spare parts, $43.5 million of stored gas and $5.9 million of work-in-process. The inventory balance at December 31, 2002, was $105.9 million. This balance is comprised of $72.1 million of spare parts, $31.4 million of stored gas and $2.4 million of work-in-process. Margin Deposits Ì As of December 31, 2003 and 2002, as credit support for the gas procurement as well as risk management activities it conducts on the Company's behalf, CES had deposited net amounts of $188.0 million and $25.2 million, respectively, in cash as margin deposits. Collateral Debt Securities Ì The Company classiÑes all short-term and long-term debt securities as held-to-maturity because the Company has the intent and ability to hold the securities to maturity. The securities act as collateral to support the King City operating lease and mature serially in amounts equal to a portion of the semi-annual lease payments. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion discounts to maturity. Property, Plant and Equipment, Net Ì See Note 4 for a discussion of the Company's accounting policies for its property, plant and equipment. Project Development Costs Ì The Company capitalizes project development costs once it is determined that it is probable that such costs will be realized through the ultimate construction of a power plant. These costs include professional services, salaries, permits and other costs directly related to the development of a new project. Upon commencement of construction, these costs are transferred to construction in progress, a component of property, plant and equipment. Upon the start-up of plant operations, these construction costs are reclassiÑed as buildings, machinery and equipment, also a component of property, plant and equipment, and are amortized as a component of the total cost of the plant over its estimated useful life. Capitalized project costs are charged to expense if the Company determines that the project is no longer probable or to the extent it is impaired. Outside services and other third party costs are capitalized for acquisition projects. Investments in Power Projects and Oil and Gas Properties Ì The Company uses the equity method to recognize its pro rata share of the net income or loss of an unconsolidated investment until such time, if applicable, that the Company's investment is reduced to zero, at which time losses are only recognized if there is a legal requirement to fund such losses. Once an investment is written down to zero equity income is generally recognized only upon receipt of cash distributions from the investee. Restricted Cash Ì The Company is required to maintain cash balances that are restricted by provisions of its debt agreements, lease agreements and regulatory agencies. These amounts are held by depository banks in order to comply with the contractual provisions requiring reserves for payments such as for debt service, rent service, major maintenance and debt repurchases. Funds that will be used to satisfy obligations due during the next twelve months are classiÑed as current restricted cash, with the remainder classiÑed as non-current restricted cash. Restricted cash is invested in accounts earning market rates; therefore the carrying value approximates fair value. Such cash is excluded from cash and cash equivalents in the consolidated statement F-13
Slide 141: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) of cash Öows. Of the Company's restricted cash, $157.6 million, $4.6 million and $60.7 million are the assets of Power Contract Financing, L.L.C. (""PCF''), Calpine Northbrook Energy Marketing, LLC (""CNEM''), and Gilroy Energy Center, LLC (""GEC''), respectively, each an entity with its existence separate from the Company and other subsidiaries of the Company. Notes Receivable Ì See Note 8 for a discussion of the Company's accounting policies for its notes receivable. Preferred Interests Ì As outlined in SFAS No. 150, ""Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,'' the Company classiÑes preferred interests that embody obligations to transfer cash to the preferred interest holder, in short-term and long-term debt. These instruments require the Company to make priority distributions of available cash, as deÑned in each preferred interest agreement, representing a return of the preferred interest holder's investment over a Ñxed period of time and at a speciÑed 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. Deferred Financing Costs Ì The deferred Ñnancing costs related to the Company's Senior Notes and the Convertible Senior Notes are amortized over the life of the related debt, ranging from 4 to 20 years, using the eÅective interest rate method (see Note 16). The deferred Ñnancing costs associated with the Calpine Construction Finance Company II, LLC (""CCFC II'') facility are amortized over the 4-year facility life using the eÅective interest rate method (see Note 14). The deferred Ñnancing costs related to the Zero-Coupon Debentures Due 2021 were amortized over 1 year due to the put option that was exercised by the holders in 2002. Costs incurred in connection with obtaining other Ñnancing are deferred and amortized over the life of the related debt. Long-Lived Assets Ì In accordance with Financial Accounting Standards Board (""FASB'') Statement of Financial Accounting Standards (""SFAS'') No. 144, ""Accounting for the Impairment or Disposal of LongLived Assets and for Long-Lived Assets to be Disposed of,'' the Company evaluates the impairment of longlived assets, including construction and development projects, based on the projection of undiscounted preinterest expense and pre-tax expense cash Öows whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. The signiÑcant assumptions that the Company uses in its undiscounted future cash Öow estimates include the future supply and demand relationships for electricity and natural gas, and the expected pricing for those commodities and the resultant spark spreads in the various regions where the Company generates. In the event such cash Öows are not expected to be suÇcient to recover the recorded value of the assets, the assets are written down to their estimated fair values (see Note 4). Certain of the Company's generating assets are located in regions with depressed demands and market spark spreads. The Company's forecasts assume that spark spreads will increase in future years in these regions as the supply and demand relationships improve. Concentrations of Credit Risk Ì Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash, accounts receivable, notes receivable, and commodity contracts. The Company's cash accounts are generally held in FDIC insured banks. The Company's accounts and notes receivable are concentrated within entities engaged in the energy industry, mainly within the United States (see Notes 8 and 21). The Company generally does not require collateral for accounts receivable from end-user customers, but evaluates the net accounts receivable, accounts payable, and fair value of commodity contracts with trading companies and may require security deposits or letters of credit to be posted if exposure reaches a certain level. Deferred Revenue Ì The Company's deferred revenue consists primarily of deferred gains for the sale/leaseback transactions as well as deferred revenue for long-term power supply contracts. F-14
Slide 142: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Trust Preferred Securities Ì Prior to the adoption of FASB Interpretation No. 46 (Revised 2003) ""Consolidation of Variable Interest Entities Ì An Interpretation of ARB No. 51'' (""FIN 46-R'') on October 1, 2003, the Company's trust preferred securities were accounted for as a minority interest in the balance sheet and reÖected as ""Company-obligated mandatorily redeemable convertible preferred securities of subsidiary trusts.'' The distributions were reÖected in the statements of operations as ""distributions on trust preferred securities'' through the third quarter of 2003. Financing costs related to these issuances are netted with the principal amounts and were accreted as minority interest expense over the securities' 30-year maturity using the straight-line method which approximated the eÅective interest rate method. Upon the adoption of FIN 46-R, the Company deconsolidated the Calpine Capital Trusts, which had issued the Trust Preferred Securities. Consequently, the Trust Preferred Securities are no longer on the Company's Consolidated Balance Sheet and were replaced with the debentures issued by the Company to the Calpine Capital Trusts. The interest payments on the debentures are now reÖected in the statements of operations as ""interest expense.'' (See Note 11). Revenue Recognition Ì The Company is primarily an electric generation company, operating a portfolio of mostly wholly owned plants but also some plants in which its ownership interest is 50% or less or the Company is not the Primary BeneÑciary under FIN 46-R and which are accounted for under the equity method. In conjunction with its electric generation business, the Company also produces, as a by-product, thermal energy for sale to customers, principally steam hosts at the Company's cogeneration sites. In addition, the Company acquires and produces natural gas for its own consumption and sells the balance and oil produced to third parties. Where applicable, revenues are recognized under EITF No. 91-6, ""Revenue Recognition of Long Term Power Sales Contracts,'' ratably over the terms of the related contracts. To protect and enhance the proÑt potential of its electric generation plants, the Company, through its subsidiary, CES, enters into electric and gas hedging, balancing, and optimization transactions, subject to market conditions, and CES has also, from time to time, entered into contracts considered energy trading contracts under EITF Issue No. 02-3. CES executes these transactions primarily through the use of physical forward commodity purchases and sales and Ñnancial commodity swaps and options. With respect to its physical forward contracts, CES generally acts as a principal, takes title to the commodities, and assumes the risks and rewards of ownership. Therefore, when CES does not hold these contracts for trading purposes and, in accordance with SAB No. 101, and EITF Issue No. 99-19, the Company records settlement of the majority of its non-trading physical forward contracts on a gross basis. On October 1, 2003, the Company adopted 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 DeÑned 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, accordingly, has begun netting certain types of hedging, balancing and optimization transactions. See discussion of the impacts of adopting EITF Issue No. 03-11 under the New Accounting Pronouncements Section of this Note. The Company settles its Ñnancial swap and option transactions net and does not take title to the underlying commodity. Accordingly, the Company records gains and losses from settlement of Ñnancial swaps and options net within net income. Managed risks typically include commodity price risk associated with fuel purchases and power sales. The Company, through its wholly owned subsidiary, Power Systems Mfg., LLC (""PSM''), designs and manufactures certain spare parts for gas turbines. The Company in the past has also generated revenue by occasionally loaning funds to power projects, by providing operation and maintenance (""O&M'') services to third parties and to certain unconsolidated power projects. The Company also sells engineering and construction services to third parties for power projects. Further details of the Company's revenue recognition policy for each type of revenue transaction are provided below: Electric Generation and Marketing Revenue Ì This includes electricity and steam sales and sales of purchased power for hedging, balancing and optimization. Subject to market and other conditions, the Company manages the revenue stream for its portfolio of electric generating facilities. The Company markets F-15
Slide 143: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) on a system basis both power generated by its plants in excess of amounts under direct contract between the plant and a third party, and power purchased from third parties, through hedging, balancing and optimization transactions. CES performs a market-based allocation of total electric generation and marketing revenue to electricity and steam sales (based on electricity delivered by the Company's electric generating facilities) and the balance is allocated to sales of purchased power. Oil and Gas Production and Marketing Revenue Ì This includes sales to third parties of oil, gas and related products that are produced by the Company's Calpine Natural Gas and Calpine Canada Natural Gas subsidiaries and, subject to market and other conditions, sales of purchased gas arising from hedging, balancing and optimization transactions. Oil and gas sales for produced products are recognized pursuant to the sales method, net of royalties. If the Company has recorded gas sales on a particular well or Ñeld in excess of its share of remaining estimated reserves, then the excessive gas sale imbalance is recognized as a liability. If the Company is under-produced on a particular well or Ñeld, and it is determined that an over-produced partner's share of remaining reserves is insuÇcient to settle the gas imbalance, the Company will recognize a receivable, to the extent collectible, from the over-produced partner. Mark-to-Market Activity, Net Ì This includes realized settlements of and unrealized mark-to-market gains and losses on both power and gas derivative instruments undesignated as cash Öow hedges, including those held for trading purposes. Gains and losses due to ineÅectiveness on hedging instruments are also included in unrealized mark-to-market gains and losses. Trading activity is presented net in accordance with EITF Issue No. 02-3, ""Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities'' (""EITF Issue No. 02-3''). See New Accounting Pronouncements discussed in this Note. Other Revenue Ì This includes O&M contract revenue, PSM and TTS revenue from sales to third parties, engineering and construction revenue and miscellaneous revenue, including amounts associated with the Company's Enron Settlement (see Note 21). Plant Operating Expense Ì This primarily includes employee expenses, repairs and maintenance, insurance, transmission cost and property taxes. Purchased Power and Purchased Gas Expense Ì The cost of power purchased from third parties for hedging, balancing and optimization activities is recorded as purchased power expense, a component of electric generation and marketing expense. The Company records the cost of gas purchased from third parties for the purposes of consumption in its power plants as fuel expense, while gas purchased from third parties for hedging, balancing, and optimization activities is recorded as purchased gas expense, a component of oil and gas production and marketing expense. Certain hedging, balance and optimization activity is presented net in accordance with EITF Issue No. 03-11. See New Accounting Pronouncements discussed in this Note. Provision (BeneÑt) for Income Taxes Ì Deferred income taxes are based on the diÅerences between the Ñnancial reporting and tax bases of assets and liabilities. The deferred income tax provision represents the changes during the reporting period in the deferred tax assets and deferred tax liabilities, net of the eÅect of acquisitions and dispositions. Deferred tax assets include tax losses and tax credit carryforwards and are reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Additionally, with respect to income taxes, the Company assumes the deductibility of certain costs in its income tax Ñlings and estimates the future recovery of deferred tax assets. Insurance Program Ì CPN Insurance Corporation, a wholly owned captive insurance subsidiary, charges the Company competitive premium rates to insure casualty lines (workers' compensation, automobile liability, and general liability) as well as all risk property insurance including business interruption. Accruals for claims under the captive insurance program pertaining to property, including business interruption claims, are recorded on a claims-incurred basis. Accruals for casualty claims under the captive insurance program are F-16
Slide 144: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) recorded on a monthly basis, and are based upon the estimate of the total cost of claims incurred during the policy period. The captive insures limits up to $25 million per occurrence for property claims, including business interruption, and up to $500,000 per occurrence for casualty claims. Derivative Instruments Ì SFAS No. 133, ""Accounting for Derivative Instruments and Hedging Activities'' 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 speciÑc hedge criteria are met, which requires that a company must formally document, designate, and assess the eÅectiveness of transactions that receive hedge accounting. The Company is required by GAAP to account for certain derivative contracts at fair value. 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 Öow and fair value hedges. SFAS No. 133 provides that the eÅective portion of the gain or loss on a derivative instrument designated and qualifying as a cash Öow hedging instrument be reported as a component of other comprehensive income and be reclassiÑed into earnings in the same period during which the hedged forecasted transaction aÅects 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 Ñrm commitment be recorded in earnings. If the fair value hedge is eÅective, the amounts recorded will oÅset in earnings. Additionally, if the underlying transaction being hedged is disposed of or otherwise terminated, the gain or loss associated with the hedge instrument is recognized currently. If the hedging instrument is terminated prior to the occurrence of the hedged transaction, 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 ""OÅsetting 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''). New Accounting Pronouncements In June 2001 FASB issued SFAS No. 143, ""Accounting for Asset Retirement Obligations.'' SFAS No. 143 applies to Ñscal years beginning after June 15, 2002 and amends SFAS No. 19, ""Financial Accounting and Reporting by Oil and Gas Producing Companies.'' This standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the assets and requires that a liability for an asset retirement obligation be recognized when incurred, recorded at fair value and classiÑed as a liability in the balance sheet. When the liability is initially recorded, the entity will capitalize the cost and increase the carrying value of the related long-lived asset. Asset retirement obligations represent future liabilities, and, as a result, accretion expense will be accrued on F-17
Slide 145: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) this liability until the obligation is satisÑed. At the same time, the capitalized cost will be depreciated over the estimated useful life of the related asset. At the settlement date, the entity will settle the obligation for its recorded amount or recognize a gain or loss upon settlement. The Company adopted the new rules on asset retirement obligations on January 1, 2003. As required by the new rules, the Company recorded liabilities equal to the present value of expected future asset retirement obligations at January 1, 2003. The Company identiÑed obligations related to operating gas-Ñred power plants, geothermal power plants and oil and gas properties. The liabilities are partially oÅset by increases in net assets recorded as if the provisions of SFAS No. 143 had been in eÅect at the date the obligation was incurred, which for power plants is generally the start of construction and typically building up during construction until commercial operations for the facility is achieved. For oil and gas properties the date the obligation is incurred is generally the start of drilling of a well or the start of construction of a facility and typically building up until completion of drilling of a well or completion of construction of a facility. Based on current information and assumptions, the Company recorded, as of January 1, 2003, an additional long-term liability of $25.9 million, an additional asset within property, plant and equipment, net of accumulated depreciation, of $26.9 million, and a pre-tax gain to income due to the cumulative eÅect of a change in accounting principle of $1.0 million. These entries include the eÅects of the reversal of site dismantlement and restoration costs previously expensed in accordance with SFAS No. 19. The table below details the change during 2003 in the Company's asset retirement obligation (in thousands): Asset retirement obligation at January 1, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities incurred in 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Liabilities settled in 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accretion expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Revisions in the estimated cash ÖowsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other (primarily foreign currency translation) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Asset retirement obligation at December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $47,274 4,368 (2,012) 5,688 1,799 (3,782) $53,335 If SFAS No. 143 had been applied for the year ended December 31, 2001, the asset retirement obligation at December 31, 2001, would have been $31.2 million. In November 2002 FASB issued Interpretation No. 45, ""Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (""FIN 45'').'' This Interpretation addresses the disclosures to be made by a guarantor in its interim and annual Ñnancial statements about its obligations under guarantees. In addition, the Interpretation clariÑes the requirements related to the recognition of a liability by a guarantor at the inception of a guarantee for the obligations that the guarantor has undertaken in issuing the guarantee. The Company adopted the disclosure requirements of FIN 45 for the Ñscal year ended December 31, 2002, and the recognition provisions on January 1, 2003. Adoption of this Interpretation did not have a material impact on the Company's Consolidated Financial Statements. F-18
Slide 146: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) On January 1, 2003, the Company prospectively adopted the fair value method of accounting for stockbased employee compensation pursuant to SFAS No. 123, ""Accounting for Stock-Based Compensation'' as amended by SFAS No. 148, ""Accounting for Stock-Based Compensation Ì Transition and Disclosure.'' 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 Ñnancial statements. SFAS No. 148 provides two additional transition options to report the change in accounting principle Ì the modiÑed 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 Ñnancial statements about the method of accounting for stock-based employee compensation and the eÅect 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 Ñnancial statements. As shown below, the adoption of SFAS No. 123 has had a material impact on the Company's Ñnancial statements. The table below reÖects the pro forma impact of stock-based compensation on the Company's net income and earnings per share for the years ended December 31, 2003, 2002 and 2001, had the Company applied the accounting provisions of SFAS No. 123 to its prior years' Ñnancial statements (in thousands, except per share amounts): 2003 2002 2001 Net income As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro Forma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings per share data: Basic earnings per share As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro Forma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per share As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro Forma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock-based compensation cost included in net income, as reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock-based compensation cost included in net income, pro forma ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $282,022 270,418 $118,618 83,025 $623,492 588,442 $ 0.72 0.69 0.71 0.68 9,724 21,328 $ 0.33 0.23 0.33 0.23 Ì 35,593 $ 2.05 1.94 1.80 1.71 Ì 35,050 $ $ $ $ $ $ The range of fair values of the Company's stock options granted in 2003, 2002, and 2001 were as follows, based on varying historical stock option exercise patterns by diÅerent levels of Calpine employees: $1.50-$4.38 in 2003, $3.73-$6.62 in 2002, and $18.29-$30.73 in 2001 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 70%-113% for 2003, 70%-83% for 2002, and 55%-59% for 2001, risk-free interest rates of 1.39%4.04% for 2003, 2.39%-3.83% for 2002, and 3.99%-5.07% for 2001, and expected option terms of 1.5-9.5 years for 2003 and 4-9 years for 2002 and 2001. 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, F-19
Slide 147: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) or both, as a result of ownership, contractual or other Ñnancial interest in the entity. Historically, entities have generally been consolidated by an enterprise when it has a controlling Ñnancial interest through ownership of a majority voting interest in the entity. The objectives of FIN 46 are to provide guidance on the identiÑcation 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, as the Primary BeneÑciary, should consolidate the Variable Interest Entity (""VIE''). This new model for consolidation applies to an entity in which either (1) suÇcient equity is lacking to absorb expected losses without additional subordinated Ñnancial support or (2) its at-risk equity holders as a group are not able to make decisions that have a signiÑcant impact on the success or failure of the entity's ongoing activities. In December 2003 FASB modiÑed FIN 46 with FIN 46-R to make certain technical corrections and to address certain implementation issues. FIN 46, as originally issued, was eÅective immediately for VIEs created or acquired after January 31, 2003. FIN 46-R delayed the eÅective date of the interpretation to no later than March 31, 2004, (for calendar-year enterprises), except for Special Purpose Entities (""SPEs'') for which the eÅective date is December 31, 2003. The Company is still evaluating the impact FIN 46-R may have on its equity method joint ventures, its wholly owned subsidiaries that are subject to long-term power purchase agreements and tolling arrangements, operating leases, entities issuing mandatory redeemable noncontrolling interests and other equity investments. However, one possible consequence of adopting FIN 46-R for non-SPEs is that certain equity investments might have to be consolidated and certain wholly owned subsidiaries might have to be de-consolidated. The ultimate determination of whether equity investments will be consolidated by the Company will be based on whether these equity investments are in entities that are VIEs and who is the Primary BeneÑciary of the VIE. Since the joint venture investments have long-term sales agreements, it is possible these agreements will cause the joint ventures to be considered VIEs. The determination of whether the Company, the other equity owner or the purchaser of the power will consolidate the VIE will be based on which variable interest holder absorbs the majority of the risk of the VIE and is therefore the Primary BeneÑciary. A similar analysis must be performed for certain 100% Company-owned subsidiaries with long term power sales or tolling agreements. If the Company-owned subsidiary is deemed a VIE by virtue of its longterm power sales or tolling agreement and if the power purchaser is the Primary BeneÑciary because it absorbs the majority of the Company-owned subsidiary's risk, the Company may be required to deconsolidate its subsidiary and account for it under the equity method of accounting. See Note 7 for more information regarding equity investments that may have to be consolidated. 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 joint venture was formed in March 2000, but due to a change in the partnership agreement in May 2003, the Company was required to reconsider its investment in the entity under FIN 46, as originally issued. The Company determined that Acadia was a VIE and that it held a signiÑcant variable interest in the entity. However, the Company was not the Primary BeneÑciary and therefore not required to consolidate the entity's assets and liabilities. The total of both partners' equity in Acadia was approximately $489.2 million as of December 31, 2003. The Company's maximum potential exposure to loss at December 31, 2003, is limited to the book value of its investment of approximately $221.0 million. The Company continues to account for this investment under the equity method. Under the transition rules of FIN 46-R, the Company is required to adopt the provisions of FIN 46-R for Acadia as of March 31, 2003. The Company anticipates that it will still not be the Primary BeneÑciary upon the adoption of FIN 46-R. On May 15, 2003, the Company's wholly owned subsidiary, Calpine Northbrook Energy Marketing, LLC (""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 the Ñxed power purchases. CNEM was established as a bankruptcy-remote entity and F-20
Slide 148: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 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 BeneÑciary. Accordingly, the entity's assets and liabilities were consolidated into the Company's accounts as of June 30, 2003. See Note 11 for information regarding this monetization. On June 13, 2003, Power Contract Financing, L.L.C. (""PCF''), a wholly owned stand-alone subsidiary of CES, completed an oÅering 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 the transferred power purchase and sales contracts and the PCF Notes. PCF was determined to be a VIE in which the Company was the Primary BeneÑciary. Accordingly, the entity's assets and liabilities were consolidated into the Company's accounts as of June 30, 2003. See Note 11 for information regarding this oÅering. Upon adoption of FIN 46-R for the Company's investments in SPEs, the Company deconsolidated Calpine Capital Trusts I, II and III (Trusts) as explained further in Note 11. The Company's remaining portfolio of investments in joint ventures, wholly owned subsidiaries, operating leases, signiÑcant power purchase agreements and other equity investments did not involve SPEs. In April 2003 FASB issued SFAS No. 149, ""Amendment of Statement 133 on Derivative Instruments and Hedging Activities.'' SFAS No. 149 amends and clariÑes Ñnancial reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. SFAS No. 149 clariÑes under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clariÑes when a derivative contains a Ñnancing component, amends the deÑnition of an underlying to conform it to language used in FIN 45, and amends certain other existing pronouncements. SFAS No. 149 is eÅective for contracts entered into or modiÑed after June 30, 2003, and should be applied prospectively, with the exception of certain SFAS No. 133 implementation issues that were eÅective for all Ñscal quarters prior to June 15, 2003. Any such implementation issues should continue to be applied in accordance with their respective eÅective dates. The adoption of SFAS No. 149 did not have a material impact on the Company's Ñnancial statements. In May 2003 FASB issued SFAS No. 150. SFAS No. 150 establishes standards for how an issuer classiÑes and measures certain Ñnancial instruments with characteristics of both liabilities and equity. SFAS No. 150 applies speciÑcally to a number of Ñnancial instruments that companies have historically presented within their Ñnancial statements either as equity or between the liabilities section and the equity section, rather than as liabilities. SFAS No. 150 was eÅective for Ñnancial instruments entered into or modiÑed after May 31, 2003, and otherwise was eÅective at the beginning of the Ñrst interim period beginning after June 15, 2003. The Company adopted SFAS No. 150 on July 1, 2003. As a result, approximately $82 million of mandatorily redeemable non-controlling interest in its King City facility, which had previously been included within the balance sheet caption ""Minority interests,'' was reclassiÑed to ""Notes payable.'' Preferential distributions related to this mandatorily redeemable non-controlling interest are to be made annually beginning November 2003 through November 2019 and total approximately $169 million over the 17-year period. The preferred interest holders' recourse is limited to the net assets of the entity and the distribution terms deÑned in the agreement. The Company has not guaranteed the payment of these preferential distributions. The distributions and accretion of issuance costs related to this preferred interest, which was previously reported as a component of ""Minority interest expense'' in the Consolidated Condensed Statements of Operations, is now accounted for as interest expense. Distributions and related accretion associated with this preferred interest was $5.3 million for the six months ended December 31, 2003. SFAS No. 150 does not permit reclassiÑcation of prior period amounts to conform to the current period presentation. F-21
Slide 149: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) During the third quarter of 2003, the Company completed the sales of preferred equity interests for Auburndale Holdings, LLC and Gilroy Energy Center (""GEC'') Holdings, LLC. These interests, in addition to the King City interest, are classiÑed as debt on the Company's Condensed Consolidated Balance Sheet as of December 31, 2003. Although the Company cannot readily determine the potential cost to repurchase the interests in Auburndale Holdings, LLC and GEC Holdings, LLC, the carrying value of its aggregate partners' interests is approximately $161.6 million. In November 2003 FASB indeÑnitely deferred certain provisions of SFAS No. 150 as they apply to mandatorily redeemable non-controlling (minority) interests associated with Ñnite-lived subsidiaries. Upon FASB's Ñnalization of this issue, the Company may be required to reclassify the minority interest relating to the Company's investment in Calpine Power Limited Partnership (""CLP'') to debt. As of December 31, 2003, the minority interest related to the CLP was approximately $338 million. The Company owns approximately 30% of CLP, which is Ñnite-lived, terminating on December 31, 2050. See Note 9 for a discussion of the Company's investment in CLP. CLP is consolidated under SFAS No. 66, ""Accounting for Sales of Real Estate'' due to the Company's signiÑcant continuing involvement in the assets transferred to CLP. The adoption of SFAS No. 150 and related balance sheet reclassiÑcations did not have an eÅect on net income or total stockholders' equity but have impacted the Company's debt-to-equity and debt-to-capitalization ratios. In June 2003 FASB issued 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.'' DIG Issue No. C20 superseded DIG Issue No. C11 ""Interpretation of Clearly and Closely Related in Contracts That Qualify for the Normal Purchases and Normal Sales Exception,'' and speciÑed additional circumstances in which a price adjustment feature in a derivative contract would not be an impediment to qualifying for the normal purchases and normal sales scope exception under SFAS No. 133. DIG Issue No. C20 is eÅective as of the Ñrst day of the Ñscal quarter beginning after July 10, 2003, (i.e. October 1, 2003, for the Company) with early application permitted. In conjunction with initially applying the implementation guidance, DIG Issue No. C20 requires the recognition of a special transition adjustment for certain contracts containing a price adjustment feature based on a broad market index for which the normal purchases and normal sales scope exception had been previously elected. In those circumstances, the derivative contract should be recognized at fair value as of the date of the initial application with a corresponding adjustment of net income as the cumulative eÅect of a change in accounting principle. It should then be applied prospectively for all existing contracts as of the eÅective date and for all future transactions. Two of the Company's power sales contracts, which meet the deÑnition of a derivative and for which it previously elected the normal purchases and normal sales scope exception, use a CPI or similar index to escalate the Operations and Maintenance (""O&M'') charges. Adoption of DIG Issue No. C20 required the Company to recognize a special transition accounting adjustment for the estimated future economic beneÑts of these contracts. The Company based the transition adjustment on the nature and extent of the key price adjustment features in the contracts and estimated future market conditions on the date of adoption, such as the forward price of power and natural gas and the expected rate of inÖation. The Company will realize the actual future economic beneÑts of these contracts over the remaining lives of these contracts which extend through 2013 and 2023 as actual power deliveries occur, although DIG Issue No. C20 required the Company to account for the estimated future economic beneÑts currently. The Company will amortize the corresponding asset recorded upon adoption of DIG Issue No. C20 through a charge to earnings in future periods. Accordingly on October 1, 2003, the date the Company adopted DIG Issue No. C20, the Company recorded other current assets and other assets of approximately $33.5 million and $259.9 million, respectively, and a cumulative eÅect of a change in accounting principle of approximately $181.9 million, net of $111.5 million of F-22
Slide 150: CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) tax. For all periods subsequent to October 1, 2003, the Company will account for the contracts as normal purchases and sales under the provisions of DIG Issue No. C20. In May 2003 the EITF reached consensus in EITF Issue No. 01-08, ""Determining Whether an Arrangement Contains a Lease,'' to clarify the requirements of identifying whether an arrangement should be accounted for as a lease at its inception. The guidance in the consensus is designed to broaden the scope of arrangements, such as power purchase agreements, accounted for as leases. EITF Issue No. 01-08 requires both parties to an arrangement to determine whether a service contract or similar arrangement is, or includes, a lease within the scope of SFAS No. 13, ""Accounting for Leases.'' The consensus is being applied prospectively to arrangements agreed to, modiÑed, or acquired in business combinations on or after July 1, 2003. Prior to adopting EITF Issue No. 01-08, the Company had accounted for certain contractual arrangements as leases under existing industry practices, and the adoption of EITF Issue No. 01-08 did not materially change accounting for previous arrangements that had been accounted for as leases prior to the adoption of EITF Issue No. 01-08. Currently the income to the Company under these arrangements is immaterial; however, the Company may, in the future, structure additional power purchase agreements as leases. For income statement presentation purposes, income from arrangements accounted for as leases is classiÑed within electricity and steam revenue in the Company's consolidated statements of operations. During 2003, the Emerging Issues Task Force (""the Task Force'') discussed EITF Issue No. 03-11. In EITF Issue No. 02-3 the Task Force reached a consensus that companies should present all gains and losses on derivative instruments held for trading purposes net in the income statement, whether or not settled physically. EITF Issue No. 03-11 addresses income statement classiÑcation of derivative instruments held for other than trading purposes. At the July 31, 2003, EITF meeting, the Task Force reached a consensus that determining whether realized gains and losses on derivative contracts not held for trading purposes' should be reported on a net or gross basis is a matter of judgment that depends on the relevant facts and circumstances. The Task Force ratiÑed this consensus at its August 13, 2003 meeting, and it is eÅective beginning October 1, 2003. The Task Force did not prescribe special eÅective date or transition guidance for this Issue. The Company determined that under the provisions of EITF Issue No. 03-11, transactions which are not physically settled should be reported net for purposes of the Consolidated Statement of Operations. Accordingly, transactions with either of the following characteristics are presented net in the Company's Ñnancial 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 Öow of the power purchase against the physical Öow of the power sale as a matter of scheduling convenience to eliminate the need to schedule actual power delivery or ""book out'' the physical power Öows. These book out transactions may occur with the same counterparty or between diÅerent counterparties where the Company has equal but oÅsetting physical purchase and delivery commitments. Based on guidance in EITF Topic No. D-1 ""Implications and Implementation of an EITF Consensus'' and because EITF Issue No. 03-11 is silent with respect to transition provisions, the Company has adopted EITF No. 03-11 on a prospective basis eÅective October 1, 2003. While adoption of EITF No. 03-11 had no eÅect on the Company's gross proÑt or net income, it reduced the Company's 2003 sales of purchased power for hedging and optimization and purchased power expense for hedging and optimization by approximately $256.6 million. In 2002 the Company sold certain gas assets, as well as the DePere Energy Center. The decision to sell these assets required the application of one of the newly issued accounting standards, SFAS No. 144, which changed the criteria for determining when the disposal or sale of certain assets meets the deÑnition of ""discontinued operations.'' Some of our asset sales in 2002 met the requirements of the new deÑnition and accordingly, the Company made reclassiÑcations to current and prior period Ñnancial statements to reÖect the sale or designation as ""held for sale'' of certain oil and gas and power plant assets and liabilities and to F-23