First Annual Report 2003 POWERING UP

Transcription

1 First Annual Report 2003 POWERING UP

2 FUND PROFILE Facilities Profile p. 01 Message to Unitholders p. 02 Frequently Asked Questions p. 04 Management and Corporate Governance p. 06 Environment and Community p. 08 Growth p. 10 Financial Review 2003 p. 12 Trustees p. 36 General Information p. 37 Innergex Power Income Fund is a trust with interests in seven hydroelectric power plants in the provinces of Québec and Ontario, Canada. All of the power generated by the Fund s power plants is sold to Hydro-Québec and the Ontario Electricity Financial Corporation under renewable long-term power purchase agreements. The Fund is administered by Innergex Management Inc., a company with extensive expertise in the development, design, ownership, operation and maintenance of independent power projects. The Fund was listed on the Toronto Stock Exchange in 2003, closing its initial public offering in July and making its first monthly cash distribution to Unitholders in August. The Fund s Trust Units are qualified investments for Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), Deferred Profit Sharing Plans (DPSPs) and Registered Education Savings Plans (RESPs) under the Canadian Income Tax Act and are not considered foreign property for such plans. The units trade on the Toronto Stock Exchange (TSX) under the symbol IEF.UN. In this Annual Report, the terms Innergex and the Fund are used interchangeably to refer to Innergex Power Income Fund.

3 Innergex Power Income Fund Annual Report 2003 FACILITIES PROFILE All of the Fund s facilities are run-of-the-river and produce green renewable energy issuing no greenhouse gas emissions. Saint-Paulin Portneuf-1 Portneuf-2 Portneuf-3 Batawa Montmagny Chaudière Saint-Paulin Chaudière Portneuf-1 Portneuf-2 Portneuf-3 Montmagny Batawa Installed Capacity (MW) Expected Annual Production (GWh) Commercial In-Service Date November 29 March 14 May 3 May 3 May 3 May 23 December Power Purchase Agreement Expiry Date p. 01

4 MESSAGE TO UNITHOLDERS To use an industry term, 2003 was the year for Innergex Power Income Fund to power up. The trust officially became a publicly-traded income fund with the closing of its initial public offering on July 4, The start of operations in July was the culmination of a rigorous planning and organization process aimed at assuring the Fund s primary objective: payment of stable, sustainable cash distributions to Unitholders. The Fund received an SR-2 rating with positive outlook from Standard& Poor s, indicating very high distribution stability. In assigning its rating, Standard & Poor s noted the high quality of the Fund s assets, along with its prudent risk-management provisions and existing management expertise. Building on a history of quality Innergex is a recently listed income fund on the Toronto Stock Exchange. We can nonetheless lay claim to a tradition of excellence in the power industry. That tradition goes back to 1990, when a company named Innergex Inc. was created in response to a Québec government call for bids to develop small-scale hydroelectric powergenerating facilities. That company went on to develop the Saint-Paulin, Chaudière, Batawa and the three Portneuf plants, and acquired the Montmagny power plant, assets that were transferred to the Fund in July This history extending back to the construction of six of its seven plants gives the Fund a key advantage: assurance of high plant quality. All Fund facilities were built in the last decade, and use proven generating technology. Partly as a result of this, we can boast a manageable, low-risk maintenance profile. The Fund s assets have an expected life of over 40 years. In December 2001, the Innergex II Income Fund ( Innergex II ), a privately owned entity, was created to continue the tradition of developing quality independent power projects. The Fund benefits from a privileged relationship with Innergex II that includes a right of first offer on any projects Innergex II sells. Although each of the entities bearing the Innergex name are legally distinct, all enjoy a close business relationship as part of the Innergex group. p Results In July 2003, the Fund closed its initial public offering, selling 14,602,267 Trust Units at $10 per unit for gross proceeds of $146.0 million. It simultaneously issued an additional 3,755,000 units for a total consideration of $37,550,000. The $169.4 million in net proceeds from these transactions was combined with a $50.0 million term loan to acquire the interests in the seven power plants and fund the reserve accounts to be used in the Fund s operation. For the 181 days following closure of the initial public offering on July 4 th, the Fund earned net income of $4.5 million or $0.25 per unit, 11% more than the $4.1 million or $0.22 per unit originally forecasted in the prospectus. Distributable cash from operating activities totalled $7.4 million, 7% more than originally forecasted. In accordance with the business plan, this amount was supplemented by $1.4 million from the levelization reserve to arrive at total distributable cash of $8.8 million, of which $8.3 million or $0.452 per unit was actually distributed, as originally planned.

5 Innergex Power Income Fund Annual Report 2003 Growth through Acquisition It is also an objective to the Fund to increase its distributable cash per unit over time, but in a way that is sustainable and maintains stability. On March 25, 2004, the Fund announced that it had entered into a definitive agreement to acquire Hydro-Windsor Inc., a 5.5 MW hydroelectric power station. This acquisition meets these objectives. The plant is located on a river that Innergex knows very well. This river offers diversification benefits with the five watersheds where the Fund s existing plants are located. The facility also benefits from a long-term power purchase agreement with Hydro-Québec that is in effect until 2016 and is renewable until All of these factors are expected to increase the stability and sustainability of the Fund s cash distributions. On April 8, 2004, the Fund concluded a private placement for the issuance of 1,050,000 units for a total net proceeds of approximately $12.0 million. On April 27, 2004, the Fund completed the acquisition and announced a 1 increase in its annual cash distribution to Unitholders. Aiming to be a positive force in the community As Manager of the Fund, we are extremely proud of our assets and operations. We are working to make a positive contribution, not only to our Unitholders, but also to the community and the environment. We are firmly committed to clean power sources that are an asset to their surroundings, as best evidenced by our Chaudière plant. From the outset, the plant was designed to preserve and enhance the natural beauty of the Chaudière Falls. The plant, with its surrounding park and visitors centre, attracts over 200,000 visitors each year, and is valued highly as a regional touristic attraction. The park continues to be developed through the annual monetary contribution of Innergex. Outlook and Acknowledgements We will continue to adhere closely to the business plan outlined in the June 2003 prospectus to achieve our objectives, namely to ensure and enhance the stability and sustainability of distributable cash per unit, and to increase distributable cash per unit through improved operating practices and acquisitions. The year 2003 was particularly important in the history of the Fund and we thank the entire team for their dedicated efforts. We welcome our Unitholders and thank them for their support. Gilles Lefrançois, CA President and Chief Executive Officer Innergex Management Inc. Manager of the Fund Jean La Couture, FCA Chairman of the Board of Trustees Innergex Power Trust p. 03

6 FREQUENTLY ASKED QUESTIONS Q. What is the relationship between Innergex and Innergex II? Q. What is the effect of the diversion of the Portneuf River? Q. What is the levelization reserve? A. Innergex Power Income Fund and Innergex II are separate legal entities. Innergex II is an entity created in 2001 to build, own and operate hydroelectric power plants and wind farms throughout North America, especially in Canada. Innergex II is owned by the management and five institutional investors, some of which are amongst the largest financial institutions in Canada. However, the two entities do have a strong business relationship, with Innergex Management Inc. acting as Manager for both entities. Innergex II has signed a cooperation agreement giving the Fund a right of first offer on any assets being sold by Innergex II. A. In 2002, Hydro-Québec began diverting a small portion of the waters naturally flowing in the Portneuf River, effectively reducing the flow available for Innergex s three power plants downstream from the diversion. Hydro-Québec therefore compensates Innergex for the lost revenue resulting from the diversion. As long as the plants are available to produce power and they utilize all the water available to them from the river, Hydro-Québec pays to Innergex the revenue it would have earned based on the average annual water flow in the river over a 20-year period. This arrangement ensures a stable stream of income for the Portneuf facilities and consequently for the Fund. It also goes a long way toward mitigating the Innergex s overall hydrology risk, as the Portneuf facilities represent 43% of the Fund s current projected annual production. A. The levelization reserve is an account created in July 2003 with approximately $6 million from Innergex s initial public offering. The principle behind the reserve is that the Fund s revenues are determined by its long-term power purchase agreements, most of which provide for a gradual increase in revenues of between 3% and 6% per year depending on the Consumer Price Index. In order to ensure maximum, stable and sustainable cash distributions to its Unitholders, the Fund based its cash distributions for the first eight years of operation on its forecasted cash flow in Year 8. Until then, a predetermined amount will be drawn from the reserve to cover the planned cash distributions. The levelization reserve is expected to be depleted in Year 8 of operations, at which time cash flow should be sufficient to meet the Fund s planned cash distribution payments. p. 04

7 Innergex Power Income Fund Annual Report 2003 Q. What is the hydrology reserve? Q. Are cash distributions taxable? A. The hydrology reserve is an account created in July 2003 with $4 million from Innergex s initial public offering. The hydrology reserve will be used to stabilize the cash distributions in case of unforeseeable factors such as unusually low water levels. The reserve amount represents the decrease that could occur in distributable cash in the event the Fund would encounter the worst two hydrological years on record in a row. A. In Canada, a portion of the cash distributions paid by the Fund to Unitholders is taxed as investment income in the hands of the Unitholder and a portion is treated as a return on capital and therefore tax-deferred. For 2003, 12% of the cash distributions received is considered a taxable dividend from a Canadian corporation, and a further 9% is considered taxable income from a trust. The remaining 79% is not taxable but must be used to reduce the adjusted cost base of Innergex units, and thus to determine any capital gain or loss when units are sold. Brokers will mail out the T3 Supplementary Information slip by March 31 st of every year indicating the amount to be declared as investment income for the previous year. If more detailed tax information is required, Unitholders should contact their tax advisor. Unitholders who are not resident of Canada for income tax purposes should seek advice from a qualified tax advisor in their country of residence for advice on how the distributions will be taxed. In any event, monthly distributions paid to non-residents of Canada are typically subject to withholding tax. p. 05

8 POWERING UP MANAGEMENT AND CORPORATE GOVERNANCE

9 Innergex Power Income Fund Annual Report 2003 Diane-Marie Gauthier 01 Vice President Legal Affairs and Corporate Secretary Michel Letellier Executive Vice President and Chief Financial Officer Annie Gaudreault 02 Accounting Jean Trudel Vice President Finance Gilles Lefrançois President and Chief Executive Officer Pascale Gagnon 03 Administrative Assistant François Hébert Vice President Operation and Maintenance Sylvie Lafaille Receptionist Normand Bouchard Vice President Wind Energy Facing page Innergex Power Trust Board of Trustees Back, standing, left to right: Daniel L. Lafrance 01 John A. Hanna 02 Richard Laflamme 03 Michel Letellier 04 Front, sitting, left to right: Lise Lachapelle 05 Gilles Lefrançois 06 Jean La Couture Management As the trustee of Innergex, National Bank Trust Inc. is responsible for administering the Fund. The trustee has delegated this responsibility to the Manager, Innergex Management Inc. The Manager is in the business of developing, designing, operating and maintening independent power projects. Its staff of 25 have expertise in operations and maintenance, design, engineering, finance and accounting. The team is headed by Gilles Lefrançois and Michel Letellier, both of whom have worked in the energy sector since Corporate Governance Innergex is listed on the TSX and is therefore subject to various rules and guidelines regarding corporate governance. The Fund is in compliance with the TSX guidelines for effective corporate governance. The Manager is supervised by the Innergex Power Trust Board of Trustees, which consists of seven trustees, four of whom qualify as unrelated. The Board sets the Fund s policies, assesses their implementation by the Manager and reviews the results. The Board has created three committees to support it in carrying out its duties. The Audit Committee is composed of three unrelated trustees. The Audit Committee s general mandate is to consider and evaluate all aspects of the Fund s financial responsibilities, such as financial reporting, accounting policies, risk management, internal control and compliance with laws and regulations. The Audit Committee also oversees the Fund s relations with its auditors. The members of the Audit Committee are John A. Hanna (Chairman), Jean La Couture and Daniel L. Lafrance. Mr. Hanna is a fellow certified general accountant, Mr. La Couture is a fellow chartered accountant and Mr. Lafrance is a chartered accountant. The Corporate Governance Committee consists of three trustees, two of whom qualify as unrelated. The committee is responsible for monitoring corporate governance and assessing the services of the Manager and reviewing the Fund s insider trading policy. The committee reviews and evaluates the performance and remuneration of the Trustees and the Manager, and provides trustee succession planning. The members of the Governance Committee are Lise Lachapelle (Chairman), Jean La Couture and Richard Laflamme. The Acquisition Committee is made up of four unrelated trustees. It is responsible for investigating and making recommendations on proposed acquisitions. Any acquisition recommendations must be approved by three of the four committee members. The members of the Acquisition Committee are Daniel L. Lafrance (Chairman), John A. Hanna, Lise Lachapelle, and Jean La Couture. p. 07

10 POWERING UP ENVIRONMENT AND COMMUNITY 01

11 Innergex Power Income Fund Annual Report 2003 Harmony Innergex is particularly proud of the quality of its installations, and of the consideration that has gone into harmonizing the facilities and their operation with the surrounding environment and communities. Consultation with the local populations has been and remains an important aspect of Innergex s approach Boat-launch 01 Portneuf River Power station 02 Saint-Paulin Suspended bridge 03 Parc des Chutes-de-la-Chaudière Observation point 04 Parc des Chutes-de-la-Chaudière The Fund produces only green power environmentally-friendly power generated by low impact facilities. Currently, all of the Fund s plants are run-of-river hydroelectric plants, meaning that they take advantage of the existing elevation drop along the river and rely on the natural river flow, avoiding the need for a reservoir and thus minimizing ecological damage. At its Portneuf facilities near the town of Sainte-Anne-de-Portneuf on the north shore of Québec s St-Lawrence River, Innergex ensures that canoeing and kayaking enthusiasts can enjoy the beauty of the Portneuf River. During the summer months, the Fund provides a shuttle service to a boat-launch some 15 kilometres upstream from the power stations. At its Saint-Paulin plant, the Fund built the park surrounding the breathtakingly beautiful Magnan Falls. Hiking trails and bridges help visitors fully appreciate the attractions of the site. The best-known of the Fund s facilities lies in the Parc des Chutes-de-la-Chaudière, just across the bridge from Québec City on the south shore of the St-Lawrence River. The plant is built on the site once occupied by a small hydroelectric plant that dated from the turn of the century. Built in the late 1990s, the new plant was designed to harness the energy of the falls while preserving their beauty and protecting the existing flora and fauna. The plant had the support of the regional county municipality, the nearby towns of Saint-Nicolas and Charny, and numerous citizens committees, and has since become a major regional tourist attraction. Every year, Innergex funds the maintenance of the park. p. 09

12 POWERING UP GROWTH 01

13 Innergex Power Income Fund Annual Report Penstock installation 01 British Columbia Control panel 02 Idaho, U.S.A. Turbine installation 03 British Columbia Umbata Falls 04 Ontario Strategy Part of Innergex s strategy for increasing cash distributions to its Unitholders along with their stability and sustainability is to invest in additional power generating facilities. The Fund plans to invest only in the green power produced by hydroelectric power plants and wind farms. Innergex is well positioned to make such acquisitions. The Manager has seasoned in-house hydroelectric and wind farm specialists and has a proven track record of identifying, developing and acquiring power generating projects. A good example of this expertise is the recently announced Hydro-Windsor acquisition, which will augment the Fund s installed capacity by 8.5%, improve the stability and increase the distributable cash to Unitholders. Furthermore, the Fund has a privileged relationship with Innergex II, an entity created specifically to develop new hydroelectric power projects and wind farms. The Fund and Innergex II have signed a cooperation agreement that grants the Fund a right of first offer on any of the power generating projects being sold by Innergex II. Innergex II is currently in the process of developing several new hydroelectric projects in British Columbia, Ontario, Québec and in the United States of America for a total of 312 MW of installed capacity and is presently developing wind farms in Québec. With the continued deregulation of the energy industry and growing consumer awareness, clean power project opportunities are expected to multiply across Canada in the coming years. Innergex is already an established participant in this trend. p. 11

14 FINANCIAL REVIEW 2003 MANAGEMENT S DISCUSSION AND ANALYSIS p. 13 RESPONSIBILITY FOR FINANCIAL REPORTING p. 21 AUDITORS REPORT TO THE UNITHOLDERS p. 21 CONSOLIDATED FINANCIAL STATEMENTS p. 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS p. 26

15 Innergex Power Income Fund Annual Report 2003 MANAGEMENT S DISCUSSION AND ANALYSIS The purpose of this management s discussion and analysis (MD&A) is to provide the reader with an overview of the financial position, operating results and cash flows of Innergex Power Income Fund ( Innergex or the Fund ) for the financial year ended December 31, As the Fund closed its initial public offering on July 4, 2003 ( IPO ), this first financial year covers only 181 days of operations. This analysis should be read in conjunction with the audited consolidated financial statements dated December 31, The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ( GAAP ). The Fund reports its results in Canadian dollars. Forward-Looking Statements In the interest of providing Unitholders and potential investors with information regarding Innergex, including management s assessment of future plans and operations, certain statements in this MD&A are forward-looking statements subject to risks, uncertainties and other important factors that could cause the Fund s actual performance to differ materially from those expressed in or implied by such forward-looking statements. The principal risk factors are discussed under the heading Risks and Uncertainties on page 19. Although the Fund believes that the expectations conveyed by the forward-looking statements are based on information available to it on the date such forward-looking statements were made, there can be no assurance that such expectations will prove to be correct. All subsequent forward-looking statements, whether written or orally attributable to the Fund or persons acting on its behalf, are expressly qualified in their entirety by these cautionary statements. OVERVIEW General Innergex is a publicly-traded Canadian income fund that indirectly owns seven hydroelectric power plants with a combined installed capacity of 65 megawatts (MW). All seven plants have been commissioned in the past ten years. Six are located in the Province of Québec, and sell the power produced to Hydro-Québec under long-term power purchase agreements ( PPA ). The seventh is in Ontario, with the power produced sold to Ontario Electricity Financial Corporation ( OEFC ) under a long-term PPA. Innergex Management Inc. (the Manager ) operates the plants under long-term agreements with the Fund. Innergex was created in October 2002, completed its initial public offering in July 2003 and began making monthly cash distributions to its Unitholders in August Standard & Poor s Ratings Service ( S&P ) has assigned a stability rating of SR-2 (Positive Outlook) to the Trust Units, indicating a very high level of cash distribution stability. Business Strategy Innergex s primary objective is to ensure the stability and sustainability of the distributable cash payable to its Unitholders, and wherever possible, to increase the amount of distributable cash per unit. The Fund seeks to achieve its objective by: supervising and enhancing the operation of its existing hydroelectric power plants; and acquiring new electricity-generating facilities. The Fund s existing power plants are supervised by the Manager s experienced personnel, who have been engaged in the development, acquisition, construction, ownership and operation of hydroelectric power plants since This team has strong capabilities in both hydroelectric and wind generating facilities. The Fund has three reserve accounts used to support stable cash distributions. The levelization reserve account was established with a portion of the proceeds from the initial public offering, and will be used over the first eight years of operation to stabilize cash distributions. The hydrology reserve account was also created using a portion of the proceeds of the initial public offering for use in the event that the distributable cash for any year is less than anticipated due to a variety of unpredictable factors, including changes in water flows. Finally, a major maintenance reserve account is funded at a rate of $260,000 per year, and is intended to fund major plant repairs needed to maintain the Fund s generating capacity. Innergex is well positioned to acquire new electric generating facilities due to the Manager s seasoned management team and a strong balance sheet. Furthermore, the Fund has signed a cooperation agreement with Innergex II, a separate privately owned entity created to build, own and operate hydroelectric power plants and wind farms throughout North America. The cooperation agreement grants the Fund a right of first offer on any power generating projects being sold by Innergex II. New power plants will only be acquired if they are likely to increase the Fund s distributable cash per unit, enhance the stability and sustainability of cash distributions, and will be limited to hydroelectric and wind farm projects. The Fund plans to make new acquisitions in such a way as to diversify its holdings in terms of geography, watersheds, customers and energy source. p.13

16 Key Performance Indicators Innergex measures its performance on a fund-wide basis through key financial indicators that include power generated in megawatt hours (MWh), gross revenues, operating expenses, general and administrative expenses, EBITDA, cash flow from operating activities and distributable cash per unit. These items are discussed in the appropriate following sections. Market Trends Electricity has traditionally been generated, transmitted and distributed to customers by monopoly utilities. However, rapid growth in electricity demand, rising electricity rates, technological advances and environmental concerns have recently led to a restructuring of the electricity industry and the encouragement of independent power producers. While the amount of electricity generated by independent power producers has been relatively modest to date, planners have recognized the benefits of independent power projects, particularly where power is produced from renewable or waste resources or at a higher efficiency than conventional utility-owned generating facilities. Consequently, independent power producers, who typically generate electricity from sources such as water, natural gas, biomass (e.g. waste wood from forestry operations), landfill gas and wind, are expected to play a growing role in the supply of future energy needs. In Canada, each province determines its own energy policy. The three provinces where Innergex owns or is most likely to acquire generating power facilities are Québec, Ontario and British Columbia. In Québec, Hydro-Québec has a broad mandate to generate, supply and deliver electric power. Hydro-Québec purchases all the power produced by independent power producers in the province, which currently totals approximately 430 MW annually. In May 2003, Hydro-Québec launched a call for tenders for an initial block of 1,000 MW of wind power, with bids to be submitted by June 15, In April 2003, the Ontario government announced its intention to take immediate steps to increase electricity reserves in the province and to reduce Ontario s reliance on expensive imports. Furthermore, the province will require substantial additional capacity, as the future of the Pickering nuclear plant remains unclear and the Liberal government has promised to close all coal-fired electricity plants which produce about 25 per cent of the province's electricity by The Ontario government has indicated its intention to look to private power generators to fill the needed capacity. In early 2004, the Ontario government announced that it will be issuing a Request for Proposals ( RFP ) for up to 2,500 MW of new electrical generation capacity and/or demand-side management initiatives to be developed as early as This would represent one-third of the government's commitment to replace coal-fired generation with cleaner sources of energy or demand-side measures. This RFP would also support the government's electricity conservation target of 5% by 2007, which represents approximately 1,350 MW at peak demand. The government has also announced that it will be issuing another RFP for up to 300 MW of renewable energy capacity to be in service as soon as possible. This will help the government meet its target that 5% (1,350 MW) of all generating capacity come from renewables by In British Columbia, BC Hydro has approximately 80% of the province s generating capacity, with the remaining capacity provided by investor-owned utilities, large and small industrial self-generators and independent power producers. Independent power producers account for 2-3% of the market in terms of production, most of which is sold through either BC Hydro or Aquila Networks Canada, an investor-owned utility. In late 2002, the BC government announced a new energy plan for the province. The plan provides for a new distribution entity to be created, while BC Hydro remains responsible for power generation. However, its role in new generation capacity is now limited to improving efficiency at existing facilities, while independent power producers will develop any new generation facilities. Furthermore, the new energy plan includes a number of significant initiatives that should see 50% of new supply acquired from clean energy sources over the next ten years. RESULTS OF OPERATIONS Operating results for 2003 span the Fund s initial operating period of 181 days from July 4, the day of the IPO, until December 31. These results are compared to forecasts for the period that were included in the IPO prospectus. Gross Revenues For its first six months of operations, Innergex reported gross revenue of $10.8 million, slightly more than the $10.5 million initially forecasted. Hydrological conditions during the first three months of the 2003 operating period were lower than average, particularly in September. However, excellent conditions in the last three months of the year, due to above average rainfalls, more than compensated for this initial shortfall. Consequently, for the first six months of operation ended December 31, 2003, the Fund s seven plants produced a total of 166,702 MWh of power, 2% more than anticipated. p.14

17 Innergex Power Income Fund Annual Report 2003 Initial operating period from July 4 to December 31, 2003 Actual (MWh) Forecast (MWh) Saint-Paulin 19,894 17,764 Portneuf-1 21,223 20,938 Portneuf-2 35,828 38,124 Portneuf-3 21,738 21,787 Chaudière 51,482 49,319 Montmagny 3,062 2,967 Batawa 13,475 13,075 Total 166, ,974 Saint-Paulin The Saint-Paulin facility consists of an 8 MW-capacity plant at Magnan Falls in the municipality of Saint-Paulin, Québec. The plant was built in 1994 and commissioned that same year. The PPA for the Saint-Paulin facility expires in 2014 and is renewable for a period of 20 years. The facility generated 19,894 MWh of power in the first six months of the Fund s operation or 12% more than forecasted. Portneuf The Portneuf facilities consist of three power plants located a few kilometres apart on the Portneuf River in the municipalities of Sainte-Anne-de-Portneuf and Longue-Pointe in Québec. All commissioned in 1996, the plants have a total installed capacity of 25.9 MW, representing 43% of the Fund s total current projected annual production. The Portneuf PPA expires in 2021 and is renewable for 25 years. In addition to revenue from power generated at the Portneuf facility, the Fund receives cash payments from Hydro-Québec to compensate for its partial diversion of the flow normally available to the Fund s plants. These payments are based on average annual water flows over a number of historical years, but are also contingent on turbine availability and maximal production with the water resources left available by Hydro-Québec. In December 2003, although hydrological conditions were better than average, the Portneuf-2 facility was negatively impacted by the phenomenon known as frazil ice, small ice crystals that form as the river begins to freeze. This partially plugged up the intake thrash racks and reduced the flow of available water to be directed to the turbine, affecting production as well as compensation payments from Hydro-Québec. Paid production from the Portneuf facilities for the period was 78,789 MWh of power, 3% less than anticipated. Chaudière The 24 MW Chaudière power plant lies on the Chaudière River near Lévis, Québec, across the St-Lawrence River from Québec City. The Chaudière PPA expires in 2019 and is renewable for 20 years. In the six months ended December 31, 2003, the Chaudière plant produced 51,482 MWh of power, 4% more than anticipated. Montmagny The Montmagny power plant has an installed capacity of 2.1 MW and is located on the Du Sud River in the town of Montmagny, Québec. It was commissioned in The PPA for the plant expires in 2021 and is renewable for 25 years. The Montmagny plant produced 3,062 MWh of power in the six-month period ended December 31, 2003, 3% more than forecasted. Batawa Located on the Trent-Severn waterway near Trenton, Ontario, the Batawa power plant has an installed capacity of 5 MW. The facility was commissioned in Its PPA has an initial term of 30 years to 2029, and will subsequently remain valid unless a party to the agreement gives a one-year cancellation notice. In the first six months of the Fund s operation, the Batawa facility produced 13,475 MWh of electricity, 3% more than forecasted. Expenses Operating expenses, which consist primarily of water rights, royalties, maintenance and repairs for the hydroelectric power plants, amounted to $1.7 million for the period from July 4 to December 31, 2003, 11% higher than forecasted. The frazil ice phenomenon discussed above resulted in extra operating expenses at the Portneuf-2 facility, and expenses for the Batawa facility were higher than anticipated due to unexpected repairs that resulted in down time and the inspections of the gearbox in the month of December and the one-time payment of the insurance deductible for the replacement of parts within the gearbox. Nevertheless, the Fund did not withdraw any amounts from its major maintenance reserve account for these unforeseen repairs. p.15

18 The Fund reported general and administrative expenses of $0.7 million for its first six months of operation, 10% more than forecasted, primarily due to higher insurance premiums. The recent increases seen in general insurance rates are expected to persist in the foreseeable future. Innergex s long-term debt consists of a four-year term loan of $50.0 million, bearing interest at varying rates (See Note 7 to the consolidated financial statements). In its first six months of operation, the Fund paid $1.1 million in interest on its long-term debt, 24% less than forecasted, as the effective interest rate for the period was 4.52% instead of the expected 6%. Interest rates are expected to remain low for Furthermore, the Fund has entered into a swap transaction that effectively fixes the interest rate on 30% of its debt at 3.95% increased by a margin until September Depreciation and amortization for the period from July 4 to December 31, 2003 totalled $2.7 million, 13% lower than forecasted. While depreciation and amortization for the first three months of the period were on target, amounts for the last three months of the year were 27% below expectations due to the final allocation of the purchase price of the assets following the initial public offering and a resulting reallocation of tangible and intangible assets. Investment income consists of interest on the reserve accounts and cash on hand. Interest income for the first six months of the Fund s operation amounted to $0.2 million, 7% less than forecasted due to lower interest rates, partly offset by a larger amount of cash on hand. The non-controlling interest represents the share of pre-tax earnings attributable to IHI Hydro Inc. ( IHI ), a subsidiary of TD Capital Group Limited that holds a 24.9% interest in an Innergex subsidiary (See Note 9 to the consolidated financial statements). The amount allocated to the non-controlling interest in Innergex Holding LP for the first six months of operation amounted to $262,912, substantially higher than initially estimated because results for the subsidiary in which IHI holds an interest were better than anticipated. EBITDA Earnings before interest, income taxes, depreciation and amortization ( EBITDA ) amounted to $8.4 million for the first six months of operations, in line with initial forecasts. The Fund calculates EBITDA as follows: Initial operating period from July 4 to December 31, 2003 Actual Forecast Net Income $ 4,507,080 $ 4,062,772 Add: Depreciation and amortization 2,663,350 3,055,418 Non-controlling interest in Innergex Holding LP 262,912 (82,377) Interest on long-term debt 1,121,257 1,475,275 Investment income (194,188) (207,805) Provision for future income taxes 56,083 49,152 Current income taxes 1,500 EBITDA $ 8,416,494 $ 8,353,935 Net Income For its first six months of operation, Innergex posted a net income of $4.5 million or $0.25 per Trust Unit, 11% higher than the forecast of $4.1 million or $0.22 per unit. Per unit figures are based on a total of 18,357,267 units outstanding during the period. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2003, the Fund had cash and cash equivalents of $3.5 million. In its first six months of operation, the Fund generated cash flow from operating activities of $4.7 million. Changes in non-cash working capital items decreased cash flow by $2.8 million, consisting mainly of an increase in accounts receivable and prepaid expenses and a decrease in accounts payable and accrued liabilities, partially offset by distributions payable to Unitholders. Cash flow from financing activities for the period amounted to $212.5 million. This amount included $169.4 million in net proceeds from the issuance of Trust Units and $50.0 million from the issuance of long-term debt as part of the initial public offering, less $6.9 million paid out to Unitholders during the period. The Fund s initial public offering consisted of 14,602,267 Trust Units at a price p.16

19 Innergex Power Income Fund Annual Report 2003 of $10 per unit. The Fund also concurrently issued 3,755,000 units at the same price to existing institutional investors as a reinvestment of their interest in the power plants. In the first six months of operation, the Fund used cash flow of $213.7 million in its investing activities. A sum of $204.9 million was used to acquire interests in seven hydroelectric power plants, net of $1.9 million in cash and cash equivalents. A further $10.3 million was used to fund the reserve accounts, including $0.1 million in capitalized interest. These amounts were offset by $1.4 million released from the levelization reserve during the period, in accordance with initial forecasts. No amounts were released from the hydrology or major maintenance reserve accounts. For an explanation of the Fund s reserve accounts, please see under the heading Business Strategy on page 13. At December 31, 2003, the Fund had total assets of $232.4 million. Working capital stood at $4.2 million, with a working capital ratio of 2.1:1. Long-term debt was $50.0 million, and the long-term debt-to-enterprise value ratio stood at 18.8%. Payments Due by Period Less than After 5 Contractual obligations Total 1 year years years years Long-term debt $ 50,000,000 $ $ 50,000,000 $ $ Operating leases 313,300 6,842 21,781 15, ,046 Purchase obligations 1,491,279 97, , , ,849 Other long-term obligations 20,620, ,661 2,991,967 1,831,621 14,995,668 Total contractual obligations $ 72,425,496 $ 906,199 $ 53,322,836 $ 2,061,898 $ 16,134,563 The other long-term obligations are mainly comprised of the 20 years Management, Administration and Services Agreements with the Manager. DISTRIBUTABLE CASH AND CASH DISTRIBUTIONS The Fund distributes cash on a monthly basis, consisting of distributable cash from operations plus an amount drawn from the levelization reserve account as forecasted. For its first six months of operation, the Fund generated total distributable cash from operations of $7.4 million and drew $1.4 million from its levelization reserve account. Cash distributions amounted to $8.3 million or $0.452 per Trust Unit. The Fund calculates distributable cash as follows: Initial operating period from July 4 to December 31, 2003 Actual Forecast EBITDA $ 8,416,494 $ 8,353,935 Less: (Investment income) (194,188) (207,805) Major maintenance account provision 130, ,000 Distribution to non-controlling interest 79,530 Interest on long-term debt 1,121,257 1,475,275 Current income taxes 1,500 Distributable cash from operating activities $ 7,359,425 $ 6,875,435 Add: Release from levelization reserve account 1,426,791 1,426,858 Distributable cash $ 8,786,216 $ 8,302,293 Trust Units issued 18,357,267 18,357,267 Distributable cash per Trust Unit $ $ Cash distributions declared per Trust Unit $ Cash distributions declared $ 8,297,485 p.17

20 The excess of distributable cash over distributions declared increased the working capital. The 2003 cash distribution schedule was as follows: Record Date Payment Date Amount Amount per Unit July 31, 2003 August 25, 2003 $ 1,229,935 $ August 29, 2003 September 25, 2003 $ 1,413,510 $ September 30, 2003 October 24, 2003 $ 1,413,510 $ October 31, 2003 November 25, 2003 $ 1,413,510 $ November 28, 2003 December 19, 2003 $ 1,413,510 $ December 31, 2003 January 23, 2004 $ 1,413,510 $ $ 8,297,485 $ TAX TREATMENT OF DISTRIBUTIONS For Canadian tax purposes, approximately 12% of the cash distributions for 2003 ($ per unit) are considered a taxable dividend from a Canadian corporation and 9% ($ per unit) is income from a trust. The remaining approximately 79% ($ per unit) is considered a return of capital and is therefore non-taxable. This last amount must be applied to reduce the adjusted cost base of the units when the units are sold. The Fund recommends that Unitholders consult their tax advisors regarding the tax implications of their investment in Trust Units. RELATED PARTY TRANSACTIONS The Manager During the year ended December 31, 2003, the Manager rendered services to the Fund and its subsidiaries. These services are governed by three 20-year agreements namely a Management Agreement, an Administration Agreement and a Services Agreement. The Manager was paid an amount of $342,500 for the services rendered under the three agreements. A complete description of these agreements is found at Note 12 to the financial statements of the Fund. IHI Hydro Inc. IHI Hydro Inc. owns a minority interest in subsidiaries of the Fund. IHI Hydro Inc. is also indebted to another subsidiary of the Fund. The obligations of IHI Hydro Inc. are secured in part against the assets of the subsidiaries of the Fund. In consideration for allowing security on their assets, the subsidiaries are entitled to a guarantee fee currently equal to 10% of the annual capital and interest amounts paid by IHI Hydro Inc. (other than a tranche of $3.0 million of the indebtedness). The guarantee fee is payable until the years 2005 to 2009 depending of the facilities. The guarantee fee income was $523,975 during the year and included as gross revenues on the income statement. CRITICAL ACCOUNTING ESTIMATES The critical accounting estimates for the Fund are related to the capital and intangibles assets. Upon the acquisition of the assets by the Fund, an allocation of the purchase price was made for each acquired asset based on their respective fair values. The capital assets are mainly comprised of hydroelectric power generating facilities. These capital assets, when properly maintained, have a very long useful life. The Fund estimated useful life of these assets is between 40 and 50 years from the date of the commissioning without any residual value. The intangible assets consist of various permits and agreements related to the hydroelectric power generating facilities. These intangible assets are amortized over the first maturity of the permits and agreements of each facility. FUTURE CHANGES IN ACCOUNTING POLICIES In order to comply with the Generally Accepted Accounting Principles as promulgated by the Accounting Standards Board, the following changes in accounting policies will become effective in The sinking fund method of depreciation and amortization will no longer be considered acceptable under the Generally Accepted Accounting Principles. The Fund was using this method of depreciation and amortization for its capital and intangible assets. The Fund will modify its depreciation and amortization method starting with the quarter beginning on January 1, The Fund will depreciate and amortize its capital and intangible assets using the straight line method over the same useful life as before. This should result in additional depreciation and amortization of $2.6 million for the year ending December 31, 2004 but it will have no impact on cash flows or distributable cash. p.18

21 Innergex Power Income Fund Annual Report 2003 The Fund will have to provide for any asset retirement obligations in its 2004 financial statements. The Fund does not foresee any material expense or liability in relation to these obligations. The Fund will have to account for under new rules for any derivatives contracts. The Fund enters into swap contracts to hedge a portion of its exposure to possible fluctuations in interest rates. These contracts are designated to hedge against a specific risk and are effective to reduce the specific risk of interest fluctuation. The Fund does not foresee any material impact on its results from these new rules. RISKS AND UNCERTAINTIES Innergex is exposed to a variety of business risks, and has outlined below those that it considers material. However, additional risks and uncertainties not presently known to the Fund or that it currently believes to be immaterial may also adversely affect its business. Operations Risk The major operations risks are plant performance and equipment failure risk. The revenues generated by the Fund s power plants are largely dependent on the amount of electrical energy generated by these plants, and primarily determine the distributable cash to the Fund s Unitholders. Such risks are minimized by the high quality of the plants and well-designed maintenance programs that ensure that the plants operate at peak efficiency. The Fund also makes annual deposits to a major maintenance reserve account, to be used to fund major repairs when needed to maintain the generating capacity of its power plants. Hydrology Risk The amount of energy generated by the plants is generally dependent on the availability of water flows. Lower-than-expected flows in any given year could have an impact on the Fund s cash flow and therefore on the cash distributions to Unitholders. It should be noted that while six of the Fund s seven power plants are in the Province of Québec, they draw on a variety of watersheds. Furthermore, the Fund has a hydrology reserve account on which it may draw to compensate for low hydrology situations. Finally, the Fund s PPA relative to the Portneuf power plants contributes to mitigating a large portion of this risk. As discussed above, Innergex receives cash compensation from Hydro-Québec for lost revenue resulting from a recent diversion of the Portneuf River. As the payments are calculated based on average water flows over a number of years, there are no annual variations in the flows. The Portneuf power plants represent 43% of the Funds current projected annual production. Reliance on Large Customers All of the power generated by the Fund s plants is sold to Hydro-Québec and Ontario Electricity Financial Corporation (OEFC) under long-term PPAs. Any failure on the part of Hydro-Québec or OEFC to fulfill their contractual obligations would have a material adverse effect on distributable cash. However, the Fund considers this risk to be minimal given the high credit ratings of both Hydro-Québec and OEFC (See Note 14 to the consolidated financial statements). Interest Rates Innergex pays interest on its long-term debt, and is therefore exposed to changes in interest rates. To mitigate this exposure, the Fund has entered into a swap transaction that fixes the interest rate on 30% of its debt at 3.95% increased by a margin until September Tax Treatment of Distributions The ability of the Fund to make cash distributions is dependent on the current tax treatment of mutual fund trusts. There can be no assurance that the Canadian federal income tax law or its interpretation in this regard will not change in a manner that will adversely affect Innergex Unitholders. Change in Laws, Regulatory Regime and Permits The profitability of the Facilities will be in part dependent upon the continuation of a favourable regulatory climate with respect to the continuing operations and the future growth and development of the independent power industry and environmentally preferred energy sources. Should the regulatory regime in an applicable jurisdiction be modified in a manner which adversely affects the Facilities, including increases in taxes and permit fees, distributable cash may be adversely affected. The failure to obtain all necessary licences or permits, including renewals thereof or modifications thereto, may adversely affect distributable cash. The Facilities encompass operations which are subject to environmental and safety standards and regulations imposed by regulatory bodies. Although the Manager believes that the operations of the Facilities are in compliance in all materials respects with such standards and regulations, failure to operate the Facilities in strict compliance with applicable regulations and standards may expose owners or operators of the Facilities to claims and clean-up costs. Any new law or regulation could require significant additional expenditures to achieve or maintain compliance, which may adversely affect distributable cash. The operation of the Facilities is highly regulated. Water rights are generally owned by governments which reserve the right to control water levels. Any reduction in water levels could result in reduced electricity generation, which could adversely affect revenues and distributable cash. p.19