<PAGE>
________________________________________________________________________________
________________________________________________________________________________
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
--------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 0-15472
_______________________________________
Environmental Power Corporation
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 04-2782065
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
500 Market Street, Suite 1-E, Portsmouth, New Hampshire 03801
(Address of principal executive offices)
(Zip code)
(603) 431-1780
Registrant's telephone number, including area code
________________________________________________________________________________
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Number of shares of Common Stock outstanding
at May 9, 1997 - 11,076,783 shares
The Exhibit Index appears on Page 19.
Total number of pages is 20.
________________________________________________________________________________
________________________________________________________________________________
<PAGE>
ENVIRONMENTAL POWER CORPORATION
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1997
(unaudited) and December 31, 1996 ....................................................... 2
Condensed Consolidated Statements of Operations (unaudited) for the
Three Months Ended March 31, 1997 and March 31, 1996 ................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited) for the
Three Months Ended March 31, 1997 and March 31, 1996 .................................... 4
Notes to Condensed Consolidated Financial Statements .................................... 5-6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................................... 7-18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................................... 19
Item 6. Exhibits and Reports on Form 8-K ............................................ 19
Signatures ............................................................................. 20
</TABLE>
1
<PAGE>
PART I. FINANCIAL INFORMATION
------------------------------
<TABLE>
<CAPTION>
ITEM 1. FINANCIAL STATEMENTS
ENVIRONMENTAL POWER CORPORATION AND
SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31 DECEMBER 31
1997 1996
------------ -------------
ASSETS (UNAUDITED)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 776,682 $ 1,178,524
Restricted cash 2,365,546 1,864,899
Receivable from utility 5,658,297 5,892,879
Notes receivable 2,974,357 2,973,629
Receivable from sale of affiliate 276,444 276,444
Other current assets 961,654 1,132,791
------------ -------------
TOTAL CURRENT ASSETS 13,012,980 13,319,166
PROPERTY, PLANT AND EQUIPMENT, NET 7,568,074 7,312,299
DEFERRED INCOME TAX ASSET 3,624,105 3,840,105
LEASE RIGHTS, NET 2,869,272 2,906,523
NOTES RECEIVABLE 75,698 85,190
ACCRUED POWER GENERATION REVENUES 26,684,935 24,456,478
OTHER ASSETS 579,542 583,383
------------ -------------
$ 54,414,606 $ 52,503,144
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 5,467,321 $ 6,283,775
Other current liabilities 3,596,363 3,188,758
------------ -------------
TOTAL CURRENT LIABILITIES 9,063,684 9,472,533
DEFERRED GAIN, NET 5,936,906 6,014,008
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 8,346,580 8,346,580
ACCRUED LEASE EXPENSES 26,684,935 24,456,478
MAINTENANCE RESERVE 1,723,659 1,533,829
------------ -------------
TOTAL LIABILITIES 51,755,764 49,823,428
SHAREHOLDERS' EQUITY
Preferred Stock ($.01 par value;
1,000,000 shares authorized; no shares
issued at March 31, 1997 and December -- --
31, 1996, respectively)
Common Stock ($.01 par value;
20,000,000 shares authorized;
12,195,423 shares issued at March 31,
1997 and December 31, 1996,
respectively; 11,076,783 shares
outstanding at March 31, 1997 and
December 31, 1996, respectively) 121,954 121,954
Additional paid-in capital 10,725,191 11,057,495
Accumulated deficit (6,970,876) (7,282,306)
------------ -------------
3,876,269 3,897,143
Treasury stock (1,118,640 common
shares, at cost, as of
March 31, 1997 and December 31, 1996, (456,271) (456,271)
respectively)
Notes receivable from officers (761,156) (761,156)
------------ -------------
TOTAL SHAREHOLDERS' EQUITY 2,658,842 2,679,716
------------ -------------
$ 54,414,606 $ 52,503,144
============ =============
See notes to condensed consolidated financial statements.
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31
-------------------------------------------
1997 1996
------------ -------------
<S> <C> <C>
POWER GENERATION REVENUES $ 11,273,300 $ 10,765,515
------------- -------------
COSTS AND EXPENSES:
Operating expenses 4,396,726 4,279,593
Lease expenses 5,706,274 5,127,619
General and administrative expenses 691,839 982,977
Depreciation and amortization 49,802 41,870
------------- -------------
10,844,641 10,432,059
------------- -------------
OPERATING INCOME 428,659 333,456
OTHER INCOME (EXPENSE):
Other income --- 42,080
Interest income 118,145 93,898
Interest expense (86,476) (79,320)
Amortization of deferred gain 77,102 77,103
Warranty income --- 900,000
------------- -------------
108,771 1,033,761
------------- -------------
INCOME BEFORE INCOME TAXES 537,430 1,367,217
INCOME TAX EXPENSE (226,000) (575,000)
------------- -------------
NET INCOME $ 311,430 $ 792,217
============= =============
PRIMARY AND FULLY-DILUTED EARNINGS PER
COMMON SHARE $ 0.03 $ 0.07
============= =============
DIVIDENDS PAID $ 332,304 $ 330,805
============= =============
DIVIDENDS PAID PER COMMON SHARE $ 0.03 $ 0.03
============= =============
See notes to condensed consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31
---------------------------------------
1997 1996
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 311,430 $ 792,217
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 49,802 41,870
Deferred income taxes 216,000 560,000
Amortization of deferred gain (77,102) (77,103)
Amortization of unearned compensation --- 20,085
Accrued power generation revenues (2,228,457) (726,235)
Accrued lease expenses 2,228,457 726,235
Changes in operating assets and liabilities:
Increase in restricted cash --- (900,000)
Decrease in receivable from utility 234,582 580,730
Decrease in other current assets 171,137 131,312
Decrease in accounts payable and accrued
expenses (816,454) (542,987)
Decrease in deferred revenue --- (830,471)
Increase in other current liabilities 407,605 367,751
Increase in maintenance reserve 189,830 112,350
------------- ---------------
Net cash provided by operating
activities 686,830 255,754
------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable 8,764 457,413
Increase in restricted cash (500,647) (156,592)
(Increase) decrease in other assets (5,069) 35,897
Property, plant and equipment expenditures (259,416) (5,975)
------------- ---------------
Net cash (used in) provided by
investing activities (756,368) 330,743
------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (332,304) (330,805)
Repayment of secured promissory notes payable and
other borrowings --- (46,500)
Purchase of treasury stock --- (232,876)
Proceeds from the collection of notes receivable
from officers --- 72,876
Proceeds from other borrowings --- 52,813
------------- ---------------
Net cash used in financing
activities (332,304) (484,492)
------------- ---------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (401,842) 102,005
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,178,524 1,011,822
------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 776,682 $ 1,113,827
============= ===============
See notes to condensed consolidated financial statements.
</TABLE>
4
<PAGE>
ENVIRONMENTAL POWER CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- BASIS OF PRESENTATION
- -------------------------------
The accompanying unaudited condensed consolidated financial statements of
Environmental Power Corporation ("EPC") and its subsidiaries (the "Company")
have been prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and footnotes required by generally accepted
accounting principles for annual financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of operations
for the three months ended March 31, 1997 are not necessarily indicative of
results to be expected for the year ending December 31, 1997. For further
information, refer to the consolidated financial statements and footnotes
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1996.
NOTE B -- PROVISION FOR INCOME TAXES
- ------------------------------------
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes". This
standard requires, among other things, recognition of future tax benefits,
measured by enacted tax rates, attributable to deductible temporary differences
between financial bases of assets and liabilities, and net operating loss
carryforwards to the extent that realization of such benefits are more likely
than not. Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and net
operating loss carryforwards for which the Company expects income tax benefits
will be realized in future years.
NOTE C -- EARNINGS PER COMMON SHARE
- -----------------------------------
The Company computes its earnings (loss) per common share using the
treasury stock method in accordance with Accounting Principles Board Opinion No.
15. Under this method, all options, warrants and their equivalents are assumed
exercised (whether dilutive or antidilutive) with aggregate proceeds used to
purchase up to 20% of the Company's outstanding common stock. If the combined
effect of the assumed exercise is dilutive, all options, warrants and their
equivalents are included in the computation. For purposes of calculating
primary earnings per share, the Company considers its shares issuable in
connection with stock options to be dilutive common stock equivalents when the
exercise price is less than the average market price of the Company's common
stock for the period. The weighted average number of shares of common stock and
dilutive common stock equivalents for the calculation of primary earnings per
share was 11,220,991 and 11,551,979 for the three months ended March 31, 1997
and 1996, respectively. For purposes of calculating fully diluted earnings per
share, the Company considers its shares issuable in connection with stock
options to be dilutive common stock equivalents when the exercise price is less
than the higher of the market price of the Company's common stock at the end of
the period or the average price of
5
<PAGE>
NOTE C -- EARNINGS PER COMMON SHARE (CONTINUED)
- -----------------------------------------------
the Company's common stock for the period. The weighted average number of
shares of common stock and dilutive common stock equivalents for the calculation
of fully diluted earnings per share was 11,220,991 and 11,551,979 for the three
months ended March 31, 1997 and 1996, respectively.
NOTE D -- NEW ACCOUNTING STANDARD
- ---------------------------------
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 128, Earnings Per Share, which establishes
new standards for computing and presenting earnings per share. The Statement is
effective for periods ending after December 15, 1997. Accordingly, the Company
will adopt the standard beginning with its fourth quarter of 1997. For the first
quarter of 1997 and 1996, respectively, the proforma basic and diluted earnings
per share amounts would not have been materially different from the earnings per
share amounts shown for the periods presented in the accompanying condensed
consolidated statements of operations.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW OF THE COMPANY
- -----------------------
The Company owns a 22 year leasehold interest in an approximately 83 Mw
(net) waste coal-fired electric generating facility (the "Scrubgrass Project")
located in Pennsylvania, the lease for which commenced on June 30, 1994. Until
December 31, 1994 the Company also held varying ownership interests (100% to
approximately 40%) in and oversaw the operation of an approximately 51 Mw (net)
waste coal-fired electric generating facility (the "Sunnyside Project") located
in Utah. The Company has one additional project (the "Milesburg Project") in the
development stage, but believes that it has limited opportunities for additional
similar project development in the United States for the foreseeable future. The
following Management's Discussion and Analysis of Financial Condition and
Results of Operations compares the Company's results of operations for the three
months ended March 31, 1997 ("1997") with its results of operations for the
three months ended March 31, 1996 ("1996") and discusses any material changes in
the Company's financial condition since its Annual Report on Form 10-K for the
year ended December 31, 1996.
CAUTIONARY STATEMENT
- --------------------
This Quarterly Report on Form 10Q contains "forward-looking statements",
as defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about the Company. For this
purpose, any statements which are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of
important factors which could cause the Company's actual results to differ
materially from those indicated by the forward looking statements. These
factors include, without limitation, those set forth below under the caption
"Certain Factors That May Affect Future Results".
RESULTS OF OPERATIONS
- ---------------------
Power generation revenues for the three months ended March 31, 1997
amounted to $11,273,300 as compared to $10,765,515 for the three months ended
March 31, 1996. The overall increase in power generation revenues during 1997
is primarily attributable to an increase in the revenue recorded as a result of
the straight-line accounting treatment of certain revenues under the power
purchase agreement which amounted to $2,228,457 for the three months ended March
31, 1997 as compared to $726,235 for the three months ended March 31, 1996.
Without consideration of the straight-line accounting treatment of certain
revenues under the power purchase agreement, the Company's power generation
revenues during 1997 decreased by comparison to 1996 primarily for two reasons.
First, the Scrubgrass plant operated at 90.6% of its capacity during the three
months ended March 31, 1997 as compared to 93.6% of its capacity during the
three months ended March 31, 1996 largely due to an extended outage of
approximately 6 days in February 1997 to consider issues related to the
generator. Second, the Company recognized certain revenues of $830,470 during
the three months ended March 31, 1996 which were previously deferred under the
Scrubgrass power
7
<PAGE>
purchase agreement. All power generation revenues earned by the Company in 1997
and 1996 related to the Scrubgrass Project.
Operating expenses for the three months ended March 31, 1997 amounted to
$4,396,726 as compared to $4,279,593 for the three months ended March 31, 1996.
The overall increase in 1997 is primarily attributable to higher fuel costs
because of instances of poor fuel quality during the winter months which
occurred more frequently in 1997 when compared to 1996. However, the impact of
the higher fuel costs was mitigated by lower operator fees in 1997 since the
Company is not presently expecting to pay 1997 bonuses to the operator because
of the anticipated financial impact of the extended spring shutdown.
Lease expense for the three months ended March 31, 1997 amounted to
$5,706,274 as compared to $5,127,619 for the three months ended March 31, 1996.
The overall increase in lease expense during 1997 is primarily attributable to
an increase in the lease expense recorded as a result of the straight-line
accounting treatment of certain lease expenses under the Scrubgrass lease which
amounted to $2,228,457 for the three months ended March 31, 1997 as compared to
$726,235 for the three months ended March 31, 1996. Without consideration of
the straight-line accounting treatment of certain lease expenses under the
Scrubgrass lease, the Company's lease expense during 1997 decreased by
comparison to lease expense for the three months ended March 31, 1996 primarily
for two reasons. First, lower interest rates incurred in 1997 reduced the
lessor's loan costs that were passed through to the Company in its facility
lease expenses. Second, as a result of lower net profits earned by the
Scrubgrass Project during 1997, the Company's equity rent to the lessor was
reduced. However, the overall reduction in lease expense was offset in part by
higher principal payments in 1997 on the lessor's senior debt which were passed
through to the Company in its facility lease expenses.
General and administrative expenses for the three months ended March 31,
1997 amounted to $691,839 as compared to $982,977 for the three months ended
March 31, 1996. The overall decrease in general and administrative expenses
during 1997 is primarily due to the Company's efforts to reduce its corporate
overhead expenses. The Company's major steps to reduce its corporate overhead
included a consolidation of its Vermont and New Hampshire offices into one
office in New Hampshire (completed by May 1996), a reduction in its executive
officer compensation and a reduction in its employee headcount by an equivalent
of two full-time employees. The Company continues to incur substantial
management and professional fees to negotiate certain contractual matters and
defend its position in certain legal matters. Accordingly, the full effect of
the Company's efforts to reduce its corporate overhead expenses still has not
yet been shown in its recent operating results.
Warranty income for the three months ended March 31, 1996 amounted to
$900,000 and resulted from a settlement with an engineering and construction
contractor for the Scrubgrass plant which was received in March 1996.
Income tax expense for the three months ended March 31, 1997 amounted
to $226,000 as compared to income tax expense of $575,000 for the three months
ended March 31, 1996. The decrease in income tax expense during 1997 resulted
primarily from lower earnings during the three months ended March 31, 1997.
8
<PAGE>
Net income for the three months ended March 31, 1997 amounted to $311,430
as compared to net income of $792,217 for the three months ended March 31, 1996.
The overall decrease in 1997 is largely attributable to the absence in 1997 of
certain revenues of $830,470 which were previously deferred under the Scrubgrass
power purchase agreement, the absence in 1997 of warranty income amounting to
$900,000, the lower revenue capacity achieved in 1997 and higher fuel costs.
The overall decrease was offset in part by the lower general and administrative
expenses, operator fees and lease expenses. The changes in the components of
net income were discussed more fully in the previous narrative under "Results of
Operations".
Outlook for the Remainder of 1997
During the fourth quarter of 1996, after learning about a generator failure
at an electric generating facility with an identical generator to the Scrubgrass
facility, the manufacturer asked the Company to perform certain tests to
determine the Scrubgrass generator's condition. Based on the results of these
tests, which became available during the first quarter of 1997, the Company
believes the Scrubgrass facility's generator exhibits certain conditions which
indicate that a similar failure might occur at some time in the future. In
light of these test results, the generator manufacturer has recommended that the
Company perform a complete rewind on the Scrubgrass facility's generator during
its 1997 annual plant outage which began on April 11, 1997 and has not yet been
finalized. As a result of the recommended generator repair, the Company
currently estimates it would incur an additional expense of approximately
$660,000 to perform the rewind procedure, $564,000 of which was recorded in
1996, and would expect to lose net revenues which average approximately $80,000
per day for each additional day the facility is inoperative during the scheduled
outage. Originally, the manufacturer of the generator had indicated that the
rewind would take no longer than 44 days, which would necessitate that the
Scrubgrass plant be shutdown for 35 days longer than the original shutdown
planned by the facility operator. However, based on recent progress in
performing the generator rewind, the Company presently expects that the rewind
will be completed in just 32 days (12 days ahead of the manufacturer's original
expectation). While the full effect of the extended shutdown will not be known
until it is finalized, the impact of the repair and extended shutdown on the
Company's operating results and/or cash flows could be mitigated by proceeds
from insurance coverage and/or modifications to the Scrubgrass Project's
financing. However, there can be no assurance that any of such mitigating
factors will occur. See "Certain Factors That May Affect Future Results" below.
Until the generator repair is completed, it is not possible to accurately
predict its effect on the Company's results of operations in 1997. However,
without giving effect to the negative impact of the generator repair on the
Company's 1997 operating results, the Company's management expects that the
Company would still be less profitable in 1997 as compared to 1996. In 1996, the
Company enjoyed the benefit of certain non-recurring revenues including the
recognition of $3,064,965 of revenues which were previously deferred under the
Scrubgrass power purchase agreement, the settlement of a warranty issue related
to the Scrubgrass Project for $900,000 and the settlement of a legal proceeding
for approximately $340,000, net of legal fees. In addition, the Company expects
to incur additional lease expense in 1997 of approximately $790,000 as a result
of additional principal payments due on one of the Lessor's term loans. However,
the Company expects that the absence of the 1996 non-recurring revenues and the
9
<PAGE>
impact of the additional 1997 lease expense would be partially offset by some
factors with a favorable impact on its results of operations in 1997. These
factors include an increase in certain power generation revenues resulting from
an approximate 5% increase in the contracted rates charged for energy produced
by the Scrubgrass Project, a reduction in lease expense from anticipated lower
equity rents and bank fees, and a reduction of general and administrative
expenses largely because approximately $800,000 of such expenses incurred in
1996 are not expected to recur in 1997. Furthermore, the Company expects that a
material portion of its 1997 expenses will continue to consist of non-cash
items, including deferred income taxes, maintenance reserves, and depreciation
and amortization. As such, the Company expects that its cash generated from
operations will continue to be greater than its operating results. However,
there can be no assurance that the Company will continue to pay dividends. The
Company's ability to continue to pay dividends will depend, in part, on the
financial impact of the generator repair (See "Liquidity and Capital Resources -
1997 Outlook").
RECENTLY ISSUED ACCOUNTING STANDARDS
- ------------------------------------
See Note D to the Condensed Consolidated Financial Statements for recently
issued accounting standards which the Company will be required to adopt in 1997.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Operating Activities
Operating activities continue to be the Company's principal source of
liquidity with cash provided by operating activities amounting to $686,830
during the three months ended March 31, 1997 as compared to $255,754 during the
three months ended March 31, 1996. During the three months ended March 31, 1997
and 1996, the Company primarily generated cash from operating activities from
the operating profits of the Scrubgrass Project and from investment earnings.
The following changes in operating assets and liabilities most notably impacted
cash provided by operating activities during the three months ended March 31,
1997:
Receivable from utility - The Company's receivable from utility relates to
the Scrubgrass Project and amounted to $5,658,297 as of March 31, 1997 as
compared to $5,892,879 as of December 31, 1996. The reduction in receivable
from utility as of March 31, 1997 is primarily due to lower revenues during
February 1997 as a result of the 6 day shutdown to consider issues related to
the generator.
Other current assets - The Company's other current assets amounted to
$961,654 as of March 31, 1997 as compared to $1,132,791 as of December 31,
1996. The overall decrease is largely attributable to the expiration of
prepaid insurance and a reduction in fuel inventory levels which were higher
than usual at December 31, 1996 because the Company had advance purchased
certain inventory during 1996 to obtain favorable pricing. The impact of the
aforementioned items was offset in part by an increase in accrued interest on
the notes receivable related to the sale of Sunnyside Project.
10
<PAGE>
Deferred income tax asset - The Company's deferred income tax asset amounted
to $3,624,105 as of March 31, 1997 as compared to $3,840,105 as of December
31, 1996. The decrease is largely attributable to the utilization of net
operating loss carryforwards during the three months ended March 31, 1997.
Current liabilities - The Company's current liabilities amounted to
$9,063,684 as of March 31, 1997 as compared to $9,472,533 as of December 31,
1996. The overall decrease is largely attributable to reduced operating
expenses during February 1997 as a result of the 6 day shutdown to consider
issues related to the generator.
Deferred gain, net - The Company's deferred gain, net amounted to $5,936,906
as of March 31, 1997 as compared to $6,014,008 as of December 31, 1996. The
decline is due to the amortization of the deferred gain related to the
Scrubgrass Project, which is being amortized on a straight-line basis over 22
years.
Maintenance reserve - The Company's maintenance reserve, which relates to the
Scrubgrass Project, increased to $1,723,659 as of March 31, 1997 from
$1,533,829 as of December 31, 1996 due to scheduled reserves provided for the
ongoing maintenance of the plant.
Investing Activities
The Company used $756,368 for investing activities during the three months
ended March 31, 1997 and received $330,743 from investing activities during the
three months ended March 31, 1996. The Company's investing activities are
concentrated primarily in the following areas:
Notes receivable - The Company presently has notes receivable related to the
1994 sale of the Sunnyside Project and related to fees earned in 1995 for the
Scrubgrass Project. The Company collected $8,764 and $457,413 from notes
receivable related to the Scrubgrass Project during the three months ended
March 31, 1997 and 1996, respectively. The notes receivable related to the
Sunnyside Project, with a principal balance of $2,937,500 and accrued
interest balance of $294,554 as of March 31, 1997, are the subject of a legal
proceeding. See "Certain Factors That May Impact Future Results" and "Part
II - Item 1. Legal Proceedings" for further information.
Restricted cash - The Company is presently required to make scheduled
deposits to a major maintenance fund to ensure that funds are available in
the future for scheduled maintenance procedures. During the three months
ended March 31, 1997 and 1996, scheduled deposits and interest earned on the
major maintenance fund aggregated $500,647 and $156,592, respectively. In
anticipation of performing significant repairs during the 1997 annual plant
outage which began on April 11, 1997, the Company advanced $350,000 to the
major maintenance fund during the three months ended March 31, 1997.
Property plant and equipment - The Company invested $259,416 and $5,975 in
property, plant and equipment expenditures during the three months ended
March 31, 1997 and 1996, respectively. The expenditures primarily relate to
development activities for the Company's Milesburg Project for which
development efforts have increased in 1997.
11
<PAGE>
Financing Activities
The Company utilized $332,304 and $484,492 in financing activities during
the three months ended March 31, 1997 and 1996, respectively. The Company's
financing activities are concentrated primarily in the following areas:
Dividends - Beginning in 1996, the Company initiated a quarterly dividend
policy which is subject to review and consideration by the Board of Directors
each quarter. In respect of this dividend policy, the Company declared and
paid dividends of $332,304 and $330,805 during the three months ended March
31, 1997 and 1996, respectively.
Treasury Stock - The Company from time to time makes purchases of its own
common stock. During March 1996, the Company purchased 520,540 shares of
common stock from a resigning executive officer for $287,876 representing all
of the officer's holdings in the Company. The Company's note receivable from
the officer in the amount of $72,876 was collected by reducing the proceeds
paid to the officer for the common stock. The Company has not made any
treasury stock purchases during 1997.
Notes payable - The Company presently has long-term obligations related to
its Milesburg Project and Scrubgrass Project in the amount of $5,858,767 and
$2,487,813, respectively. The Company also had short-term installment
obligations related to its Sunnyside Project and Milesburg Project which were
fully satisfied by aggregate payments $186,000 during 1996, with $46,500 of
such payments made during the three months ended March 31, 1996. The
Milesburg Project long-term obligations are noninterest-bearing and payable
only under certain conditions, the most significant of which relates to the
closing of construction financing and commencement of construction for the
Milesburg Project. The next installment for the Scrubgrass Project long-term
obligation is not due until 1998.
1997 Outlook
During 1997, the Company expects that its principal sources of cash to fund
its business activities will be from available cash balances, investment
earnings and cash which may become available from the Scrubgrass Project. As
discussed more fully in the Company's 1996 Annual Report on Form 10-K, the
Company is not able to receive cash from the Scrubgrass Project until all
operating expenses, base lease payments (which include the Lessor's debt
service), certain maintenance reserve payments and other subordinated payments
of the Scrubgrass Project are first satisfied. Furthermore, as described in this
Item under "Results of Operations - Outlook for the Remainder of 1997", the
Company is making significant repairs to the generator of the Scrubgrass Project
during its 1997 annual plant outage which began on April 11, 1997 and has not
yet been finalized. As a result of lost net revenues and additional maintenance
expenses during the extended plant outage, the Company will experience a
significant cash shortfall beginning shortly after the outage unless it can
arrange financing for the cash deficiency. However, based on recent discussions
with the Scrubgrass Project's lending institutions, the Company currently
expects that it may be able to spread the financial impact of the generator
12
<PAGE>
repair over a longer period through extended terms on certain of its existing
credit facilities. Furthermore, in light of the favorable performance of the
Scrubgrass Project which is expected to resume once the necessary generator
repairs are made, the Company expects that the Scrubgrass Project will be
capable of supporting the increases in the debt service requirements proposed
under the generator repair financing scenarios without compromising any of its
existing debt covenants. As such, the Company expects that it will receive
sufficient cash from the Scrubgrass Project, which when combined with its
available cash balances and investment earnings, would be sufficient to sustain
it business activities on a long-term basis. However, there can be no assurance
that the financial impact of the generator repair can be spread over a longer
period or that the favorable performance of the Scrubgrass Project will
continue. See "Certain Factors That May Affect Future Results" below.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
- ----------------------------------------------
The following important factors, among others, could cause actual results
to differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q.
Ownership of Single Operating Asset
The Company owns a 22 year leasehold interest in the Scrubgrass Project, an
approximate 83 Mw (net) waste-coal fired electric generating facility located in
Pennsylvania, the lease for which commenced on June 30, 1994. Presently, all
the Company's operating revenues are attributable to power generation from the
Scrubgrass Project. Accordingly, the Company's operations are largely dependent
upon the successful and continued operation of the Scrubgrass Project. In
particular, if the Scrubgrass Project experiences unscheduled shutdowns of
significant duration, the Company's results of operations will be materially
adversely affected.
Dependence Upon Key Employees
The success of the Company is largely dependent upon a staff of four
employees, including three executive officers. The loss of any of these
employees could adversely effect the Company's operations.
Third Party Project Management
The Company has entered into a management services agreement with U.S. Gen
to manage the Scrubgrass Project and a 15-year operations and maintenance
agreement with US Operating Services to operate the facility. Under the terms
of these agreements, there are provisions which limit the Company's
participation in the management and operation of the Scrubgrass Project, and
provisions which provide for recourse against the manager and operator for
unsatisfactory performance. However, the Company does not exercise control over
the operation or management of the Scrubgrass Project. As such, decisions may
be made affecting the Scrubgrass Project, notwithstanding the Company's
opposition, which may have an adverse affect on the Company.
13
<PAGE>
Scheduled and Unscheduled Shutdowns
The Scrubgrass Project from time to time experiences both scheduled and
unscheduled shutdowns. Periodically, the Scrubgrass Project incurs scheduled
shutdowns in order to perform maintenance procedures to equipment that cannot be
performed while the equipment is operating. Occasionally, the Scrubgrass Project
may also incur unscheduled shutdowns or may be required to operate at reduced
capacity levels following the detection of equipment malfunctions, or following
minimum generation orders received by the utility. During periods when the
Scrubgrass Project is shutdown or operating at reduced capacity levels, such as
the scheduled outage which began on April 11, 1997, the Company may incur losses
due to the loss of its operating revenues and/or due to additional costs which
may be required to complete any maintenance procedures. It is not possible for
the Company to predict the frequency of future unscheduled shutdowns or to
predict the extent of maintenance which may be required during shutdowns related
to equipment maintenance.
Legal Proceedings
As discussed in "Part II-Item 1. Legal Proceedings", the Company is
involved in a legal proceeding with the purchasers of the Company's interest in
the Sunnyside Project which was sold in 1994. Pending the resolution of the
legal proceeding, the purchasers have withheld scheduled payments of principal
and interest due on the promissory notes since June 1996, which amounted to
$1,187,500 and $294,554, respectively as of March 31, 1997. In addition, the
Company recorded in 1994 a receivable related to a purchase price adjustment, as
provided for in the Purchase and Sale Agreement, of approximately $1.1 million,
of which $708,000 was received in April 1995. The balance of purchase price
adjustment is being disputed in the legal proceeding with the purchasers who
also seek rescission of the purchase and sale agreement and unspecified damages.
Although the Company's available cash and cash provided by operating activities
has been sufficient to fund the Company's investing and financing activities,
the withholding of scheduled principal and interest payments has adversely
affected the Company's cash flow. At this time, while management believes the
Company's position in this litigation is meritorious, the Company cannot predict
whether it will prevail in the litigation and to what extent it will incur
professional fees to defend its position in the litigation. An unfavorable
resolution and/or extensive professional fees to defend the litigation could
adversely affect the Company's results of operations.
Financial Results
To date the Company has incurred substantial losses, primarily due to its
development activities, which have resulted in an accumulated deficit of
$6,970,876 as of March 31, 1997. In addition, except during 1996 when the
Scrubgrass Project became profitable, the Company has incurred losses in recent
years. Financial results can be affected by numerous factors, including without
limitation general economic conditions, general industry conditions, the amount
and rate of growth of expenses, transportation and quality of raw materials,
inflation, levels of energy rates, uncertainties relating to government and
regulatory policies, the legal environment and
14
<PAGE>
volatile and unpredictable developments. The Company believes it is well
positioned to handle such matters as they may arise during the course of its
future business activities. However, there can be no assurance that the Company
will be profitable in the future.
Development Uncertainties
The Company is currently pursuing efforts towards either the development of
the Milesburg Project or the negotiation of a buy-out of the Milesburg Project's
power purchase agreement with West Penn Power Company. However, there can be no
assurance that the Milesburg Project will be successfully developed, that the
Company will receive a buy-out proposal, or that the Company will realize any
value from the Milesburg Project. In the event the Company and its joint
development partner, U.S. Gen, seek to continue development efforts, there can
be no assurance that the Company will be able to obtain all of the necessary
site agreements, fuel supply contracts, design/build agreements, power sales
contracts, licenses, environmental and other permits, local government approvals
or financing commitments required for the successful completion of this project.
To date, the Company's efforts to develop the Milesburg Project have been
proceeding on schedule. However, the failure to accomplish any of the
aforementioned steps could materially increase the cost or prevent the
successful completion of the Milesburg Project, or cause the Company to abandon
the Milesburg Project and incur the loss of its investment to date, which could
materially impact the Company's business and results of operations.
Project Financing
The successful development of the Milesburg Project would require
substantial financing. Presently, the Company believes the Milesburg Project
could be financed. However, there can be no assurance that such financing can
be successfully arranged. Any such financing is likely to be collateralized by
the assets of the Milesburg Project, with repayment to be from the revenues
attributable to the Milesburg Project. The Company may also be required to give
up significant equity interests in the Milesburg Project or make other
concessions in order to arrange the financing.
Potential Liability, Damages and Insurance
The Company's power generation activities involve significant risks to the
Company for environmental damage, equipment damage and failures, personal injury
and fines and costs imposed by regulatory agencies. In the event a liability
claim is made against the Company, or if there is an extended outage or
equipment failure or damage at the Company's power plant for which it is
inadequately insured or subject to a coverage exclusion, and the Company is
unable to defend such claim successfully or obtain indemnification or warranty
recoveries, there may be a material adverse effect on the Company.
15
<PAGE>
Circulating Fluidized Bed Technology
The Company's Scrubgrass Project employs circulating fluidized bed
technology to produce electricity. Certain aspects of this technology, as well
as the conversion of waste products into electricity, are relatively new areas
being explored by the alternative energy market in the last ten years.
Accordingly, this technology carries greater risk than more established methods
of power generation such as hydropower. As such, the long-term costs and
implications of maintaining this technology have not been established by
historical industry data.
Customer Concentration
The Company's power generation revenues are earned under a long-term power
purchase agreement with one customer, Pennsylvania Electric Company. The
Company expects that the concentration of its revenues with this customer will
continue for the foreseeable future. Although, the Company's Milesburg Project
is in the development stage and presents an opportunity in the future for the
Company to expand its revenue sources and lessen its revenue concentration.
However, there can be no assurance that the Milesburg Project will be
successfully developed.
Interest Rates
The Company's subsidiary, as a lease cost of the Scrubgrass facility, is
required to fund the Lessor's debt service which primarily consists of $135.6
million of variable rate tax-exempt bonds maturing in 2012, a $20.8 million term
loan maturing in 2005, a $9.5 million variable rate term loan maturing in 2004
and $1.2 million in remaining junior subordinated debt obligations which mature
through 2004. The Company's subsidiary is also required to fund a variable rate
working capital loan and a $2.5 million variable rate term loan maturing in
2004. The Lessor entered into interest rate swaps which had the effect of
fixing the interest rate on the tax-exempt bonds until May 18, 1996 at
approximately 3.72% and fixing the interest rate over the life of the $20.8
million term loan at 6.42%. After May 18, 1996, the Company's specified base
rent was incurred based on floating rates on the Lessor's tax-exempt bonds. As
such, except for the Lessor's $20.8 million term loan and $1.2 million remaining
junior subordinated debt obligations, the Company will be required to fund debt
service consisting of rates which will vary with market conditions. Presently,
the Company is not able to predict how future interest rates will affect its
lease expense or debt service. Should market interest rates rise significantly,
the Company's operating results may be significantly impacted. However, the
Scrubgrass Project's financing agreements have terms which limit interest rate
increases by requiring the Lessor to enter into interest rate protection
agreements if interest rates exceed certain levels as defined in such financing
agreements. Notwithstanding, the Company believes the Lessor has good
relationships with the project lenders who would continue to support lending
terms which would not have a material adverse affect on the operating results of
the Scrubgrass Project. However, there can be no assurance that the Lessor
could renegotiate its credit facilities under terms which would ensure
continuing profitable operating results of the Scrubgrass Project.
16
<PAGE>
Fuel Quality
The Company obtains coal tailings primarily from coal mining companies on a
long-term basis because coal tailings are plentiful and generally create
environmental hazards, such as acid drainage, when not disposed of properly.
The coal tailings are burned in the Scrubgrass facility using a circulating
fluidized bed combustion system. During the circulating fluidized bed
combustion process, the coal tailings are treated with other substances such as
limestone. Depending on the quality of the coal tailings, the facility operator
may need to add additional coal tailings or other substances to create the
appropriate balance of substances which would result in the best fuel or sorbent
consistency for power generation and compliance with air quality standards.
Therefore, the cost of generating power is directly impacted by the quality of
the coal tailings which supply the Scrubgrass power generation facility. The
facility operator maintains certain controls over obtaining higher quality coal
tailings. However certain conditions, such as poor weather, can create
situations where the facility operator has less control over the quality of the
coal tailings. The Company cannot predict the extent to which poor fuel quality
may impact its future operating results.
Competition
The Company generates electricity using alternative energy sources which is
sold on a wholesale basis to utilities under contracted rates established in
power purchase agreements. There are a large number of suppliers in the
wholesale market and a surplus of capacity which has led to intense competition
in this market. The principal sources of competition in this market include
traditional utilities who have excess capacity, energy traders and brokers,
contractors, equipment suppliers and other independent power producers who have
entered, or are attempting to enter the energy market. Competition in this
industry is substantially based on price with competitors discovering lower cost
alternatives to providing electricity. Presently, the Company does not believe
it will be significantly impacted by competition in the wholesale energy market
since its revenues are subject to contracted rates which are substantially fixed
for several years. However, the contracted rates in the later years of the
Scrubgrass Project power purchase agreement switch to rates which vary more
closely with existing market conditions. Should ensuing competition in the later
years of the Company's Scrubgrass power purchase agreement create downward
pressure on wholesale energy rates, the Company's profitability could be
impacted.
The Company also competes in the market to develop power generation
facilities. The primary bases of competition in this market are quality of
development plans, ability (including financial ability) of the developer to
complete the project and the price to be paid for the development opportunity.
In certain cases, competitive bidding for a development opportunity is required.
Competition for attractive development opportunities is expected to be intense
as there are a number of competitors in the industry interested in the limited
number of such opportunities. Many of the companies competing in this market
have substantially greater resources than the Company. The Company believes its
project development experience and its experience in creating strategic
alignments with other development firms with greater financial and technical
resources could enable it to continue to compete effectively in the development
market as
17
<PAGE>
development opportunities arise. However, the Company believes it has limited
opportunities for additional project development in the United States for the
foreseeable future.
Regulation
The Company's projects benefit from regulation under federal and state
energy laws and regulations which require electric utilities to purchase energy
produced by qualifying facilities. The Company also benefits from and must
comply with certain regulations enacted pursuant to the Public Utility
Regulatory Policies Act of 1978 ("PURPA") exempting certain qualifying
facilities from certain provisions of the Federal Power Act of 1920, the Public
Utility Holding Company Act of 1935, and, except under certain limited
circumstances, state laws regulating the wholesale rates charged by electric
utilities. The Company cannot predict the affect on its business if these laws
or regulations are amended or repealed.
The Company's projects must also comply with applicable federal, state and
local laws relating to the protection of the environment, primarily in the areas
of water and air pollution. As regulations are enacted or adopted the Company
cannot predict the effect of compliance therewith on its business. Failure to
comply with all applicable requirements could result in required modifications
to facilities including the inability to operate during periods of non-
compliances. The Company is responsible to ensure compliance of its facilities
with all applicable requirements and, accordingly, attempts to minimize these
risks by dealing with reputable contractors.
The Commonwealth of Pennsylvania has recently passed legislation which
significantly restructures the electric industry, primarily in the retail
market, beginning in 1997. Presently, none of this recently passed legislation
directly impacts the Company. However, the Company cannot predict whether its
operating or development activities will be indirectly impacted by any such
legislation in the future.
18
<PAGE>
PART II. OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
On May 3, 1996, B&W Sunnyside L.P., NRG Sunnyside Inc., NRG Energy Inc., and
Sunnyside Cogeneration Associates (collectively the "Plaintiffs") filed a
complaint, which was amended on June 27, 1996, against the Company and three of
its wholly-owned subsidiaries (collectively hereafter in this Item 1 "the
Company") in Seventh District Court for Carbon County, State of Utah. The
amended complaint alleges that the Company breached the purchase and sale
agreement by which the Company transferred all of its interest in Sunnyside
Cogeneration Associates, a joint venture which owned and operated a nominal 51
megawatt waste coal fired facility located in Carbon County, Utah. The amended
complaint also alleges that the Company made certain misrepresentations in
connection with the purchase and sale agreement. As a result of the alleged
breaches of contract and misrepresentations, the Plaintiffs allege that they
suffered damages in an unspecified amount that exceed the aggregate outstanding
principal and interest balances due to the Company by B&W Sunnyside L.P. and NRG
Sunnyside, Inc. under certain notes receivable, which amounted to $2,937,500 and
$294,554, respectively at March 31, 1997. In addition to alleging unspecified
damages, the Plaintiffs also request rescission of the purchase and sale
agreement. On July 30, 1996, in response to the Plaintiffs' amended complaint,
the Company filed an answer and counterclaim. In the answer to the amended
complaint, the Company denied all material allegations of the amended complaint
and asserted numerous affirmative defenses. In the counterclaim, the Company
alleges numerous causes of action against the Plaintiffs which include breach of
contract, breach of the promissory notes, intentional, malicious and willful
breach of contract, intentional tort, interference and misrepresentation.
Through the counterclaim, the Company seeks remedies which include: (1)
compensatory, consequential and punitive damages; (2) acceleration and immediate
payment in full of the promissory notes; and (3) injunctions which require the
Plaintiffs to continue making payments under the promissory notes during the
pendency of this action and until the promissory notes are paid in full and
which enjoin the Plaintiffs from continuing certain malicious and intentional
actions that are alleged in the counterclaim, together with interest, reasonable
attorney's fees, costs and other such relief as the court deems proper. On
August 30, 1996, the Plaintiffs filed a reply to the Company's counterclaim in
which they denied all material allegations of the counterclaim and asserted
numerous affirmative defenses. The Company plans to vigorously defend against
the amended complaint and vigorously pursue the causes of action stated in the
counterclaim. The matter is currently in the discovery stage.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 11 - Computation of Earnings Per Share
(b) Reports on Form 8-K - None
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENVIRONMENTAL POWER CORPORATION
May 13, 1997 /s/ William D. Linehan
-------------------------------
William D. Linehan
Treasurer and
Chief Financial Officer
(principal accounting officer
and authorized officer)
20
<PAGE>
EXHIBIT 11
ENVIRONMENTAL POWER CORPORATION
COMPUTATION OF EARNINGS PER SHARE
MARCH 31, 1997
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED MARCH 31, 1997:
- ------------------------------------------
<S> <C>
Weighted average number of shares outstanding 11,220,991
------------
Net Income $ 311,430
------------
Earnings per share - primary and fully diluted $ .03
------------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AS OF MARCH 31, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 3,142,228<F1>
<SECURITIES> 0
<RECEIVABLES> 8,984,796<F2>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,012,980<F3>
<PP&E> 7,568,074
<DEPRECIATION> 82,253
<TOTAL-ASSETS> 54,414,606
<CURRENT-LIABILITIES> 9,063,684
<BONDS> 8,346,580
0
0
<COMMON> 121,954
<OTHER-SE> 2,536,888
<TOTAL-LIABILITY-AND-EQUITY> 54,414,606
<SALES> 11,273,300
<TOTAL-REVENUES> 11,273,300
<CGS> 4,396,726
<TOTAL-COSTS> 4,396,726
<OTHER-EXPENSES> 5,706,274
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 86,476
<INCOME-PRETAX> 537,430
<INCOME-TAX> 226,000
<INCOME-CONTINUING> 311,430
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 311,430
<EPS-PRIMARY> .03
<EPS-DILUTED> .03
<FN>
<F1>CASH INCLUDES $2,365,546 WHICH IS RESTRICTED IN USE
<F2>RECEIVABLES INCLUDES NOTES RECEIVABLE OF $75,698 WHICH ARE NONCURRENT
<F3>CURRENT ASSETS OF $3,232,054 ARE SUBJECT TO A LEGAL PROCEEDING
</FN>
</TABLE>
