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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 September 30, 1997
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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
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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 November 11, 1997 11,201,783 shares
The Exhibit Index appears on Page 25.
Total number of pages is 26.
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ENVIRONMENTAL POWER CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as
of September 30, 1997 (unaudited) and December 31, 1996........... 2
Condensed Consolidated Statements of Operations (unaudited)
for the three and nine months ended September 30, 1997 and
September 30, 1996................................................ 3
Condensed Consolidated Statements of Cash Flows (unaudited) for
the nine months ended September 30, 1997 and September 30, 1996... 4
Notes to Condensed Consolidated Financial Statements.............. 5-6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 7-23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................ 24
Item 2. Changes in Securities.................................... 24
Item 5. Other Information........................................ 25
Item 6. Exhibits and Reports on Form 8-K......................... 25
Signatures........................................................ 26
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PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30 December 31
1997 1996
------------ ------------
ASSETS (Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 471,439 $ 1,178,524
Restricted cash 331,643 1,864,899
Receivable from utility 6,651,942 5,892,879
Notes receivable 38,356 36,129
Other current assets 809,561 911,473
------------ ------------
TOTAL CURRENT ASSETS 8,302,941 9,883,904
PROPERTY, PLANT AND EQUIPMENT, NET 9,284,500 7,312,299
DEFERRED INCOME TAX ASSET 4,112,105 3,840,105
LEASE RIGHTS, NET 2,794,770 2,906,523
RECEIVABLE FROM SALE OF AFFILIATE 718,276 497,762
NOTES RECEIVABLE 2,993,638 3,022,690
ACCRUED POWER GENERATION REVENUES 31,134,919 24,456,478
OTHER ASSETS 685,682 583,383
------------ ------------
$ 60,026,831 $ 52,503,144
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 5,538,436 $ 6,033,675
Other current liabilities 3,665,046 2,696,143
------------ ------------
TOTAL CURRENT LIABILITIES 9,203,482 8,729,818
DEFERRED INTEREST REVENUE 147,278 --
DEFERRED GAIN, NET 5,782,700 6,014,008
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 10,277,841 9,089,195
ACCRUED LEASE EXPENSES 31,134,919 24,456,478
MAINTENANCE RESERVE 2,109,009 1,533,829
------------ ------------
TOTAL LIABILITIES 58,655,229 49,823,328
SHAREHOLDERS' EQUITY
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
issued at September 30, 1997 and December 31, 1996, respectively) -- --
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at September 30, 1997 and December 31, 1996, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,290,423 and 12,195,423 shares issued at September 30, 1997
and December 31, 1996,respectively; 11,171,783 and 11,076,783 shares
outstanding at September 30, 1997 and December 31, 1996, respectively) 122,904 121,954
Additional paid-in capital 10,083,794 11,057,495
Accumulated deficit (7,569,194) (7,282,306)
------------ ------------
2,637,604 3,897,243
Treasury stock (1,118,640 common shares, at cost, as of
September 30, 1997 and December 31, 1996, respectively) (456,271) (456,271)
Notes receivable from officers and board members (809,731) (761,156)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 1,371,602 2,679,816
------------ ------------
$ 60,026,831 $ 52,503,144
============ ============
</TABLE>
See notes to condensed consolidated financial statements
2
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ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
POWER GENERATION REVENUES $ 12,195,445 $ 11,758,162 $ 31,500,839 $ 35,602,294
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Operating expenses 4,494,388 4,165,275 13,559,961 13,065,918
Lease expenses 6,572,055 5,972,189 18,051,600 18,467,284
General and administrative expenses 260,857 719,833 1,432,677 2,377,509
Reversal of provision for nonrecovery of
project development costs (940,144) -- (940,144) --
Depreciation and amortization 59,257 51,426 159,245 153,703
------------ ------------ ------------ ------------
10,446,413 10,908,723 32,263,339 34,064,414
------------ ------------ ------------ ------------
OPERATING INCOME (LOSS) 1,749,032 849,439 (762,500) 1,537,880
OTHER INCOME (EXPENSE):
Other income -- 542,100 -- 584,294
Interest income 31,459 125,821 175,932 345,000
Interest expense (80,676) (41,626) (223,628) (116,748)
Amortization of deferred gain 77,103 77,103 231,308 231,308
Warranty income -- -- -- 900,000
------------ ------------ ------------ ------------
27,886 703,398 183,612 1,943,854
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES 1,776,918 1,552,837 (578,888) 3,481,734
INCOME TAX (EXPENSE) BENEFIT (674,000) (652,000) 292,000 (1,454,000)
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 1,102,918 $ 900,837 $ (286,888) $ 2,027,734
============ ============ ============ ============
PRIMARY AND FULLY-DILUTED EARNINGS
(LOSS) PER COMMON SHARE $ 0.10 $ 0.08 $ (0.03) $ 0.18
============ ============ ============ ============
DIVIDENDS PAID:
COMMON SHARES $ 335,153 $ 332,303 $ 999,760 $ 995,411
PREFERRED SHARES 1,250 -- 28,928 --
============ ============ ============ ============
$ 336,403 $ 332,303 $ 1,028,688 $ 995,411
============ ============ ============ ============
DIVIDENDS PAID PER COMMON SHARE $ 0.03 $ 0.03 $ 0.09 $ 0.09
============ ============ ============ ============
</TABLE>
See notes to condensed consolidated financial statements
3
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ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
--------------------------
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (286,888) $ 2,027,734
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities:
Depreciation and amortization 159,245 153,103
Deferred income taxes (272,000) 1,436,300
Amortization of deferred gain (231,308) (231,308)
Reversal of provision for nonrecovery of project
development costs (940,144) --
Amortization of unearned compensation -- 60,255
Accrued power generation revenues (6,678,441) (6,827,360)
Accrued lease expenses 6,678,441 6,827,360
Changes in operating assets and liabilities:
(Increase) decrease in receivable from utility (759,063) 422,596
Decrease in other current assets 101,912 253,762
Increase in receivable from sale of affiliate (220,514) (12,566)
Decrease in accounts payable and accrued expenses (495,239) (1,031,808)
Increase (decrease) in deferred revenue 147,278 (2,394,204)
Decrease in other current liabilities -- (300,000)
Increase in long-term liabilities 8,646 8,676
Increase in maintenance reserve 575,180 268,050
----------- -----------
Net cash (used in) provided by operating activities (2,212,895) 660,590
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable 26,825 474,090
Decrease (increase) in restricted cash 313,256 (389,333)
(Increase) decrease in other assets (129,029) 58,487
Property, plant and equipment expenditures (1,052,819) (44,662)
----------- -----------
Net cash (used in) provided by investing activities (841,767) 98,582
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (1,028,688) (995,411)
Net borrowings under working capital loan 368,903 970,167
Borrowings under long-term credit facility 3,000,000 --
Repayment of secured promissory notes payable and
other borrowings -- (139,517)
Purchase of treasury stock -- (287,876)
Proceeds from the issuance of common stock 7,362 14,437
Proceeds from the collection of notes receivable from officers -- 72,876
Proceeds from other borrowings -- 52,813
----------- -----------
Net cash provided by (used in) financing activities 2,347,577 (312,511)
----------- -----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (707,085) 446,661
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,178,524 1,011,822
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 471,439 $ 1,458,483
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements
See Note E to condensed consolidated financial statements for noncash financing
and investing activities
4
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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 and its subsidiaries ("EPC" or 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 nine months ended September 30, 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 the financial bases and tax 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 (LOSS) 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 11,204,599 and 11,176,211 for the three months ended September 30,
1997 and 1996, respectively and 11,195,410 and 11,288,493 for the nine months
ended September 30, 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
5
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NOTE C -- EARNINGS (LOSS) PER COMMON SHARE (CONTINUED)
- ------------------------------------------------------
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 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 11,242,282 and 11,176,211 for the three months ended
September 30, 1997 and 1996, respectively and 11,228,301 and 11,288,493 for the
nine months ended September 30, 1997 and 1996, respectively.
NOTE D -- NEW ACCOUNTING STANDARDS
- ----------------------------------
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 three
and nine months ended September 30, 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.
NOTE E -- NON CASH INVESTING AND FINANCING ACTIVITIES
- -----------------------------------------------------
During the second quarter of 1997, the Lessor of the Scrubgrass Project
assumed primary responsibility for the disbursement of funds and repayment of
debt related to the capital improvements fund of the Scrubgrass Project.
Accordingly, restricted cash and secured borrowings in the amount of $1,220,000
were transferred from the financial statements of the Company to the financial
statements of the Lessor.
During the third quarter of 1997, a member of the Company's Board of
Directors exercised options for the purchase of 80,000 shares of the Company's
common stock. In connection with this option exercise, the board member issued
a note payable to the Company for $48,575.
NOTE F -- RECLASSIFICATIONS
- ---------------------------
The Company has made certain reclassifications in the presentation of its
financial statements as of December 31, 1996 and for the three and nine months
ended September 30, 1996 in order to conform to the presentation of its
financial statements as of September 30, 1997 and for the three and nine months
ended September 30, 1997.
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 which it has contracted to sell as part of the buy-out of its
energy purchase contract with a utility (see "Part II, Item 5. Other
Information"), 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
and nine months ended September 30, 1997 ("1997") with its results of operations
for the three and nine months ended September 30, 1996 ("1996") and discusses
certain 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 10-Q 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".
SCRUBGRASS MAINTENANCE OUTAGE
The Company's results of operations for the nine months ended September 30,
1997 were significantly impacted by the Company's maintenance outage for the
Scrubgrass plant which occurred during the second quarter of 1997. As discussed
in previous filings, the Company had to perform significant repairs to the
Scrubgrass generator during this maintenance outage which necessitated that the
Scrubgrass plant be inoperative for a period of 37 days. Originally, without
knowledge of the necessary generator repair, the Company had planned that the
Scrubgrass plant would be inoperative for only 12 days to perform pre-scheduled
annual maintenance during the outage. While the Company is pleased to report
that the extended outage was completed approximately 10 days ahead of the 47 day
schedule, the Company's 1997 results were nevertheless significantly impacted by
this outage. As a result of the extended outage, the Company estimates that it
lost approximately $2,480,000 in revenues, incurred $660,000 to have
7
<PAGE>
the manufacturer repair the generator, incurred approximately $700,000 in
additional maintenance expenses which were not originally scheduled during this
outage, saved approximately $496,000 in fuel costs by not operating during the
outage and incurred approximately $300,000 in related costs such as legal fees,
management costs, bank fees, etc. As such, the Company believes that the
financial impact of this outage aggregated approximately $3.7 million. See
"Results of Operations-Outlook for the Remainder of 1997" for a discussion of
the effect of the outage on 1997 operating results and "Liquidity and Capital
Resources-Outlook" for a discussion of the cash flow implications resulting from
the outage.
RESULTS OF OPERATIONS
Power generation revenues for the three and nine months ended September 30,
1997 amounted to $12,195,445 and $31,500,839, respectively, as compared to
$11,758,162 and $35,602,294 for the three and nine months ended September 30,
1996, respectively. The overall decrease in power generation revenues during the
nine months ended September 30, 1997 is primarily attributable to the extended
maintenance outage to repair the generator. During the first quarter of 1997,
the Scrubgrass plant was inoperative for approximately 6 days to consider
generator matters. During the second quarter of 1997, the Scrubgrass annual
outage extended approximately 31 days longer than the 6 day outage in May 1996
due primarily to the generator repair. At an average of $80,000 of net revenues
per day, this accounts for an approximate reduction in power generation revenues
for the nine months ended September 30, 1997 of $3 million by comparison to the
same period in 1996. However, the impact of the lost revenues from the
Scrubgrass outage was mitigated by a 5% increase in certain rates charged to the
utility under the terms of the power sales contract and improvements in the
performance of the Scrubgrass plant after the 1997 extended outage. Further, the
Company recognized certain revenues of $2,394,204 during the nine months ended
September 30, 1996 which were previously deferred under the Scrubgrass power
purchase agreement. There were no revenues recognized during the nine months
ended September 30, 1997 which were previously deferred under the Scrubgrass
power purchase agreement. The increase in revenues during the three months ended
September 30, 1997 as compared to the three months ended September 30, 1996
primarily relates to the 5% increase in certain rates charged to the utility
under the terms of the power sales contract and an increase in the performance
of the Scrubgrass plant which operated at 97% average capacity for the third
quarter of 1997 versus 88% for the third quarter of 1996. However, the increase
for the third quarter in 1997 was offset in part by the recognition of certain
revenues of $789,934 during the third quarter of 1996 which were previously
deferred under the Scrubgrass power purchase agreement. All power generation
revenues earned by the Company in 1997 and 1996 related to the Scrubgrass
Project.
Operating expenses for the three and nine months ended September 30, 1997
amounted to $4,494,388 and $13,559,961, respectively, as compared to $4,165,275
and $13,065,918 for the three and nine months ended September 30, 1996,
respectively. The overall increase in 1997 is primarily attributable to higher
maintenance costs to complete the extended maintenance outage at the Scrubgrass
plant and higher payroll costs primarily attributable to 1997 salary increases
for plant personnel. However, the overall increase was substantially offset by
lower fuel costs because the Scrubgrass plant operated approximately 37 days
less in 1997 by comparison to 1996 and lower operator fees for the Scrubgrass
Project because the Company does not anticipate paying a year end bonus to the
operator in 1997 in light of the effect of the extended outage on performance
targets. The
8
<PAGE>
largest effect from these factors occurred during the second quarter of 1997.
The overall increase in operating expenses during the three months ended
September 30, 1997 as compared to the three months ended September 30, 1996 is
attributable to higher fuel costs because the Scrubgrass plant operated at a
higher capacity rate during the third quarter of 1997, higher maintenance costs
to replenish certain supplies and the higher payroll costs. The overall
increase during the three months ended September 30, 1997 was offset in part by
the lower operator fees.
Lease expense for the three and nine months ended September 30, 1997
amounted to $6,572,055 and $18,051,600, respectively, as compared to $5,972,189
and $18,467,284 for the three and nine months ended September 30, 1996,
respectively. The overall decrease in lease expense during 1997 occurred
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 having less cash available from the
operations of the Scrubgrass Project during 1997, the Company's equity rent to
the Lessor was substantially reduced through June 1997, and still had not
reached prior year levels by the end of September 1997. 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. During the three months ended September 30, 1997, the
Company's lease expense was higher by comparison to the three months ended
September 30, 1996 primarily as a result of higher equity rents and the higher
principal payments on the Lessor's senior debt. The Company's equity rents
during the three months ended September 30, 1997 were higher by comparison to
the three months ended September 30, 1996 primarily for two reasons. First, as
a result of the new term credit facility for the Scrubgrass project described
under "Liquidity and Capital Resources-Financing Activities" below, the
Scrubgrass project was able to pay equity distributions which were previously
deferred during the Scrubgrass outage due to cash shortfalls. Second, as a
result of better performance of the Scrubgrass plant during the third quarter of
1997 by comparison to the same period in 1996, the Company had additional cash
available for equity distributions.
General and administrative expenses for the three and nine months ended
September 30, 1997 amounted to $260,857 and $1,432,677, respectively as compared
to $719,833 and $2,377,509 for the three and nine months ended September 30,
1996, respectively. The overall decrease in general and administrative expenses
during 1997 is primarily due to the Company's efforts to reduce its corporate
overhead expenses and the capitalization of labor and overhead expenses for
development efforts related to the Milesburg project. 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, a reduction in its employee
headcount by an equivalent of two full-time employees, and a reduction of its
1997 insurance costs by restructuring insurance programs. In addition, the
Company has been able to see significant reductions in 1997 management costs for
the Scrubgrass project due to additional experience of the Manager's employees
and because the negotiation of certain contractual matters required less effort
in 1997. The Company continues to incur substantial management and professional
fees to 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.
9
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Reversal of provision for nonrecovery of project development costs relates
to the Company's Milesburg project and amounted to $940,144 for the three and
nine months ended September 30, 1997, respectively. As announced in a Current
Report on Form 8-K filed on September 9, 1997, the Company's subsidiary,
Milesburg Energy, Inc. ("Milesburg"), entered into a Buy-Out Agreement with West
Penn Power Company ("West Penn") on August 26, 1997. Pursuant to the Buy-Out
Agreement, West Penn would purchase Milesburg's rights to the Electric Energy
Purchase Agreement between the parties dated February 25, 1987 for the sum of
$15 million plus 8% interest from the date (August 29, 1997) the Buy-Out
Agreement was filed for Pennsylvania Public Utility Commission ("PUC") approval,
plus West Penn would assume ownership of and responsibility for the Milesburg
project facility. In light of this Buy-Out Agreement, which establishes a value
significantly in excess of the Company's recorded carrying value for its
investment in the Milesburg project, the Company has removed its reserve for the
impairment in value of this investment during the third quarter of 1997. The
reserve was established in 1990 by a charge against earnings due to the
uncertainties surrounding whether the Company would realize value from its
investment in the Milesburg project.
Other income for the three and nine months ended September 30, 1996
amounted to $542,100 and $584,294, respectively and related primarily to a legal
settlement of $540,000 and Sunnyside Project sales tax refunds of approximately
$42,000 arising out of activities prior to the date of sale. There was no other
income incurred during 1997.
Interest income for the three and nine months ended September 30, 1997
amounted to $31,459 and $175,932, respectively, as compared to $125,821 and
$345,000 for the three and nine months ended September 30, 1996, respectively.
The decrease in 1997 is primarily attributable to lower investments in cash and
cash equivalents, lower investments in restricted cash and less interest
recognized on the Company's notes receivable related to the sale of its interest
in the Sunnyside Project. Beginning in April 1997, the Company has deferred the
interest income on the notes receivable related to the sale of its interest in
the Sunnyside Project until the litigation with the purchasers is resolved (See
"Part II - Item 1. Legal Proceedings"). While the Company believes its
position in this litigation is meritorious, the Company also believes it may
take an extended period of time to enforce its rights and collect on these notes
receivable. Now that the Sunnyside notes receivable have been in arrears for
more than one year and are expected to remain in arrears for the foreseeable
future, the Company believes it is in the best interest of its investors to
classify these notes receivable, along with the related contingent liabilities,
as long-term and defer future interest income so that the Company's financial
position and ongoing results of operations are presented more conservatively.
Interest expense for the three and nine months ended September 30, 1997
amounted to $80,676 and $223,628, respectively as compared to $41,626 and
$116,748 for the three and nine months ended September 30, 1996, respectively.
The increase in interest expense during 1997 is primarily attributable to higher
average balances outstanding on the Lessee Working Capital Loan and the new term
credit facility which are both described further under "Liquidity and Capital
Resources-Financing Activities" below. The overall increase was offset in part
by the transfer of debt associated with the capital improvements fund from the
financial statements of the Company to the financial
10
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statements of the Lessor in 1997. In the future, the interest expense from debt
associated with the capital improvements fund will be a lease expense for the
Company.
Warranty income for the nine months ended September 30, 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 was $674,000 for the three months ended September 30,
1997 and income tax benefit was $292,000 for the nine months ended September 30,
1997 as compared to income tax expense of $652,000 and $1,454,000 for the three
and nine months ended September 30, 1996, respectively. The Company incurred a
loss before income taxes of $578,888 for the nine months ended September 30,
1997 as compared to income before income taxes of $3,481,734 for the nine months
ended September 30, 1996. As such, the Company recorded an income tax benefit in
1997 to account for the recorded tax benefit of additional net operating loss
carryforwards. The entire income tax benefit in 1997, which offset income tax
expense of $226,000 and $674,000 for the three months ended March 31, 1997 and
September 30, 1997, respectively, was recorded during the second quarter when
the Company realized a net loss primarily from the extended annual outage at the
Scrubgrass plant.
Net income for the three months ended September 30, 1997 amounted to
$1,102,918 and net loss for the nine months ended September 30, 1997 amounted to
$286,888 as compared to net income of $900,837 and $2,027,734 for the three and
nine months ended September 30, 1996, respectively. The overall decrease of
approximately $2.3 million in net results for the nine months ended September
30, 1997 by comparison to same period in 1996 is largely attributable to the
absence in 1997 of certain revenues of $2,394,204 recognized in the 1996 period
which were previously deferred under the Scrubgrass power purchase agreement,
the absence in 1997 of warranty income amounting to $900,000, the absence in
1997 of proceeds from a legal settlement of approximately $340,000 net of legal
fees, higher principal payments in 1997 of $790,000 on the Lessor's senior debt
which were passed through to the Company in its facility lease expenses and the
lost net revenues and additional expenses from the Scrubgrass extended outage.
The overall decrease was offset in part primarily by the 5% increase in certain
rates charged to the utility under the terms of the power sales contract,
improvements in the performance of the Scrubgrass plant during non-outage
periods, lower general and administrative expenses, lower operator fees, lower
fuel costs, lower interest rates related to certain facility leases expenses,
and the reversal of the provision for nonrecovery of project development costs.
While many of the items discussed above affected net results proportionately
through-out each nine month period, the reversal of the provision for
nonrecovery of project development costs was recorded during the three months
ended September 30, 1997 and the proceeds from a legal settlement of
approximately $340,000 net of legal fees was recorded during the three months
ended September 30, 1996. These two factors most significantly affected a third
quarter comparison between 1997 and 1996. The components of the net income or
loss for each period were discussed more fully in the previous narrative under
"Results of Operations".
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Outlook for the Remainder of 1997
Absent the effects of the extended Scrubgrass outage, the Company believes
that it would have shown significant profits for the year ended 1997. Yet, the
Company believes it would have been less profitable in 1997 than in 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, as demonstrated in the operating results
for the nine months ended September 30, 1997, the absence of the 1996 non-
recurring revenues and the impact of the additional 1997 lease expense have been
partially offset by several 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 has realized or is expecting to realize other benefits from
additional factors with a favorable impact on its results of operations in 1997
including earnings from the reversal of the reserve related to the Milesburg
project and reductions in certain recurring administrative expenses through
management efforts which have been discussed previously under "Results of
Operations". However, as discussed under the caption "Scrubgrass Maintenance
Outage", the Company incurred a net charge to operations of approximately $3.7
million as a result of the extended maintenance outage at the Scrubgrass plant,
for which approximately $3.1 million and $600,000 were charged to operations
during 1997 and 1996, respectively. As such, absent the effects of the
extended maintenance outage at the Scrubgrass plant, the Company estimates it
would have realized a net profit before taxes of approximately $2.5 million for
the nine months ended September 30, 1997. Furthermore, the Scrubgrass plant has
been operating close to 100% of its capacity since the Scrubgrass outage was
completed. In light of the favorable performance of the Scrubgrass Project,
which the Company has no reason to believe will not continue, the Company
expects that it is likely to show a modest profit for the year ended December
31, 1997.
Furthermore, as discussed in Part II under the caption "Item 5-Other
Information", the Milesburg Buy-Out Agreement was approved by the PUC on October
24, 1997 with the PUC's approval subject to reconsideration for 15 days and
appeal for 30 days. To date, to the Company's knowledge, no party has expressed
its intention to request a reconsideration or appeal of the PUC's Order. Should
no party request a reconsideration or appeal of the PUC's Order within the
appropriate times periods, the PUC's order would become non-appealable on or
about November 24, 1997. Accordingly, consistent with the terms of the Buy-Out
Agreement, West Penn Power would be obligated to pay the proceeds from the Buy-
Out Agreement to Milesburg within five days from the date that the PUC Order
becomes non-appealable. In such event, the transaction would be reportable in
the Company's financial statements for the year ended
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December 31, 1997. The Company currently estimates that after expensing
development costs, it would realize a net gain of approximately $5 million after
taxes from the Milesburg Buy-Out Agreement. However, due to the availability of
net operating loss carryforwards and the existence of certain temporary tax
differences, the Company expects that approximately $2.5 million of income tax
expense will be recorded as a reduction of its deferred tax asset and not
payable in cash. Furthermore, the Company estimates that approximately $2.7
million of the proceeds from the Milesburg Buy-Out Agreement will represent a
reimbursement of development costs previously incurred by the Company. As such,
the Company expects to retain approximately $10.2 million of the proceeds from
the Milesburg Buy-Out Agreement (see discussion under "Liquidity and Capital
Resources - Outlook"). Such figures are, however, subject to change in the event
additional costs or expenses are incurred prior to the date the transaction is
concluded, or if cost or expense estimates otherwise change. Any gain from the
Milesburg transaction would increase the forecasted profit discussed in the
previous paragraph.
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
Cash used by operating activities amounted to $2,212,895 during the nine
months ended September 30, 1997 as compared to cash provided by operating
activities of $660,590 during the nine months ended September 30, 1996. During
the nine months ended September 30, 1997 and 1996, the Company's only sources of
cash from operating activities were operating profits from the Scrubgrass
Project and investment earnings. The following changes in operating assets and
liabilities most notably impacted cash used by operating activities during the
nine months ended September 30, 1997:
Receivable from utility - The Company's receivable from utility relates to
the Scrubgrass Project and amounted to $6,651,942 as of September 30, 1997 as
compared to $5,892,879 as of December 31, 1996. The increase in receivable
from utility as of September 30, 1997 is primarily due to revenues during
August and September 1997 which were higher by comparison to those during
November and December 1996 primarily as a result of improvements in the
performance of the Scrubgrass facility. Additionally, revenues during
November 1996 were lower than an average month because of a short maintenance
outage which lasted approximately 3 days.
Other current assets - The Company's other current assets amounted to
$809,561 as of September 30, 1997 as compared to $911,473 as of December 31,
1996. The overall decrease is largely attributable to 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. However, the overall decrease was slightly offset by an
increase in prepaid insurance because certain insurance premiums were paid in
advance when the insurance program for the Scrubgrass project was
restructured in April 1997.
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Deferred income tax asset - The Company's deferred income tax asset amounted
to $4,112,105 as of September 30, 1997 as compared to $3,840,105 as of
December 31, 1996. The increase of $272,000 is largely attributable to the
recorded tax benefit of additional net operating loss carryforwards which
were derived from the Company's net loss during the nine months ended
September 30, 1997.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $5,538,436 as of September 30, 1997 as compared
to $6,033,675 as of December 31, 1996. The decrease is primarily
attributable to a corresponding increase in the outstanding balance of the
working capital loan for the Scrubgrass project (see further discussion under
"Liquidity and Capital Resources-Financing Activities" below). The decrease
is also related to certain accruals as of December 31, 1996, primarily for
income taxes and operator bonuses, which do not need to be recorded as of
September 30, 1997 because the Company is not expecting to be as profitable
in 1997 by comparison to 1996.
Deferred gain, net - The Company's deferred gain, net amounted to $5,782,700
as of September 30, 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 records the expense of major equipment
overhauls related to the Scrubgrass Project to a maintenance reserve on a
straight-line basis using management's best estimate of when the Company will
incur future cash outlays for the major equipment overhauls. When the
Company incurs cash outlays for major equipment overhauls, they are funded
substantially from scheduled deposits to a restricted major maintenance fund
which have been set aside to ensure that the funds are available for these
maintenance procedures (see further discussion under the caption "Investing
Activities-Restricted Cash"). The maintenance reserve increased to
$2,109,009 as of September 30, 1997 from $1,533,829 as of December 31, 1996
primarily due to scheduled reserves provided for the ongoing maintenance of
the plant.
Investing Activities
The Company used $841,767 for investing activities during the nine months
ended September 30, 1997 and received $98,582 from investing activities during
the nine months ended September 30, 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 $26,825 and $474,090 from notes
receivable related to the Scrubgrass Project during the nine months ended
September 30, 1997 and 1996, respectively. The notes receivable related to
the Sunnyside Project, which as of September 30, 1997 had a principal balance
of $2,937,500 and a receivable balance related to uncollected interest and
the disputed portion of the purchase price adjustment aggregating $718,276,
are the subject of a legal proceeding. See "Certain Factors
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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 restricted major maintenance fund to ensure that funds are
available in the future for scheduled major equipment overhauls. During the
nine months ended September 30, 1997, the Company's payments for major
equipment overhauls exceeded its deposits to the restricted major maintenance
fund and interest thereon by $313,256. Whereas, for the nine months ended
September 30, 1996, the Company's deposits to the restricted major
maintenance fund and interest thereon exceeded its payments for major
equipment overhauls by $389,333. The net decrease to the restricted cash
fund during 1997 occurred primarily as a result of expenditures for major
overhauls incurred during the Scrubgrass outage.
Property plant and equipment - The Company invested $1,052,819 and $44,662 in
property, plant and equipment expenditures during the nine months ended
September 30, 1997 and 1996, respectively. The expenditures primarily relate
to development activities for the Company's Milesburg Project for which
development efforts have significantly increased in 1997. During 1997, the
Company also made leasehold improvements to the Scrubgrass facility in the
amount of $125,000.
Other assets - The Company invested $129,029 in other assets during the nine
months ended September 30, 1997 and received $58,487 from its investment in
other assets during the nine months ended September 30, 1996. The 1997
investment consisted primarily of loan origination costs for the new term
credit facility discussed further under "Financing Activities".
Financing Activities
The Company received $2,347,577 from financing activities during the nine
months ended September 30, 1997 and utilized $312,511 in financing activities
during the nine months ended September 30, 1996. The Company's financing
activities are concentrated primarily in the following areas:
Working Capital Loan - The Company may borrow up to $4 million under a Lessee
Working Capital Loan Agreement with the Lessor for ongoing working capital
requirements of the Scrubgrass Project. The outstanding borrowings under the
Lessee Working Capital Loan Agreement increased to $3,065,046 as of September
30, 1997 from $2,696,143 as of December 31, 1996. The increase in
outstanding borrowings under the Lessee Working Capital Loan is due to timing
because the Company's accounts payable and accrued expenses balance reflects
a corresponding decrease as of September 30, 1997.
Term Credit Facility - In June 1997, the Lessor entered into a credit
facility with the lenders of the Scrubgrass Project to make additional funds
available to the Scrubgrass Project over a three year period to cover an
expected cash deficiency which would result from the extended annual outage
of the Scrubgrass Project and associated costs and expenses. The maximum
allowable borrowings under this credit facility are $3,000,000 through July
1, 1998. Beginning on July 1, 1998, the
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maximum allowable borrowings under this credit facility will reduce in
$600,000 increments every six months through July 3, 2000 when the credit
facility will be payable in full. As of September 30, 1997, the outstanding
borrowings under this credit facility, which were advanced to the Company by
the Lessor, amounted to $3,000,000.
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 $999,760 and $995,411 during the nine months ended
September 30, 1997 and 1996, respectively. During 1997, the Company also
paid dividends to its subsidiary's preferred stockholder in the amount of
$28,928. The preferred stockholder, entitled to cumulative dividends of
$5,000 per year since December 1991, was paid its dividends up to date during
the second quarter of 1997.
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.
Notes payable - In addition to the term credit facility described previously,
the Company presently has other long-term obligations related to its
Milesburg Project, Sunnyside Project and Scrubgrass Project in the amounts of
$5,858,767, $751,261 and $1,267,813, respectively. The Company also had
short-term installment obligations related to its Sunnyside Project and
Milesburg Project which were fully satisfied during 1996, for which $139,517
was paid during the nine months ended September 30, 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 Sunnyside Project long-term obligations are payable based on a
schedule which relates directly to the amount of proceeds received from the
collection of the outstanding notes receivable from the sale of the Company's
interest in the Sunnyside Project. The next installment for the Scrubgrass
Project long-term obligation is not due until 1998.
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, cash which may become available from the Scrubgrass Project and cash
which may become available from the Milesburg Buy-Out Agreement. The Company
offers the following information pertaining to cash which may become available
from the Milesburg Buy-Out Agreement and the Scrubgrass project.
Milesburg Project
As discussed under the caption "Results of Operations", Milesburg entered
into a Buy-Out Agreement with West Penn on August 26, 1997 whereby West Penn
would purchase Milesburg's
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rights to the Electric Energy Purchase Agreement between the parties dated
February 25, 1987 for the sum of $15 million and West Penn would assume
ownership of and responsibility for the Project site. Furthermore, as discussed
in Part II under the caption "Item 5-Other Information", the Buy-Out Agreement
was approved by the PUC on October 24, 1997 with the PUC's approval subject to
reconsideration for 15 days and appeal for 30 days. On a consolidated basis, the
Company currently estimates that after paying various project expenses and
development costs and after distributing a portion of the net proceeds to its
joint development partner, it would retain approximately $10.2 million of
the proceeds from the Milesburg Buy-Out Agreement after taxes. Should no party
request a reconsideration or appeal of the PUC's Order within the appropriate
times periods, the PUC's order would become non-appealable on or about November
24, 1997. Accordingly, consistent with the terms of the Buy-Out Agreement, West
Penn Power would be obligated to pay the proceeds from the Buy-Out Agreement to
Milesburg within five days from the date that the PUC Order becomes non-
appealable.
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 "Scrubgrass Maintenance Outage", the Company made significant repairs
to the generator of the Scrubgrass Project during its 1997 annual plant outage
which began on April 11, 1997 and ended on May 18, 1997, and which resulted in
estimated lost profits of approximately $3.1 million and $600,000 during 1997
and 1996, respectively. As a result of these lost profits, the Company would
have experienced a significant cash shortfall beginning in July 1997 when many
of its current liabilities were due. However, in June 1997, the Lessor entered
into a credit facility with the lenders of the Scrubgrass Project which made
additional funds available to the Scrubgrass Project over a three year period to
cover the expected cash deficiencies resulting from the extended annual outage
of the Scrubgrass Project. Under the terms of this credit facility, the Company
can borrow up to $3,000,000 through July 1, 1998. Beginning on July 1, 1998, the
maximum allowable borrowings under this credit facility will reduce in $600,000
increments every six months through July 3, 2000 when the credit facility will
be payable in full. As of September 30, 1997, the Company has borrowed the
maximum amount under this credit facility. In addition, the Company has received
extended terms from the Scrubgrass generator manufacturer which allow the
Company to pay the $660,000 cost of the generator repair in six annual
installments of $110,000, without interest, beginning in May 1997. As a result
of these additional borrowings, the Company was able to satisfy the liabilities
of the Scrubgrass Project incurred during the time frame of the outage within
their normal terms with long-term debt payable over periods ranging from three
to five years. Furthermore, the Scrubgrass plant has been performing close to
100% of its capacity since the generator repair was made. While the Company is
presently negotiating with the generator manufacturer because of continuing
excess discharge test results from the generator, it is currently expected that
such problem can be remedied without an extended outage period or material
additional cost to the Company. Assuming the favorable performance of the
Scrubgrass plant, which is expected to continue, the Company expects that the
Scrubgrass Project will be capable of supporting the increases in the debt
service requirements without compromising any of its existing
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debt covenants. As such, notwithstanding the Milesburg Project receipts, 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 its business activities on a long-term
basis. 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 full-
time employees and one part-time employee, including three executive officers.
The loss of any of these employees could adversely affect the Company's
operations.
Third Party Project Management
The Company has entered into a management services agreement with U.S.
Generating Company ("U.S. Gen") to manage the Scrubgrass Project and a 15-year
operations and maintenance agreement with US Operating Services Company 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.
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
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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, 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 $441,832, respectively as of September 30, 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
either operating or financing activities has been sufficient to fund the
Company's business 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
$7,569,194 as of September 30, 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 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 has been pursuing efforts towards either the buy-out of
Milesburg's power purchase agreement with West Penn or the development of the
Milesburg Project. As discussed under
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the caption "Results of Operations", Milesburg entered into a Buy-Out Agreement
with West Penn on August 26, 1997 whereby West Penn would purchase Milesburg's
rights to the Electric Energy Purchase Agreement between the parties dated
February 25, 1987 for the sum of $15 million and West Penn would assume
ownership of and responsibility for the Project site. Furthermore, as discussed
in Part II under the caption "Item 5-Other Information", the Buy-Out Agreement
was approved by the PUC on October 24, 1997 with the PUC's approval subject to
reconsideration for 15 days and appeal for 30 days. While, to the Company's
knowledge, no party has expressed its intention to request a reconsideration or
appeal of the PUC's Order, there can be no assurance that either of these
actions will not occur. In the event the PUC approval is appealed or
reconsidered, and the Company and its joint development partner 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. Absent the Buy-Out Agreement, the Company's efforts
to develop the Milesburg Project have been proceeding on schedule and the
Company is prepared to continue to develop the Milesburg Project if the Buy-Out
transaction is not completed. However, in the event the Buy-Out transaction is
not completed and development efforts continue, 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, if the Company and its joint development
partner were to develop the Milesburg Project, 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.
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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, if the Company's Milesburg
Project were to be developed, it would present 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 $10.7 million variable rate term loan maturing in 2004
and $0.9 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, a $1.3 million variable rate term loan maturing in 2004
and $3 million in advances from the Lessor under the variable rate credit
agreement executed in June 1997. 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 $0.9
million in 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.
21
<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
22
<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.
23
<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
$441,832, respectively at September 30, 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 2. CHANGES IN SECURITIES
(c) On September 9, 1997, Robert Weisberg, a Director of the Company,
exercised options to purchase 50,000 shares of common stock for an
aggregate exercise price of $29,375, pursuant to Section 4(2) of the
Securities Act.
24
<PAGE>
ITEM 5. OTHER INFORMATION
In a Current Report on Form 8-K filed on September 9, 1997, the Company
disclosed that Milesburg entered into a Buy-Out Agreement on August 26, 1997
with West Penn whereby West Penn would purchase Milesburg's rights to the
Electric Energy Purchase Agreement between the parties dated February 25, 1987
for the sum of $15 million plus 8% interest from the date (August 29, 1997) the
Buy-Out Agreement was filed for PUC approval (the "Cash Proceeds"), plus West
Penn would assume ownership of and responsibility for the Milesburg Project
facility. The Buy-Out Agreement is subject to, among other closing conditions,
West Penn obtaining a final non-appealable Order of the PUC approving the Buy-
Out Agreement and the pass-through of the Cash Proceeds to West Penn customers.
Under the terms of the Buy-Out Agreement, West Penn would pay the Cash Proceeds
within five days after the date (the "Termination Date") when West Penn obtains
a final non-appealable Order of the PUC approving the Buy-Out Agreement.
On October 24, 1997, the PUC entered a favorable Order with respect to PUC
Docket No. P-870216 approving the Buy-Out Agreement between Milesburg and West
Penn. Pursuant to certain Pennsylvania statutes and regulations, any party to
the matter under consideration with respect to Docket No. P-870216 may petition
the PUC to reconsider the Order at any time through November 10, 1997. The PUC
Order may also be appealed by any party through November 24, 1997. At this
time, to the Company's knowledge, no party has expressed its intention to
request a reconsideration or appeal of the PUC's Order.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 10.1 - Buy-Out Agreement dated August 26, 1997 between Milesburg
Energy, Inc. and West Penn Power Company (Incorporated by
reference to Exhibit 10.1 to Form 8-K filed on September 9,
1997).
(b) Exhibit 11 - Computation of Earnings Per Share
(c) Reports on Form 8-K
(i) On September 9, 1997, the registrant reported on Form 8-K that
its subsidiary, Milesburg Energy,Inc., entered into a Buy-Out
Agreement with West Penn Power Company.
(ii) On October 9, 1997, the registrant reported on Form 8-K that it
removed its reserve for the impairment in value of its
investment in the Milesburg Project during August 1997. The
registrant also reported on this Form 8-K that, although it had
failed to comply with the minimum capital and surplus
requirement of the NASDAQ SmallCap Market as of June 30, 1997,
it was in compliance with this requirement as of August 31,
1997.
25
<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
November 12, 1997 /s/ William D. Linehan
---------------------------------
William D. Linehan
Treasurer and
Chief Financial Officer
(principal accounting officer
and authorized officer)
26
<PAGE>
EXHIBIT 11
ENVIRONMENTAL POWER CORPORATION
COMPUTATION OF EARNINGS PER SHARE
SEPTEMBER 30, 1997
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997:
- ----------------------------------------------
Weighted average number of shares outstanding 11,242,282
----------------
Net income $ 1,102,918
----------------
Income per share - primary and fully diluted $ .10
----------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997:
- ---------------------------------------------
Weighted average number of shares outstanding 11,228,301
----------------
Net loss $ (286,888)
----------------
Loss per share - primary and fully diluted $ (.03)
----------------
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AS OF SEPTEMBER 30, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 803,082<F1>
<SECURITIES> 0
<RECEIVABLES> 10,402,212<F2><F3>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 8,302,941
<PP&E> 9,284,500
<DEPRECIATION> 99,375
<TOTAL-ASSETS> 60,026,831
<CURRENT-LIABILITIES> 9,203,482
<BONDS> 10,277,841
0
100
<COMMON> 122,904
<OTHER-SE> 1,248,598
<TOTAL-LIABILITY-AND-EQUITY> 60,026,831
<SALES> 31,500,839
<TOTAL-REVENUES> 31,500,839
<CGS> 13,559,961
<TOTAL-COSTS> 13,559,961
<OTHER-EXPENSES> 18,051,600
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 223,628
<INCOME-PRETAX> (578,888)
<INCOME-TAX> (292,000)
<INCOME-CONTINUING> (286,888)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (286,888)
<EPS-PRIMARY> (.03)
<EPS-DILUTED> (.03)
<FN>
<F1>CASH INCLUDES $331,643 WHICH IS RESTRICTED IN USE
<F2>RECEIVABLES INCLUDES $3,711,914 WHICH IS NONCURRENT
<F3>NONCURRENT RECEIVABLES OF $3,655,776 ARE SUBJECT TO A LEGAL PROCEEDING
</FN>
</TABLE>
