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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 March 31, 1998
-------------------------------------------------
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 May 11, 1998 11,406,783 shares
The Exhibit Index appears on Page 25.
Total number of pages is 26.
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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, 1998 (unaudited) and December 31, 1997.................................. 2
Condensed Consolidated Statements of Operations (unaudited) for the Three Months
Ended March 31, 1998 and March 31, 1997............................................. 3
Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months
Ended March 31, 1998 and March 31, 1997.............................................. 4
Notes to Condensed Consolidated Financial Statements................................. 5-6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................... 7-22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................... 23
Item 5. Other Matters.......................................................... 25
Item 6. Exhibits and Reports on Form 8-K....................................... 25
Signatures ....................................................................... 26
</TABLE>
1
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PART I FINANCIAL INFORMATION
----------------------------
ITEM 1. FINANCIAL STATEMENTS
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31
1998 December 31
(Unaudited) 1997
--------------- ---------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,809,181 $ 12,092,273
Restricted cash 617,826 486,659
Receivable from utility 6,668,322 6,538,645
Notes receivable 39,915 39,128
Other current assets 636,714 881,938
-------------- -------------
TOTAL CURRENT ASSETS 9,771,958 20,038,643
PROPERTY, PLANT AND EQUIPMENT, NET 125,047 129,936
DEFERRED INCOME TAX ASSET 572,755 817,755
LEASE RIGHTS, NET 2,720,268 2,757,519
RECEIVABLE FROM SALE OF AFFILIATE 864,950 791,512
NOTES RECEIVABLE 2,973,283 2,983,562
ACCRUED POWER GENERATION REVENUES 35,368,416 33,362,389
OTHER ASSETS 676,691 701,437
-------------- -------------
$ 53,073,368 $ 61,582,753
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 5,762,641 $ 6,325,062
Dividends payable on common stock 342,203 10,266,105
Other current liabilities 3,190,046 2,911,666
-------------- -------------
TOTAL CURRENT LIABILITIES 9,294,890 19,502,833
DEFERRED INTEREST REVENUE 293,952 220,514
DEFERRED GAIN, NET 5,628,495 5,705,598
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 4,076,546 4,673,727
ACCRUED LEASE EXPENSE 35,368,416 33,362,389
MAINTENANCE RESERVE 2,052,055 1,995,818
-------------- -------------
TOTAL LIABILITIES 56,714,354 65,460,879
SHAREHOLDERS' DEFICIT
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
issued at March 31, 1998 and December 31, 1997, respectively) --- ---
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at March 31, 1998 and December 31, 1997, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,525,423 shares issued at March 31, 1998 and December 31, 1997,
respectively; 11,406,783 shares outstanding at March 31, 1998 and
December 31, 1997, respectively) 125,254 125,254
Additional paid-in capital --- ---
Accumulated deficit (2,500,338) (2,737,478)
-------------- -------------
(2,374,984) (2,612,124)
Treasury stock (1,118,640 common shares, at cost, as of
March 31, 1998 and December 31, 1997, respectively) (456,271) (456,271)
Notes receivable from officers and board members (809,731) (809,731)
-------------- -------------
TOTAL SHAREHOLDERS' DEFICIT (3,640,986) (3,878,126)
-------------- -------------
$ 53,073,368 $ 61,582,753
============== =============
</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 March 31
------------------ ---------------
1998 1997
--------------- ---------------
<S> <C> <C>
POWER GENERATION REVENUES $ 12,178,487 $ 11,273,300
COSTS AND EXPENSES:
Operating expenses 4,548,684 4,396,726
Lease expenses 6,037,834 5,706,274
General and administrative expenses 545,079 691,839
Depreciation and amortization 73,037 49,802
--------------- ---------------
11,204,634 10,844,641
--------------- ---------------
OPERATING INCOME 973,853 428,659
OTHER INCOME (EXPENSE):
Interest income 53,029 118,145
Interest expense (119,392) (86,476)
Amortization of deferred gain 77,103 77,102
--------------- ---------------
10,740 108,771
--------------- ---------------
INCOME BEFORE INCOME TAXES 984,593 537,430
INCOME TAX EXPENSE (404,000) (226,000)
--------------- ---------------
NET INCOME $ 580,593 $ 311,430
=============== ===============
BASIC AND DILUTED EARNINGS PER
COMMON SHARE $ 0.05 $ 0.03
=============== ===============
DIVIDENDS PAID OR PAYABLE
Common shares $ 342,203 $ 332,304
Preferred shares 1,250 26,428
--------------- ---------------
$ 343,453 $ 358,732
=============== ===============
DIVIDENDS PAID OR PAYABLE PER
COMMON SHARE $ 0.03 $ 0.03
=============== ===============
</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>
Three Months Ended March 31
--------------- ---------------
1998 1997
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 580,593 $ 311,430
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 73,037 49,802
Deferred income taxes 245,000 216,000
Amortization of deferred gain (77,103) (77,102)
Accrued power generation revenues (2,006,027) (2,228,457)
Accrued lease expenses 2,006,027 2,228,457
Changes in operating assets and liabilities:
(Increase) decrease in receivable from utility (129,677) 234,582
Increase in receivable from sale of affiliate (73,438) (73,236)
Decrease in other current assets 245,224 244,373
Increase in other assets (955) (5,069)
Decrease in accounts payable and
accrued expenses (562,421) (816,454)
Increase in deferred interest revenue 73,438 ---
Increase in long-term liabilities 2,819 2,850
Increase in maintenance reserve 56,237 189,830
--------------- ---------------
Net cash provided by operating activities 432,754 277,006
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable 9,492 8,764
Increase in restricted cash (131,167) (500,647)
Property, plant and equipment expenditures (5,196) (259,416)
--------------- ---------------
Net cash used in investing activities (126,871) (751,299)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (10,267,355) (332,304)
Net (repayments) borrowings under working capital loan (171,620) 404,755
Repayment of secured promissory notes payable and
other borrowings (150,000) ---
--------------- ---------------
Net cash (used in) provided by financing activities (10,588,975) 72,451
--------------- ---------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (10,283,092) (401,842)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,092,273 1,178,524
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,809,181 $ 776,682
=============== ===============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
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 ("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, 1998 are not necessarily indicative of
results to be expected for the year ending December 31, 1998. 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, 1997.
NOTE B -- EARNINGS PER COMMON SHARE
- -----------------------------------
The Company computes its earnings (loss) per common share using the
treasury stock method in accordance with SFAS No. 128, "Earnings per Share".
The Company computes basic earnings (loss) per share by dividing net income
(loss) for the period by the weighted average number of shares of common stock
outstanding during the period. For purposes of calculating diluted earnings
(loss) 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 following table outlines the calculation of basic earnings (loss) per share
and diluted earnings (loss) per share for the three months ended March 31, 1998
and 1997.
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNTS
------------------ -------------------- ---------------
<S> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1998:
- ----------------------------------
Income available to shareholders $ 580,593 11,406,783 $ .05
Effect of dividends to preferred stockholders (1,250)
------------------ -------------------- ---------------
Basic EPS - income available to common shareholders 579,343 11,406,783 .05
Effect of dilutive securities:
Assumed exercise of dilutive stock options 16,827
------------------ -------------------- ---------------
Diluted EPS - income available to common shareholders $ 579,343 11,423,610 $ .05
================== ==================== ===============
THREE MONTHS ENDED MARCH 31, 1997:
- ----------------------------------
Income available to shareholders $ 311,430 11,076,783 $ .03
Effect of dividends to preferred stockholders (26,428)
------------------ -------------------- ---------------
Basic EPS - income available to common shareholders 285,002 11,076,783 .03
Effect of dilutive securities:
Assumed exercise of dilutive stock options 144,208
------------------ -------------------- ---------------
Diluted EPS - income available to common shareholders $ 285,002 11,220,991 $ .03
================== ==================== ===============
</TABLE>
5
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NOTE C -- NEW ACCOUNTING STANDARD
- ---------------------------------
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income". SFAS
No. 130 addresses the reporting and display of comprehensive income and its
components. SFAS No 130 divides comprehensive income into two categories which
are "net income" and "other comprehensive income". The category known as "other
comprehensive income" refers to all changes in stockholders' equity during a
period except changes resulting from net income or loss, investments by
stockholders and distributions to stockholders. There were no items of other
comprehensive income, as defined by SFAS No. 130, to report during the three
months ended March 31, 1998 and March 31, 1997.
6
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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. Until December 5, 1997, the Company had one additional project (the
"Milesburg Project") which had been in the development stage since 1987 and
involved in significant contract litigation since the early stages of its
development activities. On August 26, 1997, the Company entered into a Buy-Out
Agreement with the utility which had contracted to purchase electricity from the
Milesburg Project. Under the terms of the Buy-Out Agreement, the Company sold
substantially all of the assets of the Milesburg project to this utility on
December 5, 1997 and terminated the ongoing litigation. 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, 1998 ("1998") to the three months ended March 31, 1997 ("1997").
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".
RESULTS OF OPERATIONS
Power generation revenues for the three months ended March 31, 1998
amounted to $12,178,487 as compared to $11,273,300 for the three months ended
March 31, 1997 and all related to the Scrubgrass Project. The overall increase
in power generation revenues during 1998 is primarily attributable to a 5%
increase in certain rates billed to the utility under the terms of the power
purchase agreement and an increase in the capacity rate billed during the three
months ended March 31, 1998 when compared to the same period in 1997. During
the three months ended March 31, 1998, the Scrubgrass Project operated at 97.2%
of its capacity as compared to 90.6% for the same period in 1997. The
Scrubgrass Project's capacity factor in 1997 was largely impacted by an outage
of approximately 6 days in February 1997 to consider issues related to the
generator. The aforementioned increase in 1998 power generation revenues was
offset in part by a decrease in the revenue recorded as a result of the
straight-line accounting treatment of certain revenues under the
7
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power purchase agreement which amounted to $2,006,027 for the three months ended
March 31, 1998 as compared to $2,228,457 for the three months ended March 31,
1997.
Operating expenses for the three months ended March 31, 1998 amounted to
$4,548,684 as compared to $4,396,726 for the three months ended March 31, 1997
and all pertained to the Scrubgrass Project. The overall increase in 1998 is
primarily attributable to the following three reasons. First, the Company
incurred higher fuel costs and higher operator fees in 1998 as a result of cost
escalations in certain operating and supply agreements. Second, the Company
incurred higher fuel expenses because it achieved a higher capacity rate during
1998. Third, because the Company is not projecting an extended outage during
1998, the Company is accruing higher year-end operator bonuses during 1998 than
were recorded in 1997. However, the aforementioned increases in 1998 operating
expenses were offset in part because certain operating expenses were higher
during 1997 by comparison to 1998 primarily for the following reasons. First,
in preparation for the generator repair during the 1997 extended outage, the
Company purchased certain necessary materials during March 1997 which purchases
were not incurred during the first quarter of 1998. Second, due to the
approximate 6 day outage in February 1997 to consider generator related matters,
the Company incurred higher standby power expenses in 1997 by comparison to
1998. Third, as a result of enhancements made during 1997 to the fuel processing
system at the Scrubgrass Project, the Company realized a savings in routine
maintenance expenses during 1998. Finally, the Company entered into
modifications to the financing contract with the manufacturer of the Scrubgrass
generator which reduced certain long-term liabilities and operating expenses
during the first quarter in 1998. See a further discussion of these
modifications under the caption "Item 5. Other Events".
Lease expense for the three months ended March 31, 1998 amounted to
$6,037,834 as compared to $5,706,274 for the three months ended March 31, 1997.
The overall increase in lease expense during 1998 is primarily due to an
increase in equity rents paid to the Lessor and higher scheduled principal
payments on the Lessor's term loans which were passed through to the Company in
its lease expense. The increase in equity rents was primarily attributable to
an increase in the scheduled base rent payments and higher additional rents paid
based on the improved performance of the Scrubgrass plant in 1998 . The
aforementioned increase in 1998 lease expense was partially offset by a decrease
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
$2,006,027 for the three months ended March 31, 1998 as compared to $2,228,457
for the three months ended March 31, 1997.
General and administrative expenses for the three months ended March 31,
1998 amounted to $545,079 as compared to $691,839 for the three months ended
March 31, 1997. The decrease in general and administrative expenses during 1998
is primarily attributable to the following four factors. First, the Company
incurred significant legal expenses in 1997 to review documents in the discovery
phase of the Sunnyside project litigation which expenses were incurred to a much
lesser extent during 1998. Second, the management fees for the Scrubgrass
Project were lower in 1998 because the Company had incurred significant
management fees to address the Scrubgrass generator matter and to consider other
contract related matters during the three months ended March 31, 1997, which
matters did not recur in 1998. Third, the Company restructured its insurance
programs at its corporate office and at the Scrubgrass Project in April 1997
which resulted in lower insurance premiums for 1998 by comparison to 1997.
Lastly, the Company reduced the amount of certain professional fees during
8
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1998 as compared to 1997 because it used such professional services to a lesser
extent during 1998. The effect of the aforementioned reductions in 1998 expenses
were offset in part because certain labor and overhead expenses, which were
capitalized in 1997 as a result of development activities for the Milesburg
project, were redirected to operating activities during 1998.
Depreciation and amortization for the three months ended March 31, 1998
amounted to $73,037 as compared to $49,802 for the three months ended March 31,
1997. The 1998 increase is primarily attributable to 1997 additions to leasehold
improvements and deferred financing costs for the Scrubgrass Project which were
not amortized during the three months ended March 31, 1997.
Interest income for the three months ended March 31, 1998 amounted to
$53,029 as compared to $118,145 for the three months ended March 31, 1997. The
decrease in interest income is primarily attributable to 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" and "-Certain Factors That May Impact Future Results-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. The aforementioned decrease in
interest income during 1998 was offset in part by higher interest earnings in
1998 on the Company's cash reserves which have increased as a result of cash
received in December 1997 from the sale of the Milesburg project.
Interest expense for the three months ended March 31, 1998 amounted to
$119,392 as compared to $86,476 for the three months ended March 31, 1997. The
1998 increase is primarily attributable to a new term credit facility for the
Scrubgrass Project which was executed in June 1997. A discussion of this new
term credit facility is included under the caption "--Liquidity and Capital
Resources - Financing Activities".
Income tax expense for the three months ended March 31, 1998 amounted to
$404,000 as compared to income tax expense of $226,000 for the three months
ended March 31, 1997. The increase in income tax expense during 1998 resulted
primarily from higher earnings during the three months ended March 31, 1998. The
effective tax rates for both periods were comparable.
Net income for the three months ended March 31, 1998 amounted to $580,593
as compared to net income of $311,430 for the three months ended March 31, 1997.
The overall increase in 1998 is largely attributable to the increase in power
generation revenues and the decrease in general and administrative expenses. The
overall increase was primarily offset in part by the increases in operating
expenses, lease expenses and interest expense, and a decrease in interest
income. The changes in the
9
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components of net income were discussed more fully in the previous narrative
under "Results of Operations".
Outlook for the Remainder of 1998
With a view towards the remainder of 1998, the Company currently expects to
achieve continuing earnings as a result of profits from Scrubgrass project
operations and management of corporate general and administrative expenses.
The Company offers the following prospective information concerning significant
components of its 1998 Consolidated Statement of Operations which are being
compared to historical results of operations in 1997:
Power generation revenues - Power generation revenues are expected to increase
in 1998 as a result of a 5% increase in certain contracted rates under the
Scrubgrass power purchase agreement, improvements in the performance of the
Scrubgrass facility as compared to 1997 and the absence of an extended
maintenance outage in 1998. A favorable resolution of the Company's legal
action against Pennsylvania Electric Company could have a favorable impact upon
power generation revenues. See "Part II - Item 1. Legal Proceedings" and "-
Certain Factors That May Impact Future Results-Legal Proceedings" for a further
discussion.
Operating expenses - Operating expenses are expected to increase in 1998 as a
result of a 3% increase in certain contracted rates under fuel supply
agreements, a 5% increase in certain contracted rates under the operations and
maintenance agreement and anticipated increases in personnel costs at the
Scrubgrass plant. In addition, because the Company does not expect another
extended maintenance outage in 1998, operating expenses are expected to further
increase as a result of additional fuel consumption and higher operator bonuses
which are primarily based on Scrubgrass operating profits. However, absent an
extended outage in 1998, the Company would expect to incur lower maintenance
expenses in 1998. The Company also expects that certain improvements made in
1997 to its fuel handling systems may offset a portion of the increases in fuel
costs and result in decreases in maintenance expenses during 1998.
Lease expenses Lease expenses are expected to increase as a result of higher
principal payments on the Lessor's term loans which will increase the Lessor's
loan costs that are expected to be passed through to the Company in its
facility lease expenses. In addition, the Company expects to incur scheduled
increases in equity rents for the Scrubgrass Project in 1998. However,
largely due to required repayments of $1.2 million on the Company's $3 million
credit facility, the Company expects that there would be less cash available
from the Scrubgrass Project during 1998. As such, the scheduled increases in
equity rent are expected to be offset by a reduction in the additional rent
paid to the Lessor which amounts to 50 percent of the net cash flows from the
Scrubgrass Project (See further discussion under "--Liquidity and Capital
Resources - 1998 Outlook").
General and administrative expenses - General and administrative expenses are
expected to reflect a modest increase in 1998 primarily because certain labor
and overhead expenses, which were capitalized in 1997 as a result of
development activities for the Milesburg project, will be redirected to
operating activities during 1998.
10
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Other revenue In 1997, the Company enjoyed the benefit of certain non-
recurring revenues which included the gain on the sale of the Milesburg
project, the reversal of the provision for non-recovery of Milesburg project
development costs, interest earnings from proceeds on the sale of the Milesburg
project and revenue recorded as a result of the release of certain Milesburg
obligations which were payable only upon the occurrence of events related to
project development. The Company does not expect these items to recur in 1998.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note C to the Condensed Consolidated Financial Statements for a
discussion of accounting standards which the Company has adopted effective
January 1, 1998. There were no recently issued accounting standards since the
Company filed its Annual Report on Form 10-K for the year ended December 31,
1997 which would have any impact on the Company's financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash provided by operating activities amounted to $432,754 and $277,006 for
the three months ended March 31, 1998 and 1997, respectively. During 1998 and
1997, the Company's only sources of cash from operating activities were
operating profits from the Scrubgrass Project and investment earnings from cash
reserves. The Company offers the following information to discuss the changes in
operating assets and liabilities which most notably impacted its cash position
during the three months ended March 31, 1998:
Receivable from utility - The Company's receivable from utility relates to the
Scrubgrass Project and amounted to $6,668,322 as of March 31, 1998 as compared
to $6,538,645 as of December 31, 1997. The increase in receivable from utility
as of March 31, 1998 is primarily attributable to a 5% increase in certain
rates billed to the utility in 1998 under the terms of the Scrubgrass power
purchase agreement. However, the increase in the receivable balance associated
with the rate escalation was offset in part because the receivable from utility
balance at March 31, 1998 includes billings for only 59 days of power
generation as compared to 61 days as of December 31, 1997. This difference is
seasonal because revenues are billed monthly to the utility and February is a
short month.
Other current assets - The Company's other current assets amounted to $636,714
as of March 31, 1998 as compared to $881,938 as of December 31, 1997. 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, 1997 because the Company had advance purchased certain inventory
during 1997 to obtain favorable pricing.
Deferred income tax asset - The Company's deferred income tax asset amounted to
$572,755 as of March 31, 1998 as compared to $817,755 as of December 31, 1997.
The decrease is largely attributable to the utilization of alternative minimum
tax credits and the reversal of certain temporary differences between the
financial statement and income tax bases of assets and liabilities during the
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three months ended March 31, 1998. Because of the benefit from its deferred tax
asset, the Company expects that its current tax expense will be less than its
total tax expense during 1998.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $5,762,641 as of March 31, 1998 as compared to
$6,325,062 as of December 31, 1997. The decrease is largely attibutable to the
payment of corporate income taxes during the first quarter of 1998 which were
accrued as of December 31, 1997. In addition, consistent with the discussion
under the caption "--Receivable from Utility" above, the Company believes its
accounts payable and accrued expense balances at March 31, 1998 include
operating expenses for only 59 days of power generation as compared to 61 days
as of December 31, 1997. This difference is seasonal because February is a
short month and operating expenses are paid monthly as the Company collects it
receivable from utility balances.
Deferred gain, net - The Company's deferred gain, net amounted to $5,628,495 as
of March 31, 1998 as compared to $5,705,598 as of December 31, 1997. 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.
Receivable from sale of affiliate and deferred interest revenue - The Company's
receivable from sale of affiliate amounted to $864,950 as of March 31, 1998 as
compared to $791,512 as of December 31, 1997. The increase is attributable to
interest payable by the purchasers of the Sunnyside project during the three
months ended March 31, 1998. The Company's deferred interest revenue amounted
to $293,952 as of March 31, 1998 as compared to $220,514 as of December 31,
1997. The increase is attributable to interest payable by the purchasers of
the Sunnyside project during the three months ended March 31, 1998, but
deferred for financial reporting purposes. 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 the further discussion under "--Results of Operations" and
"Part II - Item 1. Legal Proceedings").
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 reduce maintenance
reserves and 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 $2,052,055 as of March 31, 1998 from $1,995,818 as of December 31,
1997 primarily due to scheduled reserves provided for the ongoing maintenance
of the plant. However, the increase attributable to the scheduled maintenance
reserves was offset in part by modifications to the financing contract with the
manufacturer of the Scrubgrass generator which reduced certain long-term
liabilities included in the maintenance reserve. See "Item 5. Other Events".
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Investing Activities
The Company used $126,871 and $751,299 in investing activities during the
three months ended March 31, 1998 and March 31, 1997, respectively. 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 $9,492 and $8,764 from notes
receivable related to the Scrubgrass Project during the three months ended
March 31, 1998 and March 31, 1997, respectively. The notes receivable related
to the Sunnyside Project, with a principal balance of $2,937,500 and accrued
interest balance of $588,506 as of March 31, 1998, are the subject of a legal
proceeding. See "--Certain Factors That May Impact Future Results-Legal
Proceedings" 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 relating to the Scrubgrass Project to
ensure that funds are available in the future for scheduled major equipment
overhauls. The Company is also allowed to spend restricted cash to fund the
cost of major equipment overhauls subject to certain restrictions. During the
three months ended March 31, 1998 and March 31, 1997, the Company's deposits to
the restricted major maintenance fund and interest thereon exceeded its
payments for major equipment overhauls by $131,167 and $500,647, 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. As such,
the deposits to the restricted major maintenance fund and interest thereon were
much higher during the three months ended March 31, 1997 by comparison to the
same period in 1998.
Property plant and equipment - The Company invested $5,196 and $259,416 in
property, plant and equipment expenditures during the three months ended March
31, 1998 and March 31, 1997, respectively. The expenditures in 1997 were
primarily related to development activities for the Company's Milesburg Project
which was sold in 1997 and for which development efforts had increased in 1997
prior to the sale. The expenditures in 1998 were primarily purchases of
computer equipment for the Company's corporate office.
Financing Activities
The Company utilized $10,588,975 in financing activities during the three
months ended March 31, 1998 and received $72,451 from financing activities
during the three months ended March 31, 1997. The Company's financing
activities are concentrated primarily in the following areas:
Dividends - The Company has a quarterly dividend program which is subject to
review and consideration by the Board of Directors each quarter. In respect of
this dividend program, the Company declared dividends of 3 cents per share
during each of the quarters ending March 31, 1998 and March 31, 1997. As of
December 31, 1997, the Company had dividends payable for common stock of
$10,266,105 or 90 cents per share (consisting of a 3 cent quarterly dividend
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and an 87 cent special dividend out of the proceeds of the Milesburg buy-out)
which were declared on December 10, 1997 and paid on January 7, 1998. The
Company also had dividends payable for common stock as of March 31, 1998 of
$342,203 or 3 cents per share which were declared on March 25, 1998 and paid on
April 10, 1998. As such, dividends paid for common stock amounted to
$10,266,105 and $332,304 during the three months ended March 31, 1998 and March
31, 1997, respectively. During 1997, the Company also commenced the payment of
dividends to its subsidiary's preferred stockholder. The preferred stockholder,
entitled to cumulative dividends of $5,000 per year since December 1991, was
paid its dividends up to date through the first quarter of 1997 with a payment
of $26,428 in April 1997. Beginning during the second quarter of 1997, the
preferred stockholder has been paid its dividends quarterly at a rate of $1,250
per quarter. As such, dividends paid for preferred stock amounted to $1,250
and $0 during the three months ended March 31, 1998 and March 31, 1997,
respectively.
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. During the three months ended March
31, 1998, the Company reduced its outstanding borrowings under the Lessee
Working Capital Loan Agreement from $2,311,666 as of December 31, 1997 to
$2,140,046 as of March 31, 1998. The Company had excess operating cash
available during the three months ended March 31, 1998 to reduce it outstanding
borrowings under the Lessee Working Capital Loan Agreement primarily because
certain fuel expenses and insurance expenses during that period resulted from a
reduction of inventory levels and prepaid insurance. See "--Other Current
Assets" above for a further discussion.
Term Credit Facility - In June 1997, the Lessor entered into a three year
credit facility with the lenders of the Scrubgrass Project to make additional
funds available to the Scrubgrass Project to cover the cash deficiency which
resulted from the extended annual outage to repair the generator 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
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 December 31, 1997, the outstanding borrowings under
this credit facility, which were advanced to the Company by the Lessor,
amounted to $3,000,000. During the three months ended March 31, 1998, the
Company paid down this obligation by $150,000 in order to begin a gradual
reduction of this obligation to the maximum allowable borrowing amount of
$2,400,000 which becomes effective on July 1, 1998. The current portion of this
obligation, which amounted to $1,050,000 as of March 31, 1998, is included in
other current liabilities.
Notes payable - In addition to the term credit facility described previously,
the Company has other long-term obligations related to its Sunnyside Project
and Scrubgrass Project in the amounts of $1,008,735 and $1,267,811,
respectively as of March 31, 1998. 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, which notes are
currently the subject of a legal proceeding (See "--Certain Factors That May
Impact Future Results-Legal Proceedings" and
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"Part II - Item 1. Legal Proceedings"). The next installment for the Scrubgrass
Project long-term obligation amounts to $39,585 and is payable later in 1998.
1998 Outlook
During 1998, 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 1997 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.
As discussed under the caption "-Results of Operations - 1998 Outlook", the
Company expects that the Scrubgrass Project will be profitable in 1998 and will
generate cash flows from its operating activities. However, the Company
anticipates that a significant portion of the expected cash flows in 1998 will
be utilized for debt and maintenance reserve repayments. According to the terms
of certain Scrubgrass Project obligations, the Company will be required to pay
down the $3 million term credit facility to $2,400,000 by July 1, 1998 and to
$1,800,000 by January 4, 1999 and make an installment payment later in 1998 of
$39,585 under the $1.3 million Scrubgrass Project note. Furthermore, pursuant to
the provisions of certain Scrubgrass Project agreements, the Company will be
required to make additional scheduled deposits aggregating $82,275 during 1998
to replenish restricted cash balances which were used to finance certain 1997
maintenance expenses. However, as discussed more fully in the Company's 1997
Annual Report on Form 10-K, the Company is required to pay the Lessor, in
addition to a specified base rent, an additional rent of 50 percent of the net
cash flows it receives from the Scrubgrass Project. Therefore, the Company
would expect to realize a savings in its additional rent expense to the extent
of 50 percent of any required debt and maintenance reserve repayments. As such,
the Company expects that the cash flows which may become available in 1998 from
the Scrubgrass Project would only be reduced by 50 percent of any required debt
and maintenance reserve repayments.
The Company continues to address the issue of Year 2000 compliance. During
the year ended December 31, 1996, the Company replaced all of the software at
its corporate office with software which is Year 2000 compliant. The Company
has reviewed all of the software at the Scrubgrass facility for Year 2000
compliance and is in the process of either upgrading or replacing this software
in accordance with a schedule which would ensure Year 2000 compliance prior to
the year 2000. The Company does not expect that any future expenditures for
software upgrades or replacements at the Scrubgrass facility related to Year
2000 compliance would have a material impact on the Company's results of
operations or financial position. The Company continues to consider whether
there are issues with Year 2000 compliance at its customer, or any of its
vendors, which could adversely affect its operations. Presently, the Company's
management is unable to assess whether there would be any impact on its
operations if its customer, or any of its vendors, fail to ensure that their
computer systems are Year 2000 compliant.
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The Company is optimistic about the future performance of the Scrubgrass
Project which is currently expected to achieve consistent earnings for the
foreseeable future. Notwithstanding, the Scrubgrass Project will obviously bear
the burden of repaying the debt obligations relating to the extended outage of
the Scrubgrass Project in the near term. Nevertheless, the Company believes
that the cash flows which may become available from the Scrubgrass Project,
together with cash reserves which the Company estimates were approximately $1
million at March 31, 1998, would be sufficient to fund the Company's business
activities on a long-term basis. However, the payment of any future dividends
will depend on the Board of Directors' evaluation, made on a quarterly basis,
based on the Company's then current and projected operating performance and
capital requirements. 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 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 U.S. 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 effect on the Company.
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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,
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 under the caption "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 $2,937,500 and $588,506, respectively as of March 31, 1998.
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 also being disputed in the legal
proceeding with the purchasers. 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.
As discussed under the caption "Part II. Item 1.-Legal Proceedings", the
Company is also a plaintiff in a legal proceeding with Pennsylvania Electric
Company, the utilty which purchases electricity from the Scrubgrass facility.
In this legal proceeding, among other complaints, the Company alleged that
PENELEC has breached the power purchase agreement by failing to pay contract
rates for energy produced by the Scrubgrass facility in excess of 80 MW in any
hour. 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 receive contract rates for energy produced by the Scrubgrass
facility in excess of 80 MW in any hour.
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Financial Results
To date the Company has incurred substantial losses, primarily due to its
development activities, which have resulted in an accumulated deficit of
$2,500,338 as of March 31, 1998. While the Company was profitable overall
during 1997, the Company incurred a loss from the operation of the Scrubgrass
Project during 1997 due to an unforeseen repair to the generator at the
Scrubgrass facility. Financial results can be affected by numerous factors,
including without limitation general economic conditions, cyclical 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 the
occurrence of unpredictable events like the generator repair. 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
From time to time, the Company invests its resources to develop power
generating facilities or invest in other projects of a development nature. The
successful development of power generating facilities or similar projects
typically require the Company 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 to complete such projects. However, the failure to
accomplish any of the aforementioned steps could materially increase the cost or
prevent the successful completion of projects under development, or cause the
Company to abandon the pursuit of such development projects and incur the loss
of its investment to date, which could materially impact the Company's business
and results of operations.
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.
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.
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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.
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 through 2012, an $18.2
million remaining term loan maturing through 2005, a $10.7 million variable rate
term loan maturing through 2004 and $.5 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 through 2004 and $2.8 million in advances from the
Lessor under a 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 $18.2 million remaining 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 $18.2 million remaining term loan and $.5 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. 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.
Fuel Quality
The Company obtains waste coal primarily from coal mining companies on a
long-term basis because waste coal is plentiful and generally creates
environmental hazards, such as acid drainage, when not disposed of properly. The
waste coal is burned in the Scrubgrass facility using a circulating fluidized
bed combustion system. During the circulating fluidized bed combustion process,
the waste coal is treated with other substances such as limestone. Depending on
the quality of the waste coal, the facility operator may need to add additional
waste coal 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 waste coal which supplies the
Scrubgrass power generation facility. The facility operator maintains certain
controls over obtaining higher quality waste coal. However certain conditions,
such as poor weather, can create situations where the facility operator has less
control over the quality of the waste coal.
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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 under long-term contracts to utilities under rates
established in power purchase agreements and approved by regulatory agencies.
The independent power industry has grown rapidly over the past twenty years.
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 regulated utilities
who have excess capacity, unregulated subsidiaries of regulated utilities,
energy brokers and traders, energy service companies in the development and
operation of energy-producing projects and the marketing of electric energy,
equipment suppliers and other non-utility generators like the Company.
Competition in this industry is substantially based on price. The electric
industry is also characterized by rapid changes in regulations which the Company
expects could continue to increase competition. For instance, as discussed more
fully in the Company's Annual Report on Form 10-K, the electric industry has
been previously affected by legislation such as the Federal Public Utility
Regulatory Policies Act of 1978 ("PURPA") and the Energy Policy Act of 1992
("Energy Act") which have encouraged companies other than utilities to enter the
electric power business by reducing regulatory constraints. More recently, as
discussed under the caption "Energy Regulation", there has been new state
legislation to deregulate the generation component of the electric business.
Furthermore, as discussed under the caption "Energy Regulation", proposed
changes to repeal or modify the Public Utility Holding Company Act of 1935
("PUHCA") and PURPA could reduce regulatory restrictions placed on electric
utilities and encourage them to seek new sources of electric power. Any of
these regulatory matters, among others, could increase competition for electric
power. Other than the risk that PENELEC will seek to renegotiate the terms of
the Scrubgrass power purchase agreement (see further discussion under the
caption "Energy Regulation"), 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 power purchase agreement switch to rates which vary more closely with
existing market conditions. Should ensuing competition in the later years of
the 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 the quality of
development plans, the ability of the developer to finance and complete the
project and the price. 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 alliances with other development firms with greater financial
and technical resources could enable it to continue to compete effectively in
the development market when opportunities arise.
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Presently, the Company believes there are limited opportunities for additional
project development in the United States for projects similar to those
previously developed by the Company.
Presently, there is significant merger and consolidation activity occurring
in the electric industry. From time to time, the Company considers sale or
merger strategies and proposals when they appear to present an opportunity to
enhance shareholder value.
Energy Regulation
The Company's projects are subject to regulation under federal and state
energy laws and regulations. The Company's facilities are either self-certified
as a Qualifying Facility under PURPA, or formally certified as a Qualifying
Facility by the Federal Energy Regulatory Commission ("FERC"). Pursuant to
PURPA, FERC has promulgated regulations which exempt certain Qualifying
Facilities from the Federal Power Act of 1920, PUHCA, and, except under certain
limited circumstances, state laws regulating the rates charged by electric
utilities. In order to qualify under PURPA, the Company's facilities must meet
certain size, fuel and ownership requirements and/or co-generate. In addition
to the regulation of Qualifying Facilities, PURPA requires that electric
utilities purchase electric energy produced by qualifying facilities at
negotiated rates or at a price equal to the incremental or avoided cost that
would have been incurred by the utility if it were to generate the power itself
or purchase it from another source. The Company is not presently subject to
regulation under PUHCA and does not presently intend to engage in any activities
that would cause it to be so regulated.
The Company believes that changes in PURPA, PUHCA and other related federal
statutes could occur in the next several years. The nature and impact of such
changes on the Company's projects is unknown at this time. Presently, there are
several legislative proposals pending in Congress which propose amendments to
certain regulations promulgated by PURPA. If Congress amends PURPA, the
statutory requirement that electric utilities purchase electricity from
Qualifying Facilities at full avoided cost could be repealed or modified. While
current legislative proposals specify the honoring of existing contracts, the
repeal or modification of these statutory purchase requirements under PURPA in
the future could increase pressure for electric utilities to renegotiate
existing contracts. Should there be changes in statutory purchase requirements
under PURPA, and should these changes result in amendments which reduce the
contracted rates under the Scrubgrass power purchase agreement, the Company's
results of operations and financial position could be negatively impacted.
State public utility commissions, pursuant to state legislative authority,
may have jurisdiction over how any new federal initiatives are implemented in
each state. Although FERC generally has exclusive jurisdiction over the rates
charged by an independent power project to its wholesale customers, state public
utility commissions have the practical ability to influence the establishment of
such rates by asserting jurisdiction over the purchasing utility's ability to
pass through the resulting cost of purchased power to its retail customers. In
addition, although thought to be unlikely, states may assert jurisdiction over
the siting and construction of independent power projects and, among other
things, the issuance of securities and the sale and
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transfer of assets. The actual scope of jurisdiction over independent power
projects by state public utility regulatory commissions varies from state to
state. Presently, through its power purchase agreement with PENELEC, the
Scrubgrass Project is indirectly subject to state legislation in the
Commonwealth of Pennsylvania.
In recent years, in response to changes in the electric industry, the
Commonwealth of Pennsylvania has passed new legislation most notably in the area
of deregulating the generation portion of the electric business. On December 3,
1996, the Commonwealth of Pennsylvania passed new legislation known as the
Electricity Generation Customer Choice and Competition Act (Customer Choice Act)
which became effective on January 1, 1997. The Customer Choice Act permits all
Pennsylvania retail electric customers to choose their electric generation
supplier over a phase-in period which expires December 31, 2000. The Customer
Choice Act has required that all electric utilities file restructuring plans
with the Pennsylvania Public Utility Commission which, among other things,
included unbundled prices for electric generation, transmission and distribution
and a competitive transition charge ("CTC") for the recovery of "stranded costs"
which would be paid by all customers receiving distribution service and certain
customers that increase their own generation of electricity. "Stranded costs"
generally are electric generation-related costs that traditionally would be
recoverable in a regulated environment but may not be recoverable in a
competitive electric generation market.
Presently, none of the new or proposed legislation directly impacts the
Company since the legislation pertains to the retail market or new contracts in
the wholesale market. However, as discussed previously, the Company could be
impacted in the future by, among other things, increases in competition as a
result of deregulation, or increasing pressure on electric utilities to
renegotiate existing power contracts. The Company is actively monitoring these
developments in energy proceedings in order to evaluate the impact on its
projects and also to evaluate new business opportunities created by the
restructuring of the electric industry.
Environmental Regulation
The Company's projects are subject to regulation under federal, state and
local environmental and mining laws and regulations and must also comply with
the applicable federal, state and local laws pertaining to the protection of the
environment, primarily in the areas of water and air pollution. These laws and
regulations in many cases require a lengthy and complex process of obtaining and
maintaining licenses, permits and approvals from federal, state and local
agencies. As regulations are enacted or adopted in any of these jurisdictions,
the Company cannot predict the effect of compliance therewith on its business.
The Company's failure to comply with all applicable requirements could result in
delays in proceeding with any projects under development or require
modifications to operating facilities. During periods of non-compliance, the
Company's operating facilities may be forced to shutdown until the non-
compliances are corrected. The Company is responsible for ensuring compliance
of its facilities with all applicable requirements and, accordingly, attempts to
minimize these risks by dealing with reputable contractors and using appropriate
technology to measure compliance with the applicable standards.
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PART II. OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
On October 11, 1995, Scrubgrass Generating Company L.P. (the "Lessor") and
Buzzard Power Corporation (the "Lessee") (collectively the "Plaintiffs") filed a
complaint against Pennsylvania Electric Company ("PENELEC") in the Court of
Common Pleas of Venango County, Pennsylvania (the "Court") seeking damages for
certain alleged breaches of the power purchase agreement entered into between
Scrubgrass Power Corporation, a predecessor to the Plaintiffs, and PENELEC on
August 7, 1987. In its complaint, the Plaintiffs allege that PENELEC has failed
to pay contract rates for energy produced by the Scrubgrass facility in excess
of 80 MW in any hour, that PENELEC has misused certain automatic regulation
equipment and that PENELEC has caused the Plaintiffs to incur losses from its
late payment for energy purchased from the Scrubgrass facility. As a result of
PENELEC's alleged failure to pay contract rates for energy produced by the
Scrubgrass facility in excess of 80 MW in any hour, the Plaintiffs estimate that
as of March 31, 1998, after giving effect to certain payments made by PENELEC
which are discussed below, they have incurred damages of approximately $2.5
million. Should the Plaintiffs prevail in this litigation and be awarded all of
these damages, the Company, as Lessee, would expect to retain 50% of these
damages because of its requirement to pay 50% of any net proceeds retained by
the Scrubgrass Project to the Lessor as additional rent. The Plaintiffs have yet
to quantify their damages from PENELEC's alleged late payments for energy
purchased from the Scrubgrass facility but do not expect that these damages
would be material relative to the other allegations. The Plaintiffs are unable
to quantify the damages they have incurred from PENELEC's alleged misuse of
certain automatic regulation equipment. From October 1995 to September 1996,
this legal proceeding was stayed informally by a letter agreement between the
parties. Pursuant to the letter agreement, PENELEC, which had previously not
made any payments for the energy it received in excess of 80 MW in any hour,
agreed to pay for all energy in excess of 80 MW in any hour, both previously
received and to be received in the future, at a rate equal to 90% of a market
based rate, subject to reimbursement based on the ultimate determination of
PENELEC's responsibility to pay for such energy and the applicable rate
therefor. Through March 31, 1998, the Scrubgrass Project has recognized
cumulative power generation revenues of approximately $1.4 million for energy in
excess of 80 MW in any hour based on the terms established in the letter
agreement. On September 27, 1996, the Plaintiffs provided written notice of
their intention to resume the litigation. Consequently, on October 24, 1996,
PENELEC filed preliminary objections to the complaint to the Court which
principally suggested that the primary jurisdiction for this dispute lies with
the Pennsylvania Public Utility Commission ("PUC"). On November 12, 1996, the
Plaintiffs filed a response to PENELEC's preliminary objections. The Court
heard oral arguments on this matter on January 31, 1997 for which the Court
ultimately decided in favor of the Plaintiffs on September 9, 1997 to deny
PENELEC's motion to transfer the jurisdiction of this dispute to the PUC. On
January 8, 1998, as a result of this ruling by the Court, PENELEC filed its
response to the allegations made in the Plaintiffs' complaint. On February 4,
1998, the Plaintiffs filed a Motion for Partial Judgment on the Pleadings which
was heard by the Court on March 30, 1998. The Court has yet to issue its ruling
on the Motion for Partial Judgment on the Pleadings. Presently, pending the
Court's determination of its responsibility under the power purchase agreement,
PENELEC continues to pay for energy in excess of 80 MW at a rate equal to 90% of
a market based rate and has commenced negotiations with the Company to resolve
this matter.
23
<PAGE>
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
$588,506, respectively at March 31, 1998. 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. On April 15, 1998, the Company filed a Motion for Summary
Judgment with Respect to Claims Regarding the Power Purchase Agreement, seeking
dismissal of a portion of the Plaintiffs' claims. The Company is currently
awaiting the Plaintiffs' response to its motion. Discovery remains ongoing.
24
<PAGE>
ITEM 5. OTHER MATTERS
Since the 1997 extended outage at the Scrubgrass Project, the Company has
continued to seek to mitigate its losses resulting from the outage. In this
regard, on April 15, 1998, the Company reached an agreement with GEC Alsthom
("GEC"), the manufacturer of the Scrubgrass generator, which modified the terms
of its original contract to finance the rewind of the Scrubgrass generator
performed during the 1997 extended plant outage. Under the terms of the original
contract, the Company was to pay the $660,000 cost of the generator repair in
six annual installments of $110,000, without interest, beginning in May 1997,
and was to pay an additional $75,000 bonus to GEC for completing its work ahead
of a pre-established schedule. The present value of these obligations was
recorded on the Company's Consolidated Balance Sheet as of December 31, 1997 in
accounts payable and accrued expenses for $185,000 and in maintenance reserves
for $364,000. Furthermore, the Company engaged GEC to perform certain
maintenance procedures to the generator during the 1998 scheduled outage at the
Scrubgrass plant. Under the terms of the revised agreement with GEC, as payment
in full for their work performed during the 1998 outage and for the five
remaining installments of $110,000 and $75,000 bonus owed under the original
contract, the Company will pay GEC a total of $450,000 over a four year period.
The revised agreement provides that $50,000 is payable upon the completion of
their work during the scheduled 1998 plant outage and that $100,000 is payable
upon each of the first four anniversaries of the first payment thereof. As of
March 31, 1998, the Company has recorded in its Consolidated Balance Sheet the
first installment of $50,000 in its accounts payable and accrued expenses and
the present value of the remaining four installments, discounted at the
Scrubgrass Project's incremental borrowing rate (6.75%), which amounted to
approximately $337,000, in its maintenance reserve. The $63,000 balance of the
$450,000 revised generator rewind cost is being recognized as interest expense
over the remaining four year term of the financing contract with GEC. During the
three months ended March 31, 1998, the Company recognized, through a reduction
of its operating expenses, the reduction of the present value of the future
installments due to GEC, which reduction amounted to approximately $169,000 as
of December 31, 1997. The Company also recognized interest expense of
approximately $7,000 during the three months ended March 31, 1998 under the
revised agreement with GEC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 11 - Computation of Earnings Per Share
(b) Reports on Form 8-K - None
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
May 11, 1998 /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
March 31, 1998
<TABLE>
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNTS
------------------ -------------------- ---------------
<S> <C> <C> <C>
THREE MONTHS ENDED MARCH 31, 1998:
- ----------------------------------
Income available to shareholders $ 580,593 11,406,783 $ .05
Effect of dividends to preferred stockholders (1,250)
------------------ -------------------- ---------------
Basic EPS - income available to common shareholders 579,343 11,406,783 .05
Effect of dilutive securities:
Assumed exercise of dilutive stock options 16,827
------------------ -------------------- ---------------
Diluted EPS - income available to common shareholders $ 579,343 11,423,610 $ .05
================== ==================== ===============
THREE MONTHS ENDED MARCH 31, 1997:
- ----------------------------------
Income available to shareholders $ 311,430 11,076,783 $ .03
Effect of dividends to preferred stockholders (26,428)
------------------ -------------------- ---------------
Basic EPS - income available to common shareholders 285,002 11,076,783 .03
Effect of dilutive securities:
Assumed exercise of dilutive stock options 144,208
------------------ -------------------- ---------------
Diluted EPS - income available to common shareholders $ 285,002 11,220,991 $ .03
================== ==================== ===============
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS OF ENVIRONMENTAL POWER CORPORATION FOR THE
THREE MONTHS ENDED MARCH 31, 1998.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 2,427,007<F1>
<SECURITIES> 0
<RECEIVABLES> 10,546,470<F2><F3>
<ALLOWANCES> 0
<INVENTORY> 580,488
<CURRENT-ASSETS> 9,771,958
<PP&E> 247,599
<DEPRECIATION> 122,552
<TOTAL-ASSETS> 53,073,368
<CURRENT-LIABILITIES> 9,294,890
<BONDS> 4,076,546
0
100
<COMMON> 125,254
<OTHER-SE> (3,766,340)
<TOTAL-LIABILITY-AND-EQUITY> 53,073,368
<SALES> 12,178,487
<TOTAL-REVENUES> 12,178,487
<CGS> 4,548,684
<TOTAL-COSTS> 4,548,684
<OTHER-EXPENSES> 6,037,834
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 119,392
<INCOME-PRETAX> 984,593
<INCOME-TAX> 404,000
<INCOME-CONTINUING> 580,593
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 580,593
<EPS-PRIMARY> .05
<EPS-DILUTED> .05
<FN>
<F1>CASH INCLUDES $617,826 WHICH IS RESTRICTED IN USE.
<F2>RECEIVABLES INCLUDES $3,838,233 WHICH IS NONCURRENT.
<F3>RECEIVABLES INCLUDES $3,802,450 WHICH IS SUBJECT TO A LITIGATION.
</FN>
</TABLE>
