<PAGE>
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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 June 30, 1999
-------------------------------------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to ________________
Commission file number 0-15472
----------------------------------------------
Environmental Power Corporation
(Exact name of registrant as specified in its charter)
Delaware 04-2782065
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
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 August 12, 1999 11,406,783 shares
The Exhibit Index appears on Page 33.
Total number of pages is 34.
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<PAGE>
ENVIRONMENTAL POWER CORPORATION
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
-------
<S> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as
of June 30, 1999 (unaudited) and December 31, 1998..................................... 2
Condensed Consolidated Statements of Operations (unaudited) for the Three and Six
Months Ended June 30, 1999 and June 30, 1998......................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended
June 30, 1999 and June 30, 1998....................................................... 4
Notes to Condensed Consolidated Financial Statements................................... 5-7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................ 8-30
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 30-31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................. 31-33
Item 4. Submission of Matters to a Vote of Security Holders........................... 33
Item 6. Exhibits and Reports on Form 8-K.............................................. 33
Signatures............................................................................. 34
</TABLE>
1
<PAGE>
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. Financial Statements
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30 December 31
1999 1998
----------------- -----------------
ASSETS (Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 329,369 $ 362,416
Restricted cash 1,877,263 797,922
Receivable from utility 5,460,233 6,598,864
Notes receivable 25,296 42,376
Other current assets 749,559 821,462
---------------- ----------------
TOTAL CURRENT ASSETS 8,441,720 8,623,040
PROPERTY, PLANT AND EQUIPMENT, NET 607,804 94,755
DEFERRED INCOME TAX ASSET 1,829,561 1,826,561
LEASE RIGHTS, NET 2,534,013 2,608,515
NOTES RECEIVABLE -- 3,686
ACCRUED POWER GENERATION REVENUES 45,269,315 41,386,500
OTHER ASSETS 584,061 619,693
----------------- ----------------
$ 59,266,474 $ 55,162,750
================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 7,928,322 $ 5,873,689
Dividends payable on common stock 171,102 --
Other current liabilities 3,322,971 3,939,664
---------------- ----------------
TOTAL CURRENT LIABILITIES 11,422,395 9,813,353
DEFERRED GAIN, NET 5,242,982 5,397,187
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 2,851,208 2,866,584
ACCRUED LEASE EXPENSES 45,269,315 41,386,500
MAINTENANCE RESERVE 1,598,678 2,258,049
---------------- ----------------
TOTAL LIABILITIES 66,384,578 61,721,673
SHAREHOLDERS' EQUITY
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
issued at June 30, 1999 and December 31, 1998, respectively) -- --
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at June 30, 1999 and December 31, 1998, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,525,423 shares issued at June 30, 1999 and December 31, 1998,
respectively; 11,406,783 shares outstanding at June 30, 1999 and
December 31, 1998, respectively) 125,254 125,254
Additional paid-in capital -- --
Accumulated deficit (5,977,456) (5,418,275)
---------------- ----------------
(5,852,102) (5,292,921)
Treasury stock (1,118,640 common shares, at cost, as of
June 30, 1999 and December 31, 1998, respectively) (456,271) (456,271)
Notes receivable from officers and board members (809,731) (809,731)
---------------- ----------------
TOTAL SHAREHOLDERS' EQUITY (7,118,104) (6,558,923)
---------------- ----------------
$ 59,266,474 $ 55,162,750
================ ================
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended June 30
------------------------------------------
1999 1998
------------------- -------------------
<S> <C> <C>
POWER GENERATION REVENUES $ 10,230,357 $ 9,546,950
------------------- -------------------
COSTS AND EXPENSES:
Operating expenses 5,955,940 4,889,564
Lease expenses 5,613,036 5,683,982
General and administrative expenses 697,595 551,513
Depreciation and amortization 63,370 73,049
------------------- -------------------
12,329,941 11,198,108
------------------- -------------------
OPERATING LOSS (2,099,584) (1,651,158)
OTHER INCOME (EXPENSE):
Interest income 30,502 40,199
Interest expense (84,298) (115,459)
Sale of NOx emission credits 0 0
Amortization of deferred gain 77,102 77,102
Other income 0 2,595
------------------- -------------------
23,306 4,437
------------------- -------------------
LOSS BEFORE INCOME TAXES (2,076,278) (1,646,721)
INCOME TAX BENEFIT 851,000 683,000
------------------- -------------------
NET LOSS $ (1,225,278) $ (963,721)
=================== ===================
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.11) $ (0.08)
=================== ===================
DIVIDENDS PAID OR PAYABLE
Common shares $ 171,102 $ 342,203
Preferred shares 1,250 1,250
=================== ===================
$ 172,352 $ 343,453
=================== ===================
DIVIDENDS PAID OR PAYABLE PER
COMMON SHARE $ 0.015 $ 0.030
=================== ===================
<CAPTION>
Six Months Ended June 30
-------------------------------------------
1999 1998
------------------- --------------------
<S> <C> <C>
POWER GENERATION REVENUES $ 22,577,360 $ 21,725,437
------------------- --------------------
COSTS AND EXPENSES:
Operating expenses 10,870,437 9,438,248
Lease expenses 11,241,488 11,721,816
General and administrative expenses 1,376,992 1,096,592
Depreciation and amortization 126,739 146,086
------------------- --------------------
23,615,656 22,402,742
------------------- --------------------
OPERATING LOSS (1,038,296) (677,305)
OTHER INCOME (EXPENSE):
Interest income 60,107 93,228
Interest expense (169,181) (234,851)
Sale of NOx emission credits 629,720 0
Amortization of deferred gain 154,205 154,205
Other income (32) 2,595
------------------- --------------------
674,819 15,177
------------------- --------------------
LOSS BEFORE INCOME TAXES (363,477) (662,128)
INCOME TAX BENEFIT 149,000 279,000
------------------- --------------------
NET LOSS $ (214,477) $ (383,128)
=================== ====================
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (0.02) $ (0.03)
=================== ====================
DIVIDENDS PAID OR PAYABLE
Common shares $ 342,204 $ 684,407
Preferred shares 2,500 2,500
------------------- --------------------
$ 344,704 $ 686,907
=================== ====================
DIVIDENDS PAID OR PAYABLE PER
COMMON SHARE $ 0.030 $ 0.060
=================== ====================
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30
--------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (214,477) $ (383,128)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 126,739 146,086
Deferred income taxes (3,000) (83,000)
Amortization of deferred gain (154,205) (154,205)
Accrued power generation revenues (3,882,815) (4,012,055)
Accrued lease expenses 3,882,815 4,012,055
Changes in operating assets and liabilities:
Decrease in receivable from utility 1,138,631 1,566,511
Decrease in other current assets 71,903 78,650
Increase in other assets (2,336) (4,248)
Increase (decrease) in accounts payable and
accrued expenses 1,591,866 (944,609)
Increase in long-term liabilities 5,700 5,669
Decrease in maintenance reserve (659,371) (154,493)
---------------- ----------------
Net cash provided by operating activities 1,901,450 73,233
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable 20,766 19,174
Increase in restricted cash (1,079,341) (481,898)
Property, plant and equipment expenditures (64,551) (5,195)
---------------- ----------------
Net cash used in investing activities (1,123,126) (467,919)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (173,602) (10,610,809)
Net borrowings under working capital loan 333,307 552,784
Repayment of secured promissory notes payable and
other borrowings (971,076) (600,000)
---------------- ----------------
Net cash used in financing activities (811,371) (10,658,025)
---------------- ----------------
DECREASE IN CASH AND CASH EQUIVALENTS (33,047) (11,052,711)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 362,416 12,092,273
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 329,369 $ 1,039,562
================ ================
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
ENVIRONMENTAL POWER CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- BASIS OF PRESENTATION
- -------------------------------
The accompanying unaudited condensed consolidated financial statements of
Environmental Power Corporation ("EPC") and its subsidiaries (collectively 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 and six months ended June 30, 1999 are not necessarily
indicative of results to be expected for the year ending December 31, 1999. 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, 1998.
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 tables outline the calculations of basic earnings (loss) per share
and diluted earnings (loss) per share for the three and six months ended June
30, 1999 and 1998.
<TABLE>
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amounts
------------------ -------------------- ---------------
<S> <C> <C> <C>
Three Months Ended June 30, 1999:
- ---------------------------------
Loss available to shareholders $(1,225,278) 11,406,783 $ (.11)
Effect of dividends to preferred stockholders (1,250)
------------------ -------------------- ---------------
Basic EPS - loss available to common shareholders (1,226,528) 11,406,783 (.11)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 113
------------------ -------------------- ---------------
Diluted EPS - loss available to common shareholders $(1,226,528) 11,406,896 $ (.11)
================== ==================== ===============
Three Months Ended June 30, 1998:
- ---------------------------------
Loss available to shareholders $ (963,721) 11,406,783 $ (.08)
Effect of dividends to preferred stockholders (1,250)
------------------ -------------------- ---------------
Basic EPS - loss available to common shareholders (964,971) 11,406,783 (.08)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 28,360
------------------ -------------------- ---------------
Diluted EPS - loss available to common shareholders $ (964,971) 11,435,143 $ (.08)
================== ==================== ===============
</TABLE>
5
<PAGE>
NOTE B -- EARNINGS PER COMMON SHARE (CONTINUED)
- -----------------------------------------------
<TABLE>
<CAPTION>
Loss Shares Per Share
(Numerator) (Denominator) Amounts
------------------ -------------------- ---------------
<S> <C> <C> <C>
Six Months Ended June 30, 1999:
- -------------------------------
Loss available to shareholders $ (214,477) 11,406,783 $ (.02)
Effect of dividends to preferred stockholders (2,500)
------------------ -------------------- ---------------
Basic EPS - loss available to common shareholders (216,977) 11,406,783 (.02)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 57
------------------ -------------------- ---------------
Diluted EPS - loss available to common shareholders $ (216,977) 11,406,840 $ (.02)
================== ==================== ===============
Six Months Ended June 30, 1998:
- -------------------------------
Loss available to shareholders $ (383,128) 11,406,783 $ (.03)
Effect of dividends to preferred stockholders (2,500)
------------------ -------------------- ---------------
Basic EPS - loss available to common shareholders (385,628) 11,406,783 (.03)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 22,594
------------------ -------------------- ---------------
Diluted EPS - loss available to common shareholders $ (385,628) 11,429,377 $ (.03)
================== ==================== ===============
</TABLE>
NOTE C -- NEW ACCOUNTING STANDARD
- ---------------------------------
In June 1999, the Financial Accounting Standards Board issued SFAS No. 137,
which deferred the effective date of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. SFAS No.
133 requires that entities recognize all derivative instruments as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative
instrument may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of an asset or liability or an unrecognized firm
commitment, or (b) a hedge to the exposure to variable cash flows of a
forecasted transaction. The Lessor of the Scrubgrass Project has entered into
certain interest rate swaps with financial institutions that may meet the
definition of derivative instruments under SFAS No. 133. The Company will be
required to adopt SFAS No. 133 by January 1, 2001 and is presently assessing
whether the adoption of SFAS No. 133 will have any impact on its Consolidated
Financial Statements.
NOTE D -- NON-CASH INVESTING AND FINANCING ACTIVITIES
- ------------------------------------------------------
The Company made certain machinery and equipment modifications to the
Scrubgrass facility during the three months ended June 30, 1999 for $462,767
which were considered non-cash investing activities because they were included
in accounts payable and accrued expenses as of June 30, 1999.
6
<PAGE>
NOTE E -- SUBSEQUENT EVENT
- ---------------------------
In July 1999, the Company and the Lessor of the Scrubgrass Project ("the
Plaintiffs"), jointly entered into a Settlement Agreement with Pennsylvania
Electric Company ("PENELEC") to terminate an ongoing litigation. The Settlement
Agreement does not become effective until the date PENELEC obtains a final non-
appealable Order of the Pennsylvania Public Utility Commission ("PAPUC")
approving the Settlement Agreement in form and substance acceptable to PENELEC
(the "Effective Date"). Under the terms of the Settlement Agreement, in full
settlement of all alleged claims, PENELEC agreed to pay the Plaintiffs for all
previous net deliveries of electric energy from the Scrubgrass facility in
excess of 80 MW at the rates set forth in the Power Purchase Agreement, minus
the total payments PENELEC previously made at 90% of a market based rate, plus
interest at the legal rate of 6%. PENELEC also agreed in the Settlement
Agreement to pay for future net deliveries of electric energy at the rates set
forth in the Power Purchase Agreement subject to, among other conditions,
certain annual and hourly limits, with energy purchased in excess of such limits
paid for at a market based rate. As of June 30, 1999, after giving effect to the
payments made by PENELEC at 90% of a market based rate, the amounts due for
previous net deliveries of electric energy and interest were $3,379,816 and
$436,632, respectively. The final amount payable by PENELEC to the Plaintiffs
would be recalculated on the Effective Date and would include consideration for
net deliveries of electric energy and interest incurred from July 1, 1999 to the
Effective Date.
7
<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. In
recent years, the Company also held varying ownership interests (100% to 40%) in
an approximately 51 Mw (net) waste coal-fired electric generating facility (the
"Sunnyside Project") located in Utah and owned the development rights to an
existing 43 Mw (net) coal-fired electric generating facility (the "Milesburg
Project") located in Pennsylvania which was retired from service in 1984. The
Company sold its remaining interest in the Sunnyside Project on December 31,
1994 and is presently involved in a litigation with the Purchasers to collect
the balance of the Purchasers' obligations for the sale. The Company sold its
development rights and real estate for the Milesburg Project on August 26, 1997
to the utility which had contracted to purchase electricity from such project
pursuant to an agreement which was finalized on December 5, 1997. 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 six
months ended June 30, 1999 with the results of operations for the three and six
months ended June 30, 1998. Historical results and trends which might appear
should not be taken as indicative of future operations.
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 and events 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
Net loss amounted to $1,225,278 (11 cents per share) and $214,477 (2 cents
per share) for the three and six months ended June 30, 1999, respectively, as
compared to a net loss of $963,721 (8 cents per share) and $383,128 (3 cents per
share) for the three and six months ended June 30, 1998, respectively. The
reasons for the changes in the Company's results of operations for the three and
six months ended June 30, 1999 from the results of operations for the three and
six months ended June 30, 1998 are discussed in more detail in the following
sections.
8
<PAGE>
Revenues
Power generation revenues for the six months ended June 30, 1999 amounted
to $22,577,360 as compared to $21,725,437 for the six months ended June 30, 1998
and all pertained to the Scrubgrass Project. The overall increase in power
generation revenues during the first half of 1999 is primarily attributable to a
5% increase in certain rates billed to the utility under the terms of the power
purchase agreement. This increase 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 power purchase agreement which amounted to $3,882,815
and $4,012,055 for the six months ended June 30, 1999 and June 30, 1998,
respectively. The Scrubgrass Project operated at 83.7% of its capacity for the
first half of 1999 as compared to 83.3% for the first half of 1998. As such, the
capacity factor did not materially affect the comparison for these periods.
Power generation revenues amounted to $10,230,357 and $9,546,950 for the
three months ended June 30, 1999 and June 30, 1998, respectively. The increase
in power generation revenues during the three months ended June 30, 1999 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 this period when compared to the same period in 1998. During
the three months ended June 30, 1999, the Scrubgrass Project operated at 73.7%
of its capacity as compared to 69.6% for the same period in 1998. The second
quarter capacity rates were primarily affected by the following two factors.
First, the Scrubgrass project had its planned annual maintenance outages during
the second quarters in both 1999 and 1998. During the 1999 and 1998 planned
annual maintenance outages, the Scrubgrass plant was inoperative for
approximately 13 days and 14 days, respectively, to perform scheduled
maintenance procedures. Second, the Scrubgrass Project incurred unscheduled
shutdowns to respond to equipment malfunctions which necessitated that the
Scrubgrass plant be inoperative for an aggregate of approximately 3 days and 11
days outside of the scheduled outage timeframes during the second quarters of
1999 and 1998, respectively. The aforementioned increase in 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 power
purchase agreement which amounted to $1,941,410 and $2,006,028 for the three
months ended June 30, 1999 and June 30, 1998, respectively.
Operating expenses
Operating expenses for the six months ended June 30, 1999 amounted to
$10,870,437, as compared to $9,438,248 for the six months ended June 30, 1998
and all pertained to the Scrubgrass Project. The overall increase during the
first half of 1999 is primarily attributable to the following reasons. First,
the Company incurred higher fuel costs and higher operator fees in 1999 as a
result of cost escalations in certain operating and supply agreements. Second,
pursuant to the terms of the Operations and Maintenance Agreement, the operator
of Scrubgrass Project passed along certain increases in its labor and related
costs to the Company. Third, as discussed in more detail in the following
paragraph, the Company incurred higher maintenance expenses in 1999 to perform
repairs during the planned maintenance outage and to accelerate its reserves for
future maintenance which the Company now expects will be performed earlier than
its previous schedule. Fourth, the Company entered into modifications to the
financing contract with the manufacturer of the Scrubgrass generator
9
<PAGE>
which reduced certain long-term liabilities and operating expenses during 1998
by comparison to 1999. The aforementioned increases in operating expenses were
offset in part by a decrease in 1999 standby power expenses. The Company's
standby power expenses were higher in 1998 because the Company had more
unscheduled outages in 1998 and therefore had more occasions to seek its
internal power from alternative sources.
Operating expenses for the three months ended June 30, 1999 amounted to
$5,955,940 as compared to $4,889,564 for the three months ended June 30, 1998.
Similar to the discussion in the previous paragraph, the second quarter
comparison was affected by the same changes in fuel, operator fees, labor and
related costs, maintenance and standby power expenses. However, because the
modifications to the financing contract with the generator manufacturer were
reported in the first quarter of 1998, this change did not effect the second
quarter comparison. Furthermore, it is important to point out that the 1999
increase in maintenance expenses occurred mostly in the second quarter. The
Company spent $2,477,590 and $898,300 for planned maintenance outage expenses
during the three months ended June 30, 1999 and June 30, 1998, respectively, of
which $1,198,490 and $342,847 were considered major equipment overhauls and
funded from major maintenance reserves as of June 30, 1999 and June 30, 1998,
respectively. Planned maintenance outage expenses are performed on a schedule
which differs from year to year. The selection of equipment for service and/or
replacement each year depends on factors such as expected wear and tear and
recommendations made by the equipment manufacturer. The Company's policy is to
expense planned maintenance outage expenses in the year incurred for items which
do not meet the definition of a major equipment overhaul. Because of their long-
term nature, the Company records the expense of major equipment overhauls 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.
Lease expenses
Lease expenses for the six months ended June 30, 1999 amounted to
$11,241,488 as compared to $11,721,816 for the six months ended June 30, 1998
and all pertained to the Scrubgrass Project. The overall decrease in lease
expenses during the first half of 1999 is primarily attributable to the
following two reasons. First, favorable interest rates decreased the Lessor's
loan costs that were passed through to the Company in its facility lease
expenses. Second, the Company realized a decrease in the lease expense recorded
as a result of the straight-line accounting treatment of certain lease expenses
under Scrubgrass lease which amounted to $3,882,815 and $4,012,055 for the six
months ended June 30, 1999 and June 30, 1998, respectively. The aforementioned
decreases in lease expense were offset in part by scheduled increases in the
base rent paid to the Lessor.
Lease expenses for the three months ended June 30, 1999 and June 30, 1998
amounted to $5,613,036 and $5,683,982, respectively. Similar to the discussion
in the previous paragraph, a comparison of the lease expenses during the three
months ended June 30, 1999 to the same period in 1998 would show decreases due
to favorable interest rates and lower straight-line lease expenses which
decreases were offset in part by increases in the base rents paid to the Lessor.
However, due to the timing of when cash flows became available for distribution
from the Scrubgrass Project, the Company realized an increase in additional rent
paid to the Lessor during the three months ended June 30, 1999 by comparison to
the same period in 1998 which offset most of the second
10
<PAGE>
quarter decrease in lease expenses. Since there was a decrease in additional
rent paid to the Lessor during the first quarter of 1999 by comparison to the
same period in 1998, this change did not materially affect the previous six
month comparison of lease expenses.
General and administrative expenses
General and administrative expenses for the three and six months ended June
30, 1999 amounted to $697,595 and $1,376,992, respectively, as compared to
$551,513 and $1,096,592 for the three and six months ended June 30, 1998. The
overall increases in general and administrative expenses during both the three
and six months ended June 30, 1999 by comparison to the same periods in 1998 are
primarily attributable to the following reasons. First, the management fees for
the Scrubgrass Project increased primarily because the project manager passed
along increases in its labor and related costs to the Company and because
certain contract matters required more management attention during 1999. Second,
the Company incurred pension expense in 1999 for a defined benefit pension plan
which was established in December 1998 for which there was no pension expense
reported during the the six months ended June 30, 1998. Third, since legal
efforts for both of its litigations accelerated in 1999, the Company incurred
significant increases in legal expenses during 1999 by comparison to 1998.
However, such increases in general and administrative expenses were offset in
part by reductions in executive salaries during the three and six months ended
June 30, 1999 by comparison to the same periods in 1998 which are described in
the following paragraph.
As discussed under the Caption "1999 Outlook - General and Administrative
Expenses", two of the Company's executive officers repaid in December 1998 a
portion of their annual salaries which is expected to result in an increase in
annual executive salaries for 1999 by comparison to 1998 since the officers are
not expected to make similar repayments in 1999. However, because the 1998
salary repayments were not made until December 1998, the results of operations
for the three and six months ended June 30, 1998 include executive officer
salaries at their original levels before the salary repayments. As such, since
the annual 1999 salaries for such executive officers were reduced from their
original annual 1998 salaries, executive salaries were reduced during the three
and six months ended June 30, 1999 by comparison to the same periods in 1998.
Other income (expense)
Interest expense for the three and six months ended June 30, 1999 amounted
to $84,298 and $169,181, respectively, as compared to $115,459 and $234,851 for
the three and six months ended June 30, 1998, respectively. The overall
decreases in interest expense during both the three and six months ended June
30, 1999 by comparison to the same periods in 1998 are primarily attributable to
reductions in interest rates and reductions in the outstanding borrowings under
the 1997 term credit facility relating to the Scrubgrass Project which is
reducing in $600,000 increments every six months through July 2000.
Sale of NOx emission credits amounted to $629,720 for the six months ended
June 30, 1999 and represented the aggregate proceeds received in February 1999
from sales of Nitrogen Oxide
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Ozone Transport Region Budget Allowances ("NOx Credits"). The sale of NOx
Credits is discussed further under "--Liquidity and Capital Resources - Cash
Flow Outlook".
Income Tax Benefit
Income tax benefit for the three and six months ended June 30, 1999
amounted to $851,000 and $149,000, respectively, as compared to $683,000 and
$279,000 for the three and six months ended June 30, 1998. The income tax
benefit reported for the three and six months ended June 30, 1999 changed from
the comparable periods in 1998 primarily due to associated changes in the loss
before income taxes. The effective income tax rate for 1999 is currently
projected to be approximately 41% which is consistent with rate reported for the
comparative periods in 1998. The Company's effective income tax rate projections
vary primarily because of changes in the allocation of taxable income between
state taxing jurisdictions.
1999 Outlook
With a view towards the remainder of 1999, the Company expects to achieve
operating earnings as a result of profits from Scrubgrass project operations and
management of its corporate general and administrative expenses. The Company
offers the following prospective information concerning significant components
of its results of operations for the year ending December 31, 1999 ("Fiscal
1999") which are being compared to historical results of operations for the year
ended December 31, 1998 ("Fiscal 1998"):
Power generation revenues - Power generation revenues are expected to
increase in Fiscal 1999 as a result of a 5% increase in certain contracted
rates under the Scrubgrass power purchase agreement and improvements in the
performance of the Scrubgrass facility. During Fiscal 1998, the Scrubgrass
facility was inoperative for approximately 23 days for unscheduled shutdowns
to respond to equipment malfunctions. While the Company expects that the
Scrubgrass facility will incur equipment malfunctions from time to time, the
Company does not believe that Fiscal 1998 results are necessarily indicative
of results expected for Fiscal 1999.
Operating expenses - Operating expenses are expected to increase in Fiscal
1999 as a result of the following factors. First, the Company expects to
incur a 4% average increase in certain contracted rates under fuel supply
agreements, a 5% increase in certain contracted rates under the Operations
and Maintenance Agreement for the Scrubgrass Project and increases in
personnel costs at the Scrubgrass plant. Second, because the Company expects
improvements in the performance of the Scrubgrass facility for Fiscal 1999,
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. Third, the Company expects to incur higher
maintenance expenses in Fiscal 1999 for two reasons: 1) the Fiscal 1999
planned maintenance outage required more extensive repairs than the Fiscal
1998 planned maintenance outage and 2) the Company expects to accelerate its
reserves for future maintenance which the Company now expects will be
performed earlier than its previous schedule. However, since the Company is
not projecting it will respond to as many
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equipment malfunctions during Fiscal 1999, the aforementioned increases in
maintenances expenses are expected to be offset in part by lower maintenance
expenses resulting from unscheduled shutdowns.
Lease expenses - Lease expenses are expected to increase in Fiscal 1999 for
the following reasons. First, the Company expects that higher contracted
principal payments on the Lessor's term loans will increase the Lessor's loan
costs that are expected to be passed through to the Company in its facility
lease expenses. Second, the Company expects to incur scheduled increases in
equity rents for the Scrubgrass Project in Fiscal 1999. Third, due to
projected increases in cash from Scrubgrass Project operations (See further
discussion under "--Liquidity and Capital Resources - Cash Flow Outlook"),
the Company expects its additional rent paid to the Lessor, which amounts to
50 percent of the net cash flows from the Scrubgrass Project, would also
increase in Fiscal 1999. However, the Company has experienced improvements
in its variable interest rates in recent months. Should recent interest
rates remain consistent during Fiscal 1999, the Company would expect to incur
a decrease in a portion of its lease expense due to reductions in the
Lessor's loan costs that would be passed through to the Company in its
facility lease expenses.
General and administrative expenses - General and administrative expenses are
expected to increase during Fiscal 1999 primarily as a result of increases in
management fees for the Scrubgrass Project and increases in payroll expense
for two of the Company's executive officers. During Fiscal 1998, such
executive officers had repaid a portion of their annual salaries in an amount
equal to the benefit they expected to receive from the Company's Fiscal 1998
contribution to its defined benefit pension plan. While the annual salaries
for such executive officers is expected to be decreased by an aggregate of
$100,000 during Fiscal 1999, such decrease is less than their aggregate
salary repayments of $241,847 made during Fiscal 1998. Depending on the
demands of the Company's two legal proceedings, the Company could also incur
significant fluctuations in its professional fees and management costs which
cannot be estimated at this time.
Other expense - In Fiscal 1998, the Company wrote-off its aggregate balances
as of December 31, 1998 of the notes receivable of $2,937,500 and the
receivable from sale of affiliate of $570,998 related to the 1994 sale of the
Sunnyside Project. This charge against operating results will not recur in
Fiscal 1999.
Other income - The Company entered into contracts to sell a portion of its
anticipated future Nitrogen Oxide Ozone Transport Region Budget Allowances
("NOx Credits"). The Company expects to generate other income from sales of
its NOx Credits beginning in Fiscal 1999. The sales of NOx credits are
discussed further under "--Liquidity and Capital Resources - Cash Flow
Outlook".
Litigation recoveries - As of June 30, 1999, the Company is seeking to
recover approximately $4.2 million owed by the Purchasers of the Sunnyside
Project and the Company and the Lessor of the Scrubgrass Project are jointly
seeking to recover approximately $3.8 million (of which 50% or approximately
$1.9 million would be retained
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by the Lessor) owed by PENELEC, which recoveries are both the subject of
legal proceedings. In July 1999, the Company and the Lessor of the Scrubgrass
Project jointly entered into a Settlement Agreement with PENELEC which does
not become effective until the date PENELEC obtains a final non-appealable
Order of the Pennsylvania Public Utility Commission ("PAPUC") approving such
agreement in form and substance acceptable to PENELEC. Under the terms of the
Settlement Agreement, if approved by the PAPUC, the Company and the Lessor of
the Scrubgrass Project expect to recover their entire claim of approximately
$3.8 million as of June 30, 1999. Furthermore, should the Sunnyside Project
legal proceeding resolve or settle in favor of the Company, the Company could
also receive additional financial recoveries which include additional
interest, punitive damages and reimbursements for attorney's expenses. Any
future recoveries from either of these legal proceedings would be recorded as
additional income in the Company's Consolidated Statement of Operations. See
"Part II. Other Information - Item 1. Legal Proceedings".
Recently Issued Accounting Standards
See Note C to the Condensed Consolidated Financial Statements for recently
issued accounting standards which are required to be adopted in the future.
Liquidity and Capital Resources
Operating Activities
The Company had cash provided by operating activities of $1,901,450 and
$73,233 for the six months ended June 30, 1999 and June 30, 1998, respectively.
During these periods, the Company's only sources of cash from operating
activities were operating cash flows from the Scrubgrass Project and investment
earnings.
The Company had a net loss of $214,477 and $383,128 during the six months
ended June 30, 1999 and June 30, 1998, respectively, which offset a portion of
the Company's cash provided by operating activities. The following adjustments,
which did not impact the Company's cash flows, need to be considered in order to
reconcile the Company's net loss for the six months ended June 30, 1999 to its
net cash provided by operating activities.
Depreciation and amortization - During the six months ended June 30, 1999,
the Company recognized depreciation and amortization for its lease rights of
$74,502, deferred financing costs of $37,968, machinery and equipment
modifications of $10,932 and equipment and furniture of $3,337.
Deferred gain, net - The Company's deferred gain, net, amounted to $5,242,982
as of June 30, 1999 as compared to $5,397,187 as of December 31, 1998. 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.
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The Company also offers the following information to discuss changes in its
operating assets and liabilities which most notably impacted its cash position
during 1999:
Receivable from utility - The Company's receivable from utility relates to
the Scrubgrass Project and amounted to $5,460,233 as of June 30, 1999 as
compared to $6,598,864 as of December 31, 1998 The decrease in receivable
from utility as of June 30, 1999 is primarily attributable to a decrease in
revenues during May 1999 as a result of the 1999 planned maintenance outage
and several unscheduled shutdowns. However, the aforementioned decrease was
offset in part by a 5% increase in certain rates billed to the utility in
1999 under the terms of the Scrubgrass power purchase agreement.
Other current assets - The Company's other current assets amounted to
$749,559 as of June 30, 1999 as compared to $821,462 as of December 31, 1998.
The change in other current assets is largely due to seasonal decreases in
fuel inventory and prepaid insurance.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $7,928,322 as of June 30, 1999 as compared to
$5,873,689 as of December 31, 1998. The increase as of June 30, 1999 is
primarily attributable to the following reasons. First, due to the timing of
the annual maintenance outage and vendor billing practices, a significant
portion of the Company's $2,477,590 in annual maintenance outage expenses was
paid in July 1999. As such, accounts payable and accrued expenses increased
as of June 30, 1999 by comparison to December 31, 1998. Second, the Company
made certain machinery and equipment modifications to the Scrubgrass Project
during the three months ended June 30, 1999 for which $462,767 remained
unpaid as of June 30, 1999 (See "Investing Activities - Restricted Cash").
Third, the Company's 1998 contribution to its defined benefit pension plan
had not been funded as of June 30, 1999. As such, the accrued pension
liability as of June 30, 1999 increased by the periodic pension cost for the
six months ended June 30, 1999. Fourth, primarily due to the increases in
certain 1999 operating expenses and general and administrative expenses
discussed under "Results of Operations" above, the Company realized an
increase in accounts payable and accrued expenses as of June 30, 1999. The
overall increase was offset in part primarily by the following factors which
decreased accounts payable and accrued expenses as of June 30, 1999 by
comparison to December 31, 1998. First, due to its 1999 tax loss for the
first half of 1999, the Company had lower corporate taxes payable as of June
30, 1999 by comparison to December 31, 1998. Second, the Company has certain
costs which are paid annually during the first quarter and accrued monthly
during the calendar year. For such costs, the Company's accrued expenses as
of June 30, 1999 included only six months of expense as compared to 12 months
of expense as of December 31, 1998. Third, the Company had an additional rent
accrual of $223,679 as of December 31, 1998. However, due to the effect of
the annual maintenance outage on the cash flows of the Scrubgrass Project,
there was no additional rent to accrue as of June 30, 1999.
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
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maintenance fund which have been set aside to ensure that the funds are
available for these maintenance procedures (see "Investing Activities-
Restricted Cash" below). The maintenance reserve decreased to $1,598,678 as
of June 30, 1999 from $2,258,049 as of December 31, 1998 primarily due to
expenditures of approximately $1.2 million for major equipment overhauls
during the 1999 planned maintenance outage. This decrease was offset in part
by scheduled reserves provided for the ongoing maintenance of the plant. As
of June 30, 1999, the Company had unpaid expenditures of approximately
$974,000 for major equipment overhauls which were included in its Accounts
Payable and Accrued Expenses and which did not reduce the cash in the
restricted major maintenance fund until the third quarter of 1999.
Investing Activities
The Company used $1,123,126 and $467,919 in investing activities during the
six months ended June 30, 1999 and June 30, 1998, 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 $20,766 and $19,174 from notes
receivable related to the Scrubgrass Project during the six months ended June
30, 1999 and June 30, 1998, respectively. The notes receivable related to the
Sunnyside Project, with a principal balance of $2,937,500 and outstanding
interest balance of $955,694 as of June 30, 1999, are the subject of a legal
proceeding. Due to uncertainties surrounding the timing of resolving this
legal proceeding, the Company wrote-off the outstanding balances of these
receivables as of December 31, 1998 and is no longer recognizing future
interest income on the notes. "See Part II. Other Information - Item 1. Legal
Proceedings" for further information about this litigation.
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 six months ended June 30, 1999 and June 30, 1998, such deposits
and interest thereon exceeded the payments for major equipment overhauls by
$536,036 and $481,898, respectively. In February 1999, the Company received
$629,720 from the sale of a portion of its NOx Credits (see the discussion
under "--Cash Flow Outlook") and designated that $600,000 of such proceeds be
used to purchase and install certain machinery related to the production of
NOx Credits. Pending the purchase and installation of this machinery, the
Company has invested such proceeds in a restricted cash account. As of June
30, 1999, the Company had $543,305 in restricted cash available for the
installation of this machinery. During the six months ended June 30, 1999,
the Company reported investment earnings of $7,856 and made capital
expenditures of $64,551 related to the cash restricted for the installation
of this machinery. As discussed under the caption "Operating Activities -
Accounts Payable and Accrued Expenses", the Company made certain machinery
and equipment modifications to the Scrubgrass Project during the three months
ended June 30, 1999
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for which $462,767 remained unpaid as of June 30, 1999. These expenditures
decreased restricted cash during the third quarter of 1999.
Property, plant and equipment - The Company invested $64,551 and $5,195 in
property, plant and equipment expenditures during the six months ended June
30, 1999 and June 30, 1998, respectively. The 1999 expenditures were
machinery and equipment modifications made at the Scrubgrass facility. The
1998 expenditures were primarily purchases of computer equipment for the
Company's corporate office. The Company made certain additional machinery and
equipment modifications to the Scrubgrass facility during the three months
ended June 30, 1999 for $462,767 which were considered non-cash investing
activities because they remained unpaid as of June 30, 1999.
Financing Activities
The Company utilized $811,371 and $10,658,025 in financing activities
during the six months ended June 30, 1999 and June 30, 1998, respectively. 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 $342,204 (three
cents per share) and $684,407 (six cents per share) during the six months
ended June 30, 1999 and June 30, 1998, respectively, and had dividends
payable of $171,102 and $342,203 as of June 30, 1999 and June 30, 1998,
respectively. The Company also had dividends payable of $10,266,105 ( 90
cents per share) as of December 31, 1997 which were declared during the
fourth quarter of 1997 and paid on January 7, 1998. As such, dividends paid
for common stock amounted to $171,102 and $10,608,309 during the six months
ended June 30, 1999 and six months ended June 30, 1998, respectively. The
Company also paid dividends to its subsidiary's preferred stockholder of
$2,500 during both the six months ended June 30, 1999 and six months ended
June 30, 1998. As such, the Company paid total dividends of $173,602 and
$10,610,809 during the six months ended June 30, 1999 and six months ended
June 30, 1998, 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. The Company increased its outstanding
borrowings under the Lessee Working Capital Loan Agreement from $2,389,664 as
of December 31, 1998 to $2,722,971 as of June 30, 1999. The increase in the
outstanding borrowings under Lessee Working Capital Loan is primarily due to
the loss of revenues in May 1999 and increased expenses associated with the
scheduled and and unscheduled shutdowns. See the further discussions above
under the captions "Operating Activities - Accounts Payable and Accrued
Expenses" and "Results of Operations -Revenues."
Term Credit Facility - The Company, through advances from the Lessor, has a
three year credit facility with the lenders of the Scrubgrass Project which
made $3 million available to the Scrubgrass Project in June 1997 to cover the
cash deficiency which resulted from the extended
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annual outage of the Scrubgrass Project and associated costs and expenses. On
July 1, 1998, the maximum allowable borrowings under this credit facility
began reducing in $600,000 increments every six months through July 3, 2000
when the credit facility will be payable in full. The Company made payments
to reduce this obligation by $950,000 and $600,000 during the six months
ended June 30, 1999 and June 30, 1998, respectively to ensure that the
outstanding borrowings would not exceed the maximum allowable borrowings on
the dates indicated in the credit facility. The Company considers reductions
in the outstanding borrowings until this term credit facility which are
required within one year to be current liabilities. As such, the Company has
classified $600,000 and $1,550,000 of this obligation in its Other Current
Liabilities as of June 30, 1999 and December 31, 1998, respectively.
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 $1,023,016 and $1,228,192,
respectively as of June 30, 1999. 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 are
the subject of a litigation described in "Part II. Other Information - Item
1. Legal Proceedings". The Scrubgrass Project obligation has scheduled
maturities which began in 1998 and continue through 2005. The Company made
payments of $21,076 and $-0- for the Scrubgrass Project obligation during the
six months ended June 30, 1999 and June 30, 1998, respectively.
Cash Flow Outlook
During 1999, 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 in its Annual Report on Form 10-K for 1998, 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 - 1999 Outlook",
the Company expects that the Scrubgrass Project will be profitable for Fiscal
1999 and will generate cash flows from its operating activities. Due primarily
to an approximate 5% increase in the contracted rates under the Scrubgrass power
purchase agreement and expected improvements in the performance of the
Scrubgrass facility, the Company believes that such expected cash flows would
exceed previous 1998 levels. Nevertheless, the Company anticipates that its
expected cash flows in Fiscal 1999 would continue to be affected by debt and
maintenance reserve repayments. According to the terms of certain Scrubgrass
Project obligations, the Company will be required to reduce the outstanding
balance of its term credit facility in Fiscal 1999 by $1,550,000 and will be
required to make installment payments in Fiscal 1999 aggregating $60,695 under
the $1.3 million Scrubgrass Project note. Furthermore, pursuant to the
provisions of certain Scrubgrass Project agreements, the Company will also be
required to make additional scheduled deposits of $82,275 in Fiscal 1999 to
replenish restricted cash balances which were used to finance certain 1997
maintenance expenses. However, as discussed in its Annual Report on Form 10-K
for Fiscal 1998,
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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 Fiscal 1999 from the Scrubgrass Project would only
be reduced by 50 percent of any required debt and maintenance reserve
repayments. During Fiscal 1998, the Company received distributions of $1,371,690
from the Scrubgrass Project. During the six months ended June 30, 1999, the
Company has received distributions from the Scrubgrass Project of $637,364. Due
to restrictions in certain operating agreements, cash was not expected to be
distributed as quickly from the Scrubgrass Project during the first half of 1999
when compared to same period in 1998. However, as discussed above, the Company
presently expects that distribution levels will increase in the latter part of
Fiscal 1999 and that aggregate Fiscal 1999 distributions will exceed
distributions for Fiscal 1998.
During December 1998 and January 1999, the Company entered into contracts
to sell a portion of its anticipated future Nitrogen Oxide Ozone Transport
Region Budget Allowances ("NOx Credits"). Each year, the Environmental
Protection Agency and the Pennsylvania Department of Environmental Protection
(the "Regional Authorities") grant NOx Credits to the Company based on numerous
factors which pertain to the design and operation of the Scrubgrass facility.
The NOx Credits establish the quantity (in tons) of nitrogen oxide that the
Scrubgrass facility can emit into the environment before the Company will be
fined by the EPA. During Fiscal 1999, the Company plans to install machinery,
with a cost of approximately $600,000, which is expected to significantly lower
the quantity of nitrogen oxide which the Scrubgrass facility would emit into the
environment. As such, the Company anticipates that it may not require a portion
of its future NOx Credits to maintain its compliance with EPA standards. Because
NOx Credits are transferable and marketable, the Company contracted to sell 839
tons of its projected available NOx Credits which it anticipates may not be
required to comply with EPA standards. However, the Company was recently
notified by the Regional Authorities that 111 tons of its projected available
NOx Credits would not be certified and, accordingly, the Company terminated the
sales contracts associated with such NOx Credits. Through June 30, 1999, the
Regional Authorities have certified 182 tons of NOx credits and the Company has
collected proceeds from sales of NOx Credits of $629,720, from which $600,000
has been designated to purchase and install the machinery discussed above. The
Company is currently awaiting certification of the remaining 546 tons of its
projected available NOx Credits. The Company currently expects to receive
aggregate proceeds from sales of the remaining 546 tons of anticipated NOx
Credits of $1,161,888 through 2000.
In July 1999, the Company and the Lessor of the Scrubgrass Project ("the
Plaintiffs"), jointly entered into a Settlement Agreement with Pennsylvania
Electric Company ("PENELEC") to terminate an ongoing litigation (see "Part II.
Other Information - Item 1. Legal Proceedings"). The Settlement Agreement does
not become effective until the date PENELEC obtains a final non-appealable Order
of the Pennsylvania Public Utility Commission ("PAPUC") approving the Settlement
Agreement in form and substance acceptable to PENELEC (the "Effective Date").
Under the terms of the Settlement Agreement, in full settlement of all alleged
claims, PENELEC agreed to pay the Plaintiffs for all previous net deliveries of
electric energy from the Scrubgrass facility in excess of 80 MW at the rates set
forth in the Power Purchase Agreement, minus the total payments PENELEC
previously made at 90% of a market based rate, plus interest at the legal rate
of 6%.
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PENELEC also agreed in the Settlement Agreement to pay for future net deliveries
of electric energy at the rates set forth in the Power Purchase Agreement
subject to, among other conditions, certain annual and hourly limits, with
energy purchased in excess of such limits paid for at a market based rate. As of
June 30, 1999, after giving effect to the payments made by PENELEC at 90% of a
market based rate, the amounts due for previous net deliveries of electric
energy and interest were $3,379,816 and $436,632, respectively. The final amount
payable by PENELEC to the Plaintiffs would be recalculated on the Effective Date
and would include consideration for net deliveries of electric energy and
interest incurred from July 1, 1999 to the Effective Date. If the Settlement
Agreement is approved by the PAPUC, PENELEC would be required to remit such
payment to the Scrubgrass Project within 20 days from the Effective Date. The
Scrubgrass Project has various contractual obligations which may require that
any cash flows from the Settlement Agreement first be used to increase reserve
accounts and/or satisfy certain contractual obligations before such cash flows
are available for distribution to the Company or the Lessor. The Company and the
Lessor share equally any cash flows which may become available for distribution
from the Scrubgrass Project. Notwithstanding any restrictions on distributions
from the Scrubgrass Project, the Settlement Agreement, if approved, is expected
to materially enhance the Company's existing and future results of operations
and financial position.
As of June 30, 1999, the Company is seeking to recover approximately $4.2
million owed by the Purchasers of SCA (See "Part II. - Other Information - Item
1. Legal Proceedings"). In addition, the Company is seeking financial recoveries
which include additional interest, punitive damages and/or reimbursements for
attorney's expenses. The Company believes its position in this litigation is
meritorious and, should the litigation resolve or settle in favor of the
Company, it could materially enhance the Company's financial position. However,
there can be no assurance if or when the Company will resolve or settle this
legal proceeding.
In September 1998, the Company filed its 1997 corporate tax returns which
clarified its corporate tax position. Prior to 1997, the Company had substantial
net operating loss carryforwards which sheltered the Company from paying Federal
and certain state corporate taxes during its profitable periods. However,
primarily as a result of the 1997 Milesburg Project sale, the Company had
substantial taxable income in 1997 which utilized all of the Company's previous
net operating loss carryforwards. As such, for tax years beginning in 1997, the
Company's cash flows have been negatively effected by the payment of significant
Federal and state corporate taxes. Presently, the Company is reviewing its
corporate tax position and is considering tax strategies which could mitigate
the effect that corporate taxes are expected to have on its future cash flows.
In recent periods, the payment of corporate taxes has significantly reduced the
Company's cash available for shareholder distributions and was a significant
component in the decision in September 1998 to reduce the Company's quarterly
dividend amount from 3 cents per share to 1.5 cents per share.
The Company is optimistic about the future performance of the Scrubgrass
Project which is currently expected to achieve earnings on an annual basis for
the foreseeable future. The Scrubgrass power purchase agreement has contracted
rate escalations which, assuming the Scrubgrass Project meets its targeted
capacity rates, would ensure a material increase in revenues in future years.
Furthermore, as discussed above, the Company is involved in settlement
discussions with PENELEC regarding its legal proceeding and has entered into
contracts for the
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sale of NOx Credits which could both materially enhance the anticipated
increases in the Company's results of operations and cash flows.
Notwithstanding, the Scrubgrass Project will obviously bear the burden of
repaying the debt obligations relating to the 1997 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
existing cash reserves, 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 its dividend policy and the Company's then current and projected
operating performance and capital requirements. See the further discussions
under "--Certain Factors That May Affect Future Results" below.
Year 2000 Readiness
General
The Company continues to address the issue of Year 2000 Readiness ("the Y2K
Project") and is proceeding on a schedule designed to complete the Y2K Project
before the end of 1999. In 1997, the Company began establishing procedures to
assess the risks associated with the Y2K Project. The Company's procedures to
assess the risks of the Y2K Project have included an inventory of stand-alone
hardware and software ("IT Systems"), an inventory of all system components
embedded in the Scrubgrass plant operating control systems ("Non-IT Systems"),
the identification of critical vendors, customers and business partners, the
testing of both IT Systems and Non-IT systems and a solicitation of responses
from all critical vendors, customers and business partners indicating their
readiness for the Year 2000.
Presently, the Company has completed its testing of IT Systems and Non-IT
Systems. Based on the results of these tests, the Company has identified IT
Systems and components of Non-IT Systems which are not Year 2000 compliant. With
respect to IT systems, the Company has either already upgraded such systems or
has placed orders to upgrade such systems in the near future. As far as Non-IT
Systems, the Company has already upgraded all systems except for its continuing
emissions monitoring system (CEMS). The Company is presently awaiting
information from the manufacturer of the CEMS who is expected upgrade the CEMS
with a Year 2000 compliant version in the near future.
Due to the completion of effective contingency plans for all non-compliant
systems and services, the Scrubgrass facility has achieved a "Y2K Ready"
certification. The Scrubgrass facility has achieved "Y2K Compliant" status for
all systems except for the CEMS.
The Company has made substantial progress in securing responses from most
critical vendors, and business partners indicating their readiness for Year
2000. Based on the responses received to date, the Company has not identified
any conditions of potential non-compliance which the Company estimates would
materially impact its business.
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Costs
The Company does not expect that the total costs to remediate Year 2000
issues would be material to its financial position. The Company has incurred
cumulative costs to remediate Year 2000 issues of approximately $194,000 through
June 30, 1999. The Company estimates that it will incur additional costs of
approximately $16,000 to remediate Year 2000 issues. The Company expects to fund
such costs from its operating cash flows.
Risks and Contingency Plans
The Company believes that it has established a viable plan designed to
ensure that the Y2K Project is completed prior to the year 2000. However, in
connection with its Y2K Project, the Company has also developed a contingency
plan for all mission critical items that have not been certified and tested as
Year 2000 compliant which describes the steps the Company would take if the Y2K
Project is not completed as planned. The Y2K Project efforts are ongoing and the
Company will endeavor to update the Y2K Project activities and its contingency
plans as new information becomes available.
The Year 2000 problem is a world-wide concern and there is a tremendous
amount of uncertainty about the effect this problem will have on any business.
The Company is endeavoring to understand the impact that failures of third
parties could have on its business. However, even with a diligent effort, the
Company may not be able to conceive every scenario in which a third party
failure could impact its business. However, through direct solicitation, the
Company has taken steps to assess the risk that known third parties with whom it
has significant business relationships are sufficiently prepared for the Year
2000.
The Company has key relationships with numerous vendors and business
partners. Presently, the Company has received responses from most key vendors
and business partners indicating their readiness for the Year 2000. Based on the
responses received to date, the Company has not identified any conditions of
potential non-compliance which the Company estimates would materially impact its
business. The Company has considered its relationships with the vendors and
business partners who have not yet indicated their readiness for Year 2000.
Based on this review, the Company does not believe that its business would be
materially effected if any of these vendors or key business partners failed to
ensure that they were Year 2000 compliant.
The Company has one customer, PENELEC, a public utility which is
contractually obligated to purchase all of the power supplied by the Scrubgrass
facility. While the Company believes that PENELEC is taking the appropriate
steps to ensure that it is ready for the Year 2000, the Company has received no
formal correspondence which indicates that PENELEC expects to be ready. While
the computer systems at Scrubgrass are not directly connected to those at
PENELEC, it is conceivable that the Company could still experience business
interruptions if PENELEC fails to ensure that its systems are Year 2000
compliant. Because the Company is dependent on this one customer, any business
interruptions could have a material impact on the Company's financial position
and results of operations.
22
<PAGE>
The Company has taken steps it deems prudent to understand its Year 2000
risks, to estimate the costs to complete its Y2K Project and to understand the
extent to which it could be impacted by third parties who fail to ensure they
are ready for the Year 2000. However, there can be no assurance that all non-
compliant systems or system components will be identified, that the Company's
systems will be Year 2000 compliant, that the Company will achieve its estimated
remediation costs or timetable, or that a failure by a third party to be Year
2000 compliant would not have a material adverse affect on the Company's
business. However, by completing its Y2K Project, the Company believes it will
have taken appropriate steps to mitigate the risk that any of the aforementioned
items would have a material adverse affect on its business.
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 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.
23
<PAGE>
Scheduled and Unscheduled Shutdowns
The Scrubgrass Project from time to time experiences both scheduled and
unscheduled shutdowns. Periodically, the Scrubgrass Project incurs scheduled
shutdowns in order to perform maintenance procedures to equipment that cannot be
performed while the equipment is operating. Occasionally, the Scrubgrass Project
may also incur unscheduled shutdowns or may be required to operate at reduced
capacity levels following the detection of equipment malfunctions, or following
minimum generation orders received by the utility. During periods when the
Scrubgrass Project is shutdown or operating at reduced capacity levels, 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. - Other Information - 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 $955,694, respectively as of June 30, 1999. The
balance of a purchase price closing 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 in "Part II. - Other Information - Item 1. Legal Proceedings",
the Company has been involved in a legal proceeding with PENELEC since October
1995 whereby, among other complaints, the Company alleges that PENELEC has
failed to pay the Lessor and the Company contract rates for power in excess of
80 MW produced by the Scrubgrass facility. The Company has recently entered into
a settlement agreement with PENELEC to resolve this litigation which, if
approved by the Pennsylvania Public Utility, could significantly improve the
Company's results of operations and financial position. However, there can be no
assurance that the Pennsylvania Public Utility Commission would approve this
settlement.
Financial Results
To date the Company has incurred substantial losses, primarily due to its
development activities, which have resulted in an accumulated deficit of
$5,977,456 as of June 30, 1999. While the Company was profitable from operating
activities during 1998, the Company incurred a net
24
<PAGE>
loss from the operation of the Scrubgrass Project during 1997 due to an
unforeseen repair to the generator at the Scrubgrass facility. The Company also
had an overall net loss during 1998 largely due to the write-off of the
Sunnyside project receivables. Financial results can be affected by numerous
factors, including without limitation general economic conditions, cyclic
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 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 consists of variable rate and
fixed rate debt obligations. The Company's subsidiary also has a variable rate
working capital loan, a variable rate term loan and a variable rate term credit
facility all of which were advanced from the Lessor under various Scrubgrass
project agreements. The Company offers the following information about these
debt obligations:
<TABLE>
<CAPTION>
Balance at Matures
Description of the Obligation 6/30/99 Interest Rate Through
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Lessor debt obligations:
Variable-rate tax exempt bonds $135,600,000 Quoted Tax Exempt Bond Rate 2012
Variable rate term loan 15,602,585 Fixed swap rate of 6.4225% 2005
Variable rate term loan 10,396,808 LIBOR rate plus 1.250% 2004
Fixed rate junior subordinated debt 175,077 8% 1999
The Company's debt obligations:
Variable rate working capital loan 2,722,971 LIBOR rate plus 1.125% Revolving
Variable rate term loan 1,228,192 LIBOR rate plus 1.250% 2004
Variable rate term credit facility 1,200,000 LIBOR rate plus 1.125% 2000
</TABLE>
The Lessor entered into interest rate swaps which had the effect of fixing
the interest rate for its term loan which matures in 2005 at 6.4225%. The Lessor
also has junior subordinated debt obligations which incur interest at a fixed
rate of 8%. However, the remainder of the Lessor's debt obligations and all of
the Company's debt obligations incur interest at 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
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<PAGE>
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. 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 with competitors
discovering lower cost alternatives for providing electricity. The electric
industry is also characterized by rapid changes in regulations which the Company
expects could continue to increase competition. For instance, the electric
industry has been previously affected by legislation such as PURPA and the
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, proposed changes to repeal or modify 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
would seek to renegotiate the terms of the Scrubgrass power purchase agreement
(see further discussion under the caption "Energy Regulation"), the Company does
not believe the Scrubgrass Project would 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
27
<PAGE>
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 alignments with other
development firms with greater financial and technical resources could enable it
to continue to compete effectively in the development market if and when
opportunities arise. 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. However, the
Company is currently evaluating whether it should seek development opportunities
in new areas.
Presently, there is significant merger and consolidation activity occurring
in the electric industry. From time to time, the Company considers merger and
acquisition 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 the 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.
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<PAGE>
State public utility commissions, pursuant to state legislative authority,
may have jurisdiction over how any new federal initiatives are implemented in
each state. Although the 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
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.
On December 3, 1996, in response to changes in the electric industry, 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 provides for the
deregulation of the generation portion of electric business by permitting 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 required that all electric utilities file restructuring plans with
the PUC 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. As such, PENELEC filed a proposed restructuring plan in 1997 with the
PUC which was heavily contested by a number of affected parties. Eventually, the
litigation resulted in a settlement which was approved by the PUC on October 20,
1998, and which satisfied all but one of the litigants. This settlement set
forth a comprehensive plan for restructuring PENELEC's service and for ensuring
there would be competition for electric generation for all of PENELEC's
customers beginning on January 1, 1999. The settlement is currently being
appealed in the Commonwealth Court of Pennsylvania by the party which opposed
such settlement. However, the Company presently does not anticipate that such
appeal will have a significant effect, if any, on PENELEC's restructuring plan
as far as that plan affects the Scrubgrass Project. Most pertinently, the
restructuring plan, as approved by the PUC, provided for PENELEC to maintain a
separate non-utility generator cost recovery mechanism for accounting purposes.
Therefore, the restructuring plan is designed, in pertinent part, to enable
PENELEC to recover all of its costs from non-utility generators such as the
Scrubgrass plant and should serve to decrease the pressure on PENELEC to
renegotiate existing power contracts with non-utility generators.
Presently, neither the Customer Choice Act (and PENELEC's restructuring
plan filed thereunder), nor proposed legislation directly impacts the Company,
since the legislation and restructuring plan pertain to the retail market or new
contracts in the wholesale market. However, as discussed above, the Company
could possibly be impacted in the future by, among other things, increases in
competition as a result of deregulation, or the chance that PENELEC would
attempt to
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<PAGE>
renegotiate the existing power contract. 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.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's most significant market risk exposure is changing interest
rates which may affect its short-term investments, its debt and certain of its
lease expenses. The Company offers the following information about these market
risks:
Short-term investments - The Company invests cash balances which are in excess
- ----------------------
of its normal operating requirements in short term investments generally with
maturities of 3 months or less. Because of the short duration of these
investments, the Company does not believe its short-term investments are subject
to material market risk.
Debt - The Company has borrowings which bear interest at variable rates which
- ----
are based on the London Interbank Offering Rate (LIBOR). The Company monitors
market conditions for interest rates and, from time to time, enters into
interest rate swaps to manage its interest payments. The interest rate swaps
have the effect of converting the variable rate borrowings to fixed rate
borrowings for specified time periods.
Lease Expense- The Company, as a lease cost of the Scrubgrass facility, is
- -------------
required to fund the Lessor's debt service which consists of fixed rate
borrowings and borrowings which bear interest at variable rates based on either
quoted bond rates or the London Interbank Offering Rate (LIBOR). U.S. Generating
Company, the Manager of the Scrubgrass Project, monitors market conditions for
interest rates and, from time to time, enters into interest rate swaps to manage
the interest payments for the Scrubgrass facility. The interest rate swaps have
the effect of converting the variable rate borrowings to fixed rate borrowings
for specified time periods.
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<PAGE>
For further information on the Company's interest rate risk, refer to "Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Factors That May Impact Future Results -- Interest Rates".
PART II. OTHER INFORMATION
---------------------------
ITEM 1. Legal Proceedings
Scrubgrass Project
On October 11, 1995, the Company and the Lessor of the Scrubgrass Project
(collectively the "Plaintiffs"), filed a complaint against 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. 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. In September 1996, the Plaintiffs elected to resume
the litigation in the Court while PENELEC continued to pay for all energy in
excess of 80 MW in any hour at a rate equal to 90% of a market based rate.
In July 1999, after considerable litigation which resulted in several Court
decisions in favor of the Plaintiffs, the Plaintiffs jointly entered into a
Settlement Agreement with PENELEC to terminate the ongoing litigation. The
Settlement Agreement does not become effective until the date PENELEC obtains a
final non-appealable Order of the Pennsylvania Public Utility Commission
("PAPUC") approving the Settlement Agreement in form and substance acceptable to
PENELEC (the "Effective Date"). Under the terms of the Settlement Agreement, in
full settlement of all alleged claims, PENELEC agreed to pay the Plaintiffs for
all previous net deliveries of electric energy from the Scrubgrass facility in
excess of 80 MW at the rates set forth in the Power Purchase Agreement, minus
the total payments PENELEC previously made at 90% of a market based rate, plus
interest at the legal rate of 6%. PENELEC also agreed in the Settlement
Agreement to pay for future net deliveries of electric energy at the rates set
forth in the Power Purchase Agreement subject to, among other conditions,
certain annual and hourly limits, with energy purchased in excess of such limits
paid for at a market based rate.
As of June 30, 1999, after giving effect to the payments made by PENELEC at
90% of a market based rate, the amounts due for previous net deliveries of
electric energy and interest were $3,379,816 and $436,632, respectively. The
final amount payable by PENELEC to the Plaintiffs would be recalculated on the
Effective Date and would include consideration for net deliveries of
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<PAGE>
electric energy and interest incurred from July 1, 1999 to the Effective Date.
If the Settlement Agreement is approved by the PAPUC, PENELEC would be required
to remit such payment to the Scrubgrass Project within 20 days from the
Effective Date. The Scrubgrass Project has various contractual obligations which
may require that any cash flows from the Settlement Agreement first be used to
increase reserve accounts and/or satisfy certain contractual obligations before
such cash flows are available for distribution to EPC or the Lessor. EPC and the
Lessor share equally any cash flows which may become available for distribution
from the Scrubgrass Project.
Sunnyside Project
On May 3, 1996, Sunnyside II L.P. (f/k/a B&W Sunnyside L.P.), Babcock &
Wilcox Investment Company, Sunnyside I, Inc. (f/k/a NRG Sunnyside Inc.), NRG
Energy Inc., and Sunnyside Cogeneration Associates (collectively the
"Plaintiffs") filed a complaint, which was amended on June 27, 1996, December
21, 1998, and March 17, 1999 against EPC and three of its wholly-owned
subsidiaries (collectively hereafter "the Company") in Seventh District Court
for Carbon County, State of Utah (the "Court"). The third 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
("SCA"), a joint venture which owned and operated a nominal 51 megawatt waste
coal fired facility located in Carbon County, Utah. The third 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 Sunnyside II L.P. and Sunnyside I, Inc. under
certain notes receivable, which amounted to $2,937,500 and $955,694,
respectively at June 30, 1999. On April 9, 1999, in response to the Plaintiffs'
third amended complaint, the Company filed an answer and restatement of its
earlier restated counterclaim dated January 21, 1999. In the answer to the third
amended complaint, the Company denied all material allegations and asserted
numerous affirmative defenses. In the restated 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 restated 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 to 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 May
17, 1999, the Plaintiffs responded to the restated counterclaim whereby the
denied all material allegations of the restated counterclaim and asserted
numerous affirmative defenses. The Company plans to vigorously defend against
the third amended complaint and vigorously pursue the causes of action in the
restated 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. On June 5, 1998, the Company
received the Plaintiffs' response to its Motion for Summary Judgment with
Respect to Claims Regarding the Power Purchase Agreement wherein the Plaintiffs
stated their opposition to such motion. The Company and the plaintiffs appeared
in Court on November 19, 1998 to present oral arguments on the Company's Motion
for Summary Judgment with Respect to Claims Regarding the
32
<PAGE>
Power Purchase Agreement. The Court has not yet rendered a decision on such
motion. On February 12, 1999, the Plaintiffs also filed a Motion for Partial
Summary Judgment wherein the Plaintiffs allege that the Company misrepresented
whether SCA had a basis to commence legal proceedings as of December 31, 1994
against Pacificorp, the utility purchasing energy from the Sunnyside facility.
On April 9, 1999, the Company filed an opposition to the Plaintiffs' Motion for
Partial Summary Judgment and also filed a cross motion for partial summary
judgment. In its cross motion, the Company asserts that the claim on which the
Plaintiffs move for partial summary judgment should be dismissed as a matter of
law. Briefing on the Plaintiffs' and the Company's cross motions for partial
summary judgment is completed and a hearing on the cross motions is expected to
be held by the Court in the early fall. Discovery remains ongoing.
ITEM 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders, held on Monday June 28, 1999,
the following actions were submitted to a vote of security holders:
1. The Company elected a Board of Directors to serve for the ensuing year until
their respective successors have been duly elected and qualified. The results
of the voting were as follows:
Number of Shares
----------------
Withheld
Elected Director For Authority
---------------- --- ---------
Joseph E. Cresci 11,146,676 66,353
Donald A. Livingston 11,146,676 66,353
Peter J. Blampied 11,146,676 66,353
Edward B. Koehler 11,146,676 66,353
Robert I. Weisberg 11,146,676 66,353
2. The Company ratified the selection of the firm Deloitte & Touche LLP as
auditors for the Company for the fiscal year ending December 31, 1999. The
results of the voting were as follows:
Result Number of Shares
------ ----------------
For 11,188,243
Against 6,349
Abstain 18,437
ITEM 6. Exhibits And Reports On Form 8-K
(a) Exhibit 11 - Computation of Earnings Per Share
(b) Reports on Form 8-K - None
33
<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
August 12, 1999 /s/ William D. Linehan
--------------------------------------
William D. Linehan
Treasurer and
Chief Financial Officer
(principal accounting officer
and authorized officer)
34
<PAGE>
EXHIBIT 11
Environmental Power Corporation
Computation of Earnings Per Share
June 30, 1999
<TABLE>
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amounts
------------ ------------- ----------
<S> <C> <C> <C>
Three Months Ended June 30, 1999:
- ---------------------------------
Loss available to shareholders $(1,225,278) 11,406,783 $(.11)
Effect of dividends to preferred stockholders (1,250)
----------- ---------- -----
Basic EPS - loss available to common shareholders (1,226,528) 11,406,783 (.11)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 113
----------- ---------- -----
Diluted EPS - loss available to common shareholders $(1,226,528) 11,406,896 $(.11)
=========== ========== =====
Three Months Ended June 30, 1998:
- ---------------------------------
Loss available to shareholders $ (963,721) 11,406,783 $(.08)
Effect of dividends to preferred stockholders (1,250)
----------- ---------- -----
Basic EPS - loss available to common shareholders (964,971) 11,406,783 (.08)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 28,360
----------- ---------- -----
Diluted EPS - loss available to common shareholders $ (964,971) 11,435,143 $(.08)
=========== ========== =====
Six Months Ended June 30, 1999:
- -------------------------------
Loss available to shareholders $ (214,477) 11,406,783 $(.02)
Effect of dividends to preferred stockholders (2,500)
----------- ---------- -----
Basic EPS - loss available to common shareholders (216,977) 11,406,783 (.02)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 57
----------- ---------- -----
Diluted EPS - loss available to common shareholders $ (216,977) 11,406,840 $(.02)
=========== ========== =====
Six Months Ended June 30, 1998:
- -------------------------------
Loss available to shareholders $ (383,128) 11,406,783 $(.03)
Effect of dividends to preferred stockholders (2,500)
----------- ---------- -----
Basic EPS - loss available to common shareholders (385,628) 11,406,783 (.03)
Effect of dilutive securities:
Assumed exercise of dilutive stock options 22,594
----------- ---------- -----
Diluted EPS - loss available to common shareholders $ (385,628) 11,429,377 $(.03)
=========== ========== =====
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS FOR THE COMPANY AS OF JUNE 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 2,206,632<F1>
<SECURITIES> 0
<RECEIVABLES> 5,485,529
<ALLOWANCES> 0
<INVENTORY> 701,005
<CURRENT-ASSETS> 8,441,720
<PP&E> 774,917
<DEPRECIATION> 167,113
<TOTAL-ASSETS> 59,266,474
<CURRENT-LIABILITIES> 11,422,395
<BONDS> 2,851,208
0
100
<COMMON> 125,254
<OTHER-SE> (7,243,458)
<TOTAL-LIABILITY-AND-EQUITY> 59,266,474
<SALES> 22,577,360
<TOTAL-REVENUES> 22,577,360
<CGS> 10,870,437
<TOTAL-COSTS> 10,870,437
<OTHER-EXPENSES> 11,241,488
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 169,181
<INCOME-PRETAX> (363,477)
<INCOME-TAX> (149,000)
<INCOME-CONTINUING> (214,477)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (214,477)
<EPS-BASIC> (.02)
<EPS-DILUTED> (.02)
<FN>
<F1>CASH INCLUDES $1,877,263 WHICH IS RESTRICTED IN USE.
</FN>
</TABLE>
