<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 September 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 November 12, 1999 11,406,783 shares
The Exhibit Index appears on Page 33.
Total number of pages is 34.
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ENVIRONMENTAL POWER CORPORATION
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as
of September 30, 1999 (unaudited) and December 31, 1998...................................... 2
Condensed Consolidated Statements of Operations (unaudited) for the Three and Nine
Months Ended September 30, 1999 and September 30, 1998...................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months
Ended September 30, 1999 and September 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 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>
September 30 December 31
1999 1998
---------------- ----------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 221,936 $ 362,416
Restricted cash 265,081 797,922
Receivable from utility 7,158,484 6,598,864
Notes receivable 14,599 42,376
Other current assets 839,804 821,462
---------------- ----------------
TOTAL CURRENT ASSETS 8,499,904 8,623,040
PROPERTY, PLANT AND EQUIPMENT, NET 817,252 94,755
DEFERRED INCOME TAX ASSET 1,815,561 1,826,561
LEASE RIGHTS, NET 2,496,762 2,608,515
NOTES RECEIVABLE -- 3,686
ACCRUED POWER GENERATION REVENUES 47,210,723 41,386,500
OTHER ASSETS 571,572 619,693
---------------- ----------------
$ 61,411,774 $ 55,162,750
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 7,107,723 $ 5,873,689
Dividends payable on common stock 171,102 --
Other current liabilities 3,779,261 3,939,664
---------------- ----------------
TOTAL CURRENT LIABILITIES 11,058,086 9,813,353
DEFERRED GAIN, NET 5,165,879 5,397,187
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 2,854,058 2,866,584
ACCRUED LEASE EXPENSES 47,210,723 41,386,500
MAINTENANCE RESERVE 1,706,986 2,258,049
---------------- ----------------
TOTAL LIABILITIES 67,995,732 61,721,673
SHAREHOLDERS' EQUITY:
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no
shares issued at September 30, 1999 and December 31, 1998, respectively) -- --
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at September 30, 1999 and December 31, 1998, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,525,423 shares issued at September 30, 1999 and December 31, 1998,
respectively; 11,406,783 shares outstanding at September 30, 1999 and
December 31, 1998, respectively) 125,254 125,254
Additional paid-in capital -- --
Accumulated deficit (5,443,310) (5,418,275)
---------------- ----------------
(5,317,956) (5,292,921)
Treasury stock (1,118,640 common shares, at cost, as of
September 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 (6,583,958) (6,558,923)
---------------- ----------------
$ 61,411,774 $ 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 September 30 Nine Months Ended September 30
---------------------------------------- ----------------------------------------
1999 1998 1999 1998
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
POWER GENERATION REVENUES $ 12,918,259 $ 11,820,273 $ 35,495,619 $ 33,545,710
---------------- ---------------- ---------------- ----------------
COSTS AND EXPENSES:
Operating expenses 5,330,512 4,875,561 16,200,949 14,313,809
Lease expenses 5,724,732 5,579,583 16,966,220 17,301,399
General and administrative expenses 556,470 550,397 1,933,462 1,646,989
Depreciation and amortization 113,658 69,693 240,397 215,779
---------------- ---------------- ---------------- ----------------
11,725,372 11,075,234 35,341,028 33,477,976
---------------- ---------------- ---------------- ----------------
OPERATING INCOME 1,192,887 745,039 154,591 67,734
OTHER INCOME (EXPENSE):
Interest income 27,761 34,506 87,868 127,734
Interest expense (106,370) (122,313) (275,551) (357,164)
Sale of NOx emission credits 0 0 629,720 0
Amortization of deferred gain 77,103 77,103 231,308 231,308
Other income 6,117 10,847 6,085 13,442
---------------- ---------------- ---------------- ----------------
4,611 143 679,430 15,320
---------------- ---------------- ---------------- ----------------
INCOME BEFORE INCOME TAXES 1,197,498 745,182 834,021 83,054
INCOME TAX EXPENSE (491,000) (308,000) (342,000) (29,000)
---------------- ---------------- ---------------- ----------------
NET INCOME $ 706,498 $ 437,182 $ 492,021 $ 54,054
================ ================ ================ ================
BASIC AND DILUTED EARNINGS PER
COMMON SHARE $ 0.06 $ 0.04 $ 0.04 $ 0.00
================ ================ ================ ================
DIVIDENDS PAID OR PAYABLE:
Common shares $ 171,102 $ 171,102 $ 513,306 $ 855,509
Preferred shares 1,250 1,250 3,750 3,750
---------------- ---------------- ---------------- ----------------
$ 172,352 $ 172,352 $ 517,056 $ 859,259
================ ================ ================ ================
DIVIDENDS PAID OR PAYABLE PER
COMMON SHARE $ 0.015 $ 0.015 $ 0.045 $ 0.075
================ ================ ================ ================
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30
--------------------------------
1999 1998
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 492,021 $ 54,054
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 240,397 215,779
Deferred income taxes 11,000 (256,000)
Amortization of deferred gain (231,308) (231,308)
Accrued power generation revenues (5,824,223) (6,018,083)
Accrued lease expenses 5,824,223 6,018,083
Changes in operating assets and liabilities:
(Increase) decrease in receivable from utility (559,620) 314,723
(Increase) decrease in other current assets (18,342) 97,134
Increase in other assets (5,474) (7,654)
Increase (decrease) in accounts payable and
accrued expenses 1,234,034 (797,842)
Increase in long-term liabilities 8,550 8,519
(Decrease) increase in maintenance reserve (551,063) 125,082
------------- -------------
Net cash provided by (used in) operating activities 620,195 (477,513)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable 31,463 29,052
Decrease (increase) in restricted cash 532,841 (212,319)
Property, plant and equipment expenditures (797,546) (5,197)
------------- -------------
Net cash used in investing activities (233,242) (188,464)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (345,954) (10,954,262)
Net borrowings under working capital loan 789,597 494,332
Repayment of secured promissory notes payable and
other borrowings (971,076) (600,000)
------------- -------------
Net cash used in financing activities (527,433) (11,059,930)
------------- -------------
DECREASE IN CASH AND CASH EQUIVALENTS (140,480) (11,725,907)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 362,416 12,092,273
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 221,936 $ 366,366
============= =============
</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 nine months ended September 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 per common share using the treasury stock
method in accordance with SFAS No. 128, "Earnings per Share". The Company
computes basic earnings per share by dividing net income for the period by the
weighted average number of shares of common stock outstanding during the period.
For purposes of calculating diluted earnings per share, the Company considers
its shares issuable in connection with stock options to be dilutive common stock
equivalents when the exercise price is less than the average market price of the
Company's common stock for the period. The following tables outline the
calculations of basic earnings per share and diluted earnings per share for the
three and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amounts
------------- --------------- ----------------
<S> <C> <C> <C>
Three Months Ended September 30, 1999:
- -------------------------------------
Income available to shareholders $706,498 11,406,783 $.06
Effect of dividends to preferred stockholders (1,250)
------------ -------------- ---------------
Basic EPS - income available to common shareholders 705,248 11,406,783 .06
Effect of dilutive securities:
Assumed exercise of dilutive stock options 1,060
------------ -------------- ---------------
Diluted EPS - income available to common shareholders $705,248 11,407,843 $.06
============ ============== ===============
Three Months Ended September 30, 1998:
- -------------------------------------
Income available to shareholders $437,182 11,406,783 $.04
Effect of dividends to preferred stockholders (1,250)
------------ -------------- ---------------
Basic EPS - income available to common shareholders 435,932 11,406,783 .04
Effect of dilutive securities:
Assumed exercise of dilutive stock options 22,597
------------ -------------- ---------------
Diluted EPS - income available to common shareholders $435,932 11,429,380 $.04
============ ============== ===============
</TABLE>
5
<PAGE>
NOTE B -- EARNINGS PER COMMON SHARE (CONTINUED)
- -----------------------------------------------
<TABLE>
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amounts
---------------- ----------------- -------------
<S> <C> <C> <C>
Nine Months Ended September 30, 1999:
- ------------------------------------
Income available to shareholders $492,021 11,406,783 $.04
Effect of dividends to preferred stockholders (3,750)
------------- ---------------- ------------
Basic EPS - income available to common shareholders 488,271 11,406,783 .04
Effect of dilutive securities:
Assumed exercise of dilutive stock options 391
------------- ---------------- ------------
Diluted EPS - income available to common shareholders $488,271 11,407,174 $.04
============= ================ ============
Nine Months Ended September 30, 1998:
- ------------------------------------
Income available to shareholders $ 54,054 11,406,783 ----
Effect of dividends to preferred stockholders (3,750)
------------- ---------------- ------------
Basic EPS - income available to common shareholders 50,304 11,406,783 ----
Effect of dilutive securities:
Assumed exercise of dilutive stock options 22,595
------------- ---------------- ------------
Diluted EPS - income available to common shareholders $ 50,304 11,429,378 ---
============== ================ ============
</TABLE>
NOTE C -- LITIGATION SETTLEMENT
- --------------------------------
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 September 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 approximately
$3,470,000 and $486,000, 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
October 1, 1999 to the Effective Date.
6
<PAGE>
NOTE D -- 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.
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. On December 5, 1997 the
Company sold its development rights and real estate for the Milesburg Project to
the utility which had contracted to purchase electricity from such project. The
following Management's Discussion and Analysis of Financial Condition and
Results of Operations compares the Company's results of operations for the three
and nine months ended September 30, 1999 with the results of operations for the
three and nine months ended September 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 income amounted to $706,498 (6 cents per share) and $492,021 (4 cents
per share) for the three and nine months ended September 30, 1999, respectively,
as compared to net income of $437,182 (4 cents per share) and $54,054 (-0- cents
per share) for the three and nine months ended September 30, 1998, respectively.
The reasons for the changes in the Company's results of operations for the three
and nine months ended September 30, 1999 from the results of operations for the
three and nine months ended September 30, 1998 are discussed in more detail in
the following sections.
8
<PAGE>
Revenues
Power generation revenues for the nine months ended September 30, 1999
amounted to $35,495,619 as compared to $33,545,710 for the nine months ended
September 30, 1998 and all pertained to the Scrubgrass Project. The overall
increase in power generation revenues during the nine months ended September 30,
1999 is primarily attributable to an increase in the capacity rate for the
Scrubgrass Project which operated at 87.7% of its capacity for the nine months
ended September 30, 1999 as compared to 85% for the same period in 1998 and 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 $5,824,223
and $6,018,083 for the nine months ended September 30, 1999 and 1998,
respectively. The following factors contributed principally to the differences
in the Scrubgrass Project's capacity rates billed for the nine month periods in
1999 and 1998. 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 20 days and 14 days, respectively, to perform scheduled
maintenance procedures. Second, the Scrubgrass Project incurred unscheduled
shutdowns and power generation reductions to respond to equipment malfunctions
which necessitated that the Scrubgrass plant be inoperative for an aggregate of
approximately 12 days and 21 days outside of the scheduled outage timeframes
during the nine months ended September 30, 1999 and 1998, respectively.
Power generation revenues amounted to $12,918,259 and $11,820,273 for the
three months ended September 30, 1999 and September 30, 1998, respectively. The
overall increase in power generation revenues during the three months ended
September 30, 1999 is primarily attributable to an increase in the capacity rate
for the Scrubgrass Project which operated at 95.4% of its capacity for the three
months ended September 30, 1999 as compared to 90.7% for the same period in 1998
and a 5% increase in certain rates billed to the utility under the terms of the
power purchase agreement. The third quarter capacity rates were affected by
unscheduled shutdowns and power generation reductions to respond to equipment
malfunctions which necessitated that the Scrubgrass plant be inoperative for an
aggregate of approximately 3 days and 7 days during the third 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 $1,941,408 and $2,006,028 for the three
months ended September 30, 1999 and 1998, respectively.
Operating expenses
Operating expenses for the nine months ended September 30, 1999 amounted to
$16,200,949 as compared to $14,313,809 for the nine months ended September 30,
1998 and all pertained to the Scrubgrass Project. The overall increase during
the nine months ended September 30, 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, due to
9
<PAGE>
certain machinery and equipment modifications made in 1999 to reduce NOx
emissions from the Scrubgrass facility, the Company incurred higher chemical
expenses in 1999. Fourth, the Company entered into modifications to the
financing contract with the manufacturer of the Scrubgrass generator which
reduced certain long-term liabilities and operating expenses during 1998 by
comparison to 1999. Fifth, 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. The Company spent $2,468,682 and
$884,255 for planned maintenance outage expenses during the nine months ended
September 30, 1999 and September 30, 1998, respectively, of which $1,171,141 and
$334,057 were considered major equipment overhauls and funded from major
maintenance reserves as of September 30, 1999 and September 30, 1998,
respectively. As such, the Company incurred a net increase in 1999 operating
expenses of $747,343 which was solely attributable to differences in the nature
of work performed during 1999 and 1998 planned maintenance outages. 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.
Operating expenses for the three months ended September 30, 1999 amounted
to $5,330,512 as compared to $4,875,561 for the three months ended September 30,
1998. Similar to the discussion in the previous paragraph, the third quarter
comparison was affected by the same changes in fuel, operator fees, labor and
related costs, and chemical 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 third quarter comparison.
Additionally, the Company reported its expenses for the planned maintenance
outage and the acceleration of its reserves for future maintenance during the
second quarter. As such, the changes in these items also did not materially
effect the third quarter comparison.
Lease expenses
Lease expenses for the nine months ended September 30, 1999 amounted to
$16,966,220 as compared to $17,301,399 for the nine months ended September 30,
1998 and all pertained to the Scrubgrass Project. The overall decrease in lease
expenses during the nine months ended September 30, 1999 is primarily
attributable to the following two reasons. First, favorable interest rates and
reductions in term loan balances 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 lease expenses recorded as a result of the
straight-line accounting treatment of certain lease expenses under the
Scrubgrass lease which amounted to $5,824,223 and $6,018,083 for the nine months
ended September 30, 1999 and September 30, 1998, respectively. The
aforementioned decreases in lease expenses were offset in part by scheduled
increases in the base rent paid to the Lessor.
10
<PAGE>
Lease expenses for the three months ended September 30, 1999 and September
30, 1998 amounted to $5,724,732 and $5,579,583, respectively. The overall
increase in lease expenses during the three months ended September 30, 1999 is
primarily attributable to scheduled increases in the base rent paid to the
Lessor. As discussed in the previous paragraph, the aforementioned increase was
offset in part by decreases in lease expenses resulting from favorable interest
rates, reductions in term loan balances and a decrease in lease expenses
recorded as a result of the straight-line accounting treatment of certain lease
expenses under Scrubgrass lease. Because the scheduled increases in base rent
paid to the Lessor did not occur evenly during 1999, and because interest rates
began increasing during the third quarter of 1999, the scheduled increases in
the base rents exceeded the aforementioned decreases in lease expenses for the
third quarter comparison.
General and administrative expenses
General and administrative expenses for the three and nine months ended
September 30, 1999 amounted to $556,470 and $1,933,462, respectively, as
compared to $550,397 and $1,646,989 for the three and nine months ended
September 30, 1998, respectively. The overall increases in general and
administrative expenses during both the three and nine months ended September
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 nine
months ended September 30, 1998. Third, since legal efforts for both of its
litigations accelerated in 1999, the Company incurred significant increases in
legal expenses during the nine months ended September 30, 1999 by comparison to
same period in 1998. However, due to the timing of the legal proceedings, the
Company actually realized a decrease in legal expenses during the three months
ended September 30, 1999 by comparison to the same period in 1998 which offset a
material portion of the 1999 increases in other general and administrative
expenses. Furthermore, the aforementioned increases in general and
administrative expenses were also offset in part by reductions in executive
salaries during the three and nine months ended September 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 nine months ended September 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 nine months ended September 30, 1999 by comparison to the same periods in
1998.
11
<PAGE>
Other income (expense)
Interest expense for the three and nine months ended September 30, 1999
amounted to $106,370 and $275,551, respectively, as compared to $122,313 and
$357,164 for the three and nine months ended September 30, 1998, respectively.
The overall decreases in interest expense during both the three and nine months
ended September 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. Interest rates began increasing during the third quarter of 1999. As a
result, the decrease in interest expense during the third quarter of 1999 was
not as large as the decrease experienced in the previous two quarters of 1999.
Sale of NOx emission credits amounted to $629,720 for the nine months ended
September 30, 1999 and represented the aggregate proceeds received in February
1999 from sales of Nitrogen Oxide 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 Expense
Income tax expense for the three and nine months ended September 30,
1999 amounted to $491,000 and $342,000, respectively, as compared to $308,000
and $29,000 for the three and nine months ended September 30, 1998,
respectively. The income tax expense reported for the three and nine months
ended September 30, 1999 changed from the comparable periods in 1998 primarily
due to associated changes in the income before income taxes. The effective
income tax rate for 1999 is currently projected to be approximately 41% which is
consistent with the rates 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 the 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. Through September 30, 1999, the
Scrubgrass facility has been inoperative for approximately 12 days in Fiscal
1999 for such unscheduled shutdowns. While the Company expects that the
Scrubgrass facility
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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 additional
chemical expenses in 1999 to accommodate certain modifications to its
machinery and equipment which were designed to reduce NOx emissions from the
Scrubgrass facility. Fourth, the Company expects to incur higher maintenance
expenses in Fiscal 1999 primarily 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 equipment malfunctions during
Fiscal 1999, the aforementioned increases in maintenance 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 legal proceedings, the Company
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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 September 30, 1999, the Company is seeking to
recover approximately $4.3 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 $4 million (of which 50% or approximately $2
million would be retained by the Lessor as additional rent) 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. 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 D 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 $620,195 for the
nine months ended September 30, 1999 and cash used by operating activities of
$477,513 for the nine months ended September 30, 1998. During these periods, the
Company's only sources of cash from operating activities were operating cash
flows from the Scrubgrass Project and investment earnings.
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The Company had net income of $492,021 and $54,054 during the nine months
ended September 30, 1999 and September 30, 1998, respectively, which contributed
to 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 income for the nine months
ended September 30, 1999 to its net cash provided by operating activities.
Depreciation and amortization - During the nine months ended September 30,
1999, the Company recognized depreciation and amortization for its lease
rights of $111,753, deferred financing costs of $53,595, machinery and
equipment modifications of $69,985, and equipment and furniture of $5,064.
Deferred gain, net - The Company's deferred gain, net, amounted to $5,165,879
as of September 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.
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 $7,158,484 as of September 30, 1999 as
compared to $6,598,864 as of December 31, 1998. The increase in receivable
from utility as of September 30, 1999 is primarily attributable to an
approximate 5% increase in certain rates billed to the utility in 1999 under
the terms of the Scrubgrass power purchase agreement and a higher capacity
rate billed to the utility.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $7,107,723 as of September 30, 1999 as compared
to $5,873,689 as of December 31, 1998. The increase as of September 30, 1999
is primarily attributable to the following reasons. First, the Company spent
$2,468,682 for major equipment overhauls and $796,068 for certain machinery
and equipment modifications during the second quarter of 1999. While the
Company had cash of $1,171,141 and $600,000 from maintenance reserves and
sales of NOx emission credits, respectively, available for these
expenditures, the extent of the remaining expenditures nevertheless put a
strain on the Company's short-term working capital position. As such, the
Company negotiated extended payment terms with certain vendors for which
balances were still outstanding as of September 30, 1999. Second, because the
Company is projecting increases in its 1999 taxable earnings when compared to
1998, the Company has recorded more corporate taxes payable as of September
30, 1999. Third, the Company recently changed the method and timing of
funding its insurance policies for the Scrubgrass Project. As of September
30, 1999, the Company had an accrued insurance liability which did not exist
at December 31, 1998 since the Scrubgrass Project prepaid its insurance
policies during the previous policy term. Fourth, as discussed under
"Results of Operations" above, the Company realized increases in certain 1999
operating expenses and general and administrative expenses which resulted in
increases in accounts payable and accrued expenses during 1999. The overall
increase was offset in part primarily by the following factors which
decreased certain accounts payable and accrued
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expenses as of September 30, 1999 by comparison to December 31, 1998. First,
because it made a contribution to its defined benefit pension plan in
September 1999, the Company had a decrease in its pension liability. 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 September 30, 1999 included only nine 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
third quarter cash flows of the Scrubgrass Project, there was no additional
rent to accrue as of September 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 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
$1,706,986 as of September 30, 1999 from $2,258,049 as of December 31, 1998
primarily due to expenditures of $1,171,141 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.
Investing Activities
The Company used $233,242 and $188,464 in investing activities during the
nine months ended September 30, 1999 and September 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 $31,463 and $29,052 from notes
receivable related to the Scrubgrass Project during the nine months ended
September 30, 1999 and September 30, 1998, respectively. The notes
receivable related to the Sunnyside Project, with a principal balance of
$2,937,500 and outstanding interest balance of $1,029,131 as of September 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 nine months ended September 30, 1999 and September 30, 1998, the
Company's payments for major equipment overhauls which were funded from the
major maintenance fund
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amounted to $1,171,141 and $334,057, respectively. Due primarily to an
increase in major equipment overhauls performed in 1999, the Company's
expenditures for major equipment overhauls exceeded its scheduled deposits to
the restricted major maintenance fund and interest thereon by $532,841 during
the nine months ended September 30, 1999. During the nine months ended
September 30, 1998, the Company's scheduled deposits to the restricted major
maintenance fund and interest thereon exceeded its payments for major
equipment overhauls by $212,319.
Property, plant and equipment - The Company invested $797,546 and $5,197 in
property, plant and equipment expenditures during the nine months ended
September 30, 1999 and September 30, 1998, respectively. The 1999
expenditures were primarily machinery and equipment modifications made at the
Scrubgrass facility. The 1998 expenditures were primarily purchases of
computer equipment for the Company's corporate office.
Financing Activities
The Company utilized $527,433 and $11,059,930 in financing activities
during the nine months ended September 30, 1999 and September 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 $513,306 (4.5
cents per share) and $855,509 (7.5 cents per share) during the nine months
ended September 30, 1999 and September 30, 1998, respectively, and had
dividends payable of $171,102 (1.5 cents per share) and $171,102 (1.5 cents
per share) as of September 30, 1999 and September 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
$342,204 (6 cents per share) and $10,950,512 (96 cents per share) during the
nine months ended September 30, 1999 and September 30, 1998, respectively.
The Company also paid dividends to its subsidiary's preferred stockholder of
$3,750 during both the nine months ended September 30, 1999 and September 30,
1998. As such, the Company paid total dividends of $345,954 and $10,954,262
during the nine months ended September 30, 1999 and September 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 $3,179,261 as of September 30, 1999. The increase in
the outstanding borrowings under Lessee Working Capital Loan is seasonal and
primarily associated with the loss of revenues and increase in expenses
associated with the Company's planned annual maintenance outage. It usually
takes several months for the Company to reduce the outstanding borrowings
under the working capital loan back to normal levels after the annual
maintenance outage. See the further discussions above
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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 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 nine months ended September
30, 1999 and September 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 September 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 $1,025,866 and $1,228,192,
respectively as of September 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 nine months ended September 30, 1999 and September 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.
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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, 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. Through the date of this Report, the Company has received distributions
from the Scrubgrass Project of $1,649,865.
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 installed machinery, with a
cost of $796,068, 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 portion of its projected NOx Credits. Through September
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 was designated for the purchase and installation of the machinery
discussed above. The remaining cost of such machinery was funded by cash flows
generated from other operating activities. 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 during 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
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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 September 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 $3,470,000 and $486,000,
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 October 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. However, in the event
the PAPUC modifies the obligations of the Company or PENELEC under the
Settlement Agreement or the Scrubgrass power purchase agreement in connection
with the approval of the Settlement Agreement, the Company or PENELEC have the
option to declare the Settlement Agreement null and void.
As of September 30, 1999, the Company is seeking to recover approximately
$4.3 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
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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 has entered into a settlement
agreement with PENELEC regarding its legal proceeding and has entered into
contracts for the 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 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, the identification of non-compliant IT
Systems and Non-IT Systems, the replacement or upgrade of non-compliant IT
Systems and Non-IT Systems, compliance testing of replacements and upgrades, 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 and tested the upgrades for all
systems except for its continuing emissions monitoring system (CEMS). The
Company has already upgraded the CEMS but expects to complete its compliance
testing of the CEMS upgrade in the near future.
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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.
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 $206,000 through
September 30, 1999. The Company estimates that it will incur additional costs
of approximately $17,000 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.
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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.
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.
23
<PAGE>
Third Party Project Management
The Company has entered into a management services agreement with P.G.& E
Generating Company 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.
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 September
1996, which amounted to $2,937,500 and $1,029,131, respectively as of September
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
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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
$5,443,310 as of September 30, 1999. While the Company was profitable from
operating activities during 1998, the Company incurred a net 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.
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<PAGE>
Circulating Fluidized Bed Technology
The Company's Scrubgrass Project employs circulating fluidized bed
technology to produce electricity. Certain aspects of this technology, as well
as the conversion of waste products into electricity, are relatively new areas
being explored by the alternative energy market in the last ten years.
Accordingly, this technology carries greater risk than more established methods
of power generation such as hydropower. As such, the long-term costs and
implications of maintaining this technology have not been established by
historical industry data.
Customer Concentration
The Company's power generation revenues are earned under a long-term power
purchase agreement with one customer, Pennsylvania Electric Company. The
Company expects that the concentration of its revenues with this customer will
continue for the foreseeable future.
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 9/30/99 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 15,092,336 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 101,040 8% 1999
The Company's debt obligations:
Variable rate working capital loan 3,179,261 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
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<PAGE>
lending terms which would not have a material adverse affect on the operating
results of the Scrubgrass Project. However, there can be no assurance that the
Lessor could renegotiate its credit facilities under terms which would ensure
continuing profitable operating results of the Scrubgrass Project.
Fuel Quality
The Company obtains waste coal primarily from coal mining companies on
a long-term basis because waste coal is plentiful and generally creates
environmental hazards, such as acid drainage, when not disposed of properly.
The waste coal is burned in the Scrubgrass facility using a circulating
fluidized bed combustion system. During the circulating fluidized bed
combustion process, the waste coal is treated with other substances such as
limestone. Depending on the quality of the waste coal, the facility operator may
need to add additional waste coal or other substances to create the appropriate
balance of substances which would result in the best fuel or sorbent consistency
for power generation and compliance with air quality standards. Therefore, the
cost of generating power is directly impacted by the quality of the waste coal
which supplies the Scrubgrass power generation facility. The facility operator
maintains certain controls over obtaining higher quality waste coal. However
certain conditions, such as poor weather, can create situations where the
facility operator has less control over the quality of the waste coal. 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
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<PAGE>
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 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
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<PAGE>
Congress which propose amendments to certain regulations promulgated by PURPA.
If Congress amends PURPA, the statutory requirement that electric utilities
purchase electricity from Qualifying Facilities at full avoided cost could be
repealed or modified. While current legislative proposals specify the honoring
of existing contracts, the repeal or modification of these statutory purchase
requirements under PURPA in the future could increase pressure for electric
utilities to renegotiate existing contracts. Should there be changes in
statutory purchase requirements under PURPA, and should these changes result in
amendments which reduce the contracted rates under the Scrubgrass power purchase
agreement, the Company's results of operations and financial position could be
negatively impacted.
State public utility commissions, pursuant to state legislative authority,
may have jurisdiction over how any new federal initiatives are implemented in
each state. Although 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
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<PAGE>
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 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 shut down 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
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<PAGE>
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). PG&E
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.
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
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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 September 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 approximately $3,470,000 and
$486,000, 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 October 1, 1999 to
the Effective Date. The Settlement Agreement is presently being considered by
the PAPUC. 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 September 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
$1,029,131, respectively at September 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
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<PAGE>
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 they
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 September 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
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 Judgement 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 Judgement 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. The Company and the Plaintiffs appeared in Court on October 6, 1999 to
present oral arguments on the recent cross motions for partial summary
judgement. The Court has not yet rendered a decision on such motions.
Discovery remains ongoing.
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
November 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
September 30, 1999
<TABLE>
<CAPTION>
Income Shares Per Share
(Numerator) (Denominator) Amounts
-------------- -------------- --------------
<S> <C> <C> <C>
Three Months Ended September 30, 1999:
- -------------------------------------
Income available to shareholders $ 706,498 11,406,783 $ 0.06
Effect of dividends to preferred stockholders (1,250)
-------------- -------------- --------------
Basic EPS - income available to common shareholders 705,248 11,406,783 0.06
Effect of dilutive securities:
Assumed exercise of dilutive stock options 1,060
-------------- -------------- --------------
Diluted EPS - income available to common shareholders $ 705,248 11,407,843 $ 0.06
============== ============== ==============
Three Months Ended September 30, 1998:
- -------------------------------------
Income available to shareholders $ 437,182 11,406,783 $ 0.04
Effect of dividends to preferred stockholders (1,250)
-------------- -------------- --------------
Basic EPS - income available to common shareholders 435,932 11,406,783 0.04
Effect of dilutive securities:
Assumed exercise of dilutive stock options 22,597
-------------- -------------- --------------
Diluted EPS - income available to common shareholders $ 435,932 11,429,380 $ 0.04
============== ============== ==============
Nine Months Ended September 30, 1999:
- ------------------------------------
Income available to shareholders $ 492,021 11,406,783 $ 0.04
Effect of dividends to preferred stockholders (3,750)
-------------- -------------- --------------
Basic EPS - income available to common shareholders 488,271 11,406,783 0.04
Effect of dilutive securities:
Assumed exercise of dilutive stock options 391
-------------- -------------- --------------
Diluted EPS - income available to common shareholders $ 488,271 11,407,174 $ 0.04
============== ============== ==============
Nine Months Ended September 30, 1998:
- ------------------------------------
Income available to shareholders $ 54,054 11,406,783 $ ----
Effect of dividends to preferred stockholders (3,750)
-------------- -------------- --------------
Basic EPS - income available to common shareholders 50,304 11,406,783 ----
Effect of dilutive securities:
Assumed exercise of dilutive stock options 22,595
-------------- -------------- --------------
Diluted EPS - income available to common shareholders $ 50,304 11,429,378 $ ----
============== ============== ==============
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY AS OF SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 487,017<F1>
<SECURITIES> 0
<RECEIVABLES> 7,173,083
<ALLOWANCES> 0
<INVENTORY> 656,071
<CURRENT-ASSETS> 8,499,904
<PP&E> 1,045,147
<DEPRECIATION> 227,895
<TOTAL-ASSETS> 61,411,774
<CURRENT-LIABILITIES> 11,058,086
<BONDS> 2,854,058
0
100
<COMMON> 125,254
<OTHER-SE> (6,709,312)
<TOTAL-LIABILITY-AND-EQUITY> 61,411,774
<SALES> 35,495,619
<TOTAL-REVENUES> 35,495,619
<CGS> 16,200,949
<TOTAL-COSTS> 16,200,949
<OTHER-EXPENSES> 16,966,220
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 275,551
<INCOME-PRETAX> 834,021
<INCOME-TAX> 342,000
<INCOME-CONTINUING> 492,021
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 492,021
<EPS-BASIC> .04
<EPS-DILUTED> .04
<FN>
<F1>CASH INCLUDES $265,081 WHICH IS RESTRICTED IN USE.
</FN>
</TABLE>
