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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE OF 1934
For the transition period from ______________ to ______________
Commission File Number 0-15472
Environmental Power Corporation
(Exact name of registrant as specified in its charter)
Delaware 04-2782065
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
500 Market Street, Suite 1-E, Portsmouth, New Hampshire 03801
(Address of principal executive offices)
(Zip code)
(603) 431-1780
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
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 |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. |X|
State the aggregate market value for the voting stock held by non-affiliates of
the registrant: The aggregate market value, computed by reference to the closing
price of such stock on March 22, 2000 was $2,524,623.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the last practicable date: On March 22, 2000 there were
11,406,783 outstanding shares of Common Stock, $.01 par value, of the
registrant.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be filed with the Securities and
Exchange Commission and delivered to shareholders in connection with the Annual
Meeting of Shareholders to be held on June 27, 2000 are incorporated by
reference into Part III of this Annual Report filed on Form 10-K. The portions
of the Proxy Statement under the headings "Report of the Compensation Committee"
and the "Stock Performance Graph" are not incorporated by reference and are not
a part of this Form 10-K Report.
TABLE OF CONTENTS
Description of Contents Page #
- ----------------------- ------
PART I:
Item 1. Business 3
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 14
PART II:
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 15
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 36
Item 8. Financial Statements and Supplementary Data 36
Item 9. Disagreements on Accounting and Financial Disclosure 37
PART III:
Item 10. Directors and Executive Officers 38
Item 11. Executive Compensation 39
Item 12. Security Ownership of Certain Beneficial Owners and Management 39
Item 13. Certain Relationships and Related Transactions 39
PART IV:
Item 14. Index to Financial Statements, Exhibits, and Reports on Form 8-K 40
Signature Page 45
CAUTIONARY STATEMENT
This Annual Report on Form 10K contains "forward-looking statements", as defined
by the Private Securities Litigation Reform Act of 1995, in order to provide
investors with prospective information about the Company. For this purpose, any
statements which are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
"believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors which could cause the Company's actual results to differ materially from
those indicated by the forward looking statements. These factors include,
without limitation, those set forth below under the caption "Item 7. - Certain
Factors That May Affect Future Results".
2
PART I
Item 1. BUSINESS
Environmental Power Corporation (individually "EPC" or consolidated "the
Company") is primarily engaged in leasing an electric generating facility fueled
by waste coal. In recent years, the Company was also engaged in the development
and ownership of electric generating facilities fueled by waste coal. The
Company's business plan has been driven by the identification and evaluation of
attractive independent power projects in various stages of development. During
its project development activities, the Company, either acting alone or in
conjunction with others, has selected and arranged for the acquisition of the
site, obtained control over a portion of the waste coal fuel sources, negotiated
contracts for the design and construction of the facilities and the sale of
output to the utilities purchasing the power, arranged for financing, and
negotiated contracts for the operation and maintenance of the projects.
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 decommissioned 43 Mw (net) coal-fired electric generating facility (the
"Milesburg Project") located in Pennsylvania. The Company sold its remaining
interest in the Sunnyside Project on December 31, 1994 and is presently involved
in litigation with the Purchasers to collect the balance of the Purchasers'
obligations for the sale. The Company sold its development rights for the
Milesburg Project on December 5, 1997 to the utility which had contracted to
purchase electricity from such project. The Company's projects are discussed
further in the following sections.
Scrubgrass
The Scrubgrass Project, located on a 600 acre site in Venango County,
Pennsylvania, is a waste coal-fired electric generating station (the "Facility")
which was constructed by Bechtel Power Corporation. The construction contract
provided for a guaranteed net electrical output of 82.85 MW and final completion
was achieved in June 1994.
On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a subsidiary of EPC,
entered into an agreement to lease the Facility from Scrubgrass Generating
Company, L.P. (the "Lessor"), a joint venture of certain wholly owned indirect
subsidiaries of PG&E Corporation and Bechtel Generating Company, Inc. On October
20, 1998, Bechtel Generating Company, Inc. transferred its interest in the
Lessor to a wholly owned subsidiary of Cogentrix Energy, Inc. The lease provides
for an initial term of 22 years with a renewal option for up to 3 years.
Pursuant to the lease, the Lessor assigned to Buzzard all principal project
agreements and its rights and obligations thereunder including, but not limited
to the power purchase agreement, operations and maintenance agreement, limestone
agreements, ground lease agreements, fuel agreements and transportation and
materials handling agreements. EPC has pledged Buzzard's common stock to the
Lessor as security for Buzzard's performance of its obligations as lessee. PG&E
Generating Company ("PG&E Gen"), a wholly owned indirect subsidiary of PG&E
Generating Company, LLC ("PG&EGenLLC"), which in turn is a wholly owned indirect
subsidiary of PG&E Corporation, manages the Scrubgrass Project.
PG&E Operating Services Company (the "Operator"), a wholly owned indirect
subsidiary of PG&EGenLLC, operates the Facility pursuant to a 15-year Operating
and Maintenance Agreement (the "O&M"). The Operator prepares a budget for all
operating expenses, including a fixed management fee, and certain targeted
output performance levels, which is approved annually. Under the terms of the
O&M, the Operator can incur a liability not to exceed its management fee if the
Operator does not achieve certain targeted output performance levels.
3
Buzzard maintains a Limestone Purchase and Sale Agreement with Quality
Aggregates, Inc. to supply the Scrubgrass Project with limestone which, in
September 1999, was extended through the year 2008 and which may be extended up
to 10 additional years. Buzzard also maintains a 15-year agreement for the
transportation of fuel, ash and limestone with Savage Industries, Inc. which
expires in 2005. The costs established under this agreement will escalate at
partially fixed and partially indexed rates.
Buzzard sells electric output to Pennsylvania Electric Company ("PENELEC"),
pursuant to a twenty-five year Power Sales Agreement ("PSA") which commenced in
June 1993, at fixed rates initially averaging 4.68 cents per kwh and which
escalate at five percent per year through calendar year 1999. For the years 2000
through 2012, the PSA provides for a rate equal to the greater of a scheduled
rate or a rate based on the PJM Billing Rate (the monthly average of the hourly
rates for purchases by the General Public Utilities Group ("GPU") from, or sale
by GPU to, the Pennsylvania-New Jersey-Maryland Interconnection). For the years
2013 through 2015 and 2016 through 2018, if the renewal term option is
exercised, the PSA provides for a rate equal to the lower of the average monthly
PJM Billing Rate or the rate paid for the calendar year 2012 adjusted annually
by the percentage change in the Gross National Product Deflator less one
percent. On June 8, 1993, the Facility achieved commercial operation. Since
October 1995, the Company had been involved in a legal proceeding with PENELEC
whereby, among other complaints, the Company alleged that PENELEC failed to pay
the Lessor and the Company contract rates for power in excess of 80 MW produced
by the Facility. On August 3, 1999, the Company entered into an agreement with
PENELEC to settle the litigation. See Item 3. - Legal Proceedings for a further
discussion of the litigation and settlement agreement.
Buzzard deposits all revenues earned under the PSA into an account administered
by a disbursement agent. Before Buzzard can receive cash generated by the
Scrubgrass Project, all operating expenses, base lease payments (which are
described below), certain maintenance reserve and other subordinated payments
must be satisfied. Buzzard, as lessee, is required to pay the Lessor, in
addition to a specified base rent, which consists of all of the Lessor's debt
service, equity repayment, base return on equity and related expenses, an
additional rent of 50 percent of the net cash flows Buzzard receives from the
Scrubgrass Project's operations. Buzzard is not required to fund operating
losses, or otherwise invest further, from sources outside of the Scrubgrass
Project.
On December 22, 1995, the Lessor restructured certain of the Scrubgrass
Project's debt, the primary effect of which was to extend the term of its demand
debt through 2004 and extend a portion of its junior subordinated debt through
1999. In connection with the Lessor's debt restructuring, Buzzard was able to
refinance a portion of its own current liabilities and establish a capital
improvements fund with a note payable of $300,000, which was paid in January
1996, and a variable note payable of $2,487,813 which matures through 2004.
During the second quarter of 1997, the Lessor assumed primary responsibility for
the disbursement of funds and repayment of debt related to the capital
improvements fund of the Scrubgrass Project. Accordingly, restricted cash and
secured borrowings of approximately $1,220,000 were transferred from the
financial statements of the Company to the financial statements of the Lessor.
Since the Lessor's debt restructuring, Buzzard has continued to fund the
Lessor's debt service obligations as a base lease payment and its own term
obligation resulting from this restructuring which are described in the
following table:
Balance at Balance at Matures
Description of the Obligation 12/31/99 12/31/98 Interest Rate Through
- --------------------------------------------------------------------------------------------------------------------
Lessor's term debt obligations:
Variable rate tax exempt bonds $135,600,000 $135,600,000 Quoted Bond Rates 2012
Variable rate term loan 14,412,000 16,623,087 Fixed swap rate of 6.4225% 2005
Variable rate term loan 10,061,427 10,575,218 LIBOR rate plus 1.250% 2004
Junior subordinated debt - 318,796 Fixed rate of 8% 1999
Buzzard's term debt obligation:
Variable rate term loan 1,188,573 1,249,268 LIBOR rate plus 1.250% 2004
On December 22, 1995, the Lessor entered into interest rate swaps which had the
effect of fixing the interest rate over the life of its variable rate term loan
which matures in 2005 at 6.4225%. The Lessor's tax-exempt bonds incurred
interest at floating rates ranging from 2.8% to 4.2% and 2.95% to 4.0% during
1999 and 1998, respectively.
4
The remainder of the term debt obligations incur interest at either fixed rates
or variable rates which are based on the London Interbank Offering Rate
("LIBOR). Under the terms of the Lessor's loan agreements, the Company is
subject to various customary financial and operating covenants. As of December
31, 1999 and 1998, PG&E Gen believes the Company was in compliance with all such
covenants.
During 1997, the Company's planned maintenance outage was significantly extended
because the Company needed to perform a complete rewind on the Facility's
generator. The Facility's extended outage created an extensive cash flow
deficiency because of the loss of revenues plus associated costs and expenses.
The Company addressed this cash deficiency by securing additional debt
financing, negotiating agreements with the generator manufacturer, and utilizing
available restricted cash which are each discussed as follows:
Term Credit Facility - In June 1997, the Lessor entered into a three-year
credit facility with the lenders of the Scrubgrass Project to provide up to
$3 million to fund general debt service expenses. The maximum allowable
borrowings under this credit facility were $3 million through July 1, 1998.
On July 1, 1998, the maximum allowable borrowings began reducing in
$600,000 increments every six months through July 3, 2000, at which time
the credit facility will be payable in full. As of December 31, 1999 and
1998, the outstanding borrowings under this credit facility, which were
advanced to the Company by the Lessor, amounted to $600,000 and $2,150,000,
respectively.
Agreements with Generator Manufacturer - Prior to the 1997 outage, the
Company negotiated extended financing terms with GEC Alsthom ("GEC"), the
manufacturer of the Facility's generator, which allowed the Company to pay
the $660,000 cost of the generator repair in six annual installments of
$110,000, without interest, beginning in May 1997. On April 15, 1998, the
Company reached an agreement with GEC which modified the terms of its
original financing contract. Under the terms of the original contract, the
Company had yet to pay five installments of $110,000 and had also agreed to
pay an additional $75,000 bonus to GEC for completing its work ahead of a
pre-established schedule. Furthermore, the Company engaged GEC to perform
certain maintenance procedures to the generator during the 1998 scheduled
outage at the Facility. Under the terms of the revised agreement with GEC,
as payment in full for the work performed during the 1998 outage and for
the five remaining installments of $110,000 and $75,000 bonus owed under
the original contract, the Company agreed to pay GEC a total of $450,000
over a four-year period. The revised agreement provides that $50,000 was
payable upon the completion of the work during the scheduled 1998 plant
outage and that $100,000 is payable upon each of the first four
anniversaries of the first payment thereof. As of December 31, 1999 and
1998, the Company has recorded on its balance sheet the next installment of
$100,000 in its other current liabilities and the present value of the
remaining installments, discounted at the Facility's incremental borrowing
rate (6.75%), which amounted to $176,948 and $256,620, respectively, in its
other borrowings. The Company is recognizing the balance of the remaining
installments under the revised agreement, which amounted to $23,052 and
$43,380 as of December 31, 1999 and 1998, respectively, as interest expense
over the remaining term of the financing contract with GEC. During 1998,
the Company recognized, through a reduction of its operating expenses, the
reduction of the present value of the future installments due to GEC, which
amounted to $169,045. The Company also recognized interest expense of
$20,328 and $26,661 during 1999 and 1998, respectively, under the
agreements with GEC.
Utilization of Restricted Cash - The Company utilized its restricted cash
reserves to finance most of its additional maintenance expenditures
incurred during the 1997 outage since substantially all of such
expenditures were deemed to be major overhauls. Under the terms of its
project agreements, the Company began replenishing these restricted funds
over a seven-year period beginning in 1998.
5
The Environmental Protection Agency and the Pennsylvania Department of
Environmental Protection (the "Regional Authorities") grant Nitrogen Oxide Ozone
Transport Region Budget Allowances ("NOx Credits") to the Company based on
numerous factors which primarily pertain to the design and operation of the
Facility. The Company is required annually to maintain sufficient NOx Credits
which equal or exceed the quantity of its nitrogen oxide emissions during a
specified seasonal period (the "ozone season"). If the Company's nitrogen oxide
emissions exceed its available NOx Credits, the Company would be subject to
fines by the Regional Authorities. During 1999, the Company installed machinery,
with a cost of $811,568, which is expected to significantly reduce its nitrogen
oxide emissions. As such, the Company anticipates that it may not require a
portion of its future NOx Credits to maintain its compliance with the applicable
regulations. Because NOx Credits are transferable and marketable, the Company
may sell its available NOx Credits or purchase additional NOx credits that are
necessary to meet the applicable regulations.
During 1998, the Company expected to receive an aggregate of 1,549 NOx Credits
during 1999 and 2000, which would be available for use during the 1999, 2000,
2001 and 2002 ozone seasons. Therefore, during December 1998 and January 1999,
the Company entered into commitments to sell an aggregate of 839 NOx Credits,
which the Company projected would not be needed to comply with the applicable
regulations during those ozone seasons. However, the Company was informed in
1999 that 111 projected available NOx Credits would not be received and,
accordingly, the Company terminated the sales commitment for that portion of the
NOx Credits. During 1999, the Company received 361 NOx Credits for the 1999
ozone season, of which 182 NOx Credits were subject to existing sales
commitments and sold for $629,720. The Company also purchased 36 NOx Credits in
1999 for $22,760 which were required to comply with the applicable regulations
for the 1999 ozone season. The net proceeds from sales of NOx Credits of
$606,960 is included in other income on the accompanying Consolidated Statement
of Operations. During 2000, the Company expects to receive the remaining 1,077
NOx Credits which pertain to the ozone seasons in 2000, 2001 and 2002. Shortly
after receipt of the remaining NOx Credits, the Company expects to receive
$1,161,888 from its outstanding sales commitments for 546 projected available
NOx Credits.
Sunnyside
The Sunnyside Project is an approximately 51 Mw (net) waste coal-fired facility
at a site located adjacent to the Sunnyside Coal Mine in Carbon County, Utah
which was constructed by Parsons Main, Inc., ("PMI"). The facility reached
commercial operation on November 19, 1993. The Sunnyside Project is owned by
Sunnyside Cogeneration Associates ("SCA"), a joint venture in which the Company
owned varying majority interests from 100% to approximately 70% until September
28, 1994 and thereafter an approximate 40% interest until December 31, 1994 at
which time the Company sold its remaining interest in SCA to B&W Sunnyside, Inc.
and NRG Sunnyside, Inc. (collectively, "the Purchasers").
In connection with the sale, the Company received total consideration of
$6,042,294 which included cash of $2,792,294 received on January 5, 1995 and
promissory notes aggregating $3,250,000, bearing interest at 10% per annum,
received on December 31, 1994. In addition, after audits were performed to
verify certain financial information for SCA, the Purchasers were required to
pay a purchase price closing adjustment of $1,061,107 in 1995. Under the terms
of the promissory notes, interest is payable quarterly to the Company and
aggregate principal payments of $312,500, $1,187,500 and $1,750,000 were due on
September 30, 1995, December 31, 1996 and December 31, 1997, respectively. To
date, the Purchasers have made principal payments aggregating $312,500 and
quarterly interest payments through March 31, 1996 pursuant to the promissory
notes. The Purchasers have also made aggregate payments of $708,000 toward the
purchase price closing adjustment. However, as more fully described in Item 3. -
Legal Proceedings, the Purchasers commenced a legal proceeding with the Company
on May 3, 1996. Pending the resolution of the legal proceeding, the Purchasers
have withheld all payments of principal and interest due on the promissory notes
since June 1996. The Purchasers are also disputing the balance of the purchase
price closing adjustment in the legal proceeding. As of December 31, 1999, in
addition to the balance of the purchase price closing adjustment, the purchasers
have principal and interest payments in arrears under the promissory notes of
$2,937,500 and $1,102,568, respectively (collectively the "Purchasers'
Obligations").
As discussed further in Item 3. - Legal Proceedings, the litigation with the
Purchasers includes claims for alleged breaches by the Company of the agreement
to sell its interest in SCA to the Purchasers. The alleged breaches of
6
contract are numerous and the litigation continues in discovery where it has
been for almost four years. In November 1998 and October 1999, the Company
presented to the Seventh District Court for Carbon County, State of Utah (the
"Court") motions for partial summary judgment concerning certain of the numerous
claims made by the Purchasers. On January 12, 2000, as discussed further in Item
3. - Legal Proceedings, the Court granted one of the Company's motions for
partial summary judgment. Because of this decision, and considering the
possibility of further similar motions, the Company hopes over time to eliminate
or limit the matters that might be presented in a jury trial or discourage the
Purchasers from continuing the litigation if the anticipated costs exceed the
benefits from litigating the remaining matters. After its Court appearances, the
Company continues to feel optimistic about the strength of its position in the
litigation. However, the Company perceives that the Purchasers are unlikely to
settle these matters unless required through Court proceedings, there currently
being little economic incentive for them to do so. Accordingly, in view of the
length and inherent risk of the litigation process and a jury trial, the Company
at this time cannot predict the ultimate outcome of this litigation or how long
it will take to enforce its rights and collect the Purchasers' Obligations. The
Purchasers' Obligations have been in arrears for almost four years now and are
expected to remain in arrears for the foreseeable future. Pursuant to Statement
of Financial Accounting Standards ("SFAS") No. 114, as amended by SFAS No. 118,
the Company is required to recognize impairment losses on loans whenever changes
in circumstances indicate that the carrying amounts of the loans exceed their
fair market values. In the case of the Purchasers' Obligations, because there
were no quoted market values, the best indication of fair market value was the
present value of the expected future cash flows from the Purchasers'
Obligations. As of December 31, 1998, given the uncertainty surrounding the
timing of collecting the Purchasers' Obligations, the Company could not
reasonably estimate a fair market value for such obligations. As such, the
Company opted to take a conservative position and write-off the Purchasers'
Obligations in its 1998 Consolidated Financial Statements. The write-off was
reported as a charge to other expense for $3,508,498 in the accompanying 1998
Consolidated Statement of Operations. The charge represents the aggregate
balance before the write-off for the notes receivable of $2,937,500 and the
receivable from sale of affiliate of $570,998. Notwithstanding, the Company
maintains its entitlement to the Purchasers' Obligations and continues to
vigorously pursue such amounts, as well as punitive damages for abuse of the
litigation process, in the Court. Should the Company prevail in the litigation
in a future period and collect the Purchasers' Obligations, or a portion
thereof, and/or punitive damages, the Company would report such collections as
other income in the period received. See Note B in the accompanying Consolidated
Financial Statements for the Company's accounting policies for reporting income
on the Purchasers' Obligations.
Milesburg
On April 30, 1987, the Company purchased, for an aggregate purchase price of
$5,400,000, all of the outstanding capital stock of Milesburg Energy, Inc.
("MEI"), the company which controlled the development rights to an existing 43
Mw (net) coal-fired facility, which was retired from service in 1984. In
connection with the stock purchase, the Company paid $100,000 in cash and issued
promissory notes totaling $5,120,000 (the "MEI Notes") and MEI assumed
pre-acquisition MEI liabilities totaling $180,000. The MEI Notes,
pre-acquisition liabilities and certain other liabilities incurred subsequent to
the purchase were to become payable only under certain conditions, the most
significant of which related to the closing of construction financing and
commencement of construction for the Milesburg Project.
In 1987, MEI executed a 30 year power purchase agreement with West Penn Power
Company ("West Penn") for the sale of all of the facility's electrical output
with a fixed capacity rate component and an additional fluctuating rate
component which is derived from West Penn's avoided energy cost. The power
purchase agreement was approved by the Public Utilities Commission of the State
of Pennsylvania ("PUC"), and was subsequently appealed to the Commonwealth Court
of Pennsylvania by certain industrial intervenors. During the lengthy appeals
process, which extended beyond certain contract milestone dates in the power
purchase agreement, West Penn requested that its original petition to approve
the power purchase agreement be dismissed by the PUC since the power purchase
agreement had expired by its own terms. In September 1989, in response to MEI's
efforts to preserve its contractual rights, the PUC, by court order, ordered
West Penn to execute a new power purchase agreement with MEI. The new power
purchase agreement was to include extended contract milestone dates and rates
which would be recalculated due to the later start-up date for this project
necessitated by the delays caused by the appeal. This order had been appealed by
the same industrial intervenors and West Penn through various courts, including
the United States Supreme Court, and upheld in every case in favor of MEI. In
August 1995, the PUC issued a tentative order for final
7
contract rates. The order had been temporarily stayed by mutual agreement of MEI
and West Penn pending discussions pertaining to a buy-out of the power purchase
agreement which began in October 1995.
Despite ongoing efforts to reach a buy-out arrangement with West Penn, the
Company had continued to invest its financial resources during 1996 and 1997 to
protect its legal and contractual interests and to support its ability to
commence construction in the event that a settlement under mutually agreeable
terms could not be reached with West Penn. In July 1996, in furtherance of those
objectives, the Company entered into a joint development agreement with PG&E Gen
(f/k/a U.S. Generating Company) to increase the financial and technical
resources available to pursue development activities and continue ongoing
discussions with West Penn concerning a buy-out of the power purchase contract.
During 1996 and 1997, the Company's development efforts for the Milesburg
Project increased considerably and the Company, along with its development
partner, was able to establish a significant value for the Milesburg Project as
a result of successful development efforts.
On August 26, 1997, following discussions which lasted almost two years, MEI and
West Penn reached a Buy-Out Agreement concerning the Milesburg project. Pursuant
to the Buy-Out Agreement, West Penn purchased Milesburg's rights to the Electric
Energy Purchase Agreement between the parties dated February 25, 1987 for the
sum of $15 million plus 8% interest from the date the Buy-Out Agreement was
filed for Pennsylvania Public Utility Commission approval. Furthermore, West
Penn also assumed ownership of and responsibility for the Milesburg project
facility, which consisted of land along with a decommissioned coal-fired
electric-generating facility erected thereon, for a stated consideration of $1.
On December 5, 1997, the date of the asset disposition, MEI received aggregate
proceeds of $15,328,768 from West Penn as consideration under the Buy-Out
Agreement. At the date of the asset disposition, before consideration of any
settlements of contingent obligations, the Company had Milesburg project
development costs included in its property, plant and equipment of $9,670,788
and Milesburg project borrowings included in its secured promissory notes and
other borrowings of $5,858,767. Shortly before the date of the asset
disposition, the Company entered into a settlement agreement pertaining to
certain Milesburg project contingent obligations, including the MEI Notes. As a
result of the settlement agreement, the Company's Milesburg project development
costs and Milesburg project borrowings were reduced to $6,170,788 and
$2,358,767, respectively. In addition, because certain other Milesburg
obligations were payable only upon the occurrence of events related to project
development, Milesburg project obligations of $558,767 and accrued interest of
$63,650 were released from liabilities during 1997 and reported as other income
of $622,417 in the accompanying Consolidated Statement of Operations. As a
result of the sale of the Milesburg Project, the Company realized net proceeds
before taxes of $10,960,120 which were derived as follows:
Proceeds from the disposal of Milesburg project assets $15,000,001
Project costs:
Development costs 6,170,788
Fee paid to development partner 1,405,746
-----------
Total project costs 7,576,534
-----------
Gain on sale of project $ 7,423,467
Adjustments to arrive at net proceeds before taxes from the disposal of
Milesburg project assets:
Development cost reimbursements to the Company for
obligations which had already been paid 2,585,469
Development costs released from liabilities 622,417
Interest income from West Penn 328,767
-----------
Net proceeds before taxes from the disposal of Milesburg project assets $10,960,120
===========
After MEI's payment of certain accrued liabilities as of December 31, 1997, the
Company estimated it would have available in excess of $10 million from the
Milesburg proceeds. In light of this projected availability of cash, the
Company's Board of Directors on December 10, 1997 declared a special dividend of
87 cents per common share
8
payable out of the proceeds received from the sale of the Milesburg project
assets. The dividend was payable on January 7, 1998 to stockholders of record on
December 30, 1997.
On December 31, 1997, because MEI did not expect to carry on further business
activities after the sale of the Milesburg Project, EPC adopted a Plan of
Liquidation to dissolve MEI. Under the Plan of Liquidation, MEI ceased to carry
on business activities except to the extent necessary to liquidate its assets,
pay its liabilities and distribute its assets remaining after the payment of its
liabilities to EPC. During 1998, MEI's assets remaining after the payment of its
liabilities were distributed to EPC.
Energy Markets
United States
Historically in the United States, regulated and government-owned utilities had
been the only significant producers of electricity for sale to third parties.
The energy crisis of the 1970's led to the enactment of the Federal Public
Utility Regulatory Policies Act of 1978 ("PURPA"), which encouraged companies
other than utilities to enter the electric energy business by reducing
regulatory constraints. In addition, PURPA, as implemented by Federal Energy
Regulatory Commission regulations, created unique opportunities for the
development of cogeneration facilities by requiring utilities to purchase
electricity generated in cogeneration plants meeting certain requirements
(referred to as "Qualifying Facilities"). See "Energy Regulation" below. As a
result of PURPA, a significant market for electricity produced by independent
power producers like the Company developed in the United States. In 1992,
Congress enacted the Energy Policy Act of 1992 ("Energy Act"), which amended the
Public Utility Holding Company Act of 1935 ("PUHCA"), to create new exemptions
from PUHCA for independent power producers selling electric energy on a
wholesale basis, to increase electricity transmission access for independent
power producers and to reduce the burdens of complying with PUHCA's restrictions
on corporate structures for owning or operating generating or transmission
facilities in the United States or abroad. The Energy Act has enhanced the
development of independent power projects and has further accelerated the
changes in the electric utility industry that were initiated by PURPA. The
implementation of federal and state policies, which have increased the
availability of transmission access for wholesale and retail transactions, have
created additional markets and competition for electric energy sales.
International
As a result of increasing demand for power generating capacity around the world,
the international sector has been a fast growing area in the electric industry.
This increase in demand has led to an increased emphasis by foreign governments
toward privatization of state-owned utilities. Many energy experts believe that
the international market represents a significant percentage of the world's new
and replacement power needs. At the same time, the national, provincial and
local laws of each host country, unique political and currency exchange
requirements, and the application of new world-wide environmental standards to
international projects, create significant risks and obligations which may be
difficult to manage. Presently, the Company is not involved in the international
sector and has no immediate plans to become involved in the international
sector.
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 or 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, as discussed under
the caption "Energy Markets", the electric industry has been previously affected
by legislation such
9
as PURPA and the Energy Act which have encouraged companies other than utilities
to enter the electric power business by reducing regulatory constraints. More
recently, as discussed under the caption "Energy Regulation", there has been new
state legislation to deregulate the generation component of the electric
business. Furthermore, proposed changes to repeal or modify PUHCA and PURPA
could reduce regulatory restrictions placed on electric utilities and encourage
them to seek new sources of electric power. Any of these regulatory matters,
among others, could increase competition for electric power. Other than the risk
that PENELEC would seek to renegotiate the terms of the Scrubgrass power
purchase agreement (see further discussion under the caption "Energy
Regulation"), the Company does not believe the Scrubgrass Project would be
significantly impacted by competition in the wholesale energy market since its
revenues are subject to contracted rates which are substantially fixed for
several years. However, the contracted rates in the later years of the
Scrubgrass power purchase agreement switch to rates which vary more closely with
existing market conditions. Should ensuing competition in the later years of the
Scrubgrass power purchase agreement create downward pressure on wholesale energy
rates, the Company's profitability could be impacted.
In previous years, the Company competed 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. As a result, the Company is not actively
pursuing new development opportunities at this time.
Presently, there is significant merger and consolidation activity occurring in
the electric industry. Recently, the Company engaged an investment consultant to
consider any sale or merger proposals and other strategic alternatives that may
present an opportunity to enhance shareholder value.
Energy Regulation
The Company's projects are subject to regulation under federal and state energy
laws and regulations. The Company's facilities are either self-certified as a
Qualifying Facility under the PURPA, or formally certified as a Qualifying
Facility by the Federal Energy Regulatory Commission ("FERC"). Pursuant to
PURPA, FERC has promulgated regulations which exempt certain Qualifying
Facilities from the Federal Power Act of 1920, PUHCA, and, except under certain
limited circumstances, state laws regulating the rates charged by electric
utilities. In order to qualify under PURPA, the Company's facilities must meet
certain size, fuel and ownership requirements and/or co-generate. In addition to
the regulation of Qualifying Facilities, PURPA requires that electric utilities
purchase electric energy produced by qualifying facilities at negotiated rates
or at a price equal to the incremental or avoided cost that would have been
incurred by the utility if it were to generate the power itself or purchase it
from another source. The Company is not presently subject to regulation under
PUHCA and does not presently intend to engage in any activities that would cause
it to be so regulated.
The Company believes that changes in PURPA, PUHCA and other related federal
statutes could occur in the next several years. The nature and impact of such
changes on the Company's projects is unknown at this time. Presently, there are
several legislative proposals pending in Congress which suggest a comprehensive
restructuring of the electric utility industry. These proposals advocate, among
other things, retail choice for all utility customers, the opportunity for
utilities to recover their prudently incurred stranded costs in varying degrees,
and the repeal of both PURPA and PUHCA. In April 1999, the Clinton
administration also introduced the Comprehensive Electricity Competition Act,
which proposes a flexible mandate for customer choice by January 1, 2003,
reliability standards, environmental provisions, and the repeal of both PURPA
and PUHCA. The flexible mandate gives individual states the option to seek
alternative policies which appear to better serve their consumers. If PURPA is
amended or repealed, the statutory requirement that electric utilities purchase
electricity from Qualifying Facilities at full avoided cost could
10
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 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.
Environmental Regulation
The Company's projects are subject to various federal, state and local
regulations pertaining to the protection of the environment, primarily in the
areas of water and air pollution. In many cases, these regulations require a
lengthy and complex process of obtaining and maintaining licenses, permits and
approvals from federal, state and local agencies. The Company also has
significant administrative responsibilities to monitor its compliance with the
regulations. 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 the applicable
requirements could require
11
modifications to operating facilities. During periods of non-compliance, the
Company's operating facilities may be forced to shutdown until the compliance
issues are corrected. The Company is responsible for ensuring the compliance of
its facilities with all the 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. The
Company believes the Scrubgrass Project, its only operating project, is
currently in compliance with all material applicable environmental regulations.
The Scrubgrass Project most notably has been affected by the following
environmental regulations:
Air Quality - The Scrubgrass Project is subject to air quality regulations
under the Federal Clean Air Act of 1970 (CAA). CAA Title I established
National Ambient Air Quality Standards (NAAQS) for certain pollutants
including ozone, sulfur dioxide, nitrogen dioxide, particulate matter,
carbon monoxide and lead. In particular, CAA Title I established the
Northeast Ozone Transport Region, which includes 12 northeast states and
the District of Columbia, to address the transport of these pollutants
which may lead to the non-attainment of the ozone NAAQS in the Northeast.
Ozone control is facilitated by the control of pollutant precursors, which
are nitrogen oxides (NOx) and volatile organic compounds. Electric
generating facilities that use fossil fuels, including the Scrubgrass
facility, are considered major sources of NOx emissions. In recent years,
the Pennsylvania Department of Environmental Protection (PaDEP) established
regulations that required companies with stationery sources of NOx
emissions to establish plans to reduce their NOx emissions. To administer
these regulations, the PaDEP began allocating Nitrogen Oxide Ozone
Transport Region Budget Allowances ("NOx Credits") to facilities based on
numerous factors including the design and operation of each facility. A
market-based trading system was established to allow companies with excess
NOx Credits to trade with companies that required additional NOx Credits to
meet the stricter requirements. More recently, an Ozone Transport
Commission (OTC) established certain inner and outer zones with seasonal
NOx emission reductions that required the Scrubgrass Project to achieve
certain targeted NOx emission levels beginning on May 1, 1999. Under the
OTC's requirements, the Scrubgrass Project will also be required to achieve
reduced emission standards by May 2003. Due to the efficient design of the
Scrubgrass facility, the Scrubgrass Project met the new 1999 requirements
without any modifications to the facility. However, the Company made
capital improvements of $811,568 in 1999 to the Scrubgrass facility, which
are expected to enable the Scrubgrass facility to meet the stricter
standards in 2003. The Company expects to meet the NAAQS for sulfur
dioxide, nitrogen dioxide, particulate matter, carbon monoxide and lead for
the foreseeable future without any additional material modifications to the
Scrubgrass facility.
Waste Disposal - The Scrubgrass Project must also comply with various
environmental regulations pertaining to the handling and disposal of
hazardous and non-hazardous wastes. The PaDEP establishes classifications
for wastes and requires companies to follow certain handling and disposal
procedures for each waste classification. Currently, the Scrubgrass Project
employs special handling procedures for the transportation of its fuel,
which is classified as a waste, from the waste sites to the Scrubgrass
facility. The fuel is burned in the Scrubgrass facility where it is treated
with various substances such as limestone during the electric generation
process. Ash, which is a byproduct of the electric generation process, is
removed from the Scrubgrass facility and returned to the original waste
site where it is reclaimed with the soil. Under existing regulations, ash
is not classified as a hazardous waste. However, various environmental
organizations have recently been lobbying for changes to the applicable
regulations for the classification of ash. If there are changes to the
waste classification of ash, the Company's ash disposal costs may
significantly increase which could have material adverse affect on the
Company's results of operations and financial position.
Employees
As of December 31, 1999, and at the time of making this filing, the Company had
five employees consisting of three full-time executive officers and two
part-time administrative personnel. The loss of any of its executive officers
could have a material adverse effect on the Company. None of the Company's
employees is represented by a collective bargaining agreement. The Company
considers relations with its employees to be good.
12
Item 2. PROPERTIES
The Company, through a subsidiary, leases the Scrubgrass waste coal-fired
electric generating facility located on approximately 600 acres in Venango
County, Pennsylvania. Until February 16, 1999, the Company, owned through a
subsidiary, approximately 80 acres in Fayette County, Pennsylvania for which it
had abandoned efforts to develop electric generating facilities utilizing coal
mine-fire technology. The land was sold pursuant to a written contract executed
on December 31, 1998. Until December 5, 1997, the Company owned through a
subsidiary, the decommissioned Milesburg coal-fired electric generating facility
located on approximately 10 acres in Centre County, Pennsylvania. The Milesburg
facility was sold to West Penn pursuant to a Buy-Out Agreement dated August 26,
1997. (See "Item 1. Business" for a further discussion of the Company's
projects).
Since February 1996, the Company has been a tenant pursuant to a lease at its
corporate headquarters in Portsmouth, New Hampshire. The lease, which was
renewed in January 1999 for three additional years, currently requires monthly
payments of $1,540.
Item 3. LEGAL PROCEEDINGS
Scrubgrass Project
On October 11, 1995, the Lessor and the Company (collectively, the "Plaintiffs")
filed a complaint against PENELEC in the Court of Common Pleas of Venango
County, Pennsylvania seeking damages for certain alleged breaches of the power
purchase agreement entered into between SPC and PENELEC on August 7, 1987. In
its complaint, the Plaintiffs allege that PENELEC failed to pay contract rates
for energy produced by the 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 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.
On August 3, 1999 the Plaintiffs jointly entered into a settlement agreement
with PENELEC to terminate the ongoing litigation. The settlement agreement did
not become effective until the date PENELEC obtained 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
rates set forth in the PSA, 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 PSA 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 December 31, 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
$3,689,000 and $537,000, respectively. On January 27, 2000, the PAPUC issued an
Order adopting the settlement agreement. After a 30 day period without any
appeals, the Order became final and non-appealable on February 27, 2000, the
Effective Date. On March 24, 2000, PENELEC remitted the outstanding balances due
under the settlement agreement for previous net deliveries of electric energy
and interest which amounted to approximately $3,802,000 and $608,000,
respectively. 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.
13
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 $1,102,568,
respectively at December 31, 1999. On April 9, 1999, in response to the
Plaintiffs' third amended complaint, the Company filed an answer and restatement
of its earlier restated counterclaim dated January 21, 1999. In the answer to
the third amended complaint, the Company denied all material allegations and
asserted numerous affirmative defenses. In the restated counterclaim, the
Company alleges numerous causes of action against the Plaintiffs which include
breach of contract, breach of the promissory notes, intentional, malicious and
willful breach of contract, intentional tort, interference and
misrepresentation. Through the restated counterclaim, the Company seeks remedies
which include: (1) compensatory, consequential and punitive damages; (2)
acceleration and immediate payment in full of the promissory notes; and (3)
injunctions to require the Plaintiffs to continue making payments under the
promissory notes during the pendency of this action and until the promissory
notes are paid in full and which enjoin the Plaintiffs from continuing certain
malicious and intentional actions that are alleged in the counterclaim, together
with interest, reasonable attorney's fees, costs and other such relief as the
court deems proper. On May 17, 1999, the Plaintiffs responded to the restated
counterclaim whereby 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 Plaintiffs responded by
stating their opposition to the Company's April 15, 1998 motion. The Company and
the Plaintiffs appeared in Court on November 19, 1998 to present oral arguments
on the Company's April 15, 1998 motion. On December 30, 1999, the Court denied
the Company's April 15, 1998 motion. The Court found that there were issues of
material fact that would warrant further consideration of the matter.
On February 12, 1999, the Plaintiffs filed a motion for partial summary judgment
wherein the Plaintiffs alleged 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' February 12, 1999 motion and also
filed a cross motion for partial summary judgment. In its cross motion, the
Company asserted that the claims at issue in the Plaintiffs' February 12, 1999
motion 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 these cross
motions. On January 12, 2000, the Court granted the Company's motion for partial
summary judgment and denied the Plaintiffs' motion for partial summary judgment.
The Court based its decision on the grounds that (1) the portion of the purchase
and sale agreement allegedly breached is concerned with legal proceedings
against or adverse to SCA and not advantageous legal proceedings against third
parties; (2) the alleged basis for legal proceedings was not "material", as
required by the purchase and sale agreement, because the Plaintiffs acquired SCA
even though the Plaintiffs had prior knowledge of the alleged basis for legal
proceedings; and (3) because the Plaintiffs were aware of the alleged basis for
legal proceedings, any failure by the Company to disclose such basis for legal
proceedings in the purchase and sale agreement was not the cause of the
Plaintiffs' loss, if any. The Plaintiffs recently filed a request for the Court
to reconsider its January 12, 2000 decision which the Company will oppose.
Discovery remains ongoing.
Item 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
14
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Stock Market Trading:
On March 15, 1999, the Company's Common Stock began trading on the NASD OTC
Bulletin Board ("OTC-BB") under the symbol POWR. Prior to that date, the
Company's Common Stock traded on the Nasdaq Stock Market ("Nasdaq") under the
symbol POWR. The Company had been designated as a SmallCap issuer on Nasdaq. As
of March 22, 2000 there were approximately 250 record holders and approximately
1,000 beneficial holders of the Company's Common Stock.
The following table shows the quarterly high and low sales prices during 1998
and 1999 as reported to the Company by the OTC-BB or Nasdaq:
Year Period High Low
- ---- ------ ---- ---
1998 First Quarter 1-13/16 3/4
Second Quarter 1-7/8 15/16
Third Quarter 1-5/8 11/16
Fourth Quarter 1-1/8 5/8
1999 First Quarter 15/16 5/8
Second Quarter 25/32 7/16
Third Quarter 25/32 19/32
Fourth Quarter 27/32 7/16
On August 22, 1997, the Securities Exchange Commission approved new listing
standards for companies who are designated as SmallCap issuers on Nasdaq. These
changes, which became effective on February 23, 1998, strengthened the
quantitative threshold criteria necessary to qualify for initial entry and
continued listing on Nasdaq. In addition, the corporate governance requirements
previously applicable only to companies designated as National Market issuers on
Nasdaq now extend to SmallCap issuers on Nasdaq. Prior to February 23, 1998,
SmallCap issuers whose securities traded below a $1 minimum bid price (such as
the Company) could remain listed if they met an alternative test based on the
market value of public float and capital and surplus. However, this alternative
to the $1 minimum bid price standard was eliminated under the new listing
standards. As such, SmallCap issuers whose securities trade below a $1 minimum
bid price for a period of 30 consecutive trading days are now subject to
delisting from Nasdaq. However, SmallCap issuers who fail to meet this $1
minimum bid price standard are given a grace period of 90 calendar days in which
to regain compliance by reporting a minimum bid price of $1 for greater than 10
consecutive trading days during this 90 day grace period.
On October 27, 1998, the Company's stock began consistently trading below a $1
minimum bid price. As a result, on December 11, 1998, the Company was notified
by Nasdaq that its stock would be subject to delisting from Nasdaq unless the
Company's stock would resume trading with a minimum bid price of $1 for greater
than 10 consecutive trading days during a 90 day grace period which expired on
March 11, 1999. On March 12, 1999, because the Company's stock failed to regain
compliance during the 90 day grace period, the Company's stock was delisted from
Nasdaq. After delisting from Nasdaq, the Company's Common Stock began trading on
the OTC-BB under the symbol POWR.
15
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 in each quarter during 1997,
1998 and 1999 as follows:
Dividends
Dividends Declared
Year Period Declared per Share
- ---- ------ -------- ---------
1997 First Quarter $ 332,303 $.030
Second Quarter 332,304 .030
Third Quarter 335,153 .030
Fourth Quarter 10,266,105 .900
-----------
$11,265,865 $.990
=========== =====
1998 First Quarter $ 342,203 $.030
Second Quarter 342,204 .030
Third Quarter 171,102 .015
Fourth Quarter 171,102 .015
----------- -----
$ 1,026,611 $.090
=========== =====
1999 First Quarter $ 171,102 $.015
Second Quarter 171,102 .015
Third Quarter 171,102 .015
Fourth Quarter 171,102 .015
----------- -----
$ 684,408 $.060
=========== =====
The Company has declared quarterly dividends of 3 cents per share during each of
the six quarters through June 30, 1998. However, during each of the six quarters
through December 31, 1999, the Company reduced its dividend to 1.5 cents per
share to preserve its cash resources to address certain changes in its financial
position and projected cash requirements. These changes are discussed further in
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources". The Company continues
to investigate business strategies to increase the cash which may become
available from its operations for future dividends. In addition to its quarterly
dividends, the Company also declared a special dividend of 87 cents per share in
1997 out of the proceeds from the Milesburg buy-out (See "Item 1. Business -
Milesburg") which resulted in aggregate dividends declared of 99 cents per share
in 1997.
The reduction in the quarterly dividend amount during the third quarter of 1998
reflects the Company's existing policy of seeking to distribute the maximum
funds available each quarter to shareholders. The maximum funds available for
distribution is determined by the Board each quarter and represents the amount
the Company does not expect it will need for ongoing operations and any planned
projects assuming expected operating results are achieved. In addition, the
Board considers the level of reserves and determines what is reasonable as a
buffer against surprises, variations from expectations and reasonable
contingencies in the upcoming periods. Behind all of these considerations is the
philosophy that the Company should not be holding reserves that it does not
expect are reasonably needed for continuing operations and contingencies. The
downside of this approach is the risk that dividends need to be reduced when
cash flow is reduced and/or projected expenses and contingencies are greater
than foreseen. Historically, the Company has not operated using a philosophy of
holding reserves for future dividends since such a philosophy would represent
the Company's investment of its shareholder's money which would be given out
later if the Company was not generating sufficient cash at that time to continue
the dividend. The Board's position has been that the Company's shareholders
acquired their shares in the Company for its management of power generation
facilities and that shareholders would be better served investing for themselves
the money that the Company can distribute.
16
As of December 31, 1997, the Company had dividends payable of $10,266,105 (90
cents per share) which were declared on December 10, 1997 and paid on January 7,
1998. Distributions are taxed to shareholders when they are received as ordinary
dividends to the extent that the distributing corporation has earnings and
profits during the tax year in which the dividend is paid. The portion of the
distribution which is in excess of the distributing corporation's earnings and
profits is treated as a tax-free return of capital and reduces the shareholder's
basis in the stock. Once the shareholder's basis in the distributing
corporation's stock is reduced to zero, any remaining excess distribution is
treated as a payment for the stock or capital gain if the stock is a capital
asset in the shareholder's hand. Due to the substantial earnings and profits
incurred during 1997 primarily from the sale of the Milesburg project, the
Company deferred the payment of its dividend declared on December 10, 1997 to
1998 so that the dividend would receive a more favorable tax treatment. By
deferring the payment of the dividend declared on December 10, 1997 to 1998,
distributions of $11,166,752 paid in 1998 were characterized as a return of
capital.
Under the laws of its state of incorporation, EPC may pay dividends out of its
surplus, as defined by statute, on an unconsolidated basis. As of December 31,
1999, although the Company's consolidated capital position reflected a deficit
of $5,470,769, EPC maintained a surplus on an unconsolidated basis. As discussed
under the caption "Item 1. Business - Scrubgrass", after satisfying certain
reserves required by Scrubgrass Project agreements, Buzzard retains 50 percent
of the net cash flows from the operations of the Scrubgrass Project and is not
required to reinvest such proceeds to finance operating losses of the project.
Buzzard has realized cumulative cash distributions of $7,320,952 through
December 31, 1999 from the Scrubgrass Project which have all been distributed as
dividends to EPC. Furthermore, as discussed under the caption "Item 1. Business
- - Milesburg", the Company sold the Milesburg project at a substantial gain and
adopted a Plan of Liquidation of MEI which resulted in significant liquidating
distributions to EPC. As a result of the distributions received from Buzzard and
the liquidating distributions received from MEI, EPC's surplus determined on an
unconsolidated basis has been sufficient to support the dividends declared and
paid to date. The payment of any future dividends will depend on the Board of
Directors' evaluation, made on a quarterly basis, based on the Company's then
current and projected operating performance and capital requirements. See "Item
7 - Management's Discussion and Analysis of Financial Condition and Results of
Operations".
17
Item 6. SELECTED FINANCIAL DATA
The following selected financial data for the five years ended December 31, 1999
is derived from the audited Consolidated Financial Statements of the Company.
The data should be read in conjunction with the Consolidated Financial
Statements and other financial information included elsewhere herein.
Year Ended December 31
----------------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
Results of Operations Data:
Power generation revenues $ 48,268 $ 45,721 $ 43,763 $ 47,854 $ 40,693
-------- -------- -------- -------- --------
Costs and expenses:
Operating expenses 21,931 19,215 17,756 18,190 16,975
Lease expenses 23,111 22,971 24,488 24,793 23,020
General and administrative expenses 2,455 2,197 1,995 3,062 3,668
Reversal of provision for nonrecovery of
project development costs (940) -- --
Depreciation and amortization 363 285 258 205 167
-------- -------- -------- -------- --------
47,860 44,668 43,557 46,250 43,830
-------- -------- -------- -------- --------
Operating income (loss) 408 1,053 206 1,604 (3,137)
Other income (expense):
Other income -- 8 622 484 1,285
Interest income 111 156 581 499 468
Interest expense (375) (461) (424) (336) (107)
Sale of NOx emission credits 607 -- -- -- --
Amortization of deferred gain 308 308 308 308 308
Warranty income -- -- -- 900 --
Write-off of receivables in litigation -- (3,508) -- -- --
Gain on sale of project -- -- 7,424 -- --
-------- -------- -------- -------- --------
651 (3,497) 8,511 1,855 1,954
-------- -------- -------- -------- --------
Income (loss) before income taxes 1,059 (2,444) 8,717 3,459 (1,183)
Income tax (expense) benefit (470) 795 (4,103) (1,894) 448
-------- -------- -------- -------- --------
Income (loss) before cumulative effect of a
change in accounting principle 589 (1,649) 4,614 1,565 (735)
Cumulative effect of a change in accounting
principle (2) 1,189 -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) $ 1,778 $ (1,649) $ 4,614 $ 1,565 $ (735)
======== ======== ======== ======== ========
Basic and diluted earnings (loss) per common share $ 0.16 $ (0.14) $ 0.41 $ 0.14 $ (0.07)
Dividends paid or payable per common share $ 0.06 $ 0.09 $ 0.99 $ 0.14 $ 0.08
Weighted average number of shares outstanding 11,407 11,424 11,260 11,286 11,197
Balance Sheet Data:
Total assets $ 58,782 $ 55,163 $ 61,362 $ 52,503 $ 45,226
Working capital (2,662) (1,190) 536 1,406 3,224
Long-term obligations (2) 51,546 46,511 40,032 35,331 24,405
Deferred gain (1) 5,089 5,397 5,706 6,014 6,322
Deferred revenue -- -- -- -- 3,065
Shareholders' (deficit) equity (5,471) (6,559) (3,878) 2,680 2,797
- ----------
(1) See Note B of the Consolidated Financial Statements.
(2) See Note Q of the Consolidated Financial Statements and the Consolidated
Statements of Operations for further disclosures pertaining to a change in
accounting principle.
18
Item 7. 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 Purchaser's obligations for the sale. The Company sold its
development rights for the Milesburg Project on December 5, 1997 to the utility
which had contracted to purchase electricity from such project. The Company's
projects are discussed further in "Item 1. Business". The following Management's
Discussion and Analysis of Financial Condition and Results of Operations
compares the Company's results of operations for the years ending December 31,
1999, 1998 and 1997 and should be read in conjunction with the Consolidated
Financial Statements and notes thereto, and the comparative summary of selected
financial data appearing elsewhere in this report. Historical results and trends
which might appear should not be taken as indicative of future operations.
Cautionary Statement
This Annual Report on Form 10-K 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
Year ended December 31, 1999 ("1999") compared with the year ended December
31, 1998 ("1998")
Net income amounted to $1,777,562 ( 16 cents per share) for 1999 as compared to
a net loss of $1,649,186 (14 cents per share) for 1998. The overall increase in
the 1999 net results is largely attributable to an increase in power generation
revenues, a decrease in interest expense, the absence in 1999 of the write-off
of receivables in litigation, sales of NOx emission credits and income from the
effect of a change in accounting principle. Such factors were offset in part by
increases in operating expenses, lease expenses, general and administrative
expenses, depreciation and amortization, and income tax expense and a decrease
in interest income. The primary reasons for the changes in these components of
the net results are discussed in the following sections.
Power generation revenues for 1999 amounted to $48,268,311 as compared to
$45,721,473 for 1998 and all pertained to the Scrubgrass Project. The overall
increase in power generation revenues during 1999 is primarily attributable to
an increase in the capacity rate for the Scrubgrass Project which operated at
89.5% of its capacity for 1999 as compared to 87.9% for 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 $7,765,631 and
$8,024,111 for 1999 and 1998, respectively. The following factors contributed
principally to the differences in the Scrubgrass Project's capacity rates billed
for 1999 and 1998. 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. In addition, the Scrubgrass Project incurred unscheduled
shutdowns and power generation reductions to respond to
19
equipment malfunctions or utility curtailments which necessitated that the
Scrubgrass plant be inoperative for an aggregate of approximately 16 days and 26
days outside of the scheduled outage timeframes during 1999 and 1998,
respectively.
Operating expenses for 1999 amounted to $21,931,318 as compared to $19,215,459
for 1998 and all pertained to the Scrubgrass Project. The overall increase
during 1999 is primarily attributable to the following reasons. First, the
Company incurred higher fuel costs as a result of cost escalations in certain
fuel supply agreements, poorer fuel quality and an increase in fuel consumption
billed to the utility. Second, pursuant to the terms of the O&M, the Operator
passed along certain increases in its labor and related costs to the Company.
Third, due to certain machinery and equipment modifications made in 1999 to
reduce NOx emissions from the Scrubgrass facility, the Company incurred higher
chemical expenses. Fourth, the Company entered into modifications to the
financing contract with the manufacturer of the Scrubgrass generator which
reduced certain operating expenses during 1998 by comparison to 1999. Fifth, the
Company incurred higher Operator fees due to fixed cost escalations pursuant to
the O&M and increases in bonuses which are based on capacity rates. Sixth, the
Company incurred significant increases in maintenance expenses which are
discussed further in the following paragraph.
Maintenance expenses, including expensed modifications, amounted to $4,380,381
and $3,048,217 during 1999 and 1998, respectively. The increase in 1999
maintenance expenses is largely due to equipment modifications related to Year
2000 compliance and differences in the nature of work performed during the 1999
and 1998 planned maintenance outages. The Company spent $2,468,682 and $884,634
for planned maintenance outage expenses during 1999 and 1998, respectively.
Planned maintenance outage expenses are performed on a schedule which differs
from year to year. The selection of equipment for service and/or replacement
each year depends on factors such as expected wear and tear and recommendations
made by the equipment manufacturer. During 1999, the Company spent $2,159,436 to
perform significant scheduled work on the steam generator which was the primary
expenditure in 1999. However, the 1999 increase was offset in part by higher
maintenance expenses in 1998 of $379,615 to increase the Company's maintenance
reserves. Due to a change in its method of accounting for major equipment
overhauls, the Company did not make additional maintenance reserves in 1999. See
Note Q to the accompanying Consolidated Financial Statements for a further
discussion of the change in accounting method.
Lease expenses for 1999 amounted to $23,110,677 as compared to $22,971,201 for
1998 and all pertained to the Scrubgrass Project. The overall increase in lease
expenses during 1999 is primarily attributable to the following reasons. First,
the Company incurred scheduled increases in the base rent paid to the Lessor.
Second, due to increases in distributable cash flows, the Company had an
increase in the additional rent paid to the Lessor. Third, the Lessor's
scheduled principal payments for its term loans, which are passed through to the
Company in its lease expense, increased in 1999. The aforementioned increases in
lease expense were substantially offset by the following decreases in lease
expense during 1999. First, the Lessor's interest costs, which are passed
through to the Company in its lease expense, decreased primarily due to
favorable interest rates on the tax-exempt bonds. Second, the Company realized a
decrease in lease expense recorded as a result of the straight-line accounting
treatment of certain lease expenses under the Scrubgrass lease which amounted to
$7,765,631 and $8,024,111 for 1999 and 1998, respectively.
General and administrative expenses for 1999 amounted to $2,455,095 as compared
to $2,196,929 for 1998. The overall increase in 1999 is 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,
such as negotiations with PENELEC, required more management attention during
1999. Second, the Company had a significant increase in legal fees due to
accelerated efforts on the Sunnyside litigation. Third, the Company had an
increase in its executive salaries. However, as a result of changes in the
insurance program at the Scrubgrass Project, the aforementioned increases in
general and administrative expenses were offset in part by a reduction in
insurance expense during 1999.
Depreciation and amortization amounted to $363,234 and $285,471 in 1999 and
1998, respectively. Depreciation and amortization increased in 1999 primarily
because the Company's 1999 capital expenditures of $829,117 were depreciated for
a portion of 1999.
Interest income amounted to $110,975 and $156,546 for 1999 and 1998,
respectively. Interest income decreased in 1999 primarily because of lower
investments of cash and cash equivalents. As of December 31, 1997, the Company
20
had cash and cash equivalents of $12,092,273 which consisted primarily of
short-term investments of proceeds from the Milesburg settlement. These
investments, which existed until the Company paid its special dividend and
certain Milesburg project obligations, generated interest income during 1998.
Interest expense amounted to $375,176 and $460,812 for 1999 and 1998,
respectively. The decrease in interest expense is primarily attributable to
reductions in the outstanding borrowings under the Scrubgrass Project term
credit facility which are reducing in $600,000 increments every six months
through July 2000.
Sale of NOx emission credits amounted to $606,960 and represented the net
proceeds received in 1999 from sales of Nitrogen Oxide Ozone Transport Region
Budget Allowances ("NOx Credits"). The sale of NOx Credits is discussed further
under "Item 1. Business--Scrubgrass".
Write-off of receivables in litigation amounted to $3,508,498 in 1998 and
represented the 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 SCA. This write-off was discussed further in "Item
1. Business - Sunnyside".
Other income amounted to $7,809 in 1998 and consisted primarily of a gain on the
sale of the Company's land in Fayette County, Pennsylvania. Other income in 1997
amounted to $622,417 and consisted of revenue recorded as a result of the
release of certain Milesburg obligations which were payable only upon the
occurrence of events related to project development.
Income tax expense was $470,552 in 1999 as compared to an income tax benefit of
$794,945 in 1998. The effective tax rates were 44% and 33% in 1999 and 1998,
respectively. During 1998, the Company's loss before income taxes was incurred
in states which did not have available deferred tax benefits. As such, despite
the loss before income taxes in 1998, the Company paid state taxes to certain
jurisdictions which reduced its effective tax benefit to 33%.
Cumulative effect of a change in accounting principle amounted to $1,188,989 for
1999 and pertained to the Company's change in its method of accounting for major
equipment overhauls. Before 1999, the Company recorded the expense of major
equipment overhauls on a straight-line basis to a major maintenance reserve in
anticipation of future outlays for the major overhauls. Effective January 1,
1999, the Company began recording the expense of major equipment overhauls when
incurred. The newly adopted method of accounting for major equipment overhauls
is consistent with the viewpoints recently expressed by the Securities and
Exchange Commission. The increase in net earnings of $1,188,989 represents the
effect of this change on years prior to 1999 and consists of an elimination of
the Company's major maintenance reserve, which had a balance of $2,001,429 at
December 31, 1998, and the reversal of $812,440 in deferred income tax benefits.
Year ended December 31, 1998 ("1998") compared with the year ended December
31, 1997 ("1997")
Net loss in 1998 amounted to $1,649,186 or 14 cents per share as compared to net
income of $4,613,863 or 41 cents per share in 1997. The overall decrease in net
results during 1998 is primarily attributable to a write-off of certain
receivables in litigation, the absence in 1998 of the gain and other income
related to the sale of the Milesburg Project, the absence in 1998 of the
reversal of the provision for non-recovery of Milesburg project development
costs, an increase in operating expenses and a decrease in interest income. The
Company's overall decrease in net results during 1998 was offset in part by an
increase in power generation revenues and a decrease in lease expenses. The
reasons for the decrease in the Company's 1998 net results are discussed in more
detail in the following paragraphs.
Power generation revenues in 1998 amounted to $45,721,473 as compared to
$43,763,223 in 1997 and all pertained to the Scrubgrass Project. The overall
increase in power generation revenues during 1998 is primarily attributable to a
5% increase in certain rates billed to the utility under the terms of the power
purchase agreement and an increase in the capacity rate billed during 1998.
During 1998, the Scrubgrass Project operated at 87.9% of its capacity as
compared to 85.6% for the same period in 1997. The following factors contributed
principally to the differences in the Scrubgrass Project's capacity factors
billed for 1998 and 1997. First, the Scrubgrass project had its annual
maintenance outages during the second quarters in 1998 and 1997. During the 1998
outage, the Scrubgrass plant was inoperative for approximately 14 days to
perform scheduled maintenance procedures whereas the 1997 maintenance outage was
extended from 12 days to approximately 37 days to perform more extensive repairs
to the Scrubgrass generator. Second, the Scrubgrass plant was inoperative for
approximately six days during the first quarter of 1997 to consider matters
related to the generator. Third, the Scrubgrass project incurred numerous
unscheduled shutdowns during 1998 to respond to equipment malfunctions which
necessitated that the Scrubgrass plant be inoperative for an aggregate of
approximately 11 days during the second quarter, seven days during the third
quarter and five days during the fourth quarter outside of the scheduled outage
timeframe. As such, other than normal curtailments of output from the utility
21
which occurred from time to time, the Scrubgrass plant did not operate for an
aggregate of approximately 37 days and 43 days as a result of scheduled and
unscheduled shutdowns during 1998 and 1997, respectively. The aforementioned
increase in 1998 power generation revenues was offset in part by a decrease in
the revenue recorded as a result of the straight-line accounting treatment of
certain revenues under the power purchase agreement which amounted to $8,024,111
and $8,905,911 in 1998 and 1997, respectively.
Operating expenses in 1998 amounted to $19,215,459 as compared to $17,755,882 in
1997 and all pertain to the Scrubgrass Project. The overall increase during 1998
is primarily attributable to the following reasons. First, the Company incurred
higher fuel costs and higher operator fees in 1998 as a result of cost
escalations in certain operating and supply agreements. Second, the Company
incurred higher fuel expenses because the Scrubgrass plant achieved a higher
capacity rate during 1998 and realized lower average heat rates from fuel
consumption in 1998 by comparison to 1997. Third, because the Scrubgrass plant
achieved a higher capacity rate during 1998, the Company accrued higher year-end
operator bonuses during 1998 than were recorded in 1997. Fourth, although
maintenance expenses incurred during the 1997 extended outage were higher than
the Company's original expectations, the Company incurred higher maintenance
expenses in 1998 to make the necessary repairs related to the 1998 equipment
malfunctions and to accelerate its reserves for future maintenance which the
Company now expects will be performed earlier than its previous schedule.
Finally, due to salary increases and increases in the number of personnel at the
Scrubgrass project, the Company incurred higher labor and related costs in 1998.
However, the aforementioned increases in 1998 operating expenses were offset in
part because certain operating expenses were higher during 1997 by comparison to
1998 primarily for the following reasons. First, as a result of enhancements
made during 1997 to the fuel processing system at the Scrubgrass Project, the
Company realized a savings in certain routine maintenance expenses during 1998.
Second, 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. See a further discussion of
these modifications under the caption "Item 1. Business - Scrubgrass".
Lease expenses in 1998 amounted to $22,971,201 as compared to $24,488,005 in
1997 and all pertain to the Scrubgrass Project. The overall decrease in lease
expenses during 1998 is primarily due to the following three reasons. First,
because there was less cash available from the Scrubgrass Project during 1998,
the Company realized a decrease in additional rent paid to the Lessor. Second,
the scheduled principal and interest payments under the Lessor's junior
subordinated debt obligations were lower in 1998 which reduced the Lessor's loan
costs that were passed through to the Company in its facility lease expenses.
Third, the Company had a decrease in the lease expense recorded as a result of
the straight-line accounting treatment of certain lease expenses under the
Scrubgrass lease which amounted to $8,024,111 and $8,905,911 in 1998 and 1997,
respectively. The overall decrease was offset in part by an increase in the
principal payments under the Scrubgrass Project term loan which increased the
Lessor's loan costs that were passed through to the Company in its facility
lease expenses.
General and administrative expenses in 1998 amounted to $2,196,929 as compared
to $1,995,491 in 1997. The overall increase in general and administrative
expenses during 1998 is primarily attributable to the following four reasons.
First, certain labor and overhead expenses, which were capitalized in 1997 as a
result of development activities for the Milesburg project, were redirected to
operating activities during 1998. Second, the management fees for the Scrubgrass
Project increased primarily because the project manager passed along increases
in its labor costs to the Company. Third, the Company incurred pension expense
for a defined benefit pension plan which was established in 1998. Fourth, the
Scrubgrass project received a sales tax refund during 1997 which reduced general
and administrative expenses by comparison to 1998. However, the aforementioned
increases in 1998 general and administrative expenses were substantially offset
because certain general and administrative expenses were lower during 1998 by
comparison to 1997 primarily for the following five reasons. First, two
executive officers, who are also significant shareholders of the Company,
elected to repay their 1998 salaries in an amount equal to the cash benefit they
would receive from the Company's 1998 contribution to the defined benefit
pension plan. Second, the Company incurred significant legal expenses in 1997 to
review documents in the discovery phase of the Sunnyside project litigation,
which expenses were incurred to a much lesser extent during 1998. Third, while
overall management costs were higher in 1998 as discussed above, the Company
incurred significant management fees during 1997 to address the Scrubgrass
generator matter and to consider other contract related matters, which matters
either did not recur or recurred to a lesser extent in 1998. Fourth, the Company
restructured its insurance programs at its corporate office and at the
Scrubgrass Project in April 1997 which resulted in lower insurance premiums in
1998. Lastly, the Company reduced the
22
amount of certain professional fees during 1998 because it used such
professional services to a lesser extent during 1998.
Reversal of provision for nonrecovery of project development costs relates to
the Company's Milesburg project and amounted to $940,144 in 1997. As discussed
under "Item 1. Business - Milesburg", the Company sold the Milesburg project to
West Penn pursuant to a Buy-Out Agreement dated August 26, 1997. In light of
this Buy-Out Agreement, which established a value significantly in excess of the
Company's recorded carrying value for its investment in the Milesburg project,
the Company removed its reserve for the impairment in value of this investment
during 1997. The reserve was established in 1990 by a charge against earnings
due to the uncertainties surrounding whether the Company would realize value
from its investment in this project. The reversal of provision for nonrecovery
of project development costs pertains to an event which occurred in 1997 and did
not recur in 1998.
Interest income in 1998 amounted to $156,546 as compared to interest income of
$581,336 in 1997. The decrease in interest income is primarily attributable to
the absence in 1998 of interest income related to the sale of the Milesburg
Project. During 1997, pursuant to the terms of the Buy-Out Agreement dated
August 26, 1997, the Company earned 8% interest on the $15 million selling price
from August 27, 1997 until the closing date (December 5, 1997). The Company's
interest income also decreased in 1998 primarily due to lower investments in
cash and cash equivalents and less interest recognized on the Company's notes
receivable related to the 1994 sale of SCA.
Interest expense in 1998 amounted to $460,812 as compared to interest expense of
$424,395 in 1997. Interest expense increased during 1998 primarily because of
the additional long-term debt obligations for the Scrubgrass Project which were
incurred during the second quarter of 1997. The additional long-term debt
obligations, which were outstanding for a full year in 1998, consist of a $3
million term credit facility which is discussed further in the section
"--Liquidity and Capital Resources - Financing Activities" and installment debt
which financed the generator repair that is discussed further in the section
"Item 1. Business - Scrubgrass". Due to lower average outstanding borrowings in
1998, the aforementioned increase in interest expense was offset in part by a
decrease in interest incurred on the Lessee Working Capital Loan.
Write-off of receivables in litigation amounted to $3,508,498 in 1998 and
represents the 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 SCA. This write-off was discussed further in "Item
1. Business - Sunnyside".
Gain on sale of project amounted to $7,423,467 in 1997 and pertains to a gain
recognized as a result of the Company's sale of the Milesburg project. This
gain, which is discussed further in "Item 1. Business - Milesburg", pertains to
an event which occurred in 1997 and did not recur in 1998.
Other income amounted to $7,810 in 1998 and consisted primarily of a gain on the
sale of the Company's land in Fayette County, Pennsylvania. Other income in 1997
amounted to $622,417 and consisted of revenue recorded as a result of the
release of certain Milesburg obligations which were payable only upon the
occurrence of events related to project development.
Income tax benefit in 1998 amounted to $794,945, or 33% of loss before income
taxes, as compared to income tax expense of $4,103,684, or 47% of income before
income taxes, in 1997. The 1997 effective tax rate was higher by comparison to
the 1998 rate primarily because of the following reasons. First, the 1997 income
tax expense includes the effect of a permanent difference between the gain for
financial reporting purposes and the gain for tax reporting purposes on the sale
of the Milesburg project. Second, due to a second layer of state income tax
incurred on distributions received by EPC from the Scrubgrass Project, the
Company was not able to realize the full benefit of its 1998 net loss for tax
reporting purposes.
2000 Outlook
The Company expects its net earnings to improve in 2000 and offers the following
prospective information concerning significant components of its results of
operations for 2000 which are being compared to historical results of operations
for 1999:
23
Power generation revenues - Power generation revenues are expected to
increase materially in 2000 primarily as a result of a 5% increase in
certain contracted rates under the Scrubgrass power purchase agreement and
additional revenues from the settlement agreement with PENELEC. As
discussed further in Item 3. Legal Proceedings, the Company settled its
legal proceeding with PENELEC and expects to recognize revenues during 2000
which were earned in prior years. The Company expects an additional
increase in its revenue because PENELEC is expected to pay full contract
rates during 2000 for capacity in excess of 80mw.
Operating expenses - Operating expenses are expected to decrease slightly
in 2000 primarily due to lower maintenance expenses, the absence of
expenses related to Year 2000 compliance, and improvements in fuel quality.
The aforementioned decreases in operating expenses are expected to be
substantially offset by a 4% average increase in contracted rates for fuel
supply agreements, a 5% increase in contracted rates for the O&M and
anticipated increases in the Operator's labor and related costs.
Lease expenses - Lease expenses are expected to increase significantly in
2000 for the following reasons. First, the Company expects that higher
interest rates on the Lessor's tax-exempt bonds and 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 base equity rents in 2000. Third, due to
projected increases in cash from Scrubgrass Project operations, which
include revenues and interest income from the settlement agreement with
PENELEC, 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 2000. Fourth, the Lessor is presently considering
changes to the financing structure of the Scrubgrass Project that could
increase the Lessor's loan costs in 2000. However, the Lessor's junior debt
obligation was fully satisfied by the end of 1999. The absence of payments
on the junior debt obligation is expected to reduce the Lessor's loan costs
in 2000 and lessen the impact of the aforementioned increases in lease
expense. The Lessor's additional rent and the potential changes to the
financing structure of the Scrubgrass Project are discussed further under
"Liquidity and Capital Resources - Cash Flow Outlook".
General and administrative expenses - General and administrative expenses
are expected to increase during 2000 for the following reasons. First, the
Company expects its casualty insurance costs to increase in 2000 due to
changes in PG&E Gen's experience rating for all its facilities. PG&E Gen,
which receives discounts by insuring all of its power plants under one
insurance program, is expected to apportion this rate increase to all its
facilities. Second, the Company is anticipating increases in PG&E Gen's
labor and related costs. Third, PG&E Gen has expressed its intention to
begin billing the Scrubgrass Project for certain corporate level support
expenses. PG&E Gen, which has improved its ability to track support
expenses by facility, previously absorbed these expenses at the corporate
level. The Company's legal fees and Scrubgrass Project management costs are
also subject to considerable variation each year due to the demands of
legal proceedings and contract matters. As such, the Company cannot predict
the full extent of changes to general and administrative expenses.
Other income - Other income is expected to materially increase in 2000
primarily for the following two reasons. First, the Company expects to
report income of $1,161,888 in 2000 from sales of Nitrogen Oxide Ozone
Transport Region Budget Allowances ("NOx Credits"). The sales of NOx
credits are discussed further under "Item 1. Business--Scrubgrass". The
Company also expects to report interest income of approximately $608,000 in
2000 from the settlement agreement with PENELEC.
Cumulative effect of a change in accounting principle - The Company
reported income in 1999 as a result of a change in its method of accounting
for major equipment overhauls. This income will not recur in 2000.
Income tax expense - Income tax expense is expected to significantly
increase in light of anticipated increases in income before income taxes.
The Company expects its effective income tax rates for 2000 would be
comparable to the actual rates experienced in 1999.
Litigation recoveries - As of December 31, 1999, the Company is seeking to
recover approximately $4.4 million owed by the Purchasers of SCA which is
the subject of legal proceeding. See "Item 1. Business - Sunnyside" and
"Item 3. Legal Proceedings". Should this legal proceeding resolve or settle
in favor of the Company, the Company could also receive additional
financial recoveries which include supplementary
24
interest, punitive damages and reimbursements for attorney's expenses. The
Company would report any future recoveries from this legal proceeding as
additional income in its Consolidated Statement of Operations.
Recently Issued Accounting Standards
See Note B to the Consolidated Financial Statements for recently issued
accounting standards which are required to be adopted after 1999.
Liquidity and Capital Resources
Operating Activities
The Company had cash provided by operating activities of $2,752,441 and $635,735
in 1999 and 1998, respectively, and cash used by operating activities of
$1,202,561 in 1997. During all of these periods, the Company's only sources of
cash from operating activities were operating profits from the Scrubgrass
Project and investment earnings. During 1997, primarily because of the financial
impact of the generator repair at the Scrubgrass project which is discussed
further under "Item 1. Business - Scrubgrass", the Company incurred a
significant decrease in cash from its operating activities. The Scrubgrass
Project was profitable during 1999 and 1998 and contributed cash to the
Company's operating activities.
While the Company reported an overall net income of $1,777,562 during 1999, the
Company generated significant additional cash from its 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 1999 net income to its net cash
provided by operating activities.
Depreciation and amortization - During 1999, the Company recognized
depreciation and amortization for its lease rights of $149,004, deferred
financing costs of $69,222, machinery and equipment modifications of
$137,836 and equipment and furniture of $7,172.
Deferred income tax asset - The Company's net deferred income tax asset
amounted to $876,305 as of December 31, 1999 as compared to $1,826,561 as
of December 31, 1998. The decrease in the deferred tax asset is largely
attributable to the reversal of tax benefits associated with the Company's
maintenance reserves. During 1999, the Company changed its method of
accounting for maintenance expenditures and eliminated its liability for
maintenance reserves. A further discussion of the change in accounting
principle is discussed below under "Cumulative effect of a change in
accounting principle".
Cumulative effect of a change in accounting principle - Effective January
1, 1999, the Company changed its method of accounting for major equipment
overhauls to a method which is consistent with the viewpoints recently
expressed by the Securities and Exchange Commission. Previously, the
Company recorded the expense of major equipment overhauls on a
straight-line basis to a major maintenance reserve in anticipation of
future outlays for the major overhauls. Beginning in 1999, the Company
recorded the expense of major equipment overhauls when incurred. The
Company recognized the effect of this change on years prior to 1999 with an
increase to net income of $1,188,989 in 1999. This increase in net income
consists of an elimination of the Company's major maintenance reserve,
which had a balance of $2,001,429 at December 31, 1998, and the reversal of
$812,440 in deferred income tax benefits.
Deferred gain, net - The Company's deferred gain, net amounted to
$5,088,776 as of December 31, 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 $3,703,922 as of December 31, 1999
as compared to $6,598,864 as of December 31, 1998. The Scrubgrass Project
collects its receivable from utility on a monthly basis 23 business days
after the month of power generation.
25
Typically, the Company's balance sheet at the end of each quarter reflects
two months of outstanding receivables from the utility. However, because
December had 23 business days in 1999, the Company collected its revenues
for power generation in November 1999 on December 30, 1999. As such, the
Company's receivable from utility as of December 31, 1999, which included
power generation revenues for December 1999, decreased significantly by
comparison to the balance as December 31, 1998, which included power
generation revenues for November and December of 1998. The aforementioned
decrease in receivable from utility as of December 31, 1999 was offset in
part by the increases in 1999 revenues discussed above under "Results of
Operations".
Other current assets - The Company's other current assets amounted to
$645,852 as of December 31, 1999 as compared to $821,462 as of December 31,
1998. The overall decrease is largely due to the following two reasons.
First, the Company's fuel inventory decreased primarily because the
Scrubgrass project modified its fuel plan and consumed a portion of its
base level fuel inventory. Second, the Company's prepaid expenses decreased
primarily because of changes in the insurance program at the Scrubgrass
project. As a result of these changes, the Scrubgrass Project reduced it
insurance premiums and distributed its premium payments more evenly during
the year.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $4,751,906 as of December 31, 1999 as compared
to $5,773,689 as of December 31, 1998. The decrease in 1999 is primarily
attributable to the following reasons. First, due to the requirements of
certain operating agreements, the Scrubgrass Project must pay certain
accounts payable and accrued expenses on the same day it collects the
receivable from utility. As such, the Company's accounts payable and
accrued expenses had a comparable decrease to the receivable from utility
(see "Receivable from utility" above). Second, the Company had an
additional rent accrual of $223,679 as of December 31, 1998. However, due
to differences in the timing of when cash flows became available for
distribution from the Scrubgrass Project, there was no additional rent to
accrue as of December 31, 1999. The previous decreases in accounts payable
and accrued expenses were offset in part by the following items which
increased accounts payable and accrued expenses during 1999. First, the
Company's accrual for the Lessor's bond interest increased in 1999 by
approximately $584,000 largely due to longer bond maturities. Second,
corporate taxes payable increased in 1999 primarily due to improvements in
earnings. Third, the Company accrued larger bonuses to the Operator in 1999
because of improvements in the performance of the Scrubgrass Project.
Fourth, the Company realized cost escalations in various operating and
administrative contracts which increased its operating and administrative
costs in 1999.
Investing Activities
The Company used $284,623 and $277,331 in investing activities during 1999 and
1998, respectively, and received $12,206,487 from investing activities during
1997. 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 $46,062, $39,128 and
$36,129 from notes receivable related to the Scrubgrass Project in 1999,
1998 and 1997, respectively. The notes receivable related to the Sunnyside
Project, with a principal balance of $2,937,500 and uncollected interest
balance of $1,102,568 as of December 31, 1999, are the subject of a legal
proceeding. See "Item 1. Business - Sunnyside" and "Item 3. Legal
Proceedings" for further information about the Sunnyside Project and this
litigation.
Restricted cash - The Company is contractually required to make scheduled
deposits to a restricted maintenance fund for the Scrubgrass Project to
ensure that funds are available in the future for scheduled major equipment
overhauls. The Company is allowed to use restricted cash for major
equipment overhauls subject to certain restrictions. During 1999, 1998 and
1997, the Company made scheduled deposits to the restricted major
maintenance fund of $739,128, $682,275 and $644,500, respectively. During
1999, 1998 and 1997, the Company's payments for major equipment overhauls
amounted to $1,271,141, $384,057 and $796,500, respectively. The remaining
changes to restricted cash primarily pertain to investments of available
restricted cash balances. During 1997, the Company performed significant
unscheduled major equipment overhauls during its annual plant outage which
was extended because of necessary generator repairs. During 1999, the
Company had significant major equipment overhauls which were planned and
scheduled for completion during
26
the annual plant outage. Planned major equipment overhauls are performed on
a schedule which can differ widely 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 equipment
manufacturers.
Proceeds from sale of project - On December 5, 1997, the Company received
$15,000,001 for the sale of the Milesburg project. The Company's sale of
the Milesburg project is discussed further under the caption "Item 1.
Business - Milesburg".
Property, plant and equipment - The Company invested $829,117, $5,196 and
$2,987,881 in property, plant and equipment expenditures during 1999, 1998
and 1997, respectively. During 1999 and 1997, the Company made machinery
and equipment modifications at the Scrubgrass facility of $811,568 and
$125,000, respectively. The machinery and equipment modifications were made
to improve the fuel processing and air quality emission systems. During
1997, the Company accelerated its Milesburg Project development activities
and made capital expenditures of $2,852,185 (See "Item 1. Business -
Milesburg"). The balance of capital expenditures in each period were
purchases of equipment for the Company's corporate office.
Financing Activities
The Company utilized $2,524,046, $12,088,261 and $90,177 in financing activities
during the years ended December 31, 1999, 1998 and 1997, 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
$684,408 (6 cents per share), $1,026,611 (9 cents per share), and
$1,341,964 (12 cents per share) during 1999, 1998 and 1997, respectively.
The Company also declared a special dividend of $9,923,901 (87 cents per
share) in 1997 out of the proceeds from the Milesburg settlement (See "Item
1. Business - Milesburg"). The Company paid dividends to its subsidiary's
preferred stockholder of $5,000, $5,000, and $30,178 during 1999, 1998 and
1997, respectively. The preferred stockholder, entitled to cumulative
dividends of $5,000 per year since December 1991, was paid its dividend
arrearage during 1997. The Company had dividends payable of $171,102 and
$10,266,105 as of December 31, 1999 and December 31, 1997, respectively. As
such, the Company paid dividends of $518,306, $11,297,716 and $1,029,938
during 1999, 1998 and 1997, respectively.
Working Capital Loan - The Company may borrow from the Lessor up to $4
million under a Lessee Working Capital Loan Agreement for the ongoing
working capital requirements of the Scrubgrass Project. The Company made
net repayments of $395,045 under the Lessee Working Capital Loan Agreement
in 1999. As discussed under "Receivable from utility" above, the Company
collected additional revenues from PENELEC during 1999 by comparison to
1998. As a result, the Company utilized the additional cash flows from
operating activities to reduce the outstanding borrowings under the Lessee
Working Capital Loan Agreement.
27
Term Credit Facility - In June 1997, the Lessor entered into a three year
credit facility with the lenders of the Scrubgrass Project which made $3
million available to the Scrubgrass Project 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
$1,550,000 and $850,000 during 1999 and 1998, respectively, to ensure that
the outstanding borrowings would not exceed the maximum allowable
borrowings.
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 $1,028,716 and
$1,188,573, respectively as of December 31, 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 "Item
3. Legal Proceedings". The Scrubgrass Project obligation has scheduled
annual maturities which began in 1998 and continue through 2004. The
Company made its scheduled payments for the Scrubgrass Project obligation
of $60,695 and $18,543 during 1999 and 1998, respectively. Until August 26,
1997, the Company had long-term obligations related to the Milesburg
project aggregating to $5,858,767. As a result of a settlement agreement
dated August 26, 1997, the Milesburg project obligations were reduced to
$2,358,767. In addition, because certain Milesburg obligations were payable
only upon the occurrence of events related to project development,
Milesburg project obligations of $558,767 and accrued interest of $63,650
were released from liabilities during 1997 and reported as other income of
$622,417 in the accompanying Consolidated Statement of Operations. The
remainder of the Milesburg project obligations, which amounted to
$1,800,000, were paid during 1997.
Common Stock - The Company received proceeds from the issuance of its
Common Stock aggregating $124,238 during 1997. The Common Stock was issued
solely pursuant to exercises of stock options.
Cash Flow Outlook
During 2000, the Company expects the 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
"Item 1. Business - Scrubgrass", the Company is not able to receive
distributions from the Scrubgrass Project until all operating expenses, base
lease payments, certain maintenance reserve payments and other subordinated
payments of the Scrubgrass Project are satisfied. Nevertheless, the Scrubgrass
Project's cash flows in 2000 are expected to be sufficient to satisfy all of
these restrictions and provide the Company with a material increase in
distributions by comparison to 1999.
As discussed under the caption "Results of Operations - 2000 Outlook", the
Company expects that the Scrubgrass Project's cash flows in 2000 will be
enhanced by an increase in the contracted rates under the PPA, sales of NOx
Credits, and additional revenues from the settlement agreement with PENELEC.
Although, the Company expects that anticipated increases in lease expenses,
administrative expenses and income taxes would consume a portion of these
additional revenues. The Company also believes that the Scrubgrass Project's
cash flows would continue to be affected by certain debt and maintenance
payments. According to certain agreements, the Scrubgrass Project is expected to
make scheduled payments in 2000 of $700,000 for debt and $678,527 for deposits
to restricted cash.
As discussed under the caption "Certain Factors That May Affect Future
Results--Environmental Regulation", the Scrubgrass Project needed to achieve
certain seasonal NOx emission levels beginning on May 1, 1999, and will also be
required to achieve reduced emission standards by May 2003. Due to the efficient
design of the Scrubgrass facility, the Scrubgrass Project met the new 1999
requirements without any modifications to the Facility. However, the Company
made capital improvements of $811,568 in 1999 to the Facility, which are
expected to enable the Facility to meet the stricter standards in 2003. By
making improvements to the Facility before 2003, the Company anticipated that it
would not require a portion of its future NOx Credits to maintain its compliance
with the applicable regulations. Consequently, the Company sold its anticipated
excess NOx Credits and used the proceeds to finance the capital improvements and
generate additional working capital. The Company expects to comply with all
28
material environmental regulations for the foreseeable future without any
additional material modifications to the Scrubgrass facility. The sales of NOx
Credits are discussed further under "Item 1. Business - Scrubgrass".
During 1999, PG&E Gen commenced long-term refinancing discussions with the
lending agents for the Scrubgrass Project. Through these discussions, PG&E Gen
expects to address several changes in the Scrubgrass Project's financing
structure that are expected to occur over the next few years. First, the
tax-exempt bond letter of credit expires in December 2000 and would need to be
replaced. Second, Buzzard is expected to pay the balance of its Lessee Working
Capital Loan to zero for a minimum of 20 days during 2001 and 2002. Third,
Buzzard's Lessee Working Capital Loan commitment expires in December 2002.
Fourth, PENELEC's contracted payment terms will be extended by 24 days beginning
in July 2003, which is expected to create the need for additional working
capital. Fifth, based on recent market trends, PG&E Gen believes there may be
better ways to manage the Scrubgrass Project's interest rate risk. The Company
believes that the Scrubgrass Project has demonstrated its ability to satisfy its
existing financial obligations and expects it could demonstrate an ability to
satisfy any proposed changes to its financing structure. As such, the Company
expects PG&E Gen could negotiate favorable terms for the financing structure at
the Scrubgrass Project. However, the Scrubgrass Project might incur additional
fees to extend or originate new financing commitments. At this time, the Company
cannot predict the impact that refinancing discussions would have on its future
results of operations or financial position.
As of December 31, 1999, the Company is seeking to recover approximately $4.4
million owed by the Purchasers of SCA (See "Item 1. Business - Sunnyside" and
"Item 3. Legal Proceedings"). The Company is also seeking additional financial
recoveries which include supplementary interest, punitive damages and/or
reimbursements for attorney's expenses. As discussed under "--Financing
Activities--Notes payable", the Company would be required to utilize a portion
of these recoveries to satisfy certain obligations of the Sunnyside Project. The
Company believes its position in this litigation is meritorious and, should the
litigation resolve or settle in favor of the Company, the Company's financial
position could be materially enhanced in the future. However, there can be no
assurance that the litigation will resolve or settle in favor of the Company.
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. As discussed in "Item 5. --Market For
Registrant's Common Equity and Related Shareholder Matters--Dividends", in
response to changes to its cash position, the Company reduced its quarterly
dividend in September 1998 from 3 cents per share to 1.5 cents per share.
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 the meantime, the Company's
cash flows continue to be affected by substantial corporate tax payments as well
as considerable professional fees for the Sunnyside litigation.
The Company is optimistic about the future performance of the Scrubgrass Project
which is currently expected to achieve significant earnings and cash flows on an
annual basis for the foreseeable future. The PPA 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 expects that the additional revenues from the
PENELEC legal settlement and the sales of NOx Credits would also materially
enhance its cash position in 2000. Notwithstanding, the Company will continue to
be affected by its obligations for corporate taxes and professional fees.
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 "Item 5. Market for Registrant's
Common Equity and Related Shareholder Matters--Dividends" and "--Certain Factors
That May Affect Future Results" below.
29
Year 2000 Readiness
General
The Company addressed the issue of Year 2000 Readiness ("the Y2K Project") and
completed all its procedures by November 1999. The Company's procedures for the
Y2K Project 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 replacement or improvement of IT Systems and
Non-IT Systems which were not Year 2000 compliant, and a solicitation of
responses from all critical vendors, customers and business partners indicating
their readiness for the Year 2000. To date, the Company has not experienced any
problems with its IT Systems or Non-IT systems which are related to the Y2K
Project.
The Company secured responses from most critical vendors and business partners
indicating their readiness for the Year 2000. Based on these responses, the
Company has not identified any conditions of potential non-compliance which the
Company estimates would materially impact its business. To date, the Company has
not experienced any problems with its critical vendors and business partners
which are related to the Y2K Project.
Costs
The Company incurred cumulative costs to complete the Y2K Project of $292,860
which were all funded by its operating cash flows. The Company does not expect
to incur any additional costs for the Y2K Project.
Risks and Contingency Plans
The Company developed a contingency plan which describes the steps the Company
would take if problems resulted from the Y2K Project. The Company has not
experienced and is not expecting any material problems related to the Y2K
Project. However, should unforeseen problems develop in the future, the Company
will address these problems using its contingency plan.
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 completed procedures it deemed prudent to understand its Year 2000 risks
and understand the extent to which third parties who failed to ensure they were
ready for the Year 2000 could impact its business. However, there can be no
assurance that all non-compliant systems or system components were identified.
It is also conceivable that the Company may later discover that a failure by a
third party to be Year 2000 compliant has impacted its business. However, by
completing the Y2K Project, the Company believes it has mitigated the risk that
any of the aforementioned items would occur and 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 Annual Report on Form 10-K.
Ownership of Single Operating Asset
The Company owns a 22 year leasehold interest in the Scrubgrass Project, an
approximate 83 Mw (net) waste coal-fired electric generating facility located in
Pennsylvania, the lease for which commenced on June 30, 1994. Presently, all the
Company's operating revenues are attributable to power generation from the
Scrubgrass Project. Accordingly, the Company's operations are largely dependent
upon the successful and continued operation of the Scrubgrass Project. In
particular, if the Scrubgrass Project experiences unscheduled shutdowns of
significant duration, the Company's results of operations will be materially
adversely affected.
30
Dependence Upon Key Employees
The success of the Company is largely dependent upon a staff of three full-time
executive officers and two part-time employees. The loss of any of the Company's
executive officers could adversely effect the Company's operations.
Third Party Project Management
The Company has a management services agreement with PG&E Gen to manage the
Scrubgrass Project and a 15-year operations and maintenance agreement with PG&E
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 PG&E Gen and the 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 "Item 1. Business - Sunnyside" and "Item 3. Legal Proceedings",
the Company is involved in a legal proceeding with the purchasers of the
Company's interest in the Sunnyside Project which was sold in 1994. Pending the
resolution of the legal proceeding, the purchasers have withheld scheduled
payments of principal and interest due on the promissory notes since June 1996,
which amounted to $2,937,500 and $1,102,568, respectively as of December 31,
1999. The balance of a purchase price closing adjustment is also being disputed
in the legal proceeding with the purchasers. To date, the Company's available
cash and cash provided by operating activities has been sufficient to fund the
Company's investing and financing activities. Nevertheless, the professional
fees incurred to defend its position in the litigation and the withholding of
scheduled principal and interest payments on the promissory notes have adversely
affected the Company's financial position. 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 continue to 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
and financial position.
Financial Results
To date the Company has incurred substantial losses, primarily due to its
development activities, which have resulted in an accumulated deficit of
$4,330,121 as of December 31, 1999. While the Company was profitable from
operating activities during 1999 and 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.
31
Potential Liability, Damages and Insurance
The Company's power generation activities involve significant risks to the
Company for environmental damage, equipment damage and failures, personal injury
and fines and costs imposed by regulatory agencies. In the event a liability
claim is made against the Company, or if there is an extended outage or
equipment failure or damage at the Company's power plant for which it is
inadequately insured or subject to a coverage exclusion, and the Company is
unable to defend such claim successfully or obtain indemnification or warranty
recoveries, there may be a material adverse effect on the Company.
Circulating Fluidized Bed Technology
The Company's Scrubgrass Project employs circulating fluidized bed technology to
produce electricity. Certain aspects of this technology, as well as the
conversion of waste products into electricity, are relatively new areas being
explored by the alternative energy market in the last 15 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:
Balance at Matures
Description of the Obligation 12/31/99 Interest Rate Through
- -----------------------------------------------------------------------------------------------------------------
Lessor debt obligations:
Variable-rate tax exempt bonds $ 135,600,000 Quoted Tax Exempt Bond Rate 2012
Variable rate term loan 14,412,000 Fixed swap rate of 6.4225% 2005
Variable rate term loan 10,061,427 LIBOR rate plus 1.250% 2004
Buzzard debt obligations:
Variable rate working capital loan 1,994,619 LIBOR rate plus 1.125% Revolving
Variable rate term loan 1,188,573 LIBOR rate plus 1.250% 2004
Variable rate term credit facility 600,000 LIBOR rate plus 1.125% 2000
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%. As such,
except for the Lessor's term loan which matures in 2005, the Company will be
required to fund debt service consisting of rates which will vary with market
conditions. Presently, the Company is not able to predict how future interest
rates will affect its debt or lease obligations. Should market interest rates
rise significantly, the Company's operating results may be significantly
impacted. Notwithstanding, the Company believes the Lessor has good
relationships with the project lenders who would continue to support lending
terms which would not have a material adverse affect on the operating results of
the Scrubgrass Project. However, there can be no assurance that the Lessor could
renegotiate its credit facilities under terms which would ensure continuing
profitable operating results of the Scrubgrass Project. See Notes H, I and M of
the accompanying Consolidated Financial Statements for further information about
the Company's debt and lease obligations.
32
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 or 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, as discussed under
the caption "Energy Markets", the electric industry has been previously affected
by legislation such as PURPA and the Energy Act which have encouraged companies
other than utilities to enter the electric power business by reducing regulatory
constraints. More recently, as discussed under the caption "Energy Regulation",
there has been new state legislation to deregulate the generation component of
the electric business. Furthermore, proposed changes to repeal or modify PUHCA
and PURPA could reduce regulatory restrictions placed on electric utilities and
encourage them to seek new sources of electric power. Any of these regulatory
matters, among others, could increase competition for electric power. Other than
the risk that PENELEC would seek to renegotiate the terms of the Scrubgrass
power purchase agreement (see further discussion under the caption "Energy
Regulation"), the Company does not believe the Scrubgrass Project would be
significantly impacted by competition in the wholesale energy market since its
revenues are subject to contracted rates which are substantially fixed for
several years. However, the contracted rates in the later years of the
Scrubgrass power purchase agreement switch to rates which vary more closely with
existing market conditions. Should ensuing competition in the later years of the
Scrubgrass power purchase agreement create downward pressure on wholesale energy
rates, the Company's profitability could be impacted.
In previous years, the Company competed 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. As a result, the Company is not actively
pursuing new development opportunities at this time.
33
Presently, there is significant merger and consolidation activity occurring in
the electric industry. Recently, the Company engaged an investment consultant to
consider any sale or merger proposals and other strategic alternatives that may
present an opportunity to enhance shareholder value. There can be no assurance
that any transaction will result from this engagement.
Energy Regulation
The Company's projects are subject to regulation under federal and state energy
laws and regulations. The Company's facilities are either self-certified as a
Qualifying Facility under the PURPA, or formally certified as a Qualifying
Facility by the Federal Energy Regulatory Commission ("FERC"). Pursuant to
PURPA, FERC has promulgated regulations which exempt certain Qualifying
Facilities from the Federal Power Act of 1920, PUHCA, and, except under certain
limited circumstances, state laws regulating the rates charged by electric
utilities. In order to qualify under PURPA, the Company's facilities must meet
certain size, fuel and ownership requirements and/or co-generate. In addition to
the regulation of Qualifying Facilities, PURPA requires that electric utilities
purchase electric energy produced by qualifying facilities at negotiated rates
or at a price equal to the incremental or avoided cost that would have been
incurred by the utility if it were to generate the power itself or purchase it
from another source. The Company is not presently subject to regulation under
PUHCA and does not presently intend to engage in any activities that would cause
it to be so regulated.
The Company believes that changes in PURPA, PUHCA and other related federal
statutes could occur in the next several years. The nature and impact of such
changes on the Company's projects is unknown at this time. Presently, there are
several legislative proposals pending in Congress which suggest a comprehensive
restructuring of the electric utility industry. These proposals advocate, among
other things, retail choice for all utility customers, the opportunity for
utilities to recover their prudently incurred stranded costs in varying degrees,
and the repeal of both PURPA and PUHCA. In April 1999, the Clinton
administration also introduced the Comprehensive Electricity Competition Act,
which proposes a flexible mandate for customer choice by January 1, 2003,
reliability standards, environmental provisions, and the repeal of both PURPA
and PUHCA. The flexible mandate gives individual states the option to seek
alternative policies which appear to better serve their consumers. If PURPA is
amended or repealed, 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
34
increase their own generation of electricity. "Stranded costs" generally are
electric generation-related costs that traditionally would be recoverable in a
regulated environment but may not be recoverable in a competitive electric
generation market. As such, PENELEC filed a proposed restructuring plan in 1997
with the PUC which was heavily contested by a number of affected parties.
Eventually, the litigation resulted in a settlement which was approved by the
PUC on October 20, 1998, and which satisfied all but one of the litigants. This
settlement set forth a comprehensive plan for restructuring PENELEC's service
and for ensuring there would be competition for electric generation for all of
PENELEC's customers beginning on January 1, 1999. The settlement is currently
being appealed in the Commonwealth Court of Pennsylvania by the party which
opposed such settlement. However, the Company presently does not anticipate that
such appeal will have a significant effect, if any, on PENELEC's restructuring
plan as far as that plan affects the Scrubgrass Project. Most pertinently, the
restructuring plan, as approved by the PUC, provided for PENELEC to maintain a
separate non-utility generator cost recovery mechanism for accounting purposes.
Therefore, the restructuring plan is designed, in pertinent part, to enable
PENELEC to recover all of its costs from non-utility generators such as the
Scrubgrass plant and should serve to decrease the pressure on PENELEC to
renegotiate existing power contracts with non-utility generators.
Presently, neither the Customer Choice Act (and PENELEC's restructuring plan
filed thereunder), nor proposed legislation directly impacts the Company, since
the legislation and restructuring plan pertain to the retail market or new
contracts in the wholesale market. However, as discussed above, the Company
could possibly be impacted in the future by, among other things, increases in
competition as a result of deregulation, or the chance that PENELEC would
attempt to renegotiate the existing power contract. The Company is actively
monitoring these developments in energy proceedings in order to evaluate the
impact on its projects.
Environmental Regulation
The Company's projects are subject to various federal, state and local
regulations pertaining to the protection of the environment, primarily in the
areas of water and air pollution. In many cases, these regulations require a
lengthy and complex process of obtaining and maintaining licenses, permits and
approvals from federal, state and local agencies. The Company also has
significant administrative responsibilities to monitor its compliance with the
regulations. 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 the applicable
requirements could require modifications to operating facilities. During periods
of non-compliance, the Company's operating facilities may be forced to shutdown
until the compliance issues are corrected. The Company is responsible for
ensuring the compliance of its facilities with all the 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. The Company believes the Scrubgrass Project, its only
operating project, is currently in compliance with all material applicable
environmental regulations. The Scrubgrass Project most notably has been affected
by the following environmental regulations:
Air Quality - The Scrubgrass Project is subject to air quality regulations
under the Federal Clean Air Act of 1970 (CAA). CAA Title I established
National Ambient Air Quality Standards (NAAQS) for certain pollutants
including ozone, sulfur dioxide, nitrogen dioxide, particulate matter,
carbon monoxide and lead. In particular, CAA Title I established the
Northeast Ozone Transport Region, which includes 12 northeast states and
the District of Columbia, to address the transport of these pollutants
which may lead to the non-attainment of the ozone NAAQS in the Northeast.
Ozone control is facilitated by the control of pollutant precursors, which
are nitrogen oxides (NOx) and volatile organic compounds. Electric
generating facilities that use fossil fuels, including the Scrubgrass
facility, are considered major sources of NOx emissions. In recent years,
the Pennsylvania Department of Environmental Protection (PaDEP) established
regulations that required companies with stationery sources of NOx
emissions to establish plans to reduce their NOx emissions. To administer
these regulations, the PaDEP began allocating Nitrogen Oxide Ozone
Transport Region Budget Allowances ("NOx Credits") to facilities based on
numerous factors including the design and operation of each facility. A
market-based trading system was established to allow companies with excess
NOx Credits to trade with companies that required additional NOx Credits to
meet the stricter requirements. More recently, an Ozone Transport
Commission (OTC) established certain inner and outer zones with seasonal
NOx emission reductions that required the Scrubgrass Project to achieve
certain targeted NOx emission levels beginning on May 1, 1999. Under the
OTC's requirements, the Scrubgrass Project will also be required to achieve
reduced
35
emission standards by May 2003. Due to the efficient design of the
Scrubgrass facility, the Scrubgrass Project met the new 1999 requirements
without any modifications to the facility. However, the Company made
capital improvements of $811,568 in 1999 to the Scrubgrass facility, which
are expected to enable the Scrubgrass facility to meet the stricter
standards in 2003. The Company expects to meet the NAAQS for sulfur
dioxide, nitrogen dioxide, particulate matter, carbon monoxide and lead for
the foreseeable future without any additional material modifications to the
Scrubgrass facility.
Waste Disposal - The Scrubgrass Project must also comply with various
environmental regulations pertaining to the handling and disposal of
hazardous and non-hazardous wastes. The PaDEP establishes classifications
for wastes and requires companies to follow certain handling and disposal
procedures for each waste classification. Currently, the Scrubgrass Project
employs special handling procedures for the transportation of its fuel,
which is classified as a waste, from the waste sites to the Scrubgrass
facility. The fuel is burned in the Scrubgrass facility where it is treated
with various substances such as limestone during the electric generation
process. Ash, which is a byproduct of the electric generation process, is
removed from the Scrubgrass facility and returned to the original waste
site where it is reclaimed with the soil. Under existing regulations, ash
is not classified as a hazardous waste. However, various environmental
organizations have recently been lobbying for changes to the applicable
regulations for the classification of ash. If there are changes to the
waste classification of ash, the Company's ash disposal costs may
significantly increase which could have material adverse affect on the
Company's results of operations and financial position.
Item 7A. 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 of less. Because of the short
duration of these investments, the Company does not believe its short-term
investments are subject to material market risk.
Debt - The Company has borrowings which bear interest at variable rates
which are based on the London Interbank Offering Rate (LIBOR). The Company
monitors market conditions for interest rates and, from time to time,
enters into interest rate swaps to manage its interest payments. The
interest rate swaps have the effect of converting the variable rate
borrowings to fixed rate borrowings for specified time periods. For further
information on the Company's interest rate risk, refer to "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Certain Factors That May Impact Future Results -- Interest
Rates".
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 Gen 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 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Certain Factors That May
Impact Future Results -- Interest Rates".
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements listed in the following Index to Financial Statements
are filed as a part of this annual report under Item 14 - Exhibits, Index to
Financial Statements, and Reports on Form 8-K.
36
Index to Financial Statements
Page
----
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
Independent Auditors' Report F-1
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-2
Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 F-3
Consolidated Statements of Shareholders' (Deficit) Equity for the Years Ended
December 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 F-5
Notes to Consolidated Financial Statements F-6
Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
37
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS
Information with respect to the directors of the Company may be found in the
section captioned "Occupations of Directors" appearing in the definitive Proxy
Statement to be delivered to shareholders in connection with the Annual Meeting
of Shareholders to be held on June 27, 2000. Such information is incorporated
herein by reference.
The executive officers of the Company are as follows:
Name Age Position
---- --- --------
Joseph E. Cresci 57 Chairman and Chief Executive Officer
Donald A. Livingston 57 President and Chief Operating Officer
William D. Linehan 34 Treasurer, Secretary and Chief Financial Officer
Officers are elected annually by the Board of Directors and serve at the
discretion of the Board.
Joseph E. Cresci, a founder of the Company, has served as Chairman and Chief
Executive Officer since the Company's inception in 1982, as Treasurer of the
Company from its inception until September 1987 and as President from inception
until September 1991. From 1976 to 1982, Mr. Cresci was President and Chief
Executive Officer of G.E. Stimpson Co., Inc. and Stimpson Systems, Inc., a
distributor of office and printing products. From 1972 to 1975, Mr. Cresci was
President of Ogden Recreation, Inc., a subsidiary of Ogden Corp. (NYSE) where he
was responsible for the operation of racing facilities, a hotel/resort, a
parking company and a promotions company providing services to large crowd
facilities. Mr. Cresci was Executive Vice President and Chief Operating Officer
of Garden State Racing Association from 1969 to 1972. From 1967 to 1969, he was
an associate lawyer with the Philadelphia law firm of Townsend, Elliott and
Munson. Mr. Cresci holds a B.A. degree from Princeton University and a law
degree from Cornell Law School and is a member of the Pennsylvania and
Massachusetts Bar Associations.
Donald A. Livingston, a founder of the Company, has served as President and
Chief Operating Officer since September 1991, and as Executive Vice President
from the Company's inception until September 1991. From 1974 to 1982, Mr.
Livingston was President and Chief Executive Officer of Green Mountain
Outfitters, Inc., a manufacturer and distributor of large plastic parts. During
the three previous years, he was a partner in the financial services firm of
Capital Resources, Inc., where he was involved in obtaining debt and equity
funds, and negotiating mergers and acquisitions. Mr. Livingston was a registered
representative in the retail stock brokerage business with Baxter, Blyden and
Selheimer from 1967 to 1971 and Bellamah, Neuhauser & Barrett from 1965 to 1967.
William D. Linehan has served as Treasurer, Secretary and Chief Financial
Officer of the Company since March 29, 1996. Prior to his employment with the
Company, Mr. Linehan was most recently employed since 1993 as manager in the
audit and consulting practice of Moody, Cavanaugh and Company, where he
specialized in providing audit, tax advisory and business consulting services to
closely-held corporations. From 1991 to 1993, Mr. Linehan was the Controller of
Technology Procurement, Inc. and later the Secretary and Treasurer of Computer
Finance and Rental, Inc., a corporation formed in 1993 after a corporate
reorganization of Technology Procurement, Inc., where he was responsible for
managing the accounting and financial activities of these corporations, which
both were distributors and lessors of computer equipment and related peripheral
products. From 1987 to 1991, Mr. Linehan was employed in the middle market audit
and consulting practice of KPMG Peat Marwick, where he advanced to the position
of supervisor and specialized in providing audit and management advisory
services to publicly-traded and privately-held growth companies. Mr. Linehan,
who received a Bachelor of Science Degree in Accountancy from Bentley College in
1987, is a Certified Public Accountant in the Commonwealth of Massachusetts and
a member of the American Institute of Certified Public Accountants and
Massachusetts Society of Certified Public Accountants.
38
Item 11. EXECUTIVE COMPENSATION
Information with respect to this item may be found in the section captioned
"Compensation and Other Information Concerning Directors and Officers" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held on June 27, 2000. Such
information is incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item may be found in the sections captioned
"Principal Holders of Voting Securities" and "Election of Directors" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held on June 27, 2000. Such
information is incorporated herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item may be found in the section captioned
"Compensation and Other Information Concerning Directors and Officers" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held on June 27, 2000. Such
information is incorporated herein by reference.
39
PART IV
Item 14. INDEX TO FINANCIAL STATEMENTS, EXHIBITS, AND REPORTS ON FORM 8-K
The following documents are filed as part of this annual report:
(a)1. Consolidated Financial Statements
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
Page
----
Independent Auditors' Report F-1
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-2
Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 F-3
Consolidated Statements of Shareholders' (Deficit) Equity for the Years Ended
December 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 F-5
Notes to Consolidated Financial Statements F-6
(a)2. Financial Statement Schedules
The Company is not required to file any financial statement schedules which are
outlined in Article 5 of the Securities and Exchange Commission regulations.
(a)3. Exhibits
The following Exhibits are included in this report:
Exhibit Incorporation
Number Description Reference
------ ----------- ---------
3.01 Certificate of Incorporation, as amended. A
4.02 Bylaws of the Registrant, as amended.
10.01 Joint Development Agreement among Milesburg Energy, Inc., U.S. Gen and E
Environmental Power Corporation dated July 30, 1996 (a written request for
confidential treatment of certain proprietary information in this agreement
has been filed with the United States Securities and Exchange Commission)
10.12 Stock Purchase Agreement for 20,000 shares of common stock of Milesburg F
Energy, Inc., between Environmental Power Corporation and Neil W. Hedrick,
Richard Mase and Sylvia B. Mase, dated April 30, 1987.
10.13 Non-resource Secured Note of Environmental Power Corporation to Neil W. F
Hedrick, Richard Mase and Sylvia B. Mase for $220,000, dated April 30, 1987.
10.14 Non-resource Secured Note of Environmental Power Corporation to Neil W. F
Hedrick, Richard Mase and Sylvia B. Mase for $4,900,000, dated April 30,
1987.
10.15 Note of Milesburg Energy, Inc., to Antrim Mining, Inc., for $41,000, dated F
April 30, 1987.
40
10.16 Note of Milesburg Energy, Inc., to Richard Mase and Sylvia B. Mase for F
$139,000, dated April 30, 1987.
10.17 Electric Energy Purchase Agreement between West Penn Power Company and F
Milesburg Energy, dated February 25, 1987.
10.18 Agreement for the Sale of Electric Energy from the Scrubgrass F
Generating Plant by and between Pennsylvania Electric Company and
Scrubgrass Power Corporation dated August 7, 1987 which was
assigned by Scrubgrass Power Corporation to Scrubgrass Generating
Company, L.P. on December 15, 1990 and assigned by Scrubgrass
Generating Company, L.P. to Buzzard Power Corporation on June 17,
1994.
10.19 Supplemental Agreement for the Sale of Electric Energy from the Scrubgrass F
Generating Plant by and between Pennsylvania Electric Company and
Scrubgrass Power Corporation dated February 22, 1989, as amended by letter
agreement dated March 28, 1989, which was assigned by Scrubgrass Power
Corporation to Scrubgrass Generating Company, L.P. on December 15, 1990 and
assigned by Scrubgrass Generating Company, L.P. to Buzzard Power
Corporation on June 17, 1994.
10.20 Second Supplemental Agreement for the Sale of Electric Energy from the F
Scrubgrass Generating Plant by and between Pennsylvania Electric
Company and Scrubgrass Power Corporation dated September 27, 1989
which was assigned by Scrubgrass Power Corporation to Scrubgrass
Generating Company, L.P. on December 15, 1990 and assigned by
Scrubgrass Generating Company, L.P. to Buzzard Power Corporation on
June 17, 1994.
10.21 Third Supplemental Agreement for the Sale of Electric Energy from the F
Scrubgrass Generating Plant by and between Pennsylvania Electric
Company and Scrubgrass Power Corporation dated August 13, 1990 which
was assigned by Scrubgrass Power Corporation to Scrubgrass Generating
Company, L.P. on December 15, 1990 and assigned by Scrubgrass
Generating Company, L.P. to Buzzard Power Corporation on June 17,
1994.
10.22 Amendment to the Third Supplemental Agreement for the Sale of Electric F
Energy from the Scrubgrass Generating Plant by and between
Pennsylvania Electric Company and Scrubgrass Power Corporation dated
November 27, 1990 which was assigned by Scrubgrass Power Corporation
to Scrubgrass Generating Company, L.P. on December 15, 1990 and
assigned by Scrubgrass Generating Company, L.P. to Buzzard Power
Corporation on June 17, 1994.
10.23 Letter Agreement dated December 20, 1990 amending the Agreement for the F
Sale of Electric Energy from the Scrubgrass Generating Plant by and between
Pennsylvania Electric Company and Scrubgrass Power Corporation dated August
7, 1987, as amended and supplemented from time to time through November 27,
1990, which was assigned by Scrubgrass Power Corporation to Scrubgrass
Generating Company, L.P. on December 15, 1990 and assigned by Scrubgrass
Generating Company, L.P. to Buzzard Power Corporation on June 17, 1994.
10.57 1990 Stock Plan with forms of Incentive Stock Option Agreement and F
Non-Qualified Stock Option Agreement.
41
10.60 Management Services Agreement by and between Scrubgrass Generating Company, F
L.P. and PG&E-Bechtel Generating Company dated December 15, 1990 which was
assigned by Scrubgrass Generating Company, L.P. to Buzzard Power
Corporation on June 17, 1994. PG&E-Bechtel Generating Company has assigned
its rights to this agreement ultimately to U.S. Gen. Exhibit A to this
agreement was omitted because it was previously filed as Exhibit 10.67.
10.61 Agreement for Operation and Maintenance of the Scrubgrass Cogeneration F
Plant between Scrubgrass Generating Company, L.P. and Bechtel Power
Corporation dated December 21, 1990 which was assigned by Scrubgrass
Generating Company, L.P. to Buzzard Power Corporation on June 17, 1994.
Bechtel Power Corporation has assigned its rights to this agreement
ultimately to U.S. Operating Services Company.
10.62 First Amendment to the Agreement for Operation and Maintenance of the F
Scrubgrass Cogeneration Plant between Buzzard Power Corporation and U.S.
Operating Services Company dated December 22, 1995.
10.67 Appendix I to the Amended and Restated Participation Agreement, dated D
as of December 22, 1995, among Buzzard Power Corporation, Scrubgrass
Generating Company, L.P., Environmental Power Corporation, Bankers
Trust Company and Credit Lyonnais, which Appendix defines terms used
and not otherwise defined in other contracts.
10.70 Stock Pledge Agreement, dated December 19, 1991, between Environmental J
Power Corporation and Scrubgrass Generating Company, L.P.
10.71 Amended and Restated Participation Agreement, dated as of December 22, D
1995, among Buzzard Power Corporation, Scrubgrass Generating Company, L.P.,
Environmental Power Corporation, Bankers Trust Company and Credit Lyonnais.
10.72 Amendment No. 1, dated as of May 22, 1997, to the Amended and Restated G
Participation Agreement, dated as of December 22, 1995, among Buzzard Power
Corporation, Scrubgrass Generating Company, L.P., Environmental Power
Corporation, Bankers Trust Company and Credit Lyonnais.
10.73 Director Option Plan.
10.80 Amended and Restated Lease Agreement between Scrubgrass Generating Company, F
L.P., a Delaware limited partnership, as Lessor, and Buzzard Power
Corporation, a Delaware corporation, as Lessee, dated as of December 22,
1995. Schedules and similar attachments listed in the Lease have been
omitted and the Company agrees to furnish supplementally a copy of any
omitted schedule or attachment to the Securities and Exchange Commission
upon request.
10.81 Purchase and Sale Agreement by and among NRG Sunnyside Inc. and B&W C
Sunnyside L.P. and Kaiser Systems, Inc., Kaiser Power of Sunnyside, Inc.,
Sunnyside Power Corporation and Environmental Power Corporation, dated
December 31, 1994. Schedules and similar attachments of the Purchase and
Sale Agreement have been omitted; the Company agrees to furnish
supplementally a copy of any omitted schedule to the Securities and
Exchange Commission upon request.
10.82 Lease between Meadow Holdings Corporation and Environmental Power F
Corporation, dated February 20, 1996.
42
10.83 Amended and Restated Disbursement and Security Agreement between Scrubgrass F
Generating Company, L.P., as Lessor, Buzzard Power Corporation, as Lessee,
Bankers Trust Company as Disbursement Agent and Credit Lyonnais acting
through its New York Branch as Agent, dated as of December 22, 1995.
Schedules and similar attachments listed in this agreement have been
omitted and the Company agrees to furnish supplementally a copy of any
omitted schedule or attachment to the Securities and Exchange Commission
upon request.
10.84 Amended and Restated Lessee Working Capital Loan Agreement between F
Scrubgrass Generating Company, L.P., as Lender, and Buzzard Power
Corporation, as Lessee, dated as of December 22, 1995.
10.85 Amendment No. 1, dated as of May 22, 1997, to the Amended and Restated G
Disbursement and Security Agreement between Scrubgrass Generating Company,
L.P., as Lessor, Buzzard Power Corporation, as Lessee, Bankers Trust
Company as Disbursement Agent and Credit Lyonnais acting through its New
York Branch as Agent, dated as of December 22, 1995.
10.86 Debt Service (Tranche A) Loan Note, dated June 3, 1997, to Credit Lyonnais G
acting through its New York Branch, as Bank, from Scrubgrass Generating
Company, L.P., as Borrower.
10.87 Debt Service (Tranche B) Loan Note, dated June 3, 1997, to Credit Lyonnais G
acting through its New York Branch, as Bank, from Scrubgrass Generating
Company, L.P., as Borrower.
10.88 Debt Service (Tranche B) Loan Note, dated June 3, 1997, to National G
Westminster Bank acting through its New York Branch, as Bank, from
Scrubgrass Generating Company, L.P., as Borrower.
10.89 Buy-Out Agreement, dated as of August 26, 1997, between West Penn H
Power Company and Milesburg Energy, Inc.
10.90 Letter Agreement, dated as of August 26, 1997, among Environmental Power I
Corporation, Richard Mase, Sylvia B. Mase, Neil W. Hedrick and Antrim
Mining, Inc.
10.91 Amendment No. 2, dated as of September 2, 1998, to the Amended and Restated K
Participation Agreement, dated as of December 22, 1995, among Buzzard Power
Corporation, Scrubgrass Generating Company, L.P., Environmental Power
Corporation, Bankers Trust Company and Credit Lyonnais.
10.92 Amendment No. 1, updated as of October 9, 1998, to the Amended and Restated K
Disbursement and Security Agreement between Scrubgrass Generating Company,
L.P., as Lessor, Buzzard Power Corporation, as Lessee, Bankers Trust
Company as Disbursement Agent and Credit Lyonnais acting through its New
York Branch as Agent, dated as of December 22, 1995.
10.93 Amendment No. 1, dated as of June 1, 1996, but not executed until July 24, K
1998, to the Amended and Restated Lease Agreement between Scrubgrass
Generating Company, L.P., a Delaware limited partnership, as Lessor, and
Buzzard Power Corporation, a Delaware corporation, as Lessee, dated as of
December 22, 1995.
10.94 Lease between Adams Realty Trust and Environmental Power Corporation, dated K
January 26, 1999.
10.95 Settlement Agreement and Release between GEC Alsthom International, Inc. K
and Buzzard Power Corporation dated May 28, 1998.
43
10.96 Purchase and Sale Agreements, dated as of December 16, 1998, January 4, K
1999 and January 8, 1999, between PG&E Energy Trading - Power, L.P. and
Buzzard Power Corporation pertaining to Nitrogen Oxide Ozone Transport
Region (NOx) Budget Allowances
10.97 Environmental Power Corporation Medical Expense Reimbursement Plan K
effective as of September 1, 1998 and dated as of December 18, 1998
10.98 Environmental Power Corporation Defined Benefit Pension Plan effective as K
of January 1, 1998 and dated as of December 23, 1998
10.99 Settlement Agreement, dated August 3, 1999 and effective February 27, 2000,
among Buzzard Power Corporation, Scrubgrass Generating Company L.P. and
Pennsylvania Electric Company.
11 Computation of Earnings per Share
18 Letter regarding change in accounting principle from independent auditors
21 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
27 Financial Data Schedule
99.01 Order of Pennsylvania Public Utility Commission in connection with F
Milesburg Energy, Inc., adopted September 21, 1989.
Incorporation References:
A Previously filed as part of Registration Statement No. 33-9808 (the
"Registration Statement"), filed with the Securities and Exchange
Commission on October 28, 1986.
C Previously filed as part of the Company's Report on Form 10-K for the year
ended December 31, 1994.
D Previously filed as part of the Company's Report on Form 10-K for the year
ended December 31, 1995.
E Previously filed as part of the Company's Report on Form 10-Q for the
period ended September 30, 1996.
F Previously filed as part of the Company's Report on Form 10-K for the year
ended December 31, 1996.
G Previously filed as part of the Company's Report on Form 10-Q for the
period ended June 30, 1997.
H Previously filed as part of the Company's Report on Form 8-K dated as of
September 8, 1997.
I Previously filed as part of the Company's Report on Form 8-K dated as of
December 19, 1997.
J Previously filed as part of the Company's Report on Form 10-K for the year
ended December 31, 1997.
K Previously filed as part of the Company's Report on Form 10-K for the year
ended December 31, 1998.
(b) Reports on Form 8-K
None
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
Dated: ENVIRONMENTAL POWER CORPORATION
March 29, 2000 By /s/ Joseph E. Cresci
---------------------------------------------
Joseph E. Cresci, Chairman
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act 1934, this
report has been signed below by the following persons on behalf of registrant
and in the capacities and on the dates indicated.
Signature Title Date
/s/ Joseph E. Cresci Chairman, Chief March 29, 2000
- -------------------------- Executive Officer,
Joseph E. Cresci & Director (Principal
Executive Officer)
/s/ Donald A. Livingston President & Chief March 29, 2000
- -------------------------- Operating Officer
Donald A. Livingston
/s/ William D. Linehan Treasurer, Chief March 29, 2000
- -------------------------- Financial Officer
William D. Linehan & Secretary (Principal
Financial Officer)
/s/ Peter J. Blampied Director March 29, 2000
- --------------------------
Peter J. Blampied
/s/ Edward B. Koehler Director March 29, 2000
- --------------------------
Edward B. Koehler
/s/ Robert I. Weisberg Director March 29, 2000
- --------------------------
Robert I. Weisberg
45
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders of
Environmental Power Corporation
We have audited the accompanying consolidated balance sheets of Environmental
Power Corporation (the "Corporation") and subsidiaries as of December 31, 1999
and 1998 and the related consolidated statements of operations, shareholders'
(deficit) equity, and cash flows for each of the three years in the period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Environmental Power Corporation and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999 in conformity with accounting principles generally accepted in
the United States of America.
As discussed in Notes B and Q to the consolidated financial statements, the
Corporation changed its method of accounting for major equipment overhauls in
1999.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
March 24, 2000
F-1
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31 December 31
1999 1998
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 306,188 $ 362,416
Restricted cash 299,490 797,922
Receivable from utility 3,703,922 6,598,864
Notes receivable -- 42,376
Other current assets 645,852 821,462
------------ ------------
TOTAL CURRENT ASSETS 4,955,452 8,623,040
PROPERTY, PLANT AND EQUIPMENT, NET 778,864 94,755
DEFERRED INCOME TAX ASSET 876,305 1,826,561
LEASE RIGHTS, NET 2,459,511 2,608,515
NOTES RECEIVABLE -- 3,686
ACCRUED POWER GENERATION REVENUES 49,152,131 41,386,500
OTHER ASSETS 559,739 619,693
------------ ------------
TOTAL ASSETS $ 58,782,002 $ 55,162,750
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 4,751,906 $ 5,773,689
Dividends payable on common stock 171,102 --
Other current liabilities 2,694,619 4,039,664
------------ ------------
TOTAL CURRENT LIABILITIES 7,617,627 9,813,353
DEFERRED GAIN, NET 5,088,776 5,397,187
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 2,394,237 3,123,204
ACCRUED LEASE EXPENSES 49,152,131 41,386,500
MAINTENANCE RESERVE -- 2,001,429
------------
------------ ------------
TOTAL LIABILITIES 64,252,771 61,721,673
------------ ------------
SHAREHOLDERS' DEFICIT:
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
issued at December 31, 1999 and December 31, 1998, respectively) -- --
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at December 31, 1999 and December 31, 1998, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,525,423 shares issued at December 31, 1999 and
December 31, 1998, respectively; 11,406,783 shares outstanding
at December 31, 1999 and December 31, 1998, respectively) 125,254 125,254
Accumulated deficit (4,330,121) (5,418,275)
------------ ------------
(4,204,767) (5,292,921)
Treasury stock (1,118,640 common shares, at cost, as of
December 31, 1999 and December 31, 1998, respectively) (456,271) (456,271)
Notes receivable from officers and board members (809,731) (809,731)
------------ ------------
TOTAL SHAREHOLDERS' DEFICIT (5,470,769) (6,558,923)
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 58,782,002 $ 55,162,750
============ ============
See Notes to Consolidated Financial Statements.
F-2
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
1999 1998 1997
------------ ------------ ------------
POWER GENERATION REVENUES $ 48,268,311 $ 45,721,473 $ 43,763,223
COSTS AND EXPENSES:
Operating expenses 21,931,318 19,215,459 17,755,882
Lease expenses 23,110,677 22,971,201 24,488,005
General and administrative expenses 2,455,095 2,196,929 1,995,491
Reversal of provision for nonrecovery of
project development costs -- -- (940,144)
Depreciation and amortization 363,234 285,471 257,677
------------ ------------ ------------
47,860,324 44,669,060 43,556,911
------------ ------------ ------------
OPERATING INCOME 407,987 1,052,413 206,312
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 110,975 156,546 581,336
Interest expense (375,176) (460,812) (424,395)
Amortization of deferred gain 308,411 308,411 308,410
Sale of NOx emission credits 606,960 -- --
Write-off of receivables in litigation -- (3,508,498) --
Gain on sale of project -- -- 7,423,467
Other income (32) 7,809 622,417
------------ ------------ ------------
651,138 (3,496,544) 8,511,235
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES 1,059,125 (2,444,131) 8,717,547
INCOME TAX (EXPENSE) BENEFIT (470,552) 794,945 (4,103,684)
------------ ------------ ------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF A CHANGE IN ACCOUNTING PRINCIPLE 588,573 (1,649,186) 4,613,863
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE, NET OF $812,440 IN INCOME TAXES 1,188,989 -- --
------------ ------------ ------------
NET INCOME (LOSS) $ 1,777,562 $ (1,649,186) $ 4,613,863
============ ============ ============
DIVIDENDS PAID OR PAYABLE:
Common shares $ 684,408 $ 1,026,611 $ 11,265,865
Preferred shares 5,000 5,000 30,178
------------ ------------ ------------
$ 689,408 $ 1,031,611 $ 11,296,043
============ ============ ============
DIVIDENDS PAID OR PAYABLE PER COMMON SHARE $ 0.06 $ 0.09 $ 0.99
============ ============ ============
BASIC AND DILUTED EARNINGS (LOSS) PER
COMMON SHARE:
Income (loss) before cumulative effect of a change in
accounting principle $ 0.05 $ (0.14) $ 0.41
Cumulative effect of a change in accounting principle 0.11 -- --
------------ ------------ ------------
Net income (loss) $ 0.16 $ (0.14) $ 0.41
============ ============ ============
PRO FORMA AMOUNTS ASSUMING THE NEW ACCOUNTING
METHOD IS APPLIED RETROACTIVELY:
Net income (loss) $ 588,573 $ (1,429,609) $ 4,941,781
Basic and diluted earnings (loss) per common share $ 0.05 $ (0.12) $ 0.44
See Notes to Consolidated Financial Statements.
F-3
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
Preferred Preferred Common
Stock Stock Stock Additional
($.01 Par (No Par ($.01 Par Paid-in
Value) Value) Value) Capital
------------ ------------ ------------ ------------
BALANCE AT JANUARY 1, 1997 $ 0 $ 100 $ 121,954 $ 11,057,495
Net income
Exercise of stock options 3,300 169,513
Dividends paid (11,227,008)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1997 0 100 125,254 0
Net loss
Dividends paid
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1998 0 100 125,254 0
Net income
Dividends paid
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1999 $ 0 $ 100 $ 125,254 $ 0
------------ ------------ ------------ ------------
Receivable Total
from Officers Shareholders'
Accumulated Treasury and Board (Deficit)
Deficit Stock Members Equity
------------ ------------ ------------ ------------
BALANCE AT JANUARY 1, 1997 $ (7,282,306) $ (456,271) $ (761,156) $ 2,679,816
Net income 4,613,863 4,613,863
Exercise of stock options (48,575) 124,238
Dividends paid (69,035) (11,296,043)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1997 (2,737,478) (456,271) (809,731) (3,878,126)
Net loss (1,649,186) (1,649,186)
Dividends paid (1,031,611) (1,031,611)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1998 (5,418,275) (456,271) (809,731) (6,558,923)
Net income 1,777,562 1,777,562
Dividends paid (689,408) (689,408)
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1999 $ (4,330,121) $ (456,271) $ (809,731) $ (5,470,769)
============ ============ ============ ============
See Notes to Consolidated Financial Statements.
F-4
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
1999 1998 1997
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,777,562 $ (1,649,186) $ 4,613,863
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 363,234 285,471 257,677
Gain on sale of project -- -- (7,423,467)
Deferred income taxes 137,816 (1,008,806) 3,014,660
Cumulative effect of a change in accounting principle (1,188,989) -- --
Amortization of deferred gain (308,411) (308,411) (308,410)
Write-off of receivables in litigation -- 3,508,498 --
Reversal of provision for nonrecovery of project
development costs -- -- (940,144)
Accrued power generation revenues (7,765,631) (8,024,111) (8,905,911)
Accrued lease expenses 7,765,631 8,024,111 8,905,911
Other income -- -- (622,417)
Changes in operating assets and liabilities:
Decrease (increase) in receivable utility 2,894,942 (60,219) (645,766)
Decrease in other current assets 175,610 60,476 29,535
Increase in receivable from sale of affiliate -- -- (73,236)
Increase in other assets (9,268) (14,346) (192,873)
(Decrease) increase in accounts payable and
accrued expenses (1,021,783) (376,373) 549,469
Increase in long-term liabilities 11,400 11,400 11,559
Decrease in long-term debt to supplier (79,672) (192,384) (14,996)
(Decrease) increase in maintenance reserve -- 379,615 541,985
------------ ------------ ------------
Net cash provided by (used in) operating activities 2,752,441 635,735 (1,202,561)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable 46,062 39,128 36,129
Decrease (increase) in restricted cash 498,432 (311,263) 158,238
Proceeds from sale of project -- -- 15,000,001
Property, plant and equipment expenditures (829,117) (5,196) (2,987,881)
------------ ------------ ------------
Net cash (used in) provided by investing activities (284,623) (277,331) 12,206,487
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (518,306) (11,297,716) (1,029,938)
Net (repayments) borrowings under working capital loan (395,045) 77,998 (384,477)
Borrowings under long-term credit facility -- -- 3,000,000
Repayment of secured promissory notes payable and
other borrowings (1,610,695) (868,543) (1,800,000)
Proceeds from the issuance of common stock -- -- 124,238
------------ ------------ ------------
Net cash used in financing activities (2,524,046) (12,088,261) (90,177)
------------ ------------ ------------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (56,228) (11,729,857) 10,913,749
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 362,416 12,092,273 1,178,524
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 306,188 $ 362,416 $ 12,092,273
============ ============ ============
See Notes to Consolidated Financial Statements.
F-5
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--BUSINESS AND ORGANIZATION
Environmental Power Corporation (individually "EPC" or consolidated "the
Company") is primarily engaged in leasing an electric generating facility fueled
by waste coal. In recent years, the Company was also engaged in the development
and ownership of electric generating facilities fueled by waste coal. The
Company's business plan has been driven by the identification and evaluation of
attractive independent power projects in various stages of development. During
its project development activities, the Company, either acting alone or in
conjunction with others, has selected and arranged for the acquisition of the
site, obtained control over a portion of the waste coal fuel sources, negotiated
contracts for the design and construction of the facilities and the sale of
output to the utilities purchasing the power, arranged for financing, and
negotiated contracts for the operation and maintenance of the projects.
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 decommissioned 43 Mw (net) coal-fired electric generating facility (the
"Milesburg Project") located in Pennsylvania. The Company sold its remaining
interest in the Sunnyside Project on December 31, 1994 and is presently involved
in litigation with the Purchasers to collect the balance of the Purchasers'
obligations for the sale. The Company sold its development rights for the
Milesburg Project on December 5, 1997 to the utility which had contracted to
purchase electricity from such project. The Company's projects are discussed
further in the following sections.
Scrubgrass
The Scrubgrass Project, located on a 600 acre site in Venango County,
Pennsylvania, is a waste coal-fired electric generating station (the "Facility")
which was constructed by Bechtel Power Corporation. The construction contract
provided for a guaranteed net electrical output of 82.85 MW and final completion
was achieved in June 1994.
On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a subsidiary of EPC,
entered into an agreement to lease the Facility from Scrubgrass Generating
Company, L.P. (the "Lessor"), a joint venture of certain wholly owned indirect
subsidiaries of PG&E Corporation and Bechtel Generating Company, Inc. On October
20, 1998, Bechtel Generating Company, Inc. transferred its interest in the
Lessor to a wholly owned subsidiary of Cogentrix Energy, Inc. The lease provides
for an initial term of 22 years with a renewal option for up to 3 years.
Pursuant to the lease, the Lessor assigned to Buzzard all principal project
agreements and its rights and obligations thereunder including, but not limited
to the power purchase agreement, operations and maintenance agreement, limestone
agreements, ground lease agreements, fuel agreements and transportation and
materials handling agreements. EPC has pledged Buzzard's common stock to the
Lessor as security for Buzzard's performance of its obligations as lessee. PG&E
Generating Company ("PG&E Gen"), a wholly owned indirect subsidiary of PG&E
Generating Company, LLC ("PG&EGenLLC"), which in turn is a wholly owned indirect
subsidiary of PG&E Corporation, manages the Scrubgrass Project.
PG&E Operating Services Company (the "Operator"), a wholly owned indirect
subsidiary of PG&EGenLLC, operates the Facility pursuant to a 15-year Operating
and Maintenance Agreement (the "O&M"). The Operator prepares a budget for all
operating expenses, including a fixed management fee, and certain targeted
output performance levels, which is approved annually. Under the terms of the
O&M, the Operator can incur a liability not to exceed its management fee if the
Operator does not achieve certain targeted output performance levels.
F-6
Buzzard maintains a Limestone Purchase and Sale Agreement with Quality
Aggregates, Inc. to supply the Scrubgrass Project with limestone which, in
September 1999, was extended through the year 2008 and which may be extended up
to 10 additional years. Buzzard also maintains a 15-year agreement for the
transportation of fuel, ash and limestone with Savage Industries, Inc. which
expires in 2005. The costs established under this agreement will escalate at
partially fixed and partially indexed rates.
Buzzard sells electric output to Pennsylvania Electric Company ("PENELEC"),
pursuant to a twenty-five year Power Sales Agreement ("PSA") which commenced in
June 1993, at fixed rates initially averaging 4.68 cents per kwh and which
escalate at five percent per year through calendar year 1999. For the years 2000
through 2012, the PSA provides for a rate equal to the greater of a scheduled
rate or a rate based on the PJM Billing Rate (the monthly average of the hourly
rates for purchases by the General Public Utilities Group ("GPU") from, or sale
by GPU to, the Pennsylvania-New Jersey-Maryland Interconnection). For the years
2013 through 2015 and 2016 through 2018, if the renewal term option is
exercised, the PSA provides for a rate equal to the lower of the average monthly
PJM Billing Rate or the rate paid for the calendar year 2012 adjusted annually
by the percentage change in the Gross National Product Deflator less one
percent. On June 8, 1993, the Facility achieved commercial operation. Since
October 1995, the Company had been involved in a legal proceeding with PENELEC
whereby, among other complaints, the Company alleged that PENELEC failed to pay
the Lessor and the Company contract rates for power in excess of 80 MW produced
by the Facility. On August 3, 1999, the Company entered into an agreement with
PENELEC to settle the litigation. See Note O - Legal Proceedings for a further
discussion of the litigation and settlement agreement.
Buzzard deposits all revenues earned under the PSA into an account administered
by a disbursement agent. Before Buzzard can receive cash generated by the
Scrubgrass Project, all operating expenses, base lease payments (which are
described below), certain maintenance reserve and other subordinated payments
must be satisfied. Buzzard, as lessee, is required to pay the Lessor, in
addition to a specified base rent, which consists of all of the Lessor's debt
service, equity repayment, base return on equity and related expenses, an
additional rent of 50 percent of the net cash flows Buzzard receives from the
Scrubgrass Project's operations. Buzzard is not required to fund operating
losses, or otherwise invest further, from sources outside of the Scrubgrass
Project.
On December 22, 1995, the Lessor restructured certain of the Scrubgrass
Project's debt, the primary effect of which was to extend the term of its demand
debt through 2004 and extend a portion of its junior subordinated debt through
1999. In connection with the Lessor's debt restructuring, Buzzard was able to
refinance a portion of its own current liabilities and establish a capital
improvements fund with a note payable of $300,000, which was paid in January
1996, and a variable note payable of $2,487,813 which matures through 2004.
During the second quarter of 1997, the Lessor assumed primary responsibility for
the disbursement of funds and repayment of debt related to the capital
improvements fund of the Scrubgrass Project. Accordingly, restricted cash and
secured borrowings of approximately $1,220,000 were transferred from the
financial statements of the Company to the financial statements of the Lessor.
Since the Lessor's debt restructuring, Buzzard has continued to fund the
Lessor's debt service obligations as a base lease payment and its own term
obligation resulting from this restructuring which are described in the
following table:
Balance at Balance at Matures
Description of the Obligation 12/31/99 12/31/98 Interest Rate Through
- -----------------------------------------------------------------------------------------------------------------------
Lessor's term debt obligations:
Variable rate tax exempt bonds $135,600,000 $135,600,000 Quoted Bond Rates 2012
Variable rate term loan 14,412,000 16,623,087 Fixed swap rate of 6.4225% 2005
Variable rate term loan 10,061,427 10,575,218 LIBOR rate plus 1.250% 2004
Junior subordinated debt -- 318,796 Fixed rate of 8% 1999
Buzzard's term debt obligation:
Variable rate term loan 1,188,573 1,249,268 LIBOR rate plus 1.250% 2004
On December 22, 1995, the Lessor entered into interest rate swaps which had the
effect of fixing the interest rate over the life of its variable rate term loan
which matures in 2005 at 6.4225%. The Lessor's tax-exempt bonds incurred
interest at floating rates ranging from 2.8% to 4.2% and 2.95% to 4.0% during
1999 and 1998, respectively.
F-7
The remainder of the term debt obligations incur interest at either fixed rates
or variable rates which are based on the London Interbank Offering Rate
("LIBOR). Under the terms of the Lessor's loan agreements, the Company is
subject to various customary financial and operating covenants. As of December
31, 1999 and 1998, the PG&E Gen believes the Company was in compliance with all
such covenants.
During 1997, the Company's planned maintenance outage was significantly extended
because the Company needed to perform a complete rewind on the Facility's
generator. The Facility's extended outage created an extensive cash flow
deficiency because of the loss of revenues plus associated costs and expenses.
The Company addressed this cash deficiency by securing additional debt
financing, negotiating agreements with the generator manufacturer, and utilizing
available restricted cash which are each discussed as follows:
Term Credit Facility - In June 1997, the Lessor entered into a three-year
credit facility with the lenders of the Scrubgrass Project to provide up to
$3 million to fund general debt service expenses. The maximum allowable
borrowings under this credit facility were $3 million through July 1, 1998.
On July 1, 1998, the maximum allowable borrowings began reducing in
$600,000 increments every six months through July 3, 2000, at which time
the credit facility will be payable in full. As of December 31, 1999 and
1998, the outstanding borrowings under this credit facility, which were
advanced to the Company by the Lessor, amounted to $600,000 and $2,150,000,
respectively.
Agreements with Generator Manufacturer - Prior to the 1997 outage, the
Company negotiated extended financing terms with GEC Alsthom ("GEC"), the
manufacturer of the Facility's generator, which allowed the Company to pay
the $660,000 cost of the generator repair in six annual installments of
$110,000, without interest, beginning in May 1997. On April 15, 1998, the
Company reached an agreement with GEC which modified the terms of its
original financing contract. Under the terms of the original contract, the
Company had yet to pay five installments of $110,000 and had also agreed to
pay an additional $75,000 bonus to GEC for completing its work ahead of a
pre-established schedule. Furthermore, the Company engaged GEC to perform
certain maintenance procedures to the generator during the 1998 scheduled
outage at the Facility. Under the terms of the revised agreement with GEC,
as payment in full for the work performed during the 1998 outage and for
the five remaining installments of $110,000 and $75,000 bonus owed under
the original contract, the Company agreed to pay GEC a total of $450,000
over a four-year period. The revised agreement provides that $50,000 was
payable upon the completion of the work during the scheduled 1998 plant
outage and that $100,000 is payable upon each of the first four
anniversaries of the first payment thereof. As of December 31, 1999 and
1998, the Company has recorded on its balance sheet the next installment of
$100,000 in its other current liabilities and the present value of the
remaining installments, discounted at the Facility's incremental borrowing
rate (6.75%), which amounted to $176,948 and $256,620, respectively, in its
other borrowings. The Company is recognizing the balance of the remaining
installments under the revised agreement, which amounted to $23,052 and
$43,380 as of December 31, 1999 and 1998, respectively, as interest expense
over the remaining term of the financing contract with GEC. During 1998,
the Company recognized, through a reduction of its operating expenses, the
reduction of the present value of the future installments due to GEC, which
amounted to $169,045. The Company also recognized interest expense of
$20,328 and $26,661 during 1999 and 1998, respectively, under the
agreements with GEC.
Utilization of Restricted Cash - The Company utilized its restricted cash
reserves to finance most of its additional maintenance expenditures
incurred during the 1997 outage since substantially all of such
expenditures were deemed to be major overhauls. Under the terms of its
project agreements, the Company began replenishing these restricted funds
over a seven-year period beginning in 1998.
F-8
The Environmental Protection Agency and the Pennsylvania Department of
Environmental Protection (the "Regional Authorities") grant Nitrogen Oxide Ozone
Transport Region Budget Allowances ("NOx Credits") to the Company based on
numerous factors which primarily pertain to the design and operation of the
Facility. The Company is required annually to maintain sufficient NOx Credits
which equal or exceed the quantity of its nitrogen oxide emissions during a
specified seasonal period (the "ozone season"). If the Company's nitrogen oxide
emissions exceed its available NOx Credits, the Company would be subject to
fines by the Regional Authorities. During 1999, the Company installed machinery,
with a cost of $811,568, which is expected to significantly reduce its nitrogen
oxide emissions. As such, the Company anticipates that it may not require a
portion of its future NOx Credits to maintain its compliance with the applicable
regulations. Because NOx Credits are transferable and marketable, the Company
may sell its available NOx Credits or purchase additional NOx credits that are
necessary to meet the applicable regulations.
During 1998, the Company expected to receive an aggregate of 1,549 NOx Credits
during 1999 and 2000, which would be available for use during the 1999, 2000,
2001 and 2002 ozone seasons. Therefore, during December 1998 and January 1999,
the Company entered into commitments to sell an aggregate of 839 NOx Credits,
which the Company projected would not be needed to comply with the applicable
regulations during those ozone seasons. However, the Company was informed in
1999 that 111 projected available NOx Credits would not be received and,
accordingly, the Company terminated the sales commitment for that portion of the
NOx Credits. During 1999, the Company received 361 NOx Credits for the 1999
ozone season, of which 182 NOx Credits were subject to existing sales
commitments and sold for $629,720. The Company also purchased 36 NOx Credits in
1999 for $22,760 which were required to comply with the applicable regulations
for the 1999 ozone season. The net proceeds from sales of NOx Credits of
$606,960 is included in other income on the accompanying Consolidated Statement
of Operations. During 2000, the Company expects to receive the remaining 1,077
NOx Credits which pertain to the ozone seasons in 2000, 2001 and 2002. Shortly
after receipt of the remaining NOx Credits, the Company expects to receive
$1,161,888 from its outstanding sales commitments for 546 projected available
NOx Credits.
Sunnyside
The Sunnyside Project is an approximately 51 Mw (net) waste coal-fired facility
at a site located adjacent to the Sunnyside Coal Mine in Carbon County, Utah
which was constructed by Parsons Main, Inc., ("PMI"). The facility reached
commercial operation on November 19, 1993. The Sunnyside Project is owned by
Sunnyside Cogeneration Associates ("SCA"), a joint venture in which the Company
owned varying majority interests from 100% to approximately 70% until September
28, 1994 and thereafter an approximate 40% interest until December 31, 1994 at
which time the Company sold its remaining interest in SCA to B&W Sunnyside, Inc.
and NRG Sunnyside, Inc. (collectively, "the Purchasers").
In connection with the sale, the Company received total consideration of
$6,042,294 which included cash of $2,792,294 received on January 5, 1995 and
promissory notes aggregating $3,250,000, bearing interest at 10% per annum,
received on December 31, 1994. In addition, after audits were performed to
verify certain financial information for SCA, the Purchasers were required to
pay a purchase price closing adjustment of $1,061,107 in 1995. Under the terms
of the promissory notes, interest is payable quarterly to the Company and
aggregate principal payments of $312,500, $1,187,500 and $1,750,000 were due on
September 30, 1995, December 31, 1996 and December 31, 1997, respectively. To
date, the Purchasers have made principal payments aggregating $312,500 and
quarterly interest payments through March 31, 1996 pursuant to the promissory
notes. The Purchasers have also made aggregate payments of $708,000 toward the
purchase price closing adjustment. However, as more fully described in Note O -
Legal Proceedings, the Purchasers commenced a legal proceeding with the Company
on May 3, 1996. Pending the resolution of the legal proceeding, the Purchasers
have withheld all payments of principal and interest due on the promissory notes
since June 1996. The Purchasers are also disputing the balance of the purchase
price closing adjustment in the legal proceeding. As of December 31, 1999, in
addition to the balance of the purchase price closing adjustment, the purchasers
have principal and interest payments in arrears under the promissory notes of
$2,937,500 and $1,102,568, respectively (collectively the "Purchasers'
Obligations").
As discussed further in Note O - Legal Proceedings, the litigation with the
Purchasers includes claims for alleged breaches by the Company of the agreement
to sell its interest in SCA to the Purchasers. The alleged breaches of
F-9
contract are numerous and the litigation continues in discovery where it has
been for almost four years. In November 1998 and October 1999, the Company
presented to the Seventh District Court for Carbon County, State of Utah (the
"Court") motions for partial summary judgment concerning certain of the numerous
claims made by the Purchasers. On January 12, 2000, as discussed further in Note
O - Legal Proceedings, the Court granted one of the Company's motions for
partial summary judgment. Because of this decision, and considering the
possibility of further similar motions, the Company hopes over time to eliminate
or limit the matters that might be presented in a jury trial or discourage the
Purchasers from continuing the litigation if the anticipated costs exceed the
benefits from litigating the remaining matters. After its Court appearances, the
Company continues to feel optimistic about the strength of its position in the
litigation. However, the Company perceives that the Purchasers are unlikely to
settle these matters unless required through Court proceedings, there currently
being little economic incentive for them to do so. Accordingly, in view of the
length and inherent risk of the litigation process and a jury trial, the Company
at this time cannot predict the ultimate outcome of this litigation or how long
it will take to enforce its rights and collect the Purchasers' Obligations. The
Purchasers' Obligations have been in arrears for almost four years now and are
expected to remain in arrears for the foreseeable future. Pursuant to Statement
of Financial Accounting Standards ("SFAS") No. 114, as amended by SFAS No. 118,
the Company is required to recognize impairment losses on loans whenever changes
in circumstances indicate that the carrying amounts of the loans exceed their
fair market values. In the case of the Purchasers' Obligations, because there
were no quoted market values, the best indication of fair market value was the
present value of the expected future cash flows from the Purchasers'
Obligations. As of December 31, 1998, given the uncertainty surrounding the
timing of collecting the Purchasers' Obligations, the Company could not
reasonably estimate a fair market value for such obligations. As such, the
Company opted to take a conservative position and write-off the Purchasers'
Obligations in its 1998 Consolidated Financial Statements. The write-off was
reported as a charge to other expense for $3,508,498 in the accompanying 1998
Consolidated Statement of Operations. The charge represents the aggregate
balance before the write-off for the notes receivable of $2,937,500 and the
receivable from sale of affiliate of $570,998. Notwithstanding, the Company
maintains its entitlement to the Purchasers' Obligations and continues to
vigorously pursue such amounts, as well as punitive damages for abuse of the
litigation process, in the Court. Should the Company prevail in the litigation
in a future period and collect the Purchasers' Obligations, or a portion
thereof, and/or punitive damages, the Company would report such collections as
other income in the period received. See Note B for the Company's accounting
policies for reporting income on the Purchasers' Obligations.
Milesburg
On April 30, 1987, the Company purchased, for an aggregate purchase price of
$5,400,000, all of the outstanding capital stock of Milesburg Energy, Inc.
("MEI"), the company which controlled the development rights to an existing 43
Mw (net) coal-fired facility, which was retired from service in 1984. In
connection with the stock purchase, the Company paid $100,000 in cash and issued
promissory notes totaling $5,120,000 (the "MEI Notes") and MEI assumed
pre-acquisition MEI liabilities totaling $180,000. The MEI Notes,
pre-acquisition liabilities and certain other liabilities incurred subsequent to
the purchase were to become payable only under certain conditions, the most
significant of which related to the closing of construction financing and
commencement of construction for the Milesburg Project.
In 1987, MEI executed a 30 year power purchase agreement with West Penn Power
Company ("West Penn") for the sale of all of the facility's electrical output
with a fixed capacity rate component and an additional fluctuating rate
component which is derived from West Penn's avoided energy cost. The power
purchase agreement was approved by the Public Utilities Commission of the State
of Pennsylvania ("PUC"), and was subsequently appealed to the Commonwealth Court
of Pennsylvania by certain industrial intervenors. During the lengthy appeals
process, which extended beyond certain contract milestone dates in the power
purchase agreement, West Penn requested that its original petition to approve
the power purchase agreement be dismissed by the PUC since the power purchase
agreement had expired by its own terms. In September 1989, in response to MEI's
efforts to preserve its contractual rights, the PUC, by court order, ordered
West Penn to execute a new power purchase agreement with MEI. The new power
purchase agreement was to include extended contract milestone dates and rates
which would be recalculated due to the later start-up date for this project
necessitated by the delays caused by the appeal. This order had been appealed by
the same industrial intervenors and West Penn through various courts, including
the United States Supreme Court, and upheld in every case in favor of MEI. In
August 1995, the PUC issued a tentative order for final
F-10
contract rates. The order had been temporarily stayed by mutual agreement of MEI
and West Penn pending discussions pertaining to a buy-out of the power purchase
agreement which began in October 1995.
Despite ongoing efforts to reach a buy-out arrangement with West Penn, the
Company had continued to invest its financial resources during 1996 and 1997 to
protect its legal and contractual interests and to support its ability to
commence construction in the event that a settlement under mutually agreeable
terms could not be reached with West Penn. In July 1996, in furtherance of those
objectives, the Company entered into a joint development agreement with PG&E Gen
(f/k/a U.S. Generating Company) to increase the financial and technical
resources available to pursue development activities and continue ongoing
discussions with West Penn concerning a buy-out of the power purchase contract.
During 1996 and 1997, the Company's development efforts for the Milesburg
Project increased considerably and the Company, along with its development
partner, was able to establish a significant value for the Milesburg Project as
a result of successful development efforts.
On August 26, 1997, following discussions which lasted almost two years, MEI and
West Penn reached a Buy-Out Agreement concerning the Milesburg project. Pursuant
to the Buy-Out Agreement, West Penn purchased Milesburg's rights to the Electric
Energy Purchase Agreement between the parties dated February 25, 1987 for the
sum of $15 million plus 8% interest from the date the Buy-Out Agreement was
filed for Pennsylvania Public Utility Commission approval. Furthermore, West
Penn also assumed ownership of and responsibility for the Milesburg project
facility, which consisted of land along with a decommissioned coal-fired
electric-generating facility erected thereon, for a stated consideration of $1.
On December 5, 1997, the date of the asset disposition, MEI received aggregate
proceeds of $15,328,768 from West Penn as consideration under the Buy-Out
Agreement. At the date of the asset disposition, before consideration of any
settlements of contingent obligations, the Company had Milesburg project
development costs included in its property, plant and equipment of $9,670,788
and Milesburg project borrowings included in its secured promissory notes and
other borrowings of $5,858,767. Shortly before the date of the asset
disposition, the Company entered into a settlement agreement pertaining to
certain Milesburg project contingent obligations, including the MEI Notes. As a
result of the settlement agreement, the Company's Milesburg project development
costs and Milesburg project borrowings were reduced to $6,170,788 and
$2,358,767, respectively. In addition, because certain other Milesburg
obligations were payable only upon the occurrence of events related to project
development, Milesburg project obligations of $558,767 and accrued interest of
$63,650 were released from liabilities during 1997 and reported as other income
of $622,417 in the accompanying Consolidated Statement of Operations. As a
result of the sale of the Milesburg Project, the Company realized net proceeds
before taxes of $10,960,120 which were derived as follows:
Proceeds from the disposal of Milesburg project assets $15,000,001
Project costs:
Development costs 6,170,788
Fee paid to development partner 1,405,746
-----------
Total project costs 7,576,534
-----------
Gain on sale of project $ 7,423,467
Adjustments to arrive at net proceeds before taxes from the disposal of
Milesburg project assets:
Development cost reimbursements to the Company for
obligations which had already been paid 2,585,469
Development costs released from liabilities 622,417
Interest income from West Penn 328,767
-----------
Net proceeds before taxes from the disposal of Milesburg project assets $10,960,120
===========
After MEI's payment of certain accrued liabilities as of December 31, 1997, the
Company estimated it would have available in excess of $10 million from the
Milesburg proceeds. In light of this projected availability of cash, the
Company's Board of Directors on December 10, 1997 declared a special dividend of
87 cents per common share
F-11
payable out of the proceeds received from the sale of the Milesburg project
assets. The dividend was payable on January 7, 1998 to stockholders of record on
December 30, 1997.
On December 31, 1997, because MEI did not expect to carry on further business
activities after the sale of the Milesburg Project, EPC adopted a Plan of
Liquidation to dissolve MEI. Under the Plan of Liquidation, MEI ceased to carry
on business activities except to the extent necessary to liquidate its assets,
pay its liabilities and distribute its assets remaining after the payment of its
liabilities to EPC. During 1998, MEI's assets remaining after the payment of its
liabilities were distributed to EPC.
NOTE B -- SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The Consolidated Financial Statements include the
accounts of Environmental Power Corporation and its wholly owned or majority
owned subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that effect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash Flows: The Company considers all highly liquid investments with a maturity
of three months or less when purchased to be cash equivalents. In 1997, the
Lessor of the Scrubgrass Project assumed primary responsibility for the
disbursement of funds and repayment of debt related to the capital improvements
fund of the Scrubgrass Project. Accordingly, restricted cash and secured
borrowings in the amount of $1,220,000 were transferred from the financial
statements of the Company to the financial statements of the Lessor in a
non-cash investing and financing activity. The Company also settled a contingent
obligation for the Milesburg project which resulted in a non-cash financing and
investing activity reducing secured promissory notes payable and property plant
and equipment by $3,500,000 during 1997 (see Note A). There were no non-cash
financing and investing activities in 1998 and 1999.
Concentrations of Credit Risk: The Company's financial instruments that are
exposed to concentrations of credit risk consist primarily of cash equivalents
and receivable from utility. The Company's cash equivalents represent short-term
financial instruments which are issued from reputable financial institutions.
Receivable from utility represents amounts due from the Company's sole customer
PENELEC, a public utility with a credit rating of A by Standard & Poors,
pursuant to the terms of the 25 year power purchase agreement.
Restricted Cash: Restricted cash includes all cash held by the disbursement
agent for the Scrubgrass Project pursuant to project agreements which require
requisition and/or certification by the Lessor or bank to withdraw (See Note A).
The Company makes scheduled deposits to restricted cash accounts which are
restricted primarily for scheduled maintenance procedures.
Fuel Inventory: Fuel inventory consists primarily of handling and hauling costs
and is recorded on a lower of cost or market basis with cost determined on a
monthly weighted average basis.
Property, Plant and Equipment: Property, plant and equipment are stated at cost
less accumulated depreciation. The Company capitalizes significant renewals and
betterments that increase the useful lives of assets while repairs and
maintenance are expensed when incurred. The cost and accumulated depreciation
for property, plant and equipment disposals are removed from the balance sheet
and any resulting gains or losses are reported in the statement of operations at
the time of the asset disposition. The Company depreciates its property plant
and equipment using straight-line and accelerated methods over the estimated
useful lives of the assets. The Company records depreciation for office
equipment and furniture using the straight-line method over five years and for
machinery and equipment modifications using the double declining balance method
over seven years. The Company periodically reviews its property plant and
equipment and other long-term assets for impairment and recognizes impairment
losses in situations where the Company estimates that it will not recover the
carrying value of these assets.
F-12
Receivable from Sale of Affiliate: Receivable from sale of affiliate represents
the recognized portion of interest income and the purchase price closing
adjustment which remain uncollected from the Purchasers of SCA. Beginning in
April 1997, in order to present its financial statements conservatively, the
Company stopped recognizing interest income on the Purchasers' notes receivable
until the litigation with the Purchasers is resolved (See Note O). Furthermore,
as discussed in Note A, the Company wrote off the Purchasers' notes receivable
and the remaining balance of the receivable from sale of affiliate during 1998
to present its financial statements conservatively. As of December 31, 1999 and
1998, the Company had aggregate uncollected balances for interest and the
purchase price closing adjustment due from the Purchasers of $1,455,675 and
$1,161,925, respectively, which are not recognized on the Company's Consolidated
Balance Sheets. During 1999, 1998 and 1997, the Company was entitled to interest
income from the Purchasers of $293,750, $293,750 and $293,750, respectively.
However, in light of the Company's interest income reporting policy, the Company
recorded interest income from the Purchasers of $0, $0 and $73,236 during 1999,
1998 and 1997, respectively.
Deferred Financing Costs: In 1997 and 1995, the Company incurred deferred
financing costs of $139,925 and $300,000, respectively in connection with
restructuring certain debt related to the Scrubgrass Project. Deferred financing
costs are being amortized over the respective lives of the related debt which
range from three to nine years (See Note E). Accumulated amortization related to
deferred financing costs was $275,801 and $206,579 at December 31, 1999 and
1998, respectively.
Lease Rights: Lease rights are recorded at cost and are being amortized over the
22 year lease term related to the Scrubgrass facility. Accumulated amortization
related to the lease rights was $819,549 and $670,545 at December 31, 1999 and
1998, respectively.
Accrued Power Generation Revenue and Accrued Lease Expense: As discussed in Note
A, the Company has entered into a long term agreement, to provide electricity to
PENELEC, which provides for scheduled rate increases. In accordance with
generally accepted accounting principles, revenue has been recorded on the
straight-line basis over the 22 year lease term. The accrual for power
generation revenue is limited to the amount of accrued lease expense, as
described below. Therefore, no amount for the straight-lining of future
revenues, which would result in profits, has been provided for in the
Consolidated Financial Statements. Accrued power generation revenue was
$49,152,131 and $41,386,500 at December 31, 1999 and 1998, respectively, and
represents that portion of revenue earned that has not yet been received.
As discussed in Note A, the Company has entered into a long term lease agreement
for the Scrubgrass Project which provides for scheduled lease expense increases.
In accordance with generally accepted accounting principles, the scheduled lease
expense has been recorded on the straight-line basis over the 22 year lease
term. Accrued lease expense was $49,152,131 and $41,386,500 at December 31, 1999
and 1998, respectively, and represents that portion of lease expense that has
not yet been paid.
Deferred Gain: The sale of the Scrubgrass Project by the Company on December 28,
1990 was not treated as a sale for financial accounting purposes. This was
originally due to the existence of an option which enabled the Company to
reacquire Buzzard and to lease the Scrubgrass Project for a substantial portion
of its commercial operation. This option constituted a significant continuing
involvement by the Company which provided evidence that it had retained
substantial risks or rewards of ownership of the Scrubgrass Project. In December
1993, the Company agreed to a modification to the proposed form of lease thereby
relinquishing the fair market value purchase option. Accordingly, the Company
removed from the Consolidated Balance Sheet the gross assets and liabilities of
the Scrubgrass Project and recorded a deferred gain of $6,785,035 arising from
the original sale of the Scrubgrass Project in 1990. The deferred gain is being
amortized over the 22 year minimum lease term, which commenced on June 30, 1994.
Accumulated amortization of the deferred gain at December 31, 1999 and 1998 was
$1,696,259 and $1,387,848, respectively.
Maintenance Reserve: Prior to 1999, the Company recorded the expense of major
equipment overhauls on a straight-line basis using management's best estimate of
the future cash outlays. Management's estimates were charged to expense and
credited to a major maintenance reserve in anticipation of the future outlays
for major
F-13
overhauls. Beginning January 1, 1999, the Company recorded the expense of major
equipment overhauls as incurred. The Company's change in accounting principle is
discussed further in Note Q.
Income Taxes: The Company accounts for income taxes in accordance SFAS No. 109,
"Accounting for Income Taxes". This standard requires, among other things,
recognition of future tax benefits, measured by enacted tax rates, attributable
to deductible temporary differences between the financial statement and income
tax bases of assets and liabilities, and net operating loss carryforwards to the
extent that realization of such benefits is more likely than not.
Earnings (Loss) 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 table outlines the calculation of basic earnings (loss) per share and
diluted earnings (loss) per share for the years ended December 31, 1999, 1998
and 1997.
Income Shares Per Share
(Numerator) (Denominator) Amounts
---------------- ------------------ ------------
Year Ended December 31, 1999:
Income available to shareholders $ 1,777,562 11,406,783 $.16
Effect of dividends to preferred stockholders (5,000)
----------- ----------- ----
Basic EPS - income available to common shareholders 1,772,562 11,406,783 .16
Effect of dilutive securities:
Assumed exercise of dilutive stock options 293
----------- ----------- ----
Diluted EPS - income available to common shareholders $ 1,772,562 11,407,076 $.16
=========== =========== ====
Year Ended December 31, 1998:
Loss available to shareholders $(1,649,186) 11,406,783 $(.14)
Effect of dividends to preferred stockholders (5,000)
----------- ----------- ----
Basic EPS - loss available to common shareholders (1,654,186) 11,406,783 (.14)
Effect of dilutive securities:
Assumed exercise of dilutive stock options
----------- ----------- ----
Diluted EPS - loss available to common shareholders $(1,654,186) 11,406,783 $(.14)
=========== =========== ====
Year Ended December 31, 1997:
Income available to shareholders $ 4,613,863 11,120,893 $.41
Effect of dividends to preferred stockholders (30,178)
----------- ----------- ----
Basic EPS - income available to common shareholders 4,583,685 11,120,893 .41
Effect of dilutive securities:
Assumed exercise of dilutive stock options 138,972
----------- ----------- ----
Diluted EPS - income available to common shareholders $ 4,583,685 11,259,865 $.41
=========== =========== ====
As of December 31, 1999, there were outstanding options to purchase 30,000
shares of the Company's common stock which were antidilutive and not included in
the computation of diluted EPS. The options expire at various dates through
2009.
Stock Options: Effective January 1, 1996, the Company adopted the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No.
123 defines a fair value method of accounting for the issuance of stock options
and other equity instruments. Under the fair value method, compensation is
measured at the grant date based on the fair value of the award and is
recognized over the service period, which is usually the vesting period.
Pursuant to SFAS No. 123, companies are encouraged, but not required, to adopt
the fair value method of accounting for employee stock-based transactions.
Companies are also permitted to continue to account
F-14
for such transactions under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", but would be required to disclose in
a note to the financial statements pro forma net income and per share amounts as
if the company had applied the new method of accounting. SFAS No. 123 also
requires increased disclosures for stock-based compensation arrangements
regardless of the method chosen to measure and recognize compensation for
employee stock-based arrangements. The Company has elected to continue to
account for its stock option transactions under the principles of Accounting
Principles Board Opinion No. 25 and has disclosed in Note L of its Consolidated
Financial Statements the pro forma net income and per share amounts as if the
Company had applied the provisions of SFAS No. 123.
Segment Information: Effective January 1, 1998 the Company adopted SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information", which
modified current segment reporting requirements and established, for public
companies, criteria for reporting disclosures about their products and services,
geographic areas and major customers in annual and interim financial statements.
Under the guidelines established by SFAS No. 131, the Company operates only in
one business segment which pertains to the operation of independent power
facilities.
New Accounting Standards: 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.
Reclassifications: - The Company made certain reclassifications to its 1998 and
1997 consolidated financial statements to conform to the presentation of the
1999 consolidated financial statements.
NOTE C -- OTHER CURRENT ASSETS
Other current assets consists of the following as of December 31, 1999 and 1998:
1999 1998
-------- --------
Fuel inventory $532,585 $711,727
Prepaid expenses 59,310 102,261
Insurance refund receivable 51,300 --
Deposits 1,300 1,300
Other 1,357 6,174
-------- --------
$645,852 $821,462
======== ========
F-15
NOTE D -- PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is recorded at cost less accumulated depreciation
and consists of the following as of December 31, 1999 and 1998:
1999 1998
--------- ---------
Power generating facilities:
Machinery and equipment modifications - Scrubgrass $ 936,568 $ 125,000
Less: Accumulated depreciation (186,311) (48,475)
--------- ---------
750,257 76,525
--------- ---------
Office:
Equipment and furniture 140,148 122,599
Less: Accumulated depreciation (111,541) (104,369)
--------- ---------
28,607 18,230
--------- ---------
$ 778,864 $ 94,755
========= =========
During 1997, the Company capitalized salary costs and indirect costs aggregating
$327,583 for Milesburg project development activities. The indirect costs were
allocated to the project development activities based on overhead rates applied
to direct salary costs incurred for such activities.
NOTE E -- OTHER ASSETS
Other assets consists of the following as of December 31, 1999 and 1998:
1999 1998
-------- --------
Scrubgrass Project receivables $272,721 $268,125
Deferred financing costs (See Note B) 164,124 233,346
Note receivable and accrued interest due from officer 122,894 118,222
-------- --------
$559,739 $619,693
======== ========
Scrubgrass Project receivables are deposits in connection with fuel reserves
under long term leases (See Note M).
NOTE F -- ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consists of the following as of December
31, 1999 and 1998:
1999 1998
---------- ----------
Accounts payable $2,269,401 $3,011,216
Accrued expenses 1,942,725 2,605,791
Corporate taxes payable 539,780 156,682
---------- ----------
$4,751,906 $5,773,689
========== ==========
Accounts payable at December 31, 1999 and 1998 includes $2,020,584 and
$2,765,184, respectively which are related to Scrubgrass Project operations.
Accrued expenses at December 31, 1999 and 1998 includes $1,823,671 and
$2,401,222, respectively which are related to Scrubgrass Project operations.
F-16
NOTE G - RETIREMENT PLAN
Effective January 1, 1998 the Company established a non-contributory defined
benefit pension plan (the "Plan") covering all of its employees who are at least
21 years of age and who have completed at least one year of service. Under the
Plan, the benefits payable to each employee at normal retirement age are based
on years of service and compensation during the three consecutive years of the
latest 10 years immediately preceding retirement which would yield the highest
monthly benefit payment. Employees who have at least 20 years of service at the
time of their retirement would receive the maximum retirement benefit. The
Company's general funding policy is to contribute annually to the Plan the
maximum amount that can be deducted for Federal income tax purposes.
As of January 1, 1998, the commencement date for the Plan, the Company had a
projected benefit obligation of $871,130. The projected benefit obligation as of
January 1, 1998 is being amortized as a prior service cost over 18 years which
represents the average future years of service for the participants in the Plan
at that date.
The following table sets forth the changes during 1999 and 1998 in the projected
benefit obligation for the Plan:
1999 1998
---------- ----------
Projected benefit obligation, beginning of the year $ 990,623 $ 871,130
Service cost 71,260 67,225
Interest cost 59,436 52,268
Actuarial loss 18,305 --
---------- ----------
Projected benefit obligation, end of the year $1,139,624 $ 990,623
========== ==========
The following table sets forth a reconciliation of the funded status of the Plan
to the amounts recognized in the consolidated balance sheets as of December 31,
1999 and 1998:
1999 1998
----------- -----------
Projected benefit obligation $ 1,139,624 $ 990,623
Fair market value of Plan assets (396,164) --
----------- -----------
Unfunded projected benefit obligation 743,460 990,623
Unrecognized loss 122,797 --
Unrecognized prior service cost (779,432) (825,281)
----------- -----------
Accrued pension cost $ 86,825 $ 165,342
=========== ===========
The amounts recognized in the consolidated balance sheets as of December 31,
1999 and 1998 consist of:
1999 1998
--------- ---------
Accrued benefit liability $ 86,825 $ 213,081
Intangible asset -- (47,739)
--------- ---------
Net amount recognized $ 86,825 $ 165,342
========= =========
The following table sets forth the changes during 1999 and 1998 in the fair
market value of Plan assets:
1999 1998
-------- -------
Fair market value of Plan assets, beginning of the period $ -- $ --
Contributions by the Company to the Plan 255,062 --
Return on Plan assets 141,102 --
-------- -------
Fair market value of Plan assets, end of the period $396,164 $ --
======== =======
The Company has invested the Plan assets in a portfolio of mutual funds which
consist primarily of growth stocks. The Company expects to make an additional
contribution of $163,130 to the Plan prior to the due date for filing its 1999
Federal income tax return.
The Company's net periodic pension cost for 1999 and 1998 are comprised of the
following components:
F-17
1999 1999
-------- --------
Service cost $ 71,260 $ 67,225
Interest cost 59,436 52,268
Amortization of prior service cost 45,849 45,849
-------- --------
Net periodic pension cost $176,545 $165,342
======== ========
The actuarial assumptions used in 1999 and 1998 to determine the pension
benefits for the Plan were:
1999 1998
---- ----
Weighted average discount rate 5.5% 5.5%
Expected long-term return on Plan assets 8.0% 8.0%
Weighted average rate of increase in compensation levels 5.0% 5.0%
NOTE H -- OTHER CURRENT LIABILITIES
Other current liabilities consists of the following as of December 31, 1999 and
1998:
1999 1998
---------- ----------
Scrubgrass Project working capital loan $1,994,619 $2,389,664
Scrubgrass Project long-term debt to supplier (See Note I) 100,000 100,000
Scrubgrass Project long-term credit facility (See Note I) 600,000 1,550,000
---------- ----------
$2,694,619 $4,039,664
========== ==========
The Scrubgrass Project working capital loan represents outstanding borrowings
due to the Lessor under a Lessee Working Capital Loan Agreement. Under the terms
of this agreement, which expires in December 2002, Buzzard may borrow up to $4
million for the ongoing working capital requirements of the Scrubgrass Project.
The outstanding borrowings under this agreement incur interest at the LIBOR rate
plus 1.125% (7.62% as of December 31, 1999 and ranging from 6.03% to 7.62%
during 1999 and 6.19% to 7.26% during 1998).
NOTE I -- SECURED PROMISSORY NOTES PAYABLE AND OTHER BORROWINGS
Secured promissory notes payable and other borrowings as of December 31, 1999
and 1998 consists of:
1999 1998
---------- ----------
Scrubgrass Project note payable $1,188,573 $1,249,268
Scrubgrass Project long-term debt to supplier 176,948 256,620
Scrubgrass Project long-term credit facility -- 600,000
Sunnyside Project obligations 1,028,716 1,017,316
---------- ----------
$2,394,237 $3,123,204
========== ==========
The Scrubgrass Project note payable represents the non-current portion of an
obligation which was incurred as part of the Lessor's debt restructuring in
December 1995, when Buzzard established a capital improvements fund and extended
the term of certain current liabilities through 2004. The outstanding borrowings
under the Scrubgrass Project note payable incur interest at the LIBOR rate plus
1.25% (7.74% as of December 31, 1999 and ranging from 6.15% to 7.74% during 1999
and 6.31% to 7.38% during 1998). The scheduled aggregate annual repayments for
the Scrubgrass Project note payable are $0 in 2000, $202,826 in 2001, $148,310
in 2002, $447,902 in 2003 and $389,535 in 2004.
F-18
On June 3, 1997, the Lessor of the Scrubgrass Project entered into a long-term
credit facility with its agent bank to provide the Scrubgrass Project with up to
$3 million to fund general debt service expenses when operating revenues became
unavailable as a result of the extended facility outage to perform a complete
rewind of the Scrubgrass generator. 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 expire. The
loan type (LIBOR-based, Certificate of Deposit rate-based or prime rate based)
and the interest period are elected by the Company. As of December 31, 1999 and
1998, the Company had outstanding borrowings of $600,000 and $2,150,000,
respectively from the Lessor under this long-term credit facility which incurred
interest at LIBOR rates plus a 1.125% (7.62% as of December 31, 1999 and ranging
from 6.03% to 7.62% during 1999 and 6.19% to 7.26% during 1998).
The Company considers reductions in the outstanding borrowings under this
long-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 current liabilities as of December 31, 1999 and 1998,
respectively (See Note H).
The Sunnyside Project obligations principally represent selling expenses in
connection with the sale of the Sunnyside Project which are payable upon receipt
of the principal proceeds from the notes receivable which were due by December
31, 1997. The repayment of these obligations is contingent upon the outcome of
the litigation with the purchasers of the Sunnyside Project (See Notes A and O).
The Scrubgrass Project long-term debt to supplier, which is discussed further in
Note A, represents the present value of the long-term installments due to GEC
under a financing agreement (See Note H).
NOTE J -- INTEREST CAPITALIZED
Interest costs consists of the following for the years ended December 31, 1999,
1998, and 1997:
1999 1998 1997
-------- -------- --------
Total interest costs incurred $375,176 $460,812 $437,948
Amounts included in operations 375,176 460,812 424,395
-------- -------- --------
Amounts capitalized in development and construction of projects $ 0 $ 0 $ 13,553
======== ======== ========
Total interest paid during the years ended December 31, 1999, 1998 and 1997
amounted to $391,857, $455,146 and $407,110, respectively.
Interest costs incurred for each period presented do not include debt service
related to the Scrubgrass Project which is included in lease expense.
F-19
NOTE K -- INCOME TAXES
Income tax expense (benefit) consists of the following for the years ended
December 31, 1999, 1998 and 1997:
1999 1998 1997
----------- ----------- -----------
Current:
Federal $ 193,035 $ 594 $ 316,136
State 139,701 213,267 772,888
----------- ----------- -----------
Total current tax expense 332,736 213,861 1,089,024
----------- ----------- -----------
Deferred:
Federal 121,292 (838,439) 2,925,237
State 16,524 (170,367) 89,423
----------- ----------- -----------
Total deferred tax expense (benefit) 137,816 (1,008,806) 3,014,660
----------- ----------- -----------
$ 470,552 $ (794,945) $ 4,103,684
=========== =========== ===========
In 1999, the Company reported deferred income tax expense of $812,440 in its
Consolidated Statement of Operations as a reduction of the cumulative effect of
a change in accounting principle (See Note Q).
In 1997, the Company's state income tax expense was substantially all current
because taxable income was incurred in states that did not have available net
operating loss carryforwards.
Income taxes paid during the years ended December 31, 1999, 1998 and 1997
amounted to $267,104, $1,187,057 and $159,906, respectively.
A reconciliation between the actual income tax expense (benefit) and the income
tax expense (benefit) computed by applying the statutory federal income tax rate
to the income (loss) before income taxes, for the years ended December 31, 1999,
1998 and 1997 is as follows:
1999 1998 1997
----------- ----------- -----------
Federal tax expense (benefit) at 34% $ 360,103 $ (831,005) $ 2,963,966
State tax expense, net of federal tax benefit 103,116 28,315 569,124
Tax basis difference related to the original
investment in Milesburg project assets -- -- 568,311
Nondeductible portion of meals and entertainment 5,626 3,525 1,659
Other 1,707 4,220 624
----------- ----------- -----------
$ 470,552 $ (794,945) $ 4,103,684
=========== =========== ===========
F-20
The components of the net deferred income tax asset as of December 31, 1999 and
1998 are as follows:
1999 1998
----------- -----------
Deferred tax assets:
Accrued lease expense $19,952,521 $16,800,187
Maintenance reserves -- 812,440
Deferred tax effect of the sale of the Scrubgrass Project for which
the net gain was deferred for financial reporting purposes 1,000,472 1,076,985
Capital loss carryforwards 98,200 96,550
State net operating loss carryforwards 20,509 20,509
Federal alternative minimum tax credit carryforwards -- 26,182
----------- -----------
21,071,702 18,832,853
----------- -----------
Deferred tax liabilities:
Accrued power generation revenue 19,952,521 16,800,187
Defined benefit pension plan contribution 29,973 34,650
Expenses deferred for financial reporting purposes 9,358 78,493
Other 203,545 92,962
----------- -----------
20,195,397 17,006,292
----------- -----------
$ 876,305 $ 1,826,561
=========== ===========
NOTE L -- SHAREHOLDERS' EQUITY
Stock Options
The Company has reserved 405,000 shares of common stock for issuance upon
exercise of stock options which are outstanding or may be granted under the
Company's 1993 Director Plan. The options granted under the 1993 Director Plan
were intended to constitute non-qualified options principally at an option price
of 100 percent of the fair market value of the common stock on the date of the
grant. All options are fully vested at the date of grant and expire on the 10th
anniversary of the date of grant. As of December 31, 1999, the Company has
options for 365,000 shares available for grant under the 1993 Director Plan. The
Company previously issued stock options pursuant to its 1990 Stock Plan. As of
December 31, 1999, there were no stock options outstanding or available for
grant under the 1990 Stock Plan.
The following table summarizes information about the Company's options
outstanding as of December 31, 1999:
Outstanding Weighted-Average
Exercise and Remaining
Price Exercisable Contractual Life
-------------------------------------------------
$ 0.6250 10,000 9.42 years
0.7500 10,000 9.50 years
1.5000 10,000 8.50 years
1.6875 10,000 8.42 years
-------------------------------------------------
$ 1.1406 40,000 8.96 years
=================================================
F-21
Stock option transactions during 1999, 1998 and 1997 are summarized as follows:
Options Outstanding
-----------------------------
Shares Price
-------- ------------
Balance at January 1, 1997 350,000 $ .25 - 1.00
Options granted 30,000 .6875-.8125
Options exercised (330,000) .25 - .9375
-------- ------------
Balance at December 31, 1997 50,000 .25 - 1.00
Options granted 30,000 1.50 - 1.688
Option surrendered (60,000) .25 - 1.625
-------- ------------
Balance at December 31, 1998 20,000 1.50-1.688
Options granted 20,000 .625 - .75
-------- ------------
Balance at December 31, 1999 40,000 $ .625-1.688
======== ============
Under the provisions of Accounting Principles Board Opinion ("APB") No. 25, the
Company does not recognize compensation expense for stock option awards since
the underlying options have exercise prices equal to 100 percent of the fair
market value of the common stock on the date of grant (110 percent of the fair
market value in the case officers or other employees holding 10% or more of the
Company's common stock for the 1990 plan). However, pursuant to the provisions
of SFAS No. 123, the Company is required to calculate the fair market value of
its stock options using different criteria from the provisions of APB No. 25.
Using the fair market value criteria required by SFAS No. 123 to calculate
compensation expense on stock options granted during 1999, 1998 and 1997, the
Company would have incurred pro forma net income of $1,775,050 and pro forma net
earnings per share of $.16 in 1999, pro forma net loss of $1,657,178 and pro
forma net loss per share of $.15 in 1998, and pro forma net income of $4,608,669
and pro forma net earnings per share of $.41 in 1997.
The estimated fair market values of the Company's options granted during 1999,
1998 and 1997 were $.23 per share, $.59 per share and $.33 per share,
respectively. The fair market values were calculated using the Binomial Option
Pricing Model with the following assumptions:
1999 1998 1997
------- ------- -------
Dividend yield 10% 8% 12%
Risk free rate of return 5.99% 5.99% 5.99%
Expected useful life 5 years 5 years 5 years
Expected stock volatility rate 57.38% 59.27% 52.54%
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 quarterly dividends of 3 cents per share
during each of the six quarters through June 30, 1998 and quarterly dividends of
1.5 cents per share during each of the six quarters through December 31, 1999.
In addition to its quarterly dividends, the Company also declared a special
dividend of 87 cents per share in 1997 out of the proceeds from the Milesburg
settlement (See Note A). Therefore, the Company declared aggregate dividends of
99 cents per share in 1997, 9 cents per share in 1998 and 6 cents per share in
1999.
During 1997, 1998 and 1999, the Company also paid dividends to its subsidiary's
preferred stockholder in the amount of $30,178, $5,000 and $5,000, respectively.
The preferred stockholder, entitled to cumulative dividends of $5,000 per year
since December 1991, was paid its cumulative dividends through 1996 of $25,178
during the second quarter of 1997. Beginning in 1997, the Company commenced
paying its subsidiary's preferred stockholder dividends at a rate of $1,250 per
quarter. Upon dissolution or liquidation of the Company, the preferred
stockholder has a liquidation preference to receive $500 per share, plus any
cumulative unpaid dividends, prior to the distribution of any remaining assets
to common shareholders.
F-22
Other Equity Transactions
The Company has notes receivable from its officers and directors for shares
purchased in connection with its 1990 Stock Plan and 1993 Directors' Plan which
amounted to $809,731 at both December 31, 1999 and 1998, respectively. The
notes, which are classified as a reduction of shareholders' equity, are payable
upon demand and bear interest at a floating rate which is payable monthly. The
Company has collected all of the interest payable by the officers and directors
on these notes through December 31, 1999.
NOTE M -- COMMITMENTS
Corporate
The Company is obligated to make payments under various operating leases for
office space and automotive vehicles. The Company is also obligated under leases
or other agreements relating to the Scrubgrass Project (see Note A).
Future minimum payments due under non-cancelable leases in effect at December
31, 1999, are as follows:
2000 $ 40,919
2001 23,740
2002 1,560
---------
Total $ 66,219
=========
Rent expense totaled $44,230, $42,787 and $38,844 in 1999, 1998 and 1997,
respectively.
Scrubgrass Project
As of December 31, 1999, the Company is obligated to make estimated minimum
lease payments over the remaining 16.5 year base term of the lease for the
Scrubgrass Project as follows:
2000 $ 14,392,000
2001 13,967,000
2002 14,884,000
2003 16,306,000
2004 19,286,000
Thereafter 323,874,000
-------------
Total $ 402,709,000
=============
Lease expense in 1999, 1998 and 1997 was $23,110,677, $22,971,201 and
$24,488,005, respectively.
In addition, the Company has been assigned various long-term noncancelable
obligations under contractual agreements for fuel handling and excavation,
limestone supply, and waste disposal. The contractual terms are generally for 5
to 15 years and provide for renewal options.
F-23
Future minimum payments due under these noncancelable obligations at December
31, 1999 are as follows (See Notes A and E):
2000 $ 744,000
2001 692,000
2002 714,000
2003 737,000
2004 760,000
Thereafter 2,956,000
-----------
Total $ 6,603,000
===========
NOTE N -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments primarily consist of cash and cash
equivalents, restricted cash, receivable from utility, note receivable from the
Scrubgrass Project, accounts payable, Lessee working capital loan and several
long-term debt obligations. As of December 31, 1999 and 1998, the carrying
amounts for cash and cash equivalents, restricted cash, receivable from utility,
note receivable from the Scrubgrass Project, accounts payable and Lessee working
capital loan approximate fair value because of the short maturity of these
instruments. As of December 31, 1999 and 1998, the carrying amounts for the
long-term debt obligations also approximate fair value because such obligations
incur interest at variable rates. As of December 31, 1998, as discussed in Note
A, the receivable from sale of affiliate and the notes receivable from the
Sunnyside Project were written-off since the Company cannot reasonably estimate
their fair market values.
NOTE O -- LEGAL PROCEEDINGS
Scrubgrass Project
On October 11, 1995, the Lessor and the Company (collectively, the "Plaintiffs")
filed a complaint against PENELEC in the Court of Common Pleas of Venango
County, Pennsylvania seeking damages for certain alleged breaches of the power
purchase agreement entered into between SPC and PENELEC on August 7, 1987. In
its complaint, the Plaintiffs allege that PENELEC failed to pay contract rates
for energy produced by the 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 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.
On August 3, 1999 the Plaintiffs jointly entered into a settlement agreement
with PENELEC to terminate the ongoing litigation. The settlement agreement does
not become effective until the date PENELEC obtains a final non-appealable Order
of the Pennsylvania Public Utility Commission ("PAPUC") approving the settlement
agreement in form and substance acceptable to PENELEC (the "Effective Date").
Under the terms of the settlement agreement, in full settlement of all alleged
claims, PENELEC agreed to pay the Plaintiffs for all previous net deliveries of
electric energy from the Scrubgrass facility in excess of 80 MW at rates set
forth in the PSA, 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 PSA 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 December 31, 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
F-24
approximately $3,689,000 and $537,000, 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 January 1, 2000 to the Effective Date. PENELEC is required to
remit such payment to the Scrubgrass Project within twenty days from the
Effective Date (See Note P). 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 $1,102,568,
respectively at December 31, 1999. On April 9, 1999, in response to the
Plaintiffs' third amended complaint, the Company filed an answer and restatement
of its earlier restated counterclaim dated January 21, 1999. In the answer to
the third amended complaint, the Company denied all material allegations and
asserted numerous affirmative defenses. In the restated counterclaim, the
Company alleges numerous causes of action against the Plaintiffs which include
breach of contract, breach of the promissory notes, intentional, malicious and
willful breach of contract, intentional tort, interference and
misrepresentation. Through the restated counterclaim, the Company seeks remedies
which include: (1) compensatory, consequential and punitive damages; (2)
acceleration and immediate payment in full of the promissory notes; and (3)
injunctions to require the Plaintiffs to continue making payments under the
promissory notes during the pendency of this action and until the promissory
notes are paid in full and which enjoin the Plaintiffs from continuing certain
malicious and intentional actions that are alleged in the counterclaim, together
with interest, reasonable attorney's fees, costs and other such relief as the
court deems proper. On May 17, 1999, the Plaintiffs responded to the restated
counterclaim whereby 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 Plaintiffs responded by
stating their opposition to the Company's April 15, 1998 motion. The Company and
the Plaintiffs appeared in Court on November 19, 1998 to present oral arguments
on the Company's April 15, 1998 motion. On December 30, 1999, the Court denied
the Company's April 15, 1998 motion. The Court found that there were issues of
material fact that would warrant further consideration of the matter.
On February 12, 1999, the Plaintiffs filed a motion for partial summary judgment
wherein the Plaintiffs alleged 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' February 12, 1999 motion and also
filed a cross motion for partial summary judgment. In its cross motion, the
Company asserted that the claims at issue in the Plaintiffs' February 12, 1999
motion 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 these cross
motions. On January 12, 2000, the Court granted the Company's motion for partial
summary judgment and denied the Plaintiffs' motion for partial summary judgment.
The Court based its decision on the grounds that (1) the portion of the purchase
and sale agreement allegedly breached is concerned with legal proceedings
against or adverse to SCA and not advantageous legal proceedings against third
parties; (2) the alleged basis for legal proceedings was not "material", as
required by the purchase and sale agreement, because the Plaintiffs acquired SCA
even though the
F-25
Plaintiffs had prior knowledge of the alleged basis for legal proceedings; and
(3) because the Plaintiffs were aware of the alleged basis for legal
proceedings, any failure by the Company to disclose such basis for legal
proceedings in the purchase and sale agreement was not the cause of the
Plaintiffs' loss, if any. The Plaintiffs recently filed a request for the Court
to reconsider its January 12, 2000 decision which the Company will oppose.
Discovery remains ongoing.
NOTE P -- SUBSEQUENT EVENT
On January 27, 2000, the PAPUC issued an Order adopting the settlement agreement
among the Company, the Lessor and PENELEC (See Note O). After a 30 day period
without any appeals, the Order became final and non-appealable on February 27,
2000, the Effective Date. On March 24, 2000, PENELEC remitted the outstanding
balances due under the settlement agreement for previous net deliveries of
electric energy and interest which amounted to approximately $3,802,000 and
$608,000. The Company reported this additional income in its Consolidated
Statement of Operations during 2000.
NOTE Q -- CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
Effective January 1, 1999, the Company changed its method of accounting for
major equipment overhauls to a method which is consistent with the viewpoints
recently expressed by the Securities and Exchange Commission. Previously, the
Company recorded the expense of major equipment overhauls on a straight-line
basis to a major maintenance reserve in anticipation of future outlays for the
major overhauls. Beginning in 1999, the Company recorded the expense of major
equipment overhauls when incurred. As a result of this change, the Company
realized an increase in operating expenses of $307,893 and a decrease in income
tax expense of approximately $125,000 during 1999. The Company also recognized
the effect of this change on years prior to 1999 with an increase to net income
of $1,188,989 in 1999. This increase in net income consists of an elimination of
the Company's major maintenance reserve, which had a balance of $2,001,429 at
December 31, 1998, and the reversal of $812,440 in deferred income tax benefits.
F-26