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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2000
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OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________ to __________________
Commission file number 0-15472
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Environmental Power Corporation
(Exact name of registrant as specified in its charter)
Delaware 04-2782065
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
500 Market Street, Suite 1-E, Portsmouth, New Hampshire 03801
(Address of principal executive offices)
(Zip code)
(603) 431-1780
Registrant's telephone number, including area code
_________________________________________________________________
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Number of shares of Common Stock outstanding
at November 13, 2000 11,406,783 shares
The Exhibit Index appears on Page 30.
Total number of pages is 30.
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ENVIRONMENTAL POWER CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as
of September 30, 2000 (unaudited) and December 31, 1999.................................. 2
Condensed Consolidated Statements of Operations (unaudited) for the Three and Nine
months Ended September 30, 2000 and September 30, 1999................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine months Ended
September 30, 2000 and September 30, 1999................................................ 4
Notes to Condensed Consolidated Financial Statements..................................... 5-6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................... 7-26
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................... 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 27-29
Item 6. Exhibits and Reports on Form 8-K............................................. 30
Signatures ............................................................................. 30
1
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. Financial Statements
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30 December 31
2000 1999
------------------ ------------------
ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 218,193 $ 306,188
Restricted cash 446,620 299,490
Receivable from utility 7,768,137 3,703,922
Other current assets 737,502 645,852
------------------ ------------------
TOTAL CURRENT ASSETS 9,170,452 4,955,452
PROPERTY, PLANT AND EQUIPMENT, NET 611,535 778,864
DEFERRED INCOME TAX ASSET 864,305 876,305
LEASE RIGHTS, NET 2,347,758 2,459,511
ACCRUED POWER GENERATION REVENUES 54,429,140 49,152,131
OTHER ASSETS 536,858 559,739
------------------ ------------------
TOTAL ASSETS $ 67,960,048 $ 58,782,002
================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 6,913,583 $ 4,751,906
Dividends payable on common stock 171,102 171,102
Other current liabilities 3,231,527 2,694,619
------------------ ------------------
TOTAL CURRENT LIABILITIES 10,316,212 7,617,627
DEFERRED GAIN, NET 4,857,468 5,088,776
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 2,312,912 2,394,237
ACCRUED LEASE EXPENSES 54,429,140 49,152,131
------------------ ------------------
TOTAL LIABILITIES 71,915,732 64,252,771
------------------ ------------------
SHAREHOLDERS' DEFICIT:
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
issued at September 30, 2000 and December 31, 1999, respectively) -- --
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at September 30, 2000 and December 31, 1999, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,525,423 shares issued at September 30, 2000 and
December 31, 1999, respectively; 11,406,783 shares outstanding
at September 30, 2000 and December 31, 1999, respectively) 125,254 125,254
Accumulated deficit (2,815,036) (4,330,121)
------------------ ------------------
(2,689,682) (4,204,767)
Treasury stock (1,118,640 common shares, at cost, as of
September 30, 2000 and December 31, 1999, respectively) (456,271) (456,271)
Notes receivable from officers and board members (809,731) (809,731)
------------------ ------------------
TOTAL SHAREHOLDERS' DEFICIT (3,955,684) (5,470,769)
------------------ ------------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 67,960,048 $ 58,782,002
================== ==================
See Notes to Condensed Consolidated Financial Statements.
2
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended September 30 Nine Months Ended September 30
1999 1999
2000 (Restated) 2000 (Restated)
----------------- ------------------ ------------------ ------------------
POWER GENERATION REVENUES $ 13,079,296 $ 12,918,259 $ 41,165,018 $ 35,495,619
----------------- ------------------ ------------------ ------------------
COSTS AND EXPENSES:
Operating expenses 5,021,065 5,227,286 17,065,816 16,667,258
Lease expenses 5,664,855 5,724,732 19,703,145 16,966,220
General and administrative expenses 707,070 556,470 2,313,679 1,933,462
Depreciation and amortization 102,044 113,658 312,826 240,397
----------------- ------------------ ------------------ ------------------
11,495,034 11,622,146 39,395,466 35,807,337
----------------- ------------------ ------------------ ------------------
OPERATING INCOME (LOSS) 1,584,262 1,296,113 1,769,552 (311,718)
----------------- ------------------ ------------------ ------------------
OTHER INCOME (EXPENSE), NET:
Interest income 33,828 27,761 707,553 87,868
Interest expense (82,025) (106,370) (240,161) (275,551)
Sale of NOx emission credits 0 0 1,161,888 629,720
Other expense 0 6,117 0 6,085
Amortization of deferred gain 77,103 77,103 231,308 231,308
----------------- ------------------ ------------------ ------------------
28,906 4,611 1,860,588 679,430
----------------- ------------------ ------------------ ------------------
INCOME BEFORE INCOME TAXES 1,613,168 1,300,724 3,630,140 367,712
INCOME TAX EXPENSE (710,000) (533,000) (1,598,000) (153,000)
----------------- ------------------ ------------------ ------------------
NET INCOME $ 903,168 $ 767,724 $ 2,032,140 $ 214,712
================= ================== ================== ==================
BASIC AND DILUTED EARNINGS PER
COMMON SHARE $ 0.08 $ 0.07 $ 0.18 $ 0.02
================= ================== ================== ==================
DIVIDENDS:
Common shares $ 171,102 $ 171,102 $ 513,305 $ 513,306
Preferred shares 1,250 1,250 3,750 3,750
----------------- ------------------ ------------------ ------------------
$ 172,352 $ 172,352 $ 517,055 $ 517,056
================= ================== ================== ==================
DIVIDENDS PER COMMON SHARE $ 0.015 $ 0.015 $ 0.045 $ 0.045
================= ================== ================== ==================
See Notes to Condensed Consolidated Financial Statements
3
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30
1999
2000 (Restated)
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,032,140 $ 214,712
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 312,826 240,397
Deferred income taxes 12,000 (178,000)
Amortization of deferred gain (231,308) (231,308)
Accrued power generation revenues (5,277,009) (5,824,223)
Accrued lease expenses 5,277,009 5,824,223
Changes in operating assets and liabilities:
Increase in receivable from utility (4,064,215) (559,620)
Increase in other current assets (91,650) (18,342)
Increase in other assets (10,563) (5,474)
Increase in accounts payable and accrued expenses 2,161,677 1,234,034
Increase in long-term liabilities 8,550 8,550
Decrease in long-term debt to supplier (89,875) (84,754)
---------------- ----------------
Net cash provided by operating activities 39,582 620,195
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the collection of notes receivable -0- 31,463
(Increase) decrease in restricted cash (147,130) 532,841
Property, plant and equipment expenditures (300) (797,546)
---------------- ----------------
Net cash used in investing activities (147,430) (233,242)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (517,055) (345,954)
Net borrowings from working capital loan 1,136,908 789,597
Repayment of secured promissory notes payable and
other borrowings (600,000) (971,076)
---------------- ----------------
Net cash provided by (used in) financing activities 19,853 (527,433)
---------------- ----------------
DECREASE IN CASH AND CASH EQUIVALENTS (87,995) (140,480)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 306,188 362,416
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 218,193 $ 221,936
================ ================
See Notes to Condensed Consolidated Financial Statements.
4
ENVIRONMENTAL POWER CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- BASIS OF PRESENTATION
- -------------------------------
The accompanying unaudited condensed consolidated financial statements of
Environmental Power Corporation ("EPC") and its subsidiaries (collectively the
"Company") have been prepared in accordance with the instructions to Form 10-Q
and do not include all of the information and footnotes required by generally
accepted accounting principles for annual financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. The results of
operations for the three and nine months ended September 30, 2000 are not
necessarily indicative of the expected results for the year ending December 31,
2000. For further information, refer to the consolidated financial statements
and footnotes included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999.
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 reported the effect of this
change in accounting principle during the fourth quarter of 1999 by recognizing
an increase in operating expenses of $307,893, a decrease in income tax expense
of approximately $125,000, and an increase in net income of $1,188,989 for the
cumulative effect of the change on years prior to 1999. The Company restated the
results of its operations and cash flows for the three and nine months ended
September 30, 1999 in order to conform to the financial presentation for the
same periods in 2000. As a result of this restatement, the Company increased
its operating expenses by $466,309 and decreased its income tax expense by
$189,000 for the nine months ended September 30, 1999, and decreased its
operating expenses by $103,226 and increased its income tax expense by $42,000
for the three months ended September 30, 1999.
NOTE B -- NEW ACCOUNTING STANDARD
- ---------------------------------
In September 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.
5
NOTE C -- EARNINGS PER COMMON SHARE
- -----------------------------------
The Company computes its earnings per common share using the treasury stock
method in accordance with SFAS No. 128, "Earnings per Share". The Company
computes basic earnings per share by dividing net income for the period by the
weighted average number of shares of common stock outstanding during the period.
For purposes of calculating diluted earnings per share, the Company considers
its shares issuable in connection with stock options to be dilutive common stock
equivalents when the exercise price is less than the average market price of the
Company's common stock for the period. The following table outlines the
calculation of basic earnings per share and diluted earnings per share for the
three and nine months ended September 30, 2000 and 1999.
Income Shares Per Share
(Numerator) (Denominator) Amounts
------------------ -------------------- ----------------
Three Months Ended September 30, 2000:
- -------------------------------------
Income available to shareholders $ 903,168 11,406,783 $.08
Effect of dividends to preferred stockholders (1,250)
------------------ -------------------- ----------------
Basic EPS - income available to common shareholders 901,918 11,406,783 .08
Effect of dilutive securities:
Assumed exercise of dilutive stock options 4,233
------------------ -------------------- ----------------
Diluted EPS - income available to common shareholders $ 901,918 11,411,016 $.08
================== ==================== ================
Three Months Ended September 30, 1999:
- --------------------------------------
Income available to shareholders $ 767,724 11,406,783 $.07
Effect of dividends to preferred stockholders (1,250)
------------------ -------------------- ----------------
Basic EPS - income available to common shareholders 766,474 11,406,783 .07
Effect of dilutive securities:
Assumed exercise of dilutive stock options 1,060
------------------ -------------------- ----------------
Diluted EPS - income available to common shareholders $ 766,474 11,407,843 $.07
================== ==================== ================
Nine months Ended September 30, 2000:
- -------------------------------------
Income available to shareholders $2,032,140 11,406,783 $.18
Effect of dividends to preferred stockholders (3,750)
------------------ -------------------- -----------------
Basic EPS - income available to common shareholders 2,028,390 11,406,783 .18
Effect of dilutive securities:
Assumed exercise of dilutive stock options 1,954
------------------ -------------------- -----------------
Diluted EPS - income available to common shareholders $2,028,390 11,408,737 $.18
================== ==================== =================
Nine Months Ended September 30, 1999:
- -------------------------------------
Income available to shareholders $ 214,712 11,406,783 $.02
Effect of dividends to preferred stockholders (3,750)
------------------ -------------------- -----------------
Basic EPS - income available to common shareholders 210,962 11,406,783 .02
Effect of dilutive securities:
Assumed exercise of dilutive stock options 391
------------------ -------------------- -----------------
Diluted EPS - income available to common shareholders $ 210,962 11,407,174 $.02
================== ==================== =================
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview of the Company
The Company owns a 22 year leasehold interest in an approximately 83 Mw (net)
waste coal-fired electric generating facility (the "Scrubgrass Project") located
in Pennsylvania, the lease for which commenced on June 30, 1994. In recent
years, the Company also held varying ownership interests (100% to 40%) in an
approximately 51 Mw (net) waste coal-fired electric generating facility (the
"Sunnyside Project") located in Utah and owned the development rights to an
existing 43 Mw (net) waste 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
following Management's Discussion and Analysis of Financial Condition and
Results of Operations compares the Company's results of operations for the three
and nine months ended September 30, 2000 with the results of operations for the
three and nine months ended September 30, 1999. Historical results and trends
which might appear should not be taken as indicative of future operations.
The Company's leasehold interest in the Scrubgrass Project is held by EPC's
subsidiary, Buzzard Power Corporation ("Buzzard"). Buzzard leases the Scrubgrass
Project from Scrubgrass Generating Company L.P. (the "Lessor"). Buzzard has a
Management Services Agreement (the "MSA") with PG&E Generating Company (the
"Manager") to manage the Scrubgrass Project during the entire lease term and a
15-year Operations and Maintenance Agreement (the "O&M") with PG&E Operating
Services Company (the "Operator") to operate the Scrubgrass Project. Buzzard
sells electric output to Pennsylvania Electric Company ("PENELEC") pursuant to a
25 year power purchase agreement (the "PPA") which expires in 2018.
Cautionary Statement
This Quarterly Report on Form 10-Q contains "forward-looking statements", as
defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about the Company. For this
purpose, any statements which are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of
important factors which could cause the Company's actual results and events to
differ materially from those indicated by the forward looking statements. These
factors include, without limitation, those set forth below under the caption "--
Certain Factors That May Affect Future Results".
7
Results of Operations
Net income for the nine months ended September 30, 2000 amounted to $2,032,140
(18 cents per share) as compared to net income of $214,712 (2 cents per share)
for the nine months ended September 30, 1999. The improvements in the net
results during 2000 are primarily attributable to increases in power generation
revenues, interest income and income from sales of NOx emission credits. Such
increases were offset in part by increases in operating expenses, lease
expenses, depreciation and amortization, and related changes in the income tax
expense. The reasons for the changes in the Company's net results are discussed
in more detail in the following paragraphs.
Power Generation Revenues
- -------------------------
Power generation revenues for the nine months ended September 30, 2000 amounted
to $41,165,018 as compared to $35,495,619 for the nine months ended September
30, 1999 and all pertained to the Scrubgrass Project. The increase in power
generation revenues during 2000 is primarily attributable to additional revenues
of approximately $3,802,000 from the settlement agreement with PENELEC,
improvements in the capacity rate for the Scrubgrass facility, a 5% increase in
certain rates billed to the utility under the terms of the PPA, and an increase
in the rates charged for power generation in excess of 80mw pursuant to the
terms of the settlement agreement with PENELEC. These increases were offset in
part by a decrease in the revenue recorded as a result of the straight-line
accounting treatment of certain revenues under the power purchase agreement
which amounted to $5,277,009 and $5,824,223 for the nine months ended September
30, 2000 and 1999, respectively. The Scrubgrass Project operated at 89.0% of its
capacity for the nine months ended September 30, 2000 as compared to 87.7% for
the nine months ended September 30, 1999. The improvements in the capacity rate
occurred primarily for the following reasons. First, the Scrubgrass project had
its planned annual maintenance outages during the second quarters in both 2000
and 1999. During the 2000 and 1999 planned annual maintenance outages, the
Scrubgrass plant was inoperative for approximately 16 days and 20 days,
respectively, to perform scheduled maintenance procedures. Second, the
Scrubgrass Project incurred unscheduled shutdowns to respond to equipment
malfunctions and utility curtailments which necessitated that the Scrubgrass
plant be inoperative for an aggregate of approximately 14 days and 14 days
outside of the scheduled outage timeframes during the nine months ended
September 30, 2000 and 1999, respectively.
Power generation revenues amounted to $13,079,296 and $12,918,259 for the three
months ended September 30, 2000 and 1999, respectively. The increase in power
generation revenues during the third quarter in 2000 is primarily attributable
to a 5% increase in certain rates billed to the utility under the terms of the
PPA and an increase in the rates charged for power generation in excess of 80MW
pursuant to the terms of the settlement agreement with PENELEC. These increases
were offset in part by the following two decreases in revenues during the third
quarter of 2000. First, the Company had a decrease in the revenue recorded as a
result of the straight-line accounting treatment of certain revenues under the
power purchase agreement which amounted to $1,759,005 and $1,941,408 for the
three months ended September 30, 2000 and September 30, 1999, respectively.
Second, the Scrubgrass Project operated at 94.2% of its capacity during third
quarter of 2000 as compared to 95.4% for the same period in 1999. The third
quarter capacity rates were primarily affected by unscheduled shutdowns to
respond to equipment malfunctions and utility curtailments.
8
Operating Expenses
- ------------------
Operating expenses for the nine months ended September 30, 2000 amounted to
$17,065,816 as compared to $16,667,258 for the nine months ended September 30,
1999 and all pertained to the Scrubgrass Project. The increase in operating
expenses is primarily attributable to the following reasons. First, the Company
incurred higher fuel costs primarily as a result of cost escalations in certain
fuel supply agreements, improvements in the capacity rate, and increases in
diesel fuel costs. Second, pursuant to the terms of the O&M, the Operator passed
along increases in its labor and related costs to the Company. These increases
were offset in part by lower maintenance expenses and the absence of expenses
related to Year 2000 compliance during 2000. Maintenance expenses decreased
during 2000 primarily because of differences in the scope of procedures
performed during the 1999 and 2000 annual maintenance outages and fewer
unplanned maintenance shutdowns.
Operating expenses for the three months ended September 30, 2000 amounted to
$5,021,065 as compared to $5,227,286 for the three months ended September 30,
1999. The decrease in operating expenses is primarily attributable to the
following reasons. First, despite increases in diesel fuel costs and contract
rate esclations during 2000, overall fuel costs decreased slightly during the
third quarter of 2000 from lower fuel consumption as a result of the reduced
capacity rate. Second, the Operator incurred certain non-recurring costs during
the third quarter of 1999 related to hiring new personnel. Third, the Company
had Year 2000 compliance costs during the third quarter of 1999 which did not
recur in 2000. The aforementioned decreases were offset in part by an increase
in maintenance expenses during the third quarter of 2000, which resulted
primarily from a higher occurrence of unscheduled shutdowns to respond to
equipment malfunctions.
Lease Expenses
- --------------
Lease expenses amounted to $19,703,145 for the nine months ended September 30,
2000 as compared to $16,966,220 for the nine months ended September 30, 1999.
The increase in lease expenses during 2000 is primarily attributable to the
following reasons. First, the Lessor's loan costs, which are passed along to
the Company as a lease expense, increased due to higher average interest rates
on its tax exempt bonds and term loans. Second, the Company incurred scheduled
increases in base equity rents. Third, due to increases in available cash flows
from the Scrubgrass Project, which included revenues and interest income from
the settlement agreement with PENELEC and income from sales of NOx emission
credits, the Company incurred an increase in additional rent paid to the Lessor,
which amounts to 50 percent of the net available cash flows from the Scrubgrass
Project. The Company's overall increase in lease expenses during 2000 was offset
in part by decreases in the following two items. First, the Lessor's junior
debt obligations were fully satisfied during Fiscal 1999. As such, the
Company's lease expense did not include principal and interest on these
obligations in 2000. Second, the Company had 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 $5,277,009 and $5,824,223
for the nine months ended September 30, 2000 and 1999, respectively.
9
Lease expenses amounted to $5,664,855 for the three months ended September 30,
2000 as compared to $5,724,732 for the three months ended September 30, 1999.
The decrease in lease expenses during the third quarter of 2000 occurred
primarily for the following reasons. First, due to the timing of cash flow
availability for distribution from the Scrubgrass Project, the Company realized
a decrease in additional rent paid to the Lessor. Second, 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 $1,759,005 and $1,941,408 for the three months ended September 30,
2000 and 1999, respectively. Similar to the discussion in the previous
paragraph, the third quarter comparison was also affected by the absence in 2000
of the junior debt obligations, the increase in base equity rents and the
increases in average interest rates for the tax exempt bonds and term loans.
However, due to the extent of the decreases in lease expense associated with
additional rent, straight-line lease expenses and junior debt obligations, the
Company had an overall decrease in lease expense during the third quarter of
2000 despite the increases in base equity rents and average interest rates.
General and Administrative Expenses
- -----------------------------------
General and administrative expenses amounted to $2,313,679 for the nine months
ended September 30, 2000 as compared to $1,933,462 for the nine months ended
September 30, 1999. The increase in general and administrative expenses during
2000 occurred primarily for the following reasons. First, pursuant to the terms
of the MSA, the Manager passed along increases in its labor and related costs to
the Company. Second, professional fees increased during the first quarter of
2000 because the Company engaged an investment banker to consider various sale
and restructuring alternatives. Third, the Company paid bonuses aggregating
$210,000 to its executive officers during the second quarter of 2000. Fourth,
the Manager began charging the Scrubgrass Project in 2000 for certain corporate
support expenses such as internet communication services. Fifth, the Scrubgrass
Project had an increase in its insurance expense beginning in the third quarter
of 2000. The aforementioned increases were offset in part by a decrease in legal
fees during 2000.
General and administrative expenses amounted to $707,070 for the three months
ended September 30, 2000 as compared to $556,470 for the same period in 1999.
Similar to the discussion in the previous paragraph, the third quarter
comparison was also affected by the increases in the Manager's labor and related
costs, the Manager's corporate support expenses and insurance expense, as well
as the decrease in legal fees. However, the increases in professional fees and
executive compensation did not affect the third quarter comparison.
Depreciation and Amortization
- -----------------------------
Depreciation and amortization amounted to $102,044 and $312,826 for the three
and nine months ended September 30, 2000, respectively, as compared to $113,658
and $240,397 for the three and nine months ended September 30, 1999,
respectively. Depreciation and amortization increased in 2000 primarily because
the Company's Fiscal 1999 capital expenditures, which were substantially made
during the third quarter, were depreciated for the entire nine months of 2000.
10
Other Income (Expense)
- ----------------------
Sale of NOx emission credits amounted to $1,161,888 and $629,720 during the nine
months ended September 30, 2000 and September 30, 1999, respectively. The
Company received proceeds of $1,161,888 in April 2000 and $629,720 in February
1999 from sales of NOx emission credits which are discussed further under
"Liquidity and Capital Resources - Cash Flow Outlook".
Interest income amounted to $33,828 and $707,553 for the three and nine months
ended September 30, 2000, respectively, as compared to $27,761 and $87,868 for
the three and nine months ended September 30, 1999, respectively. The 2000
increase is primary attributable to approximately $608,000 of interest income
during the first quarter of 2000 from the settlement agreement with PENELEC and
higher interest rates on short-term investments.
Income Tax Expense
- ------------------
Income tax expense amounted to $710,000 and $1,598,000 for the three and nine
months ended September 30, 2000, respectively, as compared to $533,000 and
$153,000 for the three and nine months ended September 30, 1999, respectively.
The changes in income tax expense for each period are primarily related to the
respective changes in income before income taxes. The effective income tax rate
for Fiscal 2000 is currently projected to be approximately 44% which is
consistent with the actual tax rate realized for Fiscal 1999. During three and
nine months ended September 30, 1999, the Company originally estimated that its
effective income tax rate for Fiscal 1999 would be approximately 41% and revised
its estimates later in the year.
2000 Outlook
- ------------
The Company expects its net earnings to improve for the year ending December 31,
2000 ("Fiscal 2000") by comparison to the year ended December 31, 1999
("Fiscal 1999") and offers the following prospective information concerning
significant components of its results of operations for Fiscal 2000 which are
being compared to historical results of operations for Fiscal 1999:
Power generation revenues - Power generation revenues are expected to increase
materially in Fiscal 2000 primarily as a result of a 5% increase in certain
contracted rates under the PPA and additional revenues from the settlement
agreement with PENELEC. As discussed further in "Part II - Item 1. Legal
Proceedings", the Company settled its legal proceeding with PENELEC and
recognized 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 Fiscal 2000 for capacity in excess of 80mw.
Operating expenses - Operating expenses are expected to increase slightly in
Fiscal 2000 primarily due to projected increases in diesel fuel costs, 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. The aforementioned increases in operating expenses are
11
expected to be substantially offset by lower maintenance expenses and the
absence of expenses related to Year 2000 compliance.
Lease expenses - Lease expenses are expected to increase significantly in Fiscal
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 during Fiscal 2000. Third, due to projected increases in
cash from Scrubgrass Project operations, which include revenues and interest
income from the settlement agreement with PENELEC and proceeds from sales of NOx
emission credits, the Company expects its additional rent paid to the Lessor,
which amounts to 50 percent of the net cash flows from the Scrubgrass Project,
would also increase in Fiscal 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 Fiscal 2000. The Company expects these increases in
lease expense would be offset in part by the following items. First, the
Company expects to realize a decrease in the lease expense recorded as a result
of the straight-line accounting treatment of certain lease expenses under the
Scrubgrass lease. Second, the Lessor's junior debt obligations were fully
satisfied by the end of Fiscal 1999. The absence of payments on the junior debt
obligations is expected to reduce the Lessor's loan costs in Fiscal 2000. 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 Fiscal 2000 for the following reasons. First, the
Company expects its casualty insurance costs to increase in Fiscal 2000 due to
changes in the Manager's experience rating for all its facilities. The Manager
insures all of its power plants under one insurance program and is expected to
apportion this overall rate increase to all its facilities. Second, the Company
is anticipating increases in the Manager's labor and related costs. Third, the
Manager expects to bill the Scrubgrass Project for certain corporate level
support expenses. The Manager, which has improved its ability to track support
expenses by facility, previously absorbed these expenses at the corporate level.
Fourth, the Company paid bonuses to its three executive officers. 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 Fiscal 2000
primarily for the following two reasons. First, the Company reported income of
$1,161,888 in Fiscal 2000 from sales of Nitrogen Oxide Ozone Transport Region
Budget Allowances ("NOx Credits"). The sales of NOx credits are discussed
further under "Liquidity and Capital Resources - Cash Flow Outlook". The
Company also reported 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 Fiscal 1999 as a result of a change in its method of accounting for
major equipment overhauls. This income will not recur in Fiscal 2000.
12
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 Fiscal 2000 to be comparable to the
actual rates experienced in Fiscal 1999.
Litigation recoveries - As of September 30, 2000, the Company is seeking to
recover approximately $4.6 million owed by the Purchasers of SCA which is the
subject of legal proceeding. See "Part II - Item 1. 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
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 Condensed Consolidated Financial Statements for recently
issued accounting standards which are required to be adopted in the future.
Liquidity and Capital Resources
Operating Activities
The Company had cash provided by operating activities of $39,582 and $620,195
during the nine months ended September 30, 2000 and 1999, respectively. During
these periods, the Company's only sources of cash from operating activities were
operating profits from the Scrubgrass Project and investment earnings.
The Company's net income of $2,032,140 contributed a significant portion of its
net cash provided by operations during the nine months ended September 30, 2000.
The following adjustments, which did not impact the Company's cash flows, need
to be considered in order to reconcile the Company's net income to its net cash
provided by operating activities for the nine months ended September 30, 2000.
Depreciation and amortization - During the nine months ended September 30,
2000, the Company recognized depreciation and amortization for its lease rights
of $111,753, deferred financing costs of $33,444, machinery and equipment
modifications of $160,776 and equipment and furniture of $6,853.
Deferred gain, net - The Company's deferred gain, net, amounted to $4,857,468 as
of September 30, 2000 as compared to $5,088,776 as of December 31, 1999. 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 2000:
13
Receivable from utility - The Company's receivable from utility relates to the
Scrubgrass Project and amounted to $7,768,137 as of September 30, 2000 as
compared to $3,703,922 as of December 31, 1999. The increase during 2000 is
primarily attributable to the increases in power generation revenues and
differences in the timing of collecting the receivable from utility. The
Scrubgrass Project collects its receivable from utility on a monthly basis 23
business days after the month of power generation. 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 24 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
September 30, 2000, which included power generation revenues for August 2000 and
September 2000, was significantly higher by comparison to the balance as of
December 31, 1999, which only included power generation revenues for December
1999.
Other current assets - The Company's other current assets amounted to $737,502
as of September 30, 2000 as compared to $645,852 as of December 31, 1999. The
increase is other current assets expenses is primarily attributable to the
following reasons. First, fuel inventory increased during 2000 largely because
of higher diesel fuel costs. Second, due to the timing of making installment
payments, the Company experienced increases in its prepaid property taxes and
prepaid insurance. The aforementioned increases were substantially offset by the
collection of an insurance refund which was receivable as of December 31, 1999.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $6,913,583 as of September 30, 2000 as compared to
$4,751,906 as of December 31, 1999. The increase in accounts payable and
accrued expenses 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 increase to the receivable from utility (see
"Receivable from utility" above). Second, the Company's corporate taxes payable
increased from $539,780 as of December 31, 1999 to $803,560 as of September 30,
2000 largely due to higher taxable income during 2000. Third, due to the timing
of the Company's 2000 annual maintenance outage, the Company had significant
outage-related obligations remaining as of September 30, 2000. The Company had
no outage-related obligations as of December 31, 1999. Fourth, due to the
fluctuations in operating expenses and general and administrative expenses
described under "Results of Operations" above, the Company realized a net
increase in certain accounts payable and accrued expenses as of September 30,
2000. The overall increase in accounts payable and accrued expenses was offset
in part primarily by the following factors which decreased accounts payable and
accrued expenses as of September 30, 2000. First, the Company has certain costs
which are paid annually during the first quarter and accrued monthly during the
calendar year. For such costs, the Company's accrued expenses as of September
30, 2000 included only nine months of expense as compared to 12 months of
expense as of December 31, 1999. Second, the Company had a decrease in accrued
bond interest which amounted to approximately $1,096,000 and $96,000 as of
December 31, 1999 and September 30, 2000, respectively. The decrease in accrued
bond interest occurred primarily because a significant percentage of the bonds
were redeemed and reissued with shorter durations during 2000.
14
Long -term debt to supplier - The Company financed the 1997 rewind of the
Scrubgrass generator with an installment note from the generator manufacturer
which had outstanding balances of $187,073 and $276,948 as of September 30, 2000
and December 31, 1999, respectively. The decrease in 2000 is primarily due to a
scheduled installment payment made during the second quarter of 2000. The
Company's next installment of $100,000 is due in May 2001 and is included in
other current liabilities on the accompanying balance sheet as of September 30,
2000.
Investing Activities
The Company used $147,430 and $233,242 in investing activities during the nine
months ended September 30, 2000 and 1999, respectively. The Company's investing
activities are concentrated primarily in the following areas:
Notes receivable - The Company presently has notes receivable related to the
1994 sale of the Sunnyside Project and had a note receivable related to fees
earned for the Scrubgrass Project which was fully satisfied in 1999. The
Company collected $31,463 from notes receivable related to the Scrubgrass
Project in 1999. The notes receivable related to the Sunnyside Project, with a
principal balance of $2,937,500 and outstanding interest balance of $1,322,881
as of September 30, 2000, are the subject of a legal proceeding. Due to
uncertainties surrounding the timing of resolving this legal proceeding, the
Company wrote-off the outstanding balances of these receivables as of December
31, 1998 and is no longer recognizing future interest income on the notes.
"See Part II - Item 1. Legal Proceedings" for further information about this
litigation.
Restricted cash - The Company is required by certain project agreements to
restrict cash for major maintenance and, from time to time, voluntarily
restricts cash for capital expenditures. The Company offers the following
information about its restricted cash:
Major Maintenance - The Company is presently required to make scheduled
-----------------
deposits to a restricted major maintenance fund relating to the Scrubgrass
Project to ensure that funds are available in the future for scheduled major
equipment overhauls. The Company is also allowed to spend restricted cash
for major equipment overhauls subject to certain restrictions. The Company
made scheduled deposits, including interest earned thereon, to the restricted
major maintenance fund of $513,468 and $738,300 during the nine months ended
September 30, 2000 and 1999, respectively. The Company's payments for major
equipment overhauls amounted to $266,338 and $1,171,141 during the nine
months ended September 30, 2000 and 1999, respectively. Major equipment
overhaul expenditures fluctuated considerably between these periods primarily
because of differences in the scope of procedures performed during the 2000
and 1999 annual maintenance outages. The Company also used restricted cash
to fund the long term debt to its supplier described above for which the
installments amounted to $100,000 and $100,000 during the nine months ended
September 30, 2000 and 1999, respectively.
Capital Expenditures - During 1999, the Company received $629,720 from sales
--------------------
of NOx emission credits and designated that $600,000 of such proceeds be
restricted for capital expenditures at the Scrubgrass Project. During the
nine months ended September 30, 1999,
15
the Company made capital expenditures of $797,546, of which $610,789 was
funded from restricted cash and investment earnings thereon.
Property, plant and equipment - The Company made capital expenditures of
$797,546 during the nine months ended September 30, 1999 primarily for machinery
and equipment modifications at the Scrubgrass facility (see previous discussion
under "Restricted Cash"). The Company has not made significant capital
expenditures in 2000.
Financing Activities
The Company's financing activities provided cash of $19,853 during the nine
months ended September 30, 2000 and used cash of $527,433 during the nine months
ended September 30, 1999. The Company's financing activities are concentrated
primarily in the following areas:
Dividends - The Company has a quarterly dividend program which is subject to
review and consideration by the Board of Directors each quarter. In respect of
this dividend program, the Company declared dividends of $513,305 (4.5 cents per
share) and $513,306 (4.5 cents per share) during the nine months ended September
30, 2000 and September 30, 1999, respectively. The Company had dividends payable
of $171,102 (1.5 cents per share), $171,102 (1.5 cents per share) and $171,102
(1.5 cents per share) as of September 30, 1999, December 31, 1999 and September
30, 2000, respectively, which were each paid during the following quarters. As
such, the Company paid dividends of $513,305 (4.5 cents per share) and $342,204
(3 cents per share) to its common stockholders during the nine months ended
September 30, 2000 and September 30, 1999, respectively. The Company also paid
dividends to its subsidiary's preferred stockholder of $3,750 during both the
nine months ended September 30, 2000 and 1999.
Working Capital Loan - The Company may borrow up to $4 million under a Lessee
Working Capital Loan Agreement with the Lessor for ongoing working capital
requirements of the Scrubgrass Project. The Company had net borrowings of
$1,136,908 and $789,597 under the Lessee Working Capital Loan Agreement during
the nine months ended September 30, 2000 and 1999, respectively, and had
outstanding borrowings under the Lessee Working Capital Loan Agreement of
$1,994,619 and $2,389,664 as of December 31, 1999 and December 31, 1998,
respectively. As discussed previously under "Receivable from utility", the
Company collected an additional revenue payment from the utility during December
1999. As such, the changes in net borrowings under the Lessee Working Capital
Loan Agreement between the nine months ended September 30, 2000 and 1999 are
primarily attributable to the timing of collecting revenues and using any
available cash balances to repay the working capital loan.
Term Credit Facility - In September 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 was payable in full. The Company made
aggregate payments of $600,000 and $950,000 during the nine months ended
September 30, 2000 and 1999, respectively, under this credit facility to ensure
16
that the outstanding borrowings would not exceed the maximum allowable
borrowings on the dates indicated. As of September 30, 2000, there were no
outstanding balances remaining under this credit facility.
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 $1,037,266 and $1,188,573, respectively as
of September 30, 2000. The Sunnyside Project long-term obligations are payable
based on a schedule which relates directly to the amount of proceeds received
from the collection of the outstanding notes receivable from the sale of the
Company's interest in the Sunnyside Project, which are the subject of a
litigation described in "Part II. - Item 1. Legal Proceedings". The Scrubgrass
Project obligation has scheduled maturities which began in 1998 and continue
through 2005. The Company made payments of $-0- and $21,076 for the Scrubgrass
Project obligation during the nine months ended September 30, 2000 and 1999,
respectively.
Cash Flow Outlook
During Fiscal 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 its Annual Report on Form 10-K for Fiscal 1999, 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 Fiscal 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 Fiscal 1999.
As discussed under the caption "Results of Operations - 2000 Outlook", the
Company expects that the Scrubgrass Project's cash flows in Fiscal 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.
However, the Company expects that anticipated increases in operating expenses,
lease expenses, general and 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 Fiscal 2000 of $700,000 for
debt and $678,527 for deposits to restricted cash. As of September 30, 2000,
the Company has already funded debt and restricted cash obligations of $700,000
and $493,472, respectively.
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 Fiscal 1999
requirements without any modifications to the Facility. However, the Company
made capital improvements of $811,568 in Fiscal 1999 to the Facility, which are
expected to enable the Facility to meet the stricter standards in 2003. By
making improvements to the Facility
17
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 material environmental
regulations for the foreseeable future without any additional material
modifications to the Scrubgrass facility. The sales of NOx Credits are discussed
further in the Company's Fiscal 1999 Annual Report on Form 10-K.
During Fiscal 1999, the Manager of the Scrubgrass Project commenced long-term
refinancing discussions with the lending agents for the Scrubgrass Project.
Through these discussions, the Manager of the Scrubgrass Project has addressed
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 or extended.
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 20 days beginning in July
2003, which is expected to create the need for additional working capital.
Recently, the Manager reached provisional agreements with the lending agents
which provided for the following proposed changes to the Scrubgrass Project
financing structure:
. the tax exempt bond letter of credit would be replaced with a letter of
credit expiring on December 31, 2006. Under the proposed terms of the
replacement letter of credit, the Company would pay a one-time fee of
$35,000 and additional fees of approximately $417,000 per year.
. the available working capital facility would be increased from $4 million
to $10 million through 2005 with annual paydown requirements of $2.5
million in 2001 and 2002, and $8 million in 2003 through 2005. After 2005,
the available working capital facility and annual paydown requirements
would reduce incrementally until the expiration of the proposed working
capital facility in 2008. Under the terms of the proposed working capital
facility, the Company is expected to pay a one-time fee of approximately
$105,000 and additional annual commitment fees of approximately $23,000 per
year.
The proposed changes to the Scrubgrass Project financing structure are presently
under consideration by the credit committees of the lending agents. At this
time, the Company has no reason to believe that these provisional agreements
would not be approved by the lending agents. However, there can be no assurance
that the terms of the provisional agreements would not be amended during the
approval process.
As of September 30, 2000, the Company is seeking to recover approximately $4.6
million owed by the Purchasers of SCA (See "Part II - Item 1. 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
18
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.
The Company's corporate structure is very complicated and includes multiple
entities resulting in several layers of tax for the Company and its
shareholders. Prior to 1998, the Company's cash position was not materially
affected by this corporate structure because of the existence of significant net
operating loss carryforwards. However, the Company's cash position has been
affected in recent years by significant corporate tax payments since the Company
utilized substantially all of its net operating loss carryforwards in 1997.
Presently, the Company is reviewing its corporate tax position and is
considering tax strategies and restructuring alternatives 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. Notwithstanding, the
Company will continue to be affected by its obligations for scheduled
maintenance reserves, term debt repayments, 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.
Year 2000 Issue
The Year 2000 Issue related to the potential problems resulting from the
incorrect processing of information using dates or date sensitive data by
computers and other machines utilizing embedded microprocessors. The problem is
attributable to hardware or software recognizing the Year 2000 as a two digit
number "00" as opposed to correctly interpreting the year as "2000". The
Company was adequately prepared for the Year 2000 Issue and did not experience
any meaningful disruptions related to the Company's information technology (IT)
and non-IT systems. Additionally, the Company did not encounter any meaningful
disruptions or communications with its mission critical vendors, its business
partners, or its customer.
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q.
19
Ownership of Single Operating Asset
The Company owns a 22 year leasehold interest in the Scrubgrass Project, an
approximate 83 Mw (net) waste coal-fired electric generating facility located in
Pennsylvania, the lease for which commenced on June 30, 1994. Presently, all
the Company's operating revenues are attributable to power generation from the
Scrubgrass Project. Accordingly, the Company's operations are largely dependent
upon the successful and continued operation of the Scrubgrass Project. In
particular, if the Scrubgrass Project experiences unscheduled shutdowns of
significant duration, the Company's results of operations will be materially
adversely affected.
Dependence Upon Key Employees
The success of the Company is largely dependent upon a staff of 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 Generating Company to
manage the Scrubgrass Project and a 15-year operations and maintenance agreement
with PG&E Operating Services Company to operate the Scrubgrass Project. Under
the terms of these agreements, there are provisions which limit the Company's
participation in the management and operation of the Scrubgrass Project, and
provisions which provide for recourse against the Manager and 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.
Interest Rates
Buzzard, 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. Buzzard 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 and lease obligations:
Balance at Matures
Description of the Obligation 9/30/2000 Interest Rate Through
- ---------------------------------------------------------------------------------------------------
Lessor debt obligations:
Variable-rate tax exempt bonds $135,600,000 Quoted Tax Exempt Bond Rate 2012
Variable rate term loan 13,051,336 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 3,131,527 LIBOR rate plus 1.125% Revolving
Variable rate term loan 1,188,573 LIBOR rate plus 1.250% 2004
20
The Lessor entered into interest rate swaps which had the effect of fixing the
LIBOR 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, Buzzard 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 these 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 the
Company's Fiscal 1999 Annual Report on Form 10-K for further information about
the Company's debt and lease obligations.
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.
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.
Legal Proceedings
As discussed in "Part II - Item 1. Legal Proceedings", the Company is involved
in a legal proceeding with the purchasers of the Company's interest in the
Sunnyside Project which was sold in 1994. Pending the resolution of the legal
proceeding, the purchasers have withheld scheduled payments of principal and
interest due on the promissory notes since September 1996, which amounted to
$2,937,500 and $1,322,881, respectively as of September 30, 2000. 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
21
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, and currently has an accumulated deficit of $2,815,036
as of September 30, 2000. The Company was profitable from operating activities
in 1998 and 1999 and expects to be profitable from operating activities for
Fiscal 2000. However, the Company experienced a net loss from operating
activities in 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.
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.
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
22
instance, the electric industry has been previously affected by legislation such
as PURPA and the Energy Act which have encouraged companies other than utilities
to enter the electric power business by reducing regulatory constraints. More
recently, as discussed under the caption "Energy Regulation", there has been new
state legislation to deregulate the generation component of the electric
business. Furthermore, proposed changes to repeal or modify PUHCA and PURPA
could reduce regulatory restrictions placed on electric utilities and encourage
them to seek new sources of electric power. Any of these regulatory matters,
among others, could increase competition for electric power. Other than the risk
that PENELEC would seek to renegotiate the terms of the PPA (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 PPA switch to rates which vary more closely with existing
market conditions. Should ensuing competition in the later years of the PPA
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. In February 2000, the Company engaged an investment
banker 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
23
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 PPA, 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
the PPA, 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 Pennsylvania Public Utility Commission ("PAPUC") which, among other things,
included unbundled prices for electric generation,
24
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 PAPUC which was heavily
contested by a number of affected parties. Eventually, the litigation resulted
in a settlement which was approved by the PAPUC 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 importantly, the restructuring plan, as
approved by the PAPUC, provided for PENELEC to maintain a separate non-utility
generator cost recovery mechanism for accounting purposes. Therefore, the
restructuring plan is designed, in 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:
25
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 requirements beginning on May 1, 1999 without any modifications to the
facility. However, the Company made capital improvements of $811,568 in Fiscal
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.
26
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's most significant market risk exposure is changing interest rates
which may affect its short-term investments, its debt and certain of its lease
expenses. The Company offers the following information about these market risks:
Short-term investments - The Company invests cash balances which are in
excess of its normal operating requirements in short term investments
generally with maturities of three months or less. Because of the short
duration of these investments, the Company does not believe its short-term
investments are subject to material market risk.
Debt - The Company has borrowings which bear interest at variable rates which
are based on the London Interbank Offering Rate (LIBOR). The Company or the
Lessor monitors market conditions for interest rates and, from time to time,
enters into interest rate swaps to manage its interest payments. The
interest rate swaps have the effect of converting the variable rate
borrowings to fixed rate borrowings for specified time periods.
Lease Expense - The Company, as a lease cost of the Scrubgrass facility, is
required to fund the Lessor's debt service which consists of fixed rate
borrowings and borrowings which bear interest at variable rates based on
either quoted bond rates or the London Interbank Offering Rate (LIBOR). The
Lessor 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.
The Company's interest rate risk is discussed further in "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Certain Factors That May Impact Future Results -- Interest Rates".
PART II. OTHER INFORMATION
--------------------------
ITEM 1. Legal Proceedings
Scrubgrass Project
On October 11, 1995, the 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 PPA.
In its complaint, the Plaintiffs alleged 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
27
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 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. 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 to the Scrubgrass Project 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.
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 $1,322,881,
respectively at September 30, 2000. 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
28
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. On February 15, 2000, the
Plaintiffs filed a request for the Court to reconsider its January 12, 2000
decision. On February 28, 2000, the Company opposed the Plaintiffs' request for
the Court to reconsider its January 12, 2000 decision. On July 31, 2000, the
Court denied the Plaintiffs' February 15, 2000 request for the Court to
reconsider its January 12, 2000 decision. On August 3, 2000, the Court also
entered a partial summary judgment in the Defendants' favor and against the
Plaintiffs, dismissing with prejudice the Plaintiffs' claims that the Defendants
breached the Purchase and Sale Agreement due to an alleged basis for legal
proceedings against Pacificorp. This partial summary judgment reaffirmed the
Court's January 12, 2000 decision and put closure to the Plaintiffs' February
12, 1999 motion. Discovery remains ongoing.
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ITEM 6. Exhibits And Reports On Form 8-K
(a) Exhibit 11 - Computation of Earnings Per Share
(b) Exhibit 27 - Financial Data Schedule
(c) Reports on Form 8-K - None
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENVIRONMENTAL POWER CORPORATION
November 13, 2000 /s/ William D. Linehan
-----------------------------------
William D. Linehan
Treasurer and
Chief Financial Officer
(principal accounting officer
and authorized officer)
30