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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark one)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
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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
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Commission file number 0-15472
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Environmental Power Corporation
(Exact name of registrant as specified in its charter)
Delaware 04-2782065
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
500 Market Street, Suite 1-E, Portsmouth, New Hampshire 03801
(Address of principal executive offices)
(Zip code)
(603) 431-1780
Registrant's telephone number, including area code
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Number of shares of Common Stock outstanding
at May 14, 2001 11,406,783 shares
The Exhibit Index appears on Page 25.
Total number of pages is 26.
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ENVIRONMENTAL POWER CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as
of March 31, 2001 (unaudited) and December 31, 2000 .................................. 2
Condensed Consolidated Statements of Operations (unaudited) for the Three Months
Ended March 31, 2001 and March 31, 2000 ............................................ 3
Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended
March 31, 2001 and March 31, 2000 ................................................... 4
Notes to Condensed Consolidated Financial Statements ................................. 5-6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations ........................................................................... 7-23
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................... 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................... 25
Item 6. Exhibits and Reports on Form 8-K .................................... 25
Signatures ........................................................................... 26
1
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. Financial Statements
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31 December 31
2001 2000
----------------- ----------------
ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 11,427 $ 307,666
Restricted cash 798,979 587,476
Receivable from utility 7,694,577 7,336,408
Other current assets 1,355,034 760,980
----------------- ----------------
TOTAL CURRENT ASSETS 9,860,017 8,992,530
PROPERTY, PLANT AND EQUIPMENT, NET 517,629 558,015
DEFERRED INCOME TAX ASSET 724,193 755,193
LEASE RIGHTS, NET 2,273,256 2,310,507
ACCRUED POWER GENERATION REVENUES 58,053,351 56,188,143
OTHER ASSETS 451,328 479,786
----------------- ----------------
TOTAL ASSETS $ 71,879,774 $ 69,284,174
================= ================
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 7,122,399 $ 6,952,054
Dividends payable on common stock --- 171,102
Other current liabilities 2,865,489 3,045,787
----------------- ----------------
TOTAL CURRENT LIABILITIES 9,987,888 10,168,943
DEFERRED GAIN, NET 4,703,262 4,780,365
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 2,118,172 2,116,309
ACCRUED LEASE EXPENSES 58,053,351 56,188,143
----------------- ----------------
TOTAL LIABILITIES 74,862,673 73,253,760
----------------- ----------------
SHAREHOLDERS' DEFICIT:
Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
issued) --- ---
Preferred Stock (no par value, 10 shares authorized; 10 shares
issued at March 31, 2001 and December 31, 2000, respectively) 100 100
Common Stock ($.01 par value; 20,000,000 shares authorized;
12,525,423 shares issued at March 31, 2001 and
December 31, 2000, respectively; 11,406,783 shares outstanding
at March 31, 2001 and December 31, 2000, respectively) 125,254 125,254
Accumulated deficit (2,206,034) (3,192,721)
----------------- ----------------
(2,080,680) (3,067,367)
Treasury stock (1,118,640 common shares, at cost, as of
March 31, 2001 and December 31, 2000, respectively) (456,271) (456,271)
Notes receivable from officers and board members (445,948) (445,948)
----------------- ----------------
TOTAL SHAREHOLDERS' DEFICIT (2,982,899) (3,969,586)
----------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 71,879,774 $ 69,284,174
================= ================
See Notes to Condensed Consolidated Financial Statements.
2
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended March 31
2001 2000
----------------------- -------------------
POWER GENERATION REVENUES $ 13,482,891 $ 16,768,555
----------------------- -------------------
COSTS AND EXPENSES:
Operating expenses 4,957,240 5,239,505
Lease expenses 6,015,022 7,651,398
General and administrative expenses 685,729 664,797
Depreciation and amortization 86,547 105,386
----------------------- -------------------
11,744,538 13,661,086
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OPERATING INCOME 1,738,353 3,107,469
----------------------- -------------------
OTHER INCOME (EXPENSE), NET:
Interest income 18,784 634,022
Interest expense (69,303) (92,004)
Amortization of deferred gain 77,103 77,102
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26,584 619,120
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INCOME BEFORE INCOME TAXES 1,764,937 3,726,589
INCOME TAX EXPENSE (777,000) (1,640,000)
----------------------- -------------------
NET INCOME $ 987,937 $ 2,086,589
======================= ===================
BASIC AND DILUTED EARNINGS PER
COMMON SHARE $ 0.09 $ 0.18
======================= ===================
DIVIDENDS:
Common shares (1) $ --- $ ---
Preferred shares 1,250 1,250
----------------------- -------------------
$ 1,250 $ 1,250
======================= ===================
DIVIDENDS PER COMMON SHARE (1) $ 0.000 $ 0.000
======================= ===================
(1) Dividends for the first quarter of 2000 of $171,102 (1.5 cents per common
share) were declared and paid in April 2000. There were no dividends
declared for the first quarter of 2001.
See Notes to Condensed Consolidated Financial Statements
3
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31
2001 2000
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 987,937 $ 2,086,589
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 86,547 105,386
Deferred income taxes 31,000 ---
Amortization of deferred gain (77,103) (77,102)
Accrued power generation revenues (1,865,208) (1,758,999)
Accrued lease expenses 1,865,208 1,758,999
Changes in operating assets and liabilities:
Increase in receivable from utility (358,169) (402,232)
(Increase) decrease in other current assets (594,054) 32,248
Decrease (increase) in other assets 19,548 (2,959)
Increase in accounts payable and accrued expenses 170,345 443,624
Increase in long-term liabilities --- 2,850
Increase in long-term debt to supplier 1,863 3,375
---------------- ----------------
Net cash provided by operating activities 267,914 2,191,779
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CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in restricted cash (211,503) (194,773)
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (172,352) (172,352)
Net repayments of working capital loan (143,215) (194,542)
Repayment of secured promissory notes payable and
other borrowings (37,083) ---
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Net cash used in financing activities (352,650) (366,894)
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(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (296,239) 1,630,112
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 307,666 306,188
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,427 $ 1,936,300
================ ================
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 accounting
principles generally accepted in the United States of America for annual
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The results of operations for the three months ended March 31,
2001 are not necessarily indicative of results to be expected for the year
ending December 31, 2001. 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, 2000.
NOTE B -- EARNINGS PER COMMON SHARE
- -----------------------------------
The Company computes its earnings per common share using the treasury stock
method in accordance with SFAS No. 128, "Earnings per Share". The Company
computes basic earnings per share by dividing net income for the period by the
weighted average number of shares of common stock outstanding during the period.
For purposes of calculating diluted earnings per share, the Company considers
its shares issuable in connection with stock options to be dilutive common stock
equivalents when the exercise price is less than the average market price of the
Company's common stock for the period. The following table outlines the
calculation of basic earnings per share and diluted earnings per share for the
three months ended March 31, 2001 and 2000.
Income Shares Per Share
(Numerator) (Denominator) Amounts
---------------- ------------------ -------------
Three Months Ended March 31, 2001:
- ----------------------------------
Income available to shareholders $ 987,937 11,406,783 $ .09
Effect of dividends to preferred stockholders (1,250)
---------------- ------------------ -------------
Basic EPS - income available to common shareholders 986,687 11,406,783 .09
Effect of dilutive securities:
Assumed exercise of dilutive stock options 1,207
---------------- ------------------ -------------
Diluted EPS - income available to common shareholders $ 986,687 11,407,990 $ .09
================ ================== =============
Three Months Ended March 31, 2000:
Income available to shareholders $ 2,086,589 11,406,783 $ .18
Effect of dividends to preferred stockholders (1,250)
---------------- ------------------ -------------
Basic EPS - income available to common shareholders 2,085,339 11,406,783 .18
Effect of dilutive securities:
Assumed exercise of dilutive stock options 543
---------------- ------------------ -------------
Diluted EPS - income available to common shareholders $ 2,085,339 11,407,326 $ .18
================ ================== =============
5
NOTE C - SUBSEQUENT EVENT
- -------------------------
On April 10, 2001, Environmental Power Corporation and certain of its
wholly-owned subsidiaries (the "Defendants") received aggregate proceeds of
$1,500,000 from B&W Sunnyside, Inc., NRG Sunnyside, Inc. and certain of their
affiliates (the "Plaintiffs") as consideration pursuant to a Binding Settlement
Agreement (the "Settlement") dated April 9, 2001. The Settlement resolved a
legal proceeding between the Plaintiffs and Defendants which had been ongoing
since May 3, 1996. The nature of the legal proceeding and the terms and
conditions of the Settlement were described in previous filings with the
Securities and Exchange Commission.
At the time of making the Settlement, the Defendants had recorded on their
balance sheets aggregate contingent obligations of approximately $1.2 million
due to third party creditors. As part of the Settlement, the Defendants were
formally released from contingent obligations which amounted to $177,961.
Because of the terms of the Settlement, which terms represented a substantial
compromise of their previous claims against the Plaintiffs, the Defendants are
presently considering their rights and obligations with respect to the remaining
contingent obligations. Until the Defendants resolve these remaining issues, the
unsettled contingent obligations will remain recorded on their balance sheets.
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. 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 National Energy Group Company (the
"Manager") to manage the Scrubgrass Project 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.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations compares the Company's results of operations for the three
months ended March 31, 2001 ("2001") with the results of operations for the
three months ended March 31, 2000 ("2000"). Historical results and trends which
might appear should not be taken as indicative of future operations.
Cautionary Statement
This Quarterly Report on Form 10-Q contains "forward-looking statements", as
defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about the Company. For this
purpose, any statements which are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements. There are a number of important
factors which could cause the Company's actual results and events to differ
materially from those indicated by the forward looking statements. These factors
include, without limitation, those set forth below under the caption "--Certain
Factors That May Affect Future Results".
Results of Operations
Net income in 2001 amounted to $987,937 (9 cents per share) as compared to net
income of $2,086,589 (18 cents per share) in 2000. The decrease in net results
during 2001 is primarily attributable to a decrease in power generation
revenues, a decrease in interest income, and an increase in general and
administrative expenses. The effect of these changes was offset in part by
decreases in operating expenses, lease expenses, and 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 in 2001 amounted to $13,482,891 as compared to
$16,768,555 in 2000. The decrease in power generation revenues during 2001 is
primarily attributable to the absence of
7
revenues of approximately $3,687,000 from the settlement agreement with PENELEC.
This decrease was offset in part by a 5% increase in certain rates billed to
PENELEC under the terms of the PPA and an increase in the revenue recorded as a
result of the straight-line accounting treatment of certain revenues under the
PPA which amounted to $1,865,208 and $1,758,999 for 2001 and 2000, respectively.
The Scrubgrass Project, which operated at 93.7% of its capacity in 2001 as
compared to 93.9% in 2000, had comparable power generation during each period.
Operating expenses in 2001 amounted to $4,957,240 as compared to $5,239,505 in
2000. The decrease in operating expenses is primarily attributable to the
following reasons. First, the Company performed certain maintenance procedures
prior to the scheduled annual outage in Fiscal 2000. Since these procedures are
typically performed in later quarters, the Company had a decrease in
maintenance expenses during 2001 by comparison to 2000. Second, diesel fuel
prices in 2001 were lower by comparison to 2000. Third, due to favorable pricing
from an advance purchase, the Company had a decrease in limestone expenses.
Fourth, due to certain non-recurring fees incurred in 2000, the Company had a
decrease in its ash handling expenses during 2001. These decreases were offset
in part by the following increases in operating expenses during 2001. First, the
Company had higher fuel costs in 2001 primarily as a result of cost escalations
in certain fuel supply agreements. Second, pursuant to the terms of the O&M, the
Operator passed along increases in its labor and related costs and operator fees
to the Company.
Lease expenses in 2001 amounted to $6,015,022 as compared to $7,651,398 in 2000.
The decrease in lease expenses during 2001 is primarily attributable to lower
additional rents paid to the Lessor. The additional rents paid to the Lessor,
which amount to 50 percent of the net cash flows from the Scrubgrass Project,
were lower during 2001 primarily due to the absence of revenues and interest
income from the PENELEC settlement. This decrease in lease expenses was offset
in part by the following increases in lease expenses during 2001. First, due to
the recent refinancing of the Lessor's letter of credit, the Company had an
increase in the Lessor's letter of credit fees which were passed through in its
facility lease expenses. Second, due primarily to higher average interest rates
on the tax exempt bonds, the Company had increases in senior debt interest which
were passed through in its facility lease expenses. Third, the Company had an
increase in lease expenses recorded as a result of the straight-line accounting
treatment of certain lease expenses under the Scrubgrass lease which amounted to
$1,865,208 and $1,758,999 for 2001 and 2000, respectively.
General and administrative expenses in 2001 amounted to $685,729 as compared to
$664,797 in 2000. While aggregate general and administrative expenses did not
materially change from 2000 to 2001, the following changes are worthy of
comment. The Company incurred increases in Scrubgrass insurance expense, pension
expense, and administrative salaries during 2001. These increases were
substantially offset by a decrease in Scrubgrass management expenses during
2001. Scrubgrass incurred significant professional fees, travel expenses and
labor related costs during 2000 to address certain non-recurring business
matters.
Interest income in 2001 amounted to $18,784 as compared to $634,022 in 2000. The
decrease during 2001 is primary attributable to the absence of approximately
$608,000 of interest income from the settlement agreement with PENELEC.
8
Income tax expense in 2001 amounted to $777,000 as compared to $1,640,000 in
2000. The decrease in income tax expense for 2001 is primarily attributable to
the decrease in pre-tax earnings and a decrease in the expected effective income
tax rate. The effective income tax rate for Fiscal 2001 is currently projected
to be approximately 44% which is lower than the actual tax rate of approximately
47% incurred in Fiscal 2000. Due to revenues from the PENELEC settlement and
sales of NOx Credits, the Company's taxable earnings were significantly
concentrated in Pennsylvania during Fiscal 2000, which state carries the highest
effective tax rate for the Company. The Company does not presently expect its
taxable earnings will be so highly concentrated in Pennsylvania during Fiscal
2001.
Fiscal 2001 Outlook
The Company offers the following prospective information concerning its results
of operations for the year ended December 31, 2001 ("Fiscal 2001") which are
being compared to the historical results of operations for the year ended
December 31, 2000 ("Fiscal 2000"):
Power generation revenues - Power generation revenues are expected to
decrease in Fiscal 2001 primarily due to the absence of revenues from the
PENELEC settlement. This decrease would be offset in part by a 5% increase
in certain contracted rates under the PPA and an increase in the revenue
recorded as a result of the straight-line accounting treatment of certain
revenues under the PPA.
Operating expenses - Operating expenses are expected to increase in Fiscal
2001 from a 4% average escalation in rates for fuel supply agreements, a
5% escalation in rates for Operator fees, changes in the scope of planned
maintenance procedures, and anticipated increases in the Operator's labor
and related costs. During Fiscal 2001 to date, these increases have been
offset in part by improvements in diesel fuel prices and fuel quality.
However, the Company cannot reasonably predict the extent of changes in
diesel fuel prices and fuel quality for the remainder of Fiscal 2001.
Lease expenses - Lease expenses are expected to decrease in Fiscal 2001
for the following reasons. First, the Company expects that lower interest
rates on the Lessor's tax-exempt bonds and term loans will decrease 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 have
scheduled decreases in base equity rents during Fiscal 2001. Third, due to
projected decreases in available cash flows from the Scrubgrass Project,
which included significant non-recurring revenues and interest income
during Fiscal 2000, 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 decrease in Fiscal 2001. These decreases are
expected to be offset in part by increases in the Lessor's letter of
credit fees and term loan payments which would be passed through to the
Company in its facility lease expenses.
General and administrative expenses - General and administrative expenses
are expected to decrease during Fiscal 2001 for the following reasons.
First, the Company paid significant bonuses to its executive officers
during Fiscal 2000 which are expected to occur to a lesser extent during
Fiscal 2001. Second, the Company incurred significant professional fees,
travel
9
expenses and Scrubgrass Project management expenses during Fiscal 2000 to
address certain non-recurring business matters. The Company presently
expects these matters would require less attention during Fiscal 2001.
Third, due to the settlement of the Sunnyside Project litigation, the
Company expects to realize a reduction in legal fees. The Company's legal
fees, professional fees and Scrubgrass Project management costs are
subject to considerable variation each year due to the demands of legal
proceedings, contractual matters and new business developments. As such,
the Company cannot predict the full extent of changes to general and
administrative expenses.
Other income - Other income is expected to materially decrease in Fiscal
2001 primarily due to the absence of interest income from the PENELEC
settlement and the absence of income from sales of NOx Credits.
Income tax expense - Income tax expense is expected to significantly
decrease in light of anticipated decreases in income before income taxes
and the effective tax rate.
Litigation recoveries -As discussed in Note C to the Condensed
Consolidated Financial Statements, the Company had been involved in a
legal proceeding for almost five years with the Plaintiffs to collect
their remaining obligations for the sale of the Sunnyside Project. On
April 10, 2001, the Company received $1,500,000 in full settlement of the
legal proceeding which was reported as additional income in Fiscal 2001.
Recently Issued Accounting Standards
There were no 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 $267,914 and $2,191,779
in 2001 and 2000, 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 during 2001 and 2000 contributed a significant portion
of the cash provided by operations. The following adjustments, which did not
impact the Company's cash flows, need to be considered in order to reconcile the
Company's 2001 net income to its net cash provided by operating activities.
Depreciation and amortization - During 2001, the Company recognized depreciation
and amortization for its lease rights of $37,251, deferred financing costs of
$8,910, machinery and equipment modifications of $38,277 and equipment and
furniture of $2,109.
10
Deferred gain, net - The Company's deferred gain, net, amounted to $4,703,262 as
of March 31, 2001 as compared to $4,780,365 as of December 31, 2000. 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 2001:
Receivable from utility - The Company's receivable from utility relates to the
Scrubgrass Project and amounted to $7,694,577 as of March 31, 2001 as compared
to $7,336,408 as of December 31, 2000. The increase in 2001 is primarily
attributable to a 5% increase in certain contracted rates under the PPA.
Other current assets - The Company's other current assets amounted to $1,355,034
as of March 31, 2001 as compared to $760,980 as of December 31, 2000. The
increase in other current assets is largely attributable to higher on-hand
quantities of limestone inventory. During January 2001, the Company purchased a
significant amount of limestone inventory in advance of its consumption
requirements to obtain favorable pricing. This increase was offset in part by a
seasonal decrease in prepaid insurance.
Accounts payable and accrued expenses - The Company's accounts payable and
accrued expenses amounted to $7,122,399 as of March 31, 2001 as compared to
$6,952,054 as of December 31, 2000. The increase in accounts payable and accrued
expenses is primarily attributable to the following reasons. First, corporate
taxes payable increased from $743,208 as of December 31, 2000 to $1,292,604 as
of March 31, 2001. The increase in corporate taxes payable is largely
attributable to Pennsylvania taxes for Fiscal 2000 which were not paid until
April 2001. Second, accrued bond interest increased from $517,196 as of December
31, 2000 to $1,128,793 as of March 31, 2001. The increase in accrued bond
interest is largely attributable to higher average interest rates and longer
bond maturities. The aforementioned increases were offset in part by the
following decreases in accounts payable and accrued expenses. 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 March 31, 2001 included only three months of expense as compared to 12
months of expense as of December 31, 2000. Second, due to expenses related to a
short planned outage in November 2000, the Company's accounts payable and
accrued expenses as of December 31, 2000 were higher by comparison to March 31,
2001. Third, due to the timing of bi-weekly pay periods, the Company's accounts
payable and accrued expenses as of December 31, 2000 included an extra payroll
billing from the Manager and Operator by comparison to March 31, 2001.
Investing Activities
The Company used $211,503 and $194,773 in investing activities during 2001 and
2000, respectively. The Company's investing activities are concentrated
primarily in the following areas:
Restricted cash - The Company is presently required to make scheduled deposits
to a restricted major maintenance fund relating to the Scrubgrass Project to
ensure that funds are available in the future for scheduled major equipment
overhauls. The Company is also allowed to spend restricted cash to
11
fund the cost of major equipment overhauls subject to certain restrictions.
During 2001 and 2000, the Company made scheduled deposits to the restricted
major maintenance fund of $197,548 and $185,052, respectively. The remaining
increases in restricted cash primarily pertain to earnings on available
restricted cash balances. The Company did not make expenditures for major
equipment overhauls during 2001 and 2000.
Property, plant and equipment - The Company did not make any investments in
property, plant and equipment during 2001 and 2000.
Financing Activities
The Company used $352,650 and $366,894 in financing activities during 2001 and
2000, respectively. The Company's financing activities are concentrated
primarily in the following areas:
Dividends - The Company has a quarterly dividend program which is subject to
review and consideration by the Board of Directors each quarter. In respect of
this dividend program, the Company declared dividends of $171,102 (1.5 cents per
share) during the fourth quarter of 2000 which were paid on January 10, 2001 and
dividends of $171,102 (1.5 cents per share) during the fourth quarter of 1999
which were paid on January 14, 2000. The Company also paid dividends to a
preferred stockholder of $1,250 during each of 2001 and 2000. As such, the
Company paid total dividends of $172,352 during each of 2001 and 2000. The
Company declared a dividend for the first quarter of 2000 in April 2000 and
elected not to declare a dividend for the first quarter of 2001. See "Cash Flow
Outlook" for a further discussion of dividends.
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 outstanding borrowings under the
Lessee Working Capital Loan Agreement were $2,599,746 and $2,742,961 as of March
31, 2001 and December 31, 2000, respectively. During 2001 and 2000, the Company
made net repayments under the Lessee Working Capital Loan Agreement of $143,215
and $194,542, respectively.
Scrubgrass Project Obligations- The Company has a long-term obligation related
to its Scrubgrass Project with scheduled maturities through 2005 and with
outstanding principal balances of $1,151,490 and $1,188,573 as of March 31, 2001
and December 31, 2000, respectively. The Company made principal payments of
$37,083 and $-0- for this obligation in 2001 and 2000, respectively.
Sunnyside Project Obligations - As of March 31, 2001, the Company had contingent
obligations of approximately $1.2 million for the Sunnyside Project which were
payable based on a schedule which was related to the proceeds received from the
collection of the Company's outstanding notes receivable from the sale of the
Sunnyside Project. The Company's notes receivable from the Sunnyside Project
were the subject of a litigation which was recently settled in April 2001. As
part of the Settlement, the Company received $1,500,000 and was formally
released from contingent obligations which amounted to $177,961. Because of the
terms of the Settlement, which terms represented a substantial compromise of its
previous claims against the Plaintiffs, the
12
Company is presently considering its rights and obligations with respect to the
remaining contingent obligations. Until the Company resolves these remaining
issues, the unsettled contingent obligations will remain recorded on its
consolidated balance sheet. The Company reported the settlement proceeds of
$1,500,000 and contingent liability release of $177,961 as income during the
second quarter of 2001.
Cash Flow Outlook
During Fiscal 2001, the Company expects the principal sources of cash to fund
its business activities will be from available cash balances, investment
earnings, proceeds from the Settlement, and cash which may become available from
the Scrubgrass Project. As discussed in its Fiscal 2000 Annual Report on Form
10-K, the Company is not able to receive distributions from the Scrubgrass
Project until all operating expenses, base lease payments, certain restricted
cash deposits and other subordinated payments of the Scrubgrass Project are
satisfied. Nevertheless, the Scrubgrass Project's cash flows in Fiscal 2001 are
expected to be sufficient to satisfy all of these restrictions and provide the
Company with continuing distributions for the foreseeable future. According to
certain agreements, the Scrubgrass Project is scheduled to make payments in
Fiscal 2001 of $302,826 for debt and $808,936 for deposits to restricted cash.
As discussed under the caption "Certain Factors That May Affect Future
Results--Environmental Regulation", the Scrubgrass Project needed to achieve
certain seasonal NOx emission levels beginning on May 1, 1999, and will also be
required to achieve reduced emission standards by May 2003. Due to the efficient
design of the Scrubgrass facility, the Scrubgrass Project met the new Fiscal
1999 requirements without any modifications to the Facility. However, the
Company made capital improvements of $811,568 during 1999 to the Facility, which
are expected to enable the Facility to meet the stricter standards in 2003. By
making improvements to the Facility before 2003, the Company anticipated that it
would not require a portion of its future NOx Credits to maintain its compliance
with the applicable regulations. Consequently, the Company sold its anticipated
excess NOx Credits and used the proceeds to finance the capital improvements and
generate additional working capital. The Company expects to comply with all
material environmental regulations for the foreseeable future without any
additional material modifications to the Scrubgrass facility.
Recently, NEG has been in long-term refinancing discussions with the lending
agent for the Scrubgrass Project. Through these discussions, NEG has addressed
or is addressing the following financing requirements for the Scrubgrass
Project:
1) the Lessor's tax-exempt bond letter of credit expired in December 2000 and
needed to be replaced or extended.
2) Buzzard is required to pay the balance of its Lessee Working Capital Loan
to zero for a minimum of 20 days during Fiscal 2001 and Fiscal 2002.
3) Buzzard's Lessee Working Capital Loan commitment expires in December 2002.
4) 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.
13
In November 2000, NEG replaced the expiring letter of credit with a new letter
of credit expiring on December 31, 2006. Under the terms of the replacement
letter of credit, the Lessor paid an origination fee of $105,000 in Fiscal 2000
and agreed to pay additional fees of approximately $417,000 per year beginning
in Fiscal 2001. Buzzard is required to reimburse the Lessor for these fees under
the terms of the Scrubgrass Project lease.
NEG continues to address the remaining three financing matters with the lending
agent of the Scrubgrass Project. Recently, NEG reached a provisional agreement
with the lending agent which is expected to address all of the remaining
financing matters. Under the terms of this provisional agreement, the available
working capital facility would be increased from $4 million to $10 million
through Fiscal 2005 with annual paydown requirements of $2.5 million in Fiscal
2001 and Fiscal 2002, and $8 million in Fiscal 2003 through Fiscal 2005. After
Fiscal 2005, the available working capital facility and annual paydown
requirements would reduce incrementally until the expiration of the proposed
working capital facility in Fiscal 2008. Due to its credit constraints, the
lending agent is expected to transfer a portion of its existing Scrubgrass
Project loan commitments to another financial institution in order to provide
the proposed working capital facility. At this time, the Company has no reason
to believe that the provisional agreement would not eventually be finalized.
However, present uncertainties in the energy market could cause delays in
locating a suitable financial institution for the lending agent's transferable
loan commitments (See "Certain Factors That May Affect Future Results - Third
Party Project Management"). Should there be delays in finalizing the working
capital facility, the Company's distributions from the Scrubgrass Project may be
delayed or reduced. As time passes, there can also be no assurance that the
terms of the provisional agreement would not be amended to reflect changes in
market conditions.
As discussed further in Note C to the Condensed Consolidated Financial
Statements, the Company had been seeking financial recoveries for almost five
years from the Purchasers of the Sunnyside Project in a legal proceeding. On
April 10, 2001, the Company received $1,500,000 in full settlement of the legal
proceeding. The litigation settlement enhanced the Company's financial results
and cash position in Fiscal 2001.
The Company's corporate structure is very complicated and involves multiple
entities resulting in several layers of tax for the Company and its
shareholders. Prior to 1998, the Company was not adversely affected by this
corporate structure because of the existence of significant net operating loss
carryforwards. However, since utilizing its remaining net operating loss
carryforwards in 1997, the Company's cash position has been materially affected
by ongoing corporate tax payments. Furthermore, due to timing differences
between earnings recognition and cash flow availability at the Scrubgrass
Project, the Company may be taxed on earnings prior to the receipt of
distributions from the Scrubgrass Project. As a result, the Company faces
considerable challenges to predict its available cash resources at any point in
time. To date, the Company has considered numerous tax and restructuring
proposals to reduce the extent of its corporate taxation. The Company has also
implemented some of these proposals and realized some modest reductions in it
overall tax burden. However, due to various limitations, such as restrictive
covenants in project financing arrangements, the Company has not been able to
pursue any of the larger tax savings proposals considered to date. While the
Company remains diligent in its pursuit
14
of tax saving strategies, the Company's cash flows are expected to be affected
by substantial corporate tax payments for the foreseeable future.
As discussed in the Fiscal 2000 Annual Report on Form 10-K, the Company is
simultaneously evaluating several options for the future of its business to
enhance shareholder value. These options include a possible sale of EPC or its
assets, merger with another entity, or re-emergence into the development market.
As one or more of these options become more apparent, the Board is likely to
give additional consideration to them in its determination of dividends. The
Board may decide to preserve the Company's available cash resources to pursue
one or more of these alternatives or, in the case of a possible sale, delay
distributions to obtain a more favorable capital gain treatment at the time of
the sale. The Board's decision to preserve the Company's cash resources could
reduce or eliminate future dividends. On April 2, 2001, the Board decided not to
declare a dividend for the first quarter of 2001. 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.
The Company believes that the Scrubgrass Project would continue to achieve
earnings and cash flows from its operations 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 each year over a long-term period. Furthermore, as
discussed above, the Company received a financial recovery from the Sunnyside
litigation which enhanced its cash position in Fiscal 2001. Notwithstanding, the
Company will continue to be affected by its obligations for corporate taxes,
restricted cash deposits and working capital. 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.
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q.
Ownership of Single Operating Asset
The Company owns a 22 year leasehold interest in the Scrubgrass Project, an
approximate 83 Mw (net) waste coal-fired electric generating facility located in
Pennsylvania, the lease for which commenced on June 30, 1994. Presently, all the
Company's operating revenues are attributable to power generation from the
Scrubgrass Project. Accordingly, the Company's operations are largely dependent
upon the successful and continued operation of the Scrubgrass Project. In
particular, if the Scrubgrass Project experiences unscheduled shutdowns of
significant duration, the Company's results of operations will be materially
adversely affected.
15
Dependence Upon Key Employees
The success of the Company is largely dependent upon a staff of three full-time
executive officers and a full-time office administrator. 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 NEG to manage the
Scrubgrass Project and a 15-year operations and maintenance agreement with PG&E
Operating Services to operate the facility. Under the terms of these agreements,
there are provisions which limit the Company's participation in the management
and operation of the Scrubgrass Project, and provisions which provide for
recourse against NEG 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.
As discussed in the Company's Annual Report on Form 10-K, NEG, PG&E Operating
Services, and certain partners of the Lessor are indirectly owned, through
subsidiaries, by PG&E Corporation ("PG&E"). As a result of an energy crisis in
California, PG&E had been experiencing financial difficulties which are
primarily related to the regulated business activities of its subsidiary,
Pacific Gas and Electric Company. Pacific Gas and Electric Company recently
filed for protection from its creditors under United States bankruptcy laws. The
Manager has advised the Company that NEG, PG&E Operating Services, and the
partners of the Lessor are separate businesses which are legally protected from
the creditors of PG&E and Pacific Gas and Electric Company. The Manager has also
advised the Company that PG&E is presently solvent after a recent financial
reorganization. Furthermore, the Scrubgrass Project is financed with secured
debt obligations which are also legally protected from the creditors of PG&E and
Pacific Gas and Electric Company. As such, the Company does not expect that it
should be directly impacted by possible financial difficulties of PG&E in the
future. Notwithstanding the foregoing, the Company cannot predict whether the
uncertainty related to these recent events would affect the perceived
creditworthiness of the Scrubgrass Project.
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.
16
Legal Proceedings
As discussed in Note C to the Condensed Consolidated Financial Statements, the
Company had been involved in a legal proceeding for almost five years with the
Purchasers of the Company's interest in the Sunnyside Project. On April 10,
2001, the Company received $1,500,000 in full settlement of the legal
proceeding.
Development Uncertainties
The Company is presently evaluating development opportunities and whether its
re-emergence into the development market could enhance shareholder value. Should
the Company re-enter the development market, there can be no assurance that the
Company would be able to obtain all of the necessary site agreements, fuel
supply contracts, design/build agreements, power sales contracts, licenses,
environmental and other permits, local government approvals or financing
commitments required for the successful completion of development projects. The
Company's failure to accomplish any of these steps could materially increase the
cost or prevent the successful completion of development projects, or cause the
Company to abandon a development project and incur the loss of its investment to
date, which could materially impact the Company's business and results of
operations.
Financial Results
To date the Company has incurred substantial losses, largely due to its
development activities, which have resulted in an accumulated deficit of
$2,206,034 as of March 31, 2001. While the Company was profitable from operating
activities for the last four years, the Company incurred a net loss from the
operation of the Scrubgrass Project during 1997 due to an unforeseen repair to
the generator at the Scrubgrass facility. The Company also had an overall net
loss during 1998 largely due to the write-off of the Sunnyside project
receivables. Financial results can be affected by numerous factors, including
without limitation general economic conditions, cyclic industry conditions, the
amount and rate of growth of expenses, transportation and quality of raw
materials, inflation, levels of energy rates, uncertainties relating to
government and regulatory policies, the legal environment and volatile and
unpredictable developments like the generator repair. The Company believes it is
well positioned to handle such matters as they may arise during the course of
its future business activities. However, there can be no assurance that the
Company will be profitable in the future.
Potential Liability, Damages and Insurance
The Company's power generation activities involve significant risks to the
Company for environmental damage, equipment damage and failures, personal injury
and fines and costs imposed by regulatory agencies. In the event a liability
claim is made against the Company, or if there is an extended outage or
equipment failure or damage at the Company's power plant for which it is
inadequately insured or subject to a coverage exclusion, and the Company is
unable to defend such claim successfully or obtain indemnification or warranty
recoveries, there may be a material adverse effect on the Company.
17
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 20 years. Accordingly,
this technology carries greater risk than more established methods of power
generation such as hydropower. As such, the long-term costs and implications of
maintaining this technology have not been established by historical industry
data.
Customer Concentration
The Company's power generation revenues are earned under a long-term power
purchase agreement with one customer, Pennsylvania Electric Company. The Company
expects that the concentration of its revenues with this customer will continue
for the foreseeable future.
Interest Rates
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 and a
variable rate term loan all of which were advanced from the Lessor under various
Scrubgrass Project agreements. The Company offers the following information
about these debt obligations:
Balance at Matures
Description of the Obligation 3/31/01 Interest Rate Through
- -------------------------------------------------- ----------------- -------------------------------- --------------
Lessor's term debt obligations:
Variable rate tax-exempt bonds $135,600,000 Quoted Bond Rates 2012
Swap rate term loan 12,061,666 Swapped LIBOR + 1.250% 2005
Variable rate term loan 9,747,510 LIBOR + 1.250% 2004
Buzzard's term debt obligations:
Variable rate working capital loan 2,599,746 LIBOR + 1.1250% 2002
Variable rate term loan 1,151,490 LIBOR + 1.250% 2004
The Lessor's debt obligations and Buzzard's debt obligation incur interest at
either quoted rates or variable rates which are based on the London Interbank
Offering Rate ("LIBOR"). On December 22, 1995, the Lessor entered into an
interest rate swap arrangement which fixed the LIBOR component for the life of
its swap rate term loan at 6.4225%. As a result, the interest rate for the swap
rate term loan was fixed at 7.5475% (LIBOR + 1.125%) through December 31, 2000
and 7.6725% (LIBOR + 1.25%) for the remaining term of the obligation. As such,
except for the Lessor's swap rate term loan, the Company will be required to
fund debt service consisting of rates which will vary with market conditions.
Presently, the Company is not able to predict how future interest rates will
affect its debt or lease obligations. Should market interest rates rise
significantly, the Company's operating results may be significantly impacted.
Notwithstanding, the Company believes the Lessor has good relationships with the
project lenders who would continue to support lending terms which would not have
a material
18
adverse affect on the operating results of the Scrubgrass Project. However,
there can be no assurance that the Lessor could renegotiate its credit
facilities under terms which would ensure continuing profitable operating
results of the Scrubgrass Project. See Notes H, I and L of the Consolidated
Financial Statements included in the Company's Fiscal 2000 Annual Report on Form
10-K for further information about the Company's debt and lease obligations.
Fuel Quality
The Company obtains waste coal primarily from coal mining companies on a
long-term basis because waste coal is plentiful and generally creates
environmental hazards, such as acid drainage, when not disposed of properly. The
waste coal is burned in the Scrubgrass facility using a circulating fluidized
bed combustion system. During the circulating fluidized bed combustion process,
the waste coal is treated with other substances such as limestone. Depending on
the quality of the waste coal, the facility operator may need to add additional
waste coal or other substances to create the appropriate balance of substances
which would result in the best fuel or sorbent consistency for power generation
and compliance with air quality standards. Therefore, the cost of generating
power is directly impacted by the quality of the waste coal which supplies the
Scrubgrass power generation facility. The facility operator maintains certain
controls over obtaining higher quality waste coal. However certain conditions,
such as poor weather, can create situations where the facility operator has less
control over the quality of the waste coal. The Company cannot predict the
extent to which poor fuel quality may impact its future operating results.
Competition
The Company, through its subsidiary, generates electricity using waste coal, an
alternative energy source, all of which electricity is sold at rates established
under a long-term power purchase agreement with PENELEC, a division of GPU. This
power purchase agreement has been approved by the Pennsylvania Public Utility
Commission. Other than the risk that PENELEC would assert a position and achieve
judicial determination that it has a right to renegotiate the terms of the power
purchase agreement (see "Energy Regulation"), the sale of power from our
existing facility is not subject to competition during the term of the power
purchase agreement. However, since the Company's contracted rates in the later
years of the agreement are determined with reference to then existing market
conditions, the rate at which such power is sold is influenced by competitive
power rates in the region. Therefore, low wholesale energy rates during the
later years of the power purchase agreement would negatively impact the
Company's profitability and could affect its financial position.
Further, expansion of our business through acquisition and/or development of
additional facilities would be affected by competition from various sources. The
principal sources of competition in this market include traditional regulated
utilities who have excess capacity, unregulated subsidiaries of regulated
utilities, energy brokers and traders, energy service companies in the
development and operation of energy-producing projects as well as the marketers
of electric energy, equipment suppliers and other non-utility generators like
the Company. The electric industry is also characterized by rapid changes in
regulations which the Company expects could
19
continue to increase competition. For instance, as discussed under "Energy
Markets", the electric industry has been previously affected by legislation such
as PURPA and the Energy Act which have encouraged companies other than utilities
to enter the electric power business by reducing regulatory constraints and
increasing access to markets. More recently, as discussed under "Energy
Regulation", there has been legislation in numerous states deregulating aspects
of the electric business and encouraging a highly competitive rate environment.
Furthermore, initiatives to repeal or modify existing regulations could further
reduce regulatory restrictions placed on electricity producers and encourage
them to create new sources of electric power. Any of these regulatory matters,
among others, could increase competition.
The Company's present operations, as well as any possible future expansion in
the industry, are also affected by requirements for compliance with various
local, state and federal environmental laws and regulations (See "Environmental
Regulation"). As such, the Company's operating costs are subject to increases
resulting from expanded environmental regulations. Such increases could
negatively impact profitability from current operations and could affect the
Company's competitive position in pursing further expansion through acquisition
and/or development.
Presently, competition in this industry is substantially based on price, with
competitors striving for lower cost alternatives for providing electricity. The
cost of producing electricity is in large measure influenced by the capital
costs of generating and transmitting facilities as well as the operating costs,
including fuel costs, of such facilities. As natural gas prices have risen and
supplies have tightened, the overall cost advantage of that fuel source has
diminished and consideration is again being given to other conventional and
non-conventional fuel sources. In addition, electricity shortages in certain
major markets, as well as a general increase in demand, have tightened overall
availability of generating capacity which may exert upward pressure on rates.
In previous years, the Company competed in the market to develop power
generation facilities. The primary bases of competition in this market are
price, the ability of the developer to generate high quality opportunities and
to select and acquire environmentally permittable sites in favorable locations
as well as to create attractive and efficient development plans which can be
financed and cost effectively constructed. In most cases, competitive bidding
for a development opportunity is required. In recent years, the Company believed
there were limited opportunities for additional project development in the
United States for projects similar to those previously developed by the Company.
Since there were many companies with substantially greater resources than the
Company competing for these limited development opportunities, the Company
believed it was not in a favorable competitive position. Therefore, the Company
has not been actively pursuing development opportunities in recent years.
However, the Company now believes that current market conditions may be more
favorable for smaller developers. As such, the Company is presently evaluating
development opportunities and whether its re-emergence into this market could
enhance shareholder value.
Presently, there is also significant merger and consolidation activity in the
electric industry. During Fiscal 2000, the Company engaged an investment
consultant to consider sale or merger proposals that may present an opportunity
to enhance shareholder value. To date, the Company has evaluated several
preliminary proposals; however, none of these preliminary proposals has offered
20
sufficient value to shareholders or likelihood of consummation to warrant
further consideration. The Company continues to evaluate proposals from time to
time and still believes this strategy could present an opportunity to maximize
shareholder value in the future. Should the Company decide to expand its
business activities, it would consider the possible acquisition of existing
facilities as well as the development of new projects.
Energy Regulation
The Company's facility is subject to certain regulation under federal and state
laws and regulations, and is certified as a QF by the FERC. Pursuant to PURPA,
FERC has promulgated regulations which exempt certain QFs from the Federal Power
Act of 1935, PUHCA, and, except under certain limited circumstances, state laws
regulating the rates charged by electric utilities. In order to be QFs under
PURPA, any facilities which the Company might acquire or develop will be
required to meet certain size, fuel and ownership requirements and/or
co-generate. In addition to the regulation of QFs, PURPA requires that electric
utilities purchase electric energy produced by QFs 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 nature and impact of potential future changes of laws or regulations on the
Company's projects is unknown at this time. Presently, there are numerous
pending legislative proposals 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. If PURPA is amended or repealed, the statutory requirement that
electric utilities purchase electricity from QFs at full avoided cost could be
repealed or modified. While existing contracts are expected to be honored, the
repeal or modification of these statutory purchase requirements under PURPA in
the future could increase pressure from electric utilities to renegotiate
existing contracts. Should there be changes in statutory purchase requirements
under PURPA, and should these changes result in amendments to the Company's
current power purchase agreement which reduce the contracted rates, 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. The actual scope of jurisdiction over independent power projects by state
public utility regulatory commissions varies from state to state. Presently,
through its power purchase agreement with PENELEC, the Scrubgrass Project is
indirectly affected by state legislation in the Commonwealth of Pennsylvania.
On December 3, 1996, in response to changes in the electric industry, the
Commonwealth of Pennsylvania passed 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
21
over a phase-in period which expired December 31, 2000. The Customer Choice Act
required that all electric utilities file restructuring plans with the PUC.
PENELEC filed its proposed restructuring plan during 1997, which was
subsequently litigated by numerous parties, and later settled by an agreement
which was approved by the PUC on October 20, 1998. The settlement agreement 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. Most pertinently, the restructuring
plan, as approved by the PUC, provided for PENELEC to maintain a separate
non-utility generator cost recovery mechanism for accounting purposes.
Therefore, the restructuring plan is designed, in pertinent part, to enable
PENELEC to recover all of its costs from non-utility generators such as the
Scrubgrass plant and should serve to decrease the pressure on PENELEC to
renegotiate existing power contracts with non-utility generators.
On November 21, 2000, the shareholders of GPU and FirstEnergy Corp. approved a
merger of these two companies. FirstEnergy and GPU have applied for approval of
their merger to Federal Energy Regulatory Commission, New Jersey Board of Public
Utilities, Pennsylvania Public Utility Commission, Nuclear Regulatory
Commission, Federal Communications Commission, Securities and Exchange
Commission, and the Department of Justice under the Hart-Scott-Rodino Act. The
Company has been monitoring these merger activities to determine whether such
activities would have an unfavorable impact on the Scrubgrass Project.
Presently, except as discussed above, neither the Customer Choice Act nor
PENELEC's restructuring plan directly impacts the Company, since the legislation
and restructuring plan pertain to the retail market or new contracts in the
wholesale market. Nevertheless, the Company continues to monitor regulatory
developments in order to evaluate any impact on the Scrubgrass Project and
possible new business opportunities.
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 resolved. 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:
22
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 stationary sources of
NOx emissions to establish plans to reduce their NOx emissions. To
administer these regulations, the PaDEP began allocating Nitrogen Oxide
Ozone Transport Region Budget Allowances ("NOx Credits") to facilities
based on numerous factors including the design and operation of each
facility. A market-based trading system was established to allow companies
with excess NOx Credits to trade with companies that required additional
NOx Credits to meet the stricter requirements. More recently, an Ozone
Transport Commission (OTC) established certain inner and outer zones with
seasonal NOx emission reductions that required the Scrubgrass Project to
achieve certain targeted NOx emission levels beginning on May 1, 1999.
Under the OTC's requirements, the Scrubgrass Project will also be required
to achieve reduced emission standards by May 2003. Due to the efficient
design of the Scrubgrass facility, the Scrubgrass Project met the new 1999
requirements without any modifications to the facility. However, the
Company made capital improvements of $811,568 in 1999 to the Scrubgrass
facility, which are expected to enable the Scrubgrass facility to meet the
stricter standards in 2003. The Company expects to meet the NAAQS for
sulfur dioxide, nitrogen dioxide, particulate matter, carbon monoxide and
lead for the foreseeable future without any additional material
modifications to the Scrubgrass facility.
Waste Disposal - The Scrubgrass Project must also comply with various
environmental regulations pertaining to the handling and disposal of
hazardous and non-hazardous wastes. The PaDEP establishes classifications
for wastes and requires companies to follow certain handling and disposal
procedures for each waste classification. Currently, the Scrubgrass
Project employs special handling procedures for the transportation of its
fuel, which is classified as a waste, from the waste sites to the
Scrubgrass facility. The fuel is burned in the Scrubgrass facility where
it is treated with various substances such as limestone during the
electric generation process. Ash, which is a byproduct of the electric
generation process, is removed from the Scrubgrass facility and returned
to the original waste site which is reclaimed in part by deposit of the
ash along 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.
23
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. For further information on the
Company's interest rate risk, refer to "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations - Certain Factors That
May Impact Future Results -- Interest Rates".
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. For further
information on the Company's interest rate risk, refer to "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Certain Factors That May Impact Future Results -- Interest Rates".
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PART II. OTHER INFORMATION
--------------------------
ITEM 1. Legal Proceedings
On April 10, 2001, Environmental Power Corporation and certain of its
wholly-owned subsidiaries (the "Defendants") received aggregate proceeds of
$1,500,000 from B&W Sunnyside, Inc., NRG Sunnyside, Inc. and certain of their
affiliates (the "Plaintiffs") as consideration pursuant to a Binding Settlement
Agreement (the "Settlement") dated April 9, 2001. The Settlement resolved a
legal proceeding between the Plaintiffs and Defendants which had been ongoing
since May 3, 1996. The nature of the legal proceeding and the terms and
conditions of the Settlement were described in previous filings with the
Securities and Exchange Commission.
At the time of making the Settlement, the Defendants had recorded on their
balance sheets aggregate contingent obligations of approximately $1.2 million
due to third party creditors. As part of the Settlement, the Defendants were
formally released from contingent obligations which amounted to $177,961.
Because of the terms of the Settlement, which terms represented a substantial
compromise of their previous claims against the Plaintiffs, the Defendants are
presently considering their rights and obligations with respect to the remaining
contingent obligations. Until the Defendants resolve these remaining issues, the
unsettled contingent obligations will remain recorded on their balance sheets.
ITEM 6. Exhibits And Reports On Form 8-K
(a) Exhibits
(i) Exhibit 11 - Computation of Earnings Per Share
(ii) Exhibit 10.02 - Binding Settlement Agreement dated April 9, 2001
between Sunnyside II, L.P., Sunnyside I, Inc., NRG Energy, Inc.,
Babcock & Wilcox Investment Company, and Sunnyside Cogeneration
Associates (collectively the "Plaintiffs") and Environmental
Power Corporation, Sunnyside Power Corporation, Kaiser Systems,
Inc. and Kaiser Power of Sunnyside, Inc. (collectively the
"Defendants") (incorporated by reference to Form 8-K filed on
April 23, 2001)
(b) Reports on Form 8-K
(i) On April 23, 2001, the Registrant reported the Settlement related
to the Sunnyside Project litigation dated April 9, 2001.
(ii) On May 9, 2001, the Registrant disclosed pursuant to Regulation
FD the Letter to Shareholders dated April 15, 2001 which will be
included in its Fiscal 2000 Annual Report to Shareholders.
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SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENVIRONMENTAL POWER CORPORATION
May 14, 2001 /s/ William D. Linehan
--------------------------
William D. Linehan
Treasurer and
Chief Financial Officer
(principal accounting officer
and authorized officer)
26