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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, 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
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 14, 2001 18,905,939 shares
The Exhibit Index appears on Page 31
Total number of pages is 73
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ENVIRONMENTAL POWER CORPORATION
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2001
(unaudited) and December 31, 2000................................ 2
Condensed Consolidated Statements of Operations (unaudited) for
the Three and Nine Months Ended September 30, 2001 and
September 30, 2000............................................... 3
Condensed Consolidated Statements of Cash Flows (unaudited) for
the Nine Months Ended September 30, 2001 and September 30, 2000.. 4
Notes to Condensed Consolidated Financial Statements.............. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 10
Item 3. Quantitative and Qualitative Disclosures About Market
Risk..................................................... 27
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................ 28
Item 4. Submission of Matters to a Vote of Security Holders...... 29
Item 5. Other Matters............................................ 29
Item 6. Exhibits and Reports on Form 8-K......................... 31
Signatures........................................................ 32
1
PART I. FINANCIAL INFORMATION
------------------------------
ITEM 1. FINANCIAL STATEMENTS
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30 December 31
2001 2000
----------------- -----------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 560,807 $ 307,666
Restricted cash 805,403 587,476
Receivable from utility 8,052,627 7,336,408
Other current assets 1,112,063 760,980
----------------- -----------------
TOTAL CURRENT ASSETS 10,530,900 8,992,530
PROPERTY, PLANT AND EQUIPMENT, NET 569,055 558,015
DEFERRED INCOME TAX ASSET 1,370,193 755,193
LEASE RIGHTS, NET 2,198,754 2,310,507
ACCRUED POWER GENERATION REVENUES 61,783,779 56,188,143
INTANGIBLE ASSETS 6,059,096 ---
OTHER ASSETS 459,920 479,786
----------------- -----------------
TOTAL ASSETS $ 82,971,697 $ 69,284,174
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 8,056,435 $ 6,952,054
Dividends payable on common stock --- 171,102
Other current liabilities 3,052,054 3,045,787
----------------- -----------------
TOTAL CURRENT LIABILITIES 11,108,489 10,168,943
DEFERRED GAIN, NET 4,549,057 4,780,365
SECURED PROMISSORY NOTES PAYABLE
AND OTHER BORROWINGS 2,025,863 2,116,309
ACCRUED LEASE EXPENSES 61,783,779 56,188,143
----------------- -----------------
TOTAL LIABILITIES 79,467,188 73,253,760
----------------- -----------------
SHAREHOLDERS' EQUITY (DEFICIT):
Preferred stock (no par value, 10 shares authorized; 10 shares
issued at September 30, 2001 and December 31, 2000, respectively) 100 100
Series B Convertible Preferred stock ($.01 par value, 1,000,000 shares
authorized; 197,760.7 shares issued at September 30, 2001 and no
shares issued at December 31, 2000) 1,528,690 ---
Common stock ($.01 par value; 20,000,000 shares authorized;
18,046,972 and 12,525,423 shares issued at September 30, 2001
and December 31, 2000, respectively; 16,928,332 and 11,406,783
shares outstanding at September 30, 2001 and December 31, 2000,
respectively) 180,469 125,254
Additional paid-in capital 4,401,444 ---
Accumulated deficit (1,503,975) (3,192,721)
----------------- -----------------
4,606,728 (3,067,367)
Treasury stock (1,118,640 common shares, at cost, as of
September 30, 2001 and December 31, 2000, respectively) (456,271) (456,271)
Notes receivable from officers and board members (645,948) (445,948)
----------------- -----------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) 3,504,509 (3,969,586)
----------------- -----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) $ 82,971,697 $ 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 September 30 Nine Months Ended September 30
2001 2000 2001 2000
--------------- ------------- -------------- ------------
POWER GENERATION REVENUES $ 13,914,475 $ 13,079,296 $ 39,494,244 $41,165,018
--------------- ------------- -------------- ------------
COSTS AND EXPENSES:
Operating expenses 5,292,285 5,021,065 17,779,358 17,065,816
Lease expenses 5,988,593 5,664,855 17,862,716 19,703,145
General and administrative expenses 1,101,420 707,070 2,589,900 2,313,679
Depreciation and amortization 111,870 102,044 284,981 312,826
--------------- ------------- -------------- ------------
12,494,168 11,495,034 38,516,955 39,395,466
--------------- ------------- -------------- ------------
OPERATING INCOME 1,420,307 1,584,262 977,289 1,769,552
--------------- ------------- -------------- ------------
OTHER INCOME (EXPENSE), NET:
Interest income 17,944 33,828 59,688 707,553
Interest expense (43,047) (82,025) (145,474) (240,161)
Other income 32,723 --- 1,710,685 ---
Sale of NOx emission credits --- --- --- 1,161,888
Amortization of deferred gain 77,103 77,103 231,308 231,308
--------------- ------------- -------------- ------------
84,723 28,906 1,856,207 1,860,588
--------------- ------------- -------------- ------------
INCOME BEFORE INCOME TAXES 1,505,030 1,613,168 2,833,496 3,630,140
INCOME TAX EXPENSE (583,000) (710,000) (1,141,000) (1,598,000)
--------------- ------------- -------------- ------------
NET INCOME $ 922,030 $ 903,168 $ 1,692,496 $ 2,032,140
=============== ============= ============== ============
EARNINGS PER COMMON SHARE:
BASIC $ 0.06 $ 0.08 $ 0.13 $ 0.18
DILUTED $ 0.05 $ 0.08 $ 0.13 $ 0.18
DIVIDENDS:
Common shares $ --- $ 171,102 $ --- $ 513,305
Preferred shares 1,250 1,250 3,750 3,750
--------------- ------------- -------------- ------------
$ 1,250 $ 172,352 $ 3,750 $ 517,055
=============== ============= ============== ============
DIVIDENDS PER COMMON SHARE $ 0.000 $ 0.015 $ 0.000 $ 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
2001 2000
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,692,496 $ 2,032,140
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 284,981 312,826
Deferred income taxes 52,000 12,000
Amortization of deferred gain (231,308) (231,308)
Accrued power generation revenues (5,595,636) (5,277,009)
Accrued lease expenses 5,595,636 5,277,009
Non-cash compensation expense 3,916 ---
Changes in operating assets and liabilities:
Increase in receivable from utility (716,219) (4,064,215)
Increase in other current assets (241,532) (91,650)
Increase in other assets (6,754) (10,563)
Increase in accounts payable and accrued expenses 303,984 2,161,677
Increase in long-term liabilities --- 8,550
Decrease in long-term debt to supplier (94,411) (89,875)
---------------- ----------------
Net cash provided by operating activities 1,047,153 39,582
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in restricted cash (217,927) (147,130)
Cash paid for acquisition of Microgy, net of cash acquired (210,465) ---
Property, plant and equipment expenditures (1,000) (300)
---------------- ----------------
Net cash used in investing activities (429,392) (147,430)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend payments (174,852) (517,055)
Net (repayments) borrowings under working capital loan (662,794) 1,136,908
Proceeds from short-term note payable 750,000 ---
Advances on notes receivable from officers (200,000) ---
Repayment of secured promissory notes payable and
other borrowings (76,974) (600,000)
---------------- ----------------
Net cash (used in) provided by
financing activities (364,620) 19,853
---------------- ----------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 253,141 (87,995)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 307,666 306,188
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 560,807 $ 218,193
================ ================
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, 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 - ACQUISITION OF MICROGY COGENERATION SYSTEMS INC.
- ---------------------------------------------------------
On July 23, 2001, the Company acquired approximately 87.7% of the outstanding
common stock of Microgy Cogeneration Systems Inc., a privately held Colorado
corporation ("Microgy"), in exchange for securities of the Company pursuant to a
Share Exchange Agreement (the "Exchange Agreement") dated as of June 20, 2001
among the Company, Microgy and the Principal Microgy Shareholders, as defined
therein. The acquisition was accounted for using the purchase method of
accounting and, accordingly, the financial results of Microgy have been included
in the condensed consolidated statements of operations of the Company beginning
July 24, 2001.
Microgy is an alternative energy company that plans to develop renewable energy
plants in the United States and other countries. Microgy plans to employ unique
proprietary technologies and services that are designed to convert biomass type
organic wastes and animal manure into clean, renewable sources of electricity
and/or fuels. These plants are expected to also reduce water and air pollution
and green house gases that are believed to cause global warming and climate
change.
Microgy holds a perpetual and exclusive license in certain territories for use
of certain proprietary technology in its cogeneration facilities. Under the
license agreement, 1) the licensor will own a 5% minority equity stake in any
legal entity that owns any project developed by Microgy using the licensor's
enhanced anaerobic digester technology wherein Microgy retains an equity
position, 2) the licensor will receive a fixed payment for each project for
engineering work and construction drawings, 3) the licensor will receive a
licensing fee, based on a percentage of the total cost for each project facility
where the licensed technology is installed, and 4) the licensor will receive a
monthly consulting fee upon commercial operation of a particular project.
Under the terms of the Exchange Agreement, the Company issued an aggregate of
5,521,549 shares of the Company's common stock, $.01 par value ("Common Stock")
and 197,760.7 shares of the Company's newly designated Series B Convertible
Preferred Stock, $.01 par value (the "Preferred Stock"), to the Principal
Microgy Shareholders in exchange for 15,919,147 shares of
5
Microgy common stock. Each share of Preferred Stock, which votes with the Common
Stock on an as converted basis, will automatically be converted into ten shares
of Common Stock upon an increase in the authorized common stock to an amount
sufficient to allow conversion of the Preferred Stock. The exchange ratio
("Exchange Ratio") used was 0.3468495 shares of Common Stock and 0.0124228
shares of Preferred Stock for each share of Microgy common stock, which Exchange
Ratio is subject to adjustment in certain circumstances. Holders of
approximately 94% of the Microgy common stock exchanged on July 23, 2001 waived
their right to adjustments in the Exchange Ratio, except for the adjustment
described in the following sentence. In connection with the issuance of 400,000
options and warrants in September 2001, the Company expects to adjust the
Exchange Ratio, resulting in the issuance of approximately 258,883 additional
shares of common stock to the Principal Microgy Shareholders.
Under the terms of the Exchange Agreement, the Company agreed to offer (the
"Subsequent Offer") the remaining security holders of Microgy (who own an
aggregate of 2,230,126 shares of Microgy common stock, warrants to purchase
885,000 shares of Microgy common stock and options to purchase 290,000 shares of
Microgy common stock) an opportunity to exchange their Microgy securities for
EPC securities based on the Exchange Ratio, as the same may be adjusted.
On July 23, 2001, one of the Principal Microgy Shareholders also exchanged a
warrant to purchase 800,000 shares of Microgy common stock for a warrant to
purchase securities of the Company based on the Exchange Ratio.
The purchase price was $6,253,435, resulting in goodwill and other intangibles
of $6,059,096. The purchase price represents the fair value of the securities
issued and the direct costs of the acquisition. The fair value of the securities
were determined using available market information and appropriate valuation
methodologies.
The allocation of the purchase price to the assets and liabilities of Microgy as
reflected in the Company's condensed consolidated balance sheets is preliminary
and tentative. The Company is in the process of obtaining information to assist
in the determination of certain assets and liabilities acquired. This
information may result in revisions to the amounts recorded in the Company's
consolidated balance sheets and include the recognition of intangible assets
that are separate from goodwill.
The following summarized unaudited pro forma information assumes the acquisition
of Microgy occurred on January 1, 2001. The unaudited pro forma results are not
necessarily indicative of the results which might actually have been obtained
had the acquisition occurred as of January 1, 2001, nor are they intended to be
indicative of future results of operations. The amounts below do not include any
amortization of goodwill or indefinite-lived intangible assets.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
---------------------------- -----------------------------
Revenues $13,914,475 $39,494,244
Net income $ 848,844 $ 1,182,896
Basic earnings per common share $ 0.05 $ 0.07
Diluted earnings per common share $ 0.04 $ 0.06
6
NOTE C - RECENT ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations".
SFAS 141 requires the purchase method of accounting for business combinations
initiated after June 30, 2001 and eliminates the pooling of interest method of
accounting. SFAS 141 also broadens the criteria for recording intangibles
separate from goodwill and revises certain financial statement disclosures. The
Microgy acquisition (see Note B) was accounted for in accordance with SFAS 141.
Also in June 2001, The FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". The most significant changes made by SFAS No. 142 are: 1) goodwill and
indefinite-lived intangible assets will be tested for impairment at least
annually; 2) goodwill and indefinite-lived intangible assets will no longer be
amortized to income; and 3) the amortization period of intangible assets with
finite lives will no longer be limited to forty years. The provisions of SFAS
142 have been applied to the goodwill and intangible assets acquired as part of
the Microgy acquisition (see Note B), as required by SFAS 142. The Company did
not have acquired goodwill or intangible assets recorded on its balance sheet
prior to the Microgy acquisition.
In June 2001, the FASB issued SFAS No.143, "Accounting for Asset Retirement
Obligations," which is effective January 1, 2003. SFAS 143 addresses the
financial accounting and reporting for obligations and retirement costs related
to the retirement of tangible long-lived assets. The Company does not expect
that the adoption of SFAS 143 will have a significant impact on its financial
statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which is effective January 1, 2002. SFAS 144
supersedes FASB Statement No 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and
reporting provisions relating to the disposal of a segment of a business of
Accounting Principles Board Opinion No. 30. The Company does not expect that
the adoption of SFAS 144 will have a significant impact on its financial
statements.
NOTE D -- 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 Company excludes antidilutive common
stock equivalents from the calculation of diluted earnings per share. The
following table outlines the
7
calculation of basic earnings per share and diluted earnings per share for the
three and nine months ended September 30, 2001 and 2000.
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNTS
------------------ -------------------- ---------------
Three Months Ended September 30, 2001:
- --------------------------------------
Income attributable to shareholders $ 922,030 15,547,945
Effect of dividends to preferred stockholders (1,250)
---------- ---------- -----
Basic EPS - Income attributable to common shareholders 920,780 15,547,945 $0.06
Effect of dilutive securities:
Assumed conversion of preferred stock 1,483,205
Assumed exercise of dilutive stock options 32,255
---------- ---------- -----
Diluted EPS - Income attributable to common shareholders $ 920,780 17,063,405 $0.05
========== ========== =====
Three Months Ended September 30, 2000:
- --------------------------------------
Income attributable to shareholders $ 903,168 11,406,783
Effect of dividends to preferred stockholders (1,250)
---------- ---------- -----
Basic EPS - Income attributable to common shareholders 901,918 11,406,783 0.08
Effect of dilutive securities:
Assumed exercise of dilutive stock options 4,233
---------- ---------- -----
Diluted EPS - Income attributable to common shareholders $ 901,918 11,411,016 $0.08
========== ========== =====
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNTS
------------------ -------------------- ---------------
Nine Months Ended September 30, 2001:
- -------------------------------------
Income attributable to shareholders $1,692,496 12,802,339
Effect of dividends to preferred stockholders (3,750)
---------- ---------- -----
Basic EPS - Income attributable to common shareholders 1,688,746 12,802,339 $0.13
Effect of dilutive securities:
Assumed conversion of preferred stock 499,835
Assumed exercise of dilutive stock options 20,503
---------- ---------- -----
Diluted EPS - Income attributable to common shareholders $1,688,746 13,322,677 $0.13
========== ========== =====
Nine Months Ended September 30, 2000:
- -------------------------------------
Income attributable to shareholders $2,032,140 11,406,783
Effect of dividends to preferred stockholders (3,750)
---------- ---------- -----
Basic EPS - Income attributable to common shareholders 2,028,390 11,406,783 0.18
Effect of dilutive securities:
Assumed exercise of dilutive stock options 1,954
---------- ---------- -----
Diluted EPS - Income attributable to common shareholders $2,028,390 11,408,737 $0.18
========== ========== =====
NOTE E - RELATED PARTY TRANSACTIONS
- -----------------------------------
On September 14, 2001, the Company borrowed $750,000 from Alco Financial
Services, LLC ("Alco"). Robert Weisberg, a Director of the Company, is the
President, Director and a member of Alco. The loan is evidenced by a one-year
promissory note which bears interest at the prime rate plus 3.5%. The Company
also pays an administrative fee of 0.6% per month. The loan is secured by all
of the Company's assets (other than the stock of its subsidiary, Buzzard Power
Corporation). In connection with the loan, the Company granted Alco five year
warrants to purchase 50,000 shares of common stock at $0.60 per share.
In September 2001, the Company paid $150,000 to George Kast, a principal
shareholder of the Company and previously a Principal Microgy Shareholder, in
full satisfaction of a Microgy
8
obligation. The original obligation, which amounted to $182,720, was settled for
$150,000 and the settlement reduction was reported as other income during the
third quarter of 2001.
In September 2001, the Company granted Mr. Weisberg five year options to
purchase 350,000 shares of common stock at $0.72 per share. In May 2001, the
Company granted Mr. Weisberg options to purchase 100,000 shares of common stock
at $.43 per share. The options were issued in exchange for Mr. Weisberg's
extraordinary efforts in seeking financing for the Company. The fair value of
these securities has been deferred and will be amortized to income over the life
of the financing.
NOTE F - NONCASH ACTIVITIES
- ---------------------------
Fair value of options for 450,000 shares issued to Mr. Weisberg for his
extraordinary efforts in seeking financing (deferred as a cost of the financing) $ 113,600
==========
Fair value of a warrant for 50,000 shares issued to Alco to secure
financing (deferred as a cost of the financing) $ 14,398
==========
Fair value of Microgy assets acquired $6,805,215
Liabilities assumed (551,780)
----------
Acquisition price - fair value of securities issued and direct costs of
acquisition (including $171,229 of direct acquisition costs that are included
in accounts payable and accrued expenses as of September 30, 2001) $6,253,435
==========
NOTE G - SUBSEQUENT EVENT
- -------------------------
At the Company's 2001 Annual Meeting of Stockholders held on November 1, 2001,
the Company's stockholders approved an amendment to the Company's Certificate of
Incorporation increasing the Company's authorized capital stock from 20 million
shares of common stock and one million shares of preferred stock to 50 million
shares of common stock and two million shares of preferred stock, all $.01 par
value per share. The amendment was filed with the Secretary of State of
Delaware on November 9, 2001, resulting in the automatic conversion of all
197,760.7 shares of Series B Convertible Preferred Stock, referred to in Note B,
into 1,977,607 shares of common stock.
In November 2001, as contemplated in the Exchange Agreement, the Company is in
the process of completing the Subsequent Offer whereby the remaining security
holders of Microgy have been offered the opportunity to exchange their Microgy
securities for securities of the Company based on the Exchange Ratio, as the
same may be adjusted.
9
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 ("NEG" or
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.
On July 23, 2001, the Company acquired approximately 87.7% of the outstanding
common stock of Microgy Cogeneration Systems, Inc., a privately held Colorado
corporation ("Microgy"). The acquisition was accounted for using the purchase
method of accounting and, accordingly, the financial results of Microgy have
been included in the operating results of the Company beginning July 24, 2001.
Microgy, a development stage company, had no revenues from operations during the
period between July 24, 2001 and September 30, 2001.
Microgy is an alternative energy company that plans to develop renewable energy
plants in the United States and other countries. Microgy plans to employ unique
proprietary technologies and services that are designed to convert biomass type
organic wastes and animal manure into clean, renewable sources of electricity
and/or fuels. These plants are expected to also reduce water and air pollution
and green house gases that are believed to cause global warming and climate
change. Microgy intends to develop and/or license from others proprietary
technologies that focus on renewable, clean, cost effective energy and fuels.
Microgy has begun to seek host sites for project facilities and negotiate power
purchase agreements to sell energy as a source of revenue, obtain license or
other rights to other technologies and explore areas of mutual interest with
others with a view toward seeking to create viable projects with sustainable
long-term revenue streams.
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, 2001 with the results of operations for the
three and nine months ended September 30, 2000. Historical results and trends
which might appear should not be taken as indicative of future operations.
10
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
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 2000.
Net income was $1,692,496 for the nine months ended September 30, 2001 as
compared to $2,032,140 for the nine months ended September 30, 2000. The
decrease in net results during the nine months ended September 30, 2001 is
primarily attributable to a decrease in power generation revenues, a decrease in
interest income, the absence of revenues from sales of NOx emission credits, and
increases in operating expenses and general and administrative expenses. The
effect of these changes was offset in part by an increase in other income and
decreases in lease expenses, interest expense and income tax expense.
Power generation revenues for the nine months ended September 30, 2001 amounted
to $39,494,244 as compared to $41,165,018 for the nine months ended September
30, 2000. The decrease in power generation revenues during the nine months ended
September 30, 2001 is primarily attributable to the absence of 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, improvements in the Scrubgrass capacity rate, 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 $5,595,636 and
$5,277,009 for the nine months ended September 30, 2001 and 2000, respectively.
The Scrubgrass average capacity factors were 89.67% and 88.96% during the nine
months ended September 30, 2001 and 2000, respectively. The capacity factors
during these periods were impacted by forced outages which resulted in lost
capacity of 3.85% and 4.31% during the nine months ended September 30, 2001 and
2000, respectively. The lost capacity from annual maintenance outages was
comparable between 2001 and 2000.
Operating expenses for the nine months ended September 30, 2001 amounted to
$17,779,358 as compared to $17,065,816 for the nine months ended September 30,
2000. The increase in operating expenses during nine months ended September 30,
2001 was primarily attributable to the following reasons. First, the Company had
higher fuel costs primarily from improvements in the Scrubgrass capacity rate,
cost escalations in certain fuel supply agreements, changes in the fuel mix and
quality from fuel sources and increases in mobile equipment costs at a fuel
site. Second, pursuant to the
11
terms of the O&M, the Operator passed along increases in its labor and related
costs and operator fees to the Company. Third, planned maintenance expenses
increased primarily because of differences in the scope of procedures performed
during the 2001 and 2000 annual maintenance outages.
Lease expenses for the nine months ended September 30, 2001 amounted to
$17,862,716 as compared to $19,703,145 for the nine months ended September 30,
2000. The decrease in lease expenses during the nine months ended September 30,
2001 is primarily attributable to the following reasons. First, the Lessor's
loan costs, which are passed along to the Company as a lease expense, decreased
due to lower variable interest rates and reduced outstanding balances on the
Scrubgrass debt. Second, the Company incurred scheduled decreases in base
equity rents paid to the Lessor. Third, the additional rents paid to the
Lessor, which amount to 50 percent of the net cash flows from the Scrubgrass
Project, were lower during the nine months ended September 30, 2001 primarily
due to the absence of revenues and interest income from the PENELEC settlement
and the absence of income from the sale of NOx emission credits. This overall
decrease in lease expenses was offset in part by the following increases in
lease expenses during the nine months ended September 30, 2001. First, due to a
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, 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 $5,595,636 and $5,277,009 for the nine
months ended September 30, 2001 and 2000, respectively. Third, the Lessor passed
along increases in its scheduled principal payments for the Scrubgrass debt.
General and administrative expenses was $2,589,900 for the nine months ended
September 30, 2001 as compared to $2,313,679 for the nine months ended September
30, 2000. The increase in general and administrative expenses during the nine
months ended September 30, 2001 was primarily attributable to the following
reasons. First, the Company acquired Microgy on July 23, 2001 and incurred
Microgy general and administrative expenses of $161,869 following the
acquisition. Second, the Company incurred significant expenses pertaining to the
Microgy acquisition for post-acquisition integration, business development, and
strategic planning. Third, the Company incurred an increase in Scrubgrass
insurance expense due to changes in the insurance market for power generation
facilities. These increases were offset in part by lower Scrubgrass management
expenses during 2001. Scrubgrass had incurred significant professional fees,
travel expenses and labor related costs during 2000 to address certain non-
recurring business matters including the settlement with PENELEC and the
replacement of the letter of credit.
Interest income for the nine months ended September 30, 2001 amounted to $59,688
as compared to $707,553 for the nine months ended September 30, 2000. The
decrease in interest income during the nine months ended September 30, 2001 is
mostly attributable to the absence of approximately $608,000 of interest income
from the settlement agreement with PENELEC. The decrease was also attributable
to lower average interest rates for investments and reductions in the average
outstanding balances of notes receivable from officers.
Interest expense was $145,474 for the nine months ended September 30, 2001 as
compared to $240,161 for the nine months ended September 30, 2000. The decrease
in interest expense during the nine
12
months ended September 30, 2001 was primarily attributable to lower variable
interest rates and reduced outstanding balances related to the Scrubgrass debt.
During the nine months ended September 30, 2001, the Company had other income of
$1,710,685, principally from the settlement of a litigation relating to the
Company's former Sunnyside Project.
During the nine months ended September 30, 2000, the Company earned $1,161,888
from the sale of NOx emissions credits. The Company's NOx emission credits are
discussed further under Liquidity and Capital Resources.
Income tax expense was $1,141,000 for the nine months ended September 30, 2001
as compared to $1,598,000 for the nine months ended September 30, 2000. The
decrease in income tax expense was primarily attributable to a decrease in
income before taxes and a lower effective tax rate during 2001. During the third
quarter of 2001, the Company revised its estimated effective tax rate for the
year ended December 31, 2001 from approximately 42% to 40%. This change was
largely attributable to the inclusion of Microgy's operations in the Company's
statement of operations for the remainder of 2001.
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2000.
Net income was $922,030 for the three months ended September 30, 2001 as
compared to $903,168 for the three months ended September 30, 2000. The
increase in net results during the three months ended September 30, 2001 was
primarily attributable to an increase in power generation revenues and a
decrease in income tax expense. The effect of these changes was offset in part
by increases in operating expenses, lease expenses and general and
administrative expenses.
Power generation revenues were $13,914,475 for the three months ended September
30, 2001 as compared to $13,079,296 for the three months ended September 30,
2000. The increase in power generation revenues during the quarter ended
September 30, 2001 was primarily attributable to an improvement in the
Scrubgrass capacity rate and a 5% increase in certain rates billed to PENELEC
under the terms of the PPA. The Scrubgrass average capacity factors were 95.18%
and 94.20% during the three months ended September 30, 2001 and 2000,
respectively. The capacity factors during these periods were primarily impacted
by forced outages which resulted in lost capacity of 4.39% and 4.85% during the
three months ended September 30, 2001 and 2000, respectively.
Operating expenses was $5,292,285 for the three months ended September 30, 2001
as compared to $5,021,065 for the three months ended September 30, 2000. The
increase in operating expenses during quarter ended September 30, 2001 was
primarily attributable to the following reasons. First, the Company had higher
fuel costs primarily from improvements in the Scrubgrass capacity rate, cost
escalations in certain fuel supply agreements and changes in fuel quality and
mix between fuel sources. Second, pursuant to the terms of the O&M, the Operator
passed along increases in its operator fees to the Company. Third, facility
enhancement expenses increased primarily because of differences in the scope of
procedures performed during the third quarters of 2001 and 2000. These increases
were
13
offset in part by decreases in the Operator's labor and related costs which were
passed through to the Company pursuant to the terms of the O&M.
Lease expenses was $5,988,593 for the three months ended September 30, 2001 as
compared to $5,664,855 for the three months ended September 30, 2000. The
increase in lease expenses during the quarter ended September 30, 2001 was
primarily attributable to increases in additional rents paid to the Lessor and
increases in scheduled principal payments and letter of credit fees pursuant to
the Scrubgrass debt. Due to a requirement to pay the Scrubgrass working capital
loan to zero during 2001, which requirement was satisfied during the second
quarter of 2001, the increase in the additional rent was primarily due to the
timing of when cash became available for distribution from the Scrubgrass
Project. The aforementioned increases were offset in part by decreases in
scheduled base equity rent payments and interest on the Scrubgrass debt. The
interest on the Scrubgrass debt decreased due to lower variable interest rates
and reduced outstanding balances of the debt.
General and administrative expenses was $1,101,420 for the three months ended
September 30, 2001 as compared to $707,070 for the three months ended September
30, 2000. The increase in general and administrative expenses during the quarter
ended September 30, 2001 was primarily attributable to the following reasons.
First, the Company acquired Microgy on July 23, 2001 and incurred Microgy
general and administrative expenses of $161,869 following the acquisition.
Second, the Company incurred significant expenses pertaining to the Microgy
acquisition for post-acquisition integration, business development, and
strategic planning. These increases were offset in part by lower Scrubgrass
management expenses which were discussed in a previous section.
Income tax expense was $583,000 for the three months ended September 30, 2001 as
compared to $710,000 for the three months ended September 30, 2000. The decrease
in income tax expense was primarily attributable to a decrease in income before
taxes and a lower effective tax rate during the third quarter of 2001. During
the third quarter of 2001, the Company revised its estimated effective tax rate
for the year ended December 31, 2001 from approximately 42% to 40%. As a result,
the effective tax rate for the third quarter of 2001 decreased to approximately
39% in order to revise the effective tax rate to 40% for the nine months ended
September 30, 2001.
LIQUIDITY AND CAPITAL RESOURCES:
From January 1, 2001 through September 30, 2001, the Company received dividends
from the Scrubgrass Project totaling $1,341,406. On September 14, 2001, the
Company borrowed $750,000 for a 12 month period from Alco Financial Services,
LLC ("Alco"). On September 30, 2001, the Company's unrestricted cash balance
was $560,807, compared to a balance of $307,666 on December 31, 2000. On
September 30, 2001, the Company's restricted cash balance was $805,403, compared
to a balance of $587,476 on December 31, 2000. The Company is allowed to spend
restricted cash to fund the cost of major equipment overhauls at the Scrubgrass
facility subject to certain restrictions.
Alco Loan - On September 14, 2001, the Company borrowed $750,000 from Alco.
Robert Weisberg, a Director of the Company, is the President, Director and a
member of Alco. The loan is evidenced by a one-year promissory note which bears
interest at the prime rate plus 3.5%. The
14
Company also pays an administrative fee of 0.6% per month. The loan is secured
by all of the Company's assets (other than the stock of its subsidiary, Buzzard
Power Corporation). In connection with the loan, the Company granted Alco five
year warrants to purchase 50,000 shares of common stock at $0.60 per share.
Working Capital Loan for Scrubgrass Project - 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 $2,080,167 and
$2,742,961 as of September 30, 2001 and December 31, 2000, respectively. Under
the terms of the Lessee Working Capital Loan Agreement, the Company is required
to pay this loan to zero for a minimum of twenty days during 2001, which
requirement was already satisfied during the second quarter of 2001. As noted
below, the Lessee Working Capital Loan Agreement expires in December 2002. There
can be no assurance that the Company will be successful in obtaining a renewal
of this loan or a replacement line of credit.
Sale of NOx Credits - The Scrubgrass Project needed to achieve certain seasonal
nitrogen oxide ("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 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. Furthermore, the
Company presently expects to receive its next award of NOx Credits early in
fiscal 2002 for the ozone seasons in 2003 through 2007. Similar to prior years,
the Company expects that it may not require a portion of these future NOx
Credits to maintain its compliance with the applicable regulations. The Company
is in the process of negotiating a contract for the sale of anticipated excess
NOx credits which, if finalized, would be entered into in early 2002 following
the anticipated award and provide additional cash flows to the Company's
operations.
Refinancing Discussions - 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 in fiscal 2002, as it did during fiscal
2001.
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.
15
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 financing matters with the lending agent
of the Scrubgrass Project. In connection with these discussions, NEG recently
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 lessee 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. 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.
The Company believes that, during the next twelve months, expected cash flows
from the Scrubgrass Project, assuming continued favorable operation of the
Scrubgrass Project, combined with the Company's current cash balance, will
likely be sufficient to fund ongoing corporate expenditures, Microgy's current
overhead requirements prior to commencing development or construction of power
projects, and, to the extent not refinanced or replaced, repayment of the Alco
loan. However, in the event Scrubgrass Project cash flows are less than
anticipated or corporate and overhead expenses are greater than anticipated, the
Company may be required to seek financing. There can be no assurance that such
financing will be obtained or, if obtained, will be on terms acceptable to the
Company.
Microgy anticipates that project financing may be obtained in the form of a
credit facility with one or more lenders, the sale of tax exempt or taxable
bonds to investors or equity or other financing. Microgy can offer no assurance
that it will be able to secure project financing in the amount required to
fulfill any development or construction requirements, that project financing
will be obtained in time to meet such requirements, or that any such proposed
project financing, if obtained, will be on terms acceptable to Microgy. Microgy
will, however, need to obtain financing to allow it to develop and construct
such projects.
16
RECENTLY ISSUED ACCOUNTING STANDARDS
There are four recently issued accounting standards which are required to be
adopted in the future which are described in Note C to the Condensed
Consolidated Financial Statements.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
In recent years, the Company's business consisted of a single operating project
and a corporate office and the Company had presented its business risks in that
manner. On July 23, 2001, the Company acquired an 87.7% controlling interest in
Microgy, a development stage company, which intends to pursue, among other
things, the development of renewable and distributed energy projects. The
Company's future business risks will be materially affected by this recent
acquisition. Therefore, the Company has presented separately its historical
business risks, which pertain principally to the Scrubgrass Project, and
Microgy's business risks to allow readers to better understand the changes in
the Company's future business from the acquisition.
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.
RISK FACTORS FOR THE COMPANY'S HISTORICAL BUSINESS
- --------------------------------------------------
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 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.
17
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.
FINANCIAL RESULTS
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 such as the Scrubgrass Project's 1997 generator repair.
POTENTIAL LIABILITY, DAMAGES AND INSURANCE
The Company's power generation activities involve significant risks to the
Company for environmental damage, equipment damage and failures, personal injury
and fines and costs imposed by regulatory agencies. In the event a liability
claim is made against the Company, or if there is an extended outage or
equipment failure or damage at the Company's power plant for which it is
inadequately insured or subject to a coverage exclusion, and the Company is
unable to defend such claim successfully or obtain indemnification or warranty
recoveries, there may be a material adverse effect on the Company.
CIRCULATING FLUIDIZED BED TECHNOLOGY
The Company's Scrubgrass Project employs circulating fluidized bed technology to
produce electricity. Certain aspects of this technology, as well as the
conversion of waste products into electricity, are relatively new areas being
explored by the alternative energy market in the last 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, PENELEC. The Company expects that the
concentration of its revenues with this customer will continue for the
foreseeable future.
18
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.
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.
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 AND MARKET RISK
The Company, through its Buzzard 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. 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.
19
Further, expansion of our business through acquisition and/or development of
additional facilities, such as the recent acquisition of Microgy, would be
affected by competition from various sources, many of which are significantly
better capitalized than the Company.
ENERGY REGULATION
The Company's Scrubgrass facility is subject to certain regulations under
federal and state laws and regulations. Changes in regulations or agency
policies could have a material effect on the Company.
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.
RISKS FACTORS RELATING TO MICROGY'S BUSINESS (ACQUIRED ON JULY 23, 2001)
- ------------------------------------------------------------------------
MICROGY HAS EXPERIENCED LOSSES TO DATE AND EPC ANTICIPATES MICROGY WILL CONTINUE
TO EXPERIENCE LOSSES IN THE FORESEEABLE FUTURE.
Microgy has minimal financial operating history and had accumulated losses of
approximately $1.9 million through July 23, 2001. Microgy expects to continue
to experience losses and accumulate an earnings deficit as it seeks to develop
its business. Microgy expects to incur additional operating deficits as it
seeks to develop its market presence in the bio-energy and distributed
cogeneration power markets, and makes a substantial investment in sales and
marketing, the acquisition of key technologies and equipment, management,
technical and administrative resources. Therefore, EPC can provide no assurance
that Microgy will achieve or sustain profitability or a positive cash flow from
its operations.
20
MICROGY IS A YOUNG COMPANY AND HAS ONLY A LIMITED OPERATING HISTORY FROM WHICH
INVESTORS CAN EVALUATE ITS BUSINESS AND PRODUCTS.
Microgy was formed in 1999, and is still in the development stage. As such,
Microgy is subject to many of the risks common to enterprises with a limited
operating history, including potential under-capitalization, limitations with
respect to personnel, financial and other resources and limited customers and
revenues. Microgy's likelihood of success must be considered in light of the
problems, expenses, difficulties, complications and delays frequently
encountered in connection with the development and marketing of large systems.
Furthermore, Microgy became a subsidiary of EPC in July 2001 and EPC does not
have experience developing and marketing products and projects similar to those
of Microgy or in integrating acquired businesses such as Microgy.
FINANCING RISK; NEED FOR ADDITIONAL CAPITAL.
Microgy's future growth is dependent on the availability of capital to finance
product development, to construct projects, to fund marketing efforts and to
provide sufficient working capital on a continuing basis. There can be no
assurance that financing for working capital, project development or other
requirements will be available on acceptable terms, if at all. If Microgy's
plans or assumptions change or are inaccurate, the timing or amount of capital
required may vary substantially.
THE TECHNICAL INFORMATION AND SPECIFICS MICROGY NEEDS TO BUILD ITS BIOENERGY
FACILITIES IS PROPRIETARY TO ITS DANISH LICENSOR. MICROGY REQUIRES TIMELY
ACCESS TO THIS INFORMATION IN ORDER TO BUILD ITS PROJECTS AND FOR IT TO BE
SUCCESSFUL.
Microgy's Danish licensor, Danish Biogas Technology, A.S. holds trade secret and
other proprietary information which is important to Microgy in building its
anaerobic digestion bioenergy projects. Notwithstanding the fact that Microgy
has executed trade secret and non-disclosure agreements with them, Microgy has
experienced certain delays in obtaining and completing the information it may
require to successfully develop and install anaerobic digester based products
and facilities, such as blue prints and detailed designs. Microgy may require
additional information from engineering resources in order for it to maximize
the process efficiencies.
MICROGY FACES COMPETITION FROM LARGE PUBLIC UTILITIES AND ENERGY COMPANIES.
Competition in the traditional energy business from electric utilities and other
energy providers is well established with many substantial entities having
multi-billion dollar multi-national operations. The company also faces
competition in the alternative fuels and renewable energy business as large
companies are entering the renewable power generation field and these companies
are significantly better capitalized than EPC.
21
MICROGY FACES COMPETITION IN THE ANAEROBIC DIGESTER TECHNOLOGY MARKET.
There are many companies that offer anaerobic digester ("AD") technologies.
Microgy has identified more than 60 companies offering complete systems or
components to AD systems in the U.S. market. These companies may be able to
offer a similar or better AD technology than Microgy and have greater financial,
marketing and organizational resources than EPC.
EPC ANTICIPATES MICROGY OR ITS SUBSIDIARIES WILL SEEK FINANCING OF PROJECTS IN
THE FUTURE.
EPC is considering corporate financing, project financing and/or group financing
(aggregating several projects together and seeking financing for all at one
time) in the future to finance the cost of development for future projects.
Project financing and other financing depends on the lender's or investor's
review of the financial capabilities of the specific project or projects and
other factors, including their assessment of EPC's ability to successfully
construct and manage the project. Accordingly, Microgy is unable to predict how
difficult it will be to obtain financing or if it will even be able to obtain
such financing.
MICROGY FACES COMPETITION IN THE MARKET FOR TURBINES AND MICROTURBINE
TECHNOLOGIES.
Microgy entered into an agreement for a certain license for applications of
microturbine technology which is owned and being developed by Electric Power
International, Inc. ("EPI"), which itself is a small company with limited
resources. EPI has not yet completed development of the microturbine technology
and may not have the resources available to do so. There are a number of larger
well-known and better capitalized companies developing microturbine technologies
which might compete with Microgy licensed microturbine technology. Many of
these companies with which EPI and Microgy would compete have spent tens of
millions of dollars developing their technologies and products and have
production ready models.
In addition, a number of manufacturers of larger combustion turbines are
developing smaller units in the 250 kW to 1,000 kW range. EPI is still in the
development stage for its microturbine technology and has had no commercial
production.
MICROGY'S TECHNOLOGIES COULD BECOME OBSOLETE.
Competitive solutions exist or new technologies may be developed in the future
by competitive firms that could make Microgy's technologies obsolete.
Accordingly, Microgy cannot guarantee that its technologies will ensure a
leadership or competitive position within the marketplace in the future.
MICROGY'S PRODUCTS/SERVICES INVOLVE AN EXTENDED SALES CYCLE.
The negotiation of fuel supply agreements, lease agreements, power sales
agreements and utility service agreements with hosts such as dairy or swine
farmers or customers such as industrial
22
operators, involves a long-term sales cycle and decision-making process. Microgy
estimates that it can take from six months to a year to obtain decisions and to
negotiate and close these complex agreements. Delays in the customer's decision-
making process are outside Microgy's control and may have a negative impact on
Microgy's receipt of revenues and sales projections.
MICROGY HAS AN UNPROVEN BUSINESS APPROACH.
It is difficult to predict whether Microgy's proprietary technologies or
business approach to the renewable energy and waste management industry will
operate and will produce results as anticipated, be profitable or be readily
accepted by the marketplace. It is hard to estimate whether demand for
Microgy's bio-energy products will materialize at the prices it expects to
charge, or whether satisfactory profit margins will be achieved. If such
pricing levels are not achieved or sustained, or if Microgy's technologies and
business approach to the energy industry do not achieve or sustain broad market
acceptance, Microgy's business, operating results and financial condition will
be materially and negatively impacted. Microgy's ability to generate future
revenues will be dependent on a number of factors, many of which are beyond
Microgy's control, including, among other things, the risk factors described
herein.
THE PERFORMANCE OF MICROGY'S RENEWABLE ENERGY TECHNOLOGIES IS DEPENDENT ON
CERTAIN WASTE RESOURCES.
The performance of Microgy's renewable energy technologies is dependent on the
availability of certain waste resources to produce the raw energy and
subsequently generate power or fuel. There can be no assurances that waste
resources, such as waste from animal manure, fats/oils/greases, plastics and
other organic material, will be available in the future or at a price that make
them affordable for Microgy's waste to energy technologies. Lack of these raw
materials would seriously affect Microgy's ability to develop and finance
projects and generate income, and as a result, Microgy's revenues and financial
condition will be materially and negatively affected.
EPC MAY NOT BE ABLE TO EFFECTIVELY MANAGE MICROGY'S GROWTH.
Microgy is currently in the early stages of development of its technologies and
business strategies. This continuing transition will place a significant strain
on EPC's management and personnel resources. The ability to manage the growth
of Microgy's business will require EPC to develop and maintain new operations,
including financial and management information systems, project operations and
management systems, to motivate and manage employees effectively, and to attract
new qualified employees. If EPC's management is unable to manage such growth
effectively, its business, operating results and financial condition could be
materially and adversely affected.
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EPC WILL NEED ADDITIONAL PERSONNEL AND OUTSIDE CONTRACTORS.
EPC requires the addition of qualified personnel to support its plans for
technology acquisition, research and development, information systems, financial
and executive management, market penetration, project management, and expanded
operations. If EPC is unable to attract, hire or retain and fund the costs of
the necessary technical, sales, marketing, information systems, financial and
executive personnel, or EPC loses the services of any member of its current
senior management team, it could have a material adverse effect on EPC's
business, operating results and financial condition. In addition, EPC must hire
outside contractors, including general contractors, site surveying contractors,
electrical contractors and equipment providing contractors, to build EPC's and
Microgy's projects.
DEVELOPMENT UNCERTAINTIES
There can be no assurance that Microgy will be able to obtain all of the
necessary site agreements, 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. Microgy's failure to accomplish any of these steps could
materially increase the cost or prevent the successful completion of development
projects, or cause Microgy to abandon a development project and incur the loss
of any investment made, which could materially impact the Company's business and
results of operations.
CONSTRUCTION RISKS
Microgy is vulnerable to the risks associated with the construction industry.
Construction involves many risks, including material and labor interruption,
work stoppages, labor disputes, weather interferences, unforeseen engineering,
environmental and geological problems and unanticipated cost overruns. There is
a risk that the cost of delays will exceed negotiated limits on liquidated
damages and insurance coverage or that delays will be caused by events that are
not within anyone's control, as to which there may be no liquidated damages or
insurance coverage.
DISSOLUTION OF BUSINESS ALLIANCES, INHERENT RISKS IN ALLIANCE.
Microgy will rely on a network of various alliances and agreements (including
licenses) with other businesses to provide important technologies for its
businesses. The termination of any business alliance or agreement may have a
detrimental impact on the success of one or all projects or categories of
projects and, thereby, negatively impact Microgy's revenue. In addition,
alliances are inherently difficult to manage and often do not meet the
expectations of the partners. Therefore, there can be no assurance that this
part of Microgy's strategy will be effective.
MICROGY RELIES ON THIRD PARTIES (INCLUDING LICENSORS) TO MAINTAIN THE
PROPRIETARY NATURE OF THE BASE OF ITS TECHNOLOGIES.
Microgy relies heavily on strategic relationships, confidentiality agreements,
licensing agreements, and its relationships with inventors and consultants to
maintain the proprietary nature of its base of
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technologies relating to currently licensed technologies. To compete
effectively, Microgy may have to defend its rights to its intellectual property
from time to time. The defense costs can be significant. As such, Microgy may
lack the financial resources to adequately defend its intellectual property.
Microgy and its partners are assessing the strategic value of filing patents. To
date, neither Microgy nor, it is believed, its primary licensors has filed any
patent applications. There can be no assurance that any patent applications
relating to Microgy's existing or future products or technologies will result in
patents being issued, if filed, that any issued patents will afford adequate
protection to Microgy or its licensors, or that such patents will not be
challenged, invalidated, infringed, or circumvented. Furthermore, there can be
no assurance that others have not developed, or will not develop, similar
products or technologies that will compete with those of Microgy or its
licensors without infringing upon, or which do not infringe upon, Microgy's or
its licensors' intellectual property rights.
Third parties, including potential competitors, may already have filed patent
applications relating to the subject matter of Microgy's licenses. In the event
that any such patents are issued to such parties, such patents may preclude
Microgy and its licensors from obtaining patent protection for their
technologies, products or processes, may hinder or prevent Microgy from
commercializing its products and could require Microgy to enter into licenses
with such parties or cease such activities. There can be no assurance that any
required licenses would be available on acceptable terms, or at all.
MICROGY'S SERVICES WILL BE SUBJECT TO NUMEROUS GOVERNMENTAL REGULATIONS.
Microgy expects to provide services involving government regulation, which
subjects Microgy to certain regulatory policies and procedures. Many involve
environmental regulations covering air and water quality and related pollution
issues. These regulations are mandated by the United States Environmental
Protection Agency ("EPA") and various state and local governments. More
specifically, Microgy's activities in anaerobic digestion and/or nutrient
management related to animal manure, bio-refineries that convert organic wastes
that may be considered toxic or hazardous, and power production will all come
under some form of scrutiny from these agencies. Microgy's activities related
to these regulations will come under a number of health and safety regulations
and OSHA requirements. Microgy's plans and operations involving these issues
could come under stricter requirements as new laws and environmental standards
apply to both air and water quality. Microgy is also impacted by laws and
regulations relating to farms and zoning, as its anaerobic digester projects are
expected to be located on leased farm property.
Many of Microgy's bio-energy projects may produce power that can be sold to the
electric grid. As such, the sale of this power may come under the regulations
of various state public utility commissions. These commissions set the price
tariffs that such energy can be sold or purchased and they set the design
standards for the interconnection of Microgy's equipment with the electric power
grid. Thereby, most of Microgy's green power projects where electricity is sold
to the grid will come under regulation by these commissions. These regulations
may impede or delay the process of approving and implementing Microgy's
projects. Substantial delays may materially affect Microgy's financial
performance and financial condition. Many state regulatory commissions,
however, have mandated renewable energy portfolio standards which may streamline
25
approval processes for these types of projects. However, there is no assurance
that renewable energy standards or mandates will continue or be available for
Microgy's projects.
Various state governments and federal energy agencies may also regulate the sale
of alternative fuels such as ethanol, hydrogen or gas/oil. These agencies may
set the price for some or all of the fuel that Microgy plans to produce at bio-
refineries which Microgy may choose to develop. Although economic and tax
incentives exist and are expected to increase in the future, price controls
and/or regulation could negatively affect the economics of Microgy's various
alternative fuels projects.
Government regulations can be burdensome and may result in delays and expense to
Microgy. In addition, modifications to regulations could adversely affect the
timing and cost of new products and services Microgy introduces. Failure to
comply with applicable regulatory requirements can result in, among other
things, operating restrictions and fines.
MICROGY MAY FACE MARKET RISKS
To the extent Microgy sells power into the unregulated and retail markets,
Microgy will be subject to market risks. Low energy rates would negatively
impact the Company's profitability and could adversely affect its financial
condition.
RISK OF SYSTEM FAILURE.
Microgy would depend on the efficient and uninterrupted operation of bio-energy
plants and systems, including automation control systems. As Microgy expands
its operations, there will be increased stress placed upon hardware and
information traffic management systems. There can be no assurance that Microgy
will not experience system failures. Any system failure that causes
interruptions in Microgy's operations could have a material adverse effect on
Microgy's business, results of operations and financial condition. A failure
which causes damage to the utility or its distribution could also adversely
impact Microgy. In addition, Microgy's systems and operations are vulnerable to
damage or interruption from fire, flood, power loss, telecommunications failure,
break-ins and similar events. Microgy's systems and operations will also face
contamination due to the actions of farmers and others who may have access to
its sites. Microgy does not presently have redundant systems or a formal
disaster recovery plan to mitigate the risk of losses that may occur. There can
also be no assurance that any business interruption or property and casualty
insurance that Microgy would carry in the future would be sufficient to
compensate it for any losses that may occur.
MICROGY FACES SECURITY RISKS TO COMPUTER, INTERNET AND AUTOMATION CONTROL
SYSTEMS.
Despite Microgy's plans to implement security measures, the networks which will
be used to monitor the facilities Microgy develops may be vulnerable to
unauthorized access, computer viruses and other disruptive problems.
Unauthorized access through the Internet has caused user problems in the past,
and Microgy may in the future experience interruptions in service or breaches
26
into Microgy's business or control systems as a result of the accidental or
intentional actions of Internet users, current and former employees or others.
Unauthorized access could also potentially jeopardize the security of
confidential information stored in Microgy's computer systems and its installed
systems or plants that may result in liability for Microgy. Although Microgy
intends to implement industry-standard security measures, such measures have
been circumvented in the past and there can be no assurance that measures
Microgy would implement will not be circumvented in the future. Eliminating
computer viruses and alleviating other security problems may have a material
adverse effect on Microgy's business, operating results and financial
conditions.
CERTAIN LIABILITIES MAY NOT BE COVERED BY INSURANCE.
Although Microgy plans to carry general liability insurance, the insurance may
not cover certain potential claims or may not be adequate to indemnify Microgy
for all liability that may be imposed. Any imposition of liability that is not
covered by insurance or is in excess of insurance coverage could have a material
adverse effect on Microgy's business, operating results, and financial
condition.
MICROGY DEPENDS ON A SMALL NUMBER OF KEY EXECUTIVES AND ITS BUSINESS COULD
SUFFER IF THEY WERE TO LEAVE.
Microgy employs a small group of skilled individuals to accomplish its strategic
business plan. Microgy believes its performance is substantially dependent on
the continued employment and performance of its senior management. None of
these individuals are currently subject to employment agreements or employee
non-compete agreements. If Microgy fails to retain the services of one or more
of these persons, its business could suffer significantly. Microgy does not
maintain key-man insurance on the life of any of its officers at this time.
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.
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
27
the Lessor under various Scrubgrass Project agreements. The Company offers the
following information about these debt obligations:
BALANCE AT Matures
DESCRIPTION OF THE OBLIGATION 9/30/01 INTEREST RATE Through
- -----------------------------------------------------------------------------------------------------------
Lessor's term debt obligations:
Variable rate tax-exempt bonds $135,600,000 Quoted Bond Rates 2012
Swap rate term loan 11,133,664 Swapped LIBOR + 1.250% 2005
Variable rate term loan 9,409,836 LIBOR + 1.250% 2004
Buzzard's term debt obligations:
Variable rate working capital loan 2,080,167 LIBOR + 1.250% 2002
Variable rate term loan 1,111,599 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 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.
PART II. OTHER INFORMATION
---------------------------
Item 2. Changes in Securities and Use of Proceeds.
On July 23, 2001 (the "Closing Date"), the Company acquired approximately 87.7%
of the outstanding common stock of Microgy Cogeneration Systems Inc. ("Microgy")
in exchange for securities of the Company pursuant to a Share Exchange Agreement
(the "Exchange Agreement") dated as of June 20, 2001 among the Company, Microgy
and the Principal Microgy Shareholders, as defined therein.
The Company issued, pursuant to Regulation D under the Securities Act of 1933,
as amended, an aggregate of 5,521,549 shares of the Company's common stock, $.01
par value ("Common Stock") and 197,760.7 shares of the Company's newly
designated Series B Convertible Preferred Stock, $.01 par value (the "EPC
Preferred Stock"), to the Principal Microgy Shareholders in exchange for
28
15,919,147 shares of Microgy common stock. Each share of Preferred Stock, which
voted with the Common Stock on an as converted basis, was automatically
converted into ten shares of Common Stock as of November 9, 2001 upon an
increase in the authorized common stock to an amount sufficient to allow
conversion of the Preferred Stock. The Exchange Ratio was determined by
negotiations among the Company, Microgy and the primary Principal Microgy
Shareholders. The Exchange Ratio is based on all of the fully diluted equity of
Microgy being exchanged for 45% of the fully diluted equity of the Company,
assuming exercise or conversion of all derivative securities. Pursuant to
Section 2.4 of the Agreement, the Exchange Ratio may be increased to reflect
certain issuances of equity by the Company to generate funds to be available for
financing Microgy. However, holders of approximately 94% of the Microgy common
stock exchanged on the Closing Date have agreed to waive their right to
adjustments in the Exchange Ratio (other than any adjustment resulting from
400,000 options and warrants issued in September 2001). The Principal Microgy
Shareholders included two Microgy shareholders who executed Joinder Agreements,
becoming parties to the Exchange Agreement. At the closing, one of the Principal
Microgy Shareholders exchanged a warrant to purchase 800,000 shares of Microgy
common stock for a warrant to purchase securities of the Company based on the
Exchange Ratio. In connection with the issuance of 400,000 options and warrants
in September 2001, the Company expects to adjust the Exchange Ratio, resulting
in the issuance of approximately 258,883 additional shares of common stock to
the Principal Microgy Shareholders.
Under the Exchange Agreement, the Company agreed to offer (the "Subsequent
Offer") the remaining security holders of Microgy (who owned an aggregate of
2,230,126 shares of Microgy common stock, warrants to purchase 885,000 shares of
Microgy common stock and options to purchase 290,000 shares of Microgy common
stock) to exchange for EPC securities based on the Exchange Ratio, as adjusted.
See Item 5 below.
In addition to the foregoing issuances, during the quarter ended September 30,
2001, the Company issued to a Director, Robert I. Weisberg, a five year option
to purchase 350,000 shares of common stock at $.72 per share, and issued to Alco
warrants to purchase 50,000 shares of common stock (as described in Part I -
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Liquidity and Capital Resources).
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's 2001 Annual Meeting of Stockholders, originally scheduled for June
26, 2001, was postponed due to the pending Microgy transaction and rescheduled
for November 1, 2001. Accordingly, no matters were submitted to a vote of
security holders in the quarter ended September 30, 2001. See Item 5. Other
Matters.
ITEM 5. OTHER MATTERS
At the Company's 2001 Annual Meeting of Stockholders, the Company's stockholders
approved an amendment to the Company's Certificate of Incorporation increasing
the Company's authorized capital stock from 20 million shares of common stock
and one million shares of preferred stock to 50 million shares of common stock
and two million shares of preferred stock, all $.01 par value per
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share. The amendment was filed with the Secretary of State of Delaware on
November 9, 2001, resulting in the automatic conversion of all 197,760.7 shares
of Series B Convertible Preferred Stock into 1,977,607 shares of common stock.
In November 2001, the Company is in the process of completing the Subsequent
Offer, whereby the remaining security holders of Microgy have been offered the
opportunity to exchange their Microgy securities for securities of the Company
based on the Exchange Ratio, as adjusted.
In November 2001, Principal Microgy Shareholders holding a majority of the
aggregate voting power of the Principal Microgy Shareholders in the Company
agreed with the Company to extend, to March 31, 2002 from November 30, 2001, the
date by which the Company is required to file a resale registration statement
for former Microgy security holders pursuant to a Registration Rights Agreement
dated July 23, 2001.
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ITEM 6. Exhibits And Reports On Form 8-K
(a) Exhibits
(i) Exhibit 3.02 - Certificate of Designations related to the Company's
newly designated, $.01 par value, Series B Convertible Preferred
Stock. (incorporated by reference to Form 8-K filed on August 7,
2001)
(ii) Exhibit 10.01 - Share Exchange Agreement dated June 20, 2001 among
the Company, Microgy and the Principal Microgy Shareholders
(incorporated by reference to Exhibit 2 to Amendment No. 7 to
Schedule 13D filed by Joseph E. Cresci on August 2, 2001 (the
"13D").
(iii) Exhibit 10.02 - Stockholders' Agreement dated July 23, 2001 among
the Company, the Principal Microgy Shareholders, Joseph E. Cresci
and Donald A. Livingston (incorporated by reference to Exhibit 4 to
the 13D).
(iv) Exhibit 10.03 - Registration Rights Agreement dated July 23, 2001
among the Company, the Principal Microgy Shareholders, Joseph E.
Cresci, Donald A. Livingston and future exchanging Microgy security
holders who become a party thereto (incorporated by reference to
Exhibit 5 to the 13D).
(v) Exhibit 10.04 - Form of Joinder Agreement (incorporated by reference
to Exhibit 6 to the 13D).
(vi) Exhibit 10.05 - Form of Waiver Agreement dated July 23, 2001
executed by certain Microgy Shareholders (incorporated by reference
to Exhibit 3 to the 13D).
(vii) Exhibit 10.06 - Warrant Agreement dated July 23, 2001 between the
Company and Daniel J. Eastman. (incorporated by reference to
Exhibit 6 to the Schedule 13D filed by Daniel J. Eastman on
August 2, 2001).
(viii) Exhibit 10.07 (See Note A below) - Technology Licensing Agreement
dated May 12, 2000 between Microgy Cogeneration Systems, Inc. and
Danish Biogas Technology, A.S.
(ix) Exhibit 10.08 - Promissory Note dated September 14, 2001 by the
Company in favor of Alco Financial Services, LLC ("Alco").
(x) Exhibit 10.09 - Security Agreement, dated as of September 14, 2001
between the Company and Alco.
(xi) Exhibit 10.10 - Warrant to purchase 50,000 shares of common stock
issued to Alco.
(xii) Exhibit 11 - Computation of Earnings Per Share.
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(b) Reports on Form 8-K
(i) On August 7, 2001, as amended on August 14, 2001, the Registrant
disclosed the completion on July 23, 2001 of an acquisition of an
87.7% controlling interest in Microgy.
(ii) On August 21, 2001, the Registrant disclosed that Martin A. Zelbow,
a consultant, was named Interim Chief Financial Officer and Interim
Treasurer on August 20, 2001.
(iii) On September 18, 2001, the Registrant disclosed pursuant to
Regulation FD the Letter to Shareholders dated September 4, 2001
which was included in its Second Quarter 2001 Quarterly Brochure to
Shareholders.
Note A: Portions of this exhibit have been omitted and filed separately with
the Securities and Exchange Commission pursuant to a request for confidential
treatment.
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 19, 2001 /s/ Martin A. Zelbow
---------------------------------
Martin A. Zelbow
Interim Chief Financial Officer
and Treasurer.
(principal accounting officer
and authorized officer)
32