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| EPG > SEC Filings for EPG > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-2009
Quarterly Report
You should read the following discussion together with our financial statements and accompanying notes included in this quarterly report and our audited financial statements included in our annual report on Form 10-K for the year ended December 31, 2008 which is on file with the Securities and Exchange Commission. In addition to historical information, the following discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated by the forward-looking statements due to important factors and risks including, but not limited to, those set forth in Part II, Item 1A - Risk Factors of this Quarterly Report on Form 10-Q and other filings we make with the Securities and Exchange Commission.
Overview
Environmental Power is a developer, owner and operator of renewable energy production facilities. Our goal is to produce energy that is Beyond Renewable ®, which we define as energy that not only is derived from waste materials instead of precious resources, but energy that is also clean, reliable and cost-effective. Environmental Power and its subsidiaries develop and own facilities that, unlike many renewable energy facilities, are intended to be profitable without the need for subsidies or other governmental assistance. Any such government assistance would, however, benefit our facilities by increasing their potential for profitability, while at the same time expanding opportunities for the profitable deployment of such facilities. We believe that a number of factors, including volatile energy prices, greater desire for renewable energy sources, more stringent environmental and waste management requirements imposed on farmers and food industry waste producers, and greater revenue opportunities from carbon sequestration credits will continue to provide favorable market conditions for our business.
In the past, we have operated in two major segments, through Microgy, Inc., as a developer of renewable energy facilities for the production and commercial application of methane-rich biogas from agricultural and food industry wastes, and through EPC Corporation and its subsidiary, Buzzard Power Corporation, referred to as Buzzard, which was the holder of a leasehold interest in a waste-coal fired generating facility in Pennsylvania known as the Scrubgrass facility. On May 31, 2007, our board of directors authorized management to enter into negotiations regarding the disposition of the leasehold interest in the Scrubgrass facility. On February 29, 2008, we completed the disposition of the leasehold interest. As a result, for financial reporting purposes, we are now consolidating all segments of continuing operations and reporting the results of Buzzard as "discontinued operations". We thus now operate only in Microgy's segment.
Microgy is a developer of renewable energy facilities for the production and commercial application of methane-rich biogas produced from animal and food industry wastes. The biogas can be sold to end-users or used to produce pipeline-grade methane, which Microgy refers to as renewable natural gas, or our RNG® product, liquefied natural gas, or LNG, compressed natural gas, or CNG, renewable electrical energy or thermal energy, as well as other useful by-products. Microgy's systems utilize a proven European biogas production technology that Microgy believes is superior to other such technologies. Currently, Microgy owns the exclusive North American license to this technology. In addition, Microgy has developed significant engineering, construction and process knowledge regarding these systems.
Due to the increased focus on renewable energy, Microgy believes its RNG® product offerings will be positively received by numerous environmentally responsible entities seeking renewable energy sources. While we do not have subsidies, rebates, grants or other credits available as to this renewable source of energy, Microgy believes that tax credits, renewable energy credits, pollution offset credits, carbon sequestration credits and other such incentives may be available now or in the future to Microgy's facilities, and such incentives would serve to enhance the addressable market and potential profitability of its facilities. Many states have either passed or are considering legislation requiring utilities to obtain or generate a certain percentage of their power from renewable sources.
In addition to the value generated from the production and sale of renewable gas, we believe that our facilities can generate additional environmental benefits with significant economic and social value by providing a valuable waste management solution for farms and other producers of organic wastes, such as those in the food industry. Federal and state agencies have either passed or are considering regulations that require concentrated animal feeding operations, referred to as CAFOs, to implement changes to their current waste management practices. We believe that these increasingly stringent environmental regulations will be another significant factor creating opportunities for the deployment of our systems.
Microgy intends to continue to focus on its strategy of developing large-scale, standardized facilities utilizing an ownership model, pursuant to which Microgy will construct, own and operate facilities and profit from the ongoing sale of biogas or RNG ® product produced by such facilities as well as sales of carbon sequestration credits or other marketable environmental benefits. This strategy encompasses the construction and operation of stand-alone plants like the Huckabay Ridge facility described below, as well as facilities dedicated to the needs of a single customer at one or more customer locations, such as the Grand Island facility described below. By pursuing this strategy, Microgy intends to accumulate gas production and carbon sequestration capacity over time. In addition, Microgy continues to standardize and streamline both its system design and its approach to the marketplace in order to allow for rapid and cost-effective scale-up of its business.
Having constructed both the multi- and single-tank system in four currently operating installations, Microgy intends to own the digester systems it develops. Our multi-digester facilities will primarily produce pipeline-quality renewable natural gas, although we will also consider opportunities to produce and sell conditioned biogas, electricity, CNG or LNG from our facilities. Microgy's development efforts are focused on applications of its technology that are resource efficient. Development of smaller scale and single-digester facilities will be targeted toward customers that have multiple sites and opportunities that have shorter development cycles. Microgy's goal with all projects is to maximize the profitability of every project by implementing the right technology and most profitable off-take arrangements.
Microgy's efforts have resulted in the start of commercial operations at the Huckabay Ridge facility in Stephenville, Texas, in the first quarter of 2008. Huckabay Ridge consists of eight 916,000-gallon digesters which operate together to process the manure from approximately 10,000 cows in combination with various substrate feedstocks in our co-digestion process. The gas is treated and compressed to produce pipeline-grade methane that is sold and delivered directly into nearby natural gas pipelines. Huckabay Ridge is expected to produce an annual sales volume of 782,000 MMBtus per year reflecting the addition of a combined heat and power ("CHP") process provided by a third party under a services agreement. This arrangement will allow us to reduce our internal parasitic loads, which had increased due to modifications required by the gas conditioning process, freeing up more gas for sale in the market. The net effect will be an increase in revenue offset by increased thermal costs but at a lower value than our RNG ® product pricing and reduced electric costs for the facility. The CHP process is expected to be in operation within 4 months after appropriate escrow accounts have been funded.
We have two other multi-digester facilities in development in Texas with an expected output. We will also consider the addition of a CHP process at each of these facilities and other projects in development to maximize RNG ® sales, while utilizing waste heat sources for more efficient energy utilization. We have also announced three proposed multi-digester RNG ® facilities in California that are in advanced stages of development. We currently expect to have outstanding $45 million in tax-exempt bond financing relating to the construction and operation of the Huckabay Ridge facility and the two additional planned facilities in Texas. Furthermore, we currently expect to have outstanding $31.2 million in tax-exempt bond financing relating to the construction and operation of one of the proposed California facilities. For a discussion of the expected redemption and repurchase of a portion of the Texas and California tax-exempt bonds see Note H - "Long-term Obligations and Contractual Obligations" - "California and Texas Bonds"
Construction at Microgy's Swift Grand Island biogas facility has progressed with major equipment procurement nearly complete. Operations are expected to commence in 2010, subject to obtaining sufficient financing to complete construction. Microgy's Grand Island biogas facility will consist of two 1.3 million gallon digesters that will process wastes generated by the Swift Grand Island processing facility. The plant is expected to produce 235,000 MMBtus per year of biogas that will be purchased by Swift under a fifteen year gas purchase agreement to offset natural gas consumption at Swift Grand Island. Swift will provide all the necessary feedstock material, both manure and substrate required by our process. We completed $7.0 million in tax-exempt bond financing in Nebraska in July 2008 to finance a portion of the construction costs of the Swift Grand Island facility.
In October 2006, we entered into a business development agreement, referred to as the BDA, with Cargill, Incorporated, referred to as Cargill. We are leveraging our relationship with Cargill to accelerate our identification and development of both facilities for the production of our RNG® product and smaller-scale, multi-digester facilities dedicated to a single customer.
Microgy is also operating three single digester facilities in Wisconsin. Microgy sold these projects to the farms on which they are located, and developed them in conjunction with Dairyland Power Cooperative, an electric cooperative utility, referred to as Dairyland. The biogas from these projects is used by Dairyland to generate electricity.
Discontinued Operations
The disposition of Buzzard's leasehold interest in the Scrubgrass facility was completed on February 29, 2008. Buzzard leased its generating facility from Scrubgrass Generating Company, L.P. The Scrubgrass plant, referred to as Scrubgrass, located on a 600-acre site in Venango County, Pennsylvania, is an approximate 83 megawatt waste coal-fired electric generating station. We decided to seek the disposition of Buzzard's leasehold interest in the Scrubgrass facility to allow management to focus its attention and resources on the development and growth of Microgy. As a result of Buzzard's disposition of its leasehold interest, we are now consolidating all segments of continuing operations for financial reporting purposes and reporting the results of Buzzard as "discontinued operations".
Going Concern
The Company's consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and satisfaction of liabilities in the ordinary course of business. As a predominately development oriented company, we have experienced substantial losses since the year ended December 31, 2002. For the nine months ended September 30, 2009, we incurred a net loss applicable to common shareholders of $14,148,000, and used cash from operating activities of $5,219,000. For the year ended December 31, 2008, we incurred a net loss applicable to common shareholders of $17,333,000 and used cash of $13,100,000 in operating activities. We anticipate incurring losses at least through 2010 as we continue
the construction of our portfolio of announced projects. As of September 30, 2009, we had an accumulated deficit of $81,823,000 and our unrestricted cash and cash equivalents amounted to $1,081,000. Currently, our facility at Huckabay Ridge, Texas, which is operating reliably, is anticipated to generate cash flow over the balance of the year. However, the cash we project to be generated from Huckabay Ridge, by itself, will be insufficient to meet our short-term and long-term corporate and project-related capital requirements.
In the past, we have been able to obtain outside financing to fund our losses and meet our capital requirements with the anticipation that once our projects are complete and operational, they would contribute to future liquidity needs. While we have substantially reduced our general and administrative expense, and Huckabay Ridge is generating positive cash flow, we will need additional funds to meet all of the required interest payments on debt and preferred dividend payment due December 1, 2009 and January 1, 2010. In addition, our cash forecasts indicate we will only be able to maintain corporate headquarters operations for a limited period. We are currently actively seeking additional funds from a variety of sources but there can be no guarantee we will raise sufficient funds to meet these obligations.
We are currently actively seeking additional sources of capital to meet our financing needs and provide sufficient equity for our existing projects. To that end, on March 13, 2009 we closed on a sale of $5.0 million original principal amount of our 14% convertible notes due January 1, 2014 for net proceeds of approximately $4.5 million, and, on May 22, 2009, we issued an additional $3.0 million principal amount of such notes to Xergi in consideration for payment of project licensing fees. We continue to work with our financial advisors to identify and explore various opportunities to raise the capital we require. The level of funds we are able to raise, if any, will determine the level of development and construction activity that we can pursue and whether we will be able to continue as a going concern.
We have been working with Marathon Capital, LLC to obtain final financing proposals from prospective investors in support of its announced project pipeline. As a result of these activities, Environmental Power and our subsidiary, Microgy Holdings, LLC ("Microgy Holdings"), have entered into a non-binding letter of intent with a potential investor relating to, among other things, the purchase of newly issued equity interests in Microgy Holdings, the proceeds of which would be used for the completion of certain projects currently under development and construction by Microgy Holdings and its subsidiaries, as well as reimbursement of certain intercompany receivables owed by Microgy Holdings to Environmental Power. The letter of intent also addresses the development and funding of future projects based on the technology of Microgy, Inc. ("Microgy"). The letter of intent is not binding, and the transactions contemplated thereby remain subject to investor due-diligence and the negotiation, execution and delivery of definitive agreements.
We cannot assure you that any such definitive agreements will be entered into or that the transactions contemplated by the letter of intent will be executed. The potential investor has the right to terminate the non-binding letter of intent at any time for any reason. In addition, Environmental Power will need to continue to seek interim financing to fund operations while it seeks to finalize and close the transactions contemplated by the letter of intent. The level of funds we are able to raise, if any, will determine the level of development and construction activity that we can pursue and whether we will be able to continue as a going concern.
The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The uncertainties described in the preceding paragraph raise substantial doubt at September 30, 2009 about our ability to continue as a going concern without additional financing. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of the carrying amount of recorded assets or to the amount and classification of liabilities that might result should we be unable to continue as a going concern.
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations compares the results of operations for the three and nine month periods ended September 30, 2009 with the results of operations for the three and nine month periods ended September 30, 2008. Historical results and trends that might be discussed below should not be taken as indicative of the results for the full year or for future operations generally.
Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008
Overview. For the nine months ended September 30, 2009, we had a net loss applicable to common shareholders of $14,148,000 or a loss of $0.91 per share, compared to a net loss applicable to common shareholders of $7,540,000 or $0.48 per share in the same period of the prior year. These results should be viewed in the context of two unusual items in 2008 and 2009 as follows:
• In the nine months ended September 30, 2008, we had net income from discontinued operations of $6,989,000 due to the disposal of our Buzzard operation.
Without the adjustments discussed above, the net loss applicable to common shareholders would have been $8,262,000 for the nine months ended September 30, 2009 and the net loss applicable to common shareholders for the nine months ended September 30, 2008 would have been $14,530,000.
Results from continuing operations, except for the impairment of assets write-down improved in the first nine months of 2009. The net loss from continuing operations, excluding the impairment, was $7,261,000 for the nine months ended September 30, 2009, as compared to a net loss from continuing operations of $13,537,000 for the nine months ended September 30, 2008. The reduction in the net loss from continuing operations was primarily due to a decline in general and administrative expenses of $4,553,000 and a decrease in operating losses before depreciation at our Huckabay Ridge facility during the first nine months of 2009 of $3,405,000 due principally to increased gas sales and a reduction in operating and maintenance expenses at the facility.
Revenues. Revenues for the nine months ended September 30, 2009 increased to $3,272,000 from $2,539,000 for the nine months ended September 30, 2008. The increase in revenues of $733,000 is primarily attributable to increased gas sales at Huckabay Ridge which more than offset a reduction in sales of greenhouse gas sequestration credits in the first nine months of 2009 derived from the Wisconsin facilities. During the first nine months of 2009, we recorded $18,000 in revenues from sales of such credits, as opposed of $198,000 in such revenues for the prior year. In the 2008 period, we received revenues from the sale of credits for vintage years 2005 to 2007 but for the first nine months of 2009 we only received revenues for credits for the first six months of 2008. We currently expect revenues to increase in future periods compared to 2008, as Huckabay Ridge revenues in the fourth quarter of 2009 should be substantially above 2008 amount. The facility experienced a prolonged downtime during the last six months of 2008, whereas in 2009 it is currently operating at normal production levels.
Operations and maintenance expenses. Operations and maintenance expense was $2,580,000 for the nine months ended September 30, 2009 as compared to $5,038,000 for the same period in 2008, a decrease of $2,458,000. The decrease was primarily due to a reduction in operations and maintenance expense at Huckabay Ridge of $2,643,000 as start up and non-recurring costs were reduced and Huckabay Ridge received certain insurance proceeds for settlement of claims related to events that occurred in 2008. In addition, in May 2009, we reversed certain reserves established in 2008 for the disposal of substrate which resulted in reduced operations and maintenance expenses for the nine months ended September 30, 2009. We currently expect non-recurring and start up costs at Huckabay Ridge to continue to decrease as operations at this facility become more reliable due to the completion of the improvements to the biogas collection and conditioning systems. In addition, we anticipate reductions in substrate costs in the fourth quarter as a result of our substrate sourcing plan, which was implemented in the third quarter of 2009 and has reduced net substrate costs.
General and administrative expenses. General and administrative expenses from continuing operations declined by $4,553,000 to $5,185,000 for the nine months ended September 30, 2009, as compared to $9,738,000 for the same period in 2008. The decline is attributable primarily to lower salary expenses in the 2009 period, reflecting the reductions in staffing, lower non-cash compensation expense in the 2009 period due to reduced expense from stock based compensation and reductions in development expense in the 2009 period as we slowed development efforts to conserve cash pending our fundraising initiatives. Without the inclusion of non-cash compensation expense, general and administrative expenses would have been $4,856,000 and $8,056,000 for the nine months ended September 30, 2009 and 2008, respectively.
Depreciation and amortization expenses. Depreciation and amortization expense increased to $1,266,000 for the nine months ended September 30, 2009 from $993,000 for the nine months ended September 30, 2008. The increase in depreciation and amortization expense was principally due to the fact that the nine months of 2009 included nine months of depreciation at the Huckabay Ridge facility whereas the nine months of 2008 included only eight months depreciation for this facility. The facility began commercial operations in February 2008, so we began to recognize depreciation expense for this facility at that time. In addition, depreciation and amortization for 2009 includes amortization of deferred financing costs related to the 14% convertible notes we issued in March and May 2009.
Impairment of assets On a regular basis management reviews long-lived assets to determine if there is any impairment that require writing down the carrying value of the asset. In the third quarter of 2009, due to the expected repurchase and redemption of a portion of the Texas and California bonds we determined that certain assets in construction in progress required write-downs of $5,545,000. Also we wrote off $341,000 of forfeited tank deposits. These adjustments were non-cash in nature.
Operating loss. As a result of the changes described above, our operating loss from continuing operations increased to $11,644,000 in the nine months of 2009 from $13,230,000 in the same period in 2008. Excluding the asset impairments, the operating loss in 2009 would have been $5,758,000.
Interest income. Interest income on unrestricted cash for the nine months ended September 30, 2009 was $31,000 as compared to $434,000 for the nine months ended September 30, 2008. Interest income decreased due to both lower invested cash balances and lower interest rates on such balances.
Interest expense. Interest expense increased to $1,600,000 for the nine months ended September 30, 2009, as compared to $705,000 for the nine months ended September 30, 2008. This increase was due to several factors. We ceased the capitalization of interest expense related to the Huckabay Ridge facility when it began commercial operations in February 2008. The interest expense related to the portion of the bonds allocated to finance the Huckabay Ridge facility is now recorded as interest expense. Therefore we had nine full months of interest expense relating to the Huckabay Ridge facility in the nine months of 2009, whereas we had only eight months of such interest expense related to Huckabay Ridge in the first nine months of 2008. In the nine months of 2009, we also incurred $537,000 in interest expense on $8,000,000 original principal amount of our 14% convertible notes which were issued in March and May 2009. Finally, beginning in April 2009 we stopped capitalizing interest on our Swift facility in Grand Island, Nebraska due to the fact that we temporarily suspended construction as of April 1, 2009. As a result, we expensed $245,000 of interest related to the Swift facility in the second and third quarters of 2009.
Other income (expense). We had other income of $94,000 for the nine months ended September 30, 2009, as compared to other expense of $37,000 for the nine months ended September 30, 2008. The other income for the nine months ended September 30, 2009 reflects principally income recognized from a reduction in the market value of certain outstanding warrants partially offset by the net loss associated with the sublease of our Golden, Colorado office facility. The other expense in the first nine months of 2008 was principally the result of the disposal of assets associated with the closing of office facilities in Portsmouth, New Hampshire and Golden, Colorado.
Income tax expense. The income tax expense for the first nine months of 2009 reflects estimated state income and franchise tax payments.
Income from discontinued operations, net of taxes. The results for the nine months ended September 30, 2009 do not include the results of discontinued operations because these operations were disposed of in February 2008. The loss from discontinued operations of $1,011,000 in 2008 reflects the operations of Buzzard for the first two months of 2008 before we disposed of it. On February 29, 2008 we disposed of Buzzards interest in the Scrubgrass facility and recognized a one time gain of $8,000,000. With the exception of a cash payment of $375,000 the gain was non-cash and consisted primarily of recognition of a previously deferred gain in the amount of $2,570,000, forgiveness of indebtedness in the amount of $3,456,000 and elimination of other obligations of $1,630,000. There was no tax provision provided on the disposition because we believe that we have sufficient net operating loss carry-forwards at the federal and state levels to offset any potential tax liability with respect to the gain on disposition. Therefore the net result of income from discontinued operations for the nine months ended September 30, 2008 was income of $6,989,000.
Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
Overview. For the three months ended September 30, 2009, we had a net loss applicable to common shareholders of $8,284,000 or a loss of $0.53 per common share compared to loss applicable to common shareholders of $5,088,000 or loss of $0.33 per common share for the three months ended September 30, 2008. In the three months ended September 30, 2009, we recorded impairment of assets, a non-cash event, in the amount of $5,886,000. Without this write-down, net loss applicable to common shareholders would have been $2,398,000. The improvement in results before the impairment write-down is primarily due to improved performance at our Huckabay Ridge facility and a reduction in general and administrative expenses consistent with our cost reduction plan. These results are explained in more detail below.
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