<PAGE>
 
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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, DC  20549

                                   FORM 10-K
(Mark one)

   [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

For the fiscal year ended                     December 31, 1998
                                  ------------------------------------------

                                      OR
                                        
   [ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
        EXCHANGE OF 1934

        For the transition period from                    to
                                         ----------------    ----------------
         Commission File Number               0-15472
                                ----------------------------------

                        Environmental Power Corporation
            (Exact name of registrant as specified in its charter)

            Delaware                                     04-2782065
  (State or other jurisdiction of                      (IRS Employer
  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

          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.01 par value
                                        
Indicate by check mark whether the registrant (1)has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes [X]          No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. [_]

State the aggregate market value for the voting stock held by non-affiliates of
the registrant: The aggregate market value, computed by reference to the closing
price of such stock on March 23, 1999 was $2,761,960.

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the last practicable date:  On March 23, 1999 there were
11,406,783 outstanding shares of Common Stock, $.01 par value, of the
registrant.

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                                       1
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                      DOCUMENTS INCORPORATED BY REFERENCE
                                        

Portions of the definitive Proxy Statement to be filed with the Securities and
Exchange Commission and delivered to shareholders in connection with the Annual
Meeting of Shareholders to be held on June 28, 1999 are incorporated by
reference into Part III of this Annual Report filed on Form 10-K. The portions
of the Proxy Statement under the headings "Report of the Compensation Committee"
and the "Stock Performance Graph" are not incorporated by reference and are not
a part of this Form 10-K Report.

                               TABLE OF CONTENTS
                                        
<TABLE>
<CAPTION>
Description of Contents                                                                                    Page #
-----------------------                                                                                    ------
<S>                                                                                                     <C>
PART I:
-------
Item 1.     Business                                                                                           3
Item 2.     Properties                                                                                        12
Item 3.     Legal Proceedings                                                                                 12
Item 4.     Submission of Matters to a Vote of Security Holders                                               14
 
PART II:
--------
Item 5.     Market for Registrant's Common Equity and Related Shareholder Matters                             15
Item 6.     Selected Financial Data                                                                           18
Item 7.     Management's Discussion and Analysis of Financial Condition and Results of Operations             19
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk                                        36
Item 8.     Financial Statements and Supplementary Data                                                       37
Item 9.     Disagreements on Accounting and Financial Disclosure                                              37
 
PART III:
---------
Item 10.    Directors and Executive Officers                                                                  38
Item 11.    Executive Compensation                                                                            39
Item 12.    Security Ownership of Certain Beneficial Owners and Management                                    39
Item 13.    Certain Relationships and Related Transactions                                                    39
 
PART IV:
--------
Item 14.    Index to Financial Statements, Exhibits, and Reports on Form 8-K                                  40
            Signature Page                                                                                    45
</TABLE>


                             CAUTIONARY STATEMENT
                                        
     This Annual Report on Form 10K contains "forward-looking statements", as
defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about the Company.  For this
purpose, any statements which are not statements of historical fact may be
deemed to be forward-looking statements.  Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements.  There are a number of
important factors which could cause the Company's actual results to differ
materially from those indicated by the forward looking statements.  These
factors include, without limitation, those set forth below under the caption
"Item 7.--Certain Factors That May Affect Future Results".

                                       2
<PAGE>
 
                                    PART I

Item 1.  BUSINESS

  Environmental Power Corporation (individually "EPC" or consolidated "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. Until December
31, 1994 the Company had varying ownership interests (100% to approximately 40%)
in, and oversaw the operation of, an approximately 51 Mw (net) waste coal-fired
electric generating facility located in Utah.  Both facilities sell power under
long-term contracts to specified utility companies whose contracts have been
approved by the respective Public Utility Commission.  In the case of these two
projects, the Company, either acting alone or in conjunction with others, has
selected and arranged for the acquisition of the site, obtained control over a
portion of their waste coal fuel sources, negotiated contracts for the design
and construction of the facilities and the sale of their output to the utilities
purchasing the power, arranged for financing, and negotiated contracts for the
operation and maintenance of the projects.  Until December 5, 1997, the Company
had one additional project (the "Milesburg Project") which had been in the
development stage since 1987 and involved in significant contract litigation
since the early stages of its development activities.  On August 26, 1997, the
Company entered into a Buy-Out Agreement with the utility company which had
contracted to purchase electricity from the Milesburg Project.  On December 5,
1997, pursuant to the Buy-Out Agreement, the Company sold substantially all of
the assets of the Milesburg project to this utility company and the ongoing
litigation was terminated.  The Company's projects are discussed in more detail
in the following sections.

  Scrubgrass

     The Scrubgrass Project located on a 600 acre site in Venango County,
Pennsylvania, is an approximately 83 Mw (net) waste coal-fired electric
generating station (the "Facility") which has been constructed by Bechtel Power
Corporation.  The construction contract provided for a guaranteed net electrical
output of  82.85 Mw.  Final completion was achieved by the contractor in June
1994.

     On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a subsidiary of
EPC, entered into an agreement to lease the Facility from Scrubgrass Generating
Company, L.P. (the "Lessor"), a joint venture of certain wholly-owned
subsidiaries of PG&E Corporation and Bechtel Generating Company, Inc.  On
October 20, 1998, Bechtel Generating Company, Inc. transferred its interest in
the Lessor to a wholly-owned subsidiary of Cogentrix Energy, Inc.  The lease
provides for an initial term of 22 years with a renewal option for up to 3
years. Pursuant to the lease, the Lessor assigned to Buzzard all principal
project agreements and its rights and obligations thereunder including, but not
limited to the power purchase agreement, operations and maintenance agreement,
limestone agreements, ground lease agreements, fuel agreements and
transportation and materials handling agreements.  EPC has pledged Buzzard's
common stock to the Lessor as security for Buzzard's performance of its
obligations as lessee.  The Scrubgrass Project is managed by U.S. Generating
Company ("U.S. Gen"), a wholly-owned indirect subsidiary of U.S. Generating
Company, LLC ("USGenLLC"), which in turn is a wholly-owned indirect subsidiary
of PG&E Corporation.

     Electric output is being sold to Pennsylvania Electric Company ("PENELEC")
pursuant to a 25-year agreement, which commenced in 1993, at fixed rates
initially averaging approximately 4.68 cents/Kwh and escalating at 5% per year
for the calendar years' 1994-1999.  Commencing in the year 2000 and through
2012, the agreement provides for a rate equal to the greater of a scheduled rate
or a rate based on the PJM Billing Rate (the monthly average of the hourly rates
for purchases by the General Public Utilities Group ("GPU") from, or sale by GPU
to, the Pennsylvania-New Jersey-Maryland Interconnection).  For the years 2013
through 2015 and 2016 through 2018, if the lease renewal term option is
exercised, the agreement provides for a rate equal to the lower of the average
monthly PJM Billing Rate or the rate paid for the calendar year 2012 adjusted
annually by the percentage change in the Gross National Product Deflator less
1%. On June 8, 1993, the Facility reached commercial operation.  Since October
1995, the Company has been involved in a legal proceeding with PENELEC whereby,
among other complaints, the Company alleges that PENELEC has failed to pay the
Lessor and Buzzard 

                                       3
<PAGE>
 
contract rates for power in excess of 80 MW produced by the Scrubgrass facility.
The Company is presently involved in discussions with PENELEC to settle this
litigation which, if settled, could significantly improve the Company's results
of operations and financial position. See "Item 3. Legal Proceedings" for a
further discussion of this litigation.

     The Facility is being operated by U.S. Operating Services Company (the
"Operator"), a wholly-owned indirect subsidiary of USGenLLC, pursuant to a 15-
year Operations and Maintenance Agreement (the "O & M"). The Operator prepares a
budget for all operational expenses, including a fixed management fee and
certain targeted output performance levels, which is approved annually.  The
Operator's failure to achieve approved annual budgets can result in operator
liability not to exceed its management fees and/or termination of the O & M.
 
  Buzzard, as assignee, entered into a Limestone Purchase and Sale Agreement
with Quality Aggregates, Inc. to supply the Scrubgrass Project with limestone
for an initial term of five years which, in December 1995, was extended through
the year 2000 and which may be extended up to 15 additional years.  The
Scrubgrass Project also maintains an agreement with an initial term of 15 years
for the transportation of fuel, ash and limestone with Savage Industries, Inc.
The costs established under this agreement will escalate at partially fixed and
partially indexed rates.

  Revenues earned by the Scrubgrass Project are deposited into an account
administered by a disbursement agent.  Before Buzzard can receive cash generated
by the Scrubgrass Project, all operating expenses, base lease payments (which
include the Lessor's debt as described below), certain maintenance reserve
payments (See Note B to the Consolidated Financial Statements) and other
subordinated payments must be satisfied.  Buzzard, as lessee, is required to pay
the Lessor, in addition to a specified base rent, consisting of all of the
Lessor's debt service and related fees and expenses, an additional rent of 50
percent of the net cash flows Buzzard receives from project operations. Buzzard
is not required to fund operating losses, or otherwise invest further, from
sources outside of the Scrubgrass Project.

     On December 22, 1995, the Lessor restructured certain of the Scrubgrass
Project's debt, the primary effect of which was to extend the term of its demand
debt through 2004 and extend a portion of its junior subordinated debt through
1999.  In connection with the Lessor's debt restructuring, Buzzard was able to
refinance a portion of its own current liabilities and establish a capital
improvements fund with a note payable of $300,000 which was paid in January
1996, and a variable note payable of $2,487,813 which matures through 2004.
During the second quarter of 1997, the Lessor assumed primary responsibility for
the disbursement of funds and repayment of debt related to the capital
improvements fund of the Scrubgrass Project.  Accordingly, restricted cash and
secured borrowings of approximately $1,220,000 were transferred from the
financial statements of the Company to the financial statements of the Lessor
which reduced Buzzard's note payable.  Since the Lessor's debt restructuring,
Buzzard has continued to fund the Lessor's debt service obligations as a base
lease payment and its own term obligation resulting from this restructuring
which are described in the following table:

<TABLE>
<CAPTION> 
                                            Balance at        Balance at                                     Matures
Description of the Obligation                12/31/98          12/31/97          Interest Rate               Through
-----------------------------------------------------------------------------------------------------------------------
<S>                                    <C>               <C>               <C>                              <C>
Lessor's term debt obligations:
     Variable rate tax exempt bonds        $135,600,000      $135,600,000    Quoted Bond Rates                 2012
     Variable rate term loan                 16,623,087        18,621,663    Fixed swap rate of 6.4225%        2005
     Variable rate term loan                 10,575,218        10,732,189    LIBOR rate plus 1.250%            2004
     Junior subordinated debt                   318,796           556,630    Fixed rate of 8%                  1999
 
Buzzard's term debt obligation:
     Variable rate term loan                  1,249,268         1,267,811    LIBOR rate plus 1.250%            2004
</TABLE>

  On December 22, 1995, the Lessor entered into interest rate swaps which had
the effect of fixing the interest rate on the variable rate tax exempt bonds
until May 18, 1996 at approximately 3.72% and fixing the 

                                       4
<PAGE>
 
interest rate over the life of its variable rate term loan which matures in 2005
at 6.4225%. After May 18, 1996, the Lessor's tax-exempt bonds incurred interest
at floating rates ranging from 2.95% to 4%. The remainder of the term debt
obligations incur interest at either fixed rates or variable rates which are
based on the London Interbank Offering Rate (LIBOR).
 
  In March 1996, the Company received proceeds of $900,000 from Bechtel Power
Corporation in final settlement of certain warranty and start-up matters which
is included in other income in the accompanying 1996 Consolidated Statement of
Operations.

   During the fourth quarter of 1996, after learning about a generator failure
at an electric generating facility with an identical generator to the Scrubgrass
facility, the manufacturer asked the Company to perform certain tests to
determine the Scrubgrass generator's condition.  Based on the results of these
tests, which became available during the first quarter of 1997, the Company
believed that the Scrubgrass facility's generator exhibited certain conditions
which indicated that a similar failure might occur at some time in the future.
As a result, the Scrubgrass facility was shutdown for a period of six days in
February 1997 to consider matters pertaining to the generator.  In light of the
results of these generator tests, the generator manufacturer recommended that
the Company perform a complete rewind on the Scrubgrass facility's generator
during its 1997 annual plant outage which began in April, and which caused the
Scrubgrass plant to be inoperative for a period of 37 days during the second
quarter of 1997.  Originally, without knowledge of the necessary generator
repair, the Company had planned that the Scrubgrass plant would be inoperative
in 1997 for a total of only 18 days to perform normal maintenance during
scheduled spring and fall outages.   As such, because the Scrubgrass plant was
inoperative for a total of 43 days as a result of the maintenance outages, the
Scrubgrass facility was inoperative for 25 days longer in 1997 than the
Company's original plans.  At an average of $80,000 of net revenues per day,
this accounted for an approximate reduction in 1997 power generation revenues,
net of estimated variable fuel expenses not incurred, of approximately $2
million by comparison to previous expectations.  As a result of the extended
plant outage, the Company incurred $660,000 to have the manufacturer repair the
generator, incurred approximately $700,000 in additional maintenance expenses
which were not originally scheduled during this outage and incurred
approximately $300,000 in related costs such as legal fees, management costs,
bank fees, etc.  As such, the Company believes that the financial impact of this
outage aggregated approximately $3.7 million. During 1997, the Company's
Consolidated Statement of Operations reflects the effect of the lost net
revenues of approximately $2,000,000, the additional maintenance expenses of
approximately $700,000 and the related expenses of approximately $300,000
pertaining to the generator matter. During 1996, the Company had recorded the
present value of the future installments to finance the generator rewind,
discounted at the Scrubgrass Project's incremental borrowing rate (6.75%), which
amounted to $564,000, and was recognizing the $96,000 remaining balance as an
interest cost over the term of the financing agreement.

   The Scrubgrass extended outage also created a significant cash flow
deficiency because of the loss of revenues plus associated costs and expenses.
The Company addressed this cash deficiency by securing debt financing,
negotiating agreements with the generator manufacturer and utilizing available
maintenance cash reserves which are each discussed as follows:

  Term Credit Facility:    In June 1997, the Lessor entered into a three year
  ---------------------                                                      
  credit facility with the lenders of the Scrubgrass Project to provide up to $3
  million to fund general debt service expenses.   The maximum allowable
  borrowings under this credit facility were $3,000,000 through July 1, 1998. On
  July 1, 1998, the maximum allowable borrowings under this credit facility
  began reducing in $600,000 increments every six months through July 3, 2000 at
  which time the credit facility will be payable in full.  As of December 31,
  1998 and 1997, the outstanding borrowings under this credit facility, which
  were advanced to the Company by the Lessor, amounted to $2,150,000 and
  $3,000,000, respectively.

  Agreements with Generator Manufacturer:  Prior to the 1997 outage, the Company
  ---------------------------------------                                       
  negotiated extended financing terms with GEC Alsthom ("GEC"), the manufacturer
  of the Scrubgrass generator, which allowed the Company to pay the $660,000
  cost of the generator repair in six annual installments of $110,000, without
  interest, beginning in May 1997. On April 15, 1998, the Company reached an
  agreement with GEC which modified the terms of its original financing
  contract. Under the terms of the original contract, the Company had yet to pay

                                       5
<PAGE>
 
  five installments of $110,000 and had also agreed to pay an additional $75,000
  bonus to GEC for completing its work ahead of a pre-established schedule.
  Furthermore, the Company had engaged GEC to perform certain maintenance
  procedures to the generator during the 1998 scheduled outage at the Scrubgrass
  plant. Under the terms of the revised agreement with GEC, as payment in full
  for GEC's work performed during the 1998 outage and for the five remaining
  installments of $110,000 and $75,000 bonus owed under the original contract,
  the Company agreed to pay GEC a total of $450,000 over a four year period. The
  revised agreement provides that $50,000 was payable upon the completion of
  their work during the scheduled 1998 plant outage and that $100,000 is payable
  upon each of the first four anniversaries of the first payment thereof. As of
  December 31, 1998, the Company has recorded in its Consolidated Balance Sheet
  the next installment of $100,000 in its accounts payable and accrued expenses
  and the present value of the remaining three installments, discounted at the
  Scrubgrass Project's incremental borrowing rate (6.75%), which amounted to
  approximately $257,000, in its maintenance reserve. The $43,000 balance of the
  $300,000 revised generator rewind cost is being recognized as interest expense
  over the remaining three year term of the financing contract with GEC. As of
  December 31, 1997, the Company had recorded on its Consolidated Balance Sheet
  in accounts payable and accrued expenses for $185,000 and in maintenance
  reserves for $364,000, the present value of the remaining obligations under
  the previous agreement. During 1998, the Company recognized, through a
  reduction of its operating expenses, the reduction of the present value of the
  future installments due to GEC, which amounted to approximately $169,000. The
  Company also recognized interest expense of approximately $27,000 and $20,000
  during 1998 and 1997, respectively under the agreements with GEC.

  Utilization of Maintenance Reserves:  The Company was able to utilize its
  ------------------------------------                                     
  restricted cash reserves to finance most of its additional maintenance
  expenditures incurred during the 1997 outage since substantially all of such
  expenditures were deemed to be major overhauls.  Under the terms of its
  project agreements, the Company will be able to replenish these restricted
  funds over a seven year period beginning in 1998.

  Sunnyside
 
     The Sunnyside Project is an approximately 51 Mw (net) waste coal-fired
facility at a site located adjacent to the Sunnyside Coal Mine in Carbon County,
Utah which was constructed by Parsons Main, Inc., ("PMI").  The facility reached
commercial operation on November 19, 1993.  The Sunnyside Project is owned by
Sunnyside Cogeneration Associates ("SCA"), a joint venture in which the Company
owned varying majority interests from 100% to approximately 70% until September
28, 1994 and thereafter an approximate 40% interest until December 31, 1994 at
which time the Company sold its remaining interest in SCA to B&W Sunnyside, Inc.
and NRG Sunnyside, Inc. (collectively, "the Purchasers").

     In connection with the sale, the Company received total consideration of
$6,042,294 which included cash of $2,792,294 received on January 5, 1995 and
promissory notes aggregating $3,250,000, bearing interest at 10% per annum,
received on December 31, 1994.  In addition, after audits were performed to
verify certain financial information for SCA, the Purchasers were required to
pay a purchase price closing adjustment of $1,061,107 in 1995.  Under the terms
of the promissory notes, interest is payable quarterly to the Company and
aggregate principal payments of $312,500, $1,187,500 and $1,750,000 were due on
September 30, 1995,  December 31, 1996 and December 31, 1997, respectively.  To
date, the Purchasers have made principal payments aggregating $312,500 and
quarterly interest payments through March 31, 1996 pursuant to the promissory
notes.  The Purchasers have also made aggregate payments of $708,000 toward the
purchase price closing adjustment.  However, as more fully described in "Item 3.
Legal Proceedings", the Purchasers commenced a legal proceeding with the Company
on May 3, 1996.  Pending the resolution of the legal proceeding, the Purchasers
have withheld all payments of principal and interest due on the promissory notes
since June 1996. The Purchasers are also disputing the balance of the purchase
price closing adjustment in the legal proceeding.  As of December 31, 1998, in
addition to the balance of the purchase price closing adjustment, the purchasers
have principal and interest payments in arrears under the promissory notes of
$2,937,500 and $808,818, respectively (collectively the "Purchasers'
Obligations"). The Company also retained certain inchoate rights, including
potential refundable sales taxes and certain legal settlements arising out of
activities prior to the date of the sale. The retained rights were fully
satisfied after the Company received sales tax refunds aggregating $1.1 million
and $42,078 in 1995 and 

                                       6
<PAGE>
 
1996, respectively, and a litigation settlement of $540,000 during 1996. The
sales tax refunds aggregating $42,078 and litigation settlement of $540,000 are
included in other income in the accompanying 1996 Consolidated Statement of
Operations.

     As discussed further in "Item 3. Legal Proceedings", the litigation with
the Purchasers includes claims for alleged breaches by the Company of the
agreement to sell its interest in SCA to the Purchasers.  The alleged breaches
of contract are numerous and the litigation continues in discovery where it has
been for almost three years.  In November 1998, the Company presented to the
Seventh District Court for Carbon County, State of Utah (the "Court") a motion
for Partial Summary Judgment concerning one of the numerous claims by the
Purchasers. To date, the Court has not ruled on this matter. If successful in
this motion and considering the possibility of further similar motions, the
Company hopes over time to eliminate or limit the matters that might be
presented in a jury trial or discourage the Purchasers from continuing the
litigation if the anticipated costs exceed the benefits from litigating the
remaining matters.  After this initial Court appearance, the Company continues
to feel optimistic about the strength of its position in the litigation.
However, the Company perceives that the Purchasers are unlikely to settle these
matters unless required through Court proceedings, there currently being little
economic incentive for them to do so. Accordingly, in view of the length and
inherent risk of the litigation process and a jury trial, the Company at this
time cannot predict how long it will take to enforce its rights and collect the
Purchasers' Obligations.  The Purchasers' Obligations have been in arrears for
almost three years now and are expected to remain in arrears for the foreseeable
future. Pursuant to Statement of Financial Accounting Standards ("SFAS") No.
114, as amended by SFAS No. 118, the Company is required to recognize impairment
losses on loans whenever changes in circumstances indicate that the carrying
amounts of the loans exceed their fair market values.  In the case of the
Purchasers' Obligations, because there are no quoted market values, the best
indication of fair market value is the present value of the expected future cash
flows from the Purchasers' Obligations.  Given the uncertainty surrounding the
timing of collecting the Purchasers' Obligations, the Company cannot reasonably
estimate a fair market value for such obligations.  As such, the Company opted
to take a conservative position and write-off the Purchasers' Obligations in its
1998 Consolidated Financial Statements.  The write-off was reported as a charge
to other expense for $3,508,498 in the accompanying 1998 Consolidated Statement
of Operations.  The charge represents the aggregate balance before the write-off
for the notes receivable of $2,937,500 and the receivable from sale of affiliate
of $570,998.  Notwithstanding, the Company maintains its entitlement to the
Purchasers' Obligations and continues to vigorously pursue such amounts, as well
as punitive damages for abuse of the litigation process, in the Court. Should
the Company prevail in the litigation in a future period and collect the
Purchasers' Obligations, or a portion thereof, and/or punitive damages, the
Company would report such collections as other income in the period received.
See Note B to the Consolidated Financial Statements for the Company's accounting
policies for reporting income on the Purchasers' Obligations.

Milesburg

  On April 30, 1987, the Company purchased, for an aggregate purchase price of
$5,400,000, all of the outstanding capital stock of Milesburg Energy, Inc.
("MEI"), the company which controlled the development rights to an existing 43
Mw (net) oil-fired facility, which was retired from service in 1984.  In
connection with the stock purchase, the Company paid $100,000 in cash and issued
promissory notes totaling $5,120,000 (the "MEI Notes") and a subsidiary of the
Company assumed pre-acquisition MEI liabilities totaling $180,000.  The MEI
Notes, pre-acquisition liabilities and certain other liabilities incurred
subsequent to the purchase were to become payable only under certain conditions,
the most significant of which related to the closing of construction financing
and commencement of construction for the Milesburg Project.

  In 1987, MEI executed a 30 year power purchase agreement with West Penn Power
Company ("West Penn") for the sale of all of the facility's electrical output
with a fixed capacity rate component and an additional fluctuating rate
component which is derived from West Penn's avoided energy cost.  The power
purchase agreement was approved by the Public Utilities Commission of the State
of Pennsylvania ("PUC"), and was subsequently appealed to the Commonwealth Court
of Pennsylvania by certain industrial intervenors.  During the lengthy appeals
process, which extended beyond certain contract milestone dates in the power
purchase agreement, West Penn requested that its original petition to approve
the power purchase agreement be dismissed by the PUC since the power purchase
agreement had expired by its own terms.  In September 1989, in response to MEI's

                                       7
<PAGE>
 
efforts to preserve its contractual rights, the PUC, by court order, ordered
West Penn to execute a new power purchase agreement with MEI.   The new power
purchase agreement was to include extended contract milestone dates and rates
which would be recalculated due to the later start-up date for this project
necessitated by the delays caused by the appeal.  This order had been appealed
by the same industrial intervenors and West Penn through various courts,
including the United States Supreme Court, and upheld in every case in favor of
MEI.  In August 1995, the PUC issued a tentative order for final contract rates.
The order had been temporarily stayed by mutual agreement of MEI and West Penn
pending discussions pertaining to a buy-out of the power purchase agreement
which began in October 1995.

     Despite ongoing efforts to reach a buy-out arrangement with West Penn, the
Company had continued to invest its financial resources during 1996 and 1997 to
protect its legal and contractual interests and to support its ability to
commence construction in the event that a settlement under mutually agreeable
terms could not be reached with West Penn.  In July 1996, in furtherance of
those objectives, the Company entered into a joint development agreement with
U.S. Gen, a wholly-owned subsidiary of PG&E Enterprises, to increase the
financial and technical resources available to pursue development activities and
continue ongoing discussions with West Penn concerning a buy-out of the power
purchase contract.   During 1996 and 1997, the Company's development efforts for
the Milesburg Project increased considerably and the Company, along with its
development partner, was able to establish a significant value for the Milesburg
Project as a result of successful development efforts.

     On August 26, 1997, following discussions which lasted almost two years,
MEI and West Penn reached a Buy-Out Agreement concerning the Milesburg project.
Pursuant to the Buy-Out Agreement, West Penn purchased Milesburg's rights to the
Electric Energy Purchase Agreement between the parties dated February 25, 1987
for the sum of $15 million plus 8% interest from the date the Buy-Out Agreement
was filed for Pennsylvania Public Utility Commission approval.  Furthermore,
West Penn also assumed ownership of and responsibility for the Milesburg project
facility, which consisted of land along with a decommissioned oil-fired
electric-generating facility erected thereon, for a stated consideration of $1.
On December 5, 1997, the date of the asset disposition, MEI received aggregate
proceeds of $15,328,768 from West Penn as consideration under the Buy-Out
Agreement.  At the date of the asset disposition, before consideration of any
settlements of contingent obligations, the Company had Milesburg project
development costs included in its property, plant and equipment of $9,670,788
and Milesburg project borrowings included in its secured promissory notes and
other borrowings of $5,858,767.  Shortly before the date of the asset
disposition, the Company entered into a settlement agreement pertaining to
certain Milesburg project contingent obligations, including the MEI Notes.  As a
result of the settlement agreement, the Company's Milesburg project development
costs and Milesburg project borrowings were reduced to $6,170,788 and
$2,358,767, respectively.  In addition, because certain other Milesburg
obligations were payable only upon the occurrence of events related to project
development, Milesburg project obligations of $558,767 and accrued interest of
$63,650 were released from liabilities during 1997 and reported as other income
of $622,417 in the accompanying Consolidated Statement of Operations.  As a
result of the sale of the Milesburg Project, the Company realized net proceeds
before taxes of $10,960,120 which were derived as follows:

<TABLE>
<S>                                                                               <C>
Proceeds from the disposal of Milesburg project assets                                        $15,000,001
Project costs:
     Development costs                                                                          6,170,788
     Fee paid to development partner                                                            1,405,746
                                                                                  -----------------------              
                     Total project costs                                                        7,576,534
                                                                                  -----------------------
                     Gain on sale of project                                                  $ 7,423,467
Adjustments to arrive at net proceeds before taxes from the disposal
    of Milesburg project assets:
          Development cost reimbursements to the Company for
                obligations which had already been paid                                         2,585,469
          Development costs released from liabilities                                             622,417
          Interest income from West Penn                                                          328,767
                                                                                  -----------------------
Net proceeds before taxes from the disposal of Milesburg project assets                       $10,960,120
                                                                                  =======================
</TABLE>

                                       8
<PAGE>
 
     The Company estimated that, after giving effect to the payment of corporate
taxes related to the Milesburg transaction which are accrued as of December 31,
1997, the Company would have available in excess of $10 million from the
Milesburg proceeds. In light of this projected availability of cash, the
Company's Board of Directors on December 10, 1997 declared a special dividend on
the issued and outstanding shares of Company`s Common Stock in the amount of 87
cents per share payable on January 7, 1998 to Stockholders of record on December
30, 1997 out of the proceeds received from the Company's sale of its Milesburg
project assets.

     On December 31, 1997, because MEI did not expect to carry on further
business activities after the sale of the Milesburg Project, EPC adopted a Plan
of Liquidation to dissolve MEI.  Under the Plan of Liquidation, MEI ceased to
carry on business activities except to the extent necessary to liquidate its
assets, pay its liabilities and distribute its assets remaining after the
payment of its liabilities to EPC. During 1998, MEI's assets remaining after the
payment of its liabilities were distributed to EPC.

Energy Markets

  United States

     Historically in the United States, regulated and government-owned utilities
had been the only significant producers of electricity for sale to third
parties. The energy crisis of the 1970's led to the enactment of the Federal
Public Utility Regulatory Policies Act of 1978 ("PURPA"), which encouraged
companies other than utilities to enter the electric energy business by reducing
regulatory constraints.  In addition, PURPA, as implemented by Federal Energy
Regulatory Commission regulations, created unique opportunities for the
development of cogeneration facilities by requiring utilities to purchase
electricity generated in cogeneration plants meeting certain requirements
(referred to as "Qualifying Facilities"). See "Energy Regulation" below.   As a
result of PURPA, a significant market for electricity produced by independent
power producers like the Company developed in the United States. In 1992,
Congress enacted the Energy Policy Act of 1992 ("Energy Act"), which amended the
Public Utility Holding Company Act of 1935 ("PUHCA"), to create new exemptions
from PUHCA for independent power producers selling electric energy on a
wholesale basis, to increase electricity transmission access for independent
power producers and to reduce the burdens of complying with PUHCA's restrictions
on corporate structures for owning or operating generating or transmission
facilities in the United States or abroad. The Energy Act has enhanced the
development of independent power projects and has further accelerated the
changes in the electric utility industry that were initiated by PURPA.  The
implementation of federal and state policies, which have increased the
availability of transmission access for wholesale and retail transactions, could
create additional markets and competition for electric energy sales.

  International

  As a result of increasing demand for power generating capacity around the
world, the fastest growing area of the electric industry is the international
sector.  This increase in demand has led to an increased emphasis by foreign
governments toward privatization of state-owned utilities.  Many energy experts
believe that the international market represents a significant percentage of the
world's new and replacement power needs.  At the same time, the national,
provincial and local laws of each host country, unique political and currency
exchange requirements, and the application of new world-wide environmental
standards to international projects, create significant risks and obligations
which may be difficult to manage.  Presently, the Company is not involved in the
international sector and has no immediate plans to become involved in the
international sector.  However, the Company continues to evaluate any business
opportunities, as they arise, in the international sector.

Competition

     The Company generates electricity using alternative energy sources which is
sold on a wholesale basis under long-term contracts to utilities under rates
established in power purchase agreements and approved by regulatory agencies.
The independent power industry has grown rapidly over the past twenty years.
There are a large number of suppliers in the wholesale market and a surplus of
capacity which has led to intense competition in 

                                       9
<PAGE>
 
this market. The principal sources of competition in this market include
traditional regulated utilities who have excess capacity, unregulated
subsidiaries of regulated utilities, energy brokers and traders, energy service
companies in the development and operation or energy-producing projects and the
marketing of electric energy, equipment suppliers and other non-utility
generators like the Company. Competition in this industry is substantially based
on price with competitors discovering lower cost alternatives for providing
electricity. The electric industry is also characterized by rapid changes in
regulations which the Company expects could continue to increase competition.
For instance, as discussed under the caption "Energy Markets", the electric
industry has been previously affected by legislation such as PURPA and the
Energy Act which have encouraged companies other than utilities to enter the
electric power business by reducing regulatory constraints. More recently, as
discussed under the caption "Energy Regulation", there has been new state
legislation to deregulate the generation component of the electric business.
Furthermore, proposed changes to repeal or modify PUHCA and PURPA could reduce
regulatory restrictions placed on electric utilities and encourage them to seek
new sources of electric power. Any of these regulatory matters, among others,
could increase competition for electric power. Other than the risk that PENELEC
would seek to renegotiate the terms of the Scrubgrass power purchase agreement
(see further discussion under the caption "Energy Regulation"), the Company does
not believe the Scrubgrass Project would be significantly impacted by
competition in the wholesale energy market since its revenues are subject to
contracted rates which are substantially fixed for several years. However, the
contracted rates in the later years of the Scrubgrass power purchase agreement
switch to rates which vary more closely with existing market conditions. Should
ensuing competition in the later years of the Scrubgrass power purchase
agreement create downward pressure on wholesale energy rates, the Company's
profitability could be impacted.

     The Company also competes in the market to develop power generation
facilities.  The primary bases of competition in this market are the quality of
development plans, the ability of the developer to finance and complete the
project and the price.  In certain cases, competitive bidding for a development
opportunity is required.  Competition for attractive development opportunities
is expected to be intense as there are a number of competitors in the industry
interested in the limited number of such opportunities.  Many of the companies
competing in this market have substantially greater resources than the Company.
The Company believes its project development experience and its experience in
creating strategic alignments with other development firms with greater
financial and technical resources could enable it to continue to compete
effectively in the development market if and when opportunities arise.
Presently, the Company believes there are limited opportunities for additional
project development in the United States for projects similar to those
previously developed by the Company.  However, the Company is currently
evaluating whether it should seek development opportunities in new areas.

     Presently, there is significant merger and consolidation activity occurring
in the electric industry.  From time to time, the Company considers merger and
acquisition proposals when they appear to present an opportunity to enhance
shareholder value.

Energy Regulation
 
     The Company's projects are subject to regulation under federal and state
energy laws and regulations.  The Company's facilities are either self-certified
as a Qualifying Facility under the PURPA, or formally certified as a Qualifying
Facility by the Federal Energy Regulatory Commission ("FERC").  Pursuant to
PURPA, FERC has promulgated regulations which exempt certain Qualifying
Facilities from the Federal Power Act of 1920, PUHCA, and, except under certain
limited circumstances, state laws regulating the rates charged by electric
utilities.  In order to qualify under PURPA, the Company's facilities must meet
certain size, fuel and ownership requirements and/or co-generate.  In addition
to the regulation of Qualifying Facilities, PURPA requires that electric
utilities purchase electric energy produced by qualifying facilities at
negotiated rates or at a price equal to the incremental or avoided cost that
would have been incurred by the utility if it were to generate the power itself
or purchase it from another source.  The Company is not presently subject to
regulation under PUHCA and does not presently intend to engage in any activities
that would cause it to be so regulated.

     The Company believes that changes in PURPA, PUHCA and other related federal
statutes could occur in the next several years.  The nature and impact of such
changes on the Company's projects is unknown at this time. 

                                       10
<PAGE>
 
Presently, there are several legislative proposals pending in Congress which
propose amendments to certain regulations promulgated by PURPA. If Congress
amends PURPA, the statutory requirement that electric utilities purchase
electricity from Qualifying Facilities at full avoided cost could be repealed or
modified. While current legislative proposals specify the honoring of existing
contracts, the repeal or modification of these statutory purchase requirements
under PURPA in the future could increase pressure for electric utilities to
renegotiate existing contracts. Should there be changes in statutory purchase
requirements under PURPA, and should these changes result in amendments which
reduce the contracted rates under the Scrubgrass power purchase agreement, the
Company's results of operations and financial position could be negatively
impacted.

     State public utility commissions, pursuant to state legislative authority,
may have jurisdiction over how any new federal initiatives are implemented in
each state.  Although the FERC generally has exclusive jurisdiction over the
rates charged by an independent power project to its wholesale customers, state
public utility commissions have the practical ability to influence the
establishment of such rates by asserting jurisdiction over the purchasing
utility's ability to pass through the resulting cost of purchased power to its
retail customers. In addition, although thought to be unlikely, states may
assert jurisdiction over the siting and construction of independent power
projects and, among other things, the issuance of securities and the sale and
transfer of assets. The actual scope of jurisdiction over independent power
projects by state public utility regulatory commissions varies from state to
state.  Presently, through its power purchase agreement with PENELEC, the
Scrubgrass Project is indirectly subject to state legislation in the
Commonwealth of Pennsylvania.

     On December 3, 1996, in response to changes in the electric industry, the
Commonwealth of Pennsylvania passed new legislation known as the Electricity
Generation Customer Choice and Competition Act (Customer Choice Act) which
became effective on January 1, 1997.  The Customer Choice Act provides for the
deregulation of the generation portion of electric business by permitting all
Pennsylvania retail electric customers to choose their electric generation
supplier over a phase-in period which expires December 31, 2000.  The Customer
Choice Act required that all electric utilities file restructuring plans with
the PUC which, among other things, included unbundled prices for electric
generation, transmission and distribution and a competitive transition charge
("CTC") for the recovery of "stranded costs" which would be paid by all
customers receiving distribution service and certain customers that increase
their own generation of electricity. "Stranded costs" generally are electric
generation-related costs that traditionally would be recoverable in a regulated
environment but may not be recoverable in a competitive electric generation
market.  As such, PENELEC filed a proposed restructuring plan in 1997 with the
PUC which was heavily contested by a number of affected parties.  Eventually,
the litigation resulted in a settlement which was approved by the PUC on October
20, 1998, and which satisfied all but one of the litigants.  This settlement set
forth a comprehensive plan for restructuring PENELEC's service and for ensuring
there would be competition for electric generation for all of PENELEC's
customers beginning on January 1, 1999.  The settlement is currently being
appealed in the Commonwealth Court of Pennsylvania by the party which opposed
such settlement.  However, the Company presently does not anticipate that such
appeal will have a significant effect, if any, on PENELEC's restructuring plan
as far as that plan affects the Scrubgrass Project.  Most pertinently, the
restructuring plan, as approved by the PUC, provided for PENELEC to maintain a
separate non-utility generator cost recovery mechanism for accounting purposes.
Therefore, the restructuring plan is designed, in pertinent part, to enable
PENELEC to recover all of its costs from non-utility generators such as the
Scrubgrass plant and should serve to decrease the pressure on PENELEC to
renegotiate existing power contracts with non-utility generators.

     Presently, neither the Customer Choice Act (and PENELEC's restructuring
plan filed thereunder), nor proposed legislation directly impacts the Company,
since the legislation and restructuring plan pertain to the retail market or new
contracts in the wholesale market.  However, as discussed above, the Company
could possibly be impacted in the future by, among other things, increases in
competition as a result of deregulation, or the chance that PENELEC would
attempt to renegotiate the existing power contract.  The Company is actively
monitoring these developments in energy proceedings in order to evaluate the
impact on its projects and also to evaluate new business opportunities created
by the restructuring of the electric industry.

                                       11
<PAGE>
 
Environmental Regulation

     The Company's projects are subject to regulation under federal, state and
local environmental and mining laws and regulations and must also comply with
the applicable federal, state and local laws pertaining to the protection of the
environment, primarily in the areas of water and air pollution.  These laws and
regulations in many cases require a lengthy and complex process of obtaining and
maintaining licenses, permits and approvals from federal, state and local
agencies.   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 applicable requirements could result in
delays in proceeding with any projects under development or require
modifications to operating facilities.  During periods of non-compliance, the
Company's operating facilities may be forced to shutdown until the non-
compliances are corrected.  The Company is responsible for ensuring compliance
of its facilities with all applicable requirements and, accordingly, attempts to
minimize these risks by dealing with reputable contractors and using appropriate
technology to measure compliance with the applicable standards.
 
Employees

     As of December 31, 1998, and at the time of making this filing, the Company
had four full-time employees and one part-time employee, including three
executive officers.  The loss of any of its executive officers could have a
material adverse effect on the Company.  None of the Company's employees is
represented by a collective bargaining agreement.  The Company considers
relations with its employees to be good.

Item 2.  PROPERTIES

     The Company, through a subsidiary, leases the Scrubgrass waste coal-fired
electric generating facility located on approximately 600 acres in Venango
County, Pennsylvania. Until February 16, 1999, the Company, owned through a
subsidiary approximately 80 acres in Fayette County, Pennsylvania for which it
had abandoned efforts to develop electric generating facilities utilizing
coal mine-fire technology. The land was sold pursuant to a written contract
executed on December 31, 1998.  Until December 5, 1997, the Company owned
through a subsidiary, the decommissioned Milesburg oil-fired electric generating
facility located on approximately 10 acres in Centre County, Pennsylvania.  The
Milesburg facility was sold to West Penn pursuant to a Buy-Out Agreement dated
August 26, 1997. (See "Item 1. Business" for a further discussion of the
Company's projects).

     Since February 1996, the Company has been a tenant pursuant to a three-year
lease at its corporate headquarters in Portsmouth, New Hampshire.  The lease,
which was renewed in January 1999 for three additional years, currently requires
monthly payments of $1,520.

Item 3.  LEGAL PROCEEDINGS

     On October 11, 1995, Scrubgrass Generating Company L.P. and Buzzard Power
Corporation (collectively the "Plaintiffs") filed a complaint against
Pennsylvania Electric Company ("PENELEC") in the Court of Common Pleas of
Venango County, Pennsylvania (the "Court") seeking damages for certain alleged
breaches of the power purchase agreement entered into between Scrubgrass Power
Corporation, a predecessor to the Plaintiffs, and PENELEC on August 7, 1987.  In
its complaint, the Plaintiffs allege that PENELEC has failed to pay contract
rates for energy produced by the Scrubgrass facility in excess of 80 MW in any
hour, that PENELEC has misused certain automatic regulation equipment and that
PENELEC has caused the Plaintiffs to incur losses from its late payment for
energy purchased from the Scrubgrass facility. As a result of PENELEC's alleged
failure to pay contract rates for energy produced by the Scrubgrass facility in
excess of 80 MW in any hour, the Plaintiffs estimate that as of December 31,
1998, after giving effect to certain payments made by PENELEC which are
discussed below, they have incurred damages of approximately $3 million. Should
the Plaintiffs prevail in this litigation and be awarded all of these damages,
the Company, as Lessee, would expect to retain 50% of these damages because of
its requirement to pay 50% of any net proceeds retained by the Scrubgrass
Project to the Lessor as additional rent. The Plaintiffs have yet to quantify
their damages from PENELEC's alleged late payments for energy purchased from the
Scrubgrass facility but do not expect that these damages would be material
relative to the other allegations. The Plaintiffs are unable to quantify the
damages they have incurred from PENELEC's 

                                       12
<PAGE>
 
alleged misuse of certain automatic regulation equipment. From October 1995 to
September 1996, this legal proceeding was stayed informally by a letter
agreement between the parties. Pursuant to the letter agreement, PENELEC, which
had previously not made any payments for the energy it received in excess of 80
MW in any hour, agreed to pay for all energy in excess of 80 MW in any hour,
both previously received and to be received in the future, at a rate equal to
90% of a market based rate, subject to reimbursement based on the ultimate
determination of PENELEC's responsibility to pay for such energy and the
applicable rate therefor. Through December 31, 1998, the Scrubgrass Project has
recognized cumulative power generation revenues of approximately $1,678,247
million for energy in excess of 80 MW in any hour based on the terms established
in the letter agreement. On September 27, 1996, the Plaintiffs provided written
notice of their intention to resume the litigation. Consequently, on October 24,
1996, PENELEC filed preliminary objections to the complaint to the Court which
principally suggested that the primary jurisdiction for this dispute lies with
the Pennsylvania Public Utility Commission ("PUC"). On November 12, 1996, the
Plaintiffs filed a response to PENELEC's preliminary objections. The Court heard
oral arguments on this matter on January 31, 1997 for which the Court ultimately
decided in favor of the Plaintiffs on September 9, 1997 by denying PENELEC's
motion to transfer the jurisdiction of this dispute to the PUC. On January 8,
1998, as a result of this ruling by the Court, PENELEC filed its response to the
allegations made in the Plaintiffs' complaint. On February 4, 1998, the
Plaintiffs filed a Motion for Partial Judgment on the Pleadings which was heard
by the Court on March 30, 1998. On June 8, 1998, the Venango County Court of
Common Pleas ruled in favor of the Plaintiffs that, under the terms and
conditions of the Scrubgrass power purchase agreement, "PENELEC is required to
purchase all energy produced in good faith, so long as the quantity is not
unreasonably disproportionate to estimate of 80 MW". Presently, pending the
ultimate determination of its responsibility under the power purchase agreement,
PENELEC continues to pay for energy in excess of 80 MW at a rate equal to 90% of
a market based rate. The Plaintiffs had been in discussions with PENELEC
concerning a proposal made by PENELEC to settle the litigation. However, because
the Plaintiffs and PENELEC could not come to a mutual agreement on all of the
terms of the proposal, PENELEC withdrew its proposal offer in July 1998 and
settlement discussions dissipated. On July 7, 1998, PENELEC filed an appeal to
the Court's order dated June 8, 1998 with the Superior Court of Pennsylvania. On
July 27, 1998, the Plaintiffs filed with the Superior Court of Pennsylvania a
Motion to Quash the Appeal. On September 4, 1998, the Superior Court of
Pennsylvania granted the Plaintiff's Motion to Quash the Appeal. Since the
decision of the Superior Court of Pennsylvania, PENELEC has indicated its desire
to resume settlement discussions. On November 12, 1998, the Plaintiffs and
PENELEC met to discuss possible settlement scenarios. At the time of the
meeting, the parties were in essential agreement on the amount currently due
assuming the correctness of the Court's Order of June 8, 1998. The primary
matter discussed at the meeting was the manner of calculating future payments
for power in excess of 80 MW. At the meeting, PENELEC made a proposal which was
taken into consideration by the Plaintiffs. On December 21, 1998, the Plaintiffs
counterproposed with an alternative to the PENELEC proposal. To date, the
Plaintiffs have not received a response from PENELEC regarding their
counterproposal. The Company is unable to predict whether a settlement will
ultimately be reached. However, because PENELEC's November 12, 1998 calculation
of the amount due to the Plaintiffs pursuant to the court's ruling was similar
to the Plaintiffs' calculation, it is currently believed that the prospect of a
final settlement of all outstanding issues is good. In the event such a
settlement is not reached, the litigation will resume, and a final adjudication
of the of the amount due from PENELEC to the Plaintiffs will be sought.

     On May 3, 1996, B&W Sunnyside L.P., Babcock & Wilcox Investment Company,
NRG Sunnyside Inc., NRG Energy Inc., and Sunnyside Cogeneration Associates
(collectively the "Plaintiffs") filed a complaint, which was amended on June 27,
1996 and December 21, 1998, against EPC and three of its wholly-owned
subsidiaries (collectively hereafter in this Item 3 "the Company") in Seventh
District Court for Carbon County, State of Utah (the "Court").  The second
amended complaint alleges that the Company breached the purchase and sale
agreement by which the Company transferred all of its interest in Sunnyside
Cogeneration Associates ("SCA"), a joint venture which owned and operated a
nominal 51 megawatt waste coal fired facility located in Carbon County, Utah.
The second amended complaint also alleges that the Company made certain
misrepresentations in connection with the purchase and sale agreement.  As a
result of the alleged breaches of contract and misrepresentations, the
Plaintiffs allege that they suffered damages in an unspecified amount that
exceed the aggregate outstanding principal and interest balances due to the
Company by B&W Sunnyside L.P. and NRG Sunnyside, Inc. under certain notes
receivable, which amounted to $2,937,500 and $808,818, respectively at December
31, 1998.  In addition to alleging unspecified damages, the Plaintiffs also
request rescission of the purchase and sale agreement.  On January 21, 1999, in
response to the Plaintiffs' second amended complaint, the Company filed an
answer and restatement of its earlier counterclaim dated July 26, 1996.  In the
answer to the second amended complaint, the Company denied all material
allegations of the second amended complaint and asserted 

                                       13
<PAGE>
 
numerous affirmative defenses. In the restated counterclaim, the Company alleges
numerous causes of action against the Plaintiffs which include breach of
contract, breach of the promissory notes, intentional, malicious and willful
breach of contract, intentional tort, interference and misrepresentation.
Through the restated counterclaim, the Company seeks remedies which include: (1)
compensatory, consequential and punitive damages; (2) acceleration and immediate
payment in full of the promissory notes; and (3) injunctions which require the
Plaintiffs to continue making payments under the promissory notes during the
pendency of this action and until the promissory notes are paid in full and
which enjoin the Plaintiffs from continuing certain malicious and intentional
actions that are alleged in the counterclaim, together with interest, reasonable
attorney's fees, costs and other such relief as the court deems proper. On
February 12, 1999, the Plaintiffs responded to the restated counterclaim whereby
they denied all material allegations of the restated counterclaim and asserted
numerous affirmative defenses. The Company plans to vigorously defend against
the second amended complaint and vigorously pursue the causes of action in the
restated counterclaim. On April 15, 1998, the Company filed a Motion for Summary
Judgment with Respect to Claims Regarding the Power Purchase Agreement, seeking
dismissal of a portion of the Plaintiffs' claims. On June 5, 1998, the Company
received the Plaintiffs' response to its Motion for Summary Judgment with
Respect to Claims Regarding the Power Purchase Agreement wherein the Plaintiffs
stated their opposition to such motion. The Company and the plaintiffs appeared
in Court on November 19, 1998 to present oral arguments on the Company's Motion
for Summary Judgment with Respect to Claims Regarding the Power Purchase
Agreement. The Court has not yet rendered a decision on such motion. On February
12, 1999, the Plaintiffs moved for leave of the Court to file an amended third
complaint which would omit rescission of the purchase and sale agreement as a
remedy to their second amended complaint. On February 25, 1999, the Company
filed a stipulation with the Court accepting the Plaintiffs motion to file an
amended third complaint. The parties are presently awaiting the Court's grant of
the leave. On February 12, 1999, the Plaintiffs also filed a Motion for Partial
Summary Judgment wherein the Plaintiffs allege that the Company misrepresented
whether SCA had a basis to make legal claims as of December 31, 1994 against
Pacificorp, the utility purchasing energy from the Sunnyside facility.
Presently, the Company is preparing a response to the Plaintiffs' Motion for
Partial Summary Judgment. Discovery remains ongoing.
 
Item 4.  SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS

     None

                                       14
<PAGE>
 
                                    PART II
                                        
Item 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
         SHAREHOLDER MATTERS

Stock Market Trading:

     Until March 12, 1999, the Common Stock of the Company (the "Common Stock")
traded on The Nasdaq Stock Market ("Nasdaq") under the symbol POWR.  As of March
23, 1999 there were approximately 260 record holders and approximately 1,100
beneficial holders of the Company's Common Stock.  The Company had been
designated as a SmallCap issuer on Nasdaq.

     The following table shows the quarterly high and low sales prices during
1997 and 1998 as reported to the Company by Nasdaq:

<TABLE>
<CAPTION>
        Year           Period                          High         Low
        ----           ------                          ----         ---
<S>              <C>                               <C>            <C>
        1997       First Quarter                         1          3/4
                   Second Quarter                       7/8         9/16
                   Third Quarter                       1-1/2       11/16
                   Fourth Quarter                      2-1/4       1-1/16
                                               
        1998       First Quarter                      1-13/16        3/4
                   Second Quarter                      1-7/8        15/16
                   Third Quarter                       1-5/8        11/16
                   Fourth Quarter                      1-1/8         5/8
</TABLE>

     On August 22, 1997, the Securities Exchange Commission approved new listing
standards for companies who are designated as SmallCap issuers on Nasdaq.  These
changes, which became effective on February 23, 1998, strengthened the
quantitative threshold criteria necessary to qualify for initial entry and
continued listing on Nasdaq.  In addition, the corporate governance requirements
previously applicable only to companies designated as National Market issuers on
Nasdaq now extend to SmallCap issuers on Nasdaq.  Prior to February 23, 1998,
SmallCap issuers whose securities traded below a $1 minimum bid price (such as
the Company) could remain listed if they met an alternative test based on the
market value of public float and capital and surplus.   However, this
alternative to the $1 minimum bid price standard was eliminated under the new
listing standards.  As such, SmallCap issuers whose securities trade below a $1
minimum bid price for a period of 30 consecutive trading days are now subject to
delisting from Nasdaq.  However, SmallCap issuers who fail to meet this $1
minimum bid price standard are given a grace period of 90 calendar days in which
to regain compliance by reporting a minimum bid price of $1 for greater than 10
consecutive trading days during this 90 day grace period.

     On October 27, 1998, the Company's stock began consistently trading below a
$1 minimum bid price.  As a result, on December 11, 1998, the Company was
notified by Nasdaq that its stock would be subject to delisting from Nasdaq
unless the Company's stock would resume trading with a minimum bid price of $1
for greater than 10 consecutive trading days during a 90 day grace period which
expired on March 11, 1999.  On March 12, 1999, because the Company's stock
failed to regain compliance during the 90 day grace period, the Company's stock
was delisted from Nasdaq.  After delisting from Nasdaq, the Company's Common
Stock began trading on the NASD OTC Bulletin Board ("OTC-BB") under the symbol
POWR.

                                       15
<PAGE>
 
Dividends:

     The Company has a quarterly dividend program which is subject to review and
consideration by the Board of Directors each quarter.  In respect of this
dividend program, the Company declared dividends in each quarter during 1996,
1997 and 1998 as follows:

<TABLE>
<CAPTION>
                                                                                   Dividends
                                                                 Dividends         Declared
          Year          Period                                   Declared          per Share
          ----          ------                                   ---------         ---------
<S>                 <C>                                     <C>                 <C>
          1996       First Quarter                                $   330,805            $.030
                     Second Quarter                                   332,303             .030
                     Third Quarter                                    332,303             .030
                     Fourth Quarter                                   553,839             .050
                                                             ----------------    -------------
                                                                  $ 1,549,250            $.140
                                                             ================    =============
 
          1997       First Quarter                                $   332,303            $.030
                     Second Quarter                                   332,303             .030
                     Third Quarter                                    335,153             .030
                     Fourth Quarter                                10,266,105             .900
                                                             ----------------    -------------
                                                                  $11,265,864            $.990
                                                             ================    =============
 
          1998       First Quarter                                $   342,203            $.030
                     Second Quarter                                   342,204             .030
                     Third Quarter                                    171,102             .015
                     Fourth Quarter                                   171,102             .015
                                                             ----------------    -------------
                                                                  $ 1,026,611            $.090
                                                             ================    =============
</TABLE>

     Historically, in addition to special dividends which have been declared
from time to time, the Company has declared quarterly dividends of 3 cents per
share during each of the ten quarters through June 30, 1998.  However, during
each of the two quarters through December 31, 1998, the Company reduced its
dividend to 1.5 cents per share to preserve its cash resources to address
certain sudden changes in its financial position and changes to its projected
cash requirements.  These changes are discussed further in "Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources". The Company continues to
investigate business strategies to increase the cash which may become available
from its operations for future dividends.  In addition to its quarterly
dividends, the Company also declared a special dividend of 2 cents per share in
1996 out of operating profits and a special dividend of 87 cents per share in
1997 out of the proceeds from the Milesburg buy-out (See "Item 1. Business--
Milesburg") which resulted in aggregate dividends declared of 14 cents per share
in 1996 and 99 cents per share in 1997.

     The recent reduction in dividend amount reflects the Company's policy of
seeking to distribute the maximum funds available each quarter to shareholders.
The maximum funds available for distribution is determined by the Board each
quarter and represents the amount the Company does not expect it will need for
ongoing operations and any planned projects assuming expected operating results
are achieved. In addition, the Board considers the level of reserves and
determines what is reasonable as a buffer against surprises, variations from
expectations and reasonable contingencies in the upcoming periods. Behind all of
these considerations is the philosophy that the Company should not be holding
reserves that it does not expect are reasonably needed for continuing operations
and contingencies.  The downside of this approach is the risk that dividends
need to be reduced when cash flow is reduced and/or projected expenses and
contingencies are greater than foreseen. Historically, the Company has not
operated using a philosophy of holding reserves for future dividends since such
a philosophy would represent the Company's investment of its shareholder's money
which would be given out later if the Company was not generating sufficient cash
at that time to continue the dividend. The Board's position has been that the
Company's shareholders acquired their shares in the Company for its management
of power generation facilities and that shareholders would be better served
investing for themselves the money that the Company can distribute.

                                       16
<PAGE>
 
     As of December 31, 1997, the Company had dividends payable of $10,266,105
which were declared on December 10, 1997 and paid on January 7, 1998.
Distributions are taxed to shareholders when they are received as ordinary
dividends to the extent that the distributing corporation has earnings and
profits during the tax year in which the dividend is paid.  The portion of the
distribution which is in excess of the distributing corporation's earnings and
profits is treated as a tax-free return of capital and reduces the shareholder's
basis in the stock.  Once the shareholder's basis in the distributing
corporation's stock is reduced to zero, any remaining excess distribution is
treated as a payment for the stock or capital gain if the stock is a capital
asset in the shareholder's hand.  Due to the substantial earnings and profits
incurred during 1997 primarily from the sale of the Milesburg project, the
Company deferred the payment of its dividend declared on December 10, 1997 to
1998 so that the dividend would receive a more favorable tax treatment.  By
deferring the payment of the dividend declared on December 10, 1997 to 1998,
distributions of $11,166,752 paid in 1998 were characterized as a return of
capital.

     Under the laws of its state of incorporation, EPC may pay dividends out of
its surplus, as defined by statute, on an unconsolidated basis.  As of December
31, 1998, although the Company's consolidated capital position reflected a
deficit of $6,558,923, EPC maintained a surplus on an unconsolidated basis.  As
discussed under the caption "Item 1. Business -- Scrubgrass", after satisfying
certain reserves required by Scrubgrass Project agreements, Buzzard retains 50
percent of the net cash flows from the operations of the Scrubgrass Project and
is not required to reinvest such proceeds to finance operating losses of the
project.  To date, Buzzard has retained cumulative cash distributions of
$5,671,087 from the Scrubgrass Project which have all been distributed as
dividends to EPC.  Furthermore, as discussed under the caption "Item 1. Business
Milesburg", the Company sold the Milesburg project at a substantial gain and
adopted a Plan of Liquidation of MEI which resulted in significant liquidating
distributions to EPC.  As a result of the dividend income received from Buzzard
and the liquidating distributions received from MEI, EPC's surplus determined on
an unconsolidated basis has been sufficient to support the dividends declared
and paid to date.  The payment of any future dividends will depend on the Board
of Directors' evaluation, made on a quarterly basis, based on the Company's then
current and projected operating performance and capital requirements.  See "Item
7 - Management's Discussion and Analysis of Financial Condition and Results of
Operations".

                                       17
<PAGE>
 
Item 6.  SELECTED FINANCIAL DATA

     The following selected financial data for the five years ended December 31,
1998 is derived from the audited Consolidated Financial Statements of the
Company.  The data should be read in conjunction with the Consolidated Financial
Statements and other financial information included elsewhere herein.
<TABLE> 
<CAPTION> 
                                                                                Year Ended December 31
                                                          -------------------------------------------------------------------
                                                             1998          1997         1996          1995           1994
                                                          ----------    ----------   ----------    -----------   ------------
                                                                           (000's omitted except per share data)
<S>                                                       <C>           <C>          <C>           <C>          <C> 
Results of Operations Data:                                              
                                                                         
Power generation revenues                                 $  45,721     $  43,763    $  47,854     $   40,693    $    30,705
                                                          ----------    ----------   ----------    -----------   ------------
                                                                                                                  
Costs and expenses:                                                                                               
     Operating expenses                                      19,215        17,756       18,190         16,975         16,123
     Lease expenses                                          22,971        24,488       24,793         23,020         10,538
     General and administrative expenses                      2,197         1,995        3,062          3,668          2,998
     Reversal of provision for nonrecovery of                                                                     
           project development costs                                         (940)       -----          -----          -----
     Depreciation and amortization                              285           258          205            167          3,018
                                                          ----------    ----------   ----------    -----------   ------------
                                                             44,668        43,557       46,250         43,830         32,677
                                                          ----------    ----------   ----------    -----------   ------------
                                                                                                                  
Operating income (loss)                                       1,053           206        1,604         (3,137)        (1,972)
                                                                                                                  
Other income (expense):                                                                                           
     Other income                                                 8           622          484          1,285          5,311
     Interest income                                            156           581          499            468            695
     Interest expense                                          (461)         (424)        (336)          (107)        (8,830)
     Amortization of deferred gain                              308           308          308            308            154
     Warranty income                                          -----         -----          900          -----          -----
     Write-off of receivables in litigation                  (3,508)        -----        -----          -----          -----
     Gain on sale of affiliate/project                        -----         7,424        -----          -----          3,946
     Minority interest                                        -----         -----        -----          -----          1,866
     Equity in net loss of affiliate                          -----         -----        -----          -----            (84)
                                                           ---------     ---------    ---------     ----------    -----------
                                                             (3,497)        8,511        1,855          1,954          3,058
                                                          ----------    ----------   ----------    -----------   ------------
                                                                                                                  
Income (loss) before income taxes                            (2,444)        8,717        3,459         (1,183)         1,086
                                                                                                                  
Income tax (expense) benefit                                    795        (4,103)      (1,894)           448           (416)
                                                          ----------    ----------   ----------    -----------   ------------
                                                                                                                  
Net income (loss)                                         $  (1,649)    $   4,614    $   1,565     $     (735)   $       670
                                                          ==========    ==========   ==========    ===========   ============
                                                                                                                  
Basic and diluted earnings (loss) per common share        $   (0.14)    $    0.41    $    0.14     $    (0.07)   $      0.06
Dividends paid or payable per common share                $    0.09     $    0.99    $    0.14     $     0.08    $     -----
Weighted average number of shares outstanding                11,424        11,260       11,286         11,197         11,321
                                                                                                                  
Balance Sheet Data:                                                                                               
                                                                                                                  
Total assets                                              $  55,163     $  61,362    $  52,503     $   45,226    $    35,962
Working capital                                              (1,190)          536        1,406          3,224          1,212
Long-term obligations                                        46,511        40,032       35,331         24,405         11,533
Deferred gain (1)                                             5,397         5,706        6,014          6,322          6,631
Deferred revenue (1)                                          -----         -----        -----          3,065          2,826
Shareholders' (deficit) equity                               (6,559)       (3,878)       2,680          2,797          4,443
</TABLE> 
___________
(1)   See Notes A and B of Notes to Consolidated Financial Statements.






                                       18
<PAGE>
 
Item 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
       OF OPERATIONS

Overview of the Company

     The Company owns a 22 year leasehold interest in an approximately 83 Mw
(net) waste coal-fired electric generating facility (the "Scrubgrass Project")
located in Pennsylvania, the lease for which commenced on June 30, 1994.  In
recent years, the Company also held varying ownership interests (100% to 40%) in
an approximately 51 Mw (net) waste coal-fired electric generating facility (the
"Sunnyside Project") located in Utah and owned the development rights to an
existing 43 Mw (net) coal-fired electric generating facility (the "Milesburg
Project") located in Pennsylvania which was retired from service in 1984.  The
Company sold its remaining interest in the Sunnyside Project on December 31,
1994 and is presently involved in a litigation with the Purchasers to collect
the balance of the Purchaser's obligations for the sale.  The Company sold its
development rights for the Milesburg Project on August 26, 1997 to the utility
which had contracted to purchase electricity from such project pursuant to an
agreement which was finalized on December 5, 1997.  The Company's projects are
discussed further in "Item 1. Business".  The following Management's Discussion
and Analysis of Financial Condition and Results of Operations compares the
Company's results of operations for the years ending December 31, 1998, 1997 and
1996 and should be read in conjunction with the Consolidated Financial
Statements and notes thereto, and the comparative summary of selected financial
data appearing elsewhere in this report.  Historical results and trends which
might appear should not be taken as indicative of future operations.

Cautionary Statement

     This Annual Report on Form 10-K contains "forward-looking statements", as
defined by the Private Securities Litigation Reform Act of 1995, in order to
provide investors with prospective information about the Company.  For this
purpose, any statements which are not statements of historical fact may be
deemed to be forward-looking statements.  Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects" and similar expressions are
intended to identify forward-looking statements.  There are a number of
important factors which could cause the Company's actual results and events to
differ materially from those indicated by the forward looking statements.  These
factors include, without limitation, those set forth below under the caption
"Certain Factors That May Affect Future Results".

Results of Operations

 Year ended December 31, 1998 ("1998") compared with the year ended December 31,
1997 ("1997")

     Net loss in 1998 amounted to $1,649,186  or 14 cents per share as compared
to net income of $4,613,863 or 41 cents per share in 1997.  The overall decrease
in net results during 1998 is primarily attributable to a write-off of certain
receivables in litigation, the absence in 1998 of the gain and other income
related to the sale of the Milesburg Project, the absence in 1998 of the
reversal of the provision for non-recovery of Milesburg project development
costs, an increase in operating expenses and a decrease in interest income.
The Company's overall decrease in net results during 1998 was offset in part by
an increase in power generation revenues and a decrease in lease expenses.  The
reasons for the decrease in the Company's 1998 net results are discussed in more
detail in the following paragraphs.

     Power generation revenues in 1998 amounted to $45,721,473 as compared to
$43,763,223 in 1997 and all pertained to the Scrubgrass Project. The overall
increase in power generation revenues during 1998 is primarily attributable to a
5% increase in certain rates billed to the utility under the terms of the power
purchase agreement and an increase in the capacity rate billed during 1998.
During 1998, the Scrubgrass Project operated at 87.9% of its capacity as
compared to 85.6% for the same period in 1997. The following factors contributed
principally to the differences in the Scrubgrass Project's capacity factors
billed for 1998 and 1997.  First, the Scrubgrass project had its annual
maintenance outages during the second quarters in 1998 and 1997. During the 1998
outage, the Scrubgrass plant was inoperative for approximately 14 days to
perform scheduled maintenance procedures whereas the 1997 maintenance outage was
extended 

                                       19
<PAGE>
 
from 12 days to approximately 37 days to perform more extensive repairs to the
Scrubgrass generator. Second, the Scrubgrass plant was inoperative for
approximately six days during the first quarter of 1997 to consider matters
related to the generator. Third, the Scrubgrass project incurred numerous
unscheduled shutdowns during 1998 to respond to equipment malfunctions which
necessitated that the Scrubgrass plant be inoperative for an aggregate of
approximately 11 days during the second quarter, seven days during the third
quarter and five days during the fourth quarter outside of the scheduled outage
timeframe. As such, other than normal curtailments of output from the utility
which occurred from time to time, the Scrubgrass plant did not operate for an
aggregate of approximately 37 days and 43 days as a result of scheduled and
unscheduled shutdowns during 1998 and 1997, respectively. The aforementioned
increase in 1998 power generation revenues was offset in part by a decrease in
the revenue recorded as a result of the straight-line accounting treatment of
certain revenues under the power purchase agreement which amounted to
$8,024,111 and $8,905,911 in 1998 and 1997, respectively.

     Operating expenses in 1998 amounted to $19,215,459 as compared to
$17,755,882 in 1997 and all pertain to the Scrubgrass Project. The overall
increase during 1998 is primarily attributable to the following reasons.  First,
the Company incurred higher fuel costs and higher operator fees in 1998 as a
result of cost escalations in certain operating and supply agreements.  Second,
the Company incurred higher fuel expenses because the Scrubgrass plant achieved
a higher capacity rate during 1998 and realized lower average heat rates from
fuel consumption in 1998 by comparison to 1997.  Third, because the Scrubgrass
plant achieved a higher capacity rate during 1998, the Company accrued higher
year-end operator bonuses during 1998 than were recorded in 1997.  Fourth,
although maintenance expenses incurred during the 1997 extended outage were
higher than the Company's original expectations, the Company incurred higher
maintenance expenses in 1998 to make the necessary repairs related to the 1998
equipment malfunctions and to accelerate its reserves for future maintenance
which the Company now expects will be performed earlier than its previous
schedule.  Finally, due to salary increases and increases in the number of
personnel at the Scrubgrass project, the Company incurred higher labor and
related costs in 1998. However, the aforementioned increases in 1998 operating
expenses were offset in part because certain operating expenses were higher
during 1997 by comparison to 1998 primarily for the following reasons. First, as
a result of enhancements made during 1997 to the fuel processing system at the
Scrubgrass Project, the Company realized a savings in certain routine
maintenance expenses during 1998.  Second, the Company entered into
modifications to the financing contract with the manufacturer of the Scrubgrass
generator which reduced certain long-term liabilities and operating expenses
during 1998.  See a further discussion of these modifications under the captions
"Item 1. Business--Scrubgrass" and  "-Liquidity and Capital Resources--Cash Flow
Outlook".

     Lease expenses in 1998 amounted to $22,971,201 as compared to $24,488,005
in 1997 and all pertain to the Scrubgrass Project. The overall decrease in lease
expenses during 1998 is primarily due to the following three reasons. First,
because there was less cash available from the Scrubgrass Project during 1998
(see a further discussion under "--Liquidity and Capital Resources"), the
Company realized a decrease in additional rent paid to the Lessor. Second, the
scheduled principal and interest payments under the Lessor's junior subordinated
debt obligations were lower in 1998 which reduced the Lessor's loan costs that
were passed through to the Company in its facility lease expenses. Third, the
Company had a decrease in the lease expense recorded as a result of the
straight-line accounting treatment of certain lease expenses under the
Scrubgrass lease which amounted to $8,024,111 and $8,905,911 in 1998 and 1997,
respectively. The overall decrease was offset in part by an increase in the
principal payments under the Scrubgrass Project term loan which increased the
Lessor's loan costs that were passed through to the Company in its facility
lease expenses.

  General and administrative expenses in 1998 amounted to $2,196,929 as compared
to $1,995,491 in 1997. The overall increase in general and administrative
expenses during 1998 is primarily attributable to the following four reasons.
First, certain labor and overhead expenses, which were capitalized in 1997 as a
result of development activities for the Milesburg project, were redirected to
operating activities during 1998. Second, the management fees for the Scrubgrass
Project increased primarily because the project manager passed along increases
in its labor costs to the Company. Third, the Company incurred pension expense
for a defined benefit pension plan which was established in 1998.  Fourth, the
Scrubgrass project received a sales tax refund during 1997 which reduced general
and administrative expenses by comparison to 1998. However, the aforementioned
increases in 1998 general and administrative expenses were substantially offset
because certain general and administrative expenses were lower during 1998 by
comparison to 1997 primarily for the following five reasons.  First, two
executive officers, who are also significant shareholders of the Company,
elected to repay their 1998 salaries in an amount equal to the cash benefit they

                                       20
<PAGE>
 
would receive from the Company's 1998 contribution to the defined benefit
pension plan.  Second, the Company incurred significant legal expenses in 1997
to review documents in the discovery phase of the Sunnyside project litigation,
which expenses were incurred to a much lesser extent during 1998.  Third, while
overall management costs were higher in 1998 as discussed above, the Company
incurred significant management fees during 1997 to address the Scrubgrass
generator matter and to consider other contract related matters, which matters
either did not recur or recurred to a lesser extent in 1998.  Fourth, the
Company restructured its insurance programs at its corporate office and at the
Scrubgrass Project in April 1997 which resulted in lower insurance premiums in
1998.  Lastly, the Company reduced the amount of certain professional fees
during 1998 because it used such professional services to a lesser extent during
1998.

     Reversal of provision for nonrecovery of project development costs relates
to the Company's Milesburg project and amounted to $940,144 in 1997. As
discussed under "Item 1. Business--Milesburg", the Company sold the Milesburg
project to West Penn pursuant to a Buy-Out Agreement dated August 26, 1997.  In
light of this Buy-Out Agreement, which established a value significantly in
excess of the Company's recorded carrying value for its investment in the
Milesburg project, the Company removed its reserve for the impairment in value
of this investment during 1997.  The reserve was established in 1990 by a charge
against earnings due to the uncertainties surrounding whether the Company would
realize value from its investment in this project. The reversal of provision for
nonrecovery of project development costs pertains to an event which occurred in
1997 and did not recur in 1998.

     Interest income in 1998 amounted to $156,546 as compared to interest income
of $581,336 in 1997.  The decrease in interest income is primarily attributable
to the absence in 1998 of interest income related to the sale of the Milesburg
Project.  During 1997, pursuant to the terms of the Buy-Out Agreement dated
August 26, 1997, the Company earned 8% interest on the $15 million selling price
from August 27, 1997 until the closing date (December 5, 1997).  The Company's
interest income also decreased in 1998 primarily due to lower investments in
cash and cash equivalents and less interest recognized on the Company's notes
receivable related to the 1994 sale of SCA.
 
     Interest expense in 1998 amounted to $460,812 as compared to interest
expense of $424,395 in 1997. Interest expense increased during 1998 primarily
because of the additional long-term debt obligations for the Scrubgrass Project
which were incurred during the second quarter of 1997.  The additional long-term
debt obligations, which were outstanding for a full year in 1998, consist of a
$3 million term credit facility which is discussed further in the section "--
Liquidity and Capital Resources--Financing Activities" and installment debt
which financed the generator repair that is discussed further in the section "--
Liquidity and Capital Resources--Cash Flow Outlook".   Due to lower average
outstanding borrowings in 1998, the aforementioned increase in interest expense
was offset in part by a decrease in interest incurred on the Lessee Working
Capital Loan.

     Write-off of receivables in litigation amounted to $3,508,498 in 1998 and
represents the aggregate balances as of December 31, 1998 of the notes
receivable of $2,937,500 and the receivable from sale of affiliate of $570,998
related to the 1994 sale of SCA.  This write-off was discussed further in "Item
1. Business--Sunnyside".

     Gain on sale of project amounted to $7,423,467 in 1997 and pertains to a
gain recognized as a result of the Company's sale of the Milesburg project.
This gain, which is discussed further in "Item 1. Business--Milesburg", pertains
to an event which occurred in 1997 and did not recur in 1998.

     Other income amounted to $7,810 in 1998 and consisted primarily of a gain
on the sale of the Company's land in Fayette County, Pennsylvania.  Other income
in 1997 amounted to $622,417 and consisted of revenue recorded as a result of
the release of certain Milesburg obligations which were payable only upon the
occurrence of events related to project development.

          Income tax benefit in 1998 amounted to $794,945, or 32.5% of loss
before income taxes, as compared to income tax expense of $4,103,684, or 47.1%
of income before income taxes, in 1997.  The 1997 effective tax rate was higher
by comparison to the 1998 rate primarily because of the following reasons.
First, the 1997 income tax expense includes the effect of a permanent difference
between the gain for financial reporting purposes and the gain for tax reporting
purposes on the sale of the Milesburg project.  Second, due to a second layer of
state income tax incurred on distributions received by EPC from the Scrubgrass
Project, the Company was not able to realize the full benefit 

                                       21
<PAGE>
 
of its 1998 net loss for tax reporting purposes. A significant portion of the
Company's income tax expense during 1997 resulted in a decrease in the Company's
deferred tax asset rather than in cash outlays. See "Liquidity and Capital
Resources" for a further discussion.
 
Year ended December 31, 1997 ("1997") compared with the year ended December 31,
1996 ("1996")

     Net income in 1997 amounted to $4,613,863  or 41 cents per share as
compared to net income of $1,565,279 or 14 cents per share in 1996.  The overall
increase in net income during 1997 is primarily attributable to the gain on the
sale of the Milesburg project, the reversal of the provision for non-recovery of
Milesburg project development costs, and a reduction in general and
administrative expenses primarily as a result of both the Company's efforts to
reduce its corporate overhead expenses and the capitalization of labor and
overhead expenses related to the Milesburg project. The Company's overall
increase in net income during 1997 was offset in part by an operating loss from
the Scrubgrass project primarily as a result of the generator repair discussed
under "Item 1. Business--Scrubgrass" which reduced the Company's power
generation revenues and affected certain of the Company's expenses.   In
comparing the Company's net income for 1997 to 1996, it is important to point
out that the Company's results of operations during 1996 were beneficially
effected by certain non-recurring revenues which included the recognition of
certain revenues of $3,064,965 which were previously deferred under the
Scrubgrass power purchase agreement, the settlement of a warranty issue related
to the Scrubgrass Project for $900,000 and the settlement of a legal proceeding
for approximately $340,000, net of legal fees.  In light of the Company's
favorable earnings and available cash, the Company declared dividends on its
Common Stock in 1997 of $11,265,865 or 99 cents per share as compared to
dividends in 1996 of $1,549,250 or 14 cents per share.

     Power generation revenues in 1997 amounted to $43,763,223 as compared to
$47,853,639 in 1996 and all pertained to the Scrubgrass Project.  The overall
decrease in power generation revenues during 1997 is largely attributable to the
extended maintenance outage to repair the Scrubgrass generator and a reduction
of power generation revenues recorded as a result of the straight-line
accounting treatment of certain revenues under the power purchase agreement
($8,905,911 in 1997 as compared to $9,294,789 in 1996).  In addition, the 1996
power generation revenues were higher by comparison to 1997 because the Company
recognized certain revenues of $3,064,965 during 1996 which were previously
deferred under the Scrubgrass power purchase agreement.  With reference to the
impact of the extended maintenance outage, the Scrubgrass plant was inoperative
for approximately  6 days during the first quarter of 1997 to consider generator
matters.  During the second quarter of 1997, the Scrubgrass annual outage also
extended approximately 31 days longer than the 6 day outage in May 1996 due
primarily to the generator repair.  At an average of $100,000 of revenues per
day, the 37 additional outage days in 1997 account for an approximate reduction
in power generation revenues for the year ended year ended December 31, 1997 of
$3.7 million by comparison to the same period in 1996.  However, the impact of
the lost revenues from the Scrubgrass outage was mitigated by a 5% increase in
certain rates charged to the utility under the terms of the power purchase
agreement and improvements in the performance of the Scrubgrass plant after the
1997 extended outage.  Specifically, the Scrubgrass plant operated at a 97.5%
average capacity for the six months ended December 31, 1997 versus 90.9% for the
six months ended December 31, 1996.

     Operating expenses in 1997 amounted to $17,755,882 as compared to
$18,190,037 in 1996.   The overall decrease is primarily attributable to lower
fuel costs and operator bonuses because the overall capacity rate in 1997 was
lower by comparison to 1996 as a result of the extended maintenance outage to
repair the generator.   However, the decrease was offset in part by higher
maintenance costs to complete the extended maintenance outage at the Scrubgrass
plant, an increase in contracted rates for certain fuel costs and higher
personnel costs incurred under the O&M.

     Lease expense in 1997 amounted to $24,488,005 as compared to $24,792,248 in
1996.  The overall decrease in lease expense during 1997 is primarily due to a
decrease in the lease expense recorded as a result of the straight-line
accounting treatment of lease expenses ($8,905,911 in 1997 as compared to
$9,294,789 in 1996) and the lowering of average interest rates which occurred in
1997 and which reduced the Lessor's loan costs that were passed through to the
Company in its facility lease expenses.  The decrease was offset in part by an
increase in the principal payments under the Scrubgrass Project term loan which
increased the Lessor's loan costs that were passed through to the Company in its
facility lease expenses.

                                       22
<PAGE>
 
     General and administrative expenses in 1997 amounted to $1,995,491 as
compared to $3,061,931 in 1996. The overall decrease in general and
administrative expenses during 1997 is primarily due to the Company's efforts to
reduce its corporate overhead expenses and the capitalization of labor and
overhead expenses aggregating to $327,583 for development efforts related to the
Milesburg project.  The Company's major steps to reduce its corporate overhead
included a consolidation of its Vermont and New Hampshire offices into one
office in New Hampshire (completed by May 1996), a reduction in its executive
officer compensation, a reduction in its employee headcount by an equivalent of
two full-time employees, and a reduction of its 1997 insurance costs by
restructuring insurance programs.   In addition, the Company has realized
reductions in 1997 management costs for the Scrubgrass project due to additional
experience of the Manager's employees and because the negotiation of certain
contractual matters required less effort in 1997.  The Company continues to
incur substantial management and professional fees to defend its position in
certain legal matters.  Accordingly, the full effect of the Company's efforts to
reduce its corporate overhead expenses still has not yet been shown in its
recent operating results.

     Reversal of provision for nonrecovery of project development costs relates
to the Company's Milesburg project and amounted to $940,144 in 1997. This item
was discussed in more detail in the comparison of 1998 and 1997 results above.

     Other income amounted to $622,417 in 1997 and consisted of revenue recorded
as a result of the release of certain Milesburg obligations which were payable
only upon the occurrence of events related to project development.  Other income
in 1996 consisted primarily of proceeds from a legal settlement of $540,000 and
Sunnyside Project sales tax refunds of approximately $42,000 arising out of
activities prior to the date of sale.  Other income in 1996 was offset in part
by a provision made for the continued decline in value of the Company's
preferred stock investment in Hamilton Technologies, Inc., a privately held
Massachusetts developer of computer aided software engineering (CASE) software.

     Interest income in 1997 amounted to $581,336 as compared to interest income
of $498,975 in 1996.  The increase in interest income is primarily attributable
to interest of $328,767 received from West Penn because the proceeds of $15
million committed pursuant to the Buy-Out Agreement dated August 26, 1997 were
not received until December 5, 1997.   Excluding the aforementioned interest
received from West Penn, the Company's interest income decreased in 1997
primarily due to lower investments in cash and cash equivalents, lower
investments in restricted cash and less interest recognized on the Company's
notes receivable related to the sale of its interest in the Sunnyside Project.
 
     Interest expense in 1997 amounted to $424,395 as compared to interest
expense of $336,449 in 1996.  The increase in 1997 is primarily attributable to
additional long-term debt for the Scrubgrass Project amounting to $3,000,000.

     Gain on sale of project amounted to $7,423,467 in 1997 and pertains to a
gain recognized as a result of the Company's sale of the Milesburg project.  The
sale of the Milesburg project and the calculation of the gain is discussed
further under the caption "Item 1. Business--Milesburg".

     Warranty income in 1996 amounted to $900,000 and resulted from a settlement
with an engineering and construction contractor for the Scrubgrass plant which
was received in March 1996.  There was no warranty income in 1997.

          Income tax expense in 1997 amounted to $4,103,684, or 47.1% of income
before income taxes, as compared to an income tax expense of $1,894,035, or
54.8% of income before income taxes, in 1996. The increase in income tax expense
resulted primarily from higher earnings during 1997.  The 1996 effective tax
rate was higher by comparison to the 1997 rate primarily as a result of the
additional charges to deferred state tax expense and because the taxability of
temporary differences reversing in 1996 occurred in states with higher tax
rates.  The overall decrease in the 1997 effective tax rate was offset in part
by a difference between the gain for financial reporting purposes and the gain
for tax reporting purposes on the sale of the Milesburg project which
contributed to a higher effective tax rate in 1997.  A significant portion of
the Company's income tax expense during 1997 and 1996 resulted in a decrease in
the Company's deferred tax asset rather than in cash outlays.   See "Liquidity
and Capital Resources" for a further discussion.

                                       23
<PAGE>
 
 1999 Outlook

  With a view towards 1999, the Company expects to achieve continuing operating
earnings as a result of profits from Scrubgrass project operations and
management of its corporate general and administrative expenses.   The Company
offers the following prospective information concerning significant components
of its 1999 results of operations which are being compared to historical results
of operations in 1998:

   Power generation revenues - Power generation revenues are expected to
   increase in 1999 as a result of a 5% increase in certain contracted rates
   under the Scrubgrass power purchase agreement and improvements in the
   performance of the Scrubgrass facility.  During 1998, the Scrubgrass facility
   was inoperative for approximately 23 days for unscheduled shutdowns to
   respond to equipment malfunctions.  While the Company expects that the
   Scrubgrass facility will incur equipment malfunctions from time to time, the
   Company does not believe that 1998 results are necessarily indicative of
   results expected for 1999.

   Operating expenses - Operating expenses are expected to increase in 1999 as a
   result of a 4% average increase in certain contracted rates under fuel supply
   agreements, a 5% increase in certain contracted rates under the O&M and
   anticipated increases in personnel costs at the Scrubgrass plant.  In
   addition, because the Company expects improvements in the performance of the
   Scrubgrass facility in 1999, operating expenses are expected to further
   increase as a result of additional fuel consumption and higher operator
   bonuses which are primarily based on Scrubgrass operating profits.  However,
   because the Company is not projecting it will respond to as many equipment
   malfunctions in 1999, the Company would expect to incur lower maintenance
   expenses in 1999.

   Lease expenses - Lease expenses are expected to increase significantly in
   1999 for the following reasons. First, the Company expects that higher
   contracted principal payments on the Lessor's term loans will increase the
   Lessor's loan costs that are expected to be passed through to the Company in
   its facility lease expenses. Second, the Company expects to incur scheduled
   increases in equity rents for the Scrubgrass Project in 1999. Third, due to
   projected increases in cash from Scrubgrass Project operations (See further
   discussion under "Liquidity and Capital Resources--1999 Outlook"), the
   Company expects its additional rent paid to the Lessor, which amounts to 50
   percent of the net cash flows from the Scrubgrass Project, would also
   increase in 1999. However, the Company has experienced improvements in its
   variable interest rates in recent months. Should recent interest rates remain
   consistent during 1999, the Company would expect to incur a decrease in lease
   expense due to reductions in the Lessor's loan costs that would be passed
   through to the Company in its facility lease expenses.

   General and administrative expenses - General and administrative expenses are
   expected to remain fairly consistent during 1999.  The principal
   administrative costs which are subject to considerable variation pertain to
   the Company's two legal proceedings.  Depending on the demands of these legal
   proceedings, the Company can incur significant fluctuations in its
   professional fees and management costs.

   Other expense - In 1998, the Company wrote-off its aggregate balances as of
   December 31, 1998 of the notes receivable of $2,937,500 and the receivable
   from sale of affiliate of $570,998 related to the 1994 sale of SCA. This
   charge against operating results will not recur in 1999.  See "Item 1.
   Business--Sunnyside"

   Other income - The Company entered into contracts to sell a portion of its
   anticipated future Nitrogen Oxide Ozone Transport Region Budget Allowances
   (`NOx Credits").  The Company expects to generate other income from sales of
   its NOx Credits beginning in 1999.  The sales of NOx credits are discussed
   further in Note O to the Consolidated Financial Statements and "-Liquidity
   and Capital Resources--1999 Outlook".

   Litigation recoveries - As of December 31, 1998, the Company is seeking to
   recover approximately $4.1 million owed by the Purchasers of SCA and
   approximately $3 million (of which 50% or approximately $1.5 million would be
   retained by the Lessor) by PENELEC which are the subject of legal
   proceedings. See "Item 1. Business--Sunnyside" and "Item 3. Legal
   Proceedings".  Furthermore, should these legal proceedings resolve or settle
   in favor of the Company, the Company could also receive additional financial
   recoveries 

                                       24
<PAGE>
 
   which include interest, punitive damages and reimbursements for attorney's
   expenses. Any future recoveries from either of these legal proceedings would
   be recorded as additional income in the Company's Consolidated Statement of
   Operations.

Recently Issued Accounting Standards

     See Note B to the Consolidated Financial Statements for recently issued
accounting standards which are required to be adopted in 1999.

Liquidity and Capital Resources

  Operating Activities

     The Company had cash provided by operating activities of $635,735 in 1998,
cash used by operating activities of $1,202,561 in 1997 and cash provided by
operating activities of $1,324,158 in 1996. During all of these periods, the
Company's only sources of cash from operating activities were operating profits
from the Scrubgrass Project and investment earnings.  During 1997, primarily
because of the financial impact of the generator repair at the Scrubgrass
project which is discussed further under "Part I - Item 1. Business --
Scrubgrass", the Company incurred a significant decrease in cash from its
operating activities.  The Scrubgrass Project was profitable during 1998 and
1996 and contributed cash to the Company's operating activities.

     While the Company reported an overall net loss of $1,649,186 during 1998,
the Company generated significant cash from its operating activities.  The
following adjustments, which did not impact the Company's cash flows, need to be
considered in order to reconcile the Company's 1998 net loss to its net cash
provided by operating activities.

   Depreciation and amortization  - During 1998, the Company recognized
   depreciation and amortization for its lease rights of $149,004, deferred
   financing costs of $96,090, machinery and equipment modifications of $30,612
   and equipment and furniture of $9,765.

   Write-off of receivables in litigation  As of December 31, 1997, the Company
   had recorded on its Consolidated Balance Sheet notes receivable of $2,937,500
   and receivable from sale of affiliate of $570,998 related to the 1994 sale of
   SCA.  As discussed further in "Item 1. Business--Sunnyside", the Company is
   involved in a litigation with the Purchasers of SCA and wrote off the notes
   receivable and receivable from sale of affiliate during 1998 to present its
   financial statements conservatively.

   Deferred income tax asset  - The Company's net deferred income tax asset
   amounted to $1,826,561 as of December 31, 1998 as compared to $817,755 as of
   December 31, 1997.  As discussed in the previous paragraph, the Company wrote
   off receivables of $3,508,498 associated with the 1994 sale of SCA.  Since
   the Company was reporting the income from this sale for tax purposes using
   the installment method, the Company's also reversed its deferred income tax
   liability of $1,198,801 associated with this sale.  The reversal of this
   deferred income tax liability was the primary reason for the increase in the
   net deferred income tax asset as of December 31, 1998.

   Deferred gain, net - The Company's deferred gain, net amounted to $5,397,187
   as of December 31, 1998 as compared to $5,705,598 as of December 31, 1997.
   The decline is due to the amortization of the deferred gain related to the
   Scrubgrass Project, which is being amortized on a straight-line basis over 22
   years.

The Company also offers the following information to discuss changes in its
operating assets and liabilities which most notably impacted its cash position
during 1998:

   Receivable from utility - The Company's receivable from utility relates to
   the Scrubgrass Project and amounted to $6,598,864 as of December 31, 1998 as
   compared to $6,538,645 as of December 31, 1997. The increase in receivable
   from utility as of December 31, 1998 is primarily due to an approximate 5%
   increase in rates billed during 1998 under the power purchase agreement.
   However, primarily due to several unscheduled short 

                                       25
<PAGE>
 
   maintenance outages during the fourth quarter of 1998, the rate increase was
   substantially offset by a lower capacity rate billed during the fourth
   quarter of 1998 by comparison to the same period in 1997.

   Other current assets - The Company's other current assets amounted to
   $821,462 as of December 31, 1998 as compared to $881,938 as of December 31,
   1997. The decrease is largely due to lower interest receivable as of December
   31, 1998.  As of December 31, 1997, interest receivable was unusually high
   since the Company was investing the net proceeds retained from the sale of
   the Milesburg Project.

   Accounts payable and accrued expenses - The Company's accounts payable and
   accrued expenses amounted to $5,873,689 as of December 31, 1998 as compared
   to $6,325,062 as of December 31, 1997.  The decrease in 1998 is primarily
   attributable to a reduction in corporate taxes payable which amounted to
   $156,682 and $1,120,639 as of December 31, 1998 and 1997, respectively.  As
   of December 31, 1997, the Company's corporate tax liabilities were
   significantly higher primarily because of taxes associated with the gain on
   the sale of the Milesburg project.  The overall decrease was offset in part
   primarily by the following three factors which increased accounts payable and
   accrued expenses in 1998.  First, the Company established a defined benefit
   pension plan in 1998 for which the Company recognized an accrued pension
   expense of $165,342 as of December 31, 1998. Second, due to improvements in
   the profitability of the Scrubgrass Project in 1998, the Company accrued a
   higher year end bonus to the Operator as of December 31, 1998.  Third, the
   Company realized cost escalations in various operating and administrative
   contracts which increased its operating and administrative costs in 1998.

   Maintenance reserve - The Company records the expense of major equipment
   overhauls related to the Scrubgrass Project to a maintenance reserve on a
   straight-line basis using management's best estimate of when the Company will
   incur future cash outlays for the major equipment overhauls.  When the
   Company incurs cash outlays for major equipment overhauls, they reduce
   maintenance reserves and are funded substantially from scheduled deposits to
   a restricted major maintenance fund which have been set aside to ensure that
   the funds are available for these maintenance procedures (see further
   discussion under the caption "Investing Activities-Restricted Cash").  The
   maintenance reserve increased to $2,258,049 as of December 31, 1998 from
   $1,995,818 as of December 31, 1997 primarily due to scheduled reserves
   provided for the ongoing maintenance of the plant.   The scheduled reserves
   were offset in part by cash outlays of $384,100 for major equipment overhauls
   and the settlement with GEC for approximately $169,000 (See "Item 1. Business
   --Scrubgrass").

 Investing Activities

     The Company used $277,331 in investing activities during 1998, received
$12,206,487 from investing activities during 1997 and used $388,939 in investing
activities during 1996.  The Company's investing activities are concentrated
primarily in the following areas:

   Notes receivable - The Company presently has notes receivable related to the
   1994 sale of the Sunnyside Project and related to fees earned in 1995 for the
   Scrubgrass Project.  The Company collected $39,128, $36,129 and $482,681 from
   notes receivable related to the Scrubgrass Project in 1998, 1997 and 1996,
   respectively.  The notes receivable related to the Sunnyside Project, with a
   principal balance of $2,937,500 and accrued interest balance of $808,818 as
   of December 31, 1998, are the subject of a legal proceeding.  See "Item 1.
   Business  Sunnyside", "Item 3. Legal Proceedings" and Note P to the Company's
   Consolidated Financial Statements for further information about the Sunnyside
   Project and this litigation.

   Restricted cash - The Company is presently required to make scheduled
   deposits to a restricted major maintenance fund relating to the Scrubgrass
   Project to ensure that funds are available in the future for scheduled major
   equipment overhauls.  The Company is also allowed to spend restricted cash to
   fund the cost of major equipment overhauls subject to certain restrictions.
   During 1998, 1997 and 1996, the Company made scheduled deposits to the
   restricted major maintenance fund of $682,275, $644,500 and $600,000,
   respectively.  During 1998 and 1996, such deposits and interest thereon
   exceeded the payments for major equipment overhauls by $311,263 and $614,561,
   respectively.  In 1997, the payments for major equipment overhauls exceeded
   the deposits and interest thereon by $158,238.  The Company's cost of major
   equipment overhauls in 1997 were significant by 

                                       26
<PAGE>
 
   comparison to the other periods primarily because of extensive maintenance
   performed during the 1997 extended outage.

   Proceeds from sale of project - On December 5, 1997, the Company received
   $15,000,001 for the sale of the Milesburg project.  The Company's sale of the
   Milesburg project is discussed further under the caption "Item 1. Business--
   Milesburg".

   Property, plant and equipment - The Company invested $5,196, $2,987,881 and
   $257,059 in property, plant and equipment expenditures during 1998, 1997 and
   1996, respectively. The 1998 expenditures were primarily purchases of
   computer equipment for the Company's corporate office. The 1997 and 1996
   expenditures primarily pertain to development activities for the Company's
   Milesburg Project for which development efforts were accelerated during the
   latter part of 1997.  During 1997, the Company also made expenditures of
   $125,000 for machinery and equipment modifications at the Scrubgrass
   facility.

 Financing Activities

     The Company utilized $12,088,261, $90,177 and $768,517 in financing
activities during the years ended December 31, 1998, 1997 and 1996,
respectively.  The Company's financing activities are concentrated primarily in
the following areas:

   Dividends - During 1996, the Company initiated a quarterly dividend program
   which is subject to review and consideration by the Board of Directors each
   quarter.  In respect of this dividend program, the Company declared dividends
   of 3 cents per share during each of the quarters during 1996 and 1997.
   During 1998, the Company declared dividends of 3 cents per share during the
   first and second quarters and dividends of 1.5 cents per share during the
   third and fourth quarters.  The Company also declared special dividends of 2
   cents per share in 1996 out of operating profits and 87 cents per share in
   1997 out of the proceeds from the Milesburg settlement (See "Item 1. Business
   --Milesburg"). Therefore, the Company declared aggregate dividends of 14
   cents per share in 1996, 99 cents per share in 1997 and 9 cents per share in
   1998. During 1997 and 1998, the Company also paid dividends to its
   subsidiary's preferred stockholder of $30,178 and $5,000, respectively. The
   preferred stockholder, entitled to cumulative dividends of $5,000 per year
   since December 1991, was paid its dividends up to date during the second
   quarter of 1997.

   Working Capital Loan - The Company may borrow up to $4 million under a Lessee
   Working Capital Loan Agreement with the Lessor for ongoing working capital
   requirements of the Scrubgrass Project. The Company increased its outstanding
   borrowings under the Lessee Working Capital Loan Agreement from $2,311,666 as
   of December 31, 1997 to $2,389,664 as of December 31, 1998 primarily as a
   result of cost escalations in various operating and administrative contracts
   which increased certain costs in 1998. The Scrubgrass Project pays its
   accounts payable according to a date schedule which is fixed by certain
   operating contracts. As a result, the outstanding balances under the Lessee
   Working Capital Loan Agreement can occasionally vary slightly due to the
   timing of receiving and paying vendor invoices. The outstanding balances
   under the Lessee Working Capital Loan Agreement were fairly consistent as of
   December 31, 1998 and 1997.

   Term Credit Facility - In June 1997, the Lessor entered into a three year
   credit facility with the lenders of the Scrubgrass Project which made $3
   million available to the Scrubgrass Project to cover the cash deficiency
   which resulted from the extended annual outage of the Scrubgrass Project and
   associated costs and expenses.  On July 1, 1998, the maximum allowable
   borrowings under this credit facility began reducing in $600,000 increments
   every six months through July 3, 2000 when the credit facility will be
   payable in full.  During 1998, the Company paid $850,000 which reduced this
   obligation from $3,000,000 as of December 31, 1997 to $2,150,000 as of 
   December 31, 1998.

   Notes payable - In addition to the term credit facility described previously,
   the Company has other long-term obligations related to its Sunnyside Project
   and Scrubgrass Project in the amounts of $1,017,316 and $1,249,268,
   respectively as of December 31, 1998. The Sunnyside Project long-term
   obligations are payable 

                                       27
<PAGE>
 
   based on a schedule which relates directly to the amount of proceeds received
   from the collection of the outstanding notes receivable from the sale of the
   Company's interest in the Sunnyside Project, which are the subject of a
   litigation described in "Item 3. Legal Proceedings". The Scrubgrass Project
   obligation has scheduled annual maturities which began in 1998 and continue
   through 2005. The Company paid its initial installment of $18,543 for the
   Scrubgrass Project obligation in 1998 and will be required to make its next
   installment of $60,695 in 1999. Until August 26, 1997, the Company had long-
   term obligations related to the Milesburg project aggregating to $5,858,767.
   As a result of a settlement agreement dated August 26, 1997, the Milesburg
   project obligations were reduced to $2,358,767. In addition, because certain
   Milesburg obligations were payable only upon the occurrence of events related
   to project development, Milesburg project obligations of $558,767 and accrued
   interest of $63,650 were released from liabilities during 1997 and reported
   as other income of $622,417 in the accompanying Consolidated Statement of
   Operations. The remainder of the Milesburg project obligations, which
   amounted to $1,800,000, were paid during 1997. The Company had short-term
   installment obligations related to its Sunnyside Project and Milesburg
   Project which were fully satisfied during 1996 with aggregate payments of
   $139,517.

   Common Stock - The Company received proceeds from the issuance of its Common
   Stock aggregating $0, $124,238 and $14,437 during 1998, 1997 and 1996,
   respectively.  The Common Stock was issued solely pursuant to exercises of
   stock options.

   Treasury Stock - The Company from time to time makes purchases of its own
   common stock. During 1996, the Company purchased 520,540 shares of common
   stock from a resigning executive officer for $287,876 representing all of the
   officer's holdings in the Company.  The Company's note receivable from the
   officer in the amount of $72,876 was collected by reducing the proceeds paid
   to the officer for the common stock.  The Company did not purchase any
   treasury stock during 1998 or 1997.

 Cash Flow Outlook

     During 1999, the Company expects that its principal sources of cash to fund
its business activities will be from available cash balances, investment
earnings and cash which may become available from the Scrubgrass Project.  As
discussed in "Item 1. Business--Scrubgrass", the Company is not able to receive
cash from the Scrubgrass Project until all operating expenses, base lease
payments (which include the Lessor's debt service), certain maintenance reserve
payments and other subordinated payments of the Scrubgrass Project are first
satisfied.

     As discussed under the caption "Results of Operations--1999 Outlook", the
Company expects that the Scrubgrass Project will be profitable in 1999 and will
generate cash flows from its operating activities.  Due to an approximate 5%
increase in the contracted rates under the Scrubgrass power purchase agreement
and expected improvements in the performance of the Scrubgrass facility, the
Company believes that such expected cash flows would exceed previous 1998
levels.   Nevertheless, the Company anticipates that its expected cash flows in
1999 would continue to be affected by debt and maintenance reserve repayments.
According to the terms of certain Scrubgrass Project obligations, the Company
will be required to reduce the outstanding balance of its term credit facility
in 1999 by $1,550,000 and will be required to make an installment payment in
1999 of $60,695 under the $1.3 million Scrubgrass Project note.  Furthermore,
pursuant to the provisions of certain Scrubgrass Project agreements, the Company
will be required to make additional scheduled deposits of $82,275 in 1999 to
replenish restricted cash balances which were used to finance certain 1997
maintenance expenses.  However, as discussed under "Item 1. Business--
Scrubgrass", Buzzard is required to pay the Lessor, in addition to a specified
base rent, an additional rent of 50 percent of the net cash flows Buzzard
receives from the Scrubgrass Project.  Therefore, the Company would expect to
realize a savings in its additional rent expense to the extent of 50 percent of
any required debt and maintenance reserve repayments.  As such, the Company
expects that the cash flows which may become available in 1999 from the
Scrubgrass Project would only be reduced by 50 percent of any required debt and
maintenance reserve repayments.

     In April 1998, the Company improved its financial position by revising the
terms of its installment contract to finance the 1997 repair of the Scrubgrass
generator.  Under the terms of the revised agreement with the 

                                       28
<PAGE>
 
manufacturer of the Scrubgrass generator ("GEC"), as payment in full for GEC'S
work performed during the 1998 outage and for the five remaining installments of
$110,000 and $75,000 bonus owed under the original contract, the Company will
pay GEC a total of $450,000 over a four year period. The revised agreement
provides that $50,000 was payable upon the completion of GEC'S work during the
scheduled 1998 plant outage and that $100,000 is payable upon each of the first
four anniversaries of the first payment thereof.

     During December 1998 and January 1999, the Company entered into contracts
to sell a portion of its anticipated future Nitrogen Oxide Ozone Transport
Region Budget Allowances ("NOx Credits").  Each year, the Environmental
Protection Agency and the Pennsylvania Department of Environmental Protection
grant NOx Credits to Buzzard based on numerous factors which pertain to the
design and operation of the Scrubgrass facility. The NOx Credits establish the
quantity (in tons) of nitrogen oxide that the Scrubgrass facility can emit into
the environment before Buzzard will be fined by the EPA.  During 1999, Buzzard
plans to install machinery, with a cost of approximately $600,000, which is
expected to significantly lower the quantity of nitrogen oxide which the
Scrubgrass facility would emit into the environment.  As such, Buzzard
anticipates that it may not require a portion of its future NOx Credits to
maintain its compliance with EPA standards.  Because NOx Credits are
transferable and marketable, Buzzard contracted to sell 839 tons of its
projected available NOx Credits which it anticipates may not be required to
comply with EPA standards.  Under the terms of the contracts, Buzzard currently
expects to receive aggregate proceeds from sales of anticipated NOx Credits of
$2,240,933 through 2000, from which $600,000 would be utilized to purchase and
install the machinery discussed above.  The sales of NOx Credits are discussed
further in Note O to the Consolidated Financial Statements.

     As of December 31, 1998, the Company is seeking to recover approximately
$4.1 million owed by the Purchasers of SCA and approximately $3 million (of
which 50% or approximately $1.5 million would be retained by the Lessor) owed by
PENELEC which are the subject of legal proceedings. See "Item 1. Business
Sunnyside" and "Item 3. Legal Proceedings".  In addition, the Company is seeking
financial recoveries which include interest, punitive damages and/or
reimbursements for attorney's expenses.  The Company believes its positions in
both of these litigations are meritorious and, should they resolve or settle in
favor of the Company, they could materially enhance the Company's financial
position in the future.  Recently, the Company has been in discussions with
PENELEC regarding a settlement of that legal proceeding. The Company currently
believes that the prospect of a final settlement of all outstanding issues with
PENELEC is good.  However, there can be so assurance if or when the Company will
resolve or settle either of these legal proceedings.

   In September 1998, the Company filed its 1997 corporate tax returns which
clarified its corporate tax position.  Prior to 1997, the Company had
substantial net operating loss carryforwards which sheltered the Company from
paying Federal and certain state corporate taxes during its profitable periods.
However, primarily as a result of the 1997 Milesburg project sale, the Company
had substantial taxable income in 1997 which utilized all of the Company's
previous net operating loss carryforwards.  As such, for tax years beginning in
1997, the Company's cash flows have been negatively effected by the payment of
significant Federal and state corporate taxes.  Presently, the Company is
reviewing its corporate tax position and is considering tax strategies which
could mitigate the effect that corporate taxes are expected to have on its
future cash flows.

   The Company is optimistic about the future performance of the Scrubgrass
Project which is currently expected to achieve earnings on an annual basis for
the foreseeable future. The Scrubgrass power purchase agreement has contracted
rate escalations which, assuming the Scrubgrass Project meets its targeted
capacity rates, would ensure a material increase in revenues in future years.
Furthermore, as discussed above, the Company is involved in settlement
discussions with PENELEC regarding its legal proceeding and has entered into
contracts for the sale of NOx Credits which could both materially enhance the
anticipated increases in the Company's cash flows.  Notwithstanding, the
Scrubgrass Project will obviously bear the burden of repaying the debt
obligations relating to the extended outage of the Scrubgrass Project in the
near term. Nevertheless, the Company believes that the cash flows which may
become available from the Scrubgrass Project, together with existing cash
reserves, would be sufficient to fund the Company's business activities on a
long-term basis.  However, the payment of any future dividends will depend on
the Board of Directors' evaluation, made on a quarterly basis, based on its
dividend policy and the Company's then current and projected operating
performance and capital requirements. 

                                       29
<PAGE>
 
See the further discussions under "Item 5.- Dividend Program" and "--Certain
Factors That May Affect Future Results" below.

Year 2000 Readiness

  General

   The Company continues to address the issue of Year 2000 Readiness ("the Y2K
Project") and is proceeding on a schedule designed to complete the Y2K Project
by June 1999.  In 1997, the Company began establishing procedures to assess the
risks associated with the Y2K Project.  The Company's procedures to assess the
risks of the Y2K Project have included an inventory of stand-alone hardware and
software ("IT Systems"), an inventory of all system components embedded in the
Scrubgrass plant operating control systems ("Non-IT Systems"), the
identification of critical vendors, customers and business partners, the testing
of both IT Systems and Non-IT systems and a solicitation of responses from all
critical vendors, customers and business partners indicating their readiness for
the Year 2000.

   Presently, the Company has completed its testing of IT Systems and Non-IT
Systems.  Based on the results of these tests, the Company has identified IT
Systems and components of Non-IT Systems which are not Year 2000 compliant.
With respect to IT systems, the Company has either already upgraded such systems
or has placed orders to upgrade such systems in the near future.  As far as Non-
IT Systems, the Company has received recommendations from third parties
regarding solutions to either upgrade or replace non-compliant system
components.  At this time, the Company has received assurances from such third
parties that solutions to remedy the non compliant system components are readily
available and could be implemented within the Company's time parameters for the
Y2K Project.  The upgrades and/or replacements of non-compliant system
components are expected to be performed during the Scrubgrass Project annual
outage which is scheduled to begin in April 1999.

   The Company has made substantial progress in securing responses from most
critical vendors, and business partners indicating their readiness for Year
2000.  Based on the responses received to date, the Company has not identified
any conditions of potential non-compliance which the Company estimates would
materially impact its business.

   Costs

   The Company does not expect that the total costs to remediate Year 2000
issues would be material to its financial position.  The Company has incurred
cumulative costs to remediate Year 2000 issues of approximately $139,000 through
December 31, 1998.  The Company estimates that it will incur additional costs of
approximately $95,000 to remediate Year 2000 issues.  The Company expects to
fund such costs from its operating cash flows.

   Risks and Contingency Plans

   The Company believes that it has established a viable plan designed to ensure
that the Y2K Project is completed prior to the year 2000.  However, in
connection with its Y2K Project, the Company is also developing a contingency
plan which describes the steps the Company would take if the Y2K Project is not
completed as planned. The Y2K Project efforts are ongoing and the Company will
endeavor to update the Y2K Project activities and its contingency plans as new
information becomes available.

   The Year 2000 problem is a world-wide concern and there is a tremendous
amount of uncertainty about the effect this problem will have on any business.
The Company is endeavoring to understand the impact that failures of third
parties could have on its business.  However, even with a diligent effort, the
Company may not be able to conceive every scenario in which a third party
failure could impact its business.  However, through direct solicitation, the
Company has taken steps to assess the risk that known third parties with whom it
has significant business relationships are sufficiently prepared for the Year
2000.

                                       30
<PAGE>
 
   The Company has key relationships with numerous vendors and business
partners.  Presently, the Company has received responses from most key vendors
and business partners indicating their readiness for the Year 2000.  Based on
the responses received to date, the Company has not identified any conditions of
potential non-compliance which the Company estimates would materially impact its
business. The Company has considered its relationships with the vendors and
business partners who have not yet indicated their readiness for Year 2000.
Based on this review, the Company does not believe that its business would be
materially effected if any of these vendors or key business partners failed to
ensure that they were Year 2000 compliant.

   The Company has one customer, PENELEC, a public utility which is
contractually obligated to purchase all of the power supplied by the Scrubgrass
facility.  While the Company believes that PENELEC is taking the appropriate
steps to ensure that it is ready for the Year 2000, the Company has received no
formal correspondence which indicates that PENELEC expects to be ready.  While
the computer systems at Scrubgrass are not directly connected to those at
PENELEC, it is conceivable that the Company could still experience business
interruptions if PENELEC fails to ensure that its systems are Year 2000
compliant.  Because the Company is dependent on this one customer, any business
interruptions could have a material impact on the Company's financial position
and results of operations.

   The Company has taken steps it deems prudent to understand its Year 2000
risks, to estimate the costs to complete its Y2K Project and to understand the
extent to which it could be impacted by third parties who fail to ensure they
are ready for the Year 2000.  However, there can be no assurance that all non-
compliant systems or system components will be identified, that the Company's
systems will be Year 2000 compliant, that the Company will achieve its estimated
remediation costs or timetable, or that a failure by a third party to be Year
2000 compliant would not have a material adverse affect on the Company's
business.  However, by completing its Y2K Project, the Company believes it will
have taken appropriate steps to mitigate the risk that any of the aforementioned
items would have a material adverse affect on its business.

Certain Factors That May Affect Future Results

     The following important factors, among others, could cause actual results
to differ materially from those indicated by forward-looking statements made in
this Annual Report on Form 10-K.

  Ownership of Single Operating Asset

     The Company owns a 22 year leasehold interest in the Scrubgrass Project, an
approximate 83 Mw (net) waste-coal fired electric generating facility located in
Pennsylvania, the lease for which commenced on June 30, 1994.  Presently, all
the Company's operating revenues are attributable to power generation from the
Scrubgrass Project.  Accordingly, the Company's operations are largely dependent
upon the successful and continued operation of the Scrubgrass Project.  In
particular, if the Scrubgrass Project experiences unscheduled shutdowns of
significant duration, the Company's results of operations will be materially
adversely affected.

  Dependence Upon Key Employees

     The success of the Company is largely dependent upon a staff of four full-
time employees and one part-time employee, including three executive officers.
The loss of any of these employees could adversely effect the Company's
operations.

  Third Party Project Management

     The Company has entered into a management services agreement with U.S. Gen
to manage the Scrubgrass Project and a 15-year operations and maintenance
agreement with U.S. 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 the manager and operator for
unsatisfactory performance. However, the Company does not exercise control over
the

                                       31
<PAGE>
 
operation or management of the Scrubgrass Project. As such, decisions may be
made affecting the Scrubgrass Project, notwithstanding the Company's opposition,
which may have an adverse effect on the Company.

  Scheduled and Unscheduled Shutdowns

     The Scrubgrass Project from time to time experiences both scheduled and
unscheduled shutdowns.  Periodically, the Scrubgrass Project incurs scheduled
shutdowns in order to perform maintenance procedures to equipment that cannot be
performed while the equipment is operating.  Occasionally, the Scrubgrass
Project may also incur unscheduled shutdowns or may be required to operate at
reduced capacity levels following the detection of equipment malfunctions, or
following minimum generation orders received by the utility.  During periods
when the Scrubgrass Project is shutdown or operating at reduced capacity levels,
the Company may incur losses due to the loss of its operating revenues and/or
due to additional costs which may be required to complete any maintenance
procedures.   It is not possible for the Company to predict the frequency of
future unscheduled shutdowns or to predict the extent of maintenance which may
be required during shutdowns related to equipment maintenance.

  Legal Proceedings

     As discussed in Item 1. Business--Sunnyside and Item 3. Legal Proceedings,
the Company is involved in a legal proceeding with the purchasers of the
Company's interest in the Sunnyside Project which was sold in 1994. Pending the
resolution of the legal proceeding, the purchasers have withheld scheduled
payments of principal and interest due on the promissory notes since June 1996,
which amounted to $2,937,500 and $808,818, respectively as of December 31, 1998.
The balance of a purchase price closing adjustment is also being disputed in the
legal proceeding with the purchasers. Although the Company's available cash and
cash provided by operating activities has been sufficient to fund the Company's
investing and financing activities, the withholding of scheduled principal and
interest payments has adversely affected the Company's cash flow.  At this time,
while management believes the Company's position in this litigation is
meritorious, the Company cannot predict whether it will prevail in the
litigation and to what extent it will incur professional fees to defend its
position in the litigation.  An unfavorable resolution and/or extensive
professional fees to defend the litigation could adversely affect the Company's
results of operations.

     As discussed in Item 1. Business--Scrubgrass and Item 3. Legal Proceedings,
the Company has been involved in a legal proceeding with PENELEC since October
1995 whereby, among other complaints, the Company alleges that PENELEC has
failed to pay the Lessor and Buzzard contract rates for power in excess of 80 MW
produced by the Scrubgrass facility.   The Company is presently involved in
discussions with PENELEC to settle this litigation which, if settled, could
significantly improve the Company's results of operations and financial
position.  However, there can be no assurance that the Company would be
successful in settling this litigation.

  Financial Results

     To date the Company has incurred substantial losses, primarily due to its
development activities, which have resulted in an accumulated deficit of
$5,418,275 as of December 31, 1998.  While the Company was profitable from
operating activities during 1998, the Company incurred a net loss from the
operation of the Scrubgrass Project during 1997 due to an unforeseen repair to
the generator at the Scrubgrass facility.  The Company also had an overall net
loss during 1998 largely due to the write-off of the Sunnyside project
receivables. Financial results can be affected by numerous factors, including
without limitation general economic conditions, cyclic industry conditions, the
amount and rate of growth of expenses, transportation and quality of raw
materials, inflation, levels of energy rates, uncertainties relating to
government and regulatory policies, the legal environment and volatile and
unpredictable developments like the generator repair.  The Company believes it
is well positioned to handle such matters as they may arise during the course of
its future business activities.  However, there can be no assurance that the
Company will be profitable in the future.

                                       32
<PAGE>
 
Development Uncertainties

     From time to time, the Company invests its resources to develop power
generating facilities or invest in other projects of a development nature.   The
successful development of power generating facilities or similar projects
typically require the Company to obtain all of the necessary site agreements,
fuel supply contracts, design/build agreements, power sales contracts, licenses,
environmental and other permits, local government approvals or financing
commitments required to complete such projects.  However, the failure to
accomplish any of the aforementioned steps could materially increase the cost or
prevent the successful completion of projects under development, or cause the
Company to abandon the pursuit of such development projects and incur the loss
of its investment to date, which could materially impact the Company's business
and results of operations.

 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 ten years.
Accordingly, this technology carries greater risk than more established methods
of power generation such as hydropower.  As such, the long-term costs and
implications of maintaining this technology have not been established by
historical industry data.

 Customer Concentration

     The Company's power generation revenues are earned under a long-term power
purchase agreement with one customer, Pennsylvania Electric Company.  The
Company expects that the concentration of its revenues with this customer will
continue for the foreseeable future.

 Interest Rates

     The Company's subsidiary, as a lease cost of the Scrubgrass facility, is
required to fund the Lessor's debt service which consists of variable rate and
fixed rate debt obligations.  The Company's subsidiary also has a variable rate
working capital loan, a variable rate term loan and a variable rate term credit
facility all of which were advanced from the Lessor under various Scrubgrass
project agreements.  The Company offers the following information about these
debt obligations:

<TABLE>
<CAPTION> 
                                                 Balance at                                             Matures
Description of the Obligation                     12/31/98             Interest Rate                    Through
--------------------------------------------------------------------------------------------------------------------
<S>                                         <C>              <C>                                    <C>
Lessor debt obligations:
     Variable-rate tax exempt bonds             $135,600,000     Quoted Tax Exempt Bond Rate              2012
     Variable rate term loan                      16,623,087     Fixed swap rate of 6.4225%               2005
     Variable rate term loan                      10,575,218     LIBOR rate plus 1.250%                   2004
     Fixed rate junior subordinated debt             318,796     8%                                       1999
Buzzard debt obligations:
     Variable rate working capital loan            2,389,664     LIBOR rate plus 1.125%                 Revolving
     Variable rate term loan                       1,249,268     LIBOR rate plus 1.250%                   2004
     Variable rate term credit facility            2,150,000     LIBOR rate plus 1.125%                   2000

</TABLE>

                                       33
<PAGE>
 
     The Lessor entered into interest rate swaps which had the effect of fixing
the interest rate on the tax-exempt bonds until May 18, 1996 at approximately
3.72% and fixing the interest rate for its term loan which matures in 2005 at
6.4225%.  After May 18, 1996, the Company's specified base rent was incurred
based on floating rates on the Lessor's tax-exempt bonds which ranged from 2.95%
to 4%.  As such, except for the Lessor's term loan which matures in 2005 and the
Lessor's junior subordinated debt obligations, 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 lease expense or debt service.  Should market interest rates rise
significantly, the Company's operating results may be significantly impacted.
Notwithstanding, the Company believes the Lessor has good relationships with the
project lenders who would continue to support lending terms which would not have
a material adverse affect on the operating results of the Scrubgrass Project.
However, there can be no assurance that the Lessor could renegotiate its credit
facilities under terms which would ensure continuing profitable operating
results of the Scrubgrass Project.  See Notes H, I and M of the Consolidated
Financial Statements for further information about the Company's debt and lease
obligations.

Fuel Quality

  The Company obtains waste coal primarily from coal mining companies on a long-
term basis because waste coal is plentiful and generally creates environmental
hazards, such as acid drainage, when not disposed of properly.  The waste coal
is burned in the Scrubgrass facility using a circulating fluidized bed
combustion system.  During the circulating fluidized bed combustion process, the
waste coal is treated with other substances such as limestone. Depending on the
quality of the waste coal, the facility operator may need to add additional
waste coal or other substances to create the appropriate balance of substances
which would result in the best fuel or sorbent consistency for power generation
and compliance with air quality standards.  Therefore, the cost of generating
power is directly impacted by the quality of the waste coal which supplies the
Scrubgrass power generation facility. The facility operator maintains certain
controls over obtaining higher quality waste coal.  However certain conditions,
such as poor weather, can create situations where the facility operator has less
control over the quality of the waste coal. The Company cannot predict the
extent to which poor fuel quality may impact its future operating results.

Competition

     The Company generates electricity using alternative energy sources which is
sold on a wholesale basis under long-term contracts to utilities under rates
established in power purchase agreements and approved by regulatory agencies.
The independent power industry has grown rapidly over the past twenty years.
There are a large number of suppliers in the wholesale market and a surplus of
capacity which has led to intense competition in this market.   The principal
sources of competition in this market include traditional regulated utilities
who have excess capacity, unregulated subsidiaries of regulated utilities,
energy brokers and traders, energy service companies in the development and
operation of energy-producing projects and the marketing of electric energy,
equipment suppliers and other non-utility generators like the Company.
Competition in this industry is substantially based on price with competitors
discovering lower cost alternatives for providing electricity.  The electric
industry is also characterized by rapid changes in regulations which the Company
expects could continue to increase competition.  For instance, as discussed
under the caption "Energy Markets", the electric industry has been previously
affected by legislation such as PURPA and the Energy Act which have encouraged
companies other than utilities to enter the electric power business by reducing
regulatory constraints.  More recently, as discussed under the caption "Energy
Regulation", there has been new state legislation to deregulate the generation
component of the electric business.  Furthermore, proposed changes to repeal or
modify PUHCA and PURPA could reduce regulatory restrictions placed on electric
utilities and encourage them to seek new sources of electric power. Any of these
regulatory matters, among others, could increase competition for electric power.
Other than the risk that PENELEC would seek to renegotiate the terms of the
Scrubgrass power purchase agreement (see further discussion under the caption
"Energy Regulation"), the Company does not believe the Scrubgrass Project would
be significantly impacted by competition in the wholesale energy market since
its revenues are subject to contracted rates which are substantially fixed for
several years.  However, the contracted rates in the later years of the

                                       34
<PAGE>
 
Scrubgrass power purchase agreement switch to rates which vary more closely with
existing market conditions.  Should ensuing competition in the later years of
the Scrubgrass power purchase agreement create downward pressure on wholesale
energy rates, the Company's profitability could be impacted.

     The Company also competes in the market to develop power generation
facilities.  The primary bases of competition in this market are the quality of
development plans, the ability of the developer to finance and complete the
project and the price.  In certain cases, competitive bidding for a development
opportunity is required.  Competition for attractive development opportunities
is expected to be intense as there are a number of competitors in the industry
interested in the limited number of such opportunities.  Many of the companies
competing in this market have substantially greater resources than the Company.
The Company believes its project development experience and its experience in
creating strategic alignments with other development firms with greater
financial and technical resources could enable it to continue to compete
effectively in the development market if and when opportunities arise.
Presently, the Company believes there are limited opportunities for additional
project development in the United States for projects similar to those
previously developed by the Company.  However, the Company is currently
evaluating whether it should seek development opportunities in new areas.

     Presently, there is significant merger and consolidation activity occurring
in the electric industry.  From time to time, the Company considers merger and
acquisition proposals when they appear to present an opportunity to enhance
shareholder value.

Energy Regulation
 
     The Company's projects are subject to regulation under federal and state
energy laws and regulations.  The Company's facilities are either self-certified
as a Qualifying Facility under the PURPA, or formally certified as a Qualifying
Facility by the Federal Energy Regulatory Commission ("FERC").  Pursuant to
PURPA, FERC has promulgated regulations which exempt certain Qualifying
Facilities from the Federal Power Act of 1920, PUHCA, and, except under certain
limited circumstances, state laws regulating the rates charged by electric
utilities.  In order to qualify under PURPA, the Company's facilities must meet
certain size, fuel and ownership requirements and/or co-generate.  In addition
to the regulation of Qualifying Facilities, PURPA requires that electric
utilities purchase electric energy produced by qualifying facilities at
negotiated rates or at a price equal to the incremental or avoided cost that
would have been incurred by the utility if it were to generate the power itself
or purchase it from another source.  The Company is not presently subject to
regulation under PUHCA and does not presently intend to engage in any activities
that would cause it to be so regulated.

     The Company believes that changes in PURPA, PUHCA and other related federal
statutes could occur in the next several years.  The nature and impact of such
changes on the Company's projects is unknown at this time. Presently, there are
several legislative proposals pending in Congress which propose amendments to
certain regulations promulgated by PURPA.  If Congress amends PURPA, the
statutory requirement that electric utilities purchase electricity from
Qualifying Facilities at full avoided cost could be repealed or modified.  While
current legislative proposals specify the honoring of existing contracts, the
repeal or modification of these statutory purchase requirements under PURPA in
the future could increase pressure for electric utilities to renegotiate
existing contracts.  Should there be changes in statutory purchase requirements
under PURPA, and should these changes result in amendments which reduce the
contracted rates under the Scrubgrass power purchase agreement, the Company's
results of operations and financial position could be negatively impacted.

     State public utility commissions, pursuant to state legislative authority,
may have jurisdiction over how any new federal initiatives are implemented in
each state.  Although the FERC generally has exclusive jurisdiction over the
rates charged by an independent power project to its wholesale customers, state
public utility commissions have the practical ability to influence the
establishment of such rates by asserting jurisdiction over the purchasing
utility's ability to pass through the resulting cost of purchased power to its
retail customers. In addition, although thought to be unlikely, states may
assert jurisdiction over the siting and construction of independent power
projects and, among other things, the issuance of securities and the sale and
transfer of assets. The actual scope of jurisdiction over independent power
projects by state public utility regulatory commissions varies from state to

                                       35
<PAGE>
 
state. Presently, through its power purchase agreement with PENELEC, the
Scrubgrass Project is indirectly subject to state legislation in the
Commonwealth of Pennsylvania.

     On December 3, 1996, in response to changes in the electric industry, the
Commonwealth of Pennsylvania passed new legislation known as the Electricity
Generation Customer Choice and Competition Act (Customer Choice Act) which
became effective on January 1, 1997.  The Customer Choice Act provides for the
deregulation of the generation portion of electric business by permitting all
Pennsylvania retail electric customers to choose their electric generation
supplier over a phase-in period which expires December 31, 2000.  The Customer
Choice Act required that all electric utilities file restructuring plans with
the PUC which, among other things, included unbundled prices for electric
generation, transmission and distribution and a competitive transition charge
("CTC") for the recovery of "stranded costs" which would be paid by all
customers receiving distribution service and certain customers that increase
their own generation of electricity. "Stranded costs" generally are electric
generation-related costs that traditionally would be recoverable in a regulated
environment but may not be recoverable in a competitive electric generation
market.  As such, PENELEC filed a proposed restructuring plan in 1997 with the
PUC which was heavily contested by a number of affected parties.  Eventually,
the litigation resulted in a settlement which was approved by the PUC on October
20, 1998, and which satisfied all but one of the litigants. This settlement set
forth a comprehensive plan for restructuring PENELEC's service and for ensuring
there would be competition for electric generation for all of PENELEC's
customers beginning on January 1, 1999. The settlement is currently being
appealed in the Commonwealth Court of Pennsylvania by the party which opposed
such settlement. However, the Company presently does not anticipate that such
appeal will have a significant effect, if any, on PENELEC's restructuring plan
as far as that plan affects the Scrubgrass Project. Most pertinently, the
restructuring plan, as approved by the PUC, provided for PENELEC to maintain a
separate non-utility generator cost recovery mechanism for accounting purposes.
Therefore, the restructuring plan is designed, in pertinent part, to enable
PENELEC to recover all of its costs from non-utility generators such as the
Scrubgrass plant and should serve to decrease the pressure on PENELEC to
renegotiate existing power contracts with non-utility generators.

     Presently, neither the Customer Choice Act (and PENELEC's restructuring
plan filed thereunder), nor proposed legislation directly impacts the Company,
since the legislation and restructuring plan pertain to the retail market or new
contracts in the wholesale market.  However, as discussed above, the Company
could possibly be impacted in the future by, among other things, increases in
competition as a result of deregulation, or the chance that PENELEC would
attempt to renegotiate the existing power contract.  The Company is actively
monitoring these developments in energy proceedings in order to evaluate the
impact on its projects and also to evaluate new business opportunities created
by the restructuring of the electric industry.

Environmental Regulation

     The Company's projects are subject to regulation under federal, state and
local environmental and mining laws and regulations and must also comply with
the applicable federal, state and local laws pertaining to the protection of the
environment, primarily in the areas of water and air pollution.  These laws and
regulations in many cases require a lengthy and complex process of obtaining and
maintaining licenses, permits and approvals from federal, state and local
agencies.   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 applicable requirements could result in
delays in proceeding with any projects under development or require
modifications to operating facilities.  During periods of non-compliance, the
Company's operating facilities may be forced to shutdown until the non-
compliances are corrected.  The Company is responsible for ensuring compliance
of its facilities with all applicable requirements and, accordingly, attempts to
minimize these risks by dealing with reputable contractors and using appropriate
technology to measure compliance with the applicable standards.

Item 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's most significant market risk exposure is changing interest rates
which may affect its short-term investments, its debt and certain of its lease
expenses. The Company offers the following information about these market risks:

                                       36
<PAGE>
 
  Short-term investments - The Company invests cash balances which are in excess
  ----------------------                                                        
  of its normal operating requirements in short term investments generally with
  maturities of 3 months of less.  Because of the short duration of these
  investments, the Company does not believe its short-term investments are
  subject to material market risk.

  Debt - The Company has borrowings which bear interest at variable rates which
  ----                                                                         
  are based on the London Interbank Offering Rate (LIBOR).  The Company monitors
  market conditions for interest rates and, from time to time, enters into
  interest rate swaps to manage its interest payments.   The interest rate swaps
  have the effect of converting the variable rate borrowings to fixed rate
  borrowings for specified time periods.   For further information on the
  Company's interest rate risk, refer to "Item 7. Management's Discussion and
  Analysis of Financial Condition and Results of Operations -- Certain Factors
  That May Impact Future Results -- Interest Rates".

  Lease Expense- The Company, as a lease cost of the Scrubgrass facility, is
  -------------                                                             
  required to fund the Lessor's debt service which consists of fixed rate
  borrowings and borrowings which bear interest at variable rates based on
  either quoted bond rates or the London Interbank Offering Rate (LIBOR).  U.S
  Gen monitors market conditions for interest rates and, from time to time,
  enters into interest rate swaps to manage the interest payments for the
  Scrubgrass facility.   The interest rate swaps have the effect of converting
  the variable rate borrowings to fixed rate borrowings for specified time
  periods.   For further information on the Company's interest rate risk, refer
  to "Item 7.  Management's Discussion and Analysis of Financial Condition and
  Results of Operations -- Certain Factors That May Impact Future Results --
  Interest Rates".


Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements listed in the following Index to Financial
Statements are filed as a part of this annual report under Item 14 - Exhibits,
Index to Financial Statements, and Reports on Form 8-K.


                         Index to Financial Statements
                                        
<TABLE>
<CAPTION>
                                                                                                         Page
                                                                                                         ----
<S>                                                                                                    <C> 
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

Independent Auditors' Report                                                                             F-1

Consolidated Balance Sheets as of  December 31, 1998 and 1997                                            F-2

Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996               F-3

Consolidated Statements of Shareholders' (Deficit) Equity for the Years Ended
December 31, 1998, 1997 and 1996                                                                         F-4

Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996               F-5

Notes to Consolidated Financial Statements                                                               F-6

Item 9.    DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
           None
</TABLE>

                                       37
<PAGE>
 
                                   PART III

Item 10.    DIRECTORS AND EXECUTIVE OFFICERS

  Information with respect to the directors of the Company may be found in the
section captioned "Occupations of Directors" appearing in the definitive Proxy
Statement to be delivered to shareholders in connection with the Annual Meeting
of Shareholders to be held on June 28, 1999.  Such information is incorporated
herein by reference.

The executive officers of the Company are as follows:

<TABLE>
<CAPTION>
       Name                                Age                    Position
       ----                                ---                    --------
<S>                                      <C>        <C>
Joseph E. Cresci                           56        Chairman and Chief Executive Officer
 
Donald A. Livingston                       56        President and Chief Operating Officer
 
William D. Linehan                         33        Treasurer, Secretary and Chief Financial Officer

</TABLE>


Officers are elected annually by the Board of Directors and serve at the
discretion of the Board.

  Joseph E. Cresci, a founder of the Company, has served as Chairman and Chief
Executive Officer since the Company's inception in 1982, as Treasurer of the
Company from its inception until September 1987 and as President from inception
until September 1991.  From 1976 to 1982, Mr. Cresci was President and Chief
Executive Officer of G.E. Stimpson Co., Inc. and Stimpson Systems, Inc., a
distributor of office and printing products.  From 1972 to 1975, Mr. Cresci was
President of Ogden Recreation, Inc., a subsidiary of Ogden Corp. (NYSE) where he
was responsible for the operation of racing facilities, a hotel/resort, a
parking company and a promotions company providing services to large crowd
facilities.  Mr. Cresci was Executive Vice President and Chief Operating Officer
of Garden State Racing Association from 1969 to 1972.  From 1967 to 1969, he was
an associate lawyer with the Philadelphia law firm of Townsend, Elliott and
Munson.  Mr. Cresci holds a B.A. degree from Princeton University and a law
degree from Cornell Law School and is a member of the Pennsylvania and
Massachusetts Bar Associations.

  Donald A. Livingston, a founder of the Company, has served as President and
Chief Operating Officer since September 1991, and as Executive Vice President
from the Company's inception until September 1991. From 1974 to 1982, Mr.
Livingston was President and Chief Executive Officer of Green Mountain
Outfitters, Inc., a manufacturer and distributor of large plastic parts.  During
the three previous years, he was a partner in the financial services firm of
Capital Resources, Inc., where he was involved in obtaining debt and equity
funds, and negotiating mergers and acquisitions.  Mr. Livingston was a
registered representative in the retail stock brokerage business with Baxter,
Blyden and Selheimer from 1967 to 1971 and Bellamah, Neuhauser & Barrett from
1965 to 1967.

  William D. Linehan has served as Treasurer, Secretary and Chief Financial
Officer of the Company since March 29, 1996.  Prior to his employment with the
Company, Mr. Linehan was most recently employed since 1993 as manager in the
audit and consulting practice of Moody, Cavanaugh and Company, where he
specialized in providing audit, tax advisory and business consulting services to
closely-held corporations.  From 1991 to 1993, Mr. Linehan was the Controller of
Technology Procurement, Inc. and later the Secretary and Treasurer of Computer
Finance and Rental, Inc., a corporation formed in 1993 after a corporate
reorganization of Technology Procurement, Inc., where he was responsible for
managing the accounting and financial activities of these corporations, which
both were distributors and lessors of computer equipment and related peripheral
products.  From 1987 to 1991, Mr. Linehan was employed in the middle market
audit and consulting practice of KPMG Peat Marwick, where he advanced to the
position of supervisor and specialized in providing audit and management
advisory services to publicly-traded and privately-held growth companies.  Mr.
Linehan, who received a Bachelor 

                                       38
<PAGE>
 
of Science Degree in Accountancy from Bentley College in 1987, is a Certified
Public Accountant in the Commonwealth of Massachusetts and a member of the
American Institute of Certified Public Accountants.

Item 11.   EXECUTIVE COMPENSATION

  Information with respect to this item may be found in the section captioned
"Compensation and Other Information Concerning Directors and Officers" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held on June 28, 1999.  Such
information is incorporated herein by reference.

Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  Information with respect to this item may be found in the sections captioned
"Principal Holders of Voting Securities" and "Election of Directors" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held on June 28, 1999.  Such
information is incorporated herein by reference.

Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  Information with respect to this item may be found in the section captioned
"Compensation and Other Information Concerning Directors and Officers" appearing
in the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held on June 28, 1999.  Such
information is incorporated herein by reference.

                                       39
<PAGE>
 
                                    PART IV

Item 14. INDEX TO FINANCIAL STATEMENTS, EXHIBITS, AND REPORTS ON FORM 8-K

The following documents are filed as part of this annual report:

     (a) 1.    Consolidated Financial Statements


<TABLE>
<CAPTION>
               ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES
                                                                                                         Page
                                                                                                         ----
<S>                                                                                                     <C>
Independent Auditors' Report                                                                              F-1

Consolidated Balance Sheets as of  December 31, 1998 and 1997                                             F-2

Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996                F-3

Consolidated Statements of Shareholders' (Deficit) Equity for the Years Ended
December 31, 1998, 1997 and 1996                                                                          F-4

Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996                F-5

Notes to Consolidated Financial Statements                                                                F-6

</TABLE> 

  (a) 2. Financial Statement Schedules

  The Company is not required to file any financial statement schedules which
are outlined in Article 5 of the Securities and Exchange Commission regulations.
 
(a) 3.    Exhibits

  The following Exhibits are included in this report:

<TABLE> 
<CAPTION>
            Exhibit                                                                 Incorporation 
             Number               Description                                         Reference
             ------               -----------                                         ---------
<S>                  <C>                                                                <C>
              3.01    Certificate of Incorporation, as amended.                           A
 
              4.02    Bylaws of the Registrant, as amended.                               B
 
             10.01    Joint Development Agreement among Milesburg Energy, Inc.,           E
                      U.S. Gen and Environmental Power Corporation dated July 30,
                      1996 (a written request for confidential treatment of certain
                      proprietary information in this agreement has been filed with
                      the United States Securities and Exchange Commission)
 
             10.12    Stock Purchase Agreement for 20,000 shares of common stock of       F
                      Milesburg Energy, Inc., between Environmental Power
                      Corporation and Neil W. Hedrick, Richard Mase and Sylvia B.
                      Mase, dated April 30, 1987.
 
             10.13    Non-resource Secured Note of Environmental Power Corporation        F
                      to Neil W. Hedrick, Richard Mase and Sylvia B. Mase for
                      $220,000, dated April 30, 1987.
 
             10.14    Non-resource Secured Note of Environmental Power Corporation        F
                      to Neil W. Hedrick, Richard Mase and Sylvia B. Mase for
                      $4,900,000, dated April 30, 1987.
 
             10.15    Note of Milesburg Energy, Inc., to Antrim Mining, Inc., for         F
                      $41,000, dated April 30, 1987.
</TABLE>

                                       40
<PAGE>
 
<TABLE>
<CAPTION>
 
<S>                   <C>                                                                 <C>
             10.16    Note of Milesburg Energy, Inc., to Richard Mase and Sylvia B.       F
                      Mase for $139,000, dated April 30, 1987.
 
             10.17    Electric Energy Purchase Agreement between West Penn Power          F
                      Company and Milesburg Energy, dated February 25, 1987.
 
             10.18    Agreement for the Sale of Electric Energy from the Scrubgrass       F
                      Generating Plant by and between Pennsylvania Electric Company
                      and Scrubgrass Power Corporation dated August 7, 1987 which
                      was assigned by Scrubgrass Power Corporation to Scrubgrass
                      Generating Company, L.P. on December 15, 1990 and assigned by
                      Scrubgrass Generating Company, L.P. to Buzzard Power
                      Corporation on June 17, 1994.
 
             10.19    Supplemental Agreement for the Sale of Electric Energy from         F
                      the Scrubgrass Generating Plant by and between Pennsylvania
                      Electric Company and Scrubgrass Power Corporation dated
                      February 22, 1989, as amended by letter agreement dated March
                      28, 1989, which was assigned by Scrubgrass Power Corporation
                      to Scrubgrass Generating Company, L.P. on December 15, 1990
                      and assigned by Scrubgrass Generating Company, L.P. to
                      Buzzard Power Corporation on June 17, 1994.
 
             10.20    Second Supplemental Agreement for the Sale of Electric Energy       F
                      from the Scrubgrass Generating Plant by and between
                      Pennsylvania Electric Company and Scrubgrass Power
                      Corporation dated September 27, 1989 which was assigned by
                      Scrubgrass Power Corporation to Scrubgrass Generating
                      Company, L.P. on December 15, 1990 and assigned by Scrubgrass
                      Generating Company, L.P. to Buzzard Power Corporation on June
                      17, 1994.
 
             10.21    Third Supplemental Agreement for the Sale of Electric Energy        F
                      from the Scrubgrass Generating Plant by and between
                      Pennsylvania Electric Company and Scrubgrass Power
                      Corporation dated August 13, 1990 which was assigned by
                      Scrubgrass Power Corporation to Scrubgrass Generating
                      Company, L.P. on December 15, 1990 and assigned by Scrubgrass
                      Generating Company, L.P. to Buzzard Power Corporation on June
                      17, 1994.
 
             10.22    Amendment to the Third Supplemental Agreement for the Sale of       F
                      Electric Energy from the Scrubgrass Generating Plant by and
                      between Pennsylvania Electric Company and Scrubgrass Power
                      Corporation dated November 27, 1990 which was assigned by
                      Scrubgrass Power Corporation to Scrubgrass Generating
                      Company, L.P. on December 15, 1990 and assigned by Scrubgrass
                      Generating Company, L.P. to Buzzard Power Corporation on June
                      17, 1994.
 
             10.23    Letter Agreement dated December 20, 1990 amending the               F
                      Agreement for the Sale of Electric Energy from the Scrubgrass
                      Generating Plant by and between Pennsylvania Electric Company
                      and Scrubgrass Power Corporation dated August 7, 1987, as
                      amended and supplemented from time to time through November
                      27, 1990, which was assigned by Scrubgrass Power Corporation
                      to Scrubgrass Generating Company, L.P. on December 15, 1990
                      and assigned by Scrubgrass Generating Company, L.P. to
                      Buzzard Power Corporation on June 17, 1994.
 
             10.57    1990 Stock Plan with forms of Incentive Stock Option                F
                      Agreement and Non-Qualified Stock Option Agreement.
</TABLE>

                                       41
<PAGE>
 
<TABLE>
<CAPTION>
 
<S>                   <C>                                                                 <C>
             10.60    Management Services Agreement by and between Scrubgrass             F
                      Generating Company, L.P. and PG&E-Bechtel Generating Company
                      dated December 15, 1990 which was assigned by Scrubgrass
                      Generating Company, L.P. to Buzzard Power Corporation on June
                      17, 1994. PG&E-Bechtel Generating Company has assigned its
                      rights to this agreement ultimately to U.S. Gen.  Exhibit A
                      to this agreement was omitted because it was previously filed
                      as Exhibit 10.67.
 
             10.61    Agreement for Operation and Maintenance of the Scrubgrass           F
                      Cogeneration Plant between Scrubgrass Generating Company,
                      L.P. and Bechtel Power Corporation dated December 21, 1990
                      which was assigned by Scrubgrass Generating Company, L.P. to
                      Buzzard Power Corporation on June 17, 1994.  Bechtel Power
                      Corporation has assigned its rights to this agreement
                      ultimately to U.S. Operating Services Company.
 
             10.62    First Amendment to the Agreement for Operation and                  F
                      Maintenance of the Scrubgrass Cogeneration Plant between
                      Buzzard Power Corporation and U.S. Operating Services Company
                      dated December 22, 1995.
 
             10.67    Appendix I to the Amended and Restated Participation                D
                      Agreement, dated as of December 22, 1995, among Buzzard Power
                      Corporation, Scrubgrass Generating Company, L.P.,
                      Environmental Power Corporation, Bankers Trust Company and
                      Credit Lyonnais, which Appendix defines terms used and not
                      otherwise defined in other contracts.
 
             10.70    Stock Pledge Agreement, dated December 19, 1991, between            J
                      Environmental Power Corporation and Scrubgrass Generating
                      Company, L.P.
 
             10.71    Amended and Restated Participation Agreement, dated as of           D
                      December 22, 1995, among Buzzard Power Corporation,
                      Scrubgrass Generating Company, L.P., Environmental Power
                      Corporation, Bankers Trust Company and Credit Lyonnais.
 
             10.72    Amendment No. 1, dated as of May 22, 1997, to the Amended and       G
                      Restated Participation Agreement, dated as of December 22,
                      1995, among Buzzard Power Corporation, Scrubgrass Generating
                      Company, L.P., Environmental Power Corporation, Bankers Trust
                      Company and Credit Lyonnais.
 
             10.73    Director Option Plan.                                               B
 
             10.80    Amended and Restated Lease Agreement between Scrubgrass             F
                      Generating Company, L.P., a Delaware limited partnership, as
                      Lessor, and Buzzard Power Corporation, a Delaware
                      corporation, as Lessee, dated as of December 22, 1995.
                      Schedules and similar attachments listed in the Lease have
                      been omitted and the Company agrees to furnish supplementally
                      a copy of any omitted schedule or attachment to the
                      Securities and Exchange Commission upon request.
 
             10.81    Purchase and Sale Agreement by and among NRG Sunnyside Inc.         C
                      and B&W Sunnyside L.P. and Kaiser Systems, Inc., Kaiser Power
                      of Sunnyside, Inc., Sunnyside Power Corporation and
                      Environmental Power Corporation, dated December 31, 1994.
                      Schedules and similar attachments of the Purchase and Sale
                      Agreement have been omitted; the Company agrees to furnish
                      supplementally a copy of any omitted schedule to the
                      Securities and Exchange Commission upon request.
 
             10.82    Lease between Meadow Holdings Corporation and Environmental         F
                      Power Corporation, dated February 20, 1996.
</TABLE>

                                       42
<PAGE>
 
<TABLE>
<CAPTION>
 
<S>                   <C>                                                                 <C>
             10.83    Amended and Restated Disbursement and Security Agreement            F
                      between Scrubgrass Generating Company, L.P., as Lessor,
                      Buzzard Power Corporation, as Lessee, Bankers Trust Company
                      as Disbursement Agent and Credit Lyonnais acting through its
                      New York Branch as Agent, dated as of December 22, 1995.
                      Schedules and similar attachments listed in this agreement
                      have been omitted and the Company agrees to furnish
                      supplementally a copy of any omitted schedule or attachment
                      to the Securities and Exchange Commission upon request.
 
             10.84    Amended and Restated Lessee Working Capital Loan Agreement          F
                      between Scrubgrass Generating Company, L.P., as Lender, and
                      Buzzard Power Corporation, as Lessee, dated as of December
                      22, 1995.
 
             10.85    Amendment No. 1, dated as of May 22, 1997, to the Amended and       G
                      Restated Disbursement and Security Agreement between
                      Scrubgrass Generating Company, L.P., as Lessor, Buzzard Power
                      Corporation, as Lessee, Bankers Trust Company as Disbursement
                      Agent and Credit Lyonnais acting through its New York Branch
                      as Agent, dated as of December 22, 1995.
 
             10.86    Debt Service (Tranche A) Loan Note, dated June 3, 1997, to          G
                      Credit Lyonnais acting through its New York Branch, as Bank,
                      from Scrubgrass Generating Company, L.P., as Borrower.
 
             10.87    Debt Service (Tranche B) Loan Note, dated June 3, 1997, to          G
                      Credit Lyonnais acting through its New York Branch, as Bank,
                      from Scrubgrass Generating Company, L.P., as Borrower.
 
             10.88    Debt Service (Tranche B) Loan Note, dated June 3, 1997, to          G
                      National Westminster Bank acting through its New York Branch,
                      as Bank, from Scrubgrass Generating Company, L.P., as
                      Borrower.
 
             10.89    Buy-Out Agreement, dated as of August 26, 1997, between West        H
                      Penn Power Company and Milesburg Energy, Inc.
 
             10.90    Letter Agreement, dated as of August 26, 1997, among                I
                      Environmental Power Corporation, Richard Mase, Sylvia B.
                      Mase, Neil W. Hedrick and Antrim Mining, Inc.
 
             10.91    Amendment No. 2, dated as of September 2, 1998, to the
                      Amended and Restated Participation Agreement, dated as of
                      December 22, 1995, among Buzzard Power Corporation,
                      Scrubgrass Generating Company, L.P., Environmental Power
                      Corporation, Bankers Trust Company and Credit Lyonnais.
 
             10.92    Amendment No. 1, updated as of October 9, 1998, to the
                      Amended and Restated Disbursement and Security Agreement
                      between Scrubgrass Generating Company, L.P., as Lessor,
                      Buzzard Power Corporation, as Lessee, Bankers Trust Company
                      as Disbursement Agent and Credit Lyonnais acting through its
                      New York Branch as Agent, dated as of December 22, 1995.
 
             10.93    Amendment No. 1, dated as of June 1, 1996, but not executed
                      until July 24, 1998, to the Amended and Restated Lease
                      Agreement between Scrubgrass Generating Company, L.P., a
                      Delaware limited partnership, as Lessor, and Buzzard Power
                      Corporation, a Delaware corporation, as Lessee, dated as of
                      December 22, 1995.
 
             10.94    Lease between Adams Realty Trust and Environmental Power
                      Corporation, dated January 26, 1999.
 
</TABLE> 

                                       43
<PAGE>
 
<TABLE> 
<CAPTION> 

<S>                   <C>                                                                 <C>
             10.95    Settlement Agreement and Release between GEC Alsthom
                      International, Inc. and Buzzard Power Corporation dated May
                      28, 1998.
 
             10.96    Purchase and Sale Agreements, dated as of December 16, 1998,
                      January 4, 1999 and January 8, 1999, between PG&E Energy
                      Trading  Power, L.P. and Buzzard Power Corporation pertaining
                      to Nitrogen Oxide Ozone Transport Region (NOx) Budget
                      Allowances
 
             10.97    Environmental Power Corporation Medical Expense Reimbursement
                      Plan effective as of September 1, 1998 and dated as of
                      December 18, 1998
 
             10.98    Environmental Power Corporation Defined Benefit Pension Plan
                      effective as of January 1, 1998 and dated as of December 23,
                      1998
 
                11    Computation of Earnings per Share
 
                21    Subsidiaries of the Registrant
 
              23.1    Consent of Deloitte & Touche LLP
 
                27    Financial Data Schedule
 
             99.01    Order of Pennsylvania Public Utility Commission in connection       F
                      with Milesburg Energy, Inc., adopted September 21, 1989.
</TABLE>

     Incorporation References:

<TABLE>
<S>                     <C>
          A             Previously filed as part of Registration Statement No. 33-9808 (the
                        "Registration Statement"), filed with the Securities and Exchange
                        Commission on October 28, 1986.
 
          B             Previously filed as part of the Company's Report on Form 10-K for the year
                        ended December 31, 1993.
 
          C             Previously filed as part of the Company's Report on Form 10-K for the year
                        ended December 31, 1994.
 
          D             Previously filed as part of the Company's Report on Form 10-K for the year
                        ended December 31, 1995.
 
          E             Previously filed as part of the Company's Report on Form 10-Q for the
                        period ended September 30, 1996.
 
          F             Previously filed as part of the Company's Report on Form 10-K for the year
                        ended December 31, 1996.
 
          G             Previously filed as part of the Company's Report on Form 10-Q for the
                        period ended June 30, 1997.
 
          H             Previously filed as part of the Company's Report on Form 8-K dated as of
                        September 8, 1997.
 
          I             Previously filed as part of the Company's Report on Form 8-K dated as of
                        December 19, 1997.
 
          J             Previously filed as part of the Company's Report on Form 10-K for the year
                        ended December 31, 1997.
</TABLE>

  (b)  Reports on Form 8-K

  None

                                       44
<PAGE>
 
                                  SIGNATURES
                                        
  Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Dated:                  ENVIRONMENTAL POWER CORPORATION

      March 29, 1999    By /s/ Joseph E. Cresci
                           -----------------------------
                           Joseph E. Cresci, Chairman
                           and Chief Executive Officer


  Pursuant to the requirements of the Securities Exchange Act 1934, this report
has been signed below by the following persons on behalf of registrant and in
the capacities and on the dates indicated.
<TABLE>
<CAPTION>
 
Signature                              Title                Date
<S>                           <C>                      <C>
 
  /s/ Joseph E. Cresci        Chairman, Chief          March 29, 1999
----------------------------  Executive Officer,   
     Joseph E. Cresci         & Director (Principal 
                              Executive Officer)    
                              
 
  /s/ Donald A. Livingston    President & Chief        March 29, 1999
----------------------------  Operating Officer 
    Donald A. Livingston      
 
 
   /s/  William D. Linehan    Treasurer, Chief         March 29, 1999
----------------------------  Financial Officer     
     William D. Linehan       & Secretary (Principal
                              Financial Officer)     
                              
 
 /s/ Peter J. Blampied        Director                 March 29, 1999
----------------------------
     Peter J. Blampied
 
/s/ Edward E. Koehler         Director                 March 29, 1999
----------------------------
    Edward E. Koehler
 
/s/ Robert I. Weisberg        Director                 March 29, 1999
----------------------------
    Robert I. Weisberg
</TABLE>

                                       45
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT
                                        


Board of Directors and Shareholders of
  Environmental Power Corporation


We have audited the accompanying consolidated balance sheets of Environmental
Power Corporation and subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of operations, shareholders' (deficit) equity,
and cash flows for each of the three years in the period ended December 31,
1998.  These consolidated financial statements are the responsibility of the
Corporation's management.  Our responsibility is to express an opinion on the
consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of Environmental Power Corporation and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.


/s/ Deloitte & Touche LLP


Boston, Massachusetts
March 19, 1999


                                      F-1
<PAGE>
 
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
<TABLE> 
<CAPTION> 
                                                                                December 31               December 31
                                                                                    1998                      1997
                                                                             -----------------         -----------------
<S>                                                                        <C>                       <C> 
ASSETS

CURRENT ASSETS:
    Cash  and  cash equivalents                                               $        362,416          $     12,092,273
    Restricted cash                                                                    797,922                   486,659
    Receivable from utility                                                          6,598,864                 6,538,645
    Notes receivable                                                                    42,376                    39,128
    Other current assets                                                               821,462                   881,938
                                                                              -----------------         -----------------
                      TOTAL CURRENT ASSETS                                           8,623,040                20,038,643

PROPERTY, PLANT  AND  EQUIPMENT, NET                                                    94,755                   129,936

DEFERRED INCOME TAX ASSET                                                            1,826,561                   817,755

LEASE RIGHTS, NET                                                                    2,608,515                 2,757,519

RECEIVABLE FROM SALE OF AFFILIATE                                                          ---                   570,998

NOTES  RECEIVABLE                                                                        3,686                 2,983,562

ACCRUED POWER GENERATION REVENUES                                                   41,386,500                33,362,389

OTHER ASSETS                                                                           619,693                   701,437
                                                                              -----------------         -----------------

                     TOTAL ASSETS                                             $     55,162,750          $     61,362,239
                                                                              =================         =================

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
    Accounts payable and accrued expenses                                     $      5,873,689          $      6,325,062
    Dividends payable on common stock                                                      ---                10,266,105
    Other current liabilities                                                        3,939,664                 2,911,666
                                                                              -----------------         -----------------
                    TOTAL CURRENT LIABILITIES                                        9,813,353                19,502,833

DEFERRED GAIN, NET                                                                   5,397,187                 5,705,598

SECURED PROMISSORY NOTES PAYABLE
    AND OTHER BORROWINGS                                                             2,866,584                 4,673,727

ACCRUED  LEASE  EXPENSES                                                            41,386,500                33,362,389

MAINTENANCE RESERVE                                                                  2,258,049                 1,995,818
                                                                              -----------------         -----------------
                   TOTAL LIABILITIES                                                61,721,673                65,240,365

SHAREHOLDERS' DEFICIT:
    Preferred Stock ($.01 par value; 1,000,000 shares authorized; no shares
         issued at December 31, 1998 and December 31, 1997, respectively)                 --                        --
    Preferred Stock (no par value, 10 shares authorized; 10 shares
         issued at December 31, 1998 and December 31, 1997, respectively)                  100                       100
    Common Stock ($.01 par value; 20,000,000 shares authorized;
         12,525,423 shares issued at December 31, 1998 and
         December 31, 1997, respectively; 11,406,783 shares outstanding
         at December 31, 1998 and December 31, 1997, respectively)                     125,254                   125,254
    Accumulated deficit                                                             (5,418,275)               (2,737,478)
                                                                              -----------------         -----------------
                                                                                    (5,292,921)               (2,612,124)

    Treasury stock (1,118,640 common shares, at cost, as of
         December 31, 1998 and December 31, 1997, respectively)                       (456,271)                 (456,271)
    Notes receivable from officers and board members                                  (809,731)                 (809,731)
                                                                              -----------------         -----------------
                    TOTAL SHAREHOLDERS' DEFICIT                                     (6,558,923)               (3,878,126)
                                                                              -----------------         -----------------

                    TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT               $     55,162,750          $     61,362,239
                                                                              =================         =================
</TABLE> 
See Notes to Consolidated Financial Statements.

                                      F-2
<PAGE>
 
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE> 
<CAPTION> 
                                                                              Year Ended December 31

                                                                1998                   1997                    1996
                                                        -------------------    -------------------     -------------------
<S>                                                     <C>                    <C>                     <C> 
POWER GENERATION REVENUES                               $       45,721,473     $       43,763,223      $       47,853,639

COSTS AND EXPENSES:
     Operating expenses                                         19,215,459             17,755,882              18,190,037
     Lease expenses                                             22,971,201             24,488,005              24,792,248
     General and administrative expenses                         2,196,929              1,995,491               3,061,931
     Reversal of provision for nonrecovery of
              project development costs                                ---               (940,144)                    ---
     Depreciation and amortization                                 285,471                257,677                 205,341
                                                        -------------------    -------------------     -------------------
                                                                44,669,060             43,556,911              46,249,557
                                                        -------------------    -------------------     -------------------

OPERATING INCOME                                                 1,052,413                206,312               1,604,082

OTHER INCOME (EXPENSE):
     Interest income                                               156,546                581,336                 498,975
     Interest expense                                             (460,812)              (424,395)               (336,449)
     Amortization of deferred gain                                 308,410                308,410                 308,411
     Write-off of receivables in litigation                     (3,508,498)                   ---                     ---
     Gain on sale of project                                           ---              7,423,467                     ---
     Warranty income                                                   ---                    ---                 900,000
     Other income                                                    7,810                622,417                 484,295
                                                        -------------------    -------------------     -------------------
                                                                (3,496,544)             8,511,235               1,855,232
                                                        -------------------    -------------------     -------------------

INCOME (LOSS) BEFORE INCOME TAXES                               (2,444,131)             8,717,547               3,459,314

INCOME TAX (EXPENSE) BENEFIT                                       794,945             (4,103,684)             (1,894,035)
                                                        -------------------    -------------------     -------------------

NET INCOME (LOSS)                                       $       (1,649,186)    $        4,613,863      $        1,565,279
                                                        ===================    ===================     ===================

BASIC AND DILUTED EARNINGS (LOSS)
           PER COMMON SHARE                             $            (0.14)    $             0.41      $             0.14
                                                        ===================    ===================     ===================

DIVIDENDS PAID OR PAYABLE:
     Common shares                                      $        1,026,611     $       11,265,865      $        1,549,250
     Preferred shares                                                5,000                 30,178                  25,178
                                                        -------------------    -------------------     -------------------
                                                        $        1,031,611     $       11,296,043      $        1,574,428
                                                        ===================    ===================     ===================

DIVIDENDS PAID OR PAYABLE PER
      COMMON SHARE                                      $            0.090     $            0.990      $            0.140
                                                        ===================    ===================     ===================
</TABLE> 
See Notes to Consolidated Financial Statements.

                                      F-3
<PAGE>
 
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
<TABLE> 
<CAPTION> 
                                                      Preferred        Common
                                                        Stock           Stock        Additional
                                                       (No Par        ($.01 Par       Paid-in        Unearned
                                                         Value)          Value)       Capital      Compensation
                                                     -------------  --------------  -------------  --------------
<S>                                                  <C>            <C>             <C>            <C> 
BALANCE AT JANUARY 1, 1996                           $        100   $     121,454   $ 12,592,808   $     (66,941)

      Net income
      Exercise of stock options                                               500         13,937
      Purchase of common shares
      Dividends paid                                                                  (1,549,250)
      Amortization of unearned compensation                                                               66,941

                                                     -------------  --------------  -------------  --------------
BALANCE AT DECEMBER 31, 1996                                  100         121,954     11,057,495               0

      Net income
      Exercise of stock options                                             3,300        169,513
      Dividends paid                                                                 (11,227,008)

                                                     -------------  --------------  -------------  --------------
BALANCE AT DECEMBER 31, 1997                                  100         125,254              0               0

      Net loss
      Dividends paid
                                                     -------------  --------------  -------------  --------------

BALANCE AT DECEMBER 31, 1998                         $        100   $     125,254   $          0   $           0
                                                     =============  ==============  =============  ==============

                                                                                       Notes
                                                                                     Receivable        Total
                                                                                    from Officers  Stockholders'
                                                     Accumulated      Treasury       and Board       (Deficit)
                                                       Deficit          Stock         Members         Equity
                                                     -------------  --------------  -------------  --------------

BALANCE AT JANUARY 1, 1996                           $ (8,847,585)  $    (168,395)  $   (834,032)  $   2,797,409

      Net income                                        1,565,279                                      1,565,279
      Exercise of stock options                                                                           14,437
      Purchase of common shares                                          (287,876)        72,876        (215,000)
      Dividends paid                                                                                  (1,549,250)
      Amortization of unearned compensation                                                               66,941

                                                     -------------  --------------  -------------  --------------
BALANCE AT DECEMBER 31, 1996                           (7,282,306)       (456,271)      (761,156)      2,679,816

      Net income                                        4,613,863                                      4,613,863
      Exercise of stock options                                                          (48,575)        124,238
      Dividends paid                                      (69,035)                                   (11,296,043)

                                                     -------------  --------------  -------------  --------------
BALANCE AT DECEMBER 31, 1997                           (2,737,478)       (456,271)      (809,731)     (3,878,126)

      Net loss                                         (1,649,186)                                    (1,649,186)
      Dividends paid                                   (1,031,611)                                    (1,031,611)

                                                     -------------  --------------  -------------  --------------
BALANCE AT DECEMBER 31, 1998                         $ (5,418,275)  $    (456,271)  $   (809,731)  $  (6,558,923)
                                                     =============  ==============  =============  ==============
</TABLE> 
See Notes to Consolidated Financial Statements.


                                      F-4
<PAGE>
 
ENVIRONMENTAL POWER CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE> 
<CAPTION> 
                                                                                      Year Ended December 31
                                                                         1998                  1997                1996
                                                                  ----------------      ----------------    -----------------
<S>                                                               <C>                   <C>                 <C> 
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net (loss) income                                             $    (1,649,186)      $     4,613,863     $      1,565,279
    Adjustments to reconcile net (loss) income to net cash
       provided by (used in) operating activities:
          Depreciation and amortization                                   285,471               257,677              205,341
          Gain on sale of project                                             ---            (7,423,467)                 ---
          Deferred income taxes                                        (1,008,806)            3,014,660            1,703,124
          Amortization of deferred gain                                  (308,411)             (308,410)            (308,411)
          Write-off of receivables in litigation                        3,508,498                   ---                  ---
          Reversal of provision for nonrecovery of project
              development costs                                               ---              (940,144)                 ---
          Amortization of unearned compensation                               ---                   ---               66,941
          Accrued power generation revenues                            (8,024,111)           (8,905,911)          (9,294,789)
          Accrued lease expenses                                        8,024,111             8,905,911            9,294,789
          Other (income) expense                                              ---              (622,417)             100,000
          Changes in operating assets and liabilities:
               (Increase) decrease in receivable from utility             (60,219)             (645,766)             643,627
               Decrease (increase) in other current assets                 60,476                29,535              (37,645)
               Increase in receivable from sale of affiliate                  ---               (73,236)             (86,606)
               (Increase) decrease in other assets                        (14,346)             (192,873)              45,869
               (Decrease) increase in accounts payable and
                   accrued expenses                                      (451,373)              614,469              (54,385)
               Decrease in deferred revenue                                   ---                   ---           (3,064,965)
               Decrease in other current liabilities                          ---                   ---             (300,000)
               Increase in long-term liabilities                           11,400                11,559               11,589
               Increase in maintenance reserve                            262,231               461,989              834,400
                                                                  ----------------      ----------------    -----------------
                     Net cash provided by (used in)
                        operating activities                              635,735            (1,202,561)           1,324,158
                                                                  ----------------      ----------------    -----------------

CASH FLOWS FROM INVESTING ACTIVITIES:
    Proceeds from the collection of notes receivable                       39,128                36,129              482,681
    (Increase) decrease in restricted cash                               (311,263)              158,238             (614,561)
    Proceeds from sale of project                                             ---            15,000,001                  ---  
    Property, plant and equipment expenditures                             (5,196)           (2,987,881)            (257,059)
                                                                  ----------------      ----------------    -----------------
                   Net cash (used in) provided by
                      investing activities                               (277,331)           12,206,487             (388,939)
                                                                  ----------------      ----------------    -----------------

CASH FLOWS FROM FINANCING ACTIVITIES:
    Dividend payments                                                 (11,297,716)           (1,029,938)          (1,549,250)
    Net borrowings (repayments) under working capital loan                 77,998              (384,477)           1,068,000
    Borrowings under long-term credit facility                                ---             3,000,000                  ---  
    Repayment of secured promissory notes payable and
         other borrowings                                                (868,543)           (1,800,000)            (139,517)
    Proceeds from the issuance of common stock                                ---               124,238               14,437
    Purchase of treasury stock                                                ---                   ---             (287,876)
    Proceeds from the collection of notes receivable from officers            ---                   ---               72,876
    Proceeds from other borrowings                                            ---                   ---               52,813
                                                                  ----------------      ----------------    -----------------
                  Net cash used in financing activities               (12,088,261)              (90,177)            (768,517)
                                                                  ----------------      ----------------    -----------------

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                      (11,729,857)           10,913,749              166,702

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                         12,092,273             1,178,524            1,011,822
                                                                  ----------------      ----------------    -----------------

CASH AND CASH EQUIVALENTS, END OF PERIOD                          $       362,416       $    12,092,273     $      1,178,524
                                                                  ================      ================    =================
</TABLE> 
See Notes to Consolidated Financial Statements.


                                      F-5
<PAGE>
 
NOTE A--BUSINESS AND ORGANIZATION

  Environmental Power Corporation (individually "EPC" or consolidated "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. Until December
31, 1994 the Company had varying ownership interests (100% to approximately 40%)
in, and oversaw the operation of, an approximately 51 Mw (net) waste coal-fired
electric generating facility located in Utah.  Both facilities sell power under
long-term contracts to specified utility companies whose contracts have been
approved by the respective Public Utility Commission.  In the case of these two
projects, the Company, either acting alone or in conjunction with others, has
selected and arranged for the acquisition of the site, obtained control over a
portion of their waste coal fuel sources, negotiated contracts for the design
and construction of the facilities and the sale of their output to the utilities
purchasing the power, arranged for financing, and negotiated contracts for the
operation and maintenance of the projects.  Until December 5, 1997, the Company
had one additional project (the "Milesburg Project") which had been in the
development stage since 1987 and involved in significant contract litigation
since the early stages of its development activities.  On August 26, 1997, the
Company entered into a Buy-Out Agreement with the utility company which had
contracted to purchase electricity from the Milesburg Project.  On December 5,
1997, pursuant to the Buy-Out Agreement, the Company sold substantially all of
the assets of the Milesburg project to this utility company and the ongoing
litigation was terminated.  The Company's projects are discussed in more detail
in the following sections.

  Scrubgrass

     The Scrubgrass Project located on a 600 acre site in Venango County,
Pennsylvania, is an approximately 83 Mw (net) waste coal-fired electric
generating station (the "Facility") which has been constructed by Bechtel Power
Corporation.  The construction contract provided for a guaranteed net electrical
output of  82.85 Mw.  Final completion was achieved by the contractor in June
1994.

     On June 30, 1994, Buzzard Power Corporation ("Buzzard"), a subsidiary of
EPC, entered into an agreement to lease the Facility from Scrubgrass Generating
Company, L.P. (the "Lessor"), a joint venture of certain wholly-owned
subsidiaries of PG&E Corporation and Bechtel Generating Company, Inc.  On
October 20, 1998, Bechtel Generating Company, Inc. transferred its interest in
the Lessor to a wholly-owned subsidiary of Cogentrix Energy, Inc.  The lease
provides for an initial term of 22 years with a renewal option for up to 3
years. Pursuant to the lease, the Lessor assigned to Buzzard all principal
project agreements and its rights and obligations thereunder including, but not
limited to the power purchase agreement, operations and maintenance agreement,
limestone agreements, ground lease agreements, fuel agreements and
transportation and materials handling agreements.  EPC has pledged Buzzard's
common stock to the Lessor as security for Buzzard's performance of its
obligations as lessee.  The Scrubgrass Project is managed by U.S. Generating
Company ("U.S. Gen"), a wholly-owned indirect subsidiary of U.S. Generating
Company, LLC ("USGenLLC"), which in turn is a wholly-owned indirect subsidiary
of PG&E Corporation.

     Electric output is being sold to Pennsylvania Electric Company ("PENELEC")
pursuant to a 25-year agreement, which commenced in 1993, at fixed rates
initially averaging approximately 4.68 cents/Kwh and escalating at 5% per year
for the calendar years' 1994-1999.  Commencing in the year 2000 and through
2012, the agreement provides for a rate equal to the greater of a scheduled rate
or a rate based on the PJM Billing Rate (the monthly average of the hourly rates
for purchases by the General Public Utilities Group ("GPU") from, or sale by GPU
to, the Pennsylvania-New Jersey-Maryland Interconnection).  For the years 2013
through 2015 and 2016 through 2018, if the lease renewal term option is
exercised, the agreement provides for a rate equal to the lower of the average
monthly PJM Billing Rate or the rate paid for the calendar year 2012 adjusted
annually by the percentage change in the Gross National Product Deflator less
1%. On June 8, 1993, the Facility reached commercial operation.  Since October
1995, the Company has been involved in a legal proceeding with PENELEC whereby,
among other complaints, the Company alleges that PENELEC has failed to pay the
Lessor and Buzzard contract rates for power in excess of 80 MW produced by the
Scrubgrass facility.   The Company is presently 


                                      F-6
<PAGE>
 
involved in discussions with PENELEC to settle this litigation which, if
settled, could significantly improve the Company's results of operations and
financial position. See Note P for a further discussion of this litigation.

     The Facility is being operated by U.S. Operating Services Company (the
"Operator"), a wholly-owned indirect subsidiary of USGenLLC, pursuant to a 15-
year Operations and Maintenance Agreement (the "O & M"). The Operator prepares a
budget for all operational expenses, including a fixed management fee and
certain targeted output performance levels, which is approved annually.  The
Operator's failure to achieve approved annual budgets can result in operator
liability not to exceed its management fees and/or termination of the O & M.
 
  Buzzard, as assignee, entered into a Limestone Purchase and Sale Agreement
with Quality Aggregates, Inc. to supply the Scrubgrass Project with limestone
for an initial term of five years which, in December 1995, was extended through
the year 2000 and which may be extended up to 15 additional years.  The
Scrubgrass Project also maintains an agreement with an initial term of 15 years
for the transportation of fuel, ash and limestone with Savage Industries, Inc.
The costs established under this agreement will escalate at partially fixed and
partially indexed rates.

  Revenues earned by the Scrubgrass Project are deposited into an account
administered by a disbursement agent.  Before Buzzard can receive cash generated
by the Scrubgrass Project, all operating expenses, base lease payments (which
include the Lessor's debt as described below), certain maintenance reserve
payments (See Note B) and other subordinated payments must be satisfied.
Buzzard, as lessee, is required to pay the Lessor, in addition to a specified
base rent, consisting of all of the Lessor's debt service and related fees and
expenses, an additional rent of 50 percent of the net cash flows Buzzard
receives from project operations. Buzzard is not required to fund operating
losses, or otherwise invest further, from sources outside of the Scrubgrass
Project.

     On December 22, 1995, the Lessor restructured certain of the Scrubgrass
Project's debt, the primary effect of which was to extend the term of its demand
debt through 2004 and extend a portion of its junior subordinated debt through
1999.  In connection with the Lessor's debt restructuring, Buzzard was able to
refinance a portion of its own current liabilities and establish a capital
improvements fund with a note payable of $300,000 which was paid in January
1996, and a variable note payable of $2,487,813 which matures through 2004.
During the second quarter of 1997, the Lessor assumed primary responsibility for
the disbursement of funds and repayment of debt related to the capital
improvements fund of the Scrubgrass Project.  Accordingly, restricted cash and
secured borrowings of approximately $1,220,000 were transferred from the
financial statements of the Company to the financial statements of the Lessor
which reduced Buzzard's note payable.  Since the Lessor's debt restructuring,
Buzzard has continued to fund the Lessor's debt service obligations as a base
lease payment and its own term obligation resulting from this restructuring 
which are described in the following table:

<TABLE>
<CAPTION> 
                                             Balance at         Balance at                                    Matures
Description of the Obligation                  12/31/98          12/31/97          Interest Rate              Through
-----------------------------------------------------------------------------------------------------------------------
<S>                                    <C>               <C>               <C>                              <C>
Lessor's term debt obligations:
     Variable rate tax exempt bonds        $135,600,000      $135,600,000    Quoted Bond Rates                 2012
     Variable rate term loan                 16,623,087        18,621,663    Fixed swap rate of 6.4225%        2005
     Variable rate term loan                 10,575,218        10,732,189    LIBOR rate plus 1.250%            2004
     Junior subordinated debt                   318,796           556,630    Fixed rate of 8%                  1999
                                                                                                               
Buzzard's term debt obligation:                                                                               
     Variable rate term loan                  1,249,268         1,267,811    LIBOR rate plus 1.250%            2004
</TABLE>

  On December 22, 1995, the Lessor entered into interest rate swaps which had
the effect of fixing the interest rate on the variable rate tax exempt bonds
until May 18, 1996 at approximately 3.72% and fixing the interest rate over the
life of its variable rate term loan which matures in 2005 at 6.4225%. After May
18, 1996, the Lessor's tax-exempt bonds incurred interest at floating rates
ranging from 2.95% to 4%. The remainder of the


                                      F-7
<PAGE>
 
term debt obligations incur interest at either fixed rates or variable rates
which are based on the London Interbank Offering Rate (See Notes H and I).
 
  In March 1996, the Company received proceeds of $900,000 from Bechtel Power
Corporation in final settlement of certain warranty and start-up matters which
is included in other income in the accompanying 1996 Consolidated Statement of
Operations.

   During the fourth quarter of 1996, after learning about a generator failure
at an electric generating facility with an identical generator to the Scrubgrass
facility, the manufacturer asked the Company to perform certain tests to
determine the Scrubgrass generator's condition.  Based on the results of these
tests, which became available during the first quarter of 1997, the Company
believed that the Scrubgrass facility's generator exhibited certain conditions
which indicated that a similar failure might occur at some time in the future.
As a result, the Scrubgrass facility was shutdown for a period of six days in
February 1997 to consider matters pertaining to the generator.  In light of the
results of these generator tests, the generator manufacturer recommended that
the Company perform a complete rewind on the Scrubgrass facility's generator
during its 1997 annual plant outage which began in April, and which caused the
Scrubgrass plant to be inoperative for a period of 37 days during the second
quarter of 1997.  Originally, without knowledge of the necessary generator
repair, the Company had planned that the Scrubgrass plant would be inoperative
in 1997 for a total of only 18 days to perform normal maintenance during
scheduled spring and fall outages.   As such, because the Scrubgrass plant was
inoperative for a total of 43 days as a result of the maintenance outages, the
Scrubgrass facility was inoperative for 25 days longer in 1997 than the
Company's original plans.  At an average of $80,000 of net revenues per day,
this accounted for an approximate reduction in 1997 power generation revenues,
net of estimated variable fuel expenses not incurred, of approximately $2
million by comparison to previous expectations.  As a result of the extended
plant outage, the Company incurred $660,000 to have the manufacturer repair the
generator, incurred approximately $700,000 in additional maintenance expenses
which were not originally scheduled during this outage and incurred
approximately $300,000 in related costs such as legal fees, management costs,
bank fees, etc.  As such, the Company believes that the financial impact of this
outage aggregated approximately $3.7 million. During 1997, the Company's
Consolidated Statement of Operations reflects the effect of the lost net
revenues of approximately $2,000,000, the additional maintenance expenses of
approximately $700,000 and the related expenses of approximately $300,000
pertaining to the generator matter. During 1996, the Company had recorded the
present value of the future installments to finance the generator rewind,
discounted at the Scrubgrass Project's incremental borrowing rate (6.75%), which
amounted to $564,000, and was recognizing the $96,000 remaining balance as an
interest cost over the term of the financing agreement.

   The Scrubgrass extended outage also created a significant cash flow
deficiency because of the loss of revenues plus associated costs and expenses.
The Company addressed this cash deficiency by securing debt financing,
negotiating agreements with the generator manufacturer and utilizing available
maintenance cash reserves which are each discussed as follows:

  Term Credit Facility:    In June 1997, the Lessor entered into a three year
  ---------------------                                                      
  credit facility with the lenders of the Scrubgrass Project to provide up to $3
  million to fund general debt service expenses.   The maximum allowable
  borrowings under this credit facility were $3,000,000 through July 1, 1998. On
  July 1, 1998, the maximum allowable borrowings under this credit facility
  began reducing in $600,000 increments every six months through July 3, 2000 at
  which time the credit facility will be payable in full.  As of December 31,
  1998 and 1997, the outstanding borrowings under this credit facility, which
  were advanced to the Company by the Lessor, amounted to $2,150,000 and
  $3,000,000, respectively.

  Agreements with Generator Manufacturer:  Prior to the 1997 outage, the Company
  ---------------------------------------                                       
  negotiated extended financing terms with GEC Alsthom ("GEC"), the manufacturer
  of the Scrubgrass generator, which allowed the Company to pay the $660,000
  cost of the generator repair in six annual installments of $110,000, without
  interest, beginning in May 1997. On April 15, 1998, the Company reached an
  agreement with GEC which modified the terms of its original financing
  contract.  Under the terms of the original contract, the Company had yet to
  pay five installments of $110,000 and had also agreed to pay an additional
  $75,000 bonus to GEC for completing its work ahead of a pre-established
  schedule. Furthermore, the Company had engaged GEC to perform certain


                                      F-8
<PAGE>
 
  maintenance procedures to the generator during the 1998 scheduled outage at
  the Scrubgrass plant.  Under the terms of the revised agreement with GEC, as
  payment in full for GEC's work performed during the 1998 outage and for the
  five remaining installments of $110,000 and $75,000 bonus owed under the
  original contract, the Company agreed to pay GEC a total of $450,000 over a
  four year period. The revised agreement provides that $50,000 was payable upon
  the completion of their work during the scheduled 1998 plant outage and that
  $100,000 is payable upon each of the first four anniversaries of the first
  payment thereof. As of December 31, 1998, the Company has recorded in its
  Consolidated Balance Sheet the next installment of $100,000 in its accounts
  payable and accrued expenses and the present value of the remaining three
  installments, discounted at the Scrubgrass Project's incremental borrowing
  rate (6.75%), which amounted to approximately $257,000, in its maintenance
  reserve. The $43,000 balance of the $300,000 revised generator rewind cost is
  being recognized as interest expense over the remaining three year term of the
  financing contract with GEC. As of December 31, 1997, the Company had recorded
  on its Consolidated Balance Sheet in accounts payable and accrued expenses for
  $185,000 and in maintenance reserves for $364,000, the present value of the
  remaining obligations under the previous agreement.  During 1998, the Company
  recognized, through a reduction of its operating expenses, the reduction of
  the present value of the future installments due to GEC, which amounted to
  approximately $169,000.  The Company also recognized interest expense of
  approximately $27,000 and $20,000 during 1998 and 1997, respectively under the
  agreements with GEC.

  Utilization of Maintenance Reserves:  The Company was able to utilize its
  ------------------------------------                                     
  restricted cash reserves to finance most of its additional maintenance
  expenditures incurred during the 1997 outage since substantially all of such
  expenditures were deemed to be major overhauls.  Under the terms of its
  project agreements, the Company will be able to replenish these restricted
  funds over a seven year period beginning in 1998.

  Sunnyside
 
     The Sunnyside Project is an approximately 51 Mw (net) waste coal-fired
facility at a site located adjacent to the Sunnyside Coal Mine in Carbon County,
Utah which was constructed by Parsons Main, Inc., ("PMI").  The facility reached
commercial operation on November 19, 1993.  The Sunnyside Project is owned by
Sunnyside Cogeneration Associates ("SCA"), a joint venture in which the Company
owned varying majority interests from 100% to approximately 70% until September
28, 1994 and thereafter an approximate 40% interest until December 31, 1994 at
which time the Company sold its remaining interest in SCA to B&W Sunnyside, Inc.
and NRG Sunnyside, Inc. (collectively, "the Purchasers").

     In connection with the sale, the Company received total consideration of
$6,042,294 which included cash of $2,792,294 received on January 5, 1995 and
promissory notes aggregating $3,250,000, bearing interest at 10% per annum,
received on December 31, 1994.  In addition, after audits were performed to
verify certain financial information for SCA, the Purchasers were required to
pay a purchase price closing adjustment of $1,061,107 in 1995.  Under the terms
of the promissory notes, interest is payable quarterly to the Company and
aggregate principal payments of $312,500, $1,187,500 and $1,750,000 were due on
September 30, 1995,  December 31, 1996 and December 31, 1997, respectively.  To
date, the Purchasers have made principal payments aggregating $312,500 and
quarterly interest payments through March 31, 1996 pursuant to the promissory
notes.  The Purchasers have also made aggregate payments of $708,000 toward the
purchase price closing adjustment.  However, as more fully described in Note P,
the Purchasers commenced a legal proceeding with the Company on May 3, 1996.
Pending the resolution of the legal proceeding, the Purchasers have withheld all
payments of principal and interest due on the promissory notes since June 1996.
The Purchasers are also disputing the balance of the purchase price closing
adjustment in the legal proceeding.  As of December 31, 1998, in addition to the
balance of the purchase price closing adjustment, the purchasers have principal
and interest payments in arrears under the promissory notes of $2,937,500 and
$808,818, respectively (collectively the "Purchasers' Obligations"). The Company
also retained certain inchoate rights, including potential refundable sales
taxes and certain legal settlements arising out of activities prior to the date
of the sale. The retained rights were fully satisfied after the Company received
sales tax refunds aggregating $1.1 million and $42,078 in 1995 and 1996,
respectively, and a litigation settlement of $540,000 during 1996. The sales tax
refunds aggregating $42,078 and litigation settlement of $540,000 are included
in other income in the accompanying 1996 Consolidated Statement of Operations.


                                      F-9
<PAGE>
 
     As discussed further in Note P, the litigation with the Purchasers includes
claims for alleged breaches by the Company of the agreement to sell its interest
in SCA to the Purchasers.  The alleged breaches of contract are numerous and the
litigation continues in discovery where it has been for almost three years.  In
November 1998, the Company presented to the Seventh District Court for Carbon
County, State of Utah (the "Court") a motion for Partial Summary Judgment
concerning one of the numerous claims by the Purchasers. To date, the Court has
not ruled on this matter. If successful in this motion and considering the
possibility of further similar motions, the Company hopes over time to eliminate
or limit the matters that might be presented in a jury trial or discourage the
Purchasers from continuing the litigation if the anticipated costs exceed the
benefits from litigating the remaining matters.  After this initial Court
appearance, the Company continues to feel optimistic about the strength of its
position in the litigation.  However, the Company perceives that the Purchasers
are unlikely to settle these matters unless required through Court proceedings,
there currently being little economic incentive for them to do so. Accordingly,
in view of the length and inherent risk of the litigation process and a jury
trial, the Company at this time cannot predict how long it will take to enforce
its rights and collect the Purchasers' Obligations.  The Purchasers' Obligations
have been in arrears for almost three years now and are expected to remain in
arrears for the foreseeable future. Pursuant to Statement of Financial
Accounting Standards ("SFAS") No. 114, as amended by SFAS No. 118, the Company
is required to recognize impairment losses on loans whenever changes in
circumstances indicate that the carrying amounts of the loans exceed their fair
market values.  In the case of the Purchasers' Obligations, because there are no
quoted market values, the best indication of fair market value is the present
value of the expected future cash flows from the Purchasers' Obligations.  Given
the uncertainty surrounding the timing of collecting the Purchasers'
Obligations, the Company cannot reasonably estimate a fair market value for such
obligations.  As such, the Company opted to take a conservative position and
write-off the Purchasers' Obligations in its 1998 Consolidated Financial
Statements.  The write-off was reported as a charge to other expense for
$3,508,498 in the accompanying 1998 Consolidated Statement of Operations.  The
charge represents the aggregate balance before the write-off for the notes
receivable of $2,937,500 and the receivable from sale of affiliate of $570,998.
Notwithstanding, the Company maintains its entitlement to the Purchasers'
Obligations and continues to vigorously pursue such amounts, as well as punitive
damages for abuse of the litigation process, in the Court.  Should the Company
prevail in the litigation in a future period and collect the Purchasers'
Obligations, or a portion thereof, and/or punitive damages, the Company would
report such collections as other income in the period received.  See Note B for
the Company's accounting policies for reporting income on the Purchasers'
Obligations.

Milesburg

  On April 30, 1987, the Company purchased, for an aggregate purchase price of
$5,400,000, all of the outstanding capital stock of Milesburg Energy, Inc.
("MEI"), the company which controlled the development rights to an existing 43
Mw (net) oil-fired facility, which was retired from service in 1984.  In
connection with the stock purchase, the Company paid $100,000 in cash and issued
promissory notes totaling $5,120,000 (the "MEI Notes") and a subsidiary of the
Company assumed pre-acquisition MEI liabilities totaling $180,000.  The MEI
Notes, pre-acquisition liabilities and certain other liabilities incurred
subsequent to the purchase were to become payable only under certain conditions,
the most significant of which related to the closing of construction financing
and commencement of construction for the Milesburg Project.

  In 1987, MEI executed a 30 year power purchase agreement with West Penn Power
Company ("West Penn") for the sale of all of the facility's electrical output
with a fixed capacity rate component and an additional fluctuating rate
component which is derived from West Penn's avoided energy cost.  The power
purchase agreement was approved by the Public Utilities Commission of the State
of Pennsylvania ("PUC"), and was subsequently appealed to the Commonwealth Court
of Pennsylvania by certain industrial intervenors.  During the lengthy appeals
process, which extended beyond certain contract milestone dates in the power
purchase agreement, West Penn requested that its original petition to approve
the power purchase agreement be dismissed by the PUC since the power purchase
agreement had expired by its own terms.  In September 1989, in response to MEI's
efforts to preserve its contractual rights, the PUC, by court order, ordered
West Penn to execute a new power purchase agreement with MEI.   The new power
purchase agreement was to include extended contract milestone dates and rates
which would be recalculated due to the later start-up date for this project
necessitated by the delays 


                                     F-10
<PAGE>
 
caused by the appeal. This order had been appealed by the same industrial
intervenors and West Penn through various courts, including the United States
Supreme Court, and upheld in every case in favor of MEI. In August 1995, the PUC
issued a tentative order for final contract rates. The order had been
temporarily stayed by mutual agreement of MEI and West Penn pending discussions
pertaining to a buy-out of the power purchase agreement which began in October
1995.

     Despite ongoing efforts to reach a buy-out arrangement with West Penn, the
Company had continued to invest its financial resources during 1996 and 1997 to
protect its legal and contractual interests and to support its ability to
commence construction in the event that a settlement under mutually agreeable
terms could not be reached with West Penn.  In July 1996, in furtherance of
those objectives, the Company entered into a joint development agreement with
U.S. Gen to increase the financial and technical resources available to pursue
development activities and continue ongoing discussions with West Penn
concerning a buy-out of the power purchase contract. During 1996 and 1997, the
Company's development efforts for the Milesburg Project increased considerably
and the Company, along with its development partner, was able to establish a
significant value for the Milesburg Project as a result of successful
development efforts.

     On August 26, 1997, following discussions which lasted almost two years,
MEI and West Penn reached a Buy-Out Agreement concerning the Milesburg project.
Pursuant to the Buy-Out Agreement, West Penn purchased Milesburg's rights to the
Electric Energy Purchase Agreement between the parties dated February 25, 1987
for the sum of $15 million plus 8% interest from the date the Buy-Out Agreement
was filed for Pennsylvania Public Utility Commission approval.  Furthermore,
West Penn also assumed ownership of and responsibility for the Milesburg project
facility, which consisted of land along with a decommissioned oil-fired
electric-generating facility erected thereon, for a stated consideration of $1.
On December 5, 1997, the date of the asset disposition, MEI received aggregate
proceeds of $15,328,768 from West Penn as consideration under the Buy-Out
Agreement.  At the date of the asset disposition, before consideration of any
settlements of contingent obligations, the Company had Milesburg project
development costs included in its property, plant and equipment of $9,670,788
and Milesburg project borrowings included in its secured promissory notes and
other borrowings of $5,858,767.  Shortly before the date of the asset
disposition, the Company entered into a settlement agreement pertaining to
certain Milesburg project contingent obligations, including the MEI Notes.  As a
result of the settlement agreement, the Company's Milesburg project development
costs and Milesburg project borrowings were reduced to $6,170,788 and
$2,358,767, respectively.  In addition, because certain other Milesburg
obligations were payable only upon the occurrence of events related to project
development, Milesburg project obligations of $558,767 and accrued interest of
$63,650 were released from liabilities during 1997 and reported as other income
of $622,417 in the accompanying Consolidated Statement of Operations.  As a
result of the sale of the Milesburg Project, the Company realized net proceeds
before taxes of $10,960,120 which were derived as follows:

<TABLE>
<S>                                                                                <C>
Proceeds from the disposal of Milesburg project assets                                        $15,000,001
Project costs:
     Development costs                                                                          6,170,788
     Fee paid to development partner                                                            1,405,746
                                                                                      -------------------
                     Total project costs                                                        7,576,534
                                                                                      -------------------
 
                     Gain on sale of project                                                  $ 7,423,467
 
Adjustments to arrive at net proceeds before taxes from the disposal
    of Milesburg project assets:
          Development cost reimbursements to the Company for
                obligations which had already been paid                                         2,585,469
          Development costs released from liabilities                                             622,417
          Interest income from West Penn                                                          328,767
                                                                                      -------------------
 
Net proceeds before taxes from the disposal of Milesburg project assets                       $10,960,120
                                                                                      ===================
</TABLE>


                                     F-11
<PAGE>
 
     The Company estimated that, after giving effect to the payment of corporate
taxes related to the Milesburg transaction which are accrued as of December 31,
1997, the Company would have available in excess of $10 million from the
Milesburg proceeds.  In light of this projected availability of cash, the
Company's Board of Directors on December 10, 1997 declared a special dividend on
the issued and outstanding shares of Company`s Common Stock in the amount of 87
cents per share payable on January 7, 1998 to Stockholders of record on December
30, 1997 out of the proceeds received from the Company's sale of its Milesburg
project assets.

     On December 31, 1997, because MEI did not expect to carry on further
business activities after the sale of the Milesburg Project, EPC adopted a Plan
of Liquidation to dissolve MEI.  Under the Plan of Liquidation, MEI ceased to
carry on business activities except to the extent necessary to liquidate its
assets, pay its liabilities and distribute its assets remaining after the
payment of its liabilities to EPC.    During 1998, MEI's assets remaining after
the payment of its liabilities were distributed to EPC.

NOTE B -- SIGNIFICANT ACCOUNTING POLICIES

  Principles of Consolidation:  The Consolidated Financial Statements include
the accounts of Environmental Power Corporation and its wholly-owned or majority
owned subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation.

  Use of Estimates:  The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that effect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.  Actual results could differ from those estimates.

     Cash Flows:  The Company considers all highly liquid investments with a
maturity of three months or less when purchased to be cash equivalents.  In
1997, the Lessor of the Scrubgrass Project assumed primary responsibility for
the disbursement of funds and repayment of debt related to the capital
improvements fund of the Scrubgrass Project.  Accordingly, restricted cash and
secured borrowings in the amount of $1,220,000 were transferred from the
financial statements of the Company to the financial statements of the Lessor in
a non-cash investing and financing activity.  The Company also settled a
contingent obligation for the Milesburg project which resulted in a non-cash
financing and investing activity reducing secured promissory notes payable and
property plant and equipment by $3,500,000 during 1997 (see Note A).  There were
no non-cash financing and investing activities in 1998 and 1996.

  Concentrations of Credit Risk:  The Company's financial instruments that are
exposed to concentrations of credit risk consist primarily of cash equivalents,
notes receivable and receivable from utility.  The Company's cash equivalents
represent certificates of deposit which are issued from reputable financial
institutions and which are substantially backed by U.S. Treasury or U.S. Agency
securities with maturities of not more than five years.  Notes receivable
represent amounts due from the acquirers of the Company's interest in the
Sunnyside Project.  The Company believes these acquirers are credit worthy
entities which have the ability to pay the scheduled note obligations (See Note
P regarding the Company's legal proceeding with the acquirers of the Sunnyside
Project).  Receivable from utility represents amounts due from the Company's
sole customer PENELEC, a public utility with a credit rating of A by Standard &
Poors, pursuant to the terms of the 25 year power purchase agreement.

  Restricted Cash:  Restricted cash includes all cash held by the disbursement
agent for the Scrubgrass Project pursuant to project agreements which require
requisition and/or certification by the Lessor or bank to withdraw (See Note A).
The Company makes scheduled deposits to restricted cash accounts which are
restricted primarily for scheduled maintenance procedures.

  Fuel Inventory:  Fuel inventory consists primarily of handling and hauling
costs and is recorded on a lower of cost or market basis with cost determined on
a monthly weighted average basis.


                                     F-12
<PAGE>
 
  Property, Plant and Equipment:  Property, plant and equipment are stated at
cost less accumulated depreciation.  The Company capitalizes significant
renewals and betterments that increase the useful lives of assets while repairs
and maintenance are expensed when incurred. The cost and accumulated
depreciation for property, plant and equipment disposals are removed from the
balance sheet and any resulting gains or losses are reported in the statement of
operations at the time of the asset disposition. The Company depreciates its
property plant and equipment using straight-line and accelerated methods over
the estimated useful lives of the assets.  The Company records depreciation for
office equipment and furniture using the straight-line method over five years
and for machinery and equipment modifications using the double declining balance
method over seven years.  The Company previously capitalized facility under
development costs in its property plant and equipment which represented
acquisition costs and development costs for the Milesburg project.  The
development costs included expenditures for professional services, salaries,
other direct costs and certain allocated indirect costs related to the Milesburg
project.  During 1997, the Company expensed its facility under development costs
when it sold the assets of the Milesburg project (See Note A).  The Company
periodically reviews its property plant and equipment and other long-term assets
for impairment and recognizes impairment losses in situations where the Company
estimates that it will not recover the carrying value of these assets.

  Receivable from Sale of Affiliate:  Receivable from sale of affiliate
represents the recognized portion of interest income and the purchase price
closing adjustment which remain uncollected from the Purchasers of SCA.
Beginning in April 1997, in order to present its financial statements
conservatively, the Company stopped recognizing interest income on the
Purchasers' notes receivable until the litigation with the Purchasers is
resolved (See Note P).  Furthermore, as discussed in Note A, the Company wrote
off the Purchasers' notes receivable and the remaining balance of the receivable
from sale of affiliate during 1998 to present its financial statements
conservatively. As of December 31, 1998 and 1997, the Company had aggregate
uncollected balances for interest and the purchase price closing adjustment due
from the Purchasers of $1,161,925 and $868,175, respectively.  The recognized
portion of such amounts which remained on the Company's Consolidated Balance
Sheets as of December 31, 1998 and 1997 was $-0- and $570,998, respectively.
During 1998, 1997 and 1996, the Company was entitled to interest income from the
Purchasers of $293,750, $293,750 and $293,750, respectively.  However, in light
of the Company's interest income reporting policy, the Company recorded interest
income from the Purchasers of $0, $73,236 and $293,750 during 1998, 1997 and
1996, respectively.

  Deferred Financing Costs:  In 1997 and 1995, the Company incurred deferred
financing costs of $139,925 and $300,000, respectively in connection with
restructuring certain debt related to the Scrubgrass Project.  Deferred
financing costs are being amortized over the respective lives of the related
debt which range from three to nine years (See Note E).  Accumulated
amortization related to deferred financing costs was $206,579 and $110,489 at
December 31, 1998 and 1997, respectively.

  Lease Rights:  Lease rights are recorded at cost and are being amortized over
the 22 year lease term related to the Scrubgrass facility.  Accumulated
amortization related to the lease rights was $670,545 and $521,541 at December
31, 1998 and 1997, respectively.

  Accrued Power Generation Revenue and Accrued Lease Expense:  As discussed in
Note A, the Company has entered into a long term agreement, to provide
electricity to PENELEC, which provides for scheduled rate increases.  In
accordance with generally accepted accounting principles, revenue has been
recorded on the straight-line basis over the 22 year lease term.  The accrual
for power generation revenue is limited to the amount of accrued lease expense,
as described below.  Therefore, no amount for the straight-lining of future
revenues, which would result in profits, has been provided for in the
Consolidated Financial Statements.  Accrued power generation revenue was
$41,386,500 and $33,362,389 at December 31, 1998 and 1997, respectively, and
represents that portion of revenue earned that has not yet been received.

     As discussed in Note A, the Company has entered into a long term lease
agreement for the Scrubgrass Project which provides for scheduled lease expense
increases.  In accordance with generally accepted accounting principles, the
scheduled lease expense has been recorded on the straight-line basis over the 22
year lease term.  



                                     F-13
<PAGE>
 
Accrued lease expense was $41,386,500 and $33,362,389 at December 31, 1998 and
1997, respectively, and represents that portion of lease expense that has not
yet been paid.

  Deferred Gain:  The sale of the Scrubgrass Project by the Company on December
28, 1990 was not treated as a sale for financial accounting purposes.  This was
originally due to the existence of an option which enabled the Company to
reacquire Buzzard and to lease the Scrubgrass Project for a substantial portion
of its commercial operation.  This option constituted a significant continuing
involvement by the Company which provided evidence that it had retained
substantial risks or rewards of ownership of the Scrubgrass Project.  In
December 1993, the Company agreed to a modification to the proposed form of
lease thereby relinquishing the fair market value purchase option. Accordingly,
the Company removed from the Consolidated Balance Sheet the gross assets and
liabilities of the Scrubgrass Project and recorded a deferred gain of $6,785,035
arising from the original sale of the Scrubgrass Project in 1990. The deferred
gain is being amortized over the 22 year minimum lease term, which commenced on
June 30, 1994. Accumulated amortization of the deferred gain at December 31,
1998 and 1997 was $1,387,848 and $1,079,437, respectively.

  Deferred Revenue:  Deferred revenue represents amounts received for power
generation from the Scrubgrass Project at rates in excess of forecasted rates as
set forth in the power sales agreement which are being deferred until earned.
As of January 1, 1996, the Company had deferred revenue of $3,064,965 which was
all earned during 1996.  There was no deferred revenue as of December 31, 1998
and December 31, 1997.

  Maintenance Reserve: The Company records the expense of major equipment
overhauls related to the Scrubgrass Project to a maintenance reserve on a
straight-line basis using management's best estimate of when the Company will
incur future cash outlays for the major equipment overhauls.  When the Company
incurs cash outlays for major equipment overhauls, they reduce maintenance
reserves and are funded substantially from scheduled deposits to restricted cash
accounts.

  Income Taxes:  The Company accounts for income taxes in accordance SFAS No.
109, "Accounting for Income Taxes".  This standard requires, among other things,
recognition of future tax benefits, measured by enacted tax rates, attributable
to deductible temporary differences between the financial statement and income
tax bases of assets and liabilities, and net operating loss carryforwards to the
extent that realization of such benefits is more likely than not.

  Earnings (Loss) Per Common Share:  In the fourth quarter of 1997, the Company
adopted SFAS No. 128, "Earnings per Share", which established new standards for
computing and presenting earnings per share ("EPS"). SFAS No. 128 replaced the
presentation of primary EPS with a presentation of basic EPS and fully diluted
EPS with diluted EPS.  The EPS data for all prior periods has been restated in
accordance with the provisions of SFAS No. 128.  The adoption of this statement
did not have a material impact on the Consolidated Financial Statements
presented herein.  The Company computes basic earnings (loss) per share by
dividing net income (loss) for the period by the weighted average number of
shares of common stock outstanding during the period.  For purposes of
calculating diluted earnings (loss) per share, the Company considers its shares
issuable in connection with stock options to be dilutive common stock
equivalents when the exercise price is less than the average market price of the
Company's common stock for the period. The following table outlines the
calculation of basic earnings (loss) per share and diluted earnings (loss) per
share for the years ended December 31, 1998, 1997 and 1996.


                                     F-14
<PAGE>
 
<TABLE>
<CAPTION>
                                                                Income                    Shares                Per Share
                                                              (Numerator)              (Denominator)             Amounts
                                                          ------------------      --------------------      ---------------
<S>                                                      <C>                     <C>                       <C>
Year Ended December 31, 1998:
-----------------------------
Loss available to shareholders                                   $(1,649,186)               11,406,783                $(.14)
Effect of dividends to preferred stockholders                         (5,000)
                                                          ------------------      --------------------      ---------------
Basic EPS - loss available to common shareholders                 (1,654,186)               11,406,783                 (.14)
Effect of dilutive securities:
     Assumed exercise of dilutive stock options
                                                          ------------------      --------------------      ---------------
Diluted EPS - loss available to common shareholders              $(1,654,186)               11,406,783                $(.14)
                                                          ==================      ====================      ===============
 
Year Ended December 31, 1997:
-----------------------------
Income available to shareholders                                 $ 4,613,863                11,120,893                $ .41
Effect of dividends to preferred stockholders                        (30,178)
                                                          ------------------      --------------------      ---------------
Basic EPS - income available to common shareholders                4,583,685                11,120,893                  .41
Effect of dilutive securities:
     Assumed exercise of dilutive stock options                                                138,972
                                                          ------------------      --------------------      ---------------
Diluted EPS - income available to common shareholders            $ 4,583,685                11,259,865                $ .41
                                                          ==================      ====================      ===============
 
Year Ended December 31, 1996:
-----------------------------
Income available to shareholders                                 $ 1,565,279                11,159,966                $ .14
Effect of dividends to preferred stockholders                        (25,178)
                                                          ------------------      --------------------      ---------------
Basic EPS  income available to common shareholders                 1,540,101                11,159,966                  .14
Effect of dilutive securities:
     Assumed exercise of dilutive stock options                                                126,320
                                                          ------------------      --------------------      ---------------
Diluted EPS - income available to common shareholders            $ 1,540,101                11,286,286                $ .14
                                                          ==================      ====================      ===============
</TABLE>
                                                                                
  As of December 31, 1998, there were outstanding options to purchase 20,000
shares of the Company's common stock which were not included in the computation
of diluted EPS because the Company had a loss in 1998.  The options expire in
2008.

     Stock Options:  Effective January 1, 1996, the Company adopted the
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation".  SFAS No. 123 defines a fair value method of accounting for the
issuance of stock options and other equity instruments.  Under the fair value
method, compensation is measured at the grant date based on the fair value of
the award and is recognized over the service period, which is usually the
vesting period.  Pursuant to SFAS No. 123, companies are encouraged, but not
required, to adopt the fair value method of accounting for employee stock-based
transactions.  Companies are also permitted to continue to account for such
transactions under Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", but would be required to disclose in a note to the
financial statements pro forma net income and per share amounts as if the
company had applied the new method of accounting.  SFAS No. 123 also requires
increased disclosures for stock-based compensation arrangements regardless of
the method chosen to measure and recognize compensation for employee stock-based
arrangements.  The Company has elected to continue to account for its stock
option transactions under the principles of Accounting Principles Board Opinion
No. 25 and has disclosed in Note L of its Consolidated Financial Statements the
pro forma net income and per share amounts as if the Company had applied the
provisions of SFAS No. 123.

  Segment Information: Effective January 1, 1998 the Company adopted SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information",
which modified current segment reporting requirements and established, for
public companies, criteria for reporting disclosures about their products and
services, geographic areas and major customers in annual and interim financial
statements. Under the guidelines established by SFAS No. 131, the Company
operates only in one business segment which pertains to the development and
operation of independent power facilities.



                                     F-15
<PAGE>
 
     New Accounting Standards: In June 1998, the Financial Accounting Standards
Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities".  SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. SFAS No. 133  requires that
entities recognize all derivative instruments as either assets or liabilities in
the statement of financial position and measure those instruments at fair value.
If certain conditions are met, a derivative instrument may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of an
asset or liability or an unrecognized firm commitment, or (b) a hedge to the
exposure to variable cash flows of a forecasted transaction.  The Lessor of the
Scrubgrass Project has entered into certain interest rate swaps with financial
institutions that may meet the definition of derivative instruments under SFAS
No. 133.  The Company will be required to adopt SFAS No. 133 by January 1, 2000
and is presently assessing whether the adoption of SFAS No. 133 will have any
impact on its Consolidated Financial Statements.

  Reclassifications: The Company made certain reclassifications to its 1997 and
1996 consolidated financial statements to conform to the presentation of the
1998 consolidated financial statements.

NOTE C -- OTHER CURRENT ASSETS

Other current assets consists of the following as of  December 31, 1998 and
1997:

<TABLE>
<CAPTION>
                                                                              1998                       1997
                                                                    ----------------------     ----------------------
<S>                                                                   <C>                        <C>
Interest receivable                                                               $    307                   $ 42,482
Fuel inventory                                                                     711,727                    730,060
Prepaid expenses                                                                   102,261                    101,605
Deposits                                                                             1,300                      1,675
Other                                                                                5,867                      6,116
                                                                    ----------------------     ----------------------
                                                                                  $821,462                   $881,938
                                                                    ======================     ======================
</TABLE>
                                                                                
NOTE D -- PROPERTY, PLANT AND EQUIPMENT

     Property, plant and equipment is recorded at cost less accumulated
depreciation and consists of the following as of December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                              1998                        1997
                                                                    ----------------------      ----------------------
Power generating facilities:
<S>                                                                   <C>                         <C>
     Machinery and equipment modifications - Scrubgrass                          $ 125,000                    $125,000
     Less: Accumulated depreciation                                                (48,475)                    (17,863)
                                                                    ----------------------     ----------------------
                                                                                    76,525                     107,137
                                                                    ----------------------      ----------------------
Office:
     Equipment and furniture                                                       122,599                     117,403
     Less: Accumulated depreciation                                               (104,369)                    (94,604)
                                                                    ----------------------     ----------------------
                                                                                    18,230                      22,799
                                                                    ----------------------      ----------------------
 
                                                                                 $  94,755                    $129,936
                                                                    ======================      ======================
</TABLE>
                                                                                
     On December 5, 1997, the Company disposed of its investment in the
Milesburg project prior to the construction phase of its development activities.
Prior to the asset disposition, the Company capitalized its Milesburg project
development costs in its property, plant and equipment.  See Note A for a
further discussion of the Milesburg project.

     During 1997 and 1996, the Company capitalized salary costs and indirect
costs aggregating $327,583 and $48,983, respectfully, for Milesburg project
development activities.  The indirect costs were allocated to the project
development activities based on overhead rates applied to direct salary costs
incurred for such activities.


                                     F-16
<PAGE>
 
NOTE E -- OTHER ASSETS
 
Other assets consists of the following as of December 31, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                                                              1998                       1997
                                                                    ----------------------     ----------------------
<S>                                                                <C>                        <C>
Scrubgrass Project receivables                                                    $268,125                   $258,648
Deferred financing costs - Note B                                                  233,346                    329,436
Note receivable and accrued interest due from officer                              118,222                    113,353
                                                                    ----------------------     ----------------------
                                                                                  $619,693                   $701,437
                                                                    ======================     ======================
</TABLE>
                                                                                
Scrubgrass Project receivables are deposits in connection with fuel reserves
under long term leases (See Note M).

NOTE F -- ACCOUNTS PAYABLE AND ACCRUED EXPENSES


<TABLE>
<CAPTION>
                                                                              1998                       1997
                                                                    ----------------------     ----------------------
<S>                                                                <C>                        <C>
Accounts payable                                                                $3,011,216                 $2,647,807
Accrued expenses                                                                 2,705,791                  2,556,616
Corporate taxes payable                                                            156,682                  1,120,639
                                                                    ----------------------     ----------------------
                                                                                $5,873,689                 $6,325,062
                                                                    ======================     ======================
</TABLE>
                                                                                
     Accounts payable at December 31, 1998 and 1997 includes $2,765,184 and
$2,424,236, respectively which are related to Scrubgrass Project operations.

     Accrued expenses at December 31, 1998 and 1997 includes $2,501,222 and
$2,502,583, respectively which are related to Scrubgrass Project operations.

NOTE G -- RETIREMENT PLAN

     Effective January 1, 1998 the Company established a non-contributory
defined benefit pension plan (the "Plan") covering all of its employees who are
at least 21 years of age and who have completed at least one year of service.
Under the Plan, the benefits payable to each employee at normal retirement age
are based on years of service and compensation during the three consecutive
years of the latest 10 years immediately preceding retirement which would yield
the highest monthly benefit payment.  Employees who have at least 20 years of
service at the time of their retirement would receive the maximum retirement
benefit.  The Company's general funding policy is to contribute annually to the
Plan the maximum amount that can be deducted for Federal income tax purposes.

     As of January 1, 1998, the commencement date for the Plan, the Company had
a projected benefit obligation of $871,130.  The projected benefit obligation as
of January 1, 1998 is being amortized as a prior service cost over 19 years
which represents the average future years of service for the participants in the
Plan at that date.

The following table sets forth the changes during 1998 in the projected benefit
obligation for the Plan:

<TABLE>
<CAPTION>
                                                                              1998
                                                                    ----------------------
<S>                                                               <C>
Projected benefit obligation, beginning of the year                               $871,130
Service cost                                                                        67,225
Interest cost                                                                       52,268
                                                                    ----------------------
Projected benefit obligation, end of the year                                     $990,623
                                                                    ======================
</TABLE>
                                                                                

                                     F-17
<PAGE>
 
The following table sets forth a reconciliation of the funded status of the Plan
as of December 31, 1998:

<TABLE>
<CAPTION>
                                                                              1998
                                                                    ----------------------
<S>                                                                <C>
Projected benefit obligation                                                     $ 990,623
Plan assets at fair value                                                               --
                                                                    ----------------------
Unfunded projected benefit obligation                                              990,623
Unrecognized prior service cost                                                   (825,281)
                                                                    ----------------------
Accrued pension cost                                                             $ 165,342
                                                                    ======================
</TABLE>
                                                                                
The amounts recognized in the balance sheet as of December 31, 1998 for the Plan
consist of:

<TABLE>
<CAPTION>
                                                                              1998
                                                                    ----------------------
<S>                                                                <C>
Accumulated benefit obligation                                                    $213,081
Intangible asset                                                                   (47,739)
                                                                    ----------------------
Accrued pension cost                                                              $165,342
                                                                    ======================
</TABLE>
                                                                                
     As of December 31, 1998, there were no assets in the Plan.  The Company
expects to make a contribution of $255,062 to the Plan prior to the due date for
filing its 1998 Federal income tax return.

The Company's net periodic pension cost for 1998 is comprised of the following
components.

<TABLE>
<CAPTION>
                                                                              1998
                                                                    ----------------------
<S>                                                                <C>
Service cost                                                                      $ 67,225
Interest cost                                                                       52,268
Amortization of prior service cost                                                  45,849
                                                                    ----------------------
Net periodic pension cost                                                         $165,342
                                                                    ======================
</TABLE>
                                                                                
     As of December 31, 1998, the projected benefit obligation, accumulated
benefit obligation and fair value of plan assets with accumulated benefit
obligations in excess of plan assets were $990,623, $213,081 and $0,
respectively.

The actuarial assumptions used in 1998 to determine the pension benefits for the
Plan were:

<TABLE>
<CAPTION>
                                                                              1998
                                                                    ----------------------
<S>                                                                              <C>
Weighted average discount rate                                                         5.5%
Expected long-term return on plan assets                                               5.0%
Weighted average rate of increase in compensation levels                               0.0%
</TABLE>
                                                                                
NOTE H -- OTHER CURRENT LIABILITIES

Other current liabilities consists of the following as of December 31, 1998 and
1997:

<TABLE>
<CAPTION>
                                                                              1998                       1997
                                                                    ----------------------     ----------------------
<S>                                                                <C>                        <C>
Scrubgrass working capital loan                                                 $2,389,664                 $2,311,666
Scrubgrass Project long-term credit facility - Note I                            1,550,000                    600,000
                                                                    ----------------------     ----------------------
                                                                                $3,939,664                 $2,911,666
                                                                    ======================     ======================
</TABLE>
                                                                                
     The Scrubgrass working capital loan represents outstanding borrowings under
a Lessee Working Capital Loan Agreement with the Lessor whereby the Lessor has
provided Buzzard with a $4 million line of credit for the ongoing working
capital requirements of the Scrubgrass Project.  The outstanding borrowings
under the Lessee Working Capital Loan Agreement incur interest at the LIBOR rate
plus 1.125% (6.19% as of December 31, 1998 and ranging from 6.19% to 7.26%
during 1998 and 6.56% to 7.12% during 1997).



                                     F-18
<PAGE>
 
NOTE I -- SECURED PROMISSORY NOTES PAYABLE AND OTHER BORROWINGS

Secured promissory notes payable and other borrowings consists of the following
as of December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                              1998                       1997
                                                                    ----------------------     ----------------------
<S>                                                                <C>                        <C>
Scrubgrass Project note payable                                                 $1,249,268                 $1,267,811
Scrubgrass Project long-term credit facility                                       600,000                  2,400,000
Sunnyside Project obligations                                                    1,017,316                  1,005,916
                                                                    ----------------------     ----------------------
                                                                                $2,866,584                 $4,673,727
                                                                    ======================     ======================
</TABLE>
                                                                                
     The Scrubgrass Project note payable represents the non-current portion of
an obligation which was incurred as part of the Lessor's debt restructuring in
December 1995, when Buzzard established a capital improvements fund and extended
the term of certain current liabilities through 2004.  The outstanding
borrowings under the Scrubgrass Project note payable incur interest at the LIBOR
rate plus 1.25% (6.31% as of December 31, 1998 and ranging from 6.31% to 7.38%
during 1998 and 6.69% to 7.25% during 1997).  During the second quarter of 1997,
the Lessor of the Scrubgrass Project assumed primary responsibility for the
disbursement of funds and repayment of debt related to the capital improvements
fund of the Scrubgrass Project.  Accordingly, restricted cash and secured
borrowings of approximately $1,220,000 were transferred from the financial
statements of the Company to the financial statements of the Lessor which
reduced the Scrubgrass Project note payable to $1,267,811.  The scheduled
aggregate annual repayments for the Scrubgrass Project note payable are $60,695
in 1999, $0 in 2000, $202,826 in 2001, $148,310 in 2002, $447,902 in 2003 and
$389,535 in 2004.

     On June 3, 1997, the Lessor of the Scrubgrass Project entered into a long-
term credit facility with its agent bank to provide the Scrubgrass Project with
up to $3 million to fund general debt service expenses when operating revenues
became unavailable as a result of the extended facility outage to perform a
complete rewind of the Scrubgrass generator. On July 1, 1998, the maximum
allowable borrowings under this credit facility began reducing in $600,000
increments every six months through July 3, 2000 when the credit facility will
expire.  The loan type (LIBOR-based, Certificate of Deposit rate-based or prime
rate based) and the interest period are elected by the Company.  As of December
31, 1998 and 1997, the Company had outstanding borrowings of $2,150,000 and
$3,000,000, respectively from the Lessor under this long-term credit facility
which incurred interest at LIBOR rates plus a 1.125% margin (6.19% as of
December 31, 1998 and ranging from 6.19% to 7.26% during 1998 and 6.56% to 7.12%
during 1997).  The maximum loan amount available to the Company during the term
of this agreement is the following:

     July 1, 1998 though January 3, 1999       2,400,000
     January 4, 1999 through June 30, 1999     1,800,000
     July 1, 1999 through December 30, 1999    1,200,000
     December 31, 1999 through July 2, 2000      600,000

     The Company considers reductions in the outstanding borrowings under this
long-term credit facility which are required within one year to be current
liabilities.  As such, the Company has classified $1,550,000 and $600,000 of
this obligation in its current liabilities as of December 31, 1998 and 1997,
respectively (See Note H).

     The Sunnyside Project obligations principally represent selling expenses in
connection with the sale of the Sunnyside Project which are payable upon receipt
of the principal proceeds from the notes receivable which were due by December
31, 1997.  The repayment of these obligations is contingent upon the outcome of
the litigation with the purchasers of the Sunnyside Project (See Notes A and P).



                                     F-19
<PAGE>
 
NOTE J -- INTEREST CAPITALIZED

Interest costs consists of the following for the years ended December 31, 1998,
1997, and 1996:

<TABLE>
<CAPTION>
                                                                        1998                1997                1996
                                                                  ---------------     ---------------     --------------
<S>                                                              <C>                 <C>                 <C>
Total interest costs incurred                                            $460,812            $437,948           $347,954
Amounts included in operations                                            460,812             424,395            336,449
                                                                  ---------------     ---------------     --------------
Amounts capitalized in development and construction of projects          $      0            $ 13,553           $ 11,505
                                                                  ===============     ===============     ==============
</TABLE>

     Total interest paid during the years ended December 31, 1998, 1997 and 1996
amounted to $455,146, $407,110 and $319,211, respectively.

     Interest costs incurred for each period presented do not include debt
service related to the Scrubgrass Project which is included in lease expense.

NOTE K -- INCOME TAXES

Income tax expense (benefit) consists of the following for the years ended
December 31, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                   1998                   1997                  1996
                                                          --------------------     -----------------     -----------------
<S>                                                      <C>                      <C>                   <C>
Current:
     Federal                                                       $       594            $  316,136            $   22,229
     State                                                             213,268               772,888               168,682
                                                          --------------------     -----------------     -----------------
                  Total current tax expense                            213,862             1,089,024               190,911
                                                          --------------------     -----------------     -----------------
 
Deferred:
     Federal                                                          (838,439)            2,925,237               879,370
     State                                                            (170,368)               89,423               823,754
                                                          --------------------     -----------------     -----------------
                 Total deferred tax expense (benefit)               (1,008,807)            3,014,660             1,703,124
 
                                                                   $  (794,945)           $4,103,684            $1,894,035
                                                          ====================     =================     =================
</TABLE>

     A reconciliation between the actual income tax expense (benefit) and the
income tax expense (benefit) computed by applying the statutory federal income
tax rate to the income (loss) before income taxes, for the years ended December
31, 1998, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                                   1998                  1997                  1996
                                                          -------------------     -----------------     -----------------
<S>                                                         <C>                     <C>                   <C>
Federal tax expense at 34%                                          $(831,005)           $2,963,966            $1,176,167
State tax expense, net of federal tax benefit                          28,315               569,124               655,008
Tax basis difference related to original investment in
 Milesburg project assets                                                 ---               568,311                   ---
 
Deferred compensation                                                     ---                   ---                60,471
Nondeductible portion of  meals and entertainment                       3,525                 1,659                 1,873
Other                                                                   4,220                   624                   516
                                                          -------------------     -----------------     -----------------
                                                                    $(794,945)           $4,103,684            $1,894,035
                                                          ===================     =================     =================
</TABLE>

     In 1997, the Company's state income tax expense was substantially all
current because the Company's taxable income was incurred in states where the
Company did not have available net operating loss carryforwards.  In 1996, the
Company's deferred state income tax expense includes a charge of $205,382
related to state net operating loss carryforwards which had expired.  In
addition, as of December 31, 1996, the Company had estimated that it would not
realize all of the recorded tax benefits of its state net operating loss
carryforwards and 


                                     F-20
<PAGE>
 
accordingly, had provided a valuation allowance in the amount of $299,745 in its
1996 provision for deferred state income taxes.

     Total income taxes paid during the years ended December 31, 1998, 1997 and
1996 amounted to $1,187,057, $159,906 and $91,527, respectively.

The components of the net deferred income tax asset as of December 31, 1998 and
1997 are as follows:

<TABLE>
<CAPTION>
                                                                                1998                     1997
                                                                       --------------------     ---------------------
Deferred tax assets:
<S>                                                                    <C>                      <C>
     Accrued lease expense                                                      $16,800,187               $13,542,928
     Accrued expenses                                                               733,947                   631,559
     Deferred tax effect of the sale of the Scrubgrass Project for
      which the gain was deferred for financial reporting purposes                1,076,985                 1,138,548
     Capital loss carryforwards                                                      96,550                    96,550
     State net operating loss carryforwards                                          20,509                    10,788
     Federal alternative minimum tax credit carryforwards                            26,182                   161,362
     Reserve for non-recovery of certain project costs not currently
          deductible for income tax purposes                                            ---                    70,711
                                                                       --------------------     ---------------------
                                                                                 18,754,360                15,652,446
                                                                       --------------------     ---------------------
Deferred tax liabilities:
     Accrued power generation revenue                                            16,800,187                13,542,928
     Defined benefit pension plan contribution                                       34,650                       ---
     Installment sale-Sunnyside                                                         ---                 1,198,801
     Other                                                                           92,962                    92,962
                                                                       --------------------     ---------------------
                                                                                 16,927,799                14,834,691
                                                                       --------------------     ---------------------
                                                                                $ 1,826,561               $   817,755
                                                                       ====================     =====================
</TABLE>

     As of December 31, 1998, the Company has remaining state net operating loss
carryforwards of $621,473 which expire in 2013 and alternative minimum tax
credit carryforwards of $26,182 which do not expire and can be credited against
future regular taxes to the extent they exceed alternative minimum taxes.

NOTE L -- SHAREHOLDERS' EQUITY

   Stock Options

     The Company has reserved 405,000 shares of common stock for issuance upon
exercise of stock options which are outstanding or may be granted under the
Company's 1993 Director Plan.  The options granted under the 1993 Director Plan
were intended to constitute non-qualified options principally at an option price
of 100 percent of the fair market value of the common stock on the date of the
grant.  All options are fully vested at the date of grant and expire on the 10th
anniversary of the date of grant.  As of December 31, 1998, the Company has
options for 385,000 shares available for grant under the 1993 Director Plan.

The following table summarizes information about the Company's options
outstanding as of December 31, 1998:

<TABLE>
<CAPTION>
                                   Outstanding         Weighted-Average
           Exercise                    and                 Remaining
            Price                  Exercisable         Contractual Life
---------------------------------------------------------------------------
 
<S>                               <C>                 <C>
$     1.688                          10,000               9.42 years
      1.500                          10,000               9.50 years
---------------------------------------------------------------------------
 
$     1.594                          20,000               9.46 years
===========================================================================
</TABLE>


                                     F-21
<PAGE>
 
Stock option transactions during 1998, 1997 and 1996 are summarized as follows:

<TABLE>
<CAPTION>
                                                                               Options Outstanding
                                                                     -------------------------------------
                                                                           Shares               Price
                                                                     ---------------     -----------------
<S>                                                                 <C>                 <C>
     Balance at January 1, 1996                                              340,000         $ .14 - .5625
     Options granted                                                          60,000          .6875 - 1.00
     Options exercised                                                       (50,000)          .14 - .4375
                                                                     ---------------     -----------------
     Balance at December 31, 1996                                            350,000           .25 -  1.00
     Options granted                                                          30,000         .6875 - .8125
     Options exercised                                                      (330,000)          .25 - .9375
                                                                     ---------------     -----------------
     Balance at December 31, 1997                                             50,000           .25 -  1.00
     Options granted                                                          30,000          1.50 - 1.688
     Option surrendered                                                      (60,000)          .25 - 1.625
                                                                     ---------------     -----------------
     Balance at December 31, 1998                                             20,000         $1.50 - 1.688
                                                                     ===============     =================
</TABLE>

     Under the provisions of Accounting Principles Board Opinion ("APB") No. 25,
the Company does not recognize compensation expense for stock option awards
since the underlying options have exercise prices equal to 100 percent of the
fair market value of the common stock on the date of grant (110 percent of the
fair market value in the case officers or other employees holding 10% or more of
the Company's common stock for the 1990 plan).  However, pursuant to the
provisions of SFAS No. 123, the Company is required to calculate the fair market
value of its stock options using different criteria from the provisions of APB
No. 25. Using the fair market value criteria required by SFAS No. 123 to
calculate compensation expense on stock options granted during 1998, 1997 and
1996, the Company would have incurred proforma net loss of $1,657,178 and
proforma net loss per share of $.15 in 1998, proforma net income of $4,608,669
and proforma net earnings per share of $.41 in 1997, and proforma net income of
$1,549,676 and proforma net income per share of $.14 in 1996.

     The estimated fair market values of the Company's options granted during
1998, 1997 and 1996 were $.59 per share, $.33 per share and $.43 per share,
respectively.  The fair market values were calculated using the Binomial Option
Pricing Model with the following assumptions:

<TABLE>
<CAPTION>
                                                        1998             1997             1996
                                                 -------------------------------------------------
<S>                                                <C>             <C>               <C>
Dividend yield                                              8%               12%             12%
Risk free rate of return                                 5.99%             5.99%           5.99%
Expected useful life                                   5 years           5 years         5 years
Expected stock volatility rate                          59.27%            52.54%         104.65%
</TABLE>

     Dividends

     During 1996, the Company initiated a quarterly dividend program which is
subject to review and consideration by the Board of Directors each quarter.  In
respect of this dividend program, the Company declared dividends of 3 cents per
share during each of the quarters during 1996 and 1997.  During 1998, the
Company declared dividends of 3 cents per share during the first and second
quarters and dividends of 1.5 cents per share during the third and fourth
quarters.  The Company also declared special dividends of 2 cents per share in
1996 out of operating profits and 87 cents per share in 1997 out of the proceeds
from the Milesburg settlement (See Note A). Therefore, the Company declared
aggregate dividends of 14 cents per share in 1996, 99 cents per share in 1997
and 9 cents per share in 1998.

     During 1997 and 1998, the Company also paid dividends to its subsidiary's
preferred stockholder in the amount of $30,178 and $5,000, respectively.  The
preferred stockholder, entitled to cumulative dividends of $5,000 per year since
December 1991, was paid its cumulative dividends through 1996 of $25,178 during
the second quarter of 1997.  Beginning in 1997, the Company paid its
subsidiary's preferred stockholder dividends at a rate of 



                                     F-22
<PAGE>
 
$1,250 per quarter. Upon dissolution or liquidation of the Company, the
preferred stockholder has a liquidation preference to receive $500 per share,
plus any cumulative unpaid dividends, prior to the distribution of any remaining
assets to common shareholders.

     Other Equity Transactions

     During 1993 the Company issued 594,356 shares of restricted common stock to
executive officers.  The shares were subject to a three year vesting period
based upon continued employment through November, 1996. The Company incurred
unearned compensation for the market value of the restricted common stock when
the shares were issued and amortized the unearned compensation ratably over the
restricted period.  During 1996, the Company amortized unearned compensation of
$66,941 in the Consolidated Statement of Operations.  There was no amortization
of unearned compensation in 1997 and 1998.

     The Company has notes receivable from officers and directors for shares
purchased in connection with the Company's 1990 Stock Plan and 1993 Directors'
Plan which amounted to $809,731 at both December 31, 1998 and 1997,
respectively, and which are classified as a reduction of shareholders' equity.
The notes are payable upon demand and bear interest at a floating rate which is
payable monthly.  The Company has collected all of the interest payable by the
officers and directors on these notes receivable through December 31, 1998.

     In March 1996, the Company purchased 520,540 shares of common stock from a
resigning executive officer for $287,876 representing all of the officer's
holdings in the Company.  The Company's note receivable from the officer in the
amount of $72,876 was collected by reducing the proceeds paid to the officer for
the common stock.

NOTE M -- COMMITMENTS

   Corporate

     The Company is obligated to make payments under various operating leases
for office space and automotive vehicles.  The Company is also obligated under
leases or other agreements relating to the Scrubgrass Project (see Note A).

     Future minimum payments due under non-cancelable leases in effect at
December 31, 1998, are as follows:

                 1999                                  $    50,594
                 2000                                       50,834
                 2001                                       30,585
                 2002                                        1,560
                                                    --------------
                 Total                                 $   133,573 
                                                    ==============

Rent expense totaled $42,787, $38,844 and $44,868 in 1998, 1997 and 1996,
respectively.


                                     F-23
<PAGE>
 
   Scrubgrass Project

     Pursuant to the lease agreement for the Scrubgrass Project the Company is
obligated to make estimated minimum lease payments at December 31, 1998, over
the remaining 17.5 year base term of the lease as follows:

                 1999                                 $ 13,662,000
                 2000                                   14,392,000
                 2001                                   13,967,000
                 2002                                   14,884,000
                 2003                                   16,306,000
              Thereafter                               343,160,000
                                                  ----------------
                Total                                 $416,371,000 
                                                  ================

Lease expense in 1998, 1997 and 1996 was $22,971,201, $24,488,005 and
$24,792,248, respectively.

In addition, the Company has been assigned various long-term noncancelable
obligations under contractual agreements for fuel handling and excavation,
limestone supply, and waste disposal. The contractual terms are generally for 5
to 15 years and provide for renewal options.

Future minimum payments due under these noncancelable obligations at December
31, 1998 are as follows (See Notes A and E):


                 1999                                  $   715,000
                 2000                                      744,000
                 2001                                      773,000
                 2002                                      165,000
                 2003                                      171,000
               Thereafter                                  958,000
                                               -------------------
                 Total                                 $ 3,526,000 
                                               ===================

NOTE N -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

     The Company's financial instruments primarily consist of cash and cash
equivalents, restricted cash, receivable from utility, receivable from sale of
affiliate, note receivable from the Scrubgrass Project, notes receivable from
the Sunnyside Project, accounts payable, Lessee working capital loan and several
long-term debt obligations.  As of December 31, 1998 and 1997, the carrying
amounts for cash and cash equivalents, restricted cash, receivable from utility,
note receivable from the Scrubgrass Project, accounts payable and Lessee working
capital loan approximate fair value because of the short maturity of these
instruments. As of December 31, 1998 and 1997, the carrying amounts for the
long-term debt obligations also approximate fair value because such obligations
incur interest at variable rates.  As of December 31, 1998, as discussed in Note
A, the receivable from sale of affiliate and the notes receivable from the
Sunnyside Project were written-off since the Company cannot reasonably estimate
their fair market values. As of December 31, 1997, the fair market values for
the receivable from sale of affiliate and the notes receivable from the
Sunnyside Project approximated their carrying values.

NOTE O -- SUBSEQUENT EVENTS

     During December 1998 and January 1999, Buzzard entered into contracts to
sell a portion of its anticipated future Nitrogen Oxide Ozone Transport Region
Budget Allowances ("NOx Credits").  Each year, the Environmental Protection
Agency and the Pennsylvania Department of Environmental Protection (the
"Regional Authorities") grant NOx Credits to Buzzard based on numerous factors
which pertain to the design and operation of the Scrubgrass facility. The NOx
Credits establish the quantity (in tons) of nitrogen oxide that the Scrubgrass
facility can emit into the environment before Buzzard will be fined by the EPA.
During 1999, Buzzard plans to install machinery, with a cost of 


                                     F-24
<PAGE>
 
approximately $600,000, which is expected to significantly lower the quantity of
nitrogen oxide which the Scrubgrass facility would emit into the environment. As
such, Buzzard anticipates that it may not require a portion of its future NOx
Credits to maintain its compliance with EPA standards. Because NOx Credits are
transferable and marketable, Buzzard has contracted to sell 839 tons of its
projected available NOx Credits which it anticipates may not be required to
comply with EPA standards. Under the terms of the contracts, Buzzard would
receive payment for the NOx Credits within 15 business days from the date the
NOx Credits become certified and allocated by the Regional Authorities and
delivered by Buzzard to the buyers. The contracts also have provisions which
protect Buzzard in the event the NOx Credits are not certified and allocated by
the Regional Authorities.

The following table sets forth the details of NOx Credits which are subject to
sales contracts:

<TABLE>
<CAPTION>
     Allowance            Expected                  Allowance      Net Selling       Net Selling
       Year            Allocation Date              Quantity      Price per Ton         Price
----------------------------------------------------------------------------------------------------
<S>                 <C>                           <C>           <C>               <C>
        1999          Early 1999                    182 tons         $3,460        $  629,720
        1999          Mid to Late 1999               86 tons          4,075           350,450
        1999          Mid to Late 1999               25 tons          3,955            98,875
        2000          Late 1999/Early 2000          182 tons          2,128           387,296
        2001          Late 1999/Early 2000          182 tons          2,128           387,296
        2002          Late 1999/Early 2000          182 tons          2,128           387,296
                                               ------------------------------------------------------
                                                    839 tons         $2,671        $2,240,933
                                               ======================================================
</TABLE>


     In February 1999, the Regional Authorities certified and allocated 182 tons
of NOx Credits to Buzzard at which time Buzzard received and reported as revenue
$629,720.  Buzzard has designated that $600,000 of such proceeds be used to
purchase and install the machinery discussed above.

     In February 1999, Duquesne Light Company ("Duquesne") filed an appeal with
the Pennsylvania Environmental Hearings Board pertaining to the NOx Credits
allocated to Buzzard and several other Pennsylvania waste coal independent power
producers.  In this appeal, Duquesne alleges that the Pennsylvania Department of
Environmental Protection ("PADEP") inappropriately allocated certain NOx Credits
to Buzzard and the other waste coal independent power producers.  If Duquesne is
successful in this matter, the PADEP could change its methodology for allocating
NOx Credits to waste coal independent power producers in the future.  Presently,
Buzzard is participating with the other waste coal independent power producers
in a joint rebuttal to this matter.

NOTE P -- LEGAL PROCEEDINGS

     On October 11, 1995, the Lessor and Buzzard (collectively the "Plaintiffs")
filed a complaint against PENELEC in the Court of Common Pleas of Venango
County, Pennsylvania (the "Court") seeking damages for certain alleged breaches
of the power purchase agreement entered into between Scrubgrass Power
Corporation, a predecessor to the Plaintiffs, and PENELEC on August 7, 1987.  In
its complaint, the Plaintiffs allege that PENELEC has failed to pay contract
rates for energy produced by the Scrubgrass facility in excess of 80 MW in any
hour, that PENELEC has misused certain automatic regulation equipment and that
PENELEC has caused the Plaintiffs to incur losses from its late payment for
energy purchased from the Scrubgrass facility. As a result of PENELEC's alleged
failure to pay contract rates for energy produced by the Scrubgrass facility in
excess of 80 MW in any hour, the Plaintiffs estimate that as of December 31,
1998, after giving effect to certain payments made by PENELEC which are
discussed below, they have incurred damages of approximately $3 million. Should
the Plaintiffs prevail in this litigation and be awarded all of these damages,
the Company, as Lessee, would expect to retain 50% of these damages because of
its requirement to pay 50% of any net proceeds retained by the Scrubgrass
Project to the Lessor as additional rent. The Plaintiffs have yet to quantify
their damages from PENELEC's alleged late payments for energy purchased from the
Scrubgrass facility but do not expect that these damages would be material
relative to the other allegations. The Plaintiffs are unable to quantify the
damages they have incurred from PENELEC's alleged misuse of certain automatic
regulation equipment.  From October 1995 to September 1996, this legal
proceeding was stayed informally by a letter agreement between the parties.
Pursuant to the 


                                     F-25
<PAGE>
 
letter agreement, PENELEC, which had previously not made any payments for the
energy it received in excess of 80 MW in any hour, agreed to pay for all energy
in excess of 80 MW in any hour, both previously received and to be received in
the future, at a rate equal to 90% of a market based rate, subject to
reimbursement based on the ultimate determination of PENELEC's responsibility to
pay for such energy and the applicable rate therefor. Through December 31, 1998,
the Scrubgrass Project has recognized cumulative power generation revenues of
approximately $1,678,247 million for energy in excess of 80 MW in any hour based
on the terms established in the letter agreement. On September 27, 1996, the
Plaintiffs provided written notice of their intention to resume the litigation.
Consequently, on October 24, 1996, PENELEC filed preliminary objections to the
complaint to the Court which principally suggested that the primary jurisdiction
for this dispute lies with the Pennsylvania Public Utility Commission ("PUC").
On November 12, 1996, the Plaintiffs filed a response to PENELEC's preliminary
objections. The Court heard oral arguments on this matter on January 31, 1997
for which the Court ultimately decided in favor of the Plaintiffs on September
9, 1997 by denying PENELEC's motion to transfer the jurisdiction of this dispute
to the PUC. On January 8, 1998, as a result of this ruling by the Court, PENELEC
filed its response to the allegations made in the Plaintiffs' complaint. On
February 4, 1998, the Plaintiffs filed a Motion for Partial Judgment on the
Pleadings which was heard by the Court on March 30, 1998. On June 8, 1998, the
Venango County Court of Common Pleas ruled in favor of the Plaintiffs that,
under the terms and conditions of the Scrubgrass power purchase agreement,
"PENELEC is required to purchase all energy produced in good faith, so long as
the quantity is not unreasonably disproportionate to estimate of 80 MW".
Presently, pending the ultimate determination of its responsibility under the
power purchase agreement, PENELEC continues to pay for energy in excess of 80 MW
at a rate equal to 90% of a market based rate. The Plaintiffs had been in
discussions with PENELEC concerning a proposal made by PENELEC to settle the
litigation. However, because the Plaintiffs and PENELEC could not come to a
mutual agreement on all of the terms of the proposal, PENELEC withdrew its
proposal offer in July 1998 and settlement discussions dissipated. On July 7,
1998, PENELEC filed an appeal to the Court's order dated June 8, 1998 with the
Superior Court of Pennsylvania. On July 27, 1998, the Plaintiffs filed with the
Superior Court of Pennsylvania a Motion to Quash the Appeal. On September 4,
1998, the Superior Court of Pennsylvania granted the Plaintiff's Motion to Quash
the Appeal. Since the decision of the Superior Court of Pennsylvania, PENELEC
has indicated its desire to resume settlement discussions. On November 12, 1998,
the Plaintiffs and PENELEC met to discuss possible settlement scenarios. At the
time of the meeting, the parties were in essential agreement on the amount
currently due assuming the correctness of the Court's Order of June 8, 1998. The
primary matter discussed at the meeting was the manner of calculating future
payments for power in excess of 80 MW. At the meeting, PENELEC made a proposal
which was taken into consideration by the Plaintiffs. On December 21, 1998, the
Plaintiffs counterproposed with an alternative to the PENELEC proposal. To date,
the Plaintiffs have not received a response from PENELEC regarding their
counterproposal. The Company is unable to predict whether a settlement will
ultimately be reached. However, because PENELEC's November 12, 1998 calculation
of the amount due to the Plaintiffs pursuant to the Court's ruling was similar
to the Plaintiffs' calculation, it is currently believed that the prospect of a
final settlement of all outstanding issues is good. In the event such a
settlement is not reached, the litigation will resume, and a final adjudication
of the of the amount due from PENELEC to the Plaintiffs will be sought.

     On May 3, 1996, B&W Sunnyside L.P., Babcock & Wilcox Investment Company,
NRG Sunnyside Inc., NRG Energy Inc., and Sunnyside Cogeneration Associates
(collectively the "Plaintiffs") filed a complaint, which was amended on June 27,
1996 and December 21, 1998, against EPC and three of its wholly-owned
subsidiaries (collectively hereafter "the Company") in Seventh District Court
for Carbon County, State of Utah (the "Court").  The second amended complaint
alleges that the Company breached the purchase and sale agreement by which the
Company transferred all of its interest in Sunnyside Cogeneration Associates
("SCA"), a joint venture which owned and operated a nominal 51 megawatt waste
coal fired facility located in Carbon County, Utah.  The second amended
complaint also alleges that the Company made certain misrepresentations in
connection with the purchase and sale agreement.  As a result of the alleged
breaches of contract and misrepresentations, the Plaintiffs allege that they
suffered damages in an unspecified amount that exceed the aggregate outstanding
principal and interest balances due to the Company by B&W Sunnyside L.P. and NRG
Sunnyside, Inc. under certain notes receivable, which amounted to $2,937,500 and
$808,818, respectively at December 31, 1998.  In addition to alleging
unspecified damages, the Plaintiffs also request rescission of the purchase and
sale agreement.  On January 21, 1999, in response to the Plaintiffs' second
amended complaint, the Company filed an answer and restatement of its earlier
counterclaim dated July 26, 1996.  In the answer to the second amended
complaint, the Company denied all material allegations of the second amended
complaint and asserted numerous affirmative defenses.  In the restated
counterclaim, the Company alleges numerous causes of action against the
Plaintiffs which include breach 


                                     F-26
<PAGE>
 
of contract, breach of the promissory notes, intentional, malicious and willful
breach of contract, intentional tort, interference and misrepresentation.
Through the restated counterclaim, the Company seeks remedies which include: (1)
compensatory, consequential and punitive damages; (2) acceleration and immediate
payment in full of the promissory notes; and (3) injunctions which require the
Plaintiffs to continue making payments under the promissory notes during the
pendency of this action and until the promissory notes are paid in full and
which enjoin the Plaintiffs from continuing certain malicious and intentional
actions that are alleged in the counterclaim, together with interest, reasonable
attorney's fees, costs and other such relief as the court deems proper. On
February 12, 1999, the Plaintiffs responded to the restated counterclaim whereby
they denied all material allegations of the restated counterclaim and asserted
numerous affirmative defenses. The Company plans to vigorously defend against
the second amended complaint and vigorously pursue the causes of action in the
restated counterclaim. On April 15, 1998, the Company filed a Motion for Summary
Judgment with Respect to Claims Regarding the Power Purchase Agreement, seeking
dismissal of a portion of the Plaintiffs' claims. On June 5, 1998, the Company
received the Plaintiffs' response to its Motion for Summary Judgment with
Respect to Claims Regarding the Power Purchase Agreement wherein the Plaintiffs
stated their opposition to such motion. The Company and the plaintiffs appeared
in Court on November 19, 1998 to present oral arguments on the Company's Motion
for Summary Judgment with Respect to Claims Regarding the Power Purchase
Agreement. The Court has not yet rendered a decision on such motion. On February
12, 1999, the Plaintiffs moved for leave of the Court to file an amended third
complaint which would omit rescission of the purchase and sale agreement as a
remedy to their second amended complaint. On February 25, 1999, the Company
filed a stipulation with the Court accepting the Plaintiffs motion to file an
amended third complaint. The parties are presently awaiting the Court's grant of
the leave. On February 12, 1999, the Plaintiffs also filed a Motion for Partial
Summary Judgment wherein the Plaintiffs allege that the Company misrepresented
whether SCA had a basis to make legal claims as of December 31, 1994 against
Pacificorp, the utility purchasing energy from the Sunnyside facility.
Presently, the Company is preparing a response to the Plaintiffs' Motion for
Partial Summary Judgment. Discovery remains ongoing.

 
                                     F-27