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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB/A
(MARK ONE)
(X) ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 0-10238
U.S. ENERGY SYSTEMS, INC.
(Name of Registrant in its Charter)
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<TABLE>
<S> <C>
DELAWARE 52-1216347
(State of Incorporation) (I.R.S. Employer
Identification Number)
515 N. FLAGLER DRIVE
SUITE 702
WEST PALM BEACH, FL 33401 (561)820-9779
(Address of Registrant's principal executive (Issuer's telephone number, including area code)
offices)
</TABLE>
Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities Registered pursuant to Section 12(g) of the Act:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
Common Stock, par value $.01 per share Nasdaq SmallCap Market
Warrants Nasdaq SmallCap Market
</TABLE>
Check whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12
months (or for a 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 [ ]
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained herein, and will not be contained, to the best of the
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB [X].
Revenue for the Fiscal Year ended January 31, 1998: $2,233,000.
The aggregate market value of the Common Stock held by nonaffiliates
computed by reference to the average bid and asked price of the Common Stock of
the registrant as of April 22, 1998 was approximately $8,324,504.
Check whether issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act. [X].
As of April 22, 1998 the number of outstanding shares of the registrant's
Common Stock was 5,160,609.
Transitional Small Business Disclosure Format (check one): Yes [X] No [ ]
Documents Incorporated by Reference: The Company intends to file the
registrant's Definitive Proxy Statement for its 1998 Annual Meeting of
Stockholders with the Securities and Exchange Commission not later than 120 days
after the end of the fiscal year covered by this Form 10-KSB pursuant to Rule
E(3) of the General Instructions for Form 10-KSB. Information from such
Definitive Proxy Statement will be incorporated by reference into Part III,
Items 10, 11 and 12 hereof.
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PART I
This Form 10-KSB contains certain "forward-looking statements" which
represent the Company's expectations or beliefs, including, but not limited to,
statements concerning industry performance and the Company's operations,
performance, financial condition, growth and strategies. For this purpose, any
statements contained in this Form 10-KSB that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
generality of the foregoing, words such as "may," "will," "expect," "believe,"
"anticipate," "intend," "could," "estimate" or "continue" or the negative or
other variations thereof or comparable terminology are intended to identify
forward-looking statements. These statements by their nature involve substantial
risks and uncertainties, certain of which are beyond the Company's control, and
actual results may differ materially depending on a variety of important factors
which are noted herein, including but not limited to the potential impact of
competition, changes in local or regional economic conditions, the ability of
the Company to continue its growth strategy, dependence on management and key
personnel, supervision and regulation issues and an inability to find financing
on terms suitable to the Company.
ITEM 1. DESCRIPTION OF BUSINESS
THE COMPANY
GENERAL
U. S. Energy Systems, Inc. (the "Company") is composed of two separate but
complementary divisions: (1) the Energy Division, which develops, owns and
operates cogeneration and independent energy facilities, and (2) the
Environmental Division, which furnishes environmental consulting and remediation
services, recovers and recycles used motor and industrial oil, and processes
waste water.
The Company was originally incorporated in the state of Delaware in 1981
under the name Cogenic Energy Systems, Inc. In late 1986, the Company was
impaired by a $2.1 million judgment resulting from a contractual dispute in
California. Although ultimately settled, the protracted court case caused
serious delays in planned expansion and in sales, resulting in a serious cash
shortage. In mid-1989, the Company filed for protection under Chapter 11 of the
Bankruptcy Code. Utility Systems Florida, Inc. ("USF"), a Company controlled by
Richard H. Nelson, one of the original founders of the Company, proposed a plan
of reorganization (the "Plan") for the Company, and upon approval of the Plan,
was merged into the Company in 1993, with the resulting entity being renamed
U.S. Envirosystems, Inc. On May 17, 1996, the Company changed its name to U.S.
Energy Systems, Inc.
ENERGY DIVISION
The Company's Energy Division is engaged in the independent power plant
("IPP") industry as a project developer, owner and operator. IPPs produce
electricity for sale to either direct end users or to regulated public electric
utility companies ("Regulated Electric Companies"). In recent years, federal and
state laws have been promulgated to eliminate the monopoly previously held by
Regulated Electric Companies over the production and sale of electric power in
order to enhance competition among electricity providers. The result has largely
been the emergence of IPPs.
The Company believes that the power production industry is in the midst of
a twofold change in direction. The first is the desire for increased
competition, thereby producing savings to the consumer. The second is the effort
to produce power with less negative effects on the environment.
To increase competition, in April 1996, the Federal Energy Regulatory
Commission ("FERC") ordered all Regulated Electric Companies to open their
transmission lines to IPPs, thus allowing the wholesale purchase of power by
Regulated Electric Companies from distant independent producers ("wholesale
wheeling"). Wholesale wheeling typically allows Regulated Electric Companies to
purchase electricity from IPPs cheaper and more efficiently than they would be
able to produce on their own. Often, these savings can be passed on to the end
users. While federal regulation does not mandate that the transmission lines be
opened
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for sale of power by IPPs directly to retail end users ("retail wheeling," which
is similar in concept to competition among long distance telephone service
providers) many states have adopted such regulations, and others are expected to
adopt them in the near future.
The Company believes that efforts to produce power which create less
pollution than traditional fossil fuel-burning engines and turbines, and
conserves the earth's depleting non-renewable energy sources, have become an
important issue over the last decade. One such method of producing power through
"environmentally-friendly" means is cogeneration. Cogeneration is the production
of two or more energy forms (typically electricity and heat) simultaneously from
the same fuel source. While producing electricity in a cogenerating system, heat
that is otherwise wasted is recovered from the exhaust and/or engine coolants.
This recovered heat can be used to replace heat which would otherwise be
generated by conventional furnaces and boilers.
Environmentally-friendly power production is also achieved by utilizing
renewable fuel sources such as geothermal, wind, solar, hydro, and waste
products, including waste oil, waste wood and other biomass, or landfill gas.
The Company's acquisition of the two operating geothermal power plants known as
Steamboat 1 and 1A, in Steamboat Hills, Nevada, provided its initial entry into
this area of power production in December 1996.
Geothermal power is considered to be one of the most environmentally-sound
methods of producing electricity because (1) there are virtually no atmospheric
emissions or pollutants in the process, (2) the natural resource (water) is
constantly returned to the earth to avoid depletion of the underground aquifer
water table, and (3) the heat source is the earth's natural magma layer rather
than the conversion of a depletable fossil fuel. Geothermal power can be
produced only where specific geological formations exist.
Further use of geothermal resources by the Company to produce energy is
expected to occur in the development of the Reno Energy Geothermal Heating
District project in Reno, Nevada ("Reno Energy"). Reno Energy will use
geothermal steam to heat fresh water in a contained "loop" which will be used
for space heating and cooling in the Reno, Nevada area. In its initial phase,
Reno Energy is scheduled to pump geothermally-heated hot water to an industrial
park located in South Meadows, Nevada, and to the Damonte Ranch development,
also located in South Meadows, Nevada (the "Phase I Facilities"). The Phase I
Facilities are located within a three mile radius of Reno, Nevada, and comprise
approximately 40 million square feet of indoor heating requirements. The Company
believes that Reno Energy, which is scheduled for mid-1999 completion, will be
one of the largest district heating facilities in the United States.
ENVIRONMENTAL DIVISION
The acquisition of American Enviro-Services, Inc. in Newburgh, Indiana
("AES") in August 1997 marked the expansion of the Company into the
environmental services field and the establishment of its Environmental
Division. While separate from the Company's energy operations, the Environmental
Division serves several complementary needs of the Company, such as
environmental consultation and the recovery and recycling of waste motor oils
which can be used to fuel the Company's generators. The Company plans to utilize
these synergistic services of its Environmental Division in its energy
operations, but also plans to expand this area of its business through internal
growth and acquisitions. The Company believes that the environmental services
field is an industry with immense growth potential, and one in which the Company
can create a profitable market niche. The Company expects that AES, and its
management team of business-oriented scientists, will be the nucleus for the
Company's growth in this area.
AES, from its beginnings as a waste oil recycler, has become a primary
supplier of a broad range of environmental services in mid-western United
States, including environmental assessments, emergency response and
environmental remediation. AES currently contracts with over 1,100 companies for
the recovery, hauling and recycling of industrial waste oil and water. AES also
contracts with local, state and federal governmental agencies and commercial
businesses for the cleanup and remediation of oil spills and leaks, Phase I, II
and III environmental assessments, environmental emergency response services,
and other environmental and environmentally-related services. At its facilities,
AES is able to convert otherwise hazardous substances into environmentally and
ecologically sound fuel; and soil and water that has been
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polluted is removed and cleaned. The result of AES' work, similar to that of the
Company's Energy Division, is a cleaner, less-polluted environment.
The Company expanded its Environmental Division in January 1998, when it
acquired Commonwealth Petroleum Recycling, Inc. of Shelbyville, Kentucky
("Commonwealth"), a waste oil recycling company, through AES. The acquisition of
Commonwealth gives AES a base in northern Kentucky, and strengthens its market
and operating position in the greater Indiana-Kentucky area. The Company plans
to continue to expand its Environmental Division through acquisitions and
internal growth during the current fiscal year.
OPERATIONS
Energy Division
Steamboat 1 and 1A Geothermal Power Plants. The Company's 95%-owned
subsidiary, Steamboat Envirosystems, LLC ("Steamboat LLC"), owns two geothermal
power plants in Steamboat Hills, Nevada: Steamboat 1 and 1A. The remaining 5% of
Steamboat LLC is owned by Far West Capital ("Far West"), from whom the plants
were purchased. Steamboat 1 and 1A produce electricity through a "binary system"
in which hot water from the earth's sub-strata magma is circulated in one closed
loop, which heats inert gas in another closed loop. The heated gas is compressed
and is used to drive the turbines which generate electricity. The geothermal
water used in this process is reinjected into the earth to be re-heated.
Pursuant to its agreement with Far West, the Company receives the first
$1.8 million of Steamboat LLC annual net income, 45% of net income over $1.8
million during the first five years, and 95% of annual net income over $1.8
million thereafter.
Steamboat 1 and 1A were built in 1986 and 1988, respectively, by Far West
and are managed by SB Geo, Inc. ("SB Geo"), a company in which the principals of
Far West own a majority equity interest. The Company has contracted with SB Geo
for its continued management services at prices negotiated at arms-length, which
may not exceed charges for similar services which could be obtained from other
sources.
Steamboat 1 and 1A produce a combined eight megawatts of electric power
which is sold under two power purchase agreements with Sierra Pacific Power
Company ("Sierra"). The agreements call for price adjustments at the end of the
first ten years of operation, which require Sierra to purchase and Steamboat LLC
to provide electricity at Sierra's then-prevailing short term avoided cost. Ten
years of operation for Steamboat 1 ended in December 1996, and the ten years for
Steamboat 1A will end in December 1998. The short term avoided cost being paid
by Sierra on Steamboat 1 power production is substantially lower than what had
been paid until December 1996. To remedy this, and to prevent the rates for
Steamboat 1A dropping in the same way in December 1998, the Company has
commenced negotiations with Sierra.
The Company is currently negotiating either an increase in the rates that
Sierra pays for power produced by Steamboat 1 and 1A, or a termination of the
power purchase contract in order to allow the Company to find a different buyer.
In such negotiations, Sierra has admitted that there are several power producers
being paid at Sierra's short term avoided cost, but Steamboat LLC is the only
one being paid such rates under a long term contract. The Company is also a
member of the Nevada Geothermal Industry Council, an industry association
comprised of several geothermal producers in Nevada, which has filed an
intervention with the Nevada Public Utilities Commission on hearings being held
to determine the short term avoided cost rates Sierra should be allowed to
offer. The Company feels the current revenue it is receiving for Steamboat 1
power can be increased significantly either through adjustments in the rate from
Sierra or, alternatively, selling its power outside of Sierra's territory under
existing wheeling laws with the consent of Sierra. There is no assurance of the
extent to which the Company will be successful in these efforts.
Plymouth State College, New Hampshire. In 1994, the Company, through its
subsidiary, Plymouth Envirosystems, Inc., acquired a 50% interest in Plymouth
Cogeneration which owns and operates a cogeneration plant which produces 2.5
megawatts of electricity and 25 million BTUs for heat at Plymouth State College,
in Plymouth, New Hampshire. The facility provides 100% of the electrical and
heating requirements for the campus, which is a part of the University of New
Hampshire system, under a twenty-year contract. The project, which cost $5.9
million to construct, is comprised of a combination of diesel engine-
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generators, heat recovery and supplemental boilers, and the complete civil works
tying all campus buildings into a single heating loop. The project was financed
through $5.1 million in State of New Hampshire tax exempt revenue bonds and
$700,000 in equity prior to the Company's acquisition of its interest. The
Company paid a total of $636,000 in cash and 11,400 shares of its Common Stock
for its 50% interest.
The Company's partners in Plymouth Cogeneration are Central Hudson
Enterprises Corporation ("Central Hudson"), a wholly owned subsidiary of Central
Hudson Gas & Electric Corporation of New York, and Independent Energy
Corporation ("IEC"), a division of Equitable Resources, Inc. The project was
completed in November 1994 and put into full commercial service in January 1995.
IEC Plymouth, Inc., a wholly-owned subsidiary of IEC, runs the day-to-day
operations of the plant and the management decisions are resolved by a
management committee which is composed of representatives of the Company, IEC
and Central Hudson.
The State of New Hampshire has initiated a study to determine the
feasibility of expanding the existing facility to wheel electric power to two
other state college campuses. Also, plans are currently being developed by
Plymouth Cogeneration to install special fuel treatment equipment which will
allow the existing engines to burn less costly and more efficient fuels. Fuel
cost savings would be shared equally between the college and the partnership.
There can be no assurance that such fuel treatment equipment will be installed
or that such fuel cost savings will be realized.
Lehi Cogeneration Project, Utah. In January 1994, the Company, through its
subsidiary, Lehi Envirosystems, Inc. ("LEHI"), purchased a 50% equity interest
in Lehi Independent Power Associates ("LIPA"), which owned a cogeneration
facility in Lehi, Utah (the "Lehi Facility") and the underlying real estate,
hardware and permits to operate. The Lehi Facility has been dormant since 1990,
and the Company, together with its LIPA partners, has been exploring the means
by which the Lehi Facility can begin operating and generating revenue.
The Lehi Facility originally had three engine generators totaling 17
megawatts of electrical output. One unit, which would have required extensive
and costly repairs, was sold in December 1995. The two remaining units, totaling
10 megawatts, could be placed in operation if a satisfactory purchase agreement
for their output can be obtained. However, LIPA has determined that better
results would be obtained if these engines were replaced with combined cycle gas
turbines of larger output and substantially greater efficiency.
Under the new Title V of the Clean Air Act, which became effective in 1995,
the Lehi Facility must have an air quality permit from the Utah Division of Air
Quality. Most of this application has already been filed, and it is expected
that the one remaining filing will be completed by the third fiscal quarter of
1998. Once the application has been completed, the Utah Division of Air Quality
customarily takes 90 to 120 days to issue the permit. The Company knows of no
reason at this time why such air quality permit would not be issued. Actual work
on the replacement of the generators will begin as soon as the air quality
permit is secured and it is clear that power purchase contracts can be arranged
for the power output of the plant. The Company believes that the substantial
industrial and population growth in the Lehi area is creating a large future
market for power. In addition, the new wheeling rules make it possible to market
the power to areas outside the immediate Lehi area at prices that would afford a
profitable result.
Reno Energy District Heating Project. The Company has an 89.6% interest in
USE Geothermal, LLC ("USE GEO"), which has entered into a convertible loan
agreement with Reno Energy. Reno Energy plans to construct and operate the
facility which will use geothermally-heated fresh water for space heating and
cooling, as well as for process heating, for nearby developments, including an
industrial park in South Meadows, Nevada (the "Reno Facility"). The Nevada
Public Utilities Commission issued its Compliance Order approval for the
district heating project in November 1997, and the Washoe County Planning
Commission issued its Special Use Permit for the project in December 1997.
The Company has loaned funds for the Reno Facility totaling $1.9 million,
of which $1.4 million is under the convertible loan agreement. The Company
received a convertible note (the "Note") in return for its investment. The Note
matures on April 10, 2027, subject to acceleration upon the occurrence of
certain events of default. The Note accrues interest at a rate of 12% per annum
while the Reno Facility is being developed,
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provided that such interest will be waived in the event USE GEO exercises its
option to convert the Note into an equity interest in Reno Energy, or if Reno
Energy pays all "operating period interest" (described below) in a timely
manner. After the Reno Facility has commenced commercial operations, Reno Energy
will be required to pay "operating period interest" on the Note based on a
percentage (currently 50%) of (i) Reno Energy's net cash flow from operations
and (ii) net cash proceeds from certain capital transactions, after payment of
certain distributions to members of Reno Energy. USE GEO may convert the Note
for no additional consideration into a 50% equity interest in Reno Energy at any
time prior to the maturity of the Note. Such equity percentage will be adjusted
proportionately in the event of additional funding of Reno Energy by USE GEO or
Reno Energy's members prior to the exercise of the option to convert. The Note
is secured by a first lien on all of the assets of Reno Energy and is personally
guaranteed by Reno Energy's members. Such personal guarantees are, in turn,
secured by a first lien and pledge of the respective guarantors' membership
interest in Reno Energy.
The industrial park currently being developed in close proximity to the
Reno Facility is located on a 1,200 acre parcel. The first of several phases of
the park are already sold out, and the entire park is expected to be developed
within the next four to seven years. The Company anticipates that the park,
which will contain commercial and industrial facilities, will create a
substantial demand for space heating and cooling, as well as process heating. It
is expected that all the buildings in the park, totaling approximately 30
million square feet of floor space, will be connected to the geothermal grid to
meet their heating and cooling needs. In addition to the commercial park, the
Reno Facility may provide heating to a nearby 200-bed hospital, a 300-room
hotel, a high school, a proposed college campus and other developments in the
area, totaling an additional 10 million square feet.
It is currently expected that the Reno Facility will have a pipeline with
supply and return lines that would loop through the nearby industrial park. A
binary hot water system with fresh water circulating through the loop will be
used to avoid any concerns associated with the direct use of geothermal brine,
such as scale build-up in the pipes, corrosion of pipes and equipment, and
possible pollution of the ground in case of a spill. Fresh water will be heated
in heat exchangers at the site where geothermal brine is extracted and
reinjected. The heat thus provided may be sold at a discount from the cost of
producing an equivalent amount of heat from conventional natural gas furnaces.
Reno Energy has represented to the Company that it has used or will use the
proceeds of the Note to provide preliminary engineering, design and financial
services in connection with the Reno Facility, which is still in the planning
and development stage. As of yet, there are no actual contracts with end users,
although several letters of intent have been signed. It is estimated that $40
million will be required for the construction, procurement and other costs
associated with the commencement of operations of the Reno Facility. Such amount
is expected to be financed through industrial revenue bonds or other
conventional financing means. There is no assurance, however, that such
financing can be obtained on terms acceptable to Reno Energy.
Environmental Division
On August 18, 1997, the Company acquired AES, thus entering the
environmental services field and establishing the cornerstone of its
Environmental Division. AES specializes in the recycling of used motor and
industrial oils, waste water treatment, environmental counseling, remediation
services and Phase I, II and III environmental assessments. AES also provides
24-hour emergency response services throughout the mid-western United States. On
January 5, 1998 the Company acquired all of the assets of Commonwealth, which is
currently operating as a division of AES under the AES name.
Environmental Remediation. A large portion of the operations of
Environmental Division consists of environmental remediation, clean-up and
monitoring. AES is currently working on several on-going projects in this
respect. In February 1997, AES commenced the analysis, clean-up and ground water
monitoring of an underground storage tank leak in Robards, Kentucky which was
leaking certain fuel substances. AES presently has three employees containing,
cleaning and monitoring this cleanup, for which the State of Kentucky Department
of Environmental Protection has allocated and approved $847,000 towards its
remediation. AES predicts that work will continue on this project until at least
the end of 1998.
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In March 1998, AES was retained by the Warrick County Commission to oversee
and manage the closure and monitoring of the solid waste landfill, along with
all substations, in the County of Warrick, Indiana. Over the term of the
three-year contract, AES will close and monitor the landfill, build a transfer
station, and expand the substations and the recycling facility for the County.
In April 1998, AES received the acceptance of its bid from the United
States Department of Defense as a subcontractor to remediate and monitor
contaminated soil and perform construction projects located at the Crane Naval
Ammunition Depot in central Indiana. AES expects that this project will take
approximately five to six months to complete. AES is also currently in
discussions with the United States Coast Guard to secure the rights to assist in
a program to clean up the Ohio River and the surrounding internal waters.
Pursuant to a 1988 U.S. Environmental Protection Agency ("EPA") mandate,
all underground storage tanks in the United States must be retrofitted by
December 22, 1998 for leak detection, corrosion protection and spillage/overfill
protection devices. AES estimates that, as of the present date, approximately
70% of such underground tanks in the United States do not meet these EPA
regulations, and in the state of Indiana alone, such non-compliance may equate
to over $35 million in required work. AES has several employees trained to
conduct underground storage tank retrofitting, and is in the process of hiring
additional trained employees. AES is presently able to meet a small portion of
the substantial demand for this compliance work from local governmental
agencies, corporations and other businesses. With additional personnel, AES
believes that it will be able to secure a considerably larger portion of this
market. AES believes that this EPA mandate will generate several years of
revenue from such retrofitting projects. The EPA has notified such entities that
it will begin to fine persons for non-compliance with its 1988 regulation
commencing in December 1998.
Oil and Waste Recovery and Recycling. The Company's Environmental
Division, through its Indiana and Kentucky AES facilities, conducts oil and
water recovery from approximately 1,100 clients, which include service stations,
garages, factories and other facilities that collect used motor and industrial
oil and oily or contaminated water. Between its two facilities, AES has eight
pump trucks and four tractor trailers to recover and haul such fluids back to
its facilities for recycling or treatment. Oil is typically cleaned using
centrifuge, heat and chemical processes which separate the elements and allow
the operator to remove metal deposits and other contaminants. Recycled oil is
then stored in AES' aboveground tanks and sold to industrial users. Contaminated
water is hauled to the AES facility for chemical treatment to remove harmful
contaminants, and is then disposed of in the municipal sewer. AES' clients
typically pay AES to remove and treat their oily and contaminated water, which
is otherwise difficult and costly to discard.
Emergency Response. AES conducts emergency response operations throughout
the Indiana-Kentucky area. Such operations include response to automobile, truck
and train accidents which involve spilled fuel or other hazardous substances,
and emergency underground tank spills or rescue operations. AES contracts with
several local fire departments and emergency response technician teams, as well
as insurance companies and trucking companies to handle all such emergency
situations. AES has 15 employees, four response vehicles and two equipment
trailers which respond to two to three calls per week. Additionally, AES has the
only "confined space entry" team in the state of Indiana certified by the
Indiana Department of Environmental Management.
COMPETITION
Energy Division
There are approximately 150 companies nationwide currently involved in the
IPP industry, within which the Company currently occupies a relatively minor
position. The IPP industry is basically divided into three areas, based upon
size or physical placement of facility: (i) large power plants (over 50
megawatts); (ii) small to medium-sized power plants (3 to 50 megawatts); and
(iii) inside-the-fence plants (which can be of varying sizes, but usually under
50 megawatts).
Many of the large plants are owned and operated by subsidiaries of
Regulated Electric Companies and large industrial companies which have
established these subsidiaries to participate in the IPP industry. Approximately
18 of the 25 largest independent power companies are owned and operated in such
a manner.
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The operations of most of these companies are geared to power plants in the over
50 megawatt size range due to the need to make significant investments to
achieve returns large enough to have an impact on a public utility's or
industrial company's operating results. Some of these companies have been highly
successful in the development of these large plants; but under federal law,
utility subsidiaries may not own more than 50% of non-regulated (i.e., IPP)
projects. Subsidiaries of large industrial companies and other non-utility
companies, however, have no similar restrictions. Additionally, under federal
law, a new category of independent power producer has been created known as
exempt wholesale generators ("EWGs"). EWGs have no ownership limitations nor do
they have requirements similar to non-regulated plants with regard to useful
thermal output or fuel efficiency and operating efficiency criteria. To receive
qualification as an EWG, the owner need only demonstrate that the entire output
of the facility is sold exclusively in the wholesale market. EWGs are prohibited
from making retail sales and therefore cannot be developed for inside-the-fence
projects. In many instances, subsidiaries of public utilities and large
industrial companies make ideal partners for any such projects and the Company
intends to work with such companies when it locates a specific project fitting
its investment parameters.
In the category of small to medium-sized IPPs, the vast majority of the
developers are either subsidiaries of other non-utility industrial companies,
small privately owned partnerships, or energy funds established to invest in
such projects. Inside-the-fence plants are generally owned and operated by the
end user, although a number of such plants are built, owned and operated for the
end user by third parties.
Environmental Division
The Company's Environmental Division competes with several local and
national companies in the areas of environmental services and oil and water
recovery. Many of these companies are better capitalized than the Company and
have longer operating histories and larger client basis. Such companies include
Safety Klean, Corp., a subsidiary of Laidlaw Environmental Services, Inc., and
First Recovery, Inc., a subsidiary of Ashland Oil Company. Locally, the
Company's Environmental Division competes with Koester Corporation, which
conducts environmental services in Indiana and throughout the United States.
YEAR 2000 COMPUTER ISSUE
The Company has assessed the issues associated with the programming code in
its existing computer systems with respect to a two digit year value as the year
2000 approaches and believes that addressing such issues is not a material event
or uncertainty that would cause reported financial information not to be
indicative of future operating results or financial condition. The Company has
also considered the effect of the year 2000 issue as it pertains to its
customers and believes that only Sierra, to which the Company sells power from
its Steamboat Facilities, may be affected by the programming code problem to an
extent which could have a material adverse effect on the Company. Sierra has
assured the Company, however, that it is currently working on resolving its year
2000 issues.
EMPLOYEES
At April 15, 1998, the Company, including its subsidiaries, employed
approximately 35 full- and part-time personnel in its various locations. The
Company considers its relations with employees to be satisfactory.
GOVERNMENT REGULATION
Energy Division
Under present federal law, the Company is not and will not be subject to
regulation as a holding company under the Public Utility Holding Company Act
("PUHCA") as long as each power plant in which it has an interest is a
qualifying facility (a "QF") as such term is defined under the Public Utility
Regulatory Policy Act ("PURPA") or is subject to another exemption. In order to
be a QF, a facility must be not more than 50% owned by an electric utility or
electric utility holding company. A QF that is a cogeneration facility must
produce not only electricity but also useful thermal energy for use in an
industrial or commercial process or heating or cooling applications in certain
proportions to the facility's total energy output and must meet certain energy
efficiency standards. Therefore, loss of a thermal energy customer could
jeopardize a cogeneration facility's QF status. If one of the power plants in
which the Company has an interest were to lose its QF status and not receive
another PUHCA exemption, the project subsidiary or partnership in which the
Company has
7
<PAGE> 9
an interest that owns or leases that plant could become a public utility
company, which could subject the Company to various federal, state and local
laws, including rate regulation. In addition, loss of QF status could allow the
power purchaser to cease taking and paying for electricity or to seek refunds of
past amounts paid and thus could cause the loss of some or all contract revenues
or otherwise impair the value of a project and could trigger defaults under
provisions of the applicable project contracts and financing agreements. There
can be no assurance that if a power purchaser ceased taking and paying for
electricity or sought to obtain refunds of past amounts paid the costs incurred
in connection with the project could be recovered through sales to other
purchasers.
A geothermal plant will be a QF if it meets PURPA's ownership requirements
and certain other standards. Each of Steamboat 1 and Steamboat 1A meet such
ownership requirements and standards and is therefore a QF. QF status exempts
the owner of an IPP from regulation under various federal laws including PUHCA
and the regulation of the rates for sale from the IPP as well as certain state
laws. However, QF status does not exempt in IPP from state utility law
regulation in those states where the sale of electricity directly to an
industrial or commercial customer is regulated as a retail sale. Most states
currently do not regulate the sale of electricity from a QF to an
inside-the-fence customer.
The construction and operation of power generation facilities require
numerous permits, approvals and certificates from appropriate federal, state and
local governmental agencies, as well as compliance with environmental protection
legislation and other regulations. With the exception of an air operating permit
for the Lehi facility, the Company believes that it is in substantial compliance
with all applicable rules and regulations and that the projects in which it is
involved have the requisite approvals for existing operations and are operated
in accordance with applicable laws. However, the operations of the Company and
its projects remain subject to a varied and complex body of laws and regulations
that both public officials and private individuals may seek to enforce. There
can be no assurance that new or existing laws and regulations which would have a
materially adverse affect would not be adopted or revised, nor can there be any
assurance that the Company will be able to obtain all necessary licenses,
permits, approvals and certificates for proposed projects or that completed
facilities will comply with all applicable permit conditions, statutes or
regulations. In addition, regulatory compliance for the construction of new
facilities is a costly and time consuming process, and intricate and changing
environmental and other regulatory requirements may necessitate substantial
expenditures for permitting and may create a significant risk of expensive
delays or significant loss of value in a project if the project is unable to
function as planned due to changing requirements or local opposition.
Environmental Division
Governmental regulations applicable to the Company's Environmental Division
govern, among other things: the handling of a number of substances collected by
the Company which are classified as hazardous or solid wastes under these
regulations; the operation of the facilities at which the Company stores or
processes the substances it collects; and the ultimate disposal of waste the
Company removes from the substances it collects. An increase in governmental
requirements for the treatment of any particular material generally increases
the value of the Company's services to its customers, but may also increase the
Company's costs.
Various permits are generally required by federal and state environmental
agencies for the Company's recycling and oil and water processing facilities.
Most of these permits must be renewed periodically and the governmental
authorities involved have the power, under various circumstances, to revoke,
modify or deny issuance or renewal of these permits. Zoning, land use and siting
restrictions also apply to these facilities. Regulations also govern matters
such as the disposal of residual chemical wastes, operating procedures,
stormwater and wastewater discharges, fire protection, worker and community
right-to-know and emergency response plans. Air and water pollution regulations
govern certain operations at the Company's facilities. Safety standards under
the Occupational Safety and Health Act in the United States and similar laws are
also applicable. Governmental regulations also apply to the operation of
vehicles used by the Company to transport the substances it collects, including
licensing requirements for the vehicles and the drivers, vehicle safety
requirements, vehicle weight limitations, shipment manifesting and vehicle
placarding requirements. Governmental authorities have the power to enforce
compliance and violators are subject to civil and criminal
8
<PAGE> 10
penalties. Private individuals may also have the right to sue to enforce
compliance with certain of the governmental requirements.
The Company's Environmental Division has an internal staff of engineers,
geologists, hydrogeologists, chemists and other environmental and safety
professionals whose responsibility is to continuously improve the procedures and
practices to be followed by the Company to comply with various federal, state
and local laws and regulations involving the protection of the environment and
worker health and safety and to monitor compliance.
AES' services involve the collection, transportation, storage, processing,
recycling and disposal of automotive and industrial hazardous and nonhazardous
materials. Substantially all of these materials are regulated in the United
States as "solid wastes" under the Resource Conservation and Recovery Act of
1976 ("RCRA"). In addition to being regulated as solid wastes, many of these
materials are further regulated as "hazardous wastes." Accordingly, AES is
subject to federal and state regulations governing hazardous and solid wastes.
RCRA established a national program which classified various substances as
"hazardous wastes," established requirements for storage, treatment and disposal
of hazardous wastes, and imposed requirements for facilities used to store,
treat or dispose of such wastes. RCRA was amended in 1984 by the Hazardous and
Solid Waste Amendments ("HSWA") which expanded the scope of RCRA to include
businesses which generate smaller quantities of waste materials (so-called
"small quantity generators"), expanded the substances classified as hazardous
wastes by RCRA and prohibited direct disposal of those wastes in landfills
(thereby, in effect, requiring that the wastes be recycled, treated, or
destroyed). Hazardous and solid waste regulations impose requirements which must
be met by facilities used to store, treat and dispose of these wastes. Operators
of hazardous waste storage, disposal and treatment facilities, such as AES, must
obtain a RCRA permit from federal or authorized state governmental authorities
to operate those facilities. States may also require a solid waste permit.
In September 1992, the United States Environmental Protection Agency
("EPA") finalized regulations that govern the management of used oils. Although
used oil is not classified as a hazardous waste under federal law, certain
states do regulate used oil as hazardous. AES operates its used oil facilities
to standards similar to those required for hazardous waste facilities, and
believes that its oil management standards are more protective of human health
and the environment than current federal standards.
The Clean Air Act ("CAA") was passed by Congress to control the emissions
of pollutants to the air, and requires permits to be obtained for certain
sources. In 1990, Congress amended the CAA to require further reductions of air
pollutants with specific targets for nonattainment areas in order to meet
certain ambient air quality standards. These amendments also require the EPA to
promulgate regulations which: (i) control emissions of 189 toxic air pollutants;
(ii) create uniform operating permits for major industrial facilities similar to
RCRA operating permits; (iii) mandate the phase-out of ozone depleting
chemicals; and (iv) provide for enhanced enforcement.
The Clean Air Act required regulations which resulted in the reduction of
volatile organic compound ("VOC") emissions in order to meet certain ozone
attainment standards under the CAA. The Company has installed control technology
to meet its obligations under the CAA. Additional emission reductions at the
Company's recycle centers and branches could be required as the Company
completes its air permitting program. In addition, the United States EPA has
developed Maximum Achievable Control Technology ("MACT") standards under the
Clean Air Act which impose additional restrictions on the emission of certain
toxic air pollutants.
The Comprehensive Environmental Response, Compensation and Liability Act of
1980 ("CERCLA") was originally enacted in December 1980, and amended in 1986 by
the Superfund Amendments and Reauthorization Act ("SARA"). CERCLA creates a fund
of monies ("Superfund") which can be used by the EPA and state governments to
clean up hazardous waste sites pending recovery of those costs from defined
categories of "potentially responsible parties" ("PRPs"). Most EPA cleanup
efforts are at sites listed or proposed for listing on the National Priorities
List ("NPL"). Various states have also enacted statutes which contain provisions
substantially similar to CERCLA. Generators and transporters of hazardous
substances, as well as past and present owners and operators of sites where
there has been a release of hazardous substances are made strictly, jointly and
severally liable for the clean-up costs resulting from releases and threatened
9
<PAGE> 11
releases of CERCLA-regulated "hazardous substances." Under CERCLA, these
responsible parties can be ordered to perform a clean-up, can be sued for costs
associated with private party or public agency clean-up, or can voluntarily
settle with the government concerning their liability for clean-up costs.
ADDITIONAL CAPITAL AND NEGOTIATIONS FOR NEW PROJECTS
On March 25, 1998 the Company raised $2.25 million in a private placement
of 250,000 shares of its Series A Convertible Preferred Stock (the "Preferred
Stock") with Energy Systems Investors, LLC, a Delaware limited liability company
controlled by Lawrence I. Schneider ("Energy Systems Investors"). Each share of
Preferred Stock is currently convertible into four shares of common stock of the
Company at a conversion price of $2.25 per share and carries a dividend of 9%
per annum. Energy Systems Investors also holds a one year option to acquire up
to an additional $8.0 million of Preferred Stock on the same terms and
conditions, subject to stockholder approval.
The Company from time to time evaluates acquisitions of new projects and
companies in the energy and environmental services fields. Preliminary work has
been done in connection with certain of these potential acquisitions, but none
have reached the negotiation stage and there is no assurance that any of them
will be developed at all.
ITEM 2. DESCRIPTION OF PROPERTY
The Steamboat facilities are owned by the Company's 95%-owned subsidiary,
Steamboat LLC. Located on a geothermal field in Steamboat Hills, Nevada,
Steamboat 1 and 1A own buildings and improvements, generators, motors,
switchgear and controls, production and injection wells and associated piping.
Management of the Company believes the plants are adequately covered by
insurance.
The Plymouth Facility is owned by Plymouth Cogeneration, a Delaware
partnership, of which the Company owns a 50% equity interest. Plymouth
Cogeneration owns all the plant and equipment associated with the cogeneration
project including the diesel engines, generators, three auxiliary boilers,
switchgear, controls and piping. The New Hampshire state university system has
two contracts with Plymouth Cogeneration: (1) a 20-year lease on the equipment,
and (2) a 20-year management contract. Both contracts have escalation clauses.
Management believes the plant is adequately covered by insurance.
The Lehi Facility is owned by LIPA, a Utah limited liability company, of
which the Company owns a 50% equity interest. The property includes two acres of
land in Lehi, Utah, and all buildings, engine/ generators, ancillary generating
equipment, heat recovery equipment, switchgear and controls, storage tanks,
spare parts, tools and permits. All costs associated with LIPA and the operation
of the Lehi Facility, and all income which might be derived from sales of
electric power, is divided pro-rata among the Company and the owners of the
remaining 50% of LIPA. Other than the Company's obligations to its debenture
holders, there are no other encumbrances or debt associated with LIPA or the
Lehi Facility. Management believes the plant is adequately covered by insurance.
The AES Facilities are located in Newburgh, Indiana and Shelbyville,
Kentucky. The Newburgh facility is on a five and one-half acre property, and the
Shelbyville facility is on a two acre property. Both facilities include
buildings, processing equipment, storage tanks, controls and related piping, and
are considered in satisfactory condition. There are mortgages on the buildings
that totaled $317,000 at January 31, 1998. Management believes the plants are
adequately covered by insurance.
The headquarters of the Company are in 1,800 square feet of office space
under a five year lease in a commercial office building in West Palm Beach,
Florida. The Company also leases from SB GEO regional offices in Reno, Nevada,
on the site of the Steamboat facilities. The Company has no separate lease
agreement for the Reno office space, but rental fees are included in the fees
the Company pays to SB GEO for the operation and management of the Steamboat
facilities.
10
<PAGE> 12
ITEM 3. LEGAL PROCEEDINGS
On March 12, 1997 the Company filed an action for declaratory judgment
against Enviro Partners LP et al and Energy Management Corporation ("EMC"),
which are related entities, in the U.S. District Court for the Southern District
of New York. The dispute involves certain agreements the Company entered into
with Enviro Partners and EMC in 1996 for a private sale of Company securities.
The agreements were conditional upon (1) a public offering of Company securities
occurring simultaneously with the private sale to Enviro Partners and EMC, and
(2) the Company's securities being approved for listing on the Nasdaq SmallCap
Market. During the approval process, Nasdaq determined that the private sale
would be contrary to just and equitable principles of trade, and refused listing
if the private sale were consummated. Thus, a critical condition of the
agreements, which had been imposed by EnviroPartners and EMC themselves, could
not be met. EnviroPartners and EMC have asserted demands against the Company for
lost profits of up to $6 million.
The defendants have filed their objections to the Company's action for
declaratory judgment, and the Company's attorneys have filed rebuttals. No
decision has yet been made by the court. An adverse outcome to this proceeding
could have a material adverse effect on the Company's financial condition.
In October 1997, the Company settled an arbitration proceeding with Indus
Enterprises, L.L.C. and its president, Ravi Singh, regarding a contract dispute
for an undisclosed amount. In November 1997, a property damage suit against the
Company in Utah was withdrawn by the plaintiff.
There are no other legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote by security holders during the fourth
quarter of the fiscal year ended January 31, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Common Stock was subject to a 1 for 40 reverse split, effective May 10,
1996. The prices in the following tables reflect this change.
The Common Stock traded on the NASD OTC Bulletin Board until December 2,
1996. The first table below sets forth, for the periods indicated, the high and
low closing bid quotations for the Common Stock as reported by the NASD OTC
Bulletin board. These amounts represent quotations between dealers (not actual
transactions) and do not include retail markups, markdowns or commissions. On
December 3, 1996, the Common Stock began trading on the Nasdaq SmallCap Market
under the symbol USEY. The second table below sets forth, for the periods
indicated, the high and low sales prices for the Common Stock as reported by the
Nasdaq SmallCap Market.
NASD OTC BULLETIN BOARD
<TABLE>
<CAPTION>
BID PRICE
-------------
HIGH LOW
----- -----
<S> <C> <C>
Fiscal Year Ended January 31, 1997:
First Quarter............................................. $3.75 $2.50
Second Quarter............................................ 2.50 1.50
Third Quarter............................................. 3.38 1.50
Fourth Quarter (November 1, 1996 to December 2, 1996)..... 5.56 3.00
</TABLE>
11
<PAGE> 13
NASDAQ SMALLCAP MARKET
<TABLE>
<CAPTION>
SALES PRICE
-------------
HIGH LOW
----- -----
<S> <C> <C>
Fiscal Year Ended January 31, 1997:
Fourth Quarter (December 3, 1996 to January 31, 1997)..... $5.56 $3.88
Fiscal Year Ended January 31, 1998:
First Quarter............................................. $5.63 $3.63
Second Quarter............................................ 4.94 3.50
Third Quarter............................................. 3.88 2.75
Fourth Quarter............................................ 3.31 1.75
Fiscal Year Ended January 31, 1999:
First Quarter............................................. $2.25 $1.81
</TABLE>
PRICE RANGE OF WARRANTS
The Company's warrants were issued December 6, 1996, and began trading on
the Nasdaq Small Cap Market under the symbol USEYW. The following table sets
forth, for the period indicated, the high and low sales prices for the Warrants
as reported by the Nasdaq Small Cap Market.
<TABLE>
<CAPTION>
SALES PRICE
-------------
HIGH LOW
----- -----
<S> <C> <C>
Fiscal Year Ended January 31, 1997:
Fourth Quarter (December 3, 1996 to January 31, 1997)..... $1.69 $0.75
Fiscal Year Ended January 31, 1998:
First Quarter............................................. $1.88 $1.00
Second Quarter............................................ 1.63 0.88
Third Quarter............................................. 1.13 0.56
Fourth Quarter............................................ 1.10 0.38
Fiscal Year Ended January 31, 1999:
First Quarter............................................. $0.69 $0.38
</TABLE>
As of April 30, 1998 there were 600 record holders on record of the
Company's Common Stock. On the same date there were 25 holders of record of the
Company's Warrants. The Company estimates that additional holders of stock and
warrants in street name total approximately 2,000 and 200 respectively.
DIVIDENDS
The Company has not paid cash dividends on the Common Stock and does not
anticipate paying cash dividends on the Common Stock in the foreseeable future.
The Preferred Stock issued on March 23, 1998 is accruing dividends at an annual
rate of 9%, or $202,500. No dividends may be paid on the Common Stock unless the
Company is current with all dividend payments due on the Preferred Stock.
RECENT SALES OF UNREGISTERED SECURITIES
On March 23, 1998, the Company raised $2.25 million in a private placement
of 250,000 shares of Preferred Stock with Energy Systems Investors. All of the
purchasers involved were qualified investors as defined under the Securities Act
of 1933, as amended (the "Securities Act"). Each share of Preferred Stock is
currently convertible into four shares of Common Stock of the Company at a
conversion price of $2.25 per share, carries a dividend of 9% per annum. The
Preferred Stock votes with the Common Stock on a ratio equal to the per share
purchase price of the Preferred Stock ($9.00) divided by the conversion price
(currently $2.25), which presently equates to four votes for every share of
Preferred Stock. Energy Systems Investors also holds a one year option to
acquire up to an additional $8.0 million of Preferred Stock on the same terms
and conditions, subject to stockholder approval. No placement agent or broker
was used in connection with this sale.
12
<PAGE> 14
On January 5, 1998, the Company issued 150,000 shares of its Common Stock
in connection with its acquisition of substantially all of the assets of
Commonwealth. The issuance was made in reliance on Regulation D promulgated
under the Securities Act, which offers an exception from the registration
requirements under the Securities Act under certain circumstances.
On August 18, 1997, the Company issued 665,000 shares of its Common Stock
in connection with the acquisition of AES. The issuance was made in reliance on
Regulation D promulgated under the Securities Act, which offers an exception
from the registration requirements under the Securities Act under certain
circumstances.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATIONS
GENERAL
The Company's fiscal year ended January 31, 1998 ("Fiscal 1997")
constituted its first full year of operations since its public offering of
Common Stock and Warrants in December 1996 (the "1996 Offering").
As part of the 1996 Offering, the Company acquired a 95% interest in
Steamboat 1 and 1A, secured an interest in Reno Energy, converted $500,000 of
convertible subordinated debentures into 125,000 shares of Common Stock and
125,000 Warrants, and exchanged all of the 57,500 outstanding shares of the
Company's Series One Preferred Stock for 205,000 shares of Common Stock (the
"Concurrent Transactions"). The result of the 1996 Offering and the Concurrent
Transactions was an infusion of approximately $12 million in capital to the
Company, the acquisition of revenue producing facilities in Steamboat 1 and 1A,
and the reduction of the debt of the Company.
During Fiscal 1997, the Company entered into the environmental industry
with its acquisitions of AES in August and Commonwealth in December. The Company
believes that its Environmental Division adds a strong, new dimension to its
overall operations, as well as providing substantial revenue and exciting growth
opportunities.
RESULTS OF OPERATIONS
Year ended January 31, 1998 compared to year ended January 31, 1997.
Fiscal 1997 revenues increased by $1,967,000 or 840% over Fiscal 1996
principally as a result of a full year of operations of the Steamboat Facilities
which generated $1,520,000 in revenue in Fiscal 1997 compared to $225,000 in the
fiscal year ended January 31, 1997 ("Fiscal 1996"). Revenues in Fiscal 1997 also
included $713,000 from AES and Commonwealth from the dates of their
acquisitions, August 18, 1997 and December 31, 1997, respectively. The Company
treats its investments in its LEHI and Plymouth subsidiaries on the equity
basis, and the revenues of LEHI and Plymouth are not included in the revenues
line item. Details of the results of the LEHI and Plymouth joint ventures may be
found in the accompanying notes to the financial statements.
Costs and expenses in Fiscal 1997 increased $1,963,000 or 232% over Fiscal
1996 principally as a result of the inclusion of the Steamboat Facilities for
the full year in Fiscal 1997, and AES and Commonwealth since the dates of their
acquisitions. The expenses for the two subsidiaries in Fiscal 1997 were as
follows:
<TABLE>
<CAPTION>
STEAMBOAT AES AND
FACILITIES COMMONWEALTH
---------- ------------
<S> <C> <C>
Operating expenses.......................................... $674,000 $453,000
Selling, general and administrative expenses................ 319,000 174,000
Depreciation and amortization............................... 149,000 98,000
</TABLE>
Operating expenses for Fiscal 1997 totaled $1,127,000 as compared to
$162,000 for Fiscal 1996. The Steamboat Facilities generated operating expenses
of $674,000 for the twelve months of Fiscal 1997 compared to $162,000 for the
period from the date of acquisition, December 6, 1996, to January 31, 1997.
Operating expenses in Fiscal 1997 for AES and Commonwealth totaled 453,000.
There are no comparable costs in the
13
<PAGE> 15
previous fiscal year, as the respective acquisitions took place on August 18 and
December 31, 1997. Operating expenses are the costs directly relating to the
revenues shown.
Included in administrative expenses were salaries and consulting fees of
$518,000 in Fiscal 1997 compared to $704,000 in Fiscal 1996. Fiscal 1996 fees
included a $187,000 charge in connection with the issuance of options to persons
other than officers and directors of the Company. Administrative expenses in
Fiscal 1997 also reflect an increase in legal and professional fees from
$147,000 in Fiscal 1996 to $476,000 in Fiscal 1997 as a result of litigation in
which the Company was involved (see "Legal Proceedings"). Two of the litigation
actions in which the Company was involved in Fiscal 1997 were resolved during
the year: one was settled and the other was withdrawn by the party who brought
the action. Corporate expenses rose to $128,000 in Fiscal 1997 from $46,000 the
previous year due to the increased activity in pursuing the Company's business
plans for expansion.
Interest income was $265,000 in Fiscal 1997 as compared to $18,000 in the
previous year due to the larger cash balances carried in Fiscal 1997, and
because of the interest paid or accrued on notes receivable. The decrease in
interest expense from $823,000 in Fiscal 1996 to $121,000 in Fiscal 1997, was
due to the conversion and redemption of a portion of the convertible
subordinated secured debentures as a result of the 1996 Offering, and the
decrease in the annual interest rate that the debentures carry, from 18% to the
current 9%.
As of January 31, 1997, the Company had pre-reorganization income taxes and
payroll taxes payable amounting to $383,000. During Fiscal 1997, the Company
settled these payables for a total amount of $347,000. As a result, the Company
recognized a gain of $36,000. During Fiscal 1996, the Company had similar
settlement agreements with state taxing authorities relating to
pre-reorganization payroll taxes payable, whereby the Company paid $25,000 in
excess of what was recorded on its books, which amount was recorded as a loss on
settlement.
The net loss of the Company decreased to $1,042,000 in Fiscal 1997, or 51%,
as compared to $2,048,000 in the previous year. Primarily as a result of this
reduction in net loss, cash used in operating activities was $904,000 in Fiscal
1997 as compared to $2,382,000 in Fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
As stated above, cash flow used in operating activities improved to
$904,000 in Fiscal 1997 as compared to $2,382,000 in Fiscal 1996, primarily due
to the lower net loss from the Company's operations. Payment of old tax claims
used cash of $347,000, as stated below in the discussion of financing
activities, but resulted in a gain of $36,000 which appears as an extraordinary
item on the Consolidated Statement of Operations.
Cash flow used in investing activities during Fiscal 1997 totaled
$2,534,000, primarily as a result of the acquisitions of AES and Commonwealth,
which accounted for $414,000 and $353,000, respectively, and included loans to
Reno Energy in the aggregate amount of $1,695,000. In Fiscal 1996, cash used in
investing activities totaled $3,715,000, of which $3,357,000 was for the
acquisition of the Steamboat Facilities.
Cash flow used in financing activities totaled $368,000 in Fiscal 1997,
primarily due to the payment of pre-reorganization taxes payable in the amount
of $347,000. In the previous year, cash flow provided by financing activities
amounted to $10,220,000, representing the net proceeds of the issuance of common
stock of the Company in a public offering, less the payment of certain costs of
and liabilities in connection with the offering.
Pre-construction work on Reno Energy has commenced now that the state and
local authorities have granted necessary initial permits. The Company estimates
that it will spend up to an additional $100,000 in pre-construction work on Reno
Energy. The Company expects institutional lenders to finance the estimated $40
million construction price of the project. The Company believes that Reno Energy
could become a large income producing property in the years to come.
In connection with the possible expansion and re-configuration of the
Plymouth Cogeneration facility, the Company does not anticipate any future
capital expenditures. It is estimated that any construction on the
14
<PAGE> 16
Plymouth Cogeneration facility would be financed through the University of New
Hampshire system, using dormitory authority bonds, as the original project was
financed.
Positive cash flow from the Steamboat Facilities and from the recently
acquired AES and Commonwealth, together with the funds provided by the private
placement of Preferred Stock referred to below, assure the adequacy of liquidity
during the next 12 months. In the long term, the Company expects adequate
liquidity to be provided by the Steamboat Facilities and by AES and
Commonwealth, plus possible additional acquisitions and financings.
SUBSEQUENT EVENT
On March 23, 1998, the Company sold 250,000 shares of its Preferred Stock
to Energy Systems Investors in a private placement for a purchase price of $2.25
million. See "Recent Sales of Unregistered Securities" above.
ITEM 7. FINANCIAL STATEMENTS
See the Financial Statements and Independent Auditors' Report which are
attached hereto as the "Financial Statement Appendix" on pages F-1 through F-21.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Theodore Rosen......................... 73 Chairman of the Board of Directors
Richard H. Nelson...................... 58 President, Chief Executive Officer and
Director
Howard A. Nevins....................... 42 Executive Vice President and Director
Henry Schneider........................ 33 Vice President
Seymour J. Beder....................... 71 Secretary, Treasurer and Chief
Financial Officer
Terrence Page.......................... 51 Vice President
Evan Evans............................. 72 Director
Allen J. Rothman....................... 41 Director
Todd Goodwin........................... 66 Director
Lawrence I. Schneider.................. 62 Director
</TABLE>
Theodore Rosen. Mr. Rosen has been a Director of the Company and Chairman
of the Board of Directors since November 1993. Since June 1993, Mr. Rosen has
been Managing Director of Burnham Securities. He was Senior Vice President of
Oppenheimer & Co. from January 1991 to June 1993, and was Vice President of
Smith Barney & Co. from 1989 to 1991. Mr. Rosen also currently serves as a
director of Waterhouse Investors Cash Management Co., an investment management
company engaged in management of money market mutual funds. Mr. Rosen holds a BA
degree from St. Lawrence University and did graduate work at both Albany Law
School and Columbia University School of Business.
Richard H. Nelson. Mr. Nelson has been President, Chief Executive Officer
and Director of the Company since November 1993. Mr. Nelson has been engaged in
the power plant industry for more than twenty years and has been involved with
over 200 power projects throughout the world, 125 of which have been
cogeneration projects. In 1973, Mr. Nelson formed Sartex Corp., which was merged
into the Company,
15
<PAGE> 17
then called Cogenic Energy Systems, Inc. ("Cogenic"), in 1981. Mr. Nelson served
as president of Cogenic until 1989. From January 1989 until January 1991, Mr.
Nelson was president of Utility Systems Corp., a subsidiary of Cogenic. In
January 1991, Mr. Nelson formed Utility Systems Florida, Inc. ("USF") where he
served as president until November 1993, when USF and Cogenic merged, with
Cogenic being the surviving corporation and changing its name to U.S.
Envirosystems, Inc. U.S. Envirosystems changed its name to U.S. Energy Systems,
Inc. in November 1996. Mr. Nelson was Special Assistant to the Director of the
Peace Corps from 1961 to 1962; thereafter he served as Military Aide to the Vice
President of the United States from 1962 to 1963 and Assistant to the President
of the United States from 1963 to 1967. From 1967 to 1969, Mr. Nelson was Vice
President of American International Bank, and from 1969 to 1973 he was Vice
President of Studebaker-Worthington Corp. Mr. Nelson received his BA degree from
Princeton University.
Howard A. Nevins. Mr. Nevins has been Executive Vice President of the
Company's Environmental Division and Director of the Company since August 1997.
Mr. Nevins has wide ranging experience in the fields of mineral exploration,
chemical operations and environmental compliance. In 1985, he founded Trey
Explorations, Inc., a land exploration and development drilling company which
presently operates 80 oil and gas wells in the Illinois Basin. In 1990, he
co-founded Midwest Custom Chemicals, Inc., a manufacturer and international
distributor of specialty chemicals used for oil and water demulsification,
specializing in used oil recycling. In 1994, he co-founded both Quality
Environmental Laboratories, Inc. and America Enviro-Services, Inc., the latter
company which was acquired by the Company in August 1997. Mr. Nevins remains on
the boards of Midwest Custom Chemicals and Quality Environmental Laboratories.
Mr. Nevins is a Certified Professional Geologist, past President of the
Indiana-Kentucky Geological Society, past Chairman of the Society of Petroleum
Engineers (Illinois Basin) and is currently on the boards of both the Illinois
Oil & Gas Association and the Independent Oil Producers. He is also on the
Advisory Council of the Indiana Department of Natural Resources. Mr. Nevins
received his BS degree in Geology from Western Michigan University in 1978.
Terrence Page. Mr. Page has been Vice President -- Western Resources of
the Company since March 1997. Previously, Mr. Page served with the Nevada Public
Service Commission since 1982. From 1982 to 1989 he was Regulatory Operations
Supervisor and from 1989 until he resigned to join the Company, he served as
Director of Regulatory Operations. In this position, he had final responsibility
for developing all staff positions brought before the Commission and coordinated
with federal, state and local governments on matters of regulatory policy. He
has served on the Nevada Department of Information Services Advisory Committee,
the Ohio State University's National Regulatory Research Institute Advisory
Committee, the Las Vegas Regional Transportation Advisory Committee and the
Washoe Regional Water Planning Commission. Mr. Page holds his BS in Business
from the University of the State of New York and his MS in Management from the
American University.
Henry Schneider. Mr. Schneider, a member of Energy Systems Investors, LLC,
was appointed Vice President for Development in March 1998. From 1986 to 1988,
Mr. Schneider was an associate at Drexel Burnham Lambert specializing in taxable
institutional fixed income products and portfolio strategies. From 1989 to 1994,
Mr. Schneider was an associate with S & S Investments and Wood Gundy,
specializing in mergers, acquisitions and corporate restructuring. From 1994 to
1996, Mr. Schneider was a principal of Global Capital Resources, Inc., a private
merchant bank. Since 1996, Mr. Schneider has been a private investor. He has
been involved in arranging acquisitions and funding for the telecommunications,
energy, apparel, airline, financial and garage industries. Mr. Schneider holds
an Economics degree from Tufts University and a Master of Business
Administration from Boston University. Mr. Schneider is the son of Lawrence I.
Schneider.
Seymour J. Beder. Mr. Beder has been Secretary, Treasurer, Controller and
Chief Financial Officer of the Company since November 1993. From 1970 through
1980 he was Chief Financial Officer for Lynnwear Corporation, a textile company,
and from 1980 to September 1993, Mr. Beder was president of Executive Timeshare,
Inc., a provider of executive consulting talent. Mr. Beder is a Certified Public
Accountant, and a member of the New York State Society of Certified Public
Accountants and the American Institute of Certified Public Accountants. Mr.
Beder received his BA degree from City College of New York.
16
<PAGE> 18
Evan Evans. Mr. Evans has been a Director of the Company since August
1995. Since 1983 he has been chairman of Holvan Properties, Inc. ("Holvan"), a
real estate developer, and was managing director of Easco Marine, Ltd. from 1983
to 1988. Also, from 1985 to 1986 Mr. Evans was general manager of Belgian
Refining Corporation ("BRC"), pursuant to a contract between BRC and Holvan, and
from 1992 to 1996, Mr. Evans was a director of BRC. From 1981 to 1983 he was
vice president of Getty Trading and Transportation Company and president of its
subsidiary, Getty Trading International, Inc. From 1970 to 1981 Mr. Evans was
vice president and member of the board of directors of United Refining Corp
("URC"). Mr. Evans also currently serves as a director of Holvan, and since 1997
has been a director of URC. Mr. Evans received his BS degree in Mathematics from
St. Lawrence University and his BS in Civil Engineering from M.I.T.
Allen J. Rothman. Mr. Rothman was appointed to the Board of Directors of
the Company in January 1997. Mr. Rothman is a partner with the law firm of
Robinson, Brog, Leinwand, Greene, Genovese & Gluck P.C. in New York with whom he
has been associated since January 1996. Mr. Rothman specializes in corporate,
finance and real estate law. Prior to joining Robinson Brog, he was associated
with several New York law firms. Mr. Rothman received his BA degree from
Columbia University and his JD degree from Harvard University.
Todd Goodwin. Mr. Goodwin was appointed to the Board of Directors of the
Company in January 1997. From 1984 until the present, Mr. Goodwin has been a
general partner of Gibbons, Goodwin, van Amerongen, an investment banking firm
in New York. From 1978 until 1984, he was a Managing Director of Merrill Lynch,
specializing in corporate finance, advising major client corporations on
acquisitions, divestitures and financings. Mr. Goodwin was a general partner of
White Weld & Co. from 1969 until that firm was acquired by Merrill Lynch in
1978. Mr. Goodwin also currently serves as a director of Johns Manville
Corporation, The Rival Company, Schult Homes Corporation and Wells Aluminum
Corp. He is a trustee of Southampton Hospital and the Madison Square Boys and
Girls Club. Mr. Goodwin received his AB degree in Economics from Harvard
College.
Lawrence I. Schneider. Mr. Schneider, manager of Energy Systems Investors,
LLC, was elected to the Board of Directors in March 1998 and serves as Chairman
of its Executive Committee. Mr. Schneider has been associated with numerous
corporations through the years, including Newpark Resources, Inc., a company
involved with oil field environmental remediation, where he was Chairman of the
Executive Committee. Mr. Schneider was also a partner in the New York Stock
Exchange firm Sassower, Jacobs and Schneider. He holds his BS degree from New
York University. Mr. Schneider is the father of Henry Schneider.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires certain officers, directors, and beneficial owners of
more than ten percent (10%) of the Company's Common Stock to file reports of
ownership and changes in their ownership of the equity securities of the Company
with the Securities and Exchange Commission and Nasdaq. Based solely on a review
of the reports and representations furnished the Company during the last fiscal
year, the Company believes that each of these persons is in compliance with all
applicable filing requirements.
ITEM 10. EXECUTIVE COMPENSATION
The information contained under the caption "Executive Compensation" to
appear in the Definitive Proxy Statement for the 1998 Annual Meeting of
Stockholders (the "Annual Meeting Proxy Statement") is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained under the caption "Security Ownership of Certain
Beneficial Owners and Management" to appear in the Annual Meeting Proxy
Statement is incorporated herein by reference.
17
<PAGE> 19
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the caption "Certain Relationships and
Related Transactions" to appear in the Annual Meeting Proxy Statement is
incorporated herein by reference.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
a. Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
2.1 -- Merger Agreement by and between the Company, AES Merger
Corp., American Enviro-Services, Inc., and the Shareholders
of American Enviro-Services, Dated as of August 4, 1997+
3.1 -- Restated Certificate of Incorporation of the Company filed
with the Secretary of State of Delaware*
3.2 -- By-Laws of the Company**
3.3 -- Articles of Organization of Steamboat Envirosystems, L.C.*
4.1 -- Specimen Stock Certificate*
4.2 -- Form of Warrant*
4.3 -- Form of Warrant Agreement*
4.4 -- Form of Representative's Purchase Option*
4.5 -- Certificate of Designation of Series A Convertible Preferred
Stock of the Company as filed with the Secretary of State of
Delaware on March 23, 1998++++
10.1 -- Plan of Reorganization of Cogenic Energy Systems, Inc.**
10.2 -- 8% Convertible Subordinated Debenture due 2004**
10.3 -- Employment Agreement, dated as of November 11, 1993, between
the Company and Richard Nelson**
10.3(a) -- Amendment to Employment Agreement between October 15, 1996**
10.4 -- Employment Agreement, dated as of December 11, 1993, between
the Company and Theodore Rosen**
10.4(a) -- Amendment to Employment Agreement between the Company and
Theodore Rosen dated October 15, 1996*
10.5 -- Purchase Agreement, dated as of January 24, 1994, between
Lehi Co-Gen Associates, L.C. and Lehi Envirosystems, Inc.**
10.6 -- Operating Agreement among Far West Capital, Inc., Suma
Corporation and Lehi Envirosystems, Inc. dated January 24,
1994*
10.7 -- Form of Purchase and Sale Agreement between Far West
Capital, Inc., Far West Electric Energy Fund, L.P., 1-A
Enterprises, the Company and Steamboat LLC*
10.8 -- Form of Operation and Maintenance Agreement between
Steamboat LLC and S.B. Geo, Inc.*
10.9 -- Letter Agreement, dated as of November 8, 1994, between the
Company, PSC Cogeneration Limited Partnership, Central
Hudson Cogeneration, Inc. and Independent Energy Finance
Corporation*
10.10 -- Agreement among the Company, Plymouth Envirosystems, Inc.,
IEC Plymouth, Inc. and Independent Energy Finance
Corporation dated November 16, 1994*
10.11 -- Amended and Restated Agreement of Limited Partnership of
Plymouth Cogeneration Limited Partnership among PSC
Cogeneration Limited Partnership, Central Hudson
Cogeneration, Inc. and Plymouth Envirosystems, Inc. dated
November 1, 1994*
</TABLE>
18
<PAGE> 20
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
10.12 -- Amended and Restated Agreement of Limited Partnership of PSC
Cogeneration Limited Partnership among IEC Plymouth, Inc.,
Independent Energy Finance Corporation and Plymouth
Envirosystems, Inc. dated December 28, 1994*
10.13 -- Purchase and Sale Agreement, dated as of December 31, 1995,
between the Company, Far West Capital, Inc., Far West
Electric Energy Fund, L.P., 1-A Enterprises and Steamboat
Envirosystems, LLC*
10.13(a) -- Letter Agreement, dated September 25, 1996, between the
Company and Far West Capital, Inc.*
10.14 -- Joint Development Memorandum of Intent dated September 20,
1994, between the Company and Cowen Partnership*
10.15 -- Agreement dated May 4, 1995 between the Company and Indus
LLC*
10.16 -- Security Agreement and Financing Statement among the
Company, Lehi Envirosystems, Inc., Plymouth Envirosystems,
Inc. and Anchor Capital Company, LLC dated June 14, 1995, as
amended*
10.17 -- Stock Pledge Agreement among Richard H. Nelson, Theodore
Rosen, Anchor Capital Company, LLC and the Company dated
June 14, 1995*
10.18 -- Loan Agreement among the Company, Lehi Envirosystems, Inc.,
Plymouth Envirosystems and Solvation, Inc. dated as of
December 15, 1995, as amended*
10.19 -- Pledge Agreement between the Company and Solvation, Inc.
dated as of December 15, 1995*
10.20 -- Lease dated September 1, 1995 between the Company and
Gaedeke Holdings, Ltd.*
10.21 -- Documents related to Private Placement*
10.21(a) -- Certificate of Designations*
10.22 -- Purchase Agreement between the Company and Westinghouse
Electric Corporation dated as of November 6, 1995 and
amendments thereof*
10.23 -- Letter of intent to the Company from Bluebeard's Castle,
Inc. dated August 8, 1996*
10.24 -- Form of Joint Venture Agreement among the Company and
Bluebeard's Castle, Inc. and Bluebeard Hilltop Villas dated
as of August 6, 1996*
10.25(a) -- Long-Term Agreement for the Purchase and Sale of Electricity
Between Sierra Pacific Power Company and Far West Capital,
Inc. dated October 29, 1988*
10.25(b) -- Assignment of Interest, dated December 10, 1988 by and
between Far West Capital, Inc. and 1-A Enterprises*
10.25(c) -- Letter dated August 18, 1989 by Gerald W. Canning, Vice
President of Electric Resources, consenting to the
Assignment of Interest on behalf of Sierra Pacific Power
Company*
10.26(a) -- Agreement for the Purchase and Sale of Electricity, dated as
of November 18, 1983 between Geothermal Development
Associates and Sierra Pacific Power Company*
10.26(b) -- Amendment to Agreement for Purchase and Sale of Electricity,
dated March 6, 1987, by and between Far West Hydroelectric
Fund, Ltd. and Sierra Pacific Power Company*
10.27 -- Loan and Option Agreement dated August, 1996 by and among
NRG Company, LLC and Reno Energy, LLC and ART, LLC and FWC
Energy, LLC, and amendments thereto*
10.28 -- Promissory Note dated August 9, 1996 for $300,000 from Reno
Energy, LLC to NRG Company, LLC*
10.29 -- Letter of Intent dated July 15, 1996 on behalf of Reno
Energy, LLC*
10.30 -- Limited Liability Company Operating Agreement of NRG
Company, LLC dated as of September 8, 1996, and amendments
thereto*
</TABLE>
19
<PAGE> 21
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <C> <S>
10.31 -- Form of Limited Liability Company Operating Agreement of
Steamboat, Envirosystems, L.C. dated as of October, 1996*
10.32 -- Form of Debenture Conversion Agreement*
10.33(a) -- First Amended and Restated Loan and Option Agreement, dated
April 9, 1997, by and between USE Geothermal LLC, and Reno
Energy LLC, ART, LLC and FWC Energy, LLC***
10.33(b) -- Note in the amount of $1,200,000, dated as of April 9, 1997,
made by Reno Energy LLC in favor of USE Geothermal LLC****
10.33(c) -- Security Agreement, dated as of April 9, 1997, made by Reno
Energy LLC in favor of USE Geothermal LLC****
10.33(d) -- Form of Security Agreement and Collateral Assignment,
entered into by and between USE Geothermal LLC and both FWC
Energy LLC and ART LLC****
10.33(e) -- Guaranty Agreement, dated as of April 9, 1997, made by FWC
Energy LLC and ART LLC in favor of USE Geothermal LLC****
10.34 -- 1996 Stock Option Plan++
10.35 -- Employment Agreement, dated as of March 1, 1997, between the
Company and Terrence Page++
10.36 -- Form of 9% Convertible Subordinated Secured Debenture due
2004+++
10.37 -- Form of Employment Agreement by and between the Company and
Howard Nevins+
10.38 -- Subscription Agreement, dated March 20, 1998, between the
Company and Energy Systems Investors, LLC++++
10.39 -- Registration Rights Agreement, dated March 20, 1998, between
the Company and Energy Systems Investors, LLC++++
21.1 -- Subsidiaries of the Company
23.1 -- Consent of Richard A. Eisner & Company, LLP, auditors of the
Company
27 -- Financial Data Schedule
</TABLE>
- ---------------
<TABLE>
<C> <S>
* Incorporated by reference to the Company's Registration
Statement on Form SB-2 (File No. 333-94612).
** Incorporated by reference to the Company's Annual Report on
Form 10-KSB for the year ended January 31, 1994.
*** Incorporated by reference to the Company's Quarterly Report
on Form 10-QSB for the quarter ended July 31, 1996.
**** Incorporated by reference to the Company's Current Report on
Form 8-K filed on April 24, 1997.
+ Incorporated by reference to the Company's Current Report on
Form 8-K dated August 12, 1997.
++ Incorporated by reference to the Company's Annual Report on
Form 10-KSB for the year ended January 31, 1997.
+++ Incorporated by reference to the Company's Current Report on
Form 8-K dated August 18, 1997.
++++ Incorporated by reference to the Company's Current Report on
Form 8-K filed on March 26, 1998.
</TABLE>
b. Reports on Form 8-K
On November 3, 1997, the Company filed an amendment to its Form 8-K
originally filed on August 18, 1997, reporting the consummation of its
acquisition of AES. The amended 8-K was filed to include pro-forma financial
statements of AES.
20
<PAGE> 22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act, the Issuer has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
U.S. ENERGY SYSTEMS, INC.
July 17, 1998 By: /s/ SEYMOUR J. BEDER
------------------------------------
Seymour J. Beder
Chief Financial and Accounting
Officer
and Controller
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ SEYMOUR J. BEDER* Chairman of the Board of July 17, 1998
- ----------------------------------------------------- Directors
Theodore Rosen
/s/ RICHARD H. NELSON President and Chief Executive July 17, 1998
- ----------------------------------------------------- Officer (Principal Executive
Richard H. Nelson Officer)
/s/ SEYMOUR J. BEDER Chief Financial and Accounting July 17, 1998
- ----------------------------------------------------- Officer and Controller
Seymour J. Beder (Principal Financial and
Accounting Officer)
/s/ SEYMOUR J. BEDER* Director and Executive Vice July 17, 1998
- ----------------------------------------------------- President
Howard Nevins
/s/ SEYMOUR J. BEDER* Director July 17, 1998
- -----------------------------------------------------
Lawrence I. Schneider
/s/ SEYMOUR J. BEDER* Director July 17, 1998
- -----------------------------------------------------
Evan Evans
/s/ SEYMOUR J. BEDER* Director July 17, 1998
- -----------------------------------------------------
Allen Rothman
Director
- -----------------------------------------------------
Todd Goodwin
*As Attorney-in-Fact.
</TABLE>
21
<PAGE> 23
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Financial Statements
Independent auditors' report.............................. F-2
Consolidated balance sheet as of January 31, 1998......... F-3
Consolidated statements of operations for the years ended
January 31, 1998 and 1997.............................. F-4
Consolidated statements of changes in stockholders' equity
for the years ended January 31, 1998 and 1997.......... F-5
Consolidated statements of cash flows for the years ended
January 31, 1998 and 1997.............................. F-6
Notes to financial statements............................. F-7
</TABLE>
F-1
<PAGE> 24
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
U.S. Energy Systems, Inc.
West Palm Beach, Florida
We have audited the accompanying consolidated balance sheet of U.S. Energy
Systems, Inc. and subsidiaries as of January 31, 1998 and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the years in the two-year period then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these 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, the consolidated financial statements enumerated above
present fairly, in all material respects, the financial position of U.S. Energy
Systems, Inc. and subsidiaries at January 31, 1998, and the results of their
operations and their cash flows for each of the years in the two-year period
then ended in accordance with generally accepted accounting principles.
Richard A. Eisner & Company, LLP
New York, New York
March 20, 1998
With respect to Note P
March 23, 1998
F-2
<PAGE> 25
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
JANUARY 31,
1998
-----------
<S> <C>
ASSETS
Current assets:
Cash...................................................... $ 319,000
Accounts receivable (less allowance for doubtful accounts
$11,000)............................................... 757,000
Notes receivable -- current portion....................... 105,000
Other current assets...................................... 276,000
-----------
Total current assets.............................. 1,457,000
Property, plant and equipment, net.......................... 5,780,000
Notes receivable, less current portion...................... 1,799,000
Investments in joint ventures:
Lehi Independent Power Associates, L.C.................... 984,000
Plymouth Cogeneration Limited Partnership................. 549,000
Goodwill, net............................................... 2,053,000
Other assets................................................ 407,000
-----------
$13,029,000
===========
LIABILITIES
Current liabilities:
Current portion of long-term debt......................... $ 85,000
Note payable -- bank...................................... 200,000
Accounts payable.......................................... 460,000
Accrued expenses.......................................... 470,000
Royalties payable......................................... 428,000
-----------
Total current liabilities......................... 1,643,000
Long-term debt, less current portion........................ 397,000
Convertible subordinated secured debentures (including due
to related parties of $207,000)........................... 875,000
Advances from joint ventures................................ 41,000
-----------
2,956,000
-----------
Minority interest........................................... 504,000
-----------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 5,000,000
shares; issued and outstanding, none
Common stock, $.01 par value, authorized 35,000,000
shares; issued and outstanding 5,160,609............... 51,000
Additional paid-in capital.................................. 15,454,000
Accumulated deficit......................................... (5,936,000)
-----------
9,569,000
-----------
$13,029,000
===========
</TABLE>
See notes to financial statements.
F-3
<PAGE> 26
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenues.................................................... $ 2,233,000 $ 266,000
----------- -----------
Cost and expenses:
Operating expenses........................................ 1,127,000 162,000
Administrative expenses................................... 1,613,000 1,136,000
Litigation costs.......................................... 326,000 --
Depreciation.............................................. 260,000 23,000
Loss from joint ventures.................................. 121,000 163,000
----------- -----------
3,447,000 1,484,000
----------- -----------
Loss before interest income (expense) and extraordinary
item...................................................... (1,214,000) (1,218,000)
Interest income............................................. 265,000 18,000
Interest (expense).......................................... (129,000) (823,000)
----------- -----------
Loss before extraordinary item.............................. (1,078,000) (2,023,000)
Extraordinary gain (loss) from restructuring of
liabilities............................................... 36,000 (25,000)
----------- -----------
NET LOSS.................................................... (1,042,000) (2,048,000)
Fair value of common shares issued over carrying amount of
preferred stock exchanged................................. -- (633,000)
----------- -----------
Loss applicable to common stock............................. $(1,042,000) $(2,681,000)
=========== ===========
LOSS PER SHARE OF COMMON STOCK -- BASIC AND DILUTED:
LOSS BEFORE EXTRAORDINARY ITEM............................ $ (0.23) $ (2.56)
=========== ===========
NET LOSS.................................................. $ (0.22) $ (2.58)
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING.................. 4,654,555 1,037,239
=========== ===========
</TABLE>
See notes to financial statements.
F-4
<PAGE> 27
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
PREFERRED STOCK ----------------------------------
------------------- ADDITIONAL
NUMBER OF NUMBER OF PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------- --------- ------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE -- JANUARY 31,
1996...................... 57,500 $ 1,000 439,650 $ 4,000 $ 112,000 $(2,846,000) $(2,729,000)
Cash paid for fractional
shares.................... (457) --
Proceeds from public
offering, net of
registration costs........ 3,565,000 36,000 11,921,000 11,957,000
Conversion of debentures to
common stock and
warrants.................. 125,000 1,000 499,000 500,000
Exchange of preferred stock
for common stock.......... (57,500) (1,000) 205,000 2,000 (1,000) --
Fair value of options issued
for consulting services... 187,000 187,000
Net loss for the
year ended
January 31,
1997............. (2,048,000) (2,048,000)
------- ------- --------- ------- ----------- ----------- -----------
BALANCE -- JANUARY 31,
1997...................... -- -- 4,334,193 43,000 12,718,000 (4,894,000) 7,867,000
Cash paid for fractional
shares.................... (14)
Shares issued in connection
with acquisition of
American Enviro-Services,
Inc....................... 676,430 7,000 2,387,000 2,394,000
Shares issued in connection
with acquisition of
Commonwealth Petroleum
Recycling, Inc............ 150,000 1,000 332,000 333,000
Fair value of options issued
for consulting services... 17,000 17,000
Net loss for the
year ended
January 31,
1998............. (1,042,000) (1,042,000)
------- ------- --------- ------- ----------- ----------- -----------
BALANCE -- JANUARY 31,
1998...................... -- $ -- 5,160,609 $51,000 $15,454,000 $(5,936,000) $ 9,569,000
======= ======= ========= ======= =========== =========== ===========
</TABLE>
See notes to financial statements.
F-5
<PAGE> 28
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(1,042,000) $(2,048,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 260,000 23,000
Amortization of debt discount........................... 54,000
Equity in loss of joint ventures........................ 121,000 163,000
Options issued for consulting services.................. 187,000
(Gain) loss from restructuring of liabilities........... (36,000) 25,000
Changes in:
Accounts receivable................................... 82,000 (225,000)
Other current assets.................................. (126,000) (96,000)
Other assets.......................................... (120,000) 93,000
Accounts payable and accrued expenses................. (471,000) (596,000)
Royalties payable..................................... 428,000
Accrued interest on pre-reorganization income taxes
payable.............................................. 38,000
----------- -----------
Net cash used in operating activities.............. (904,000) (2,382,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of business, net of cash acquired............. (414,000) (3,357,000)
Loans to Reno Energy LLC.................................. (1,695,000) (300,000)
Repayments of loan by Reno Energy LLC..................... 91,000
Acquisition of equipment and leasehold improvements....... (353,000)
Distributions from joint ventures, net of contributions... 11,000 42,000
Deposit................................................... 100,000 (100,000)
Other..................................................... (274,000)
----------- -----------
Net cash used in investing activities.............. (2,534,000) (3,715,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable............................... 87,000
Payment of convertible subordinated secured debentures.... (150,000)
Payment of pre-reorganization income taxes payable........ (347,000) (28,000)
Payment of long-term debt................................. (138,000)
Minority equity investment in subsidiary.................. 170,000 60,000
Proceeds from issuance of common stock.................... 14,616,000
Public offering costs..................................... (2,659,000)
Proceeds from loans payable and preferred stock........... 175,000
Payment of notes payable.................................. (1,000,000)
Payment of loans payable.................................. (960,000)
Advances from joint ventures.............................. 10,000 16,000
----------- -----------
Net cash provided by (used in) financing
activities....................................... (368,000) 10,220,000
----------- -----------
NET INCREASE (DECREASE) IN CASH............................. (3,806,000) 4,123,000
Cash -- beginning of period................................. 4,125,000 2,000
----------- -----------
CASH -- END OF PERIOD....................................... $ 319,000 $ 4,125,000
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 188,000 $ 1,083,000
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES:
Conversion of debentures to common stock and warrants..... $ 500,000
Exchange of common stock for preferred stock.............. $ 3,000
DETAILS OF ACQUISITIONS:
Fair value of assets acquired............................. $ 4,282,000 $ 4,134,000
Liabilities assumed....................................... (1,124,000) (503,000)
Fair value of common stock and options issued............. (2,744,000)
Minority interest......................................... (274,000)
----------- -----------
Cash paid for acquisitions.................................. $ 414,000 $ 3,357,000
=========== ===========
</TABLE>
See notes to financial statements.
F-6
<PAGE> 29
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
A. THE COMPANY
U.S. Energy Systems, Inc. and subsidiaries (collectively the "Company") is
in the business of owning, developing and operating cogeneration and independent
power plants through a subsidiary and through joint ventures. The Company,
through subsidiaries acquired during the year ended 1998, also provides
environmental and remedial services which include collecting and recycling used
motor and industrial oils and waters.
B. SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies followed in the preparation of the
financial statements are as follows:
(1) Consolidation. The consolidated financial statements of the
Company include the accounts of the Company and its subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
the consolidated balance sheet.
(2) Property, Plant and Equipment. Property, plant and equipment are
stated at cost and are depreciated using the straight-line method over
their estimated useful lives ranging from five to forty years.
(3) Investments in Joint Ventures. Investments in joint ventures are
accounted for under the equity method based on the investees' year end of
December 31.
(4) Goodwill. Goodwill represents the excess of the cost of acquired
companies over the fair value of their tangible net assets acquired and is
being amortized over 15 years using the straight-line method. The periods
of amortization of goodwill and other long-lived assets are evaluated at
least annually to determine whether events and circumstances warrant
revised estimates of useful lives. This evaluation considers, among other
factors, expected cash flows and profits of the businesses to which the
goodwill and other long-lived assets relate. Based upon the periodic
analysis, such assets are written down or written off if it appears that
future profits or cash flows will be insufficient to recover their carrying
values.
(5) Revenue Recognition.
Environmental and remedial services -- Revenue on cost plus fixed
fee jobs is recognized as costs are incurred using the time and material
method. Revenues from jobs that are based on fixed bids are recognized
based on the proportion of cost incurred to date to the total estimated
contract cost. Costs are recognized as incurred.
Cogeneration and independent power plants -- Revenues are
recognized upon delivery of power to a customer.
(6) Per Share Data. The Company adopted Statement of Financial
Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128") in the year
ended January 31, 1998 and has retroactively applied the effects thereof to
the prior fiscal year. SFAS 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. In 1997, the excess of the fair value of the common
shares issued over the carrying amount of the preferred stock has been
added to net loss to arrive at net loss applicable to common shareholders.
Basic and diluted loss per share is based on the weighted average number of
common shares outstanding during the years.
(7) Use of Estimates. The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of
F-7
<PAGE> 30
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
(8) Fair Values of Financial Instruments. The estimated fair value of
financial instruments has been determined based on available market
information and appropriate valuation methodologies. The carrying amounts
of cash, accounts receivable, other current assets, accounts payable and
accrued expenses and royalties payable approximate fair value at January
31, 1998 because of the short maturity of these financial instruments. The
estimated carrying value of the notes receivable, note payable -- bank,
mortgage and equipment notes payable and the convertible subordinated
secured debentures approximate fair value because the interest rates on
these instruments approximate the market rates at January 31, 1998. The
fair value estimates were based on information available to management as
of January 31, 1998.
(9) Stock-Based Compensation. In October 1995, the Financial
Accounting Standards Board issued Statement of Financial Accounting
Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation".
SFAS 123 encourages, but does not require, companies to record compensation
cost for stock-based employee compensation plans at fair value. The Company
has elected to continue to account for its stock-based compensation plans
using the intrinsic value method prescribed by Accounting Principles Board
Opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees"
and disclose the pro forma effects on net loss and loss per share had the
fair value of options been expensed. Under the provisions of APB No. 25,
compensation arising from the grant of stock options is measured as the
excess, if any, of the quoted market price of the Company's common stock at
the date of the grant over the amount an employee must pay to acquire the
stock (see Note M(2)).
(10) Recent Accounting Pronouncements. In June 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting
Standards No. 131, "Disclosure about Segments of an Enterprise and Related
Information". The Company believes that the above pronouncement will not
have a significant effect on the information presented in the financial
statements.
C. ACQUISITIONS
(1) American Enviro-Services, Inc. On August 18, 1997, the Company
acquired American Enviro-Services, Inc. ("AES") a provider of environmental and
remedial services, for $2,498,000. The purchase price consisted of $150,000 in
cash and 665,000 shares of the Company's common stock valued at $2,348,000. In
addition, the Company incurred acquisition costs of $276,000, including the
issuance of 11,430 common shares valued at $46,000 and options valued at
$17,000. The cost of the acquisition has been allocated to the assets acquired
and liabilities assumed based on their fair values as follows:
<TABLE>
<S> <C>
Assets acquired and liabilities assumed:
Current assets............................................ $ 599,000
Property, plant and equipment............................. 948,000
Goodwill.................................................. 2,118,000
Current liabilities....................................... (891,000)
----------
$2,774,000
==========
</TABLE>
The acquisition has been accounted for as a purchase and, accordingly, the
accompanying consolidated financial statements include the accounts of AES from
the date of acquisition.
(2) Commonwealth Petroleum Recycling, Inc. On January 5, 1998, the
Company, through its subsidiary AES, acquired Commonwealth Petroleum Recycling,
Inc. ("Commonwealth") for $333,000. Commonwealth also provides environmental and
remedial services. The purchase price consisted of 150,000 shares of the
Company's common stock valued at $333,000. The Company has placed in escrow
15,000 of such shares
F-8
<PAGE> 31
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
of the purchase price to cover the cost of environmental remediation and any
other possible contingencies. The purchase price, including $51,000 of
acquisition costs, has been allocated to the assets acquired and liabilities
assumed based on their fair values as follows:
<TABLE>
<S> <C>
Assets acquired and liabilities assumed:
Current assets............................................ $ 54,000
Property, plant and equipment............................. 563,000
Current liabilities....................................... (233,000)
---------
$ 384,000
=========
</TABLE>
The acquisition has been accounted for as a purchase and, accordingly, the
accompanying consolidated financial statements include the accounts of
Commonwealth from the date of acquisition.
(3) Steamboat Envirosystems, L.L.C. In December 1996, the Company acquired
a 95% interest in Steamboat Envirosystems, L.L.C. ("Steamboat") which has
purchased two geothermal power plants (the "Steamboat Facilities") from Far West
Electric Energy Fund ("FWEEF") and from 1-A Enterprises. Far West Capital Inc.,
the general partner and a limited partner in FWEEF, owns the remaining 5%. The
transaction was accounted for as a purchase. The operating results of Steamboat
have been included in the consolidated statement of operations from date of
acquisition.
The Company paid a total of $3,870,000 (including $50,000 as a down payment
which was previously paid by the Company) to Steamboat to complete the
acquisition of the plants and a mortgage to which the Steamboat Facilities were
subject, and fund the future acquisition of certain royalty interests and plant
improvements.
Pursuant to the agreements, the Company will receive the first $1,800,000
of Steamboat's annual net income. For net income above $1,800,000, Far West
Capital Inc. will receive: (i) 55% for the first five years and (ii) 5%
thereafter, with the balance going to the Company.
The Steamboat Facilities produce eight megawatts of electric power which is
sold under two power purchase agreements to Sierra Pacific Power Company
("Sierra"). The current power purchase agreements with Sierra provide for price
adjustments in December 1996 for Steamboat Facility 1 and December 1998 for
Steamboat Facility 1A. The rate currently being paid to the Company by Sierra
for Steamboat Plant 1's power production is substantially lower than what had
been paid until December 1996. Under the contracts, Steamboat is required to
sell power to Sierra for an additional ten-year period at the then-prevailing
short-term avoided costs for electricity for Sierra.
The Steamboat facilities are subject to certain royalty agreements which
include royalty payments for steam extraction rights and also provide for
royalty payments equivalent to thirty percent of the net revenue of Steamboat
Facility 1 after certain deductions, starting March 1, 1997. The Company has
been negotiating to acquire such royalty interests.
(4) USE Geothermal, LLC (Formerly NRG Company, LLC). During the year ended
January 31, 1997, the Company invested $265,000 in USE Geothermal, LLC ("USE
GEO"), a newly-formed Delaware limited liability company for an 81.5% ownership
interest . USE GEO is involved in the development of a geothermal heating
project (the "Reno Project") with Reno Energy LLC ("Reno Energy"), a Nevada
limited liability company. During the year ended January 31, 1998, the Company
increased its capital contribution to $1,970,000 for an 89.57% interest in USE
GEO.
Under the terms of the initial agreements between USE GEO and Reno Energy,
USE GEO has an option to acquire a 50% interest in Reno Energy, subject to
certain preferential distribution interests of the founders of Reno Energy (the
"Reno Option"). USE GEO paid $100,000 as an extension fee toward the Reno
Option. On April 10, 1997, USE GEO and Reno Energy signed a First Amended and
Restated Loan
F-9
<PAGE> 32
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
and Option Agreement, whereby as consideration and inducement for the loans made
by USE GEO to Reno Energy (see Note D), Reno Energy granted USE GEO an
irrevocable option to acquire a 50% membership in Reno Energy. Such option
expires on April 9, 2027.
(5) Unaudited Pro Forma Information. The following unaudited pro forma
information of the Company for the years ended January 31, 1998 and 1997 gives
effect to the acquisition of AES, Commonwealth and Steamboat as though the
acquisitions occurred at February 1, 1996 and reflect adjustments for
amortization of goodwill and depreciation of property, plant and equipment
resulting from allocation of the purchase price.
<TABLE>
<CAPTION>
JANUARY 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenue..................................................... $ 3,536,000 $ 4,424,000
Loss before extraordinary item.............................. (1,021,000) (1,139,000)
Net loss.................................................... (985,000) (1,164,000)
Net loss per share -- basic and diluted..................... $ (0.19) $ (0.62)
</TABLE>
D. NOTES RECEIVABLE
Notes receivable consist of the following:
<TABLE>
<S> <C>
Convertible loan(a)......................................... $1,420,000
First note(b)............................................... 209,000
Second note(c).............................................. 275,000
----------
1,904,000
Less current portion........................................ 105,000
----------
$1,799,000
==========
</TABLE>
- ---------------
(a) In April 1997, USE GEO consummated a convertible loan agreement with Reno
Energy in the initial amount of $1,200,000 at an interest rate of 12% per
annum maturing on April 10, 2027. The loan is convertible into a 50% equity
interest in Reno Energy. The percentage is subject to pro-rata adjustment
in the event of additional funding of the Reno Project. The loan is secured
by a first lien on all assets of Reno Energy and guaranteed by Reno
Energy's members.
At January 31, 1998, accrued interest on this note amounting to $126,000 is
included in other assets on the balance sheet.
(b) This represents a $300,000 loan granted by USE GEO to Reno Energy on
December 1996 to fund pre-development expenses associated with the Reno
Project. This loan is repayable in twelve equal quarterly payments of
$28,895 including interest at 9% per annum commencing on March 31, 1997
until final maturity on December 31, 1999.
(c) This loan was granted by the Company to Geo Energy, LLC (a company
affiliated with Reno Energy) on December 1, 1997 to fund site property
acquisition. This loan is repayable in eleven quarterly payments of $11,585
including interest at 15% per annum commencing on March 1, 1998 until final
maturity on December 1, 2000 at which time a balloon payment of $258,000
will be due.
F-10
<PAGE> 33
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
E. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at January 31, 1998:
<TABLE>
<S> <C>
Land........................................................ $ 78,000
Building.................................................... 784,000
Steamboat Springs Thermal Hydroelectric Power Plants........ 4,260,000
Equipment................................................... 458,000
Leasehold improvements...................................... 36,000
Office equipment and furnishings............................ 72,000
Vehicles.................................................... 328,000
----------
6,016,000
Less accumulated depreciation............................... (236,000)
----------
$5,780,000
==========
</TABLE>
F. INVESTMENT IN JOINT VENTURES
(1) LEHI Independent Power Associates, L.C. ("LIPA"). In January 1994,
Lehi Envirosystems, Inc. ("LEHI"), a subsidiary of the Company, purchased a 50%
equity interest in LIPA, which owns a cogeneration project (the "Project")
located in Lehi, Utah.
The operating agreement of LIPA provides for, among other matters, the
allocation of the net profits and net losses to the owners in proportion to
their ownership interest. The agreement also provides for additional
contributions totaling $875,000 to be shared by the owners in the event that any
modification, as defined, is required to bring the Project back to full
operational condition. LIPA terminates in January 2024, unless sooner dissolved
by certain conditions as set forth in the operating agreement.
From the date of LEHI's investment through January 31, 1998, the Project
has not been in operation.
The Company is exploring two alternatives for realizing its investment in
LIPA. The Company and its partners believe that LIPA can sell its existing
equipment and replace it with new generators that would produce power at a rate
that could be sold profitably. Additionally, the Company has filed an
application to update its air quality permit which allows the plant to operate
with emissions of up to 250 tons of Nitrous Oxide annually. The Company believes
that there is a market for the permit's tonnage, in excess of that required for
operations.
Far West Capital Inc., the other 50% owner of LIPA, also owns a 5% interest
in Steamboat Envirosystems, L.L.C. (see Note C(3)).
(2) Plymouth Cogeneration Limited Partnership ("PCLP"). In 1994, the
Company, through its subsidiary, Plymouth Envirosystems, Inc. acquired a 50%
interest in PCLP which owns and operates a cogeneration plant which produces
electricity and heat at Plymouth State College, in Plymouth, New Hampshire. The
facility provides 100% of the electrical and heating requirements for the
campus, which is a part of the University of New Hampshire system, under a
twenty year contract. The project, which cost $5.9 million to construct, is
comprised of a combination of diesel engine-generators, heat recovery and
supplemental boilers, and the complete civil works that link all campus
buildings into a single heating loop. The project was financed through
$5,110,000 in State of New Hampshire tax exempt revenue bonds and $700,000 in
equity, prior to the Company's acquisition of a 50% interest. The Company paid a
total of $636,000 in cash and 11,400 shares of common stock for its 50%
interest.
F-11
<PAGE> 34
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(3) At acquisition, LEHI's equity in the net assets of LIPA was
approximately $146,000 and Plymouth's equity in the net assets of PCLP was
approximately $668,000. The excess of purchase price over the underlying
equities of LEHI and Plymouth have been allocated to the plants of LIPA and
PCLP, respectively, and is being amortized over the remaining life of such
assets. At January 31, 1998, the estimated remaining life of the plants is as
follows:
<TABLE>
<S> <C> <C>
LIPA -- buildings................................................ 27 years
-- machinery and equipment.................................. 5 years
Plymouth -- plant.................................................... 18 years
</TABLE>
(4) The following is summarized financial information of LIPA and PCLP as
of December 31, 1997 and for each of the two-years in the period then ended:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------
LIPA PCLP
-------- -----------
<S> <C> <C>
Current assets.............................................. $ 4,000 $ 213,000
Property, plant and equipment at cost (net)................. 257,000 5,059,000
Other assets................................................ 1,005,000
-------- -----------
Total assets...................................... 261,000 6,277,000
Current liabilities......................................... (14,000) (489,000)
Long-term debt.............................................. (4,830,000)
-------- -----------
Equity...................................................... $247,000 $ 958,000
======== ===========
Share of equity in joint ventures........................... $124,000 $ 479,000
Investments in joint ventures in excess of equity........... 860,000 70,000
-------- -----------
Total investments in joint ventures............... $984,000 $ 549,000
======== ===========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
LIPA PCLP
------------------- -----------------------
1997 1996 1997 1996
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Revenue.................................... $1,198,000 $1,189,000
========== ==========
Net income (loss).......................... $(31,000) $(87,000) $ (91,000) $ (120,000)
======== ======== ========== ==========
Equity in net income (loss)................ $(16,000) $(44,000) $ (46,000) $ (60,000)
Amortization of purchase price over
equity................................... (55,000) (55,000) (4,000) (4,000)
-------- -------- ---------- ----------
Net income (loss) from joint ventures...... $(71,000) $(99,000) $ (50,000) $ (64,000)
======== ======== ========== ==========
Distributions received by Company.......... $ 20,000 $ 20,000
========== ==========
</TABLE>
G. NOTE PAYABLE -- BANK
At January 31, 1998, AES has borrowed $200,000 under a $200,000 line of
credit. The line of credit bears interest at 9% per annum and matures on March
16, 1998. The line of credit is secured by AES's accounts receivable, inventory
and equipment.
F-12
<PAGE> 35
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
H. LONG-TERM DEBT
Long-term debt, all incurred by AES, at January 31, 1998 consisted of the
following:
<TABLE>
<S> <C>
Mortgage payable, U.S. Small Business Administration, 4%,
$447 per month, due November, 2017(A)..................... $ 72,000
Mortgage payable, Old National Bank, prime plus .5%, $3,246
per month, due February, 2006(A).......................... 245,000
Notes payable, various, 8.3% - 12.2%, $7,227 per month, due
September 1998 to March 2003, collateralized by all the
assets of AES............................................. 165,000
--------
482,000
Less current portion........................................ 85,000
--------
$397,000
========
</TABLE>
- ---------------
(A) Collateralized by AES land and building
As of January 31, 1998, future annual maturities are as follows:
<TABLE>
<S> <C>
1999........................................................ $ 85,000
2000........................................................ 62,000
2001........................................................ 43,000
2002........................................................ 47,000
2003........................................................ 53,000
2004 and thereafter......................................... 192,000
--------
Long-term debt.............................................. 482,000
Less current portion of long-term debt...................... 85,000
--------
$397,000
========
</TABLE>
I. INCOME TAXES
Deferred taxes at January 31, 1998 consist of the following:
<TABLE>
<S> <C>
Potential benefit of operating loss carryforward............ $ 1,442,000
Expenses for financial reporting, not yet deductible for
taxes..................................................... 133,000
Valuation allowance......................................... (1,575,000)
-----------
$ 0
===========
</TABLE>
The Company has fully reserved against the deferred tax asset since the
likelihood of realization cannot be determined.
The difference between the statutory tax rate of 34% and the Company's
effective tax rate of 0% is due to an increase in the valuation allowance of
$181,000 in 1998 and $461,000 in 1997 to offset the tax benefit attributable to
the increases in operating loss carryforwards, resulting from the losses in each
year.
At January 31, 1998, the Company has net operating loss carryforwards
expiring through 2013. Under Section 382 of the Internal Revenue Code, the
Company is subject to annual limitation on utilization of its net operating loss
carryforwards because of an ownership change of more than 50% that occurred upon
the public offering in December 1996. This annual limitation is approximately
$150,000 plus any built-in gains recognized in the five year period beginning on
the date of the ownership change. After giving recognition to
F-13
<PAGE> 36
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
this limitation, the net operating loss carryforwards available to be utilized
by the Company of approximately $3,600,000, plus any recognized built in gains,
expire as follows:
<TABLE>
<CAPTION>
JANUARY 31,
- -----------
<S> <C>
2002...................................................... $ 750,000
2003...................................................... 150,000
2004...................................................... 150,000
2005...................................................... 150,000
2007...................................................... 124,000
2009...................................................... 19,000
2010...................................................... 607,000
2011...................................................... 150,000
2012...................................................... 565,000
2013...................................................... 939,000
----------
$3,604,000
==========
</TABLE>
J. CONVERTIBLE SUBORDINATED SECURED DEBENTURES
The Convertible Subordinated Debentures (the "Debentures") bear interest at
9% per annum and are due on January 25, 2004. The Debenture holders are entitled
to 50% of the Company's share of net profits of LIPA, as defined. The Debentures
are collateralized by the outstanding shares of LEHI and are subordinated to
senior indebtedness. Commencing January 25, 1998, the Company has the option to
redeem the Debentures at 102% of principal, plus unpaid and accrued interest.
The conversion rate of the Debentures is $8.00 per share (109,375 shares of
common stock).
K. STOCKHOLDERS' EQUITY
(1) Preferred Stock. Concurrent with the public offering in December 1996,
57,500 shares of Series One Preferred Stock were converted into 205,000 shares
of common stock. The excess of the fair value of the common shares issued over
the carrying amount of the preferred stock has been added to net loss to arrive
at net loss applicable to common shareholders for earnings per share purposes.
(2) 1996 Stock Option Plan. In December 1996, the Board of Directors
approved the 1996 Stock Option Plan (the "1996 Plan") which provides for the
granting of nonstatutory options to purchase up to 1,000,000 shares of common
stock to officers, employees, directors and consultants of the Company. The 1996
Plan is administered by a committee appointed by the Board of Directors which,
within the limitation of the 1996 Plan, determines the persons to whom options
will be granted, the number of shares to be covered by each option, the duration
and rate of exercise of each option, the exercise price and manner of exercise,
and the time, manner and form of payment upon exercise of an option. Options
granted under the 1996 Plan may not be granted at a price less than the fair
value of the common stock, as determined by the committee on the date of grant,
and will expire not more than ten years from the date of grant.
Options granted under the 1996 Plan are exercisable one (1) year after the
date of its grant with respect to 50% of the total number of shares subject to
the option, and two (2) years after the date of its grant with respect to the
remaining 50% of the total number of shares subject to the option.
(3) 1997 Stock Option Plan. In November 1997, the Board of Directors
approved the 1997 Stock Option Plan (the "1997 Plan") which provides for the
granting of nonstatutory options to purchase up to 1,000,000 shares of common
stock to officers, employees, directors and consultants of the Company. The 1997
Plan has substantially the same terms and provisions as the 1996 Plan, however,
options granted under the 1997 Plan are exercisable one (1) year after the date
of grant with respect to 25% of the total number of shares
F-14
<PAGE> 37
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
subject to option, and 25% at the end of each of the three succeeding (1) year
periods with respect to the remaining number of shares subject to the option.
(4) Stock Options and Warrants. Prior to December 1996, the Company
granted 174,100 options to officers, employees, directors and consultants of the
Company under several Stock Option Agreements. Options granted under these
agreements are exercisable for a period of up to five (5) years from date of
grant at an exercise price as stated in the agreements.
Stock option activity is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
-------------------------------------------
1998 1997
--------------------- -------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
--------- --------- ------- ---------
<S> <C> <C> <C> <C>
Options outstanding at beginning of year........ 816,600 $4.71 174,100 $7.66
Granted......................................... 473,000 3.19 642,500 3.92
--------- -------
Options outstanding at end of year.............. 1,289,600 4.16 816,600 4.71
========= =======
Options exercisable at end of year.............. 495,350 5.23 174,100 7.66
========= =======
</TABLE>
The following table presents information relating to stock options
outstanding at January 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -------------------------------------------------------------------------- --------------------
WEIGHTED-
WEIGHTED- AVERAGE WEIGHTED-
AVERAGE REMAINING AVERAGE
EXERCISE LIFE IN EXERCISE
RANGE OF EXERCISE PRICE SHARES PRICE YEARS SHARES PRICE
- ----------------------- --------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
$ 2.03 - $2.125........................ 151,000 $ 2.04 9.76
3.25 - 3.875........................ 677,000 3.55 4.50 202,500 $ 3.875
4.00 - 4.375........................ 307,500 4.04 5.21 138,750 4.00
8.00................................. 144,000 8.00 2.76 144,000 8.00
10.00................................. 10,100 10.00 1.90 10,100 10.00
--------- ---- -------
1,289,600 5.07 495,350
========= ==== =======
</TABLE>
As of January 31, 1998, a total of 884,500 options are available for future
grant.
The weighted-average fair value of options at date of grant for grants
during 1998 and 1997 was $2.16 and $3.14 per option, respectively. The fair
value of the options at date of grant was estimated using the Black-Scholes
option-pricing model utilizing the following weighted average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 31,
-------------
1998 1997
---- -----
<S> <C> <C>
Risk-free interest rates.................................... 6.02% 6.43%
Expected option life in years............................... 6.50 10.00
Expected stock price volatility............................. .70 .70
Expected dividend yield..................................... .00 .00
</TABLE>
Had the Company elected to recognize compensation cost based on the fair
value of the options at the date of grant as prescribed by FASB 123, pro-forma
net loss applicable to common stock in 1998 and 1997 would have been
($1,631,000) and ($2,729,000), respectively, or ($0.35) per share and ($2.63)
per share, respectively.
F-15
<PAGE> 38
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As of January 31, 1998, the Company has warrants outstanding for the
purchase of its common stock as follows:
<TABLE>
<CAPTION>
EXERCISE EXPIRATION
DESCRIPTION SHARES PRICE DATE
- ----------- --------- -------- ----------
<S> <C> <C> <C>
Convertible debt.................................. 125,000(a) $ 4.00 December 2001
Debt.............................................. 114,000 5.00 October 1999
Consulting services............................... 3,750 16.00 October 1999
Public offering................................... 3,565,000(a) 4.00 December 2001
</TABLE>
- ---------------
(a) Redeemable at $.01 per warrant under certain conditions.
L. EXTRAORDINARY GAIN (LOSS) FROM RESTRUCTURING OF LIABILITIES
As of January 31, 1997, the Company had pre-reorganization income taxes and
payroll taxes payable amounting to $383,000. During the year ended January 31,
1998, the Company settled these payables by paying $347,000. $36,000 was
recognized as a gain from such settlement.
For the year ended January 31, 1997, the Company had similar settlement
agreements with state taxing authorities relating to pre-reorganization payroll
taxes payable, whereby the Company paid $25,000 in excess of what was recorded
in the books, which amount was recorded as a loss on settlement.
M. COMMITMENTS AND CONTINGENCIES
(1) Use International, L.L.C. During the year ended January 31, 1998, the
Company settled its arbitration with a former joint venture partner for a
payment of $163,000 of which $79,000 was charged to litigation costs for the
year ended January 31, 1998.
(2) U.S. Energy Systems, Inc. v. Enviro Partners, L.P. et al. On March 27,
1997, the Company filed for a declaratory judgement action against Enviro
Partners, L.P. ("Enviro") and other partners of the Enviro Limited Partnership.
The Company had intended to close a private placement of its securities to
Enviro concurrent with a public offering of its securities. The Company was
unable to close the private placement because a condition to the private
placement, NASDAQ's approval of listing the Company's publicly offered
securities on the NASDAQ Small Cap Market, would not be satisfied if the private
placement proceeded. NASDAQ refused to approve the requested listing because it
concluded that the private placement was unfair to potential NASDAQ investors.
The Company completed its public offering without closing the private placement
in December 1996.
The Company commenced the action because of threats to sue the Company by
Enviro for damages sustained as a result of not completing the private
placement. On March 28, 1997, Enviro counterclaimed seeking $6,000,000 of
damages. Management believes the counterclaim has no merit and intends to
contest vigorously, however, the outcome is presently indeterminable.
N. RELATED PARTY TRANSACTIONS
Included in the outstanding debentures are amounts due to an officer of
$80,000. In connection with the notes payable issued in November 1994 and paid
in December 1996, an affiliate of a director was granted warrants to purchase
78,000 shares of the Company's common stock at $5.00 per share before October
31, 1999.
During the years ended January 31, 1998 and 1997, the Company paid interest
of $7,000 and $286,000, respectively, to the Related Parties.
F-16
<PAGE> 39
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
O. BUSINESS SEGMENTS
The Company's business segments are the developing and operating of
cogeneration and independent power plants and providing environmental and
remedial services. The following is the Company's business segment data:
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenues:
Cogeneration and independent power plants................. $ 1,520,000 $ 266,000
Environmental and remedial services....................... 713,000
----------- -----------
$ 2,233,000 $ 266,000
=========== ===========
Operating income (loss):
Cogeneration and independent power plants................. $ 379,000 $ 60,000
Environmental and remedial services....................... (12,000)
----------- -----------
Total operating income............................ 367,000 60,000
Corporate expenses........................................ (1,460,000) (1,115,000)
Loss from Joint Ventures.................................. (121,000) (163,000)
Interest income........................................... 265,000 18,000
Interest (expense)........................................ (129,000) (823,000)
Extraordinary gain (loss) from restructuring of
liabilities............................................ 36,000 (25,000)
----------- -----------
Net loss.......................................... $(1,042,000) $(2,048,000)
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Assets:
Cogeneration and independent power plants................. $ 4,350,000 $ 4,382,000
Environmental and remedial services....................... 4,368,000
Corporate assets.......................................... 4,311,000 6,269,000
----------- -----------
$13,029,000 $10,651,000
=========== ===========
Capital expenditures:
Cogeneration and independent power plants................. $ 126,000 $ 4,134,000
Environmental and remedial services....................... 1,655,000
Corporate................................................. 83,000
----------- -----------
$ 1,864,000 $ 4,134,000
=========== ===========
Depreciation and amortization:
Cogeneration and independent power plants................. $ 148,000 $ 23,000
Environmental and remedial services....................... 98,000
Corporate................................................. 14,000
----------- -----------
$ 260,000 $ 23,000
=========== ===========
</TABLE>
P. SUBSEQUENT EVENT
On March 23, 1998, the Company issued 250,000 shares of its Series A
convertible preferred stock, par value $0.01 per share for $2,250,000 ($9.00 per
share). Each share of preferred stock is convertible into four shares of common
stock, subject to certain anti-dilutive adjustments upon the occurrence of
certain events, and is entitled to a cumulative dividend of 9% per annum, in
cash or shares of common stock of the Company.
F-17
<PAGE> 40
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company may redeem the preferred stock after March 1, 2001, and may force
the conversion of the preferred stock to common stock after March 1, 2006.
Additionally, subject to shareholder approval, the investor has the right
to purchase an additional 222,000 shares of the Series A convertible preferred
stock prior to March 23, 1999, on the same terms as the original offering.
F-18
