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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(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
ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______
COMMISSION FILE NUMBER 0-10238
U.S. ENERGY SYSTEMS, INC.
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(NAME OF REGISTRANT IN ITS CHARTER)
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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 OFFICES) (ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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Securities registered pursuant to Section 12(b) of the Act: None.
Securities Registered pursuant to Section 12(g) of the Act:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, par value $.01 per share Nasdaq SmallCap Market
Warrants Nasdaq SmallCap Market
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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
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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 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.
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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 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
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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-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
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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 operating 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 shortly. 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, 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
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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.
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.
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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
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IPP industry. Approximately 18 of the 25 largest independent power companies are
owned and operated in such a manner. 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.
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
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project subsidiary or partnership in which the Company has 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
9
<PAGE> 11
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 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.
10
<PAGE> 12
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 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.
11
<PAGE> 13
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 maintains regional offices in Reno, Nevada, on
the site of the Steamboat facilities.
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.
12
<PAGE> 14
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>
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 (To April 23, 1998) .......................... $2.25 $1.81
</TABLE>
13
<PAGE> 15
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 (To April 23, 1998) .......................... $0.69 $0.38
</TABLE>
As of April 23, 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.
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
14
<PAGE> 16
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 $1,520,00 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 $673,000 $489,000
Selling, general and administrative expenses 319,000 174,000
Depreciation and amortization 149,000 62,000
</TABLE>
Included in Administrative Expenses were Salaries and Consulting Fees
of $518,000 in Fiscal 1997 compared to $704,000 in Fiscal 1996. The decrease was
due to the fact that in Fiscal 1996,
15
<PAGE> 17
$187,000 was charged in connection with the issuance of options to persons other
than officers and directors of the Company. Legal and Professional Fees
increased to $476,000 in Fiscal 1997 from $147,000 in the previous year due to
the costs of litigation in which the Company was involved. 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 sizable
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%.
The net loss of the Company was reduced to $1,042,000 in Fiscal 1997 as
compared to $2,048,000 in Fiscal 1996. Primarily as a result of this, cash used
in operating activities was $904,000 in Fiscal 1997 as compared to $2,382,000 in
Fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
During Fiscal 1997, the Company's working capital, which was at
$3,218,000 at January 31, 1997, was primarily used as disclosed in the Company's
Registration Statement on Form SB-2, dated December 2, 1996, in connection with
the 1996 Offering, namely for investment and acquisition. The costs of acquiring
AES and Commonwealth amounted to $414,000 and $353,000 respectively. Management
believes that these acquisitions will add to the Company's profitability in the
current fiscal year. An additional $1,695,000 was used for loans to Reno Energy,
which the Company believes could become a large income producing property in the
years to come. Pre-construction work on Reno Energy is proceeding now that the
state and local authorities have granted necessary initial permits.
In connection with the Company's need for additional capital to proceed
with its expansion plans, the Company completed a private placement of its
Preferred Stock in March 1998. See "Recent Sales of Unregistered Securities"
above.
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.
16
<PAGE> 18
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, 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
17
<PAGE> 19
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.
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
18
<PAGE> 20
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.
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.
19
<PAGE> 21
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
A. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
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*
</TABLE>
20
<PAGE> 22
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
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*
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*
</TABLE>
21
<PAGE> 23
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
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*
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****
</TABLE>
22
<PAGE> 24
\
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
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>
- -----------------
* 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.
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.
23
<PAGE> 25
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.
By: /s/ Seymour J. Beder
--------------------------------------
Seymour J. Beder
Chief Financial and Accounting Officer
and Controller
May 1, 1998
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints each of Richard H. Nelson and Seymour J.
Beder as his true and lawful attorney-in-fact and agent with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this Annual Report on
Form 10-KSB and to file the same with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorney-in-fact and agent full power and authority to do and perform
each and every act and thing requisite and necessary to be done in and about the
foregoing, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his substitute or substitutes, may lawfully do or cause to be done by
virtue thereof.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/ THEODORE ROSEN Chairman of the Board of Directors May 1, 1998
- ------------------------------------------
Theodore Rosen
/s/ RICHARD H. NELSON President and Chief Executive Officer (Principal May 1, 1998
- ------------------------------------------ Executive Officer)
Richard H. Nelson
/s/ SEYMOUR J. BEDER Chief Financial and Accounting May 1, 1998
- ------------------------------------------ Officer and Controller
Seymour J. Beder (Principal Financial and Accounting Officer
/s/ HOWARD NEVINS Director and Executive Vice President May 1, 1998
- ------------------------------------------
Howard Nevins
/s/ LAWRENCE I. SCHNEIDER Director May 1, 1998
- ------------------------------------------
Lawrence I. Schneider
/s/ EVAN EVANS Director May 1, 1998
- ------------------------------------------
Evan Evans
/s/ ALLEN ROTHMAN Director May 1, 1998
- ------------------------------------------
Allen Rothman
Director
- ------------------------------------------
Todd Goodwin
</TABLE>
25
<PAGE> 26
FINANCIAL STATEMENT APPENDIX
<PAGE> 27
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONTENTS
PAGE
----
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
F-1
<PAGE> 28
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 O
March 23, 1998
F-2
<PAGE> 29
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
JANUARY 31, 1998
<TABLE>
<CAPTION>
<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> 30
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> 31
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------ -----------------------------------
NUMBER NUMBER ADDITIONAL
OF 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) 0
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) 0
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 0 0 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 0 $ 0 5,160,609 $ 51,000 $ 15,454,000 $ (5,936,000) $ 9,569,000
========= ========= =========== ========== ============= ============= =============
</TABLE>
See notes to financial statements
F-5
<PAGE> 32
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> 33
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE 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.
NOTE 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. Goodwill will be
periodically reviewed for impairment based on an assessment of future
operations of the acquired companies.
[5] 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.
F-7
<PAGE> 34
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[6] 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 the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
[7] 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.
[8] 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]).
[9] 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.
F-8
<PAGE> 35
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE 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:
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
==========
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 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:
Assets acquired and liabilities assumed:
Current assets $ 54,000
Property, plant and equipment 563,000
Current liabilities (233,000)
---------
$ 384,000
=========
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.
F-9
<PAGE> 36
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE C - ACQUISITIONS (CONTINUED)
[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 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.
F-10
<PAGE> 37
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE C - ACQUISITIONS (CONTINUED)
[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>
NOTE D - NOTES RECEIVABLE
Notes receivable consist of the following:
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
=============
(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-11
<PAGE> 38
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE E - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at January 31, 1998:
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
=============
NOTE 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
LEHI. 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]).
F-12
<PAGE> 39
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE F - INVESTMENT IN JOINT VENTURES (CONTINUED)
[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.
[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:
LIPA - buildings 27 years
- machinery and equipment 5 years
Plymouth - plant 18 years
[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>
F-13
<PAGE> 40
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE F - INVESTMENT IN JOINT VENTURES (CONTINUED)
[4] (continued)
<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>
NOTE 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.
NOTE H - LONG-TERM DEBT
Long-term debt, all incurred by AES, at January 31, 1998 consisted of the
following:
<TABLE>
<CAPTION>
<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
F-14
<PAGE> 41
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE H - LONG-TERM DEBT (CONTINUED)
As of January 31, 1998, future annual maturities are as follows:
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
========
NOTE I - INCOME TAXES
Deferred taxes at January 31, 1998 consist of the following:
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
===========
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 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:
JANUARY 31,
-----------
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
==========
F-15
<PAGE> 42
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE 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).
NOTE 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
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.
F-16
<PAGE> 43
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE K - STOCKHOLDERS' EQUITY (CONTINUED)
[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-
RANGE OF AVERAGE REMAINING AVERAGE
EXERCISE EXERCISE LIFE IN 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>
F-17
<PAGE> 44
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE K - STOCKHOLDERS' EQUITY (CONTINUED)
[4] STOCK OPTIONS AND WARRANTS: (CONTINUED)
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:
YEAR ENDED
JANUARY 31,
-----------------
1998 1997
---- -----
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%
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.
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.
F-18
<PAGE> 45
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE L - COMMITMENTS AND CONTINGENCIES (CONTINUED)
[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.
NOTE M - 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-19
<PAGE> 46
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE N - 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>
F-20
<PAGE> 47
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
NOTE O - 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. 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-21
<PAGE> 1
EXHIBIT (21)
SUBSIDIARIES OF THE REGISTRANT
DATE OF STATE OF
SUBSIDIARY INCORPORATION INCORPORATION
- ---------- ------------- -------------
Lehi Envirosystems, Inc. 1991 Delaware
Plymouth Envirosystems, Inc. 1994 Delaware
USE International, L.L.C. 1995 New Jersey
Steamboat Envirosystems, L.L.C. 1996 Delaware
USE Geothermal, L.L.C. 1996 Delaware
American Enviro-Services, Inc. 1997 Indiana
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We hereby consent to the incorporation by reference in the Company's
Registration Statement on Form S-3 Registration No. 333-36307 filed on September
28, 1997 of our report dated March 20, 1998 (March 23, 1998 with respect to Note
O), which appears on page F-2 of the Annual Report on Form 10-KSB of U.S. Energy
Systems, Inc. and subsidiaries for the year ended January 31, 1998 and to the
reference to our firm under the caption "Experts" in the prospectus.
/s/ Richard A. Eisner & Company, L.L.P.
New York, New York
May 1, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> FEB-01-1998
<CASH> 319,000
<SECURITIES> 0
<RECEIVABLES> 862,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,457,000
<PP&E> 6,016,000
<DEPRECIATION> 236,000
<TOTAL-ASSETS> 13,029,000
<CURRENT-LIABILITIES> 1,643,000
<BONDS> 1,272,000
0
0
<COMMON> 51,00
<OTHER-SE> 9,518,000
<TOTAL-LIABILITY-AND-EQUITY> 13,029,000
<SALES> 121,000
<TOTAL-REVENUES> 2,233,000
<CGS> 97,000
<TOTAL-COSTS> 1,127,000
<OTHER-EXPENSES> 2,199,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 129,000
<INCOME-PRETAX> (1,078,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,078,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 36,000
<CHANGES> 0
<NET-INCOME> (1,042,000)
<EPS-PRIMARY> (0.23)
<EPS-DILUTED> (0.22)
</TABLE>
