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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, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-10238
U.S. ENERGY SYSTEMS, INC.
(Name of Registrant in its Charter)
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<S> <C>
52-1216347
DELAWARE (I.R.S. Employer
(State of Incorporation) 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)
</TABLE>
Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities Registered pursuant to Section 12(g) of the Act:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
Common Stock, par value $.01 per share Nasdaq SmallCap Market
Warrants Nasdaq SmallCap Market
</TABLE>
Check whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act during the past 12
months (or for a shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-B is not contained herein, and will not be contained, to the best of the
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB [X].
Revenue for the Fiscal Year ended January 31, 1999: $4,195,000
The aggregate market value of the Common Stock held by nonaffiliates
computed by reference to the closing sales price of the Common Stock of the
registrant as of April 29, 1999 was approximately $12,000,000.
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 29, 1999 the number of outstanding shares of the registrant's
Common Stock was 5,153,005.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
Documents Incorporated by Reference: The Company intends to file the
registrant's Definitive Proxy Statement for its 1999 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
synergistic 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, in its present form, was created in 1993 through the merger of
Utility Systems Florida, Inc. ("USF"), a private company controlled by Richard
H. Nelson, and Cogenic Energy Systems, Inc. ("Cogenic"), a publicly traded
company of which Mr. Nelson had been one of the founders. Cogenic was originally
incorporated in 1981 and filed for protection under Chapter 11 of the Bankruptcy
Code in 1990. Pursuant to a USF proposed plan of reorganization, which was
approved by the court in late 1993, USF merged into Cogenic. The resulting
entity was renamed U.S. Envirosystems, Inc. In May 1996 the Company's name was
changed to U.S. Energy Systems, Inc.
RECENT DEVELOPMENTS
The Board of Directors of the Company, at a meeting duly called and held on
January 21, 1999, authorized the creation of 1,000 shares of Series B
Convertible Preferred Stock, $0.01 par value per share (the "Series B Preferred
Stock"). Each share of the Series B Preferred Stock is convertible into 275
shares of common stock of the Company, par value $.01 per share (the "Common
Stock"), and carries a dividend of 9% per annum. The Company subsequently
offered the holders of the Company's 9% Subordinated Convertible Debentures (the
"Convertible Debentures") the right to exchange $1,000 principal amount of their
Convertible Debentures for one share of Series B Preferred Stock. The offer was
accepted by 74% of the holders, representing 58% of the Debentures (or $509,000
in principal amount), and was consummated on March 8, 1999.
ENERGY DIVISION
The Company's Energy Division engages 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"). Generally, IPPs have emerged
as a result of recent federal and state laws promulgated to eliminate the
monopoly previously held by Regulated Electric Companies over the production and
sale of electric power in order to enhance competition among electricity
providers.
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The Company believes that the power production industry is in the midst of
a twofold change. The first is the movement towards increased competition,
thereby producing savings to the consumer. The second is the effort to produce
power with fewer harmful 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 (a process known
as "wholesale wheeling"). Wholesale wheeling typically allows Regulated Electric
Companies to purchase electricity from IPPs more cheaply and efficiently than
they would be able to produce electricity 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 (a process known as "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 through methods which
create less pollution than traditional fossil fuel-burning engines and boilers,
and which conserve the earth's depleting non-renewable energy sources by using
less fuel, are becoming increasingly important issues. One such method of
producing power through "environmentally-friendlier" 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 December 1996 acquisition of the two operating geothermal power
plants known as Steamboat 1 and 1A, in Steamboat Hills, Nevada (collectively,
the "Steamboat Facilities", provided the Company's initial entry into this area
of "green" power production.
Geothermal power is considered to be one of the most environmentally-sound
methods of producing electricity due to the facts that (1) there are virtually
no atmospheric emissions or pollutants in the process, (2) the natural resource
(water) is constantly returned to the earth thereby avoiding 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.
The Company expects to explore further uses of geothermal resources to
produce energy through the development of the Company's 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 commercial
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
completion in 2000, will be one of the largest district heating facilities in
the United States.
ENVIRONMENTAL DIVISION
The Company's acquisition of American Enviro-Services, Inc. in Newburgh,
Indiana ("AES") in August 1997 marked its expansion into the environmental
services field. 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 potentially can be used to fuel the Company's and third party power
plants. The Company plans both to utilize these synergistic services of its
Environmental Division in its energy operations and to expand this area of its
business through internal growth and acquisitions. The Company believes that the
environmental services field is an industry with
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growth potential, and one in which the Company can create a profitable market
niche. The Company expects that AES 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 the 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 environmental-related services. At its facilities in
Newburgh, Indiana, AES converts otherwise hazardous substances into
environmentally and ecologically sound fuel and cleans polluted soil and water.
The result of AES' work, similar to that of the Company's Energy Division, is a
cleaner, less-polluted environment. AES has also developed a system for recovery
and reprocessing of oil from spills on inland waterways.
The Company expanded its Environmental Division in January 1998, when it
acquired Commonwealth Petroleum Recycling, Inc., a waste oil recycling company
located in Shelbyville, Kentucky ("Commonwealth"). The Company believes that the
acquisition of Commonwealth gives AES a base in northern Kentucky, and
strengthens its market and operating position in the greater Indiana-Kentucky
area.
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 which the Company
purchased the Steamboat Facilities. 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 until December 2001, and 95% of annual net income over $1.8 million
thereafter. 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 30% of the net revenue of Steamboat 1 after
certain deductions. The Company has been negotiating to acquire such royalty
interests.
Steamboat 1 and 1A were built in 1986 and 1988, respectively, by Far West
and are managed by SB Geo, Inc. ("SB Geo"), a company in which the principals of
Far West own a majority equity interest. The Company has contracted with SB Geo
for its continued management services at prices 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 to 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 ended in December 1998. At each adjustment time, Sierra's
short-term avoided cost was substantially lower than the rate then being paid.
The Company, together with the Nevada Geothermal Industry Council, an
industry association comprised of several geothermal producers in Nevada, filed
an intervention with the Nevada Public Utilities Commission on hearings to
determine the rates Sierra should pay for the purchase of electricity. The
Company argued that the revenue it was receiving for Steamboat 1 power could be
increased significantly either through adjustments in the rate from Sierra or,
alternatively, selling its power outside of Sierra's
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territory under existing wheeling laws, with the consent of Sierra. On July 20,
1998, Sierra signed a stipulation committing to the use of market rates under
the power purchase agreements. Market rates vary seasonally, but the annual
average is more favorable to the Company than the filed tariff short term rates
Sierra had been paying. This effectively raised the rates being paid for
Steamboat 1 power as of July 1998 and for Steamboat 1A power as of December 1998
above Sierra's short-term avoided costs.
Under the terms of the stipulation, the Company has presented to Sierra a
claim for $210,000 for underpayments from December 1996 to July 1998, that arose
from calculations at lower-than-market rates during that period. This claim is
currently being negotiated, but there is no assurance that the Company will be
successful in these efforts.
Plymouth State College, New Hampshire. In 1994, the Company, through its
wholly-owned subsidiary, Plymouth Envirosystems, Inc., acquired a 50% interest
in Plymouth Cogeneration Limited Partnership ("Plymouth Cogeneration") which
owns and operates a cogeneration plant producing 2.5 megawatts of electricity
and 25 million BTUs of heat at Plymouth State College, in Plymouth, New
Hampshire. The Plymouth 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 20-year contract expiring in 2014. 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 in 1994 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 Plymouth Facility and the management decisions are made by a
committee which is composed of representatives of the Company, IEC and Central
Hudson.
The State of New Hampshire is conducting a study to determine the
feasibility of expanding the existing facility to wheel electric power to two
other state college campuses. The state university system has also approached
the Company and its partner, Central Hudson, to inquire if the partners would be
interested in selling their interests in the project. The parties are currently
negotiating such an option.
Lehi Cogeneration Project, Utah. In January 1994, the Company, through its
wholly-owned subsidiary, Lehi Envirosystems, Inc. ("LEHI"), purchased a 50%
equity interest in Lehi Independent Power Associates ("LIPA"), which owns a
cogeneration facility in Lehi, Utah (the "Lehi Facility") and the underlying
real estate, hardware and permits to operate the Lehi Facility. The Lehi
Facility has been dormant since 1990, and the Company, together with its LIPA
partners, has been exploring alternatives by which the Lehi Facility can begin
operating.
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, are capable of being placed in operation if a satisfactory
purchase agreement for their output can be obtained. However, the Company has
determined that it would obtain better results if these engines were replaced
with combined cycle gas turbines of larger output and substantially greater
efficiency. The Company is negotiating a joint venture with third parties to
pursue such plans.
Under the new Title V of the Clean Air Act, which became effective in 1995,
the Lehi Facility must have an air quality permit from the Utah Division of Air
Quality. It is expected that the one remaining filing for this air quality
permit application will be completed by the third fiscal quarter of 1999. Once
the application has been completed, the Utah Division of Air Quality customarily
takes 90 to 120 days to issue the permit. The Company knows of no reason why
such air quality permit would not be issued. LIPA would not replace the
generators until the air quality permit is secured and power purchase contracts
can be arranged for the output
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of the plant. The Company believes that the industrial and population growth in
the Lehi area will create a large future market for power. In addition, the
wheeling rules make it possible for the Company to market the power to areas
outside the immediate Lehi area.
Reno Energy District Heating Project. The Company has an 89.6% interest in
USE Geothermal, LLC ("USE GEO"), which has agreed to loan Reno Energy funds,
pursuant to a convertible loan agreement for use in providing engineering,
design and financial services in connection with a 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 Reno Facility is still in the
planning and development stage. The Nevada Public Utilities Commission issued
its Compliance Order approval for the Reno Facility in November 1997, and the
Washoe County Planning Commission issued its Special Use Permit for the Reno
Facility in December 1997.
The Company has loaned Reno Energy $1.6 million under the convertible loan
agreement, evidenced by a convertible note (the "Note") which matures on April
10, 2027. 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 if 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" in a timely
manner. "Operating period interest" is the interest to be paid after the Reno
Facility has commenced commercial operations. At that time, Reno Energy will be
required to pay interest on the Note based on a percentage (currently 50%) of
(i) Reno Energy's net cash flow from operations and (ii) net cash proceeds from
certain capital transactions, after payment of certain distributions to members
of Reno Energy. USE GEO may convert the Note for no additional consideration
into a 50% equity interest in Reno Energy at any time prior to the maturity of
the Note. Such equity percentage will be adjusted proportionately in the event
of additional funding of Reno Energy by USE GEO or Reno Energy's members prior
to the exercise of the option to convert. The Note is secured by a first lien on
all of the assets of Reno Energy and is personally guaranteed by Reno Energy's
members. Such personal guarantees are, in turn, secured by a first lien and
pledge of the respective guarantors' membership interest in Reno Energy.
An additional $109,000 remains outstanding on a $300,000 loan granted by
the Company to Reno Energy in December 1996 to fund pre-development expenses
associated with the Reno project. This loan is payable in quarterly installments
with interest at 9% per annum, and matures on December 31, 1999.
A $275,000 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 payable quarterly with interest at 15% per annum until
final maturity on December 1, 2000.
The industrial park currently being developed in close proximity to the
Reno Facility is located on a 1,200 acre parcel and 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 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
heat for 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 minimize 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.
The Company estimates 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.
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Environmental Division
On August 18, 1997, the Company acquired AES, thus entering the
environmental services field. 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 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 the
Company's Environmental Division consists of environmental remediation, clean-up
and monitoring. Examples of the projects currently in progress are the
following:
- AES is continuing to work on a three-year contract with 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. The contract, which commenced in March 1998, requires
that AES close and monitor the landfill, build a transfer station, and
expand and redesign the substations and the recycling facility for the
County.
- AES has expanded its services to provide emergency response on inland
waterways. These services have been approved by the United States Coast
Guard. The waterway response system includes 2,000 feet of containment
booms, a pontoon recovery system, a drum skimmer and a 19 foot support
boat, in addition to the on-shore recovery and handling equipment. All
recovered fluid is transported to the AES treatment and recycling
facilities.
- Pursuant to a 1988 U.S. Environmental Protection Agency ("EPA") mandate,
all underground storage tanks in the United States must have been
retrofitted by December 22, 1998 for leak detection, corrosion protection
and spillage/overfill protection devices. AES estimates that, as of the
present date, approximately 30% of such underground tanks in the United
States do not meet these EPA regulations. AES has several employees
trained to conduct underground storage tank retrofitting, and is in the
process of hiring additional trained employees. The EPA has notified such
entities that it will fine persons for non-compliance with its 1988
regulation. AES believes that the EPA mandate will generate several
additional years of revenue from such retrofitting projects or removal of
facilities not in compliance.
Oil and Waste Recovery and Recycling. The Company's Environmental
Division, through its Indiana and Kentucky AES facilities, conducts oil and
water recovery for 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 heat
and chemical processes which separate the elements and allow AES to remove metal
deposits and other contaminants. Recycled oil is then stored in AES' aboveground
tanks and sold to industrial users. Contaminated water is also hauled to the AES
facility. It is then chemically treated to remove harmful contaminants, and is
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-Illinois area. Such operations include response to
automobile, truck, train and waterway 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 such emergency situations. AES has 15 employees, four response
vehicles and two equipment trailers which typically respond to two to three
calls per week.
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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. The IPP industry is basically divided into three areas, based upon
size or physical placement of facility: (i) large power plants (over 50
megawatts); (ii) small to medium-sized power plants (3 to 50 megawatts); and
(iii) inside-the-fence plants (which can be of varying sizes, but usually under
50 megawatts).
Many of the large plants are owned and operated by subsidiaries of
Regulated Electric Companies and large industrial companies which have
established these subsidiaries to participate in the IPP industry. Approximately
18 of the 25 largest independent power companies are owned and operated in such
a manner. 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. Under
federal law, however, 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 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 the category of small to medium-sized IPPs, the 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., and First Recovery, Inc., a subsidiary of Ashland Oil
Company. Locally, in the Indiana-Kentucky-Illinois area, the Company's
Environmental Division competes with Koester Corporation, which conducts
environmental services in both Indiana and elsewhere throughout the United
States.
EMPLOYEES
At April 21, 1999, 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
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energy efficiency standards. Therefore, loss of a thermal energy customer could
jeopardize a cogeneration facility's QF status. If one of the power plants in
which the Company has an interest were to lose its QF status and not receive
another PUHCA exemption, the project subsidiary or partnership in which the
Company has 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. However, QF status
does not exempt an 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 will 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 the substances collected by the
Company which are classified as hazardous or special wastes; the operation of
the facilities at which the Company stores or processes the substances it
collects; and the ultimate disposal of waste generated by the Company during
processing of 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 and risks of noncompliance.
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 wastes, operating procedures, stormwater and
wastewater discharges, fire protection, worker and community right-to-know and
emergency response plans. Water pollution regulations govern certain operations
at the Company's facilities. Safety standards under the Occupational Safety and
Health Act in the United States and similar laws are also applicable. Federal
Department of Transportation 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.
8
<PAGE> 10
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.
AES' services involve the collection, transportation, storage, processing,
recycling and disposal of automotive and industrial nonhazardous materials. AES
is also involved in the transportation and disposal of hazardous materials. 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 solid wastes and transportation of hazardous wastes.
The Resource Conservation and Recovery Act of 1976 ("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.
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 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.
The Company's Environmental Division has an internal staff of engineers,
geologists, licensed water treatment plant operators, 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.
ITEM 2. DESCRIPTION OF PROPERTY
Steamboat I and IA are owned by the Company's 95%-owned subsidiary,
Steamboat LLC, and are 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 50%. 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 expiring in 2014,
and (2) a 20-year management contract expiring in 2014. Both
9
<PAGE> 11
contracts have escalation clauses. Management believes the plant is adequately
covered by insurance. The state university has approached the partners in
Plymouth Cogeneration with a view to purchasing their interests and negotiations
are currently in progress.
The Lehi Facility is owned by LIPA, a Utah limited liability company, of
which the Company owns 50%. 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.
Management believes the plant is adequately covered by insurance.
The AES facilities are located in Newburgh, Indiana and Shelbyville,
Kentucky. The Newburgh facility is on a five and one-half acre property, and the
Shelbyville facility is on a two acre property. Both facilities include
buildings, processing equipment, storage tanks, controls and related piping, and
are considered in satisfactory condition. There are mortgages on the buildings
that totaled $273,000 at January 31, 1999. Management believes the plants are
adequately covered by insurance.
The headquarters of the Company are in 3,000 square feet under a five year
lease in a commercial office building in West Palm Beach, Florida. The Company
also leases from SB GEO regional offices in Reno, Nevada, on the site of the
Steamboat facilities. The Company has no separate lease agreement for the Reno
office space, but rental fees are included in the fees the Company pays to SB
GEO for the operation and management of the Steamboat facilities.
ITEM 3. LEGAL PROCEEDINGS
On March 8, 1999, the United States District Court for the Southern
District of New York entered a decision in the case of U.S. Energy Systems, Inc.
vs. Enviro Partners, L.P. and Energy Management Corporation ("EMC") et. al., 97
Civ. 1748 (JFK)denying both sides' motion and cross-motion for summary judgment
and scheduling the pre-trial process. 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.
Enviro Partners and EMC have asserted demands against the Company for lost
profits of up to $6 million. The Company has filed a Motion for Reconsideration,
and defendants have filed their objections to the motion. An adverse outcome to
this proceeding could have a material adverse effect on the Company's financial
condition.
The Company is not aware of any other pending or threatened legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders in
the fourth quarter of Fiscal 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock trades on the Nasdaq SmallCap Market under the
symbol USEY. The 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.
10
<PAGE> 12
<TABLE>
<CAPTION>
SALES PRICE
-------------
HIGH LOW
----- -----
<S> <C> <C>
Fiscal Year Ended January 31, 1998:
First Quarter............................................. $5.63 $3.63
Second Quarter............................................ 4.94 3.50
Third Quarter............................................. 3.88 2.75
Fourth Quarter............................................ 3.31 1.75
Fiscal Year Ended January 31, 1999:
First Quarter............................................. $2.25 $1.81
Second Quarter............................................ 2.50 1.00
Third Quarter............................................. 1.50 0.75
Fourth Quarter............................................ 3.31 1.00
</TABLE>
The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions. On April 29,
1999, the last sale price of the Common Stock as reported on the Nasdaq SmallCap
Market was $2.375.
PRICE RANGE OF WARRANTS
The Company's warrants were issued December 6, 1996, and began trading on
the Nasdaq SmallCap 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 SmallCap Market.
<TABLE>
<CAPTION>
SALES PRICE
-------------
HIGH LOW
----- -----
<S> <C> <C>
Fiscal Year Ended January 31, 1998:
First Quarter............................................. $1.88 $1.00
Second Quarter............................................ 1.63 0.88
Third Quarter............................................. 1.13 0.56
Fourth Quarter............................................ 1.10 0.38
Fiscal Year Ended January 31, 1999:
First Quarter............................................. $0.75 $0.38
Second Quarter............................................ 0.59 0.13
Third Quarter............................................. 0.19 0.03
Fourth Quarter............................................ 0.75 0.06
</TABLE>
The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions. On April 29,
1999, the last sale price of the Common Stock as reported on the Nasdaq SmallCap
Market was $0.3125.
HOLDERS
As of April 21, 1999 there were 600 record holders 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 Series A Preferred Stock issued on March 23, 1998 accrues dividends at an
annual rate of 9%, or $202,500, which have been paid in cash quarterly. The
Series B Preferred Stock issued on March 8, 1999 accrues dividends at an annual
rate of 9%, or $45,800, which are being paid monthly. No dividends may be paid
on the Common Stock unless the Company is current with all dividend payments due
on each series of preferred stock.
11
<PAGE> 13
RECENT SALES OF UNREGISTERED SECURITIES
On March 8, 1999, the Company issued 509.088 shares of Series B Preferred
Stock in exchange for $509,088 of 9% Convertible Subordinated Debentures. Each
share of Series B Preferred Stock is convertible at the option of the holder
into 275 shares of Common Stock of the Company.
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 Series A 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. The Series A Preferred Stock votes with the Common Stock on a ratio equal
to the per share purchase price of the Series A Preferred Stock ($9.00) divided
by the conversion price (currently $2.25), which presently equates to four votes
for every share of Series A Preferred Stock. Energy Systems Investors also holds
a one year option, expiring in August 1999, to acquire up to an additional $8.0
million of Series A 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.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
GENERAL
The Company's fiscal year ended January 31, 1999 ("Fiscal 1998")
constituted its first full year of operations to include the Environmental
Division units in Indiana and Kentucky.
The Company treats its investments in its LEHI and Plymouth subsidiaries on
the equity method, and the revenues and expenses of LEHI and Plymouth are not
included in its Statement of Operations. Condensed financial information on the
LEHI and Plymouth joint ventures may be found in the Notes to Financial
Statements.
RESULTS OF OPERATIONS
Year Ended January 31, 1999 Compared to Year Ended January 31, 1998 ("Fiscal
1997")
Fiscal 1998 revenues increased by $1,962,000 or 88% over Fiscal 1997
principally as a result of a full year of operations of the Environmental
Division which generated $2,419,000 in revenue in Fiscal 1998 compared to
$713,000 in Fiscal 1997. Revenues of the Energy Division increased from
$1,520,000 in Fiscal 1997 to $1,776,000 in Fiscal 1998 mainly due to the
Company's successful efforts to obtain increased rates for the output of the
Steamboat 1 plant. On July 20, 1998 Sierra agreed to a stipulation to pay market
rates for power produced by the Company's geothermal plants. Rates paid for
Steamboat 1 power until that point were below market. Steamboat 1A rates had
been contractually set until December 1998, at which point they also changed to
market rates, which in this case were the lower winter season rates.
12
<PAGE> 14
Costs and expenses in Fiscal 1998 increased $1,478,000 or 44% over Fiscal
1997 principally as a result of the inclusion of the Environmental Division for
the full year in Fiscal 1998. The expenses for the Steamboat Facilities and the
Company's Environmental Division (AES and Commonwealth) in Fiscal 1998 were as
follows:
<TABLE>
<CAPTION>
STEAMBOAT AES AND
FACILITIES COMMONWEALTH
---------- ------------
<S> <C> <C>
Operating expenses.......................................... $637,000 $1,629,000
Administrative expenses..................................... 365,000 432,000
Depreciation and amortization............................... 157,000 319,000
</TABLE>
Operating expenses, which are the costs directly relating to revenues,
totaled $2,266,000 for Fiscal 1998 as compared to $1,127,000 for Fiscal 1997.
The Steamboat Facilities generated operating expenses of $637,000 for Fiscal
1998 compared to $674,000 for the previous year. Operating expenses for the 12
months of Fiscal 1998 for AES and Commonwealth totaled $1,629,000 compared to
$453,000 for Fiscal 1997, which was for the period from the dates of their
acquisitions in August 1997 and December 1997 to January 31, 1998. The AES
operating expenses include development costs associated with the new marine
emergency response system, which were expensed as incurred. This system has not
yet generated revenue.
Administrative expenses totaled $1,992,000 in Fiscal 1998 compared to
$1,613,000 in Fiscal 1997. Major items included in these totals are:
<TABLE>
<CAPTION>
FISCAL 1998 FISCAL 1997
----------- -----------
<S> <C> <C>
Payroll costs and consulting fees........................... $ 721,000 $ 643,000
Legal and professional fees (not connected with
litigation)............................................... 215,000 191,000
Royalty expenses (Steamboat)................................ 247,000 214,000
Corporate expenses.......................................... 204,000 128,00
Insurance costs............................................. 157,000 146,000
Rent and utilities.......................................... 110,000 82,000
Other....................................................... 338,000 209,000
---------- ----------
Total....................................................... $1,992,000 $1,613,000
========== ==========
</TABLE>
The increase in corporate expenses was due to greater activity in pursuing
the Company's plans for expansion. Other increases were due primarily to the
inclusion of the Environmental Division for a full 12 months in Fiscal 1998 as
against a shorter period in Fiscal 1997.
Litigation costs dropped from $326,000 in Fiscal 1997 to $47,000 in Fiscal
1998 because the Fiscal 1997 total included costs associated with settlement of
certain actions, whereas the Fiscal 1998 costs arose only from the single action
still pending (see "Legal Proceedings").
Depreciation and amortization expenses increased from $260,000 in Fiscal
1997 to $499,000 in Fiscal 1998 primarily due to the inclusion of the
Environmental Division for a full 12 months in the later year.
Interest income increased to $299,000 in Fiscal 1998 from $265,000 in
Fiscal 1997. The increase in interest expense from $129,000 in Fiscal 1997 to
$141,000 in Fiscal 1998, was due primarily to the fact that the Environmental
Division loan was outstanding for the full year in Fiscal 1998.
As of January 31, 1997, the Company had pre-reorganization income taxes and
payroll taxes payable amounting to $383,000. During Fiscal 1997, the Company
settled these payables for a total amount of $347,000. As a result, the Company
recognized a gain of $36,000 in that year.
The net loss of the Company, before dividends on the Series A Preferred
Stock, decreased by 45% to $569,000 in Fiscal 1998, as compared to $1,042,000 in
the previous year. Primarily as a result of this reduction in net loss, cash
used in operating activities was $490,000 in Fiscal 1998 as compared to $904,000
in Fiscal 1997.
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<PAGE> 15
LIQUIDITY AND CAPITAL RESOURCES
Cash flow used in operating activities improved to $490,000 in Fiscal 1998
as compared to $904,000 in Fiscal 1997, primarily due to the lower net loss from
the Company's operations. During Fiscal 1998, the Company paid $374,000 to
reduce royalties owed in connection with the Steamboat Facilities, which figure
was offset in part by changes in assets and in depreciation and amortization.
Cash flow used in investing activities during Fiscal 1998 totaled
$1,210,000, compared to $2,534,000 in the previous year. In Fiscal 1997 loans
amounting to $1,695,000 had been made to Reno Energy, while in the later year
the loans to Reno Energy decreased to $198,000. This was offset by the
acquisition of equipment and leasehold improvements of $437,000 and expenditures
of deferred acquisition costs of $668,000 in connection with acquisitions being
worked on but not yet concluded.
Cash flow provided by financing activities totaled $2,157,000 in Fiscal
1998 as compared to cash flow used in financing activities of $368,000 in Fiscal
1997. The Fiscal 1998 total was composed primarily of the proceeds from the sale
of preferred stock amounting to $2,190,000, and dividends paid on the preferred
stock of $174,000. In the previous year, financing activities cash flow was used
mainly for the payment of pre-reorganization taxes in the amount of $347,000.
AES had a bank line of credit of $300,000, which is fully used.
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 "Series A
Preferred Stock") with Energy Systems Investors, LLC, a Delaware limited
liability company controlled by Lawrence I. Schneider, a director of the Company
("Energy Systems Investors"). Each share of Series A 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.
Proceeds from the sale have been used for internal and external expansion and
general working capital purposes. At the Company's annual stockholders meeting
on August 26, 1998, the stockholders approved granting to Energy Systems
Investors, LLC, an option, expiring in August 1999, to acquire up to 888,888
additional shares of the Company's Series A Convertible Preferred Stock at an
aggregate purchase price of approximately $8.0 million for the same corporate
purposes and on the same terms and conditions.
Pre-construction work on Reno Energy is continuing, with the necessary
initial permits granted. The Company estimates that it will spend up to an
additional $100,000 in such pre-construction work. The Company expects
institutional lenders to finance the estimated $40 million construction price of
the project. The Company believes that Reno Energy could become a large income
producing property in the years to come.
The Company does not anticipate any future capital expenditures. In
connection with the possible expansion and re-configuration of the Plymouth
Cogeneration facility, it is estimated that any construction on the Plymouth
Cogeneration facility would be financed through the University of New Hampshire
system, using dormitory authority bonds, as the original project was financed.
The Company believes that positive cash flow from the Steamboat Facilities
and from the recently acquired AES and Commonwealth, together with funds on hand
from the private placement of Series A Preferred Stock referred to previously,
will provide sufficient liquidity for the next 12 months. In the long term, the
Company expects adequate liquidity to be provided by the Steamboat Facilities
and by AES and Commonwealth, plus possible additional acquisitions and
financings.
On March 8, 1999, the holders of $509,000 of the Company's Debentures
agreed to an exchange whereby they received an aggregate of 509.088 shares of
Series B Preferred Stock. This exchange replaces $509,088 of debt with preferred
stock, leaving $366,000 as debenture debt, and will be reflected in the
Company's Fiscal 1999 financial reports.
Other long term debt amounts to $510,000, including mortgages on buildings
of $296,000, and applies primarily to the plants and equipment of the
Environmental Division.
The Company from time to time evaluates acquisitions of new projects and
companies in the energy and environmental services fields. In particular, the
Company is negotiating joint ventures with third parties which would broaden its
presence in the geothermal energy industry and which would enable the Lehi
Facility to be
14
<PAGE> 16
expanded and put into operation. Significant time and cost has been incurred in
connection with due diligence with respect to these potential ventures. There is
no assurance that such ventures, or other acquisitions, will be consummated.
YEAR 2000 COMPUTER ISSUE
The Company has assessed the issues associated with the programming code in
its existing computer systems with respect to a two digit year value as the year
2000 approaches and believes that its internal systems are in full compliance.
In addition, the Company has communicated with its major suppliers and
customers to determine their year 2000 compliance readiness and the extent to
which the Company is vulnerable to any third party year 2000 issues. The Company
believes that only Sierra, to which the Company sells power from its Steamboat
facilities, may be affected by the programming code problem to an extent that
could have a material adverse effect on the Company. Sierra has assured the
Company, however, that the interface with the Steamboat facilities is in
compliance with year 2000 requirements. However, there can be no guarantee that
the systems of other companies on which the Company's systems rely will be
timely converted, or that a failure to convert by another company, or a
conversion that is incompatible with the Company's systems, would not have a
material adverse effect on the Company. The Company is reviewing possible
contingency plans in this respect.
The total cost to the Company of these year 2000 compliance activities has
not been and is not anticipated to be material to its financial position or
results of operations in any given year. This is based on management's best
estimates, which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ from those
plans.
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-17.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- - ---- --- --------
<S> <C> <C>
Theodore Rosen....................... 74 Chairman of the Board of Directors
Richard H. Nelson.................... 59 President, Chief Executive Officer and Director
Howard A. Nevins..................... 43 Executive Vice President and Director
Henry Schneider...................... 34 Vice President and Director
Seymour J. Beder..................... 72 Secretary, Treasurer and Chief Financial Officer
Terrence Page........................ 52 Vice President
Evan Evans........................... 73 Director
Asher E. Fogel....................... 50 Director
Allen J. Rothman..................... 42 Director
Lawrence I. Schneider................ 63 Director and Chairman of Executive Committee
</TABLE>
15
<PAGE> 17
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 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.
Henry Schneider. Mr. Schneider, a member of Energy Systems Investors, LLC,
was appointed Vice President for Development in March 1998 and was appointed a
Director of the Company in December 1998. From 1986 to 1988, Mr. Schneider was
an associate at Drexel Burnham Lambert specializing in taxable institutional
fixed income products and portfolio strategies. From 1989 to 1994, Mr. Schneider
was an associate with S & S Investments and Wood Gundy, specializing in mergers,
acquisitions and corporate restructuring. From 1994 to 1996, Mr. Schneider was a
principal of Global Capital Resources, Inc., a private merchant bank. Since
1996, Mr. Schneider has been a private investor. He has been involved in
arranging acquisitions and funding for the telecommunications, energy, apparel,
airline, financial and garage industries. Mr. Schneider holds an Economics
degree from Tufts University and a Master of Business Administration from Boston
University. Mr. Schneider is the son of Lawrence I. Schneider.
Seymour J. Beder. Mr. Beder has been Secretary, Treasurer, Controller and
Chief Financial Officer of the Company since November 1993. From 1970 through
1980 he was Chief Financial Officer for Lynnwear Corporation, a textile company,
and from 1980 to September 1993, Mr. Beder was president of Executive Timeshare,
Inc., a provider of executive consulting talent. Mr. Beder is a Certified Public
Accountant, and a member of the New York State Society of Certified Public
Accountants and the American Institute of Certified Public Accountants. Mr.
Beder received his BA degree from City College of New York.
16
<PAGE> 18
Terrence Page. Mr. Page has been Vice President C 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.
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.
Asher E. Fogel. Mr. Fogel was appointed to the Board of Directors of the
Company in October 1998. From 1985 to 1997 Mr. Fogel held senior positions at
Citicorp in London and New York specializing in corporate finance, capital
markets and investment advice and was a Managing Director of Citicorp
Securities, Inc. For twelve years prior to joining Citicorp Mr. Fogel held a
number of positions in Bank or America and Samuel Montagu & Co. In June 1997,
Mr. Fogel founded Dovertower Capital, a merchant banking boutique providing
corporate finance services in the United States and international markets. Mr.
Fogel holds a BA in Economics and an MBA from Hebrew University.
Allen J. Rothman. Mr. Rothman has been a member of the Board of Directors
of the Company since January 1997. Mr. Rothman is a partner with the law firm of
Robinson, Brog, Leinwand, Greene, Genovese & Gluck P.C. in New York with whom he
has been associated since January 1996. Mr. Rothman specializes in corporate,
finance and real estate law. Prior to joining Robinson Brog, he was associated
with several New York law firms. Mr. Rothman received his BA degree from
Columbia University and his JD degree from Harvard University.
Lawrence I. Schneider. Mr. Schneider, manager of Energy Systems Investors,
LLC, has been a member of Board of Directors since 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.
COMMITTEES
The Company's Audit Committee is comprised of Messrs. Henry Schneider, Evan
Evans and Asher E. Fogel. The Audit Committee met twice in 1998.
The Company's Executive Committee is comprised of Messrs. Lawrence
Schneider, Theodore Rosen, Richard Nelson and Alan Rothman. The Executive
Committee met 12 times in 1998.
17
<PAGE> 19
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 1999 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 1999 Annual Meeting Proxy Statement is
incorporated herein by reference.
18
<PAGE> 20
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
a. Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- - -------- -----------
<S> <C> <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(4)
3.1 -- Restated Certificate of Incorporation of the Company filed
with the Secretary of State of Delaware(1)
3.2 -- By-Laws of the Company(2)
3.3 -- Articles of Organization of Steamboat Envirosystems, L.C.(1)
4.1 -- Specimen Stock Certificate(1)
4.2 -- Form of Warrant(1)
4.3 -- Form of Warrant Agreement(1)
4.4 -- Form of Representative's Purchase Option(1)
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(7)
4.6 -- Certificate of Designation of Series B Convertible Preferred
Stock of the Company as filed with the Secretary of the
State of Delaware
5.1 -- Consent of Richard A. Eisner & Co., LLP (filed as part of
the financials hereto)
10.1 -- Plan of Reorganization of Cogenic Energy Systems, Inc.(2)
10.2 -- 8% Convertible Subordinated Debenture due 2004(2)
10.3 -- Employment Agreement, dated as of November 11, 1993, between
the Company and Richard Nelson(2)
10.3(a) -- Amendment to Employment Agreement between the Company and
Richard Nelson October 15, 1996(2)
10.4 -- Employment Agreement, dated as of December 11, 1993, between
the Company and Theodore Rosen(2)
10.4(a) -- Amendment to Employment Agreement between the Company and
Theodore Rosen dated October 15, 1996(1)
10.5 -- Purchase Agreement, dated as of January 24, 1994, between
Lehi Co-Gen Associates, L.C. and Lehi Envirosystems, Inc.(2)
10.6 -- Operating Agreement among Far West Capital, Inc., Suma
Corporation and Lehi Envirosystems, Inc. dated January 24,
1994(2)
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(1)
10.8 -- Form of Operation and Maintenance Agreement between
Steamboat LLC and S.B. Geo, Inc.(1)
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(1)
10.10 -- Agreement among the Company, Plymouth Envirosystems, Inc.,
IEC Plymouth, Inc. and Independent Energy Finance
Corporation dated November 16, 1994(1)
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(1)
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(1)
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
Enviro systems, LLC(1)
</TABLE>
19
<PAGE> 21
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- - -------- -----------
<S> <C> <C>
10.13(a) -- Letter Agreement, dated September 25, 1996, between the
Company and Far West Capital, Inc.(1)
10.14 -- Joint Development Memorandum of Intent dated September 20,
1994, between the Company and Cowen Partnership(1)
10.15 -- Agreement dated May 4, 1995 between the Company and Indus
LLC(1)
10.16 -- Security Agreement and Financing Statement among the
Company, Lehi Envirosystems, Inc., Plymout Envirosystems,
Inc. and Anchor Capital Company, LLC dated June 14, 1995, as
amended(1)
10.17 -- Stock Pledge Agreement among Richard H. Nelson, Theodore
Rosen, Anchor Capital Company, LLC and the Company dated
June 14, 1995(1)
10.18 -- Loan Agreement among the Company, Lehi Envirosystems, Inc.,
Plymouth Envirosystems and Solvation, Inc. dated as of
December 15, 1995, as amended(1)
10.19 -- Pledge Agreement between the Company and Solvation, Inc.
dated as of December 15, 1995(1)
10.20 -- Lease dated September 1, 1995 between the Company and
Gaedeke Holdings, Ltd.(1)
10.21 -- Documents related to Private Placement(1)
10.21(a) -- Certificate of Designations(1)
10.22 -- Purchase Agreement between the Company and Westinghouse
Electric Corporation dated as of November 6, 1995 and
amendments thereof(1)
10.23 -- Letter of intent to the Company from Bluebeard's Castle,
Inc. dated August 8, 1996(1)
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(1)
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(1)
10.25(b) -- Assignment of Interest, dated December 10, 1988 by and
between Far West Capital, Inc. and 1-A Enterprises(1)
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(1)
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(1)
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(1)
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(1)
10.28 -- Promissory Note dated August 9, 1996 for $300,000 from Reno
Energy, LLC to NRG Company, LLC(1)
10.29 -- Letter of Intent dated July 15, 1996 on behalf of Reno
Energy, LLC(1)
10.30 -- Limited Liability Company Operating Agreement of NRG
Company, LLC dated as of September 8, 1996, and amendments
thereto(1)
10.31 -- Form of Limited Liability Company Operating Agreement of
Steamboat, Envirosystems, L.C. dated as of October, 1996(1)
10.32 -- Form of Debenture Conversion Agreement(1)
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(3)
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(3)
10.33(c) -- Security Agreement, dated as of April 9, 1997, made by Reno
Energy LLC in favor of USE Geothermal LLC(3)
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(3)
</TABLE>
20
<PAGE> 22
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- - -------- -----------
<S> <C> <C>
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(3)
10.34 -- 1996 Stock Option Plan(5)
10.35 -- Employment Agreement, dated as of March 1, 1997, between the
Company and Terrence Page(5)
10.36 -- Form of 9% Convertible Subordinated Secured Debenture due
2004(6)
10.37 -- Form of Employment Agreement by and between the Company and
Howard Nevins(4)
10.38 -- Subscription Agreement, dated March 20, 1998, between the
Company and Energy Systems Investors, LLC(7)
10.39 -- Registration Rights Agreement, dated March 20, 1998, between
the Company and Energy Systems Investors, LLC(7)
21.1 -- Subsidiaries of the Company
23.1 -- Consent of Richard A. Eisner & Company, LLP, auditors of the
Company
27 -- Financial Data Schedule
</TABLE>
- - -------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-94612).
(2) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the year ended January 31, 1994.
(3) Incorporated by reference to the Company's Current Report on Form 8-K filed
on April 24, 1997.
(4) Incorporated by reference to the Company's Current Report on Form 8-K dated
August 12, 1997.
(5) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the year ended January 31, 1997.
(6) Incorporated by reference to the Company's Current Report on Form 8-K dated
August 18, 1997.
(7) Incorporated by reference to the Company's Current Report on Form 8-K filed
on March 26, 1998.
(8) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the year ended January 31, 1998.
b. Reports on Form 8-K
No reports on Form 8-K were filed during the Quarter Ended January 31,
1999.
21
<PAGE> 23
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.
April 30, 1999 By: /s/ SEYMOUR J. BEDER
----------------------------------------
Seymour J. Beder
Chief Financial and Accounting Officer
and Controller
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<S> <C> <C>
/s/ THEODORE ROSEN Chairman of the Board of Directors April 30, 1999
- - ----------------------------------------
Theodore Rosen
/s/ RICHARD H. NELSON President and Chief Executive Officer April 30, 1999
- - ---------------------------------------- (Principal Executive Officer)
Richard H. Nelson
/s/ SEYMOUR J. BEDER Chief Financial and Accounting April 30, 1999
- - ---------------------------------------- Officer and Controller (Principal
Seymour J. Beder Financial and Accounting Officer)
/s/ HENRY SCHNEIDER Vice President and Director April 30, 1999
- - ----------------------------------------
Henry Schneider
/s/ HOWARD NEVINS Director and Executive Vice President April 30, 1999
- - ----------------------------------------
Howard Nevins
/s/ LAWRENCE I. SCHNEIDER Director and Chairman of Executive April 30, 1999
- - ---------------------------------------- Committee
Lawrence I. Schneider
/s/ EVAN EVANS Director April 30, 1999
- - ----------------------------------------
Evan Evans
/s/ ALLEN ROTHMAN Director April 30, 1999
- - ----------------------------------------
Allen Rothman
/s/ ASHER E. FOGEL Director April 30, 1999
- - ----------------------------------------
Asher E. Fogel
</TABLE>
22
<PAGE> 24
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Financial Statements
Independent auditors' report.............................. F-2
Balance sheet as of January 31, 1999...................... F-3
Statements of operations for the years ended January 31,
1999 and 1998.......................................... F-4
Statements of changes in stockholders' equity for the
years ended January 31, 1999 and 1998.................. F-5
Statements of cash flows for the years ended January 31,
1999 and 1998.......................................... F-6
Notes to financial statements............................. F-7
</TABLE>
F-1
<PAGE> 25
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, 1999 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 financial statements enumerated above present fairly,
in all material respects, the consolidated financial position of U.S. Energy
Systems, Inc. and subsidiaries as of January 31, 1999, and the consolidated
results of their operations and their consolidated cash flows for each of the
years in the two-year period then ended in conformity with generally accepted
accounting principles.
Richard A. Eisner & Company, LLP
New York, New York
March 12, 1999
F-2
<PAGE> 26
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
JANUARY 31,
1999
-----------
<S> <C>
ASSETS
Current assets:
Cash...................................................... $ 776,000
Accounts receivable (less allowance for doubtful accounts
$15,000)............................................... 763,000
Notes receivable -- current portion....................... 196,000
Other current assets...................................... 355,000
-----------
Total current assets................................... 2,090,000
Property, plant and equipment, net.......................... 5,832,000
Notes receivable, less current portion...................... 1,883,000
Investments in joint ventures:
Lehi Independent Power Associates, L.C.................... 939,000
Plymouth Cogeneration Limited Partnership................. 503,000
Deferred acquisition costs.................................. 668,000
Goodwill, net............................................... 1,939,000
Other assets................................................ 317,000
-----------
$14,171,000
===========
LIABILITIES
Current liabilities:
Current portion of long-term debt......................... $ 114,000
Note payable -- bank...................................... 300,000
Accounts payable.......................................... 838,000
Royalties payable......................................... 54,000
-----------
Total current liabilities.............................. 1,306,000
Long-term debt, less current portion........................ 396,000
Convertible subordinated debentures (including due to
related parties of $80,000)............................... 875,000
Advances from joint ventures................................ 57,000
-----------
Total liabilities........................................... 2,634,000
-----------
Minority interest........................................... 524,000
-----------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 10,000,000
shares; Series A, 9% cumulative, convertible, issued and
outstanding 250,000 shares (liquidation value of
$2,301,000)
(see Note K(1))........................................... 3,000
Common stock, $.01 par value, authorized 50,000,000 shares;
issued 5,160,605 shares................................... 51,000
Treasury stock, 2,600 shares common stock at cost........... (3,000)
Additional paid-in capital.................................. 17,467,000
Accumulated deficit......................................... (6,505,000)
-----------
11,013,000
-----------
$14,171,000
===========
</TABLE>
See notes to financial statements
F-3
<PAGE> 27
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
------------------------
1999 1998
---------- -----------
<S> <C> <C>
Revenues.................................................... $4,195,000 $ 2,233,000
---------- -----------
Cost and expenses:
Operating expenses........................................ 2,266,000 1,127,000
Administrative expenses................................... 1,992,000 1,613,000
Litigation costs.......................................... 47,000 326,000
Depreciation and amortization............................. 499,000 260,000
---------- -----------
4,804,000 3,326,000
---------- -----------
Loss before other income (expense) and extraordinary item... (609,000) (1,093,000)
Interest income............................................. 299,000 265,000
Interest expense............................................ (141,000) (129,000)
Equity in loss of joint ventures............................ (98,000) (121,000)
Minority interest (20,000)
---------- -----------
Loss before extraordinary item.............................. (569,000) (1,078,000)
Extraordinary gain from restructuring of liabilities........ 36,000
---------- -----------
NET LOSS.................................................... (569,000) (1,042,000)
Dividends on preferred stock................................ (174,000)
---------- -----------
LOSS APPLICABLE TO COMMON STOCK............................. $ (743,000) $(1,042,000)
========== ===========
LOSS PER SHARE OF COMMON STOCK -- BASIC AND DILUTED:
LOSS BEFORE EXTRAORDINARY ITEM............................ $ (.14) $ (0.23)
EXTRAORDINARY ITEM........................................ .01
---------- -----------
NET LOSS.................................................. $ (.14) $ (0.22)
========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING.................. 5,158,005 4,654,555
========== ===========
</TABLE>
See notes to financial statements
F-4
<PAGE> 28
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK TREASURY STOCK COMMON STOCK
---------------- ---------------- ---------------------------------
NUMBER NUMBER NUMBER ADDITIONAL
OF OF OF PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
------- ------ ------ ------- --------- ------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE -- JANUARY 31,
1997...................... 4,334,193 $43,000 $12,718,000 $(4,894,000) $ 7,867,000
Cash paid for fractional
shares.................... (14) 0
Shares issued in connection
with acquisition of
American
Enviro-Services, Inc...... 676,430 7,000 2,387,000 2,394,000
Shares issued in connection
with acquisition of
Commonwealth Petroleum
Recycling, Inc............ 150,000 1,000 332,000 333,000
Fair value of options issued
for consulting services... 17,000 17,000
Net loss for the year ended
January 31, 1998.......... (1,042,000) (1,042,000)
--------- ------- ----------- ----------- -----------
BALANCE -- JANUARY 31,
1998...................... 5,160,609 51,000 15,454,000 (5,936,000) 9,569,000
Cash paid for fractional
shares.................... (4) 0
Shares issued in connection
with private placement
offering.................. 250,000 $3,000 2,187,000 2,190,000
Shares purchased............ (2,600) $(3,000) (3,000)
Dividends on preferred
stock..................... (174,000) (174,000)
Net loss for the year ended
January 31, 1999.......... (569,000) (569,000)
------- ------ ------ ------- --------- ------- ----------- ----------- -----------
BALANCE -- JANUARY 31,
1999...................... 250,000 $3,000 (2,600) $(3,000) 5,160,605 $51,000 $17,467,000 $(6,505,000) $11,013,000
======= ====== ====== ======= ========= ======= =========== =========== ===========
</TABLE>
See notes to financial statements
F-5
<PAGE> 29
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (569,000) $(1,042,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 499,000 260,000
Equity in loss of joint ventures........................ 98,000 121,000
Minority interest....................................... 20,000
Gain from restructuring of liabilities.................. (36,000)
Changes in:
Accounts and notes receivable, trade.................. (83,000) 82,000
Other current assets.................................. (79,000) (126,000)
Other assets.......................................... 90,000 (120,000)
Accounts payable and accrued expenses................. (92,000) (471,000)
Royalties payable..................................... (374,000) 428,000
----------- -----------
Net cash used in operating activities............... (490,000) (904,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of business, net of cash acquired............. (414,000)
Loans to Reno Energy LLC.................................. (198,000) (1,695,000)
Repayments of loan by Reno Energy LLC..................... 100,000 91,000
Acquisition of equipment and leasehold improvements....... (437,000) (353,000)
(Investment in) distributions from joint ventures......... (7,000) 11,000
Deferred acquisition costs................................ (668,000)
Deposit................................................... 100,000
Other..................................................... (274,000)
----------- -----------
Net cash used in investing activities............... (1,210,000) (2,534,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable............................... 100,000 87,000
Payment of convertible subordinated debentures............ (150,000)
Payment of pre-reorganization income taxes payable........ (347,000)
Payment of long-term debt................................. (138,000)
Minority equity investment in subsidiary.................. 170,000
Proceeds from long-term debt.............................. 28,000
Proceeds from issuance of preferred stock................. 2,190,000
Purchase of treasury shares............................... (3,000)
Dividends on preferred stock.............................. (174,000)
Advances from joint ventures................................ 16,000 10,000
----------- -----------
Net cash provided by (used in) financing
activities.......................................... 2,157,000 (368,000)
----------- -----------
NET INCREASE (DECREASE) IN CASH............................. 457,000 (3,806,000)
Cash -- beginning of year................................... 319,000 4,125,000
----------- -----------
CASH -- END OF YEAR....................................... $ 776,000 $ 319,000
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 315,000 $ 188,000
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES:
Details of acquisitions:
Fair value of assets acquired........................... $ 4,282,000
Liabilities assumed..................................... (1,124,000)
Fair value of common stock and options issued........... (2,744,000)
-----------
Cash paid for acquisitions.......................... $ 414,000
===========
</TABLE>
See notes to financial statements
F-6
<PAGE> 30
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1999
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 January 31, 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 wholly-owned and
majority owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in the consolidated balance sheet. Income
attributable to the minority interest for the year ended January 31, 1998
was insignificant.
(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 and are included based on the
investees' December 31 year ends.
(4) Goodwill and Other Long-Lived Assets. Goodwill represents the
excess of the cost of acquired companies over the fair value of their
tangible net assets acquired and is being amortized over 15 years using the
straight-line method. The periods of amortization of goodwill and other
long-lived assets are evaluated at least annually to determine whether
events and circumstances warrant revised estimates of useful lives. This
evaluation considers, among other factors, expected cash flows and profits
of the businesses to which the goodwill and other long-lived assets relate.
Based upon the periodic analysis, such assets are written down or written
off if it appears that future profits or cash flows will be insufficient to
recover their carrying values.
(5) Per Share Data. Basic and diluted loss per share are computed by
dividing income available to common stockholders by the weighted average
number of common shares outstanding during the years. In arriving at income
available to common stockholders, preferred stock dividends have been
deducted. Potential common shares have not been included due to their
anti-dilutive effect (see Note K).
(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) Revenue Recognition. Environmental and remedial
services -- revenue on cost plus fixed fee jobs is recognized as costs are
incurred using the time and material method. Revenues from jobs that are
based on fixed bids are recognized based on the proportion of cost incurred
to date to the total estimated contract cost. Costs are recognized as
incurred.
Cogeneration and independent power plants -- revenues are recognized
upon delivery of power to a customer.
(8) Fair Values of Financial Instruments. The estimated fair value of
financial instruments has been determined based on available market
information and appropriate valuation methodologies. The
F-7
<PAGE> 31
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
carrying amounts of cash, accounts receivable, other current assets,
accounts payable and royalties payable approximate fair value at January
31, 1999 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
debentures approximate fair value because the interest rates on these
instruments approximate the market rates at January 31, 1999. The fair
value estimates were based on information available to management as of
January 31, 1999.
(9) Stock-Based Compensation. The Company accounts 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 discloses 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 K).
(10) Segment Information. The Company follows the requirements of
Statement of Financial Accounting Standards Board No. 131 ("SFAS 131"),
"Disclosures about Segments of an Enterprise and Related Information". The
adoption of SFAS 131 has not had a significant effect on the information
presented in the financial statements.
NOTE C -- SUBSIDIARIES AND AFFILIATES
(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 was allocated to the assets acquired and
liabilities assumed based on their fair values as follows:
<TABLE>
<S> <C>
Assets acquired and liabilities assumed:
Current assets............................................ $ 599,000
Property, plant and equipment............................. 948,000
Goodwill.................................................. 2,118,000
Current liabilities....................................... (891,000)
----------
$2,774,000
==========
</TABLE>
The acquisition was 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 purchase price, including $51,000
of acquisition costs, was allocated to the assets acquired and liabilities
assumed based on their fair values as follows:
<TABLE>
<S> <C>
Assets acquired and liabilities assumed:
Current assets............................................ $ 54,000
Property, plant and equipment............................. 563,000
Current liabilities....................................... (233,000)
--------
$384,000
========
</TABLE>
F-8
<PAGE> 32
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The acquisition was accounted for as a purchase and, accordingly, the
accompanying consolidated financial statements include the accounts of
Commonwealth from the date of acquisition.
(3) Steamboat Envirosystems, L.L.C. The Company owns a 95% interest in
Steamboat Envirosystems, L.L.C. ("Steamboat") which owns and operates two
geothermal power plants (the "Steamboat Facilities").
The first $1,800,000 of Steamboat's annual net income is allocated to the
Company. For net income above $1,800,000, the other owner's interest will be
allocated: (i) 55% through December 2001 and (ii) 5% thereafter, with the
balance going to the Company.
The Steamboat Facilities produce eight megawatts of electric power which is
sold, at market rates, under two power purchase agreements to Sierra Pacific
Power Company ("Sierra"). The agreements for Steamboat 1 and 1A expire in
December 2006 and December 2008, respectively.
The Steamboat facilities are subject to certain royalty agreements which
include royalty payments for steam extraction rights. In addition, one facility
is required to make royalty payments equivalent to thirty percent of its' net
revenue after certain deductions, starting March 1, 1997. The Company has been
negotiating to acquire such royalty interests. Royalty expense for the years
ended January 31, 1999 and 1998 were $247,000 and $214,000, respectively.
(4) Use Geothermal, LLC (Formerly NRG Company, LLC). The Company has
invested $1,970,000 in USE Geothermal, LLC ("USE GEO"), for an 89.57% 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.
NOTE D -- NOTES RECEIVABLE
Notes receivable consist of the following:
<TABLE>
<S> <C>
Convertible loan(a)......................................... $ 1,618,000
First note(b)............................................... 109,000
Second note(c).............................................. 275,000
Various notes(d)............................................ 77,000
-------------
2,079,000
Less current portion........................................ 196,000
-------------
$ 1,883,000
=============
</TABLE>
- - -------------------------
(a) A Convertible loan agreement between USE GEO and Reno Energy 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 collateralized by a first lien on all assets of Reno Energy and
guaranteed by Reno Energy's members. Additional advances made on the note
have not effected the 50% conversion feature.
At January 31, 1999, accrued interest on this note amounting to $184,000 is
included in other assets on the balance sheet.
(b) Loan by USE GEO to Reno Energy is repayable in equal quarterly payments of
$28,895 including interest at 9% per annum until final maturity on December
31, 1999.
(c) Loan granted by the Company to Geo Energy, LLC (a company affiliated with
Reno Energy) payable in quarterly payments of $11,585 including interest at
15% per annum until final maturity on December 1, 2000 at which time a
balloon payment of $258,000 will be due.
F-9
<PAGE> 33
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(d) Notes receivable from AES customers with terms of three months to two years.
The notes are either noninterest bearing or bear interest at 18%.
NOTE E -- PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at January 31, 1999:
<TABLE>
<S> <C>
Land........................................................ $ 78,000
Building.................................................... 841,000
Steamboat Springs Thermal Hydroelectric Power Plants........ 4,244,000
Equipment................................................... 654,000
Leasehold improvements...................................... 51,000
Office equipment and furnishings............................ 105,000
Vehicles.................................................... 451,000
----------
6,424,000
Less accumulated depreciation............................... (592,000)
----------
$5,832,000
==========
</TABLE>
NOTE F -- INVESTMENTS IN JOINT VENTURES
(1) Lehi Independent Power Associates, L.C. ("LIPA"). Lehi Envirosystems,
Inc. ("LEHI"), a wholly owned subsidiary of the Company, owns a 50% equity
interest in LIPA, which owns a cogeneration project (the "Project") located in
Lehi, Utah. From the date of LEHI's investment through January 31, 1999, the
Project has not been in operation.
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 divided proportionately by the owners in
the event that any modification, as provided, 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.
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.
An owner of a 25% interest in LIPA also owns a 5% interest in Steamboat
Envirosystems, L.L.C. (see Note C[3]).
(2) Plymouth Cogeneration Limited Partnership ("PCLP"). The Company,
through its wholly owned subsidiary, Plymouth Envirosystems, Inc. ("Plymouth")
owns 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 contract expiring in 2014. The project 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.
(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,
F-10
<PAGE> 34
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
and is being amortized over the remaining life of such assets. At January 31,
1999, the estimated remaining life of the plants is as follows:
<TABLE>
<S> <C> <C>
LIPA -- buildings 26 years
-- machinery and equipment 4 years
Plymouth -- plant 17 years
</TABLE>
(4) The following is summarized financial information of LIPA and PCLP as
of December 31, 1998 and for each of the two-years in the period then ended:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
----------------------
LIPA PCLP
-------- -----------
<S> <C> <C>
Current assets.............................................. $ 28,000 $ 458,000
Property, plant and equipment at cost (net)................. 257,000 4,746,000
Other assets................................................ 1,047,000
-------- -----------
Total assets...................................... 285,000 6,251,000
Current liabilities......................................... (18,000) (665,000)
Long-term debt.............................................. (4,711,000)
-------- -----------
Equity...................................................... $267,000 $ 875,000
======== ===========
Share of equity in joint ventures........................... $133,000 $ 437,000
Investments in joint ventures in excess of equity........... 806,000 66,000
-------- -----------
Total investments in joint ventures............... $939,000 $ 503,000
======== ===========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
LIPA PCLP
------------------- -----------------------
1998 1997 1998 1997
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Revenue.................................... $1,219,000 1,198,000
========== ==========
Net income (loss).......................... $ 6,000 $(31,000) $ (84,000) $ (91,000)
======== ======== ========== ==========
Equity in net income (loss)................ $ 3,000 $(16,000) $ (42,000) $ (46,000)
Amortization of purchase price over
equity................................... (55,000) (55,000) (4,000) (4,000)
-------- -------- ---------- ----------
Net loss from joint ventures............... $(52,000) $(71,000) $ (46,000) $ (50,000)
======== ======== ========== ==========
Distributions received by Company.......... $ 20,000
==========
</TABLE>
NOTE G -- NOTE PAYABLE -- BANK
At January 31, 1999, AES owed the bank $300,000, the full amount of its
line of credit. The line bears interest at prime plus .5%, (8.25%) at December
31, 1998. The line of credit is collateralized by AES's accounts receivable,
inventory and equipment.
F-11
<PAGE> 35
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE H -- LONG-TERM DEBT
Long-term debt, all incurred by AES, at January 31, 1999 consisted of the
following:
<TABLE>
<S> <C>
Mortgage payable, U.S. Small Business Administration, 4%,
$447 per month, due November, 2017(A)..................... $ 70,000
Mortgage payable, Old National Bank, prime plus .5%, $3,246
per month, due February, 2006(A).......................... 226,000
Notes payable, various, 8.0% -- 10.5%, $10,411 per month,
due September 1998 to March 2003, collateralized by all
the assets of AES......................................... 214,000
--------
510,000
Less current portion........................................ 114,000
--------
$396,000
========
</TABLE>
- - -------------------------
(A) Collateralized by AES land and building
As of January 31, 1999, future annual maturities are as follows:
<TABLE>
<S> <C>
2000........................................................ $114,000
2001........................................................ 93,000
2002........................................................ 58,000
2003........................................................ 53,000
2004 and thereafter......................................... 192,000
--------
$510,000
========
</TABLE>
NOTE I -- INCOME TAXES
Deferred taxes at January 31, 1999 consist of the following:
<TABLE>
<S> <C>
Deferred tax assets:
Potential benefit of operating loss carryforward.......... $ 1,482,000
Expenses for financial reporting, not yet deductible for
taxes.................................................. 157,000
-----------
1,639,000
Valuation allowance....................................... (1,639,000)
-----------
$ 0
===========
</TABLE>
The Company has fully reserved against the deferred tax asset since the
likelihood of realization cannot be determined.
The difference between the statutory tax rate of 34% and the Company's
effective tax rate of 0% is due to an increase in the valuation allowance of
$64,000 in 1999 and $181,000 in 1998 to offset the potential tax benefit
attributable to the increases in operating loss carryforwards, resulting from
the losses in each year.
At January 31, 1999, the Company has net operating loss carryforwards
expiring through 2019. Under Section 382 of the Internal Revenue Code, the
Company is subject to annual limitation on utilization of its net operating loss
carryforwards because of an ownership change of more than 50% that occurred upon
the public offering in December 1996. This annual limitation is approximately
$150,000 plus any built-in gains recognized in the five year period beginning on
the date of the ownership change. After giving recognition to
F-12
<PAGE> 36
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
this limitation, the net operating loss carryforwards available to be utilized
by the Company of approximately $3,706,000, plus any recognized built in gains,
expire as follows:
<TABLE>
<CAPTION>
JANUARY 31,
- - -----------
<S> <C>
2002...................................................... $ 750,000
2003...................................................... 150,000
2004...................................................... 150,000
2005...................................................... 150,000
2007...................................................... 124,000
2009...................................................... 19,000
2010...................................................... 607,000
2011...................................................... 150,000
2012...................................................... 565,000
2013...................................................... 545,000
2019...................................................... 496,000
----------
$3,706,000
==========
</TABLE>
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).
The Company made an exchange offer to its debenture holders under which the
principal amount of the holders' notes would be exchanged for shares of the
Company's Series B 9% Convertible Preferred Stock ("Series B Preferred").
Holders of 58% of the debentures accepted the offer, and on March 8, 1999, the
Company issued 509 shares of Series B Preferred in exchange for $509,000 of the
Debentures. The Series B Preferred pays an annual dividend at 9% and each share
is convertible into 275 shares of the Company's common stock.
NOTE K -- STOCKHOLDERS' EQUITY
(1) Preferred Stock. 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.
Each share of preferred stock is entitled to the number of votes equal to
$9.00 divided by the conversion price as of the record date, currently four
votes per preferred share. The liquidation value of each share of preferred is
equal to $9.00 plus accrued dividends, whether or not declared. The preferred
will have a preference on liquidation equal to the liquidation value ($2,301,000
at January 31, 1999). Dividends of $51,000 paid on February 1, 1999, are
included in accounts payable in the accompanying balance sheet.
Additionally, the investor has the right to purchase an additional 222,000
shares of the Series A convertible preferred stock prior to August 26, 1999, on
the same terms as the original offering.
F-13
<PAGE> 37
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(2) 1996 Stock Option Plan. The 1996 Stock Option Plan (the "1996 Plan")
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.
(3) 1997 Stock Option Plan. The 1997 Stock Option Plan (the "1997 Plan")
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.
(4) 1998 Executive Incentive Compensation Plan. In August 1998, the
Company adopted the 1998 Executive Incentive Compensation Plan (the "1998
Plan"). The 1998 Plan provides for the granting of stock options, stock
appreciation rights, restricted stock, deferred stock and other stock related
awards and incentive awards that may be settled in cash, stock or property. The
1998 Plan is intended to supersede the 1997 Plan and the 1996 Plan (the
"Preexisting Plans"). Under the 1998 Plan, 1,500,000 shares of common stock may
be subject to the granting of awards, plus the number of shares with respect to
shares previously granted under the Preexisting Plans that terminate without
being exercised, and the number of shares that are surrendered in payment of any
awards or tax withholding requirements.
The Plan is to be administered by a committee designated by the Board of
Directors consisting of not less than two outside, nonemployee directors. The
committee is authorized to select to whom awards will be granted, determine type
and number of awards to be granted and the number of shares of common stock to
which awards will relate and specify times at which awards will be exercisable
or settleable.
(5) 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,
-------------------------------------------
1999 1998
-------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Options outstanding at beginning of year....... 1,289,600 $4.16 816,600 $4.71
Granted(1)..................................... 589,500 2.43 473,000 3.19
Cancelled...................................... (50,000) 3.91
--------- ---------
Options outstanding at end of year............. 1,829,100 3.08 1,289,600 4.16
========= =========
Options exercisable at end of year............. 1,754,100 3.11 495,350 5.23
========= =========
</TABLE>
- - -------------------------
(1) Excludes 589,000 options previously outstanding which were repriced to
$2.50 on December 9, 1998.
F-14
<PAGE> 38
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents information relating to stock options
outstanding at January 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
- - ---------------------------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED --------------------
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
EXERCISE LIFE IN EXERCISE
RANGE OF EXERCISE PRICE SHARES PRICE YEARS SHARES PRICE
- - ----------------------- --------- -------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
$2.00-$2.50............................... 1,228,500 $2.47 5.65 1,153,500 $ 2.47
3.25-3.875............................... 243,000 3.79 3.87 243,000 3.875
4.00...................................... 270,000 4.00 4.01 270,000 4.00
8.00...................................... 83,750 8.00 1.72 83,750 8.00
10.00..................................... 3,850 10.00 .75 3,850 10.00
--------- ---------
1,829,100 3.80 1,754,100
========= =========
</TABLE>
As of January 31, 1999, a total of 1,052,500 options are available for
future grant.
The weighted average fair value of options at date of grant for grants
during 1999 and 1998 was $.90 and $2.16 per option, respectively. Additionally,
the Company repriced 589,000 outstanding stock options. The fair value of the
repriced options was $1.53 per option. The fair value of the options at date of
grant was estimated using the Black-Scholes option-pricing model utilizing the
following weighted average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 31,
----------------------------------------
1999 1998
------------------- -------------------
<S> <C> <C>
Risk-free interest rates........................... 4.39 - 5.55% 5.71 - 6.37%
Expected option life in years...................... 5.7 5.10
Expected stock price volatility.................... .70 .70
Expected dividend yield............................ .00% .00%
</TABLE>
Had the Company elected to recognize compensation cost based on the fair
value of the options at the date of grant as prescribed by FASB 123, pro forma
net loss applicable to common stock in 1999 and 1998 would have been
($2,711,000) and ($1,631,000), respectively, or ($.53) per share and ($0.35) per
share, respectively.
As of January 31, 1999, the Company has warrants outstanding for the
purchase of its common stock as follows:
<TABLE>
<CAPTION>
EXERCISE EXPRIATION
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.
NOTE L -- COMMITMENTS AND CONTINGENCIES
(1) Use International, L.L.C. During the year ended January 31, 1998, the
Company settled its arbitration with a former joint venture partner for a
payment of $163,000 of which $84,000 was previously accrued and $79,000 was
charged to litigation costs for the year ended January 31, 1998.
F-15
<PAGE> 39
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(2) U.S Energy Systems, Inc. v. Enviro Partners, L.P. et al. On March 27,
1997, the Company filed for a declaratory judgement 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 a 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. On March 8, 1999 motions by both parties for summary judgements were
denied and the pre-trial process has been scheduled. Management believes, based
on consultation with counsel, that 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 a
stockholder/director 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 each of the years ended January 31, 1999 and 1998, the Company paid
interest of $7,000 to the related party.
F-16
<PAGE> 40
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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>
COGENERATION AND ENVIRONMENTAL
INDEPENDENT POWER AND REMEDIAL
PLANTS SERVICES CORPORATE TOTAL
----------------- ------------- ----------- -----------
<S> <C> <C> <C> <C>
Year ended January 31, 1999:
Revenues....................... $1,776,000 $2,419,000 $ 4,195,000
Operating income (loss)........ 612,000 52,000 $(1,273,000) (609,000)
Assets......................... 4,101,000 4,516,000 5,554,000 14,171,000
Significant noncash
transactions:
Capital expenditures........ 6,000 373,000 58,000 437,000
Depreciation and
amortization.............. 157,000 319,000 23,000 499,000
Loss from joint ventures and
minority interest......... 118,000 118,000
Year ended January 31, 1998:
Revenues....................... 1,520,000 713,000 2,233,000
Operating income (loss)........ 379,000 (12,000) (1,460,000) (1,093,000)
Assets......................... 4,350,000 4,368,000 4,311,000 13,029,000
Significant noncash
transactions:
Capital expenditures........ 126,000 1,655,000 83,000 1,864,000
Depreciation and
amortization.............. 148,000 98,000 14,000 260,000
Loss from joint ventures.... 121,000 121,000
</TABLE>
F-17
<PAGE> 1
EXHIBIT 4.5
CERTIFICATE OF DESIGNATION
OF
SERIES B CONVERTIBLE PREFERRED STOCK
OF
U.S. ENERGY SYSTEMS, INC.
(PURSUANT TO SECTION 151 OF THE
DELAWARE GENERAL CORPORATION LAW)
------------------------------------
U.S. Energy Systems, Inc., a corporation organized and existing under
the General Corporation Law of the State of Delaware (hereinafter called the
"Corporation"), hereby certifies that the following resolution was adopted by
the Board of Directors of the Corporation as required by Section 151 of the
Business Corporation Law at a meeting duly called and held on January 21, 1999:
RESOLVED, that pursuant to the authority granted to and vested in the
Board of Directors of this Corporation (hereinafter called the "Board of
Directors" or the "Board") in accordance with the provisions of the Certificate
of Incorporation of the Corporation, the Board of Directors hereby creates a
Series B Convertible Preferred Stock, $.01 par value per share (the "Preferred
Stock"), of the Corporation and hereby states the designation and number of
shares, and fixes the relative rights, preferences, and limitations thereof as
follows:
Section 1. DESIGNATION AND AMOUNT. The shares of such series shall be
designated as "Series B Convertible Preferred Stock" (the "Preferred Stock") and
the number of shares constituting the Preferred Stock shall be 875. Such number
of shares may be increased or decreased by resolution of the Board of Directors;
provided, that no decrease shall reduce the number of shares of Preferred Stock
to a number less than the number of shares then outstanding and no increase
shall increase the number of shares of Preferred Stock above the total number of
authorized shares.
Section 2. RANK. The Preferred Stock shall rank as to distributions of
assets upon liquidation, dissolution or winding up of the Corporation, whether
voluntary or involuntary: (i) senior to all of the Corporation's common stock,
par value $.01 per share (the "Common Stock"); (ii) senior to any class or
series of capital stock of the Corporation hereafter created specifically
ranking by its terms junior to the Preferred Stock (collectively, with the
Common Stock, "Junior Securities" or "Junior Stock"); (iii) junior to the
Corporation's Series A Convertible Preferred Stock, par value $.01 per share
(the "Series A Preferred Stock"); and (iv) on parity with any class or series of
capital stock of the Corporation hereafter created
<PAGE> 2
specifically ranking by its terms on parity with the Preferred Stock ("Parity
Securities" or "Parity Stock").
Section 3. DIVIDENDS.
(a) The holders of the Preferred Stock shall be entitled to
receive out of funds of the Corporation legally available for payment, cash
dividends, payable monthly in arrears, at the rate of $90 per share of Preferred
Stock per annum. Dividends on the Preferred Stock shall accrue from the date of
issuance or thereafter, from the most recent date on which dividends were
payable, and shall be payable monthly on the last day of each month (each a
"Dividend Payment Date"), commencing with a pro-rata dividend on the first
Dividend Payment Date after the initial issuance of the Preferred Stock;
PROVIDED, HOWEVER, that if any such day is a non-business day, the Dividend
Payment Date will be the next business day. Each declared dividend shall be
payable to holders of record as they appear at the close of business on the
stock books of the Corporation on such record date, not more than 30 calendar
days and not less than 10 calendar days preceding the Dividend Payment Date
therefor, as determined by the Board of Directors (each of such dates a "Record
Date").
(b) No dividends shall be declared or paid or set apart for
payment on any Common Stock, Parity Stock or Junior Stock during any calendar
quarter unless full dividends on the Preferred Stock for all Dividend Periods
ending prior to or during such calendar quarter have been or contemporaneously
are declared and paid or declared and a sum sufficient for the payment thereof
is set apart for such payment. When dividends are not so paid in full (or a sum
sufficient for such full payment is not so set apart) upon the Preferred Stock
and any other Parity Stock, dividends upon the Preferred Stock and dividends on
such other Parity Stock payable during such calendar quarter shall be declared
pro rata so that the amount of such dividends so payable per share on the
Preferred Stock and such other Parity Stock shall in all cases bear to each
other the same ratio that full dividends on the shares of Preferred Stock and
full dividends, if any, on shares of such other Parity Stock, bear to each
other. If full dividends on the Preferred Stock have not been declared and paid
or set apart for payment, no dividend or distribution, other than in shares of
capital stock ranking junior to the Preferred Stock as to dividends or
liquidation preference ("Junior Stock"), may be declared, set aside or paid on
any shares of Junior Stock. Holders of the Preferred Stock shall not be entitled
to any dividends, whether payable in cash, property or stock, in excess of the
dividends provided for herein. No interest or sum of money in lieu of interest
shall be payable in respect of any declared dividend payment or payments on the
Preferred Stock which may be in arrears. As used herein, the phrase "set apart"
in respect of the payment of dividends shall require deposit of any funds in a
bank or trust company in a separate deposit account maintained for the benefit
of the holders of the Preferred Stock.
Section 4. VOTING RIGHTS. The holders of Preferred Stock shall have no
voting rights except as required by law. To the extent that under Delaware law
the vote of the holders of shares of Preferred Stock, voting separately as a
class, is required to authorize a given action of the Corporation, the
affirmative vote or consent of the holders of at least a majority of the
outstanding shares of the Preferred Stock shall constitute the approval of such
action by the class.
2
<PAGE> 3
Section 5. CONVERSION. Subject to and upon compliance with this Section
5, the holders of shares of Preferred Stock shall have conversion rights as
follows:
(a) OPTIONAL CONVERSION. Each holder of a share of Preferred
Stock shall have the right, at any time, at the office of the Corporation or any
transfer agent for the Preferred Stock, to convert such share of Preferred Stock
into that number of fully paid and nonassessable shares of Common Stock equal to
$1,000 divided by the Conversion Price of such share of Preferred Stock as set
forth in Section 6 hereof.
(b) MECHANICS OF CONVERSION. In order to convert shares of
Preferred Stock into shares of Common Stock, the holder of shares of Preferred
Stock shall (i) fax or otherwise deliver a copy of the fully executed notice of
conversion in the form attached hereto as Exhibit A ("Notice of Conversion") to
the Corporation at its principal office and to the transfer agent for the
Preferred Stock, that such holder elects to convert his shares of Preferred
Stock, which notice shall specify the number of shares of Preferred Stock to be
converted and shall contain the Conversion Price (together with a copy of the
first page of each certificate to be converted) prior to 5:00 p.m., Eastern Time
(the "Conversion Notice Deadline") on the date of conversion specified on the
Notice of Conversion and (ii) surrender the original certificate or certificates
for the shares of Preferred Stock to be converted, duly endorsed, and deliver
the original Notice of Conversion by either overnight courier or two-day
courier, to the principal office of the Corporation or the office of the
transfer agent for the Preferred Stock; provided, however, that the Corporation
shall not be obligated to issue certificates evidencing the shares of Common
Stock issuable upon such conversion unless the certificates evidencing such
shares of Preferred Stock are delivered to the Corporation or its transfer agent
as provided above. Upon receipt by the Corporation of evidence of the loss,
theft, destruction or mutilation of any certificate representing shares of
Preferred Stock, and (in the case of loss, theft or destruction) of indemnity or
security reasonably satisfactory to the Corporation, and upon surrender and
cancellation of any certificate representing shares of Preferred Stock, if
mutilated, the Corporation shall execute and deliver a new certificate of like
tenor and date. No fractional shares of Common Stock shall be issued upon
conversion of the Preferred Stock. In lieu of any fractional share to which the
holder of shares of Preferred Stock would otherwise be entitled, the Corporation
shall pay cash to such holder in an amount equal to such fraction multiplied by
the Conversion Price then in effect. In the case of a dispute as to the
calculation of the Conversion Rate, the Corporation's calculation shall be
deemed conclusive absent manifest error.
The Corporation shall use all reasonable efforts to issue and deliver
within seven (7) business days after delivery to the Corporation of the
certificates representing the shares of Preferred Stock to be converted, or
after such agreement and indemnification, to such holder of Preferred Stock at
the address of the holder on the books of the Corporation, a certificate or
certificates for the number of shares of Common Stock to which the holder shall
be entitled as aforesaid. The date on which conversion occurs (the "Date of
Conversion") shall be deemed to be the date set forth in such Notice of
Conversion, provided (i) that the advance copy of the Notice of Conversion is
delivered to and received by the Corporation before 5:00 p.m., Eastern Time, on
the Date of Conversion, and (ii) that the original stock certificates
representing the shares of Preferred Stock to be converted are received by the
Corporation or the transfer agent
3
<PAGE> 4
within two (2) business days thereafter. The person or persons entitled to
receive the shares of Preferred Stock issuable upon such conversion shall be
treated for all purposes as the record holder or holders of such shares of
Common Stock on the Date of Conversion. If the original certificates
representing the shares of Preferred Stock to be converted are not received by
the Corporation or the transfer agent within two (2) business days after the
Date of Conversion or if the facsimile of the Notice of Conversion is not
received by the Corporation or its transfer agent prior to the Conversion Notice
Deadline, the Notice of Conversion, at the Corporation's option, may be declared
null and void.
Following any conversion of shares of Preferred Stock, such shares of
Preferred Stock shall no longer be outstanding and all rights of a holder with
respect to the shares surrendered for conversion shall immediately terminate
except for the right to receive Common Stock.
(c) MANDATORY CONVERSION. The Corporation may require the
conversion of the Preferred Stock into shares of Common Stock, at the Conversion
Price then in effect, at any time after January 31, 2003, if the Common Stock
has traded for 10 consecutive trading days at a price equal to or above 150% of
then current Conversion Price.
(c) RESERVATION OF SHARES. The Corporation shall at all times
reserve and keep available out of its authorized but unissued shares of Common
Stock such number of shares of Common Stock as shall from time to time be
sufficient to effect the conversion of all then outstanding shares of Preferred
Stock and to pay the dividends thereon in Common Stock; and if at any time the
number of authorized but unissued shares of Common Stock shall not be sufficient
to effect the conversion of all then outstanding shares of Preferred Stock or to
pay the dividends thereon in Common Stock, the Corporation will take such
corporate action as may be necessary to increase its authorized but unissued
shares of Common Stock to such number of shares as shall be sufficient for such
purpose.
Section 6. CONVERSION PRICE. The "Conversion Price" per share of the
Preferred Stock shall be $3.625, subject to adjustment as set forth below.
(a) The Conversion Price shall be adjusted from time to time
as follows:
(i) If, prior to the conversion of all outstanding
shares of Preferred Stock, the number of outstanding shares of Common Stock is
increased by a stock split, stock dividend or other similar event, the
Conversion Price shall be proportionately reduced, or if the number of
outstanding shares of Common Stock is decreased by a combination or
reclassification of shares or other similar event, the Conversion Price shall be
proportionately increased.
(ii) If, prior to the conversion of all outstanding
shares of Preferred Stock, there shall be any merger, consolidation, exchange of
shares, recapitalization, reorganization or other similar event, as a result of
which shares of Common Stock of the Corporation shall be changed into the same
or a different number of shares of the same or another class or classes of stock
or securities of the Corporation or another entity, then the
4
<PAGE> 5
holders of shares of Preferred Stock shall thereafter have the right to purchase
and receive upon conversion of Preferred Stock, upon the basis and upon the
terms and conditions specified herein and in lieu of the shares of Common Stock
immediately theretofore issuable upon conversion, such shares of stock and/or
securities as may be issued or payable with respect to or in exchange for the
number of shares of Common Stock immediately theretofore purchasable and
receivable upon the conversion of the Preferred Stock held by such holders had
such merger, consolidation, exchange of shares, recapitalization or
reorganization not taken place, and in any such case appropriate provisions
shall be made with respect to the rights and interests of the holders of the
Preferred Stock to the end that the provisions hereof (including, without
limitation, provisions for adjustment of the Conversion Price and of the number
of shares issuable upon conversion of the Preferred Stock) shall thereafter be
applicable, as nearly as may be practicable in relation to any shares of stock
or securities thereafter deliverable upon the exercise hereof.
(iii) No adjustment of the Conversion Price shall be
made in an amount less than $.01 per share.
(b) Upon any adjustment of the Conversion Price, then and in
each case the Corporation shall give written notice thereof, by first class
mail, postage prepaid, addressed to each holder of shares of the Preferred Stock
at the address of such holder as shown on the books of the Corporation, which
notice shall state the Conversion Price resulting from such adjustment, setting
forth in reasonable detail the method of calculation and the facts upon which
such calculation is based.
(c) In case at any time:
(i) the Corporation shall declare any dividend upon
its Common Stock payable in cash or stock or make any other distribution to the
holders of its Common Stock;
(ii) the Corporation shall offer for subscription PRO
RATA to the holders of its Common Stock any additional shares of stock of any
class or other rights;
(iii) there shall be any capital reorganization or
reclassification of the capital stock of the Corporation, or a consolidation or
merger of the Corporation with, or a sale of all or substantially all its assets
to, another corporation; or
(iv) there shall be a voluntary or involuntary
dissolution, liquidation or winding up of the Corporation;
then, in any one or more of said cases, the Corporation shall give, by first
class mail, postage prepaid, addressed to each holder of any shares of Preferred
Stock at the address of such holder as shown on the books of the Corporation,
(i) at least 30 days' prior written notice of the date on which the books of the
Corporation shall close or a record shall be taken for such dividend,
distribution or subscription rights or for determining rights to vote in respect
of any such reorganization, reclassification, consolidation, merger, sale,
dissolution, liquidation or winding up, and (ii) in the case of any such
reorganization, reclassification, consolidation, merger, sale,
5
<PAGE> 6
dissolution, liquidation or winding up, at least 30 days' prior written notice
of the date when the same shall take place. Such notice in accordance with the
foregoing clause (y) shall also specify, in the case of any such dividend,
distribution or subscription rights, the date on which the holders of Common
Stock shall be entitled thereto, and such notice in accordance with the
foregoing clause (z) shall also specify the date on which the holders of Common
Stock shall be entitled to exchange their Common Stock for securities or other
property deliverable upon such reorganization, reclassification, consolidation,
merger, sale, dissolution, liquidation or winding up, as the case may be, and in
the case of such merger or sale, the aggregate consideration to be received by
the holder of the Corporation's capital stock.
Section 7. STATUS OF CONVERTED OR REACQUIRED SHARES. Any shares of
Preferred Stock converted into shares of Common Stock pursuant to Section 5
hereof or purchased or otherwise acquired by the Corporation in any manner
whatsoever shall be retired and canceled promptly after the conversion or
acquisition thereof. All such shares shall upon their cancellation become
authorized but unissued shares of Preferred Stock and may be reissued as part of
a new series of Preferred Stock subject to the conditions and restrictions on
issuance set forth herein, in the Certificate of Incorporation, or in any other
Certificate of Designation creating a series of Preferred Stock or any similar
stock or as otherwise required by law.
Section 8. LIQUIDATION, DISSOLUTION OR WINDING UP.
(a) In the event of any liquidation, dissolution or winding up
of the Corporation, either voluntary or involuntary, the holders of shares of
Preferred Stock shall be entitled to receive out of the assets of the
Corporation available for distribution to stockholders under applicable law,
prior and in preference to any distribution to holders of the Common Stock or
any Junior Securities but in parity with any distribution to holders of Parity
Securities, the amount of $1,000 per share of Preferred Stock, plus a sum equal
to all dividends accrued on such shares (whether or not declared) and unpaid for
the then current Dividend Period. If upon the occurrence of such event, the
assets and funds to be distributed among the holders of shares of Preferred
Stock and Parity Securities shall be insufficient to permit the payment to such
holders of the full preferential amounts due to the holders of shares of
Preferred Stock and Parity Securities, respectively, then the entire assets and
funds of the Corporation legally available for distribution shall be distributed
among the holders of shares of Preferred Stock and Parity Securities, pro rata,
based on the respective liquidation amounts to which each such series of stock
is entitled by the Corporation's Certificate of Incorporation and any
certificate of designation of preferences.
(b) Upon the completion of the distribution required by
subsection 8(a) above, if assets remain in the Corporation, they shall be
distributed to holders of Parity Securities (unless holders of Parity Securities
have received distributions pursuant to subsection 8(a)) and Junior Securities
in accordance with the Corporation's Certificate of Incorporation, including any
duly adopted certificate(s) of designation of preferences.
(c) A consolidation or merger of the Corporation with or into
any other corporation or corporations, or a sale, exchange, conveyance or
disposition of all or substantially
6
<PAGE> 7
all of the assets of the Corporation or the effectuation by the Corporation of a
transaction or series of related transactions in which the voting power of the
Corporation is disposed of (not withstanding the fact that such disposition may
be in excess of 50% of the voting power), shall not be deemed to be a
liquidation, dissolution or winding up of the Corporation within the meaning of
this Section 8.
Section 9. CONSOLIDATION, MERGER, ETC. In the event of a merger,
reorganization, recapitalization or similar event of or with respect to the
Corporation (a "Corporate Change") (other than a Corporate Change in which all
or substantially all of the consideration received by the holders of the
Corporation's equity securities upon such Corporate Change consists of cash or
assets other than securities issued by the acquiring entity or any affiliate
thereof), the Preferred Stock shall be assumed by the acquiring entity and
thereafter the Preferred Stock shall be convertible into such class and type of
securities as the holder of shares of Preferred Stock would have received had
such holder converted the Preferred Stock immediately prior to such Corporate
Change.
Section 10. REDEMPTION.
(a) At the option of the Corporation at any time and from time
to time after January 31, 2001, the Preferred Stock may be redeemed in full or
in part for cash at a price equal to 102% of the Liquidation Value of the
Preferred Stock, plus, in each case, an amount equal to all accrued but unpaid
dividends (whether or not declared) for all Dividend Periods preceding the date
fixed for redemption (the "Redemption Date").
(b) Notice of redemption of the Preferred Stock, specifying
the Redemption Date and place of redemption, shall be given by first class mail
to each holder of record of the shares to be redeemed, at his address of record,
not less than 30 nor more than 60 calendar days prior to the Redemption Date.
Each such notice shall also specify the redemption price applicable to the
shares to be redeemed. If less than all the shares owned by such holder are then
to be redeemed, the notice shall also specify the number of shares thereof which
are to be redeemed and the fact that a new certificate or certificates
representing any unredeemed shares shall be issued without cost to such holder.
(c) Notice of redemption of shares of the Preferred Stock
having been given as provided in Section 10(b), then unless the Corporation
shall have defaulted in the payment of the redemption price and all accrued and
unpaid dividends (whether or not declared), all rights of the holders thereof
(except the right to receive the redemption price and all accrued and unpaid
dividends, whether or not declared) shall cease with respect to such shares on
the Redemption Date and such shares shall not, after the Redemption Date, be
deemed to be outstanding and shall not have the status of Preferred Stock. In
case fewer than all the shares represented by any such certificate are redeemed,
a new certificate shall be issued representing the unredeemed shares without
cost to the holder thereof.
(d) Shares of the Preferred Stock are not subject or entitled
to the benefit of a sinking fund.
7
<PAGE> 8
(e) Notwithstanding the foregoing, if notice of redemption
shall have been given pursuant to this Section 10 and any holder of the
Preferred Stock shall, prior to the close of business on the date three business
days next preceding the Redemption Date, give written notice to the Corporation
pursuant to Section 5 hereof of the conversion of any or all of the shares held
by the holder (accompanied by a certificate or certificates for such shares,
duly endorsed or assigned to the Corporation), then the redemption shall not
become effective as to such shares and the conversion shall become effective as
provided in Section 5.
IN WITNESS WHEREOF, this Certificate of Designation has been executed
on behalf of the Corporation by its Chairman of the Board and attested by its
Secretary this 28th day of January 1999.
On behalf of the Board of Directors:
/s/ Theodore Rosen
-----------------------------------
Theodore Rosen
Chairman of the Board of Directors
Attest:
/s/ Seymour J. Beder
- - ------------------------------------
Seymour J. Beder
Secretary
8
<PAGE> 9
EXHIBIT A
NOTICE OF CONVERSION
(TO BE EXECUTED BY THE REGISTERED HOLDER
IN ORDER TO CONVERT THE SERIES B CONVERTIBLE PREFERRED STOCK)
The undersigned hereby irrevocably elects to convert ______ shares of
Series B Convertible Preferred Stock, represented by stock certificate No(s).
________________ (the "Preferred Stock Certificates") into shares of common
stock ("Common Stock") of U.S. Energy Systems, Inc. (the "Corporation")
according to the conditions of the Certificate of Designation of the Preferred
Stock, as of the date written below. If shares are to be issued in the name of a
person other than the undersigned, the undersigned will pay all transfer taxes
payable with respect thereto. No fee will be charged to the holder for any
conversion, except for transfer taxes, if any.
The undersigned represents and warrants that all offers and sales by
the undersigned of the shares of Common Stock issuable to the undersigned upon
conversion of the Preferred Stock shall be made pursuant to registration of such
shares of Common Stock under the Securities Act of 1933, as amended, or pursuant
to an exemption from registration under such Act.
Conversion Calculations:
----------------------------------------
Date of Conversion
----------------------------------------
Applicable Conversion Price
----------------------------------------
Signature
----------------------------------------
Name
Address:
----------------------------------------
----------------------------------------
*No shares of Common Stock will be issued until the original Preferred Stock
Certificate(s) to be converted and the Notice of Conversion are received by the
Corporation's Transfer Agent. The original Stock Certificate(s) representing the
Preferred Stock to be converted and the Notice of Conversion must be received by
the Corporation's Transfer Agent by the second business day following the Date
of Conversion, or the Notice of Conversion, at the Corporation's option, may be
declared null and void.
<PAGE> 1
EXHIBIT (21)
SUBSIDIARIES OF THE REGISTRANT
DATE OF STATE OF
SUBSIDIARY INCORPORATION INCORPORATION
- - ---------- ------------- -------------
Lehi Environsystems, 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
INDEPENDENT AUDITORS' CONSENT
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 12, 1999 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, 1999 and to the reference to our
firm under the caption "Experts" in the prospectus.
Richard A. Eisner & Company, LLP
New York, New York
April 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JAN-31-1999
<CASH> 776,000
<SECURITIES> 0
<RECEIVABLES> 959,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,090,000
<PP&E> 6,424,000
<DEPRECIATION> 592,000
<TOTAL-ASSETS> 14,171,000
<CURRENT-LIABILITIES> 1,306,000
<BONDS> 875,000
0
3,000
<COMMON> 51,000
<OTHER-SE> 10,959,000
<TOTAL-LIABILITY-AND-EQUITY> 14,171,000
<SALES> 0
<TOTAL-REVENUES> 4,195,000
<CGS> 0
<TOTAL-COSTS> 2,266,000
<OTHER-EXPENSES> 2,538,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 141,000
<INCOME-PRETAX> (569,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (569,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (569,000)
<EPS-PRIMARY> (0.14)
<EPS-DILUTED> (0.14)
</TABLE>
