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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, 2000
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.
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(Name of Registrant in its Charter)
Delaware 52-1216347
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(State of Incorporation) (I.R.S. Employer
Identification Number)
515 N. Flagler Drive
Suite 702
West Palm Beach, FL 33401 (561) 820-9779
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(Address of Registrant's principal (Issuer's telephone number,
executive offices) including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities Registered pursuant to Section 12(g) of the Act:
Name of Each Exchange
Title of Each Class On Which Registered
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Common Stock, par value $.01 per share Nasdaq SmallCap Market
Warrants Nasdaq SmallCap Market
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, 2000: $4,715,000.
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 20, 2000 was approximately $26,000,000.
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 20, 2000 the number of outstanding shares of the
registrant's Common Stock was 6,192,069. Transitional Small Business Disclosure
Format (check one): Yes [X] No [ ]
Documents Incorporated by Reference: Registrant intends to file its
Definitive Proxy Statement for its 2000 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
Our business is composed of two separate but interrelated divisions:
o the Energy Division, which develops, owns and operates
cogeneration and independent energy facilities, and
o the Environmental Division, which furnishes environmental
consulting and remediation services, recovers and recycles
used motor and industrial oil, and processes waste water.
U.S. Energy Systems, Inc. (the "Company"), was created in 1993 through
the merger of Utility Systems Florida, Inc. ("USF"), and Cogenic Energy Systems,
Inc. ("Cogenic"). 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
Richard H. Nelson, President of the Company since its inception, died
suddenly on January 24, 2000. The Board of Directors of the Company appointed
Mr. Lawrence I. Schneider, Chairman of the Company's Executive Committee, as
interim President and Chief Executive Officer.
On March 28, 2000 the Company announced its intention to acquire on a
stock for stock basis SPARKenergy.com and its affiliated entities
("SPARKenergy"). SPARKenergy is a private, Midwestern holding company, with
FERC-certified gas storage and gas transmission assets. SPARKenergy, with joint
venture partners, is developing a 500 MW natural gas powered plant, which is
expected to be operational in mid-2001.
In November 1999, we entered into a four-month agreement with a
consulting company affiliated with Lawrence I. Schneider, President, Chief
Executive Officer and a Director, Henry Schneider, Vice-President and Director
and Asher Fogel, a member of our Board of Directors. The agreement provided for
the consultant to provide advisory and investment banking services in exchange
for a fee of 7.5% of the face amount of financing received by us and warrants to
purchase our common stock at an exercise price of $2.25. The number of warrants
would be an amount equal to 10% of the total dollar amount raised. The
consultant would also receive a fee for any mergers arranged by the consultant.
The agreement expired in February, 2000.
On April 12, 2000, the Company announced its intention to purchase an
equity interest in Marathon Capital, L.L.C. a Bannockburn, IL company engaged in
the financing of energy conservation projects, independent power
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production and renewable energy projects. Marathon's President is Richard T.
Brandt, a member of our Board of Directors. In addition, our CEO, Lawrence I.
Schneider, has an equity interest in Marathon. We also agreed to retain Marathon
as a consultant to assist on negotiating and financing future projects.
ENERGY DIVISION
Our 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.
We believe 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. This process is
known as wholesale wheeling and generally allows regulated electric companies to
purchase electricity from IPPs more cheaply and efficiently than they might 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, many states have adopted these regulations, and others are expected to
adopt them in the near future. This process is known as retail wheeling, which
is similar in concept to competition among long distance telephone service
providers.
We believe 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 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, which include geothermal, wind, solar, hydro, and waste
products, including waste oil, waste wood and other biomass, or landfill gas.
Our December 1996 acquisition of the two operating geothermal power plants known
as Steamboat 1 and 1A, in Steamboat Hills, Nevada provided the Company's initial
entry into this area of "green" power production. The further acquisition of
Steamboat 2 and 3, as discussed below, will enhance this position.
Geothermal power is considered to be one of the most
environmentally-sound methods of producing electricity due to the fact 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.
We expect to explore further uses of geothermal resources to produce
energy through the development of our 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, which will be completed
in 2001, Reno Energy will 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. These facilities are located
within a three mile radius of Reno, Nevada, and comprise approximately 40
million square feet of indoor heating and cooling requirements. We believe that
Reno Energy, which is scheduled for completion in 2002, will be one of the
largest district heating facilities in the United States.
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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. While we believe that we are in substantial
compliance with all applicable rules and regulations and that the projects in
which we are involved have the requisite approvals for existing operations and
are operated as required by applicable laws, our operations and our projects
require compliance with a varied and complex body of laws and regulations that
both public officials and private individuals may seek to enforce. There can be
no assurance that new or existing laws and regulations which would have a
materially adverse affect would not be adopted or revised, nor can there be any
assurance that we 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
Our acquisition of American Enviro-Services, Inc. in August 1997 marked
our expansion into the environmental services field. While separate from our
energy operations, the Environmental Division serves several of our
complementary needs including 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. We plan both to utilize the synergistic
services of our Environmental Division in our energy operations and to expand
this area of our business through internal growth and acquisitions. We believe
that the environmental services field is an industry with growth potential, and
one in which we can create a profitable market niche. We expect that AES will be
the nucleus for our 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 industrial waste 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.
We expanded our Environmental Division in January 1998, when we
acquired Commonwealth Petroleum Recycling, Inc., a waste oil recycling company
located in Shelbyville, Kentucky ("Commonwealth"). We believe that the
acquisition of Commonwealth allows AES to service the entire region of north
Kentucky and strengthens its market and operating position in the greater
midwestern U.S. region.
We believe that each of our facilities has all necessary operating
permits and that each permit will be renewed at the end of its existing term.
However, the issuance or renewal of any permit could include conditions
requiring further capital expenditures or corrective actions. Although we also
believe that each of our operating facilities complies in all material respects
with the applicable governmental requirements, it may be necessary to expend
considerable time, effort and money to keep existing or acquired facilities in
compliance with applicable requirements, including new regulations, to maintain
existing permits and approvals and to obtain the permits and approvals necessary
to increase their capacity.
OPERATIONS
ENERGY DIVISION
STEAMBOAT 1 AND 1A GEOTHERMAL POWER PLANTS. Our 95%-owned subsidiary,
Steamboat Envirosystems, LLC ("Steamboat LLC"), owns two geothermal power plants
in Steamboat Hills, Nevada: Steamboat 1 and 1A.
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The remaining 5% of Steamboat LLC is owned by Far West Capital ("Far
West"), from which we 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.
Under our agreement with Far West, we receive the first $1.8 million of
annual net income of Steamboat LLC, 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 must make royalty payments for steam extraction rights and
also royalty payments equivalent to 30% of the net revenue of Steamboat 1 after
limited deductions.
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. We have 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 required price adjustments at the end of the
first ten years of operation to a rate equal to the cost to Sierra to produce
one more kilowatt of power than it was currently producing, termed the
"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.
Together with the Nevada Geothermal Industry Council, an industry
association comprised of several geothermal producers in Nevada, we filed an
intervention with the Nevada Public Utilities Commission on hearings to
determine the rates Sierra should pay for the purchase of electricity. We argued
that the revenue we were receiving for Steamboat 1 power could be increased
significantly either through adjustments in the rate from Sierra or,
alternatively, selling our power outside of Sierra's 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 us 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, we have presented a claim for
$210,000 to Sierra 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, and there is no assurance that the Company will be
successful in these efforts.
STEAMBOAT 2 AND 3 GEOTHERMAL POWER PLANTS. As previously announced, we
reached agreement in principle with Far West Capital, Inc. to acquire Far West's
wholly owned subsidiary, Steamboat Development Corp., which owns the Steamboat 2
and 3 geothermal power plants and rights to the 600 acres of underlying
geothermal resource fields. Steamboat 2 and 3 produce an aggregate of 40
megawatts of power. The original letter of intent has expired but the parties
are continuing to negotiate towards a definitive agreement and the completion of
the transaction. The plants, which are adjacent to the smaller Steamboat 1 and
1A power plants, were financed by General Electric Capital Corporation and
produce approximately $12 million in annual sales under a long term contract for
sale of power to Sierra Pacific Power Corp.
PLYMOUTH STATE COLLEGE, NEW HAMPSHIRE. In 1994, we, through our
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, consists 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 before our acquisition of our interest. We paid a total of $636,000 in
cash and 11,400 shares of its Common Stock in 1994 for our 50% interest.
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Our 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 our representatives, IEC and Central Hudson.
Because the power requirements at the college have increased, one of
the engine-generators is being replaced with a new model providing increased
production. All costs of this project will be borne by the college and
completion is expected by July 2000. When the new unit is operational Plymouth
Cogeneration will have increased earnings, 50% of which will flow through to us.
LEHI COGENERATION PROJECT, UTAH. In January 1994, we through our
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 we, together with our partners, have
been exploring alternatives by which the Lehi Facility can begin operating.
The Lehi facility originally had three engine generators capable of
producing in the aggregate 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, we have determined that we would obtain better results if these engines
were replaced with combined cycle gas turbines of larger output and
substantially greater efficiency. We are negotiating a joint venture with third
parties to pursue these plans, however, we cannot assure you that an agreement
with respect to such joint venture will be reached, or if reached, that the
anticipated benefits will be realized.
Under 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 we will complete our application for this air
quality permit by mid-2000. Once the application has been completed, the Utah
Division of Air Quality customarily takes 90 to 120 days to issue the permit. We
know of no reason why the 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 of the plant. We believe 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 us to
market the power to areas outside the immediate Lehi area.
RENO ENERGY DISTRICT HEATING PROJECT. We have an 89.6% interest in USE
Geothermal, LLC ("USE Geo"), which has loaned Reno Energy $1.7 million for use
in providing engineering, design and financial services. The services will be
provided 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 is still in the planning and development stage. The Nevada Public
Utilities Commission inssued 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 loan is evidenced by a convertible note which matures on April 10,
2027. The loan accrues interest at a rate of 12% per annum while the Reno
Facility is being developed. However, the interest will be waived if USE Geo
exercises its option to convert the loan 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 loan based on a percentage, which is currently 50%, of
(1) Reno Energy's net cash flow from operations and (2) net cash proceeds from
specified capital transactions, after payment of distributions to members of
Reno Energy. USE Geo may convert the loan for no additional consideration into a
50% equity interest in Reno Energy at any time before the loan matures. The
equity percentage will be adjusted proportionately in the event of additional
funding of Reno Energy by USE Geo or Reno Energy's members before the exercise
of the option to convert. The loan is secured by a first lien on all of the
assets of Reno Energy and is personally guaranteed by Reno Energy's members.
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Such personal guarantees are, in turn, secured by a first lien and
pledge of the respective guarantors' membership interest in Reno Energy.
Final payment has been received on a $300,000 loan made by us to Reno
Energy in December 1996 to fund pre-development expenses associated with the
Reno project. Furthermore, a $275,000 loan made by us to Geo Energy, LLC, in
December 1997 to fund site property acquisition has been repaid.
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. We anticipate 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.
We currently expect 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 theloop will be
used to minimize concerns associated with the direct use of geothermal brine,
including 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.
We estimate that the construction, procurement and other costs
associated with the commencement of operations of the Reno facility will be
approximately $40 million. Such amount is expected to be financed through
industrial revenue bonds or other conventional financing means. There is no
assurance, however, that this financing can be obtained.
ENVIRONMENTAL DIVISION
On August 18, 1997, we 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, we 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 our
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.
OIL AND WASTE RECOVERY AND RECYCLING. Our Environmental Division
conducts oil and water recovery for approximately 1,100 clients, including
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 these 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.
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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.
AES is presently expanding its waste oil collection services into the
southern Ohio area. This expansion includes the daily collection of used oil and
industrial waters.
EMERGENCY RESPONSE. AES conducts emergency response operations
throughout the Indiana-Kentucky-Illinois area. Such operations include response
to automobile, truck 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 these types of emergency situations. Our emergency response division
has expanded and maintains fully trained and equipped personnel, including
emergency medical technicians, to perform permitted confined space entry and
confined space rescue. A confined space has limited or restricted means for
entry or exit, and includes tanks, vessels, silos, storage bins, hoppers, vaults
and pits. OSHA guidelines specify that such rescuers must be adequately equipped
and trained to respond effectively to rescue calls. In our operational area we
are the only company that meets these requirements. In addition, this division
has embarked upon training its personnel in railcar response and cleanup.
AES has recently expanded into the clean up and disposal of material
from clandestine laboratories. The recent growth in illegal methamphetamine
laboratories has provided new opportunities for emergency response services. AES
has signed service contracts with state and federal enforcement agencies to
clean up these sites.
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:
o large power plants (over 50 megawatts);
o small to medium-sized power plants (3 to 50 megawatts); and
o 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.
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<PAGE> 9
ENVIRONMENTAL DIVISION
Our 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 we are and have longer
operating histories and larger client basis. Such companies include Safety
Klean, Corp., a subsidiary of Laidlaw Environmental Services, Inc., and First
Recovery, Inc., a subsidiary of Ashland Oil Company. In the
Indiana-Kentucky-Illinois area, our Environmental Division competes with several
small independent environmental companies, which offer regional environmental
services.
EMPLOYEES
At April 20, 2000, the Company, including its subsidiaries, employed
approximately 40 full-and part-time personnel in its various locations. Not
included are personnel at our geothermal power plants, provided under contract
with the plant operator. We consider our 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 meets the criteria for 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
specified proportions to the facility's total energy output and must meet
certain energy efficiency standards. Therefore, loss of a thermal energy
customer could jeopardize a cogeneration facility's QF status. If one of the
power plants in which we have an interest were to lose its QF status and not
receive another PUHCA exemption, the project subsidiary or partnership could
become a public utility company, which could subject us 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. This 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 other standards. Each of Steamboat 1 and Steamboat 1A meets
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, we believe that we are in substantial compliance with all
applicable rules and regulations and that the projects in which we are involved
have the requisite approvals for existing operations and are operated in
accordance with applicable laws. However, our operations and our projects must
at all times comply with 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 we 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 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.
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<PAGE> 10
ENVIRONMENTAL DIVISION
Governmental regulations applicable to our environmental division
govern, among other things:
o the handling of the substances we collect which are classified
as hazardous or special wastes;
o the operation of the facilities at which we store or process
the substances we collect; and
o the ultimate disposal of waste generated by us during
processing of the substances we collect.
An increase in governmental requirements for the treatment of any
particular material generally increases the value of our services to customers,
but may also increase our costs and risks of noncompliance. Various permits are
generally required by federal and state environmental agencies for our 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 some of the operations at our 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 our
operation of vehicles to transport the substances we collect, including
licensing requirements for the vehicles and the drivers, vehicle safety
requirements, vehicle weight limitations, shipment manifesting and vehicle
placarding requirements. Governmental authorities have the power to enforce
compliance and violators may face civil and criminal penalties. Private
individuals may also have the right to sue to enforce compliance with certain of
the governmental requirements.
The services provided by our Environmental Division involve the
collection, transportation, storage, processing, recycling and disposal of
automotive and industrial nonhazardous fluids. We are 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, we must comply with 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, 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". Most EPA cleanup
efforts are at sites listed or proposed for listing on the National Priorities
List. 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,
9
<PAGE> 11
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.
Our 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 us 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.
RAISING OF ADDITIONAL CAPITAL AND NEGOTIATIONS FOR NEW PROJECTS
On March 25, 1998 the Company raised $2.25 million in a private
placement of 250,000 shares of its Series A Convertible Preferred Stock (the
"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 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 on the same terms and conditions.
On June 9, 1999 a $250,000 portion of the option was exercised, and
27,778 shares of Series A Convertible Preferred Stock were issued to Lawrence I.
Schneider. The Board of Directors also approved the extension of the option
exercise period to August 25, 2000.
From February 1, 2000 to April 20, 2000 we received a total of
$2,758,000 from the exercise of Warrants issued in connection with our public
offering in December 1996, resulting in the issuance of 689,000 shares of our
Common Stock. We also received $447,000 from the exercise of options, resulting
in the issuance of 140,000 shares of our Common Stock.
From time to time we evaluate acquisitions of new projects and
companies in the energy and environmental service fields. Preliminary work has
been done in connection with certain of these potential acquisitions and on
March 28, 2000 we announced our intention to acquire, in exchange for shares of
our Common Stock, SPARKenergy.com, a private, Midwestern holding company, which
possesses FERC-certified gas storage and gas transmission assets. SPARKenergy,
with joint venture partners, is also developing a 500 MW natural gas powered
plant located in Cinergy's (ECAR) service territory comprising the nine
east-central states. The plant is expected to be operational in mid-2001.
SPARKenergy further plans to acquire Gas Power Systems, L.L.C. ("GPS"), which
has developed a 1.2 MW natural gas-powered mini-turbine (called the Innovator
Genset) that is designed to be delivered at a price substantially below
competing units of similar size. These acquisitions are subject to the
completion of due diligence definitive documentation.
On April 12, 2000, we announced our intent to purchase an equity
interest in Marathon Capital, L.L.C., a Bannockburn, IL company specializing in
the financing of energy conservation projects, independent power production and
renewable energy projects. Marathon's president is Richard T. Brandt, a member
of our Board of Directors. In addition, our CEO, Lawrence I. Schneider, has an
equity interest in Marathon. As currently contemplated, we will contribute
200,000 shares of Common Stock in exchange for a preferred equity security
currently representing a 37.5% interest in Marathon. Marathon will also act as a
consultant to assist us on negotiating and financing new projects. This will
provide us with direct and significant financial expertise and access to new
deals.
We are negotiating joint ventures with third parties which would
broaden our presence in the geothermal energy industry and which would enable
the Lehi Facility to be expanded and put into operation.
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<PAGE> 12
ITEM 2. DESCRIPTION OF PROPERTY
Steamboat 1 and 1A are owned by our 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.
The Plymouth Facility is owned by Plymouth Cogeneration, a Delaware
partnership, of which we own 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:
a 20-year lease on the equipment expiring in 2014 and a 20-year management
contract expiring in 2014. Both contracts have escalation clauses. Because the
power requirements at the college have increased, one of the engine-generators
is being replaced with a new model providing increased production. All costs of
this project will be borne by the college and completion is expected by July
2000. When the new unit is operational, we expect to have increased earnings
from Plymouth Cogeneration, 50% of which will flow through to us.
The Lehi Facility is owned by LIPA, a Utah limited liability company,
of which we own 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 us and the owners of the remaining 50% of LIPA.
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 $267,000 at January 31, 2000. Management believes the plants are
adequately covered by insurance.
Our headquarters are in 3,000 square feet under a lease expiring in
October 2005 in a commercial office building in West Palm Beach, Florida. We
also lease from SB GEO regional offices in Reno, Nevada, on the site of the
Steamboat facilities. We have no separate lease agreement for the Reno office
space, but rental fees are included in the fees we pay to SB GEO for the
operation and management of the Steamboat facilities.
All our properties are in good condition and management believes that
they are adequately covered by insurance.
ITEM 3. LEGAL PROCEEDINGS
On September 1, 1999 we settled our lawsuit in the United States
District Court for the Southern District of New York against Enviro Partners,
L.P. and Energy Management Corporation ("EMC") et. al., 97 Civ. 1748 (JFK), for
$900,000. Enviro Partners and EMC had asserted demands against the Company for
lost profits of up to $6 million. Payment in full of the $900,000 was completed
in April 2000.
We are engaged from time to time in other legal proceedings, which at
this time, we do not expect to materially effect our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our annual meeting of stockholders on November 16, 1999, Allen J.
Rothman, Evan Evans and Henry Schneider were reelected to the Board of Directors
for terms ending in 2002, and Richard T. Brandt II was elected to a term ending
in 2001. (Votes for all were 5,235,389 in favor, 47,475 opposed, no abstantions,
and there were no broker non-votes). No other matters were voted on.
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<PAGE> 13
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.
<TABLE>
<CAPTION>
SALES PRICE
------------------
HIGH LOW
---- ---
<S> <C> <C>
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
Fiscal Year Ended January 31, 2000:
First Quarter................................................ $2.94 $2.00
Second Quarter............................................... 3.47 2.31
Third Quarter................................................ 2.94 1.88
Fourth Quarter............................................... 5.69 2.13
</TABLE>
The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions. On April 20,
2000, the last sale price of the Common Stock as reported on the Nasdaq SmallCap
Market was $4.56.
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, 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
Fiscal Year Ended January 31, 2000:
First Quarter........................................... $0.5625 $0.3125
Second Quarter.......................................... 0.5625 0.2813
Third Quarter........................................... 0.4688 0.2500
Fourth Quarter.......................................... 1.7500 0.2813
</TABLE>
The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions. On April 20,
2000, the last sale price of the Warrants as reported on the Nasdaq SmallCap
Market was $1.59.
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<PAGE> 14
HOLDERS
As of April 20, 2000 there were 600 holders of record of the Company's
Common Stock. On the same date there were 24 holders of record of the Company's
Warrants. The Company estimates that additional holders of Common 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%, 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%, 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.
RECENT SALES OF UNREGISTERED SECURITIES
On December 8, 1999, 187,234 shares of the Company's common stock were
issued to Lawrence I. Schneider in lieu of fees owed for consulting services in
the amount of $275,000. This represented a 50% discount from the market price at
the time, but are instead included in the financial statements as deferred
financing costs at 90% of the quoted market price.
On November 15, 1999, four officers of the Company, in an effort to
conserve cash, agreed to be paid in the common stock of the Company in lieu of
cash, resulting in the issuance of 16,287 shares. These were issued at a 50%
discount from the market price at the time, but are included in the financial
statements as compensation expense at 100% of the quoted market price.
On June 9, 1999 a $250,000 portion of the option to purchase shares of
Series A Convertible Preferred Stock was exercised and 27,778 shares of Series A
Convertible Preferred Stock were issued to Lawrence I. Schneider. The Board of
Directors also approved the extension of the option exercise period to August
25, 2000.
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 to acquire up to an additional
$8.0 million of Series A Preferred Stock on the same terms and conditions. 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.
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<PAGE> 15
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATIONS
GENERAL
The Company treats its investments in its LEHI and Plymouth
subsidiaries on the equity method, therefore 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, 2000 ("FISCAL 1999") COMPARED TO YEAR ENDED
JANUARY 31, 1999 ("FISCAL 1998")
Fiscal 1999 revenues increased by 12% or $520,000 over Fiscal 1998,
reflecting a decrease in revenues of the Energy Division and an increase in
revenues of the Environmental Division. Revenues of the Energy Division
decreased from $1,776,000 in Fiscal 1998 to $1,318,000 in Fiscal 1999 due almost
entirely to the fact that rates paid for power produced by Steamboat 1A had been
contractually higher until December 1998, at which point they changed to market
rates. Revenues of the Environmental Division increased from $2,419,000 in
Fiscal 1998 to $3,397,000 in Fiscal 1999 primarily as a result of the expansion
in its water and oil treatment business.
Costs and expenses in Fiscal 1999, exclusive of litigation settlement
costs, increased by $1,085,000 to $5,842,000 from $4,757,000 in the prior year.
Expenses of the Environmental Division increased by $502,000 due to increased
operations. Also, contributing to increased costs and expenses was a $441,000
write-off of deferred acquisition costs.
<TABLE>
<CAPTION>
Energy Environmental
Division Division
--------- ------------
<S> <C> <C>
Operating expense ................................ $ 686,000 $2,131,000
Selling, general and administrative expenses...... 257,000 458,000
Depreciation and amortization..................... 166,000 383,000
</TABLE>
Operating expenses, which are the costs directly relating to revenues,
totaled $2,817,000 for Fiscal 1999 as compared to $2,266,000 for Fiscal 1998.
Operating expenses for the Energy Division were $686,000 for Fiscal 1999
compared to $637,000 for Fiscal 1998. Operating expenses for Fiscal 1999 for the
Environmental Division totaled $2,131,000 compared to $1,629,000 for Fiscal
1998, as a result of the division's increased operations.
Included in general and administrative expenses were payroll costs and
consulting fees of $843,000 in Fiscal 1999 compared to $721,000 in Fiscal 1998.
The increase was due primarily to the increased staffing required to support the
Company's growth. Legal and professional fees totaled $658,000 in Fiscal 1999,
an increase of $443,000 from Fiscal 1998, attributable to the write-off of
previously deferred acquisition costs. We reviewed the deferred costs of
acquisition of the Steamboat 2 and 3 properties and related energy assets and
decided that certain costs did not relate to the acquisition in its present
form. The acquisition, however, is proceeding and is expected to be completed
during the second quarter of 2000.
Litigation costs increased from $47,000 in Fiscal 1998 to $932,000 in
Fiscal 1999 as a result of the settlement of the lawsuit against Enviro Partners
and EMC for $900,000 (see "Legal Proceedings").
Depreciation and amortization expenses increased from $499,000 in
Fiscal 1998 to $579,000 in Fiscal 1999 primarily due to the increased equipment
levels in the Environmental Division.
Interest income decreased to $143,000 in Fiscal 1999 from $299,000 in
Fiscal 1998 as a result of the lower cash balances carried by the Company in
Fiscal 1999. The decrease in interest expense from $141,000 in Fiscal 1998 to
$115,000 in Fiscal 1999 was due primarily to the exchange of $509,000 of
Subordinated Convertible Debentures for Series B Preferred Stock in March 1999.
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<PAGE> 16
After the death of Richard H. Nelson on January 24, 2000, the Company
recorded a receivable for insurance proceeds of $1,000,000 under a life
insurance policy, and has accrued the estimated costs of the items that are
expected to be paid to his estate, resulting in income, net of costs and
expenses, of approximately $600,000.
As a result of the foregoing items, the net loss of the Company, before
dividends on preferred stock, increased to $1,468,000 in Fiscal 1999 from
$569,000 in Fiscal 1998.
LIQUIDITY AND CAPITAL RESOURCES
In March 1998 the Company raised $2.25 million in a private placement
of 250,000 shares of its Series A Preferred Stock. Furthermore, at the Company's
annual stockholders meeting on August 26, 1998, the stockholders approved the
grant of an option for an additional 888,888 shares of the Company's Series A
Preferred Stock at an aggregate purchase price of approximately $8.0 million.
The Series A Preferred Stock is more fully described under "Raising of
Additional Capital and Negotiations for New Projects." An additional $250,000
was provided in March 1999 through the partial exercise of the option, resulting
in the issuance of 27,778 shares of Series A Preferred Stock. The time period
for exercising the remaining $7.75 million was extended to August 25, 2000.
The Company has received $2,758,000 since February 1, 2000 for the
exercise of 689,000 warrants. We received an additional $447,000 for the
exercise of outstanding stock options, resulting in the issuance of 140,000
shares of Common Stock.
At January 31, 2000 cash totaled approximately $301,000 as compared to
$776,000 at January 31, 1999. The $475,000 decrease in cash, along with $51,000
from financing activities, was used to fund $101,000 in operating activities and
$425,000 in investing activities.
During the year ended January 31, 2000, we used $101,000 in operating
activities compared with $490,000 used in operating activities in the same
period a year earlier. The exchange of $509,000 of Subordinated Convertible
Debentures for 509 shares of Series B Convertible Preferred Stock resulted in a
gain of $69,000 during Fiscal 1999. The net loss for Fiscal 1999 included the
write-off of $441,000 in deferred acquisition costs. The current year also
included net proceeds from life insurance of $600,000. During Fiscal 1999 we
incurred charges totaling $61,000 for the extension of certain outstanding
options for the purchase of Common Stock by one year to October 31, 2000, and
the payment of salaries in common stock in lieu of cash. In Fiscal 1999,
accounts and notes receivable decreased by $308,000 while in Fiscal 1998
accounts receivable increased by $83,000. All other assets in Fiscal 1999
increased by $184,000 as compared to a decrease of $11,000 in Fiscal 1998.
Accounts payable and accrued expenses in Fiscal 1999 decreased by $175,000 while
in Fiscal 1998 there was a decrease of $92,000. In the year ended January 31,
2000 provision for payment of the settlement of the litigation was $900,000. The
decrease in accounts payable and accrued expenses for Fiscal 1998 included the
payment in full of previously accrued royalties of $374,000.
We used $425,000 in investing activities in the year ended Fiscal 1999
compared to $1,210,000 in Fiscal 1998. We made new loans to Reno Energy totaling
$154,000 in Fiscal 1999 compared to $198,000 in Fiscal 1998. Repayments of loans
owed by Reno Energy, LLC totaled $384,000 in Fiscal 1999 compared to $100,000 in
Fiscal 1998. We used cash of $170,000 for additional deferred acquisition costs
in the year ended January 31, 2000. In Fiscal 1998, $668,000 was used for this
purpose.
Cash provided by financing activities in Fiscal 1999 was a net of
$51,000, with $250,000 having been provided by the additional issuance of Series
A Convertible Preferred Stock as a result of the partial exercise of the option
held by ESI. In Fiscal 1998 cash of $2,190,000 was provided from the sale of the
Series A Convertible Preferred Stock to ESI in a private placement. In Fiscal
1999 we repurchased 5,000 shares of our Common Stock for $12,000. In the
previous year we had repurchased 2,600 shares of our Common Stock for $3,000.
Dividends on Preferred Stock during Fiscal 1999 totaled $263,000 compared to
$174,000 in Fiscal 1998 as a result of the issuance of the additional Series A
and Series B Preferred Stock during the year.
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<PAGE> 17
As of January 31, 2000 we had $366,000 in aggregate principal amount of
our 9% Convertible Debentures outstanding. We also had $300,000 outstanding
under a line of credit with Old National Bank in Evansville, Indiana, bearing
interest at 9% per annum.
Pre-construction work on Reno Energy is continuing, with the necessary
initial permits granted. We estimate that we will spend up to $100,000 in such
pre-construction work. We expect institutional lenders to finance the estimated
$40 million construction price of the project, though there is no assurance that
such financing will be available. We believe that Reno Energy can become an
income producing property in the future.
Our working capital deficit was $255,000 at January 31, 2000 compared
to a surplus of $784,000 at January 31, 1999. During the next twelve months we
anticipate positive cash flows from both the Energy Division and the
Environmental Division along with proceeds from the option and warrant
exercises will be sufficient to meet working capital needs. However, there is
no assurance that we will receive the anticipated cash flows and proceeds.
ITEM 7. FINANCIAL STATEMENTS
See the Financial Statements and Independent Auditors' Report which are
attached hereto as the "Financial Statement Appendix" on pages F-1 through F-21.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Management
Mr. Richard Nelson, who had been President and Chief Executive Officer
of the Company since November 1993, died suddenly on January 24, 2000.
Our directors and executive officers are presently as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Theodore Rosen 74 Chairman of the Board of Directors
Lawrence I. Schneider 63 President, Chief Executive Officer, Chairman
of the Executive Committee
and Director.
Howard A. Nevins 44 Executive Vice President and Director
Henry Schneider 34 Vice President and Director
Seymour J. Beder 73 Secretary, Treasurer and Chief Financial Officer
Burton Joel Ahrens 62 Director
Richard T. Brandt II 43 Director
Evan Evans 73 Director
Asher E. Fogel 50 Director
Stanleigh G. Fox 53 Director
Allen J. Rothman 43 Director
</TABLE>
THEODORE ROSEN. Mr. Rosen has been 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.
16
<PAGE> 18
LAWRENCE I. SCHNEIDER. Mr. Schneider has served as President and Chief
Executive Officer of our Company since January 24, 2000 and has been a member of
Board of Directors and Chairman of the Executive Committee since March 1998. Mr.
Schneider is also the manager of Energy Systems Investors, LLC and 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 wasalso a
partner in Sassower, Jacobs and Schneider, a member firm of the New York Stock
Exchange. He holds his BS degree from New York University. Mr. Schneider is the
father of Henry Schneider.
HOWARD A. NEVINS. Mr. Nevins has been Executive Vice President of our
Environmental Division and a Director of our 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 our 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 our Secretary, Treasurer and Chief
Financial Officer 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.
BURTON JOEL AHRENS was appointed to the Board of Directors of our
Company in April, 2000. Since 1992 he has been President of Edgehill
Corporation, a diversified venture capital and money management company. He has
been a director of several public and private corporations, and is currently a
Director of USIR Capital, L.L.C.,President and a Director of Cryogenic Tadoptr
Corp., Co-Manager of Maple Leaf Energy Group, L.L.C. and Chairman and a Director
of ACTI, L.L.C. Mr. Ahrens received his B.A. degree from Cornell University in
1959, and his J.D. from Yale Law School in 1962, where he was an Editor of the
Yale Law Journal. He began his law career with Cravath, Swaine & Moore, and for
20 years was the founding Senior Partner of Feit & Ahrens, specializing in oil
and gas and venture capital matters. He was consultant to Senator Russell Long,
Chairman of the Senate Finance Committee, on energy-related matters. He has
appeared as an expert witness on energy matters domestically and in an
International Court of Arbitration. He has been active in a number of pro bono
activities, including Chairman Emeritus of the Northeastern region of AIPAC,
former President of the American Friends of Haifa University and the Executive
Committee of the Yale Law School Association.
RICHARD T. BRANDT II. Richard Brandt has been a Director of our Company
since November 1999. He is the Chairman and Chief Executive Officer of Marathon
Capital, LLC, a Chicago based financing company specializing in the origination,
processing and financing of non-conforming commercial loans and leases. Prior to
17
<PAGE> 19
founding Marathon in 1999, Mr. Brandt served as the Senior Vice President and
General Manager of the Vendor Financial Services unit of Transamerica
Distribution Finance. During his tenure at Transamerica, Mr. Brandt created a
dedicated Energy Financing Group, which provided capital for energy equipment
retrofit projects as well as various other small and medium energy related
project financing situations. Prior to his employment with Transamerica in 1997,
Mr. Brandt held senior positions in several other niche financing companies
including, Prime Capital, Inc., Lessor Capital Services and Dana Commercial
Credit. He holds an undergraduate degree in economics from Oberlin College and
an MBA from the University of Chicago.
EVAN EVANS. Mr. Evans has been a Director 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"), under 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 in
December 1998, and was elected to a full term at the annual meeting of
stockholders in November 1999. 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 before 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.
STANLEIGH G. FOX was elected to the Board of Directors on March 22,
2000. Mr. Fox is Managing Partner of the Fossil Power Business Unit of Harza
Engineering Company, Chicago, Illinois. Harza Engineering Company, founded in
1920, is a $175 million energy engineering and consulting company, ranked number
11 in power on the Engineering News Record top 500 Engineering Companies. Mr.
Fox has over 30 years of experience in engineering and project management of the
design of power generation facilities. Mr. Fox is a Registered Professional
Engineer in Illinois, holds an MBA from Dominican University and a BA in
Engineering from Iowa State University. He is a member of the American Society
of Mechanical Engineers, the Consulting Engineer Council of Illinois, the
Illinois Society of Professional Engineers, the National Society of Professional
Engineers and the Western Society of Engineers.
ALLEN J. ROTHMAN. Mr. Rothman has been a member of the Board of
Directors 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.
COMMITTEES
The Company's Audit Committee is comprised of Messrs. Henry Schneider,
Evan Evans and Asher E. Fogel. The Audit Committee met twice in 1999.
The Company's Executive Committee is comprised of Messrs. Lawrence
Schneider, Theodore Rosen and Alan Rothman. The Executive Committee met 12 times
in 1999.
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
18
<PAGE> 20
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 2000 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 2000 Annual Meeting Proxy Statement is
incorporated herein by reference.
19
<PAGE> 21
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
a. EXHIBITS.
<TABLE>
<CAPTION>
Exhibit
Number Description
------ -----------
<S> <C>
2.1 Merger Agreement by and between the Company, AES Merger
Corp., American Enviro-Services, Inc., and the Shareholders
of American Enviro-Services, Dated as of August 4, 1997 (3)
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 (4)
4.6 Certificate of Designation of Series B Convertible
Preferred Stock of the Company as filed with the Secretary
of State of Delaware (5)
21.1 Subsidiaries of the Company
23.1 Consent of Richard A. Eisner & Company, LLP
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
dated August 12, 1997.
(4) Incorporated by reference to the Company's Current Report on Form 8-K
filed on March 26, 1998.
(5) Incorporated by reference to the Company's Annual Report on Form 10-KSB
for the year ended January 31, 1999.
b. REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the Quarter Ended January 31,
2000.
20
<PAGE> 22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act, the Issuer has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
U.S. ENERGY SYSTEMS, INC.
May 1, 2000 By: /s/ SEYMOUR J. BEDER
--------------------------------------
Seymour J. Beder
Chief Financial and Accounting Officer
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ TEHODORE ROSEN
----------------------------- Chairman of the Board of Directors April 30, 2000
Theodore Rosen
President and Chief Executive April 30, 2000
/s/ LAWRENCE I. SCHNEIDER Officer (Principal Executive
----------------------------- Officer), Chairman of Executive
Lawrence I. Schneider Committee
and Director
/s/ SEYMOUR J. BEDER Chief Financial and Accounting April 30, 2000
------------------------------ Officer (Principal Financial and
Seymour J. Beder Accounting Officer)
/s/ HENRY SCHNEIDER
----------------------------- Director April 30, 2000
Henry Schneider
/s/ HOWARD NEVINS
----------------------------- Director and Executive Vice President April 30, 2000
Howard Nevins
/s/ BURTON JOEL AHRENS
----------------------------- Director April 30, 2000
Burton Joel Ahrens
/s/ RICHARD T. BRANDT II
----------------------------- Director April 30, 2000
Richard T. Brandt II
/s/ EVAN EVANS
----------------------------- Director April 30, 2000
Evan Evans
/s/ ASHER E. FOGEL
----------------------------- Director April 30, 2000
Asher E. Fogel
/s/ STANLEIGH G. FOX
----------------------------- Director April 30, 2000
Stanleigh G. Fox
/s/ ALLEN J. ROTHMAN
----------------------------- Director April 30, 2000
Allen J. Rothman
</TABLE>
21
<PAGE> 23
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS
Independent auditors' report....................................................................................... F-2
Balance sheet as of January 31, 2000............................................................................... F-3
Statements of operations for the years ended January 31, 2000 and 1999............................................. F-4
Statements of changes in stockholders' equity for the years ended January 31, 2000 and 1999........................ F-5
Statements of cash flows for the years ended January 31, 2000 and 1999............................................. F-6
Notes to financial statements...................................................................................... F-7
</TABLE>
F-1
<PAGE> 24
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
U.S. Energy Systems, Inc.
West Palm Beach, Florida
We have audited the accompanying consolidated balance sheet of U.S.
Energy Systems, Inc. and subsidiaries as of January 31, 2000 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, 2000, 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
April 7, 2000
F-2
<PAGE> 25
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
January 31,
2000
------------
<S> <C>
ASSETS
Current assets:
Cash $ 301,000
Accounts receivable (less allowance for doubtful accounts $15,000) 532,000
Notes receivable - current portion 20,000
Other current assets 352,000
Life insurance claim receivable 1,001,000
------------
Total current assets 2,206,000
Property, plant and equipment, net 5,881,000
Notes receivable, less current portion 1,752,000
Accrued interest receivable 459,000
Investments in joint ventures:
Lehi Independent Power Associates, L.C 886,000
Plymouth Cogeneration Limited Partnership 470,000
Deferred acquisition costs, net 397,000
Deferred financing costs 480,000
Goodwill, net 1,796,000
Other assets 27,000
------------
$ 14,354,000
============
LIABILITIES
Current liabilities:
Current portion of long-term debt $ 169,000
Notes payable - bank 300,000
Accounts payable and accrued expenses 717,000
Payable to estate of former officer 375,000
Litigation settlement payable 900,000
------------
Total current liabilities 2,461,000
Long-term debt, less current portion 384,000
Convertible subordinated debentures 366,000
Advances from joint ventures 90,000
Total liabilities 3,301,000
------------
Minority interests 559,000
------------
Contingencies (Note L)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 10,000,000 shares:
Series A, 9% cumulative, convertible, issued and outstanding 277,778
shares (liquidation value of $2,613,000) 3,000
Series B, 9% cumulative, convertible, issued and outstanding 509 shares --
Common stock, $.01 par value, authorized 50,000,000 shares; issued and
outstanding 5,364,124 shares 54,000
Treasury stock, 7,600 shares of common stock at cost (15,000)
Additional paid-in capital 18,425,000
Accumulated deficit (7,973,000)
------------
Total stockholders' equity 10,494,000
------------
$ 14,354,000
============
</TABLE>
See notes to financial statements
F-3
<PAGE> 26
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended January 31
-----------------------------
2000 1999
----------- -----------
<S> <C> <C>
Revenues $ 4,715,000 $ 4,195,000
----------- -----------
Costs and expenses:
Operating expenses 2,817,000 2,266,000
Administrative expenses 2,446,000 1,992,000
Litigation settlements and costs 932,000 47,000
Depreciation and amortization 579,000 499,000
----------- -----------
6,774,000 4,804,000
----------- -----------
Loss before other income (expense) and extraordinary item (2,059,000) (609,000)
Interest income 143,000 299,000
Interest expense (115,000) (141,000)
Equity in loss of joint ventures (100,000) (98,000)
Minority interest (6,000) (20,000)
Life insurance proceeds, net of costs and expenses 600,000 --
Loss before extraordinary item (1,537,000) (569,000)
Extraordinary gain from early extinguishment of debt (Note J) 69,000 --
----------- -----------
NET LOSS (1,468,000) (569,000)
Dividends on preferred stock (263,000) (174,000)
----------- -----------
LOSS APPLICABLE TO COMMON STOCK $(1,731,000) $ (743,000)
=========== ===========
LOSS PER SHARE OF COMMON STOCK - BASIC AND DILUTED:
LOSS BEFORE EXTRAORDINARY ITEM $ (0.34) $ (0.14)
EXTRAORDINARY ITEM $ 0.01 --
----------- -----------
NET LOSS $ (0.33) $ (0.14)
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 5,185,546 5,158,005
=========== ===========
</TABLE>
See notes to financial statements
F-4
<PAGE> 27
INSERT STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JANUARY 31, 2000 AND 1999
U.S. ENERGY SYSTEMS AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN CAPITAL
FOR THE YEAR ENDED JANUARY 31, 2000
<TABLE>
<CAPTION>
Preferred Stock - Series A Preferred Stock - Series B
---------------------------- --------------------------
Number Number
of Shares Amount of Shares Amount
--------- -------- --------- -----------
<S> <C> <C> <C> <C>
BALANCE - JANUARY 31, 1998
Cash paid for fractional shares
Shares issued in connection with
private placement offering 250,000 $ 3,000
Shares purchased for treasury
Dividends on preferred stock
Net loss for the year ended
January 31, 1999
--------- -------- --------- ------------
BALANCE - JANUARY 31, 1999 250,000 3,000 -- --
Cash paid for fractional shares
Shares purchased for treasury
Debentures exchanged for
preferred stock $ 509 (*)
Compensatory warrant modification
Shares issued for compensation
Shares issued as financing fee (Note K(1))
Shares issued in connection with private
placement offering, net of financing costs 27,778 (*)
Net loss for the year ended
January 31, 2000
Dividends on Preferred Stock:
Series A
Series B
--------- -------- --------- ------------
BALANCE - JANUARY 31, 2000 277,778 $ 3,000 509 $ --
========= ======== ========= ============
</TABLE>
<TABLE>
<CAPTION>
Treasury Stock Common Stock
--------------------- ----------------------
Number Number
Shares Amount of Shares Amount
------- -------- --------- -------
<S> <C> <C> <C> <C>
BALANCE - JANUARY 31, 1998 5,160,609 $51,000
Cash paid for fractional shares (4)
Shares issued in connection with
private placement offering
Shares purchased for treasury (2,600) $ (3,000)
Dividends on preferred stock
Net loss for the year ended
January 31, 1999
--------- -------- --------- -------
BALANCE - JANUARY 31, 1999 (2,600) (3,000) 5,160,605 51,000
Cash paid for fractional shares (2)
Shares purchased for treasury (5,000) (12,000)
Debentures exchanged for
preferred stock
Compensatory warrant modification
Shares issued for compensation 16,287
Shares issued as financing fee (Note K(1)) 187,234 3,000
Shares issued in connection with private
placement offering, net of financing costs
Net loss for the year ended
January 31, 2000
Dividends on Preferred Stock:
Series A
Series B
--------- -------- --------- -------
BALANCE - JANUARY 31, 2000 (7,600) $(15,000) 5,364,124 $54,000
========= ======== ========= =======
</TABLE>
<TABLE>
<CAPTION>
Additional
Paid-in Accumulated
Capital Deficit Total
----------- ----------- ------------
<S> <C> <C> <C>
BALANCE - JANUARY 31, 1998 $ 15,454,000 $ (5,936,000) $ 9,569,000
Cash paid for fractional shares --
Shares issued in connection with
private placement offering 2,187,000 2,190,000
Shares purchased for treasury (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 17,467,000 (6,505,000) 11,013,000
Cash paid for fractional shares --
Shares purchased for treasury (12,000)
Debentures exchanged for
preferred stock 433,000 433,000
Compensatory warrant modification 15,000 15,000
Shares issued for compensation 46,000 46,000
Shares issued as financing fee (Note K(1)) 493,000 496,000
Shares issued in connection with private
placement offering, net of financing costs 234,000 234,000
Net loss for the year ended
January 31, 2000 (1,468,000) (1,468,000)
Dividends on Preferred Stock:
Series A (217,000) (217,000)
Series B (46,000) (46,000)
------------- ----------- -----------
BALANCE - JANUARY 31, 2000 $18,425,000 $(7,973,000) $10,494,000
============= =========== ===========
</TABLE>
(*) Less than $1,000
See notes to financial statements
F-5
<PAGE> 28
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended January 31,
-----------------------------
2000 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss (1,468,000) (569,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 579,000 499,000
Equity in loss of joint ventures 100,000 98,000
Minority interest 6,000 20,000
Gain from exchange of debentures for preferred stock (69,000) --
Write off of deferred acquisition costs 441,000 --
Gain on life insurance claim, net (600,000) --
Compensatory stock and option grants 61,000 --
Changes in:
Accounts receivable, trade 231,000 (83,000)
Notes receivable, trade 77,000 --
Other current assets 3,000 (79,000)
Other assets (187,000) 90,000
Accounts payable and accrued expenses (175,000) (466,000)
Litigation settlement payable 900,000 --
----------- -----------
Net cash used in operating activities (101,000) (490,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans to Reno Energy, LLC (154,000) (198,000)
Repayments of loan by Reno Energy, LLC 384,000 100,000
Acquisition of equipment and leasehold improvements (485,000) (437,000)
Investment in joint ventures -- (7,000)
Deferred acquisition costs (170,000) (668,000)
----------- -----------
Net cash used in investing activities (425,000) (1,210,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable -- 100,000
Payment of long-term debt (136,000) (100,000)
Proceeds from long-term debt 179,000 128,000
Proceeds from issuance of preferred stock 250,000 2,190,000
Purchase of treasury shares (12,000) (3,000)
Dividends on preferred stock (263,000) (174,000)
Advances from joint ventures 33,000 16,000
----------- -----------
Net cash provided by financing activities 51,000 2,157,000
----------- -----------
NET INCREASE (DECREASE) IN CASH (475,000) 457,000
Cash - beginning of period 776,000 319,000
----------- -----------
CASH - END OF YEAR $ 301,000 $ 776,000
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 91,000 $ 315,000
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCIANG ACTIVITIES:
Debentures exchanged for preferred stock $ 433,000 --
Common stock issued as financing fee $ 496,000 --
Amortization of deferred financing costs $ 16,000 --
</TABLE>
F-6
<PAGE> 29
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 2000
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, 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, 1999 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.
(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.
F-7
<PAGE> 30
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
(8) FAIR VALUES OF FINANCIAL INSTRUMENTS. The estimated fair
value of financial instruments has been determined based on available
market information and appropriate valuation methodologies. The
carrying amounts of cash, accounts receivable, other current assets,
accounts payable and royalties payable approximate fair value at
January 31, 2000 because of the short maturity of these financial
instruments. The estimated carrying value of the notes receivable,
notes payable - bank, mortgage and equipment notes payable and the
convertible subordinated secured debentures approximate fair value
because the interest rates on these instruments approximate the market
rates at January 31, 2000. The fair value estimates were based on
information available to management as of January 31, 2000.
(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).
NOTE C -- SUBSIDIARIES AND AFFILIATES
(1) AMERICAN ENVIRO-SERVICES, INC. In August 1997, the Company
completed the acquisition of American Enviro-Services, Inc. ("AES"), a provider
of environmental and remedial services, for $2,774,000 including acquisition
costs of $276,000.
The acquisition was accounted for as a purchase.
(2) COMMONWEALTH PETROLEUM RECYCLING, INC. In January 1998, the
Company, through its subsidiary AES, completed the acquisition of Commonwealth
Petroleum Recycling, Inc. ("Commonwealth") for $384,000, including acquisition
costs of $51,000. Commonwealth also provides environmental and remedial
services.
(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, Royalty expense for the years ended
January 31, 2000 and 1999 were $227,000 and $247,000, 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.
F-8
<PAGE> 31
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE D -- NOTES RECEIVABLE
Notes receivable consist of the following:
Convertible loan (a).......................... $1,752,000
First loan (b)................................ 20,000
-----------
1,772,000
Less current portion.......................... 20,000
-----------
$1,752,000
===========
- ----------
(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 to Reno Energy have not effected the 50%
conversion feature. At January 31, 2000, accrued interest on this note
approximately amounting to $459,000 is included in other assets on the
balance sheet.
(b) Loan granted by the Company to Geo Energy (a Company affiliated with
Reno Energy) in the original principal amount of $275,000. The loan and
accrued interest thereon was repaid except for $20,000 which bears
interest at 10% and is due on November 20, 2000.
NOTE E -- PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following at January 31, 2000:
Land................................................ $ 78,000
Building............................................ 863,000
Steamboat Power Plants.............................. 4,284,000
Equipment........................................... 834,000
Leasehold improvements.............................. 51,000
Office equipment and furnishings.................... 122,000
Vehicles............................................ 660,000
-----------
6,892,000
Less accumulated depreciation....................... (1,011,000)
-----------
$ 5,881,000
===========
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,
2000, 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
F-9
<PAGE> 32
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
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 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, 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:
LIPA -- buildings 25 years
-- machinery and equipment 3 years
Plymouth -- plant 16 years
(4) The following is summarized financial information of LIPA and PCLP
as of December 31, 1999 and for each of the two-years in the period then ended:
<TABLE>
<CAPTION>
December 31, 1999
-----------------------------
LIPA PCLP
----------- -----------
<S> <C> <C>
Current assets ........................................ $ 53,000 $ 348,000
Property, plant and equipment at cost (net) ........... 257,000 4,426,000
Other assets .......................................... 1,052,000
----------- -----------
Total assets ....................................... 310,000 5,826,000
Current liabilities ................................... (41,000) (465,000)
Long-term debt ........................................ (4,543,000)
----------- -----------
Equity ................................................ $ 269,000 $ 818,000
=========== ===========
Share of equity in joint ventures ..................... $ 134,000 $ 409,000
Investments in joint ventures in excess of equity ..... 752,000 61,000
----------- -----------
Total investments in joint ventures ................ $ 886,000 $ 470,000
=========== ===========
</TABLE>
F-10
<PAGE> 33
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------
LIPA PCLP
----------------------------- -----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue ....................................... $ 7,000 $ 1,292,000 $ 1,219,000
=========== =========== ===========
Net income (loss) ............................. $ (25,000) $ 6,000 $ (57,000) $ (84,000)
=========== =========== =========== ===========
Equity in net income (loss) ................... $ (12,000) $ 3,000 $ (29,000) $ (42,000)
Amortization of purchase price over equity .... (55,000) (55,000) (4,000) (4,000)
----------- ----------- ----------- -----------
Net loss from joint ventures .................. $ (67,000) $ (52,000) $ (33,000) $ (46,000)
=========== =========== =========== ===========
</TABLE>
NOTE G -- NOTE PAYABLE -- BANK
At January 31, 2000, AES owed Old National Bank, $300,000, the full
amount of its line of credit. The line bears a variable interest rate of prime
plus 0.5%, (9.00%) at January 31, 2000. The line of credit is collateralized by
AES's accounts receivable, inventory and equipment.
NOTE H -- LONG-TERM DEBT
Long-term debt, all incurred by AES, consisted of the following at
January 31, 2000:
<TABLE>
<S> <C>
Mortgage payable, U.S. Small Business Administration, 4%, $447
per month, due November, 2017 (A) ........................... $ 67,000
Mortgage payable, Old National Bank, prime plus .5%, $3,266
per month, due February, 2017 (A) ........................... 206,000
Notes payable, various, 6.9% - 9.5%, $13,975 per month, due
August 2000 to March 2003, collateralized by all the assets of AES 280,000
--------
553,000
Less current portion ........................................... 169,000
--------
$384,000
========
</TABLE>
(A) Collateralized by AES land and building
As of January 31, 2000, future annual maturities are as follows:
2001 ....................... $169,000
2002 ....................... 123,000
2003 ....................... 69,000
2004 ....................... 32,000
2005 and thereafter ........ 159,000
--------
$552,000
F-11
<PAGE> 34
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE I -- INCOME TAXES
Deferred taxes at January 31, 2000 consist of the following:
<TABLE>
<S> <C>
Deferred tax assets:
Potential benefit of operating loss carryforward .... $ 2,290,000
Expenses not yet deductible for tax purposes ........ 119,000
-----------
2,409,000
Valuation allowance ................................. (2,409,000)
-----------
$ 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
$770,000 in 2000 and $64,000 in 1999 to offset the potential tax benefit
attributable to the increases in operating loss carryforwards, resulting from
the losses in each year.
At January 31, 2000, the Company has net operating loss carryforwards
expiring through 2020. Under Section 382 of the Internal Revenue Code, the
Company is subject to annual limitation on utilization of its net operating loss
carryforwards because of an ownership change of more than 50% that occurred upon
the public offering in December 1996. This annual limitation is approximately
$150,000 plus any built-in gains recognized in the five year period beginning on
the date of the ownership change. After giving recognition to this limitation,
the net operating loss carryforwards available to be utilized by the Company of
approximately $5,019,000, plus any recognized built in gains, expire as follows:
JANUARY 31,
2002 $ 750,000
2003 150,000
2004 150,000
2005 150,000
2007 124,000
2009 19,000
2010 607,000
2011 150,000
2012 565,000
2013 545,000
2019 496,000
2020 2,019,000
-------------
$ 5,725,000
=============
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 a portion of the Company's share of net profits of LIPA, as defined
(approximately 12% at January 31, 2000). The Debentures are collateralized by
the outstanding shares of LEHI and are subordinated to senior indebtedness. 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 (45,750 shares of common stock).
F-12
<PAGE> 35
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
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 in
principal amount of the Debentures. The exchange resulted in a gain of $69,000
net of $7,000 in related expenses. 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 require 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 ($2,613,000
at January 31, 2000). Dividends accrued of $113,000 are included in accounts
payable in the accompanying balance sheet.
The Company had granted an option to Energy Systems Investors, LLC
("ESI"), an entity controlled by its President. The option is for the purchase
of 888,888 shares of the Company's Series A Convertible Preferred Stock at $9
per share ($8,000,000). The expiration date of the option was extended by one
year to August 26, 2000 in consideration for ESI exercising a portion of the
option and acquiring 27,778 shares for $250,000 on June 14, 1999.
In connection with the option, the Company agreed to pay its President a
fee of 6.25% on the $8 million to be invested. The fee was to be paid in cash,
however, the parties agreed to satisfy the obligation by the Company issuing
187,234 shares of common stock value at $496,000 (10% discount to quoted market
price) which it recorded as deferred financing costs. The Company charged the
portion ($16,000) of the deferred 27,778 shares under the option. The
unamortized portion of the deferred financing costs will be charged to expense
if the Company does not raise additional capital by the expiration of the
option.
(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
F-13
<PAGE> 36
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
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 Board of Directors, on March 22,
2000, voted to present to the next annual meeting of stockholders its
recommendation that this number be increased to 5,000,000 shares.
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,
--------------------------------------------------
2000 1999
--------------------- ----------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Options outstanding at beginning of year........... 1,829,100 $ 3.08 1,289,600 $ 4.16
Granted (1)........................................ 847,950 2.86 589,500 2.43
Cancelled.......................................... (54,850) 3.28 (50,000) 3.91
--------- ---------
Options outstanding at end of year................. 2,622,200 2.94 1,829,100 3.08
========= =========
Options exercisable at end of year................. 2,111,725 2.94 1,754,100 3.11
========= =========
</TABLE>
The following table presents information relating to stock options
outstanding at January 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------------- --------------------
Weighted
Weighted Average Weighted
Range of Average Remaining Average
Exercise Exercise Life in Exercise
Price Shares Price Years Shares Price
-------- ------ -------- -------- ------ --------
<S> <C> <C> <C> <C> <C>
$2.00 - $2.50......... 1,392,500 $2.41 4.8 1,314,500 $2.41
2.875 - 3.00.......... 794,950 2.89 9.0 362,475 2.88
3.25 - 3.875.......... 86,000 3.86 2.9 86,000 3.86
4.00.................. 265,000 4.00 3.0 265,000 4.00
8.00.................. 83,750 8.00 0.7 83,750 8.00
--------- ---------
2,622,200 5.7 2,411,725
========= =========
</TABLE>
As of January 31, 2000, a total of 204,550 options are available for
future grant.
F-14
<PAGE> 37
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
The weighted average fair value of options at date of grant for grants
during the year ended January 31, 2000 and 1999 was $1.45 and $0.90 per option,
respectively. Additionally, on December 9, 1998 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,
----------------------
2000 1999
---- ----
<S> <C> <C>
Risk-free interest rates............................................ 5.17 - 6.02% 4.39 - 5.55%
Expected option life in years ...................................... 3.00 5.70
Expected stock price volatility..................................... .76 .70
Expected dividend yield............................................. 0.00% 0.00%
</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 during the year ended January 31, 1999 and
1998 would have been ($1,949,000) and ($2,711,000), respectively, or ($0.38) per
share and ($0.53) per share, respectively.
As of January 31, 2000, the Company has warrants outstanding for the
purchase of its common stock as follows:
<TABLE>
<CAPTION>
Exercise Expiration
Shares Price Date
------ ----- ----------
<S> <C> <C>
125,000 (a)(b) $4.00 December 2001
114,000 (c) 5.00 October 2000
3,565,000 (a)(d) 4.00 December 2001
</TABLE>
- ----------
(a) Redeemable at $.01 per warrant under certain conditions.
(b) Issued on conversion of debentures.
(c) Issued in connection with debt.
(d) Issued as part of an offering in common stock.
NOTE L -- COMMITMENTS AND CONTINGENCIES
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
F-15
<PAGE> 38
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
of damages. On March 8, 1999, motions by both parties for summary judgements
were denied and the pretrial process was scheduled. On September 1, 1999, the
Company settled with Enviro for $900,000.
NOTE M -- RELATED PARTY TRANSACTIONS
During the year ended January 31, 1999, the Company paid interest of $7,000 to
the a stockholder/director who had outstanding debentures totaling $80,000 which
were exchanged for Series B Preferred Stock in March 1999. (see Note J)
In November 1999, the Company entered into a four-month agreement with a
consulting company affiliated with the President of the Company. The agreement
provided for the consultant to provide advisory and investment banking services
in exchange for a fee of 7.5% of the face amount of financing received by the
Company and warrants to purchase common stock at an exercise price of $2.25. The
number of warrants would be an amount equal to 10% of the total dollar amount
raised. The consultant would also receive a fee for any mergers arranged by the
consultant.
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
Independent Environmental
Power and Remedial
Plants Services Corporate Total
---------------- ----------- ----------- -------------
<S> <C> <C> <C>
Year ended January 31, 2000:
Revenues ............................. $ 1,318,000 $ 3,397,000 $ 4,715,000
Operating income (loss) .............. 61,000 425,000 $(2,545,000) (2,059,000)
Assets ............................... 4,068,000 4,531,000 5,755,000 14,354,000
Capital expenditures ................. 40,000 440,000 5,000 485,000
Significant noncash transactions:
Depreciation and amortization ..... 166,000 383,000 30,000 579,000
Loss from joint ventures and
minority interest ............... 106,000 106,000
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
Capital expenditures ................. 6,000 373,000 58,000 437,000
Significant noncash transactions:
Depreciation and amortization ..... 157,000 319,000 23,000 499,000
Loss from joint ventures and
minority interest ............... 118,000 118,000
</TABLE>
F-16
<PAGE> 39
U.S. ENERGY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (Continued)
NOTE O -- SUBSEQUENT EVENETS
Since February 1, 2000, the Company has received approximately $2,758,000
from the exercise of approximately 689,000 warrants and approximately $447,000
from the exercise of approximately 140,000 stock options.
F-17
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
American Enviro-Services, Inc.
LEHI Envirosystems, Inc.
Plymouth Envirosystems, Inc.
Steamboat Envirosystems, Inc.
USE Geothermal, LLC
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We hereby consent to the incorporation by reference in the Company's
Registration Statements on Form S-8 (No. 333-31030) and Form S-3 (No. 333-36307)
of our report dated April 7, 2000, which appears in the Annual Report on Form
10-KSB of U.S. Energy Systems, Inc. and subsidiaries for the year ended January
31, 2000 and to the reference to our firm under the caption "Experts" in the
prospectus.
Richard A. Eisner & Company, LLP
New York, New York
April 28, 2000
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