[May 13, 2013] US GEOTHERMAL INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) INFORMATION REGARDING FORWARD LOOKING STATEMENTS This document contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of risks and uncertainties. We caution readers that any forward-looking statement is not a guarantee of future performance and that actual results could differ materially from those contained in the forward-looking statement. These statements are based on current expectations of future events. You can find many of these statements by looking for words like "believes," "expects," "anticipates," "intend," "estimates," "may," "should," "will," "could," "plan," "predict," "potential," or similar expressions in this document or in documents incorporated by reference in this document. Examples of these forward-looking statements include, but are not limited to: º our business and growth strategies; º our future results of operations; º anticipated trends in our business; º the capacity and utilization of our geothermal resources; º our ability to successfully and economically explore for and develop geothermal resources; º our exploration and development prospects, projects and programs, including timing and cost of construction of new projects and expansion of existing projects; º availability and costs of drilling rigs and field services; º our liquidity and ability to finance our exploration and development activities; º our working capital requirements and availability; º our illustrative plant economics; º market conditions in the geothermal energy industry; and º the impact of environmental and other governmental regulation. These forward-looking statements are based on the current beliefs and expectations of our management and are subject to significant risks and uncertainties. If underlying assumptions prove inaccurate or unknown risks or uncertainties materialize, actual results may differ materially from current expectations and projections. The following factors, among others, could cause actual results to differ from those set forth in the forward-looking statements: º the failure to obtain sufficient capital resources to fund our operations; º unsuccessful construction and expansion activities, including delays or cancellations; º incorrect estimates of required capital expenditures; º increases in the cost of drilling and completion, or other costs of production and operations; º the enforceability of the power purchase agreements for our projects; º impact of environmental and other governmental regulation, including delays in obtaining permits or ongoing impacts of the sequester; º hazardous and risky operations relating to the development of geothermal energy; º our ability to successfully identify and integrate acquisitions; -34- -------------------------------------------------------------------------------- º the failure of the geothermal resource to support the anticipated power capacity; º our dependence on key personnel; º the potential for claims arising from geothermal plant operations; º general competitive conditions within the geothermal energy industry; and º financial market conditions. All subsequent written or oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events, except as may be required under applicable U.S. securities law. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements. The U.S. dollar is the Company's functional currency; however some transactions have involved the Canadian dollar. All references to "dollars" or "$" are to United States dollars and all references to $ CDN are to Canadian dollars. General Background and Discussion The following discussion should be read in conjunction with our unaudited consolidated financial statement for the period ended March 31, 2013 and notes thereto included in this report. U.S. Geothermal Inc. ("the Company") is a Delaware corporation. The Company's common stock trades on the Toronto Stock Exchange under the symbol "GTH" and on the NYSE MKT LLC under the trade symbol "HTM." For the three months ended March 31, 2013, the Company was focused on: 1) Commissioning and operating the Neal Hot Springs power plant in Oregon; 2) Operating the Phase I San Emidio power plant in Nevada; 3) Operating the Raft River Unit I power plant in Idaho; 4) Negotiating long term financing for the San Emidio Phase I power plant and for a potential future Phase II, and discussing development funding for Phase III; 5) Conducting negotiations on a power purchase agreement and discussions with potential equity partners for the El Ceibillo project in Guatemala; 6) Conducting geophysical surveys, starting on-site development and planning the drilling program at El Ceibillo; and 7) The evaluation of potential new geothermal projects. Project Overview The following is a list of projects that are in operation, under development or under exploration. Projects in operation have producing geothermal power plants. Projects under development have a geothermal resource discovery or may have wells in place, but require the drilling of new or additional production and injection wells in order to supply enough geothermal fluid sufficient to operate a commercial power plant. Projects under exploration do not have a geothermal resource discovery occurrence yet, but have significant thermal and other physical evidence that warrants the expenditure of capital in search of the discovery of a geothermal resource. Due to inflation and marketplace increases in the costs of labor and construction materials, previous estimates of property development costs may be low. -35- -------------------------------------------------------------------------------- Projects in Operation Generating Capacity Contract Project Location Ownership (megawatts)(1) Power Purchaser Expiration Raft River (Unit I) Idaho JV(2) 13.0 Idaho Power 2032 San Emidio (Unit I) Nevada 100% 9.0 Sierra Pacific 2038 Neal Hot Springs Oregon JV(3) 22.0 Idaho Power 2036 (1) Based on the designed annual average net output. The actual output of the Raft River Unit I plant currently varies between 7.1 and 10.0 megawatts. (2) As part of the financing package for Unit I of the Raft River project, we have contributed $16.5 million in cash and approximately $1.4 million in property to Raft River Energy I LLC, the Unit I project joint venture company. Raft River I Holdings, LLC, a subsidiary of The Goldman Sachs Group, contributed $34 million to finance the construction of the project. (3) In September 2010, the Company's wholly owned subsidiary (Oregon USG Holdings LLC) entered into agreements that formulated a strategic partnership with Enbridge (U.S.) Inc. ("Enbridge"). As of September 30, 2012, Enbridge has contributed approximately $32.8 million to the Neal Hot Springs geothermal project. The Company and Enbridge have not yet determined Enbridge's current equity interest in the project, but current estimates show that Enbridge could own between 30% and 40% of the project depending on cash grant sharing and the return of unused contingency funds. Projects Under Development Estimated Target Projected Capital Development Commercial Required Project Location Ownership (Megawatts) Operation Date ($million) Power Purchaser El Ceibillo Phase I Guatemala 100% 25 4th Quarter 2015 $135 MOU El Ceibillo Phase II Guatemala 100% 25 TBD TBD MOU San Emidio Phase II Nevada 100% 11 2nd Quarter 2015 $55 NV Energy San Emidio Phase III Nevada 100% 17.2 TBD $100 TBD Neal Hot Springs II Oregon 100% 28 TBD TBD TBD Raft River (Unit II) Idaho 100% 26 TBD $134 TBD Raft River (Unit III) Idaho 100% 32 TBD $166 TBD Additional Properties Project Location Ownership Target Development (Megawatts) Gerlach Nevada 60% TBD Granite Creek Nevada 100% TBD Resource Details Resource Property Size Temperature Potential Property (square miles) (ºF) (Megawatts) Depth (Ft) Technology Raft River 10.8 275-302 127.0 4,500-6,000 Binary San Emidio 35.8 289-305 64.0 1,500-3,000 Binary Neal Hot Springs 9.6 311-347 50.0 2,500-3,000 Binary Gerlach 5.6 338-352 18.0 2,000-3,000 Binary Granite Creek 3.8 TBD TBD TBD Binary El Ceibillo 38.6 410-446 50.0 1,800-TBD Steam Neal Hot Springs, Oregon Neal Hot Springs is located in Eastern Oregon near the town of Vale, the county seat of Malheur County. A 22 net megawatt power plant, consisting of three separate, 7.33 net megawatt modules, has been constructed and is undergoing commissioning. The facility achieved commercial operation under the terms of the power purchase agreement on November 16, 2012. Generation from the facility during the first quarter of 2013 totaled 46,159 megawatt-hours. -36- -------------------------------------------------------------------------------- The new plant was designed and constructed by Industrial Builders Inc. pursuant to the Engineering-Procurement-Construction Agreement ("EPC") and by TAS Energy pursuant to the Equipment Supply Agreement ("ESA") contractor (TAS Energy). The plant consists of three separate, air cooled power modules rated at 7.33 megawatts each, and is designed to deliver approximately 22 megawatts of power net to the grid on an annual average basis. Physical construction of the total project under the EPC agreement is complete and commissioning under the terms of the ESA is underway. On May 27, 2012, the Company was notified by the EPC contractor that mechanical completion was achieved on the first of the three units. On June 28, 2012, the construction contractor provided notice of mechanical completion for the second of the three modules and on July 31, 2012 notice of mechanical completion was received for the third power plant module. All three units continued to undergo commissioning and tuning operations during the current quarter. All three modules received upgraded bearings in the turbine gearbox, swirl brakes were installed behind each of the three module's turbine wheels, and the silencers were replaced on each module. These modifications were first identified at the Company's San Emidio project and were implemented at Neal Hot Springs to address unwanted vibration. Subsequent to the quarter ended March 31, 2013, during plant testing at simulated summer conditions (high ambient temperature), it was determined that the turbine/gearbox had higher than acceptable vibration under specific conditions. At the direction of TAS Energy, the turbine manufacturer installed a dampening bearing on the Unit 2 module, which appears to have resolved the vibration issue related to summer operating conditions. Both Units 1 and 3 are in the process of having the dampening bearing installed. The modifications are expected to be finished by mid-May. Additional testing on all three Units is scheduled to take place during the second quarter 2013 to confirm the repairs. On February 26, 2009, the Company submitted a loan application for the Neal Hot Springs project to the DOE's Energy Efficiency, Renewable Energy and Advanced Transmission and Distribution Solicitation loan guarantee program under Title XVII of the Energy Policy Act of 2005. The financial closing for the DOE loan guarantee took place on February 23, 2011 which secured a $96.8 million loan guarantee from the Department of Energy and a direct loan from the U.S. Treasury's Federal Financing Bank. The $96.8 million loan represents 67% of the total project cost which is now estimated to be $143.6 million for the project, a $14.6 million increase from the previous estimate. The DOE loan is a combined construction and 22 year term loan. The annual interest rate on the loan is set at 37.5 basis points over the current average yield on outstanding marketable obligations of the United States of comparable maturity as determined on each date that a draw is made on the loan and is estimated to be 2.616% as an aggregate rate of the individual draws that occurred through March 31, 2013. Over the course of the ongoing construction, the budget was increased by $14.6 million in equity contributions by the partners. The first increase of $7.0 million was to cover additional drilling costs and modifications in plant controls and the cooling mechanism. Enbridge Inc., our partner at Neal Hot Springs, provided the additional investment in exchange for increased ownership interest in the project from 20% to a percentage to be calculated based on an agreed upon financial model. A second budget increase of $6 million, also provided by Enbridge Inc., was to establish a contingency fund for potential additional drilling program to complete the well field. Each of the additional investments made by Enbridge Inc. will be subject to calculations that will result in increased ownership interest in the project. Current estimates show that Enbridge could own between 30% and 40% of the project depending on ITC and BETC cash grant sharing. $2,478,000 of the $6.0 million contingency fund was used and the balance may be returned to Enbridge thereby adjusting the final Enbridge ownership. The project now has 100% of the required production and injection capacity drilled and proven. Enbridge and the Company expect to finalize the ownership percentages during the second quarter 2013. -37- -------------------------------------------------------------------------------- As of March 31, 2013, ten draws totaling $74.4 million have been made upon the DOE loan, which has annual interest rates between 2.396% and 2.997%. The project received a $32.75 million cash grant under Section 1603 Specified Energy Property in Lieu of Tax Credits from the Treasury Department. The cash grant, originally approved at $35.4 million, was subject to an 8.7% reduction due to Federal sequestration. The planned use of the grant proceeds is to: 1) fund cash reserves required by the DOE loan terms at the project level, 2) pay down approximately $13.5 million on the DOE loan and 3) use the balance to reimburse equity investors. In July 2010, the Company applied to the Oregon Department of Energy ("ODOE") for the Business Energy Tax Credit ("BETC"), which allows an income tax credit for up to $20 million in qualifying capital expenditures for a renewable energy project. On December 31, 2012, ODOE issued a Final Certificate Conditional for the Neal Hot Springs project BETC which can be sold to a pass-through tax partner and monetized at a cash value of $7.36 million. The final certificate was issued on March 1, 2013. It is anticipated that the BETC cash may be available within the first six months of 2013. After a long term flow test of the reservoir was completed in January 2011, a computerized numerical reservoir model was constructed on March 24, 2011 by the Company's consulting reservoir engineer, and after review, the DOE's independent reservoir engineer issued a reservoir certificate on March 31, 2011. The final reservoir report and certificate confirmed that the reservoir is able to sustain the production necessary for the completed 22 megawatt project from the existing four production wells. During the second quarter 2013, four production wells (NHS-1, NHS-2, NHS-5, and NHS-8) are providing up to 12,000 gpm of geothermal fluid to the power plant at an average inlet temperature of 287°F. Four large diameter injection wells (NHS-3, NHS-4, NHS-11, and NHS-13) and two slim-hole injection wells (NHS-10, and NHS-6,) are in use for injection of the cooled fluid exiting the power plant. To evaluate the performance of the geothermal reservoir, a colorimetric tracer test program was initiated on January 10, 2013 with separate tracers introduced in to the three largest injection wells. Tracer testing helps map the subterranean flow of geothermal fluid through the reservoir, and between production and injection wells. Sampling the four production wells for the tracers extended for over 60 days. Data from the test will be incorporated into the numerical reservoir model and an updated forecast will be completed. The Company received a Conditional Use Permit from the Malheur County Planning Commission for construction of the 22 net megawatt power plant on October 28, 2009 after unanimous approval from the Planning Commission at a September 24, 2009 meeting. All of the Federal Energy Regulatory Commission ("FERC") mandated transmission studies were completed by the Idaho Power Company. An interconnection agreement was signed with the Idaho Power Company in February 2009. Idaho Power completed the transmission line and substation during the second quarter of 2012. The PPA for the project was signed on December 11, 2009 with the Idaho Power Company. The PPA has a 25 year term with a starting average price for the year 2012 of $96.00 per megawatt-hour and escalates at a variable percentage annually. On May 20, 2010, the Idaho Public Utilities Commission approved the PPA with no changes to the terms and conditions. Power generated during 2013 will be paid at an average price of $99.00 per megawatt-hour. San Emidio, Nevada The new Phase I power plant at San Emidio achieved commercial operation on May 25, 2012. During the quarter ended March 31, 2013, the plant achieved 94.6% availability and generated an average of 9.4 net megawatts per hour. Power production totaled 19,157 megawatt-hours for the quarter. Further expansion of the San Emidio resource is planned to take place in two additional phases. Phase II is a planned expansion within the bounds of the existing San Emidio geothermal reservoir and is subject to the successful development of additional production wells through exploration and drilling activities. Phase III is planned for 17.2 megawatt net utilizing two additional power modules similar to Phases I and II. -38- -------------------------------------------------------------------------------- On November 9, 2011, the Company's wholly owned subsidiary, USG Nevada LLC, entered into a bridge loan agreement with Ares Capital Corporation. The bridge loan monetized the Section 1603 ITC cash grant associated with the new Phase I power plant at San Emidio. The loan agreement provided for borrowing of up to 90% of the total expected cash grant and consisted only of a single funding of $7.5 million. The funds were drawn from a loan facility that included commercial terms for the payment of interest and associated fees. An application for an $11.65 million ITC cash grant was submitted to the United States Department of the Treasury on July 17, 2012, and on November 14, 2012 the Treasury issued $10.65 million of the requested ITC cash grant amount. $7.78 million was paid to Ares Capital to satisfy the bridge loan facility, with the remaining $2.87 million paid to USG Nevada LLC. In March 2013, the remaining cash grant balance of $1.05 million, for items included in the original submission, was received from the Treasury. The Phase I repower began construction in the third calendar quarter of 2010 and was delayed in the startup due to EPC contractor's delay in completing Unit I and certain technical issues related to the new plant. The Phase II expansion is delayed due to the extended time it has taken to get Phase I online, and we are not able to accurately determine when Phase II will be completed at this time. Due to the EPC contractor's delay in completing the Unit I repower plant and the impact the delay has on future Phases, the Company expects to utilize the ITC cash grant in lieu of the Production Tax Credit only in connection with the Phase I repower. The Phase II expansion is still dependent on successful development of additional production well capacity. The total capital cost of the Phase I repower was $29.5 million, with Phase II estimated at approximately $55 million and Phase III approximately $100 million. We expect that approximately 75% of the Phase II and Phase III development may be funded by project loans, with the remainder funded through equity financing. The Company entered into agreements with Science Applications International Corporation ("SAIC") for a project loan and an engineering procurement and construction contract for the San Emidio Phase I power plant. SAIC's design-build subsidiary, SAIC Energy, Environment & Infrastructure LLC, constructed the 9.0 net megawatt power plant. TAS Energy of Houston, Texas supplied a modular power plant to the project. Phase I achieved mechanical completion in December 2011, and following performance testing of the power plant, which began in early May 2012, achieved commercial operation on May 25, 2012. Commissioning was extended due to a series of mechanical issues related to the use of an innovative configuration of proven technology that include defective capacitors, the mechanical failure of the 2,500 horsepower process pump, excessive vibration in the turbine gear box, and failure of the silencer. The SAIC provided its services under a fixed price contract that included financial guarantees for the original completion date and power output of the plant. Discussions with the SAIC are complete and Substantial Completion under the SAIC contract was achieved February 21, 2013. The Phase I plant completed its capacity testing during the quarter, and as a result of the capacity test exceeding the design output, the plant was up rated to 9.0 net annual average megawatts per hour from the design point basis of 8.6 megawatts. A final settlement agreement was executed as part of the Substantial Completion and included a fixed total construction loan payable to the EPC Contractor of $29.5 million. A long term permanent loan is currently under negotiation with a lender, and is expected to close in the third quarter of 2013. The Company expects to use the long term loan to repay the SAIC construction loan. On June 1, 2011, an amended and restated PPA was signed with Sierra Pacific Power Company d/b/a NV Energy for the sale of up to 19.9 megawatts of electricity on an annual average basis. The PPA has a 25 year term with a base price of $89.75 per megawatt-hour, and a 1% annual escalation rate. The electrical output from both Phase I and Phase II will be sold under the terms of the amended and restated PPA. The PPA was approved by the Public Utility Commission of Nevada on December 27, 2011. A Small Generator Interconnection Agreement for 16 megawatts of transmission capacity was executed with Sierra Pacific Power Company on December 28, 2010. -39- -------------------------------------------------------------------------------- On October 30, 2009, the Company was awarded $3.77 million in Recovery Act funding for the exploration and development of its San Emidio geothermal power project using advanced geophysical exploration techniques. This award was categorized under the "Innovative Exploration and Drilling Projects" section of the American Recovery and Reinvestment Act. The project at San Emidio has applied innovative, seismic and satellite imagery techniques along with state-of-the-art structural modeling, to locate large aperture fractures that represent high-productivity geothermal drilling targets. Two zones along the 4.5 mile long San Emidio fault structure were identified as high quality targets for drilling during the first phase of the DOE program, a South Zone and a North Zone. The first phase was completed in 2011. The second stage of the DOE program is a 50-50 cost shared drilling plan that followed up on the South Zone targets identified in the first stage. In order to meet construction targets for Phase II plant construction, the drilling stage of the program commenced prior to DOE approval, and two observation wells were completed by the Company. The proposed drilling program was approved by the DOE in early November 2011. One of the first two wells was deepened and three additional wells have been completed in the South Zone under the 50-50 cost share grant. Three of the five wells drilled in the South Zone exhibit commercial permeability and temperature. Well OW-10 produced a flowing temperature of 302°F, well OW-9 produced a flowing temperature of 280°F and well OW-6 produced a flowing temperature of 279°F. Well OW-9 also has a zone of high permeability at 1,830' deep, which was put behind casing during drilling operations that has a measured static temperature of 294°F. Additional drilling operations would be required to test this zone. Well OW-8 encountered 320°F fluid, but did not produce commercial quantities during flow testing. The last well drilled, 45A-21 did not encounter commercial permeability, but recorded a temperature of 316°F, which extends the high temperature reservoir approximately one-half of a mile south of OW-10. The North Resource Area has an additional five observation/temperature gradient wells and one production well planned and will be the focus of the next round of drilling. No start date has been set. Raft River, Idaho During the quarter ended March 31, 2013, Raft River Unit I operated at 97.7% availability and generated an average of 9.32 net megawatts per hour. Power production totaled 19,670 megawatt-hours during the quarter. For the 2012 calendar year, the plant averaged 8.6 net megawatts of generation with 98.7% availability. The funding for the DOE cost-shared, thermal fracturing program was increased from $10.2 million to $11.4 million by an additional $1.2 million contribution from the DOE. NEPA approval for the injection program was received, allowing the injection phase of the program to inject fluid that may induce thermal fracturing, and it is anticipated that injection may start during the second quarter of 2013. If the program is successful, and permeability is improved to a commercial level, well RRG-9 may be utilized as a production or injection well for the existing Raft River power plant. The Company's contributions for the thermal fracturing program are made in-kind by the use of the RRG-9 well, well field data and monitoring support totaling $816,877. Eight solar powered seismic stations were installed in June 2010 to provide a base line of seismic data and will be used to monitor potential impacts from the test. Construction is complete on the injection pipeline that extends from the Unit I power plant to well RRG-9. A detailed, 3-D magnetotelluric survey was completed during the fourth quarter of 2010. Subsequent to the end of the quarter March 31, 2013, four, 300 foot deep seismic monitoring wells were completed in the area around RRG-9 and geophones installed. Background seismic monitoring will be conducted for approximately two weeks prior to starting the first phase of injection using cooled brine from the power plant. -40- -------------------------------------------------------------------------------- Republic of Guatemala A geothermal energy rights concession located 14 kilometers southwest of Guatemala City was awarded to U.S. Geothermal Guatemala S.A., a wholly owned subsidiary of the Company in April 2010. The concession contains 24,710 acres (100 square kilometers) in the center of the Aqua and Pacaya twin volcano complex. An office and staff are located in Guatemala City and a 17.2 acre plant site has been leased on land adjacent to the existing wells. Discussions are taking place with several interested parties for the potential sale of an equity interest in the El Ceibillo project. El Ceibillo, the first development target on the concession, is located near the town of Amatitlan, in a developed industrial zone immediately adjacent to the highway that connects Guatemala City to the Port of San Jose on the Pacific coast. An initial development of a 25 megawatt (Phase I), flash steam power plant is planned in the El Ceibillo area of the concession, but the final size of the facility will be determined after drilling and resource delineation has advanced. Initial transmission studies have been completed, and identified the grid interconnection point approximately 1.2 miles (2 kilometers) from the site. A binding Memorandum of Understanding ("MOU") was signed on October 18, 2012 with one of the largest power brokers in Central America. The MOU establishes the framework for a PPA that includes a 15-year term for an initially estimated 25 megawatts of power generation up to a maximum of 50 megawatts of power generation. The MOU includes a project power price that the Company believes is competitive with the prevailing energy prices in the region. Several conditions precedent must be met before the PPA is negotiated and becomes effective, including confirming the geothermal reservoir by an independent reservoir engineer, obtaining all required permits and authorizations, and securing a project finance commitment. The MOU may be terminated (i) as a result of the bankruptcy of any of the parties, (ii) on January 1, 2015, unless such date is extended by mutual agreement, because the construction of the project has not been initiated and/or the commercial operation date has been moved beyond the date set out in the PPA framework, or (iii) if the geothermal resource found lacks the conditions to sustain a long-term commercial production that allows electric power to be produced under the necessary conditions of profitability. On December 28, 2012 an environmental report titled "Construction and Operation of the Geothermal Electric Plant, El Ceibillo" was submitted to the Ministry of Environment and Natural Resources. This report is an EIS level review of the potential impacts from development of a 25 megawatt power plant and satisfied a requirement of the contract that granted the concession. A public review period concluded on January 29, 2013 without any comments received and it is now under formal review by the Ministry. The El Ceibillo geothermal project area has nine existing geothermal wells that were drilled in the 1990s and have depths ranging from 560 to 2,000 feet (170 to 610 meters). Six of the wells have measured reservoir temperatures in the range of 365°F to 400°F and have high conductive gradients that indicate rapidly increasing temperature with depth. Fluid samples and mineralization from the wells indicate the existence of a high permeability reservoir below the existing well field. Two geophysical surveys were completed during the quarter. Subsequent to the quarter ended December 31, 2012, preparations for the commencement of site work started with the construction of a temporary office and fencing on the plant site. Two geophysical surveys, a VES survey and a gravity survey, have been contracted and are expected to be complete by the end of March. A plan and budget for an exploration slim hole of up to 1,000 meters deep has been developed. Results from the geophysical surveys will be used to select a location for the well to target the potential production zone. -41- -------------------------------------------------------------------------------- Gerlach Joint Venture The Gerlach Joint Venture, located adjacent to the town of Gerlach in Washoe County, Nevada is made up of both private and BLM geothermal leases. The Peregrine well, a historic exploration slim hole that encountered a lost circulation zone at a depth of 975 feet, was redrilled and the hole was opened from a 6.5 inch diameter well to a 12.5 inch diameter well. Lost circulation was confirmed with three zones through the 900 to 1,024 foot interval. The well was stopped at 1,070 feet total depth. Temperature surveys and a short clean out flow test were conducted on the well. The well flowed at an estimated 300-400 gallons per minute and the flowing temperature was 208°F. Geochemistry indicates an average potential source temperature of 374°F for the Gerlach site. Drilling commenced on observation well 18-10a on October 30, 2011. The upper section of the well was drilled to 826 feet deep and an 8 inch liner was cemented in place. The well was secured and the drill rig was moved back to San Emidio. Temperature measurements in the well have provided the highest measured temperature in the field to date at 268°F within 160' of surface and a temperature gradient of 6.4°F per 100' in the bottom section of the hole. There are two previously identified lost circulation targets at 1,600' and 2,800' deep that will be targeted when drilling is resumed. Drilling resumed on well 18-10a on April 14, 2012 and was stopped on April 18, 2012 at 1,943 feet deep. Circulation was lost in minor zones at 1,530 and 1,595 feet deep. Subsequent temperature surveys indicate an isothermal temperature profile at 241°F which may indicate that higher temperature fluid does not occur below the 18-10a well site. A plan and budget for 2013 has been developed to deepen well 18-10a to intersect the lost circulation zone at 2,800 feet deep to provide temperature information on the deep structure. Further work is dependent upon additional funding from the partners. Granite Creek, Nevada The Granite Creek assets are located about 6 miles north of Gerlach, Nevada along a geologic structure known to host geothermal features including the Great Boiling Spring and the Fly Ranch Geyser. A first stage gravity geophysical program was completed in the third quarter of 2008 and will be used to evaluate the resource potential, and help determine where to drill temperature-gradient exploration wells. After a detailed review of the geologic setting, the lease position at Granite Creek was reduced to 2,443.7 acres (3.8 square miles). One full lease and portions of the two remaining leases were relinquished to the Bureau of Land Management. Operating Results For the three months ended March 31, 2013, the Company reported net income attributable to the Company of $1.4 million ($0.01 income per share) which represented a $3.0 million favorable increase from the net loss of $1.6 million reported in the same period in 2012 ($0.02 loss per share). The primary difference related to the profit generated by the Company's three power plants. Other notable favorable variances were reported in stock based compensation and other income/expenses. Notable unfavorable variances were reported in corporate administration, professional and management fees, salaries and related compensation, interest expense, and leases and well testing. -42- -------------------------------------------------------------------------------- Plant Operations During the three months ended March 31, 2013, the Company's energy production revenues and related operating costs originated from three power plants that were fully operational for the entire quarter. The San Emidio plant (USG Nevada LLC) is located in the San Emidio Desert in the northwestern part of the State of Nevada. The original San Emidio plant and related water rights were purchased in 2008. The old plant ceased operations in December 2011 and was replaced with a new plant that began commercial operations in May 2012. The Raft River plant (Raft River Energy I LLC) is located in South Eastern Idaho. The Raft River plant began operations in January of 2008. The new plant at Neal Hot Springs, Oregon (USG Oregon LLC) began commercial operations on November 16, 2012. A summary of energy sales by plant location for the two reporting periods are as follows: For the Three Months Ended March 31, 2013 2012 $ %* $ %* Energy sales by plant: Neal Hot Spring, Oregon 4,197,252 60.1 - - San Emidio, Nevada 1,726,927 24.7 - - Raft River, Idaho 1,064,481 15.2 1,057,092 100.0 6,988,660 100.0 1,057,092 100.0 %* - represents the percentage of total plant energy sales. Neal Hot Springs, Oregon (USG Oregon LLC) Plant Operations The Neal Hot Springs plant began producing power in the quarter ended December 31, 2012 and was considered to be commercially operational on November 16, 2012. The three months ended March 31, 2013, was the plant's first full quarter of operations. Summarized statements of operations for the Neal Hot Springs, Oregon plant are as follows: Ave. Net Depreciation Kilowatt Energy Rate per Operating & Hours x Sales Kilowatt- Income Amortization Quarter Ended: 1,000 ($) Hour ($) ($) ($) December 31, 2012 23,256 2,320,867 0.0887 1,590,005 256,670 March 31, 2013 46,137 4,197,252 0.0906 2,899,708 779,298 San Emidio, Nevada Plant Energy Sales and Plant Operating Expenses (USG Nevada LLC) For the three months ended March 31, 2013, the San Emidio plant reported net operating profit of $896,883 which was a favorable increase of $1,373,555 from the operating loss of $476,672 (288.2% increase) reported in the same period in 2012. In the quarter ended March 31, 2012, the new plant was under construction and no operating revenues were being generated. All of the costs directly associated with the construction effort were capitalized. The new plant became commercially operational on May 25, 2012. During the quarter ended March 31, 2013, the plant produced the highest amount of energy revenues and kilowatt hours ($1,726,927 energy sales; 19,228,121 kilowatt hours) than any other quarter in operating history of USG Nevada LLC. The largest variance in operating costs for the three months ended March 31, 2013 and 2012 was reported in employee compensation. For the three months ended March 31, 2013, plant salaries and related costs were $258,969 which was an increase of $215,733 (499.0% increase) from the same period in 2012. The majority of the activities (over 85% of the employee's time) during the three months ended March 31, 2012 were related to plant construction, and were capitalized. During the current quarter, the Company collected a $226,860 refund on property taxes related to an error in the 2012 tax year assessment. -43--------------------------------------------------------------------------------- Summarized statements of operations for the San Emidio, Nevada plant are as follows: Three Months Ended March 31, 2013 2012 Variance $ %* $ % $ %** Plant revenues: Energy sales 1,726,927 100.0 - - 1,726,927 # Energy credit sales - - (6,124 ) - 6,124 100.0 1,726,927 100.0 (6,124 ) - 1,733,051 # Plant expenses: Operations 485,613 28.1 281,422 - (204,191 ) (72.6 ) Depreciation and 407,060 23.6 189,126 - (217,934 ) (115.2 ) amortization 892,673 51.7 470,548 - (422,125 ) (89.7 ) Operating 834,254 48.3 (476,672 ) - 1,310,926 275.0 income (loss) Other income 12 0.0 - - (699 ) # Net 834,266 48.3 (475,961 ) - 1,310,227 275.3 income %* - represents the percentage of total plant operating revenues. %** - represents the percentage of change from 2012 to 2013. Increases in revenues and decreases in expenses from the prior period to the current period are considered to be favorable and are presented as positive figures. # - variance percentage that is extremely high or undefined. The percentage of total plant operating revenues was not presented since the plant was not operational during the three months ended March 31, 2012. Key quarterly production data for the San Emidio, Nevada plant is summarized as follows: Net Ave. Operating Depreciation Kilowatt Energy Rate per Income & Hours x Sales Kilowatt- (Loss) Amortization Quarter Ended: 1,000 ($) Hour ($) ($) ($) March 31, 2011 5,656 600,702 0.1062 (61,083 ) 299,010 June 30, 2011 5,556 623,731 0.1123 (16,818 ) 246,038 September 30, 2011 4,943 629,582 0.1274 45,876 210,366 December 31, 2011 (1) 3,291 361,876 0.1100 (433,861 ) 206,522 March 31, 2012 (1) - - - (475,961 ) 189,126 June 30, 2012 (2) 5,465 427,931 0.0776 (8,748 ) 181,333 September 30, 2012 8,280 745,494 0.0897 101,103 253,429 December 31, 2012 16,231 1,459,078 0.0900 (223,412 ) 416,091 March 31, 2013 19,228 1,726,927 0.0903 834,254 407,060 (1) - The old power plant ceased operations on December 12, 2011, to facilitate the transfer of operations to the new power plant. -44- -------------------------------------------------------------------------------- (2) - The new power plant became commercially operational on May 25, 2012. The plant produced power at a lower "test rate" in May and at the full contract rate of .08975 per kilowatt hour in June. Raft River, Idaho Unit I (Raft River Energy I LLC) Plant Operations Net income from Raft River Energy I LLC ("RREI") operations of $67,620 for the three months ended March 31, 2013, increased favorably by $764,309 from the operating loss of $696,689 the reported in the same period in 2012. In May 2011, the repairs of wells RRG-2 and RRG-7 began under the Repair Service Agreement ("RSA") between the two members. The repairs were completed in January 2012, and the plant produced at expected levels for both the three months ended March 31, 2013 and 2012. Therefore, the operating revenues and production levels were consistent for the two periods. The major difference related to the amount of repair costs incurred and the grant proceeds received related to some of those repairs. During the three months ended March 31, 2012, RREI incurred repair costs (primarily to the two wells noted above) that exceeded $475,000. In addition to lower repair costs incurred in the three months ended March 31, 2013, RREI collected two grant awards related to the well repairs that totaled $217,594, which offset repair costs. The summarized statements of operations for RREI are as follows: Three Months Ended March 31, 2013 2012 Variance $ %* $ %* $ %** Plant revenues: Energy sales 1,064,481 91.5 1,057,091 90.7 7,390 0.7 Energy credit sales 98,330 8.5 108,119 9.3 (9,789 ) (9.1 ) 1,274,255 100.0 1,165,210 100.0 (2,399 ) (0.2 ) Plant expenses: General operations 636,562 54.7 1,353,072 116.1 716,510 53.0 Depreciation and 472,040 40.6 509,027 43.7 36,987 7.3 amortization 1,108,602 95.3 1,862,099 159,.8 753,497 40.5 Operating 54,209 4.7 (696,889 ) (59.8 ) 751,098 107.8income (loss) Other income 13,411 1.2 200 0.0 13,211 # Net 67,620 5.8 (696,689 ) (59.8 ) 764,309 109.7 income (loss) %* - represents the percentage of total plant operating revenues. %** - represents the percentage of change from 2012 to 2013. Increases in revenues and decreases in expenses from the prior period to the current period are considered to be favorable and are presented as positive figures. # - variance percentage that is extremely high or undefined. The intercompany elimination adjustments for interest expense, management fees and lease costs are not incorporated into the presentation of the subsidiary's operations. -45- -------------------------------------------------------------------------------- Key quarterly production data for RREI is summarized as follows: Kilo- Ave. Rate Depreciation watt Energy per Net Income & Hours x Sales Kilowatt- (Loss)* Amortization Quarter Ended: 1,000 ($) Hour ($) ($) ($) March 31, 2011 16,898 914,457 0.0541 321,507 514,300 June 30, 2011 14,144 651,059 0.0487 (1,986,673 ) 510,367 September 30, 2011 14,562 942,111 0.0673 (489,767 ) 508,968 December 31, 2011 17,888 1,159,245 0.0670 (965,553 ) 508,405 March 31, 2012 19,639 1,057,091 0.0557 (696,689 ) 509,027 June 30, 2012 15,999 765,255 0.0503 (805,286 ) 507,783 September 30, 2012 17,836 1,176,107 0.0681 2,348 505,560 December 31, 2012 21,170 1,398,218 0.0679 154,752 505,559 March 31, 2013 19,675 1,064,481 0.0561 67,620 472,040 * - Net income (loss) does not include intercompany elimination adjustments for interest expense, management fees and lease costs. Corporate Administration For the three months ended March 31, 2013, the Company incurred corporate administration costs of $292,240, which was an increase of $113,301 (63.3% increase) from the same period in 2012. The increase was, primarily, due to insurance and stock exchange filing fee costs. During the three months ended March 31, 2012, a large portion of the insurance costs (over $90,000) were allocated to the Neal Hot Springs and the San Emidio projects. The filing fee costs increased $57,736 (94.9% increase) from the three months ended March 31, 2012 to the same period ended 2013. The Company raised additional capital by issuing 11,810,816 shares on December 21, 2012 which increased the filing fee costs charged by both exchanges that were expensed in the three months ended March 31, 2013. Professional and Management Fees For the three months ended March 31, 2013, the Company incurred professional and management fees of $299,381, which was an increase of $187,218 (166.9% increase) from the same period in 2012. The increase was primarily related to the change in the corporate reporting year end. Many of the legal and audit related costs that had been incurred in quarters ended June 30th in prior years were incurred in the current period ended March 31, 2013. During the current reporting period, the Company incurred audit/audit related, legal and SOX consulting costs that amounted to approximately $115,000, $44,000 and $57,000; respectively. Salaries and Wages For the three months ended March 31, 2013, the Company reported $564,488 in salaries and related costs, which was an increase of $358,738 (174.4% increase) from the same period in 2012. The increase was due to bonuses awarded and significantly lower amounts of compensation that were allocated to the two major projects. During the current reporting period, the Company paid bonuses that amounted to $171,000. During the three months ended March 31, 2012, significant portions of the management and development compensation costs were allocated to the Company's capital projects. Since both projects were substantially completed prior to and operational during the current period, salary cost allocations for both projects decreased significantly. -46- -------------------------------------------------------------------------------- Management and development employee salaries and related costs allocated to major U.S. Geothermal projects are summarized as follows: For the Three Months Ended March 31, 2013 2012 Variance Financial $ $ $ % Element Total Company salary and related costs, 582,812 522,183 60,629 11.6 excluding plant operations Salary and related costs capitalized for the following projects: USG Nevada LLC (San Emidio Phase (7,263 ) (248,600 ) 241,337 97.1 I Project) USG Oregon LLC (Neal Hot Springs (8,935 ) (55,914 ) 46,979 84.0 Project) Small projects (2,126 ) (11,919 ) 9,793 82.2 564,488 205,750 358,738 174.4 % - represents the percentage of change from 2012 to 2013. Stock Based Compensation For the three months ended March 31, 2013, the Company reported $59,362 in stock based compensation, which was a decrease of $244,769 (80.5% decrease) from the same period in 2012. Stock based compensation includes the calculated values for both Company stock and stock options. The final vesting period of the last stock compensation award occurred in March 2012; therefore there were no stock compensation costs in the current reporting period. The compensation related to the value of the stock options issued to employees was significantly lower in the current period from the same period in 2012 due to the lower market price of the Company's outstanding stock. The components of the total stock compensation are summarized as follows: For the Three Months Ended March 31, 2013 2012 Variances $ $ $ % Total Stock Based Compensation: Stock option 59,362 225,276 (165,914 ) (55.6 ) compensation Stock compensation - 78,855 (78,855 ) (100.0 ) 59,362 304,131 (244,769 ) (80.5 ) Leases and Well Testing For the three months ended March 31, 2012, the Company reported $162,009 in other leases and well testing expenses, which was an increase of $136,989 (547.5% increase) from the same period in 2012. During the three months ended March 31, 2013, the Company incurred costs for a drill pad and a temporary office building that amounted to $169,409 at Guatemala (U.S. Geothermal Guatemala S.A.). These costs are necessary to start drilling the first test well which began on April 29, 2013. These types of expenditures will continue to be expensed until it is determined that there is a viable project. -47- -------------------------------------------------------------------------------- Interest Expense During the three months ended March 31, 2013, the Company reported $480,102 in interest expense from plant construction loans. All of the construction loan interest incurred during the three months ended March 31, 2012 was capitalized as a component of the total construction costs. Other Income/Expenses For the three months ended March 31, 2013, the Company reported $40,657 in income in other income/expenses which was a favorable increase of $535,381 (108.2% increase) from the net expense/loss from the same period in 2012. In February 2012, water rights on 2,917 acres leased property in the Granite Creek area located in the State of Nevada were relinquished and removed from intangible assets at their carrying amounts that totaled $548,701. The relinquishment was considered to be a loss that was recognized in the three months ended March 31, 2012. Net Income/Loss Attributable to the Non-Controlling Interests The net income/loss attributable to the non-controlling interest entities is the line item that removes the portion of the total consolidated operations that are owned by the Company's subsidiaries. For the three months ended March 31, 2013, the Company reported $846,556 in net income attributable to non-controlling interests, which was an increase of $1,618,691 (209.6% increase) from the net loss reported in the same period ended 2012. The primary reason for the increase was due to the operations of the Neal Hot Springs plant which reported net income of $2,424,647. The impact of the Neal Hot Springs operations on the Company's reported income attributable to non-controlling entities was an increase of $848,627 from the three months ended March 31, 2012 as compared to the three months ended March 31, 2013. Off Balance Sheet Arrangements As of March 31, 2013, the Company does not have any off balance sheet arrangements. Liquidity and Capital Resources We believe our cash and liquid investments at March 31, 2013 are adequate to fund our general operating activities through December 31, 2013. Other project development, such as Guatemala, may require additional funding. In addition to government loans and grants discussed below, we anticipate that additional funding may be raised through financial and strategic partnerships, market loans, issuance of equity and/or through the sale of ownership interest in tax credits and benefits. The current financial credit crisis is not anticipated to impact the ability of our customers, Idaho Power Company and Sierra Pacific Power, to pay for their power. This power is sold under long-term contracts at fixed prices to large utilities. The current status of the credit and equity markets could delay our project development activities while the Company seeks to obtain economic credit terms or a favorable equity market price to further the drilling and construction activities. The Company continues discussions with potential investors to evaluate alternatives for funding at the corporate and project levels. Under the Loan Guarantee Agreement at Neal Hot Springs with the Department of Energy, all funds for USG Oregon LLC are deposited into PNC Bank subject to certain procedural restrictions on use of the funds. At March 31, 2013, $9.0 million in funds were deposited at PNC Bank and unavailable for immediate corporate needs. For projects under construction before the end of 2010 and online before the end of 2013, a project can elect to take a 30% investment tax credit ("ITC") in lieu of the production tax credit ("PTC"). The ITC may be converted into a cash grant within the first 90 days of operation of the plant. Phase I at San Emidio attained commercial operation on May 25, 2012. An application was submitted in July 2012 electing to take the ITC cash grant in lieu of the PTC. The United States Department of Treasury notified the Company that it would allow $10.65 million in cash grant. The cash grant proceeds were received on November 10, 2012 and used to repay the Ares Capital bridge loan facility, with the remaining balance payable to USG Nevada LLC. An additional $1.05 million of cash grant items were subsequently approved and paid in March 2013. For the Neal Hot Springs project, an application was submitted in the first quarter 2013 electing to take the ITC cash grant, in lieu of the PTC, for approximately $35.9 million from U.S. Treasury and the funds will be used to fund reserves required under the DOE Loan Guarantee Agreement and return funds to our partner in the project, Enbridge. Due to federal sequestration in early 2013, the ITC cash grant amount received in April 2013 was reduced by 8.7% to $32.7 million. -48- -------------------------------------------------------------------------------- In July 2010, the Company applied to the Oregon Department of Energy for the Business Energy Tax Credit ("BETC"), which allows an income tax credit for up to $20 million in qualifying expenditures for a renewable energy project. The Neal Hot Springs project has completed final certification for the credit which can be sold to a pass-through partner and monetized at a cash value of $7.36 million. It is anticipated that the BETC cash will be available within the first six months of 2013. On May 21, 2012, the Company entered into a purchase agreement (the "Purchase Agreement") with Lincoln Park Capital Fund, LLC ("LPC"), pursuant to which the Company has the right to sell to LPC up to $10,750,000 in shares of the Company's common stock, ("Common Stock"), subject to certain limitations and conditions set forth in the Purchase Agreement and imposed by the Company's board of directors and pricing committee thereof. Pursuant to the Purchase Agreement LPC initially purchased $750,000 in shares of Common Stock at $0.38 per share. Following this initial purchase, on any business day and as often as every other business day over the 36-month term of the Purchase Agreement, and up to an aggregate amount of an additional $10,000,000 (subject to certain limitations) in shares of Common Stock, the Company has the right, from time to time, at its sole discretion and subject to certain conditions to direct LPC to purchase up to 250,000 shares of Common Stock, which amount may be increased in accordance with the Purchase Agreement if the closing sale price of Common Stock on the NYSE MKT exceeds certain specified levels. The purchase price of shares of Common Stock pursuant to the Purchase Agreement will be based on prevailing market prices of Common Stock at the time of sales without any fixed discount, and the Company will control the timing and amount of any sales of Common Stock to LPC. No sales of Common Stock under the Purchase Agreement will be made through the TSX. The Purchase Agreement contains customary representations, warranties and agreements of the Company and LPC, limitations and conditions to completing future sale transactions, indemnification rights and other obligations of the parties. There is no upper limit on the price per share that LPC could be obligated to pay for Common Stock under the Purchase Agreement. LPC shall not have the right or the obligation to purchase any shares of Common Stock if the purchase price of those shares, determined as set forth in the Purchase Agreement, would be below $0.25 per share. The Company has the right to terminate the Purchase Agreement at any time, at no cost or penalty. Actual sales of shares of Common Stock to LPC under the Purchase Agreement will depend on a variety of factors to be determined by the Company from time to time, including (among others) market conditions, the trading price of the Common Stock and determinations by the Company as to available and appropriate sources of funding for the Company and its operations. As consideration for entering into the Purchase Agreement, the Company has issued to LPC 651,819 shares of Common Stock. The Company will not receive any cash proceeds from the issuance of these 651,819 shares. As of September 30, 2012, the Company has sold LPC an aggregate of 4,625,506 shares of common stock pursuant to the Purchase Agreement for net proceeds of approximately $1,343,639. On December 21, 2012, the Company and LPC entered into an Amendment No. 1 to the Purchase Agreement (the "Amendment") to reduce the total amount that can be purchased under the Purchase Agreement, including amounts already purchased, from $10,750,000 to $6,500,000. The Company also entered into an agreement with Kuhns Brothers Securities Corporation ("KBSC"), pursuant to which KBSC agreed to act as the placement agent in connection with the sale of shares of Common Stock to LPC. The Company has agreed to pay KBSC the following compensation for its services in acting as placement agent in the sale of Common Stock to LPC: (A) the Company will pay a cash fee to KBSC in an amount equal to: (i) 6% of the aggregate gross proceeds received by the Company from the initial sale of $750,000 in shares of Common Stock to LPC pursuant to the Purchase Agreement, and (ii) 3% of the aggregate gross proceeds received by the Company from additional sales of Common Stock to LPC pursuant to the Purchase Agreement; and (B) the Company will issue to KBSC the number of warrants (the "Compensation Warrants") equal to: (i) in the case of the initial sale of $750,000 in shares of Common Stock to LPC, 6% of the aggregate number of shares sold to LPC; and (ii) in the case of additional sales of Common Stock to LPC, 3% of the aggregate gross proceeds received by the Company from such sales divided by 115% of the closing sale price of one share of Common Stock on the day prior to the respective issuance of the Compensation Warrant. The Compensation Warrants issued pursuant to clause (ii) in the preceding sentence will be based on incremental sales to LPC of $2 million in aggregate gross proceeds. Each Compensation Warrant will have an exercise price equal to 115% of the closing sale price of one share of Common Stock on the day prior to its issuance, a term of five years from the date of its issuance and will otherwise comply with the rules of the Financial Industry Regulatory Authority, Inc. On December 26, 2012, the Company completed a registered direct offering with a number of investors, pursuant to which they acquired, in total, 11,810,816 units (each a "Unit") of the Company at a price of $0.37 per Unit. Each Unit consists of one share of common stock of the Company and one half of one common stock purchase warrant (each whole warrant a "Warrant"). Each Warrant will entitle the holder thereof to acquire one additional share of common stock of the Company for a period of 60 months following the closing of the offering for $0.50 per share of common stock. The gross proceeds of the Unit offering were approximately $4.37 million. Kuhns Brothers Securities Corporation acted as placement agent for this offering and was paid a placement fee of $262,000, plus expenses of approximately $20,000. -49- -------------------------------------------------------------------------------- On September 30, 2011, the Company entered into an At Market Issuance Sales Agreement (the "Sales Agreement") with McNicoll, Lewis & Vlak LLC ("MLV"), pursuant to which the Company, from time to time, was entitled to issue and sell through MLV, acting as the Company's sales agent, shares of the Company's Common Stock. The Company's board of directors authorized the issuance and sale of shares of the Company's Common Stock under the Sales Agreement for aggregate gross sales proceeds of up to $10,000,000, subject to certain limitations based on the sales price per share, for a period of one year from the date of execution of the Sales Agreement. Pursuant to the Sales Agreement, MLV was entitled to compensation at a fixed commission rate of the greater of (i) 3% of the gross sales price per share sold or (ii)(1) $0.03 per share sold if the sale price per share was $0.80 or greater or (2) $0.0225 per share sold if the sale price per share was less than $0.80 (but in no event would compensation exceed 8% of gross proceeds). The Company has, also, agreed to reimburse a portion of MLV's expenses in connection with the offering of the Company's Common Stock under the Sales Agreement. The Company terminated the Sales Agreement effective May 19, 2012. Prior to such termination, the Company sold 241,989 shares of common stock pursuant to the Sales Agreement for net proceeds of approximately $126,133. On February 24, 2011, the Company completed the financial closing with the U.S. Department of Energy ("DOE") of a $96.8 million loan guarantee to construct the Company's planned 22-megawatt-net power plant at Neal Hot Springs in Eastern Oregon. Neal Hot Springs was the first geothermal project to complete a loan guarantee under the DOE's Title XVII loan guarantee program, which was created by the Energy Policy Act of 2005 to support the deployment of innovative clean energy technologies. The DOE loan guarantee will guarantee a loan from the U.S. Treasury's Federal Financing Bank. The $96.8 million Federal Financing Bank loan represents 67% of total project cost. When combined with the previously announced equity investments by the project's partner, Enbridge Inc., the loan provides 100% of the anticipated capital remaining to fully construct the project. In September 2010, Oregon USG Holdings, LLC (a wholly owned subsidiary) entered into agreements with Enbridge (U.S.) Inc. that formed a strategic and financial partnership to finance the Neal Hot Springs project located in eastern Oregon. A component of these agreements included a $5 million convertible promissory note, which converted. DOE guaranteed project loan and was treated as an equity contribution by Enbridge to the project. The agreements also provided for additional equity contributions of $13.8 million from Enbridge that when combined with the $5 million convertible promissory note earned Enbridge a 20% direct ownership in the project. As a result of cost overruns for the project, and at the election of the Company, an additional payment obligation of up to $8 million was contributed by Enbridge that increased their direct ownership in the project by 1.5 percentage points for each $1 million contributed. Added to their base 20% ownership, additional payments increased Enbridge's ownership to 27.5%. An additional $6 million cost overrun facility was established by Enbridge to cover costs that resulted from unexpected poor results from injection well drilling. The additional investment by Enbridge will increase their ownership in USG Oregon LLC based on running a project financial model and determining what percentage of the forecasted project income will be allocated to Enbridge to arrive at a predetermined rate of return for the additional investment. Current estimates of the ownership assuming that all of the investment is used for drilling shows that Enbridge could own up to 40% of the subsidiary. The model will be rerun after all of the variables have been fixed which is anticipated to be in the second quarter of 2013 to set the final ownership ratios between the two parties. -50- -------------------------------------------------------------------------------- Potential Acquisitions The Company intends to continue its growth through the acquisition of ownership or leasehold interests in properties and/or property rights that it believes will add to the value of the Company's geothermal resources, and through possible mergers with or acquisitions of operating power plants and geothermal or other renewable energy properties. Critical Accounting Policies The discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Certain accounting policies involve judgments and uncertainties to such an extent that there is reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been made. We evaluate our estimates and assumptions on a regular basis. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for the financial statements. See Management's Discussion and Analysis and the financial statements and related footnotes included in our Annual Report on Form 10-KT for the nine months ended December 31, 2012, for a description of our critical accounting policies. 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