10QSB 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 001-13869 ENVIRONMENTAL SAFEGUARDS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEVADA 87-0429198 (STATE OR OTHER JURISDICTION (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 2600 SOUTH LOOP WEST, SUITE 645 HOUSTON, TEXAS 77054 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (713) 641-3838 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) CHECK WHETHER THE ISSUER (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 or 15(d) OF THE EXCHANGE ACT DURING THE PAST 12 MONTHS (OR FOR SUCH 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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS AT NOVEMBER 1, 2003, APPROXIMATELY 10,745,091 SHARES OF COMMON STOCK, $.001 PAR VALUE, WERE OUTSTANDING. TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): Yes [ ] No [X] 1 ENVIRONMENTAL SAFEGUARDS, INC. CONTENTS PART I -- FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Condensed Balance Sheet as of September 30, 2003 (unaudited) and December 31, 2002. Unaudited Consolidated Condensed Statement of Operations for the three months and nine months ended September 30, 2003 and 2002. Unaudited Consolidated Condensed Statement of Stockholders' Equity for the nine months ended September 30, 2003. Unaudited Consolidated Condensed Statement of Cash Flows for the nine months ended September 30, 2003 and 2002. Selected Notes to Unaudited Consolidated Condensed Financial Statements. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Controls and Procedures PART II -- OTHER INFORMATION Item 1. Legal Proceedings Item 6. Exhibits and Reports on Form 8-K SIGNATURES 2 PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 3
ENVIRONMENTAL SAFEGUARDS, INC. CONSOLIDATED CONDENSED BALANCE SHEET ---------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) SEPTEMBER 30, 2003 DECEMBER 31, ASSETS (UNAUDITED) 2002 ------ ------------ -------------- Current assets: Cash and cash equivalents $ 548 $ 97 Accounts receivable 400 97 Prepaid expenses 153 173 ------------ -------------- Total current assets 1,101 367 Property and equipment, net 5,157 5,506 Intangible asset - acquired engineering design and technology, net 899 1,203 Other assets 2 3 ------------ -------------- Total assets $ 7,159 $ 7,079 ============ ============== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Notes payable to related parties $ 250 $ 250 Current portion of Long-term debt 152 - Accounts payable 135 31 Dividends payable 789 617 Accrued interest 135 63 Other accrued liabilities 792 592 ------------ -------------- Total current liabilities 2,253 1,553 Long-term debt 849 - Minority interest 1,925 1,943 Commitments and contingencies Stockholders' equity: Preferred stock; Series B convertible; voting, $.001 par value (aggregate liquidation value - $2,898); 5,000,000 shares authorized; 2,733,686 shares issued and outstanding 3 3 Preferred stock; Series D convertible, non-voting, cumulative $.001 par value (aggregate liquidation value $4,000); 400,000 shares authorized, issued and outstanding 1 1 Common stock; $.001 par value; 50,000,000 shares authorized; 10,745,091 shares issued and outstanding 10 10 Additional paid-in capital 15,332 14,981 Accumulated deficit (13,214) (11,412) ------------ -------------- Total stockholders' equity 2,132 3,583 ------------ -------------- Total liabilities and stockholders' equity $ 7,159 $ 7,079 ============ ==============
The accompanying notes are an integral part of these unaudited consolidated condensed financial statements. 4
ENVIRONMENTAL SAFEGUARDS, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS ----------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------------- ------------------------- 2003 2002 2003 2002 ----------- ------------ ------------ ----------- Revenue $ 600 $ 69 $ 1,123 $ 808 Cost of revenue 348 352 874 1,741 ----------- ------------ ------------ ----------- Gross margin 252 (283) 249 (933) Selling, general and administrative expenses 458 305 1,390 1,486 Amortization of intangible asset- acquired engineering design and technology 102 102 306 306 Research and development 15 5 45 25 ----------- ------------ ------------ ----------- Loss from operations (323) (695) (1,492) (2,750) Interest income - - - 2 Interest expense (93) (16) (156) (28) Other - - - (3) ----------- ------------ ------------ ----------- Loss before provision for income taxes and minority interest (416) (711) (1,648) (2,779) Benefit (provision) for income taxes - - 79 ----------- ------------ ------------ ----------- Loss before minority interest (416) (711) (1,648) (2,700) Minority interest 5 19 18 88 ----------- ------------ ------------ ----------- Net loss $ (411) $ (692) $ (1,630) $ (2,612) =========== ============ ============ =========== Net loss applicable to common stock- holders $ (467) $ (757) $ (1,802) $ (2,802) =========== ============ ============ =========== Net loss per share-basic and diluted $ (0.04) $ (0.07) $ (0.17) $ (0.28) =========== ============ ============ =========== Weighted average shares outstanding-basic and diluted 10,745 10,112 10,745 10,112 =========== ============ ============ ===========
The accompanying notes are an integral part of these unaudited consolidated condensed financial statements. 5
ENVIRONMENTAL SAFEGUARDS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY ------------ (IN THOUSANDS, EXCEPT SHARE AMOUNTS) TOTAL SERIES B SERIES D ADDITIONAL STOCK- PREFERRED PREFERRED COMMON PAID-IN ACCUMULATED HOLDERS' STOCK STOCK STOCK CAPITAL DEFICIT EQUITY ---------- ---------- ------- ------------ ------------- --------- Balance as of December 31, 2002 $ 3 $ 1 $ 10 $ 14,981 $ (11,412) $ 3,583 Issuance of a warrant to purchase 1,500,000 shares of common stock in connection with long-term debt (Note 4) - - - 345 - 345 Exercise of warrants to purchase 632,947 shares of common stock at $0.01 per share - - - 6 - 6 dividends on Series D Preferred stock - - - - (172) (172) Net loss - - - - (1,630) (1,630) ---------- ---------- ------- ------------ ------------- --------- Balance as of September 30, 2003 $ - 3 $ 1 $ 10 $ 15,332 $ (13,214) $ 2,132 ========== ========== ======= ============ ============= =========
The accompanying notes are an integral part of these consolidated financial statements. 6
ENVIRONMENTAL SAFEGUARDS, INC. UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS ---------- (IN THOUSANDS) NINE MONTHS ENDED SEPT EMBER 30, ------------------------- 2003 2002 ------------ ----------- Cash flows from operating activities: Net loss $ (1,630) $ (2,612) Adjustment to reconcile net loss to net cash provided by operating activities 771 2,102 ------------ ----------- Net cash used by operating activities (859) (510) ------------ ----------- Cash flows from investing activities: Purchases of equipment - (104) ------------ ----------- Net cash used by investing activities - (104) ------------ ----------- Cash flows from financing activities: Net proceeds from note payable 1,388 - Net proceeds from note payable to related party - 250 Payments on note payable (78) - Proceeds from sale of common stock upon exercise of warrants 6 - ------------ ----------- Net cash provided by financing activities 1,310 250 ------------ ----------- Net increase (decrease) in cash and cash equivalents 451 (364) Cash and cash equivalents, beginning of period 97 798 ------------ ----------- Cash and cash equivalents, end of period $ 548 $ 434 ============ ===========
The accompanying notes are an integral part of these unaudited consolidated condensed financial statements. 7 ENVIRONMENTAL SAFEGUARDS, INC. SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ----------- 1. GENERAL ------- The unaudited consolidated condensed financial statements included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted, pursuant to such rules and regulations. These unaudited consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto of Environmental Safeguards, Inc. (the "Company") included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion of management, the unaudited consolidated condensed financial information included herein reflect all adjustments, consisting only of normal, recurring adjustments, which are necessary for a fair presentation of the Company's financial position, results of operations and cash flows for the interim periods presented. The results of operations for the interim periods presented herein are not necessarily indicative of the results to be expected for a full year or any other interim period. 2. LIQUIDITY AND CAPITAL RESOURCES ---------------------------------- During the years ended December 31, 2002 and 2001, the Company faced significant liquidity issues that caused the Company's prior independent accountants to include an explanatory paragraph in their auditor's report on the Company's consolidated financial statements, as of December 31, 2001 and for the two years in the period then ended, describing the uncertainty about the Company's ability to continue as a going concern. Below is an analysis of the circumstances that led to a going concern explanatory paragraph in the Company's 2001 financial statements, followed by a description of changes in circumstances that resulted in the current auditors issuing an unqualified opinion, without a going concern explanatory paragraph, on the Company's 2002 financial statements. BACKGROUND AND 2001 CIRCUMSTANCES Since its inception, the Company has expended a significant portion of its resources to develop markets and industry awareness of the capabilities of its indirect thermal desorption ("ITD") recycling process. The Company's efforts have been focused on the development, production and sale of environmental recycling technologies and services to oil and gas industry participants, waste management companies and other industrial customers. The Company's efforts to develop markets and produce equipment have required significant amounts of capital including long-term debt secured by the Company's ITD units and related ITD technology. In 1995, the Company formed Onsite Technology, L.L.C. with a 50% partner, Parker Drilling Company ("Parker"). In 1997, the company purchased Parker's 50% interest for $8,000,000 and repaid a loan of $3,000,000 from an affiliate of Parker. The sources of funds for the acquisition came from the issuance of Series B and C Preferred Stock and a secured loan of $6,000,000. The Series C Preferred Stock was exchanged for Series D Preferred Stock in 2000. With the exception of the profitability impact from the Company's sale of three ITD units and certain licensing rights in late 2001 (as noted below), the Company has incurred recurring net losses and has been dependent on revenue from a limited customer base to provide cash flows. These factors were the basis for the Company's predecessor auditor's conclusion that at December 31, 2001, substantial doubt existed about the Company's ability to continue as a going concern. Continued 8 ENVIRONMENTAL SAFEGUARDS, INC. SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ---------- 2. LIQUIDITY AND CAPITAL RESOURCES, CONTINUED ---------------------------------------------- The Company is continually seeking to obtain service contracts in the markets that it serves. In December 2001, the Company completed the sale of three of its ITD units and certain licensing rights, and the proceeds were used to pay off all the Company's senior debt. At December 31, 2001, the Company's predecessor auditor believed that the Company's long-term viability as a going concern was dependent on the repositioning of its asset base and the achievement of a sustaining level of profitability. To the extent the Company's cash reserves and future cash flows from operations were insufficient to meet future cash requirements, the Company would need to raise funds through the infusion of equity, the issuance of debt securities or the sale of ITD units. Doubt existed as to whether such financing would be available on terms acceptable to the Company or at all. Further, the sale of additional equity or convertible debt securities may result in dilution to the Company's stockholders. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. NEW DEVELOPMENTS IN 2003 In January and March 2003, the Company entered into two important agreements that management believes will provide cash resources sufficient to cover the Company's 2003 cash requirements. The first agreement is a processing contract with a major waste management and disposal contractor as disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. The contract is currently in the long term operation phase. The second agreement is a $1,500,000 long-term debt arrangement collateralized by certain of the Company's ITD units (See Note 4). OTHER Management has evaluated the carrying value of long-lived assets, including associated intangibles. An evaluation of recoverability is performed by comparing the estimated future undiscounted cash flows associated with the assets to their carrying amount to determine if a write-down to market value or discounted cash flow is required. Given the homogeneous nature and geographic deployment flexibility of such assets, and based upon this evaluation by management, impairment of the Company's long-lived assets has not been deemed necessary. 3. INCOME TAXES ------------- Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has provided for a deferred tax valuation allowance for cumulative net operating tax losses to the extent that the net operating losses may not be realized. The difference between the federal statutory income tax rate and the Company's effective income tax rate is primarily attributed to foreign income taxes and changes in valuation allowances for deferred tax assets related to U.S. net operating losses. The differences between the Federal statutory income tax rates and the Company's effective income tax rates were as follows: Continued 9 ENVIRONMENTAL SAFEGUARDS, INC. SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ---------- 3. INCOME TAXES, CONTINUED -------------------------
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- --------------------- 2003 2002 2003 2002 --------- ----------- --------- ---------- Federal statutory rate (34)% (34)% (34)% (34)% Change in valuation allowance 34 34 34 31 --------- ----------- --------- ---------- - % - % - % (3)% ========= =========== ========= ==========
As of September 30, 2003, for U.S. federal income tax reporting purposes, the Company has approximately $7,656,000 of unused net operating losses ("NOLs") to future years. The Company's NOLs do not include the undistributed losses from certain controlled foreign corporations. The benefit from such NOLs will expire during the years ending December 31, 2017 to 2023. Because U.S. federal income tax laws limit the time during which NOLs may be applied against future taxable income, the Company may be unable to take full advantage of its NOLs for federal income tax purposes should the Company generate taxable income. Based on such limitation, the Company has significant NOLs for which realization of tax benefits is uncertain. The benefit from utilization of NOLs could be subject to limitations if material ownership changes occur in the Company. 4. LONG-TERM DEBT --------------- In March 2003 the Company signed a $1,500,000 long-term loan agreement. The loan is collateralized by three ITD units and bears interest at a stated rate of 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. In connection with this long-term loan, the Company issued 1,500,000 warrants to purchase shares of its common stock at an exercise price of $0.01 per share and these warrants were valued at $345,000. The loan origination fees and warrants results in an effective interest rate on the loan of approximately 35% per year. (See Note 10) In September 2003 the Company borrowed $8,000 from a financial institution to purchase a vehicle. The loan bears interest of 6.5% per year and is due in payments of $245 per month, including interest, through September 2006. The vehicle is collateral for the loan. Long-term debt as of September 30, 2003 consists of amounts due under the long-term debt agreements as described in the previous paragraphs. The long-term debt has an original face value of $1,508,000 and is carried net of unamortized loan costs of approximately $432,000 as of September 30, 2003. Such loan costs are being amortized over the term of the long-term debt using the interest method. Following is an analysis of long-term debt as of September 30, 2003 (in thousands): Contractual balance $ 1,433 Less unamortized loan costs (432) ------- Long-term debt 1,001 Less current maturities (152) ------- Long-term debt, net of current portion $ 849 ======= Continued 10 ENVIRONMENTAL SAFEGUARDS, INC. SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ----------- 5. LOSS PER SHARE ---------------- The Company computes basic earnings per share based on the weighted average number of shares of common stock outstanding for the period, and includes common stock equivalents outstanding for the computation of diluted earnings per share. As a result of incurred net losses, for the three months and nine months ended September 30, 2003 and 2002 all common stock equivalents have been excluded from the calculation of earnings per share as their effect is anti-dilutive. In future periods, the calculation of diluted earnings per share may require that the Company's common stock equivalents (totaling 23,333,518 shares at September 30, 2003) be included in the calculation of the weighted average shares outstanding for periods in which net income is reported. Following is a reconciliation of net loss to the net loss available to common stockholders:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ----------------------- 2003 2002 2003 2002 --------- ------------- ---------- ----------- (IN THOUSANDS) (IN THOUSANDS) Net loss $ (411) $ (692) $ (1,630) $ (2,612) Series D preferred stock dividends (56) (65) (172) (190) --------- ------------- ---------- ----------- Net loss available to common stockholders $ (467) $ (757) $ (1,802) $ (2,802) ========= ============= ========== ===========
6. SEGMENT INFORMATION -------------------- The Company operates in the environmental remediation and hydrocarbon reclamation/recycling services industry. Substantially all revenue results from the sale of services using the Company's ITD units. The Company's reportable segments are based upon geographic area. All intercompany revenue and expenses have been eliminated. Following is a summary of segment information:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ----------------------- 2003 2002 2003 2002 ----------- ----------- ---------- ----------- (IN THOUSANDS) (IN THOUSANDS) Revenue: United States $ 600 $ - $ 1,123 $ - Latin America - 66 - 805 ----------- ----------- ---------- ----------- Total revenue $ 600 $ 66 $ 1,123 $ 805 =========== =========== ========== =========== Loss from operations: United States $ (246) $ (600) $ (1,249) $ (2,276) Latin America - 12 (11) (124) Middle East (10) (37) (36) (176) Corporate (67) (70) (196) (174) ----------- ----------- ---------- ----------- Total loss from operations $ (323) $ (695) $ (1,492) $ (2,750) =========== =========== ========== ===========
Continued 11 ENVIRONMENTAL SAFEGUARDS, INC. SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ----------- 6. SEGMENT INFORMATION, CONTINUED --------------------------------
SEPTEMBER DECEMBER 30, 2003 31, 2002 ---------- ---------- (IN THOUSANDS) Assets: United States $ 3,555 $ 3,402 Latin America 201 228 Middle East 3,393 3,397 Corporate 10 52 ---------- ---------- Total assets $ 7,159 $ 7,079 ========== ==========
7. REVENUE ------- During the three months and nine months ended September 30, 2003, service revenue was derived from full-service contract utilization of ITD units owned by the Company. During the three months and nine months ended September 30, 2002, revenue was derived from an operations and maintenance contract covering the three ITD units sold to a customer in Mexico in the fourth quarter of 2001.
8. SUPPLEMENTAL NON-CASH TRANSACTIONS ---------------------------------- NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 2003 2002 ---------- ---------- (IN THOUSANDS) Dividends declared but not yet paid $ 172 $ 190 Stock warrants issued to obtain long-term debt $ 345 $ -
9. LITIGATION ---------- In July 2002, OnSite filed a lawsuit styled OnSite Technology LLC v. Duratherm, Inc., Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds; Civil Action No. H-02-2624; In the United States District Court for the Southern District of Texas against Duratherm, Inc. and Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds. OnSite's lawsuit alleges that Duratherm's remediation operations at its Galveston County, Texas facility infringed on OnSite's U.S. Patent No. 5,738,031 and requested a declaratory judgment that OnSite's operation of its remediation process does not infringe either of Heuer and Reynolds' U.S. Patent Nos. 4,990,237 and 5,269,906 over which Duratherm alleges control. OnSite is also seeking damages for patent infringement, injunctive relief to prevent further patent infringement, and other relief that the court finds appropriate. The Defendants have filed an answer asserting that they do not infringe on OnSite's patent and that such patent is invalid. The Defendants' denial that there is any controversy between the parties regarding the Heuer and Reynolds' patents, has been rejected by the court. The defendants have now alleged in their pleadings that OnSite infringes on the above patents and U.S. Patent No. 5,523,060. Discovery is complete, and the case is set for trial in the January / February, 2004 trial docket. Continued 12 ENVIRONMENTAL SAFEGUARDS, INC. SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS ---------- 9. LITIGATION, CONTINUED ---------------------- In July 2002, OnSite also initiated litigation styled OnSite Technology, LLC v. Duratherm, Inc. et al.; Cause No. 02CV0801; In the 56th Judicial District Court of Galveston County, Texas, against Duratherm, Inc., Duratherm Group, Inc., Barry Hogan and Jim Hogan. This lawsuit alleges that in November 1999, OnSite and Waste Control Specialists, L.L.C. ("WCS") entered into a contract wherein OnSite would, among other things, provide the necessary services, supplies and equipment to perform recycling and remediation services utilizing an indirect thermal desorption unit as specified therein. OnSite alleges that, in late July or early August 2000, Defendants, acting in concert through Duratherm, Inc., sent or caused to be sent a letter(s) and/or other communication(s) to WCS, which OnSite alleges contained statements that were false and intended to deceive WCS as to OnSite and OnSite's technology and indirect thermal desorption unit. OnSite also alleges that a suit filed by Duratherm in August 2000 for patent infringement against OnSite and WCS in the United States District Court for the Southern District of Texas under Civil Action No. H-00-2727, which was subsequently dismissed with prejudice by the United States District Judge, was malicious and contained false statements and allegations about OnSite and OnSite's technology and indirect thermal desorption unit. OnSite alleges that as a result of such alleged false, deceptive and malicious statements, WCS terminated its contract with OnSite. In February 2003 OnSite amended its petition to add John C. Hilliard as a defendant and to add as a claim against the defendants, the loss of a contract or prospective contract with ExxonMobil. OnSite has also amended its petition to include as a defendant Duratherm's counsel, Conley Rose P.C. The causes of action alleged by OnSite against the Defendants are (i) interference with contract and prospective business relations; (ii) unfair competition and business disparagement; (iii) unjust enrichment; and (iv) injury to OnSite's business reputation. OnSite is seeking actual, consequential, incidental and compensatory damages, including, but not limited to, disgorgement, pre- and post-judgment interest, attorney's fees and costs, and exemplary and punitive damages. OnSite is also seeking to enjoin these defendants and Duratherm's counsel, Conley Rose P.C., from interfering with the current and prospective business relationships of OnSite with regard to the thermal desorption units. The Defendants in this litigation have filed an answer denying the allegations contained in OnSite's petition. This case is in the discovery stage and is set for trial in July, 2004. 10. RELATED PARTY TRANSACTIONS ---------------------------- In July 2002, the Company obtained uncollateralized loans totaling $250,000 from Cahill Warnock Strategic Partners, L.P. and Strategic Associates, L.P. These loans bear interest of 12% per year and were originally due in January 2003 but have been extended to April 2004. David L. Warnock, one of the Directors of the Company, is a general partner of Cahill Warnock Strategic Partners, L.P. and a managing member of the general partner of Strategic Associates, L.P. In March 2003 the Company obtained a loan of $1,500,000 (See Footnote 4). The Company issued 1,500,000 warrants to purchase shares of its common stock at an exercise price of $0.01 per share in connection with this loan. This transaction resulted in the lender becoming a related party and the beneficial owner of 12% of the Company's common stock, although none of the warrants have been exercised as of November 1, 2003. In January 2003, the Company signed a contract to process various waste streams with an entity affiliated with the lender described in the previous paragraph. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated condensed financials statements and related notes included elsewhere in this report, and with our Annual Report on Form 10-K for the year ended December 31, 2002. INFORMATION REGARDING AND FACTORS AFFECTING FORWARD-LOOKING STATEMENTS We are including the following cautionary statement in this Form 10-QSB to make applicable and take advantage of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by us, or on behalf of us. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. Certain statements in this Form 10-QSB are forward-looking statements. Words such as "expects", "anticipates", "estimates" and similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties are set forth below. Our expectations, beliefs and projections are expressed in good faith and are believed to have a reasonable basis, including without limitation, our examination of historical operating trends, data contained in our records and other data available from third parties. There can be no assurance, however, that our expectations, beliefs or projections will result, be achieved, or be accomplished. In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in our view, could cause material adverse affects on our financial condition and results of operations: our ability to secure contracts for our ITD units; our ability to attain widespread market acceptance of our technology; our ability to obtain acceptable forms and amounts of financing; the demand for, and price level of, our services; competitive factors; the actual useful life of our ITD Units; ability to mitigate concentration of business in a small number of customers; the evolving industry and technology standards; the ability to protect proprietary technology; the dependence on key personnel; the effect of business interruption due to political unrest; and our ability to maintain acceptable utilization rates on our equipment. We are not obligated to update or revise these forward-looking statements to reflect the occurrence of future events or circumstances. OVERVIEW We are engaged in the development, production and sale of environmental recycling technologies and services to waste management companies, oil and gas companies and other industrial customers through our wholly owned subsidiary, OnSite Technology, L.L.C. ("OnSite"). We are devoting substantially all of our efforts to the development of markets for OnSite's services. We are currently providing recycling services to companies engaged in waste management, refining, and other industrial applications. Refining and other types of industrial activities, often produce significant quantities of petroleum-contaminated waste, from which our Indirect Thermal Desorption ("ITD") process can extract and recover the hydrocarbons as re-useable or re-saleable liquids, and produce recycled solids compliant with environmental regulations. The activities of OnSite include use of ITD technology to address hydrocarbon contamination problems and hydrocarbon recycling and reclamation opportunities at heavy industrial, refining, petrochemical and waste management sites, as well as at Superfund, DOD and DOE sites. We are currently concentrating our marketing efforts and resources on domestic downstream plants, manufacturing facilities and waste management facilities, where our proprietary equipment and process have a competitive advantage in waste minimization, and recycling/reuse of hazardous waste markets -- including industrial, petroleum and petro-chemical waste streams. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of its financial condition and results of operations are based upon our 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 judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and our 14 estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. These estimates and assumptions provide a basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from our estimates under different assumptions or conditions, and these differences may be material. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We recognize revenue at the time services are performed, or in the event of the sale of an ITD unit, when the equipment is shipped. We record property and equipment at cost. and compute depreciation using the straight-line method over an estimated useful live of 8 years on our ITD Units and 3 to 5 years on our office furniture and equipment and transportation and other equipment. Effective October 1, 2002, we changed the estimated useful lives of our ITD units from 5 years to 8 years to more accurately reflect our experience with the useful lives of the units and to conform to industry practices for equipment used in similar applications. Any additions or improvements that increase the value or extend the life of our assets are capitalized and expenditures for normal maintenance and repairs are expensed as incurred. Disposals are removed from the accounts at cost less accumulated depreciation and any gain or loss from disposition is reflected in operations currently. As of October 2003, we own five ITD units outright, and have an interest in two additional units in our 50%-owned subsidiary Onsite Arabia, Inc. Of the five fully-owned units, one is in operation and four are available for contract operations. The two 50%-owned units are available for contract operations in the Arabian Gulf region. QUARTERLY FLUCTUATIONS Our revenue may be affected by the timing and deployment of ITD Units to customer sites under existing contracts, and by the timing of obtaining new contracts. Accordingly, our quarterly results may fluctuate and the results of one fiscal quarter should not be deemed to be indicative of the results of any other quarter, or for the full fiscal year. RESULTS OF OPERATIONS COMPARISON OF OPERATING RESULTS - THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 Summary. During the third quarter of 2003, we incurred a net loss of $410,000 as compared to a 2002 third quarter net loss of $692,000. The loss for both periods was principally due to insufficient equipment utilization, along with offsetting expenses as noted below. Revenue and Gross Margin. Revenue of $600,000 during the third quarter of 2003 generated $252,000 of gross margin as compared to revenue of $69,000 and negative gross margin of $283,000 in the comparable 2002 quarter. The increase in revenue and improvement in gross margin were mainly due to a contract for an ITD unit to process various waste streams in the third quarter of 2003 as compared to an operations and maintenance contract in the same quarter of 2002. Selling, General and Administrative ("SGA") Expenses. SGA expenses during the third quarter of 2003 were higher than the comparable quarter in 2002 primarily due to a change in estimate of Texas franchise and property taxes in 2002 that reduced SGA expenses by $115,000 during the quarter ended September 30, 2002. Amortization of Engineering Design and Technology. This represents the amortization of Acquired Engineering Design and Technology costs, an intangible asset related to the December 1997 acquisition of the remaining 50% interest in OnSite from Parker Drilling. The intangible asset is being amortized over an 8-year estimated economic life. Interest Expense. During the third quarter of 2003, interest expense of $93,000 relating to deferred preferred stock dividend, our long term debt and note payable to related parties compares to interest expense of $16,000 on deferred preferred stock dividends and note payable to related parties for the third quarter of 2002. 15 Income Taxes. There were no tax provision effects in the third quarter of 2003 or 2002. During both comparative quarters we incurred net operating losses ("NOLs") primarily in the U.S., which may be used to offset taxable income reported in future periods. The NOLs associated with the taxes paid in OnSite's foreign subsidiaries have generated deferred tax assets, but due to uncertainties regarding the future realization of these assets, a valuation allowance has been provided for the full amount of the deferred tax assets. Minority Interest. Minority interest for the third quarter of 2003 and 2002 relates to our 50% minority partner's interest in the net loss of OnSite Arabia. COMPARISON OF OPERATING RESULTS - NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 Summary. During the nine months ended September 30, 2003, we incurred a net loss of $1,630,000 as compared to a 2002 net loss of $2,612,000. The loss for both periods was principally due to insufficient equipment utilization, along with operating expenses as noted below. Revenue and Gross Margin. Revenue of $1,123,000 during the first nine months of 2003 generated $249,000 of gross margin as compared to revenue of $808,000 and negative gross margin of $96,000 in the comparable 2002 period. The increase in revenue and the improvement in gross margin were mainly due to the fact that in the first nine months of 2002 all of our revenue was derived from an operations and maintenance contract (covering the three units sold in the latter part of 2001 to a Mexican client) compared with an average of 0.7 units under full-service contract operations in the first nine months of 2003. Selling, General and Administrative ("SGA") Expenses. SGA expenses during the first nine months of 2003 were lower than the comparable nine months in 2002 primarily due to foreign operation close-down and a general reduction in SGA expenses. Amortization of Engineering Design and Technology. This represents the amortization of Acquired Engineering Design and Technology costs, an intangible asset related to the December 1997 acquisition of the remaining 50% interest in OnSite from Parker Drilling. The intangible asset is being amortized over an 8-year estimated economic life. Interest Expense. During the first nine months of 2003, interest expense of $156,000 relating to deferred preferred stock dividend, our long term debt, and note payable to related parties compares to interest expense on deferred preferred stock dividend and note payable to related parties of $28,000 for the first nine months of 2002 Income Taxes. We have reported a tax benefit in the first nine months of 2002 related to the recovery of alternative minimum taxes provided at December 31, 2001. During both comparative nine month periods we incurred net operating losses ("NOLs") primarily in the U.S., which may be used to offset taxable income reported in future periods. The NOLs associated with the taxes paid in OnSite's foreign subsidiaries have generated deferred tax assets, but due to uncertainties regarding the future realization of these assets, a valuation allowance has been provided for the full amount of the deferred tax assets. Minority Interest. Minority interest for the first nine months of 2003 and 2002 relates to our 50% minority partner's interest in the net loss of OnSite Arabia. LIQUIDITY AND CAPITAL RESOURCES GENERAL ------- We currently have no significant commitments for capital expenditures. Since our inception, we have expended a significant portion of our resources to develop markets and industry awareness of our ITD remediation and recycling/reclamation process technology. Our efforts have been focused primarily on hydrocarbon soil contamination inherent in oil and gas exploration activities. Our efforts to develop markets and produce equipment have required significant amounts of capital. 16 To the extent our cash reserves and cash flows from operations are insufficient to meet future cash requirements, we will need to successfully raise funds through an equity infusion, the issuance of debt securities or the sale of ITD units. Financing may not be available on terms acceptable to us, or at all. Further, the sale of additional equity or convertible debt securities may result in dilution to our stockholders. We expect that our existing cash reserves, cash flows from operations, and our borrowing of $1,500,000 in March 2003 will be sufficient to cover our cash requirements for 2003. However, there can be no assurance that existing sources of cash will cover our 2003 cash flow requirements. OPERATIONS ---------- In December 2001 we completed the sale of three of our ITD units along with certain licensing rights, and utilized the bulk of the proceeds from the sale to retire our senior debt. With the exception of this sale, we have incurred recurring net losses and have been dependent on revenue from a limited customer base to provide cash flows. We completed our most significant service contract in December 2000 and during 2001 and 2002 have been exploring ways to replace that revenue. During 2001 and 2002 we've experienced a continued tightening of cash reserves and prior to repaying our senior debt in December 2001, we took actions to delay payments on that debt. In January 2003 we signed a contract to process various waste streams at a facility in Arkansas. We are currently seeking to obtain additional service contracts in our served markets and are considering strategic alternatives including the possible additional sale of certain of our assets. FINANCING --------- During July 2002, we obtained uncollateralized loans totaling $250,000 from Cahill Warnock Strategic Partners, L. P. and Strategic Associates, L.P. These loans bear interest at 12% per year and are due in April 2004. During March 2003, we obtained a loan of $1,500,000 from a private investor group. The loan is collateralized by three ITD units and bears interest at 12% per year. Principal payments are due in 20 quarterly installments of $75,000 beginning in August 2003 with the final payment due in May 2008. Warrants to purchase 1,500,000 shares of our common stock at a price of $0.01 were issued in connection with this loan. If we default on the $1,500,000 loan and if the lender forecloses on the collateral, we would be left with only two ITD Units in the U.S. The loss of the three ITD Units would (i) greatly reduce our capacity to serve customers in the U.S., (ii) would put a limit on the potential revenue we could achieve in the U.S., and (iii) would create an additional competitor in the U.S. AUDIT OPINIONS --------------- During the years ended December 31, 2002 and 2001, the Company faced significant liquidity issues that caused the Company's prior independent accountants to include an explanatory paragraph in their auditor's report on the Company's consolidated financial statements, as of December 31, 2001 and for the two years in the period then ended, describing the uncertainty about the Company's ability to continue as a going concern. Below is an analysis of the circumstances that led to a going concern explanatory paragraph in the Company's 2001 financial statements, followed by a description of changes in circumstances that resulted in the current auditors issuing an unqualified opinion, without a going concern explanatory paragraph, on the Company's 2002 financial statements. BACKGROUND AND 2001 CIRCUMSTANCES --------------------------------- Since its inception, the Company has expended a significant portion of its resources to develop markets and industry awareness of the capabilities of its indirect thermal desorption ("ITD") recycling process. The Company's efforts have been focused on the development, production and sale of environmental recycling technologies and services to oil and gas industry participants, waste management companies and other industrial customers. The Company's efforts to develop markets and produce equipment have required significant amounts of capital including long-term debt secured by the Company's ITD units and related ITD technology. In 1995, the Company formed Onsite Technology, L.L.C. with a 50% partner, Parker Drilling Company ("Parker"). In 1997, the company purchased Parker's 50% interest for $8,000,000 and repaid a loan of $3,000,000 from an affiliate of Parker. The sources of funds for the acquisition came from the issuance of Series B and C Preferred Stock and a secured loan of $6,000,000. The Series C Preferred Stock was exchanged for Series D Preferred Stock in 2000. 17 With the exception of the profitability impact from the Company's sale of three ITD units and certain licensing rights in late 2001, the Company has incurred recurring net losses and has been dependent on revenue from a limited customer base to provide cash flows. These factors were the basis for the Company's predecessor auditor's conclusion that at December 31, 2001, substantial doubt existed about the Company's ability to continue as a going concern. The Company is continually seeking to obtain service contracts in the markets that it serves. In December 2001, the Company completed the sale of three of its ITD units and certain licensing rights, and the proceeds were used to pay off all the Company's senior debt. At December 31, 2001, the Company's predecessor auditor believed that the Company's long-term viability as a going concern was dependent on the repositioning of its asset base and the achievement of a sustaining level of profitability. To the extent the Company's cash reserves and future cash flows from operations were insufficient to meet future cash requirements, the Company would need to raise funds through the infusion of equity, the issuance of debt securities or the sale of ITD units. Doubt existed as to whether such financing would be available on terms acceptable to the Company or at all. Further, the sale of additional equity or convertible debt securities may result in dilution to the Company's stockholders. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. NEW DEVELOPMENTS IN 2003 --------------------------- In January and March 2003, the Company entered into two important agreements that management believes will provide cash resources sufficient to cover the Company's 2003 cash requirements. The first agreement is a processing contract with a major waste management and disposal contractor as disclosed in Footnote 14 to the December 31, 2002 Financial Statements. The contract is currently in the long term operation phase. The second agreement is a $1,500,000 long-term debt arrangement collateralized by certain of the Company's ITD units. ITEM 3. CONTROLS AND PROCEDURES James S. Percell, our Chief Executive Officer and Michael D. Thompson , our Chief Financial Officer, have concluded that that our disclosure controls and procedures are appropriate and effective. They have evaluated these controls and procedures as of a date within 90 days of the filing date of this report on Form 10-QSB. There were no significant changes in the our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-14(b) or Rule 15d-14(b) that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 18 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In July 2002, OnSite filed a lawsuit styled OnSite Technology LLC v. Duratherm, Inc., Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds; Civil Action No. H-02-2624; In the United States District Court for the Southern District of Texas against Duratherm, Inc. and Duratherm Group, Inc., Steven R. Heuer and Victor R. Reynolds. OnSite's lawsuit alleges that Duratherm's remediation operations at its Galveston County, Texas facility infringed on OnSite's U.S. Patent No. 5,738,031 and requested a declaratory judgment that OnSite's operation of its remediation process does not infringe either of Heuer and Reynolds' U.S. Patent Nos. 4,990,237 and 5,269,906 over which Duratherm alleges control. OnSite is also seeking damages for patent infringement, injunctive relief to prevent further patent infringement, and other relief that the court finds appropriate. The Defendants have filed an answer asserting that they do not infringe on OnSite's patent and that such patent is invalid. The Defendants' denial that there is any controversy between the parties regarding the Heuer and Reynolds' patents, has been rejected by the court. The defendants have now alleged in their pleadings that OnSite infringes on the above patents and U.S. Patent No. 5,523,060. Discovery is complete, and the case is set for trial in the January / February, 2004 trial docket. In July 2002, OnSite also initiated litigation styled OnSite Technology, LLC v. Duratherm, Inc. et al.; Cause No. 02CV0801; In the 56th Judicial District Court of Galveston County, Texas, against Duratherm, Inc., Duratherm Group, Inc., Barry Hogan and Jim Hogan. This lawsuit alleges that in November 1999, OnSite and Waste Control Specialists, L.L.C. ("WCS") entered into a contract wherein OnSite would, among other things, provide the necessary services, supplies and equipment to perform recycling and remediation services utilizing an indirect thermal desorption unit as specified therein. OnSite alleges that, in late July or early August 2000, Defendants, acting in concert through Duratherm, Inc., sent or caused to be sent a letter(s) and/or other communication(s) to WCS, which OnSite alleges contained statements that were false and intended to deceive WCS as to OnSite and OnSite's technology and indirect thermal desorption unit. OnSite alleges that a suit filed by Duratherm in August 2000 for patent infringement against OnSite and WCS in the United States District Court for the Southern District of Texas under Civil Action No. H-00-2727, which was subsequently dismissed with prejudice by the United States District Judge, was malicious and contained false statements and allegations about OnSite and OnSite's technology and indirect thermal desorption unit. OnSite alleges that as a result of such alleged false, deceptive and malicious statements, WCS terminated its contract with OnSite. In February 2003 OnSite amended its petition to add John C. Hilliard as a defendant and to add as a claim against the defendants, the loss of a contract or prospective contract with ExxonMobil. OnSite has also amended its petition to include as a defendant Duratherm's counsel, Conley Rose P.C. The causes of action alleged by OnSite against the Defendants are (i) interference with contract and prospective business relations; (ii) unfair competition and business disparagement; (iii) unjust enrichment; and (iv) injury to OnSite's business reputation. OnSite is seeking actual, consequential, incidental and compensatory damages, including, but not limited to, disgorgement, pre- and post-judgment interest, attorney's fees and costs, and exemplary and punitive damages. OnSite is also seeking to enjoin these defendants and Duratherm's counsel, Conley Rose P.C., from interfering with the current and prospective business relationships of OnSite with regard to the thermal desorption units. The Defendants in this litigation have filed an answer denying the allegations contained in OnSite's petition. This case is in the discovery stage and is set for trial in July, 2004. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits Exhibit 31.1 - Certification of Chief Executive Officer of Environmental Safeguards, Inc. required by Rule 13a - 14(1) or Rule 15d - 14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2 - Certification of Chief Financial Officer of Environmental Safeguards, Inc. required by Rule 13a - 14(1) or Rule 15d - 14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 19 Exhibit 32.1 -- Certification of Chief Executive Officer of Environmental Safeguards, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Section 1350 of 18 U.S.C. 63. Exhibit 32.2 -- Certification of Chief Financial Officer of Environmental Safeguards, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Section 1350 of 18 U.S.C. 63. (B) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ENVIRONMENTAL SAFEGUARDS, INC. Date: November 13, 2003 By: /s/ James S. Percell James S. Percell, President Date: November 13, 2003 By: /s/ Michael D. Thompson Michael D. Thompson, Chief Financial Officer 20