-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Dhxt5NbGNWSCFxWQlFauoWpSSTQzeuOmwhmN6llqkHwtcFe46GyMMXAjjuRnmNk+ 86qYv6kgH4Nhnq19tt1k+Q== 0000912057-97-013043.txt : 19970416 0000912057-97-013043.hdr.sgml : 19970416 ACCESSION NUMBER: 0000912057-97-013043 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970415 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: CET ENVIRONMENTAL SERVICES INC CENTRAL INDEX KEY: 0000944627 STANDARD INDUSTRIAL CLASSIFICATION: HAZARDOUS WASTE MANAGEMENT [4955] IRS NUMBER: 330285964 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 033-91602 FILM NUMBER: 97580684 BUSINESS ADDRESS: STREET 1: 14761 BENTLEY CIRCLE CITY: TUSTIN STATE: CA ZIP: 92680 BUSINESS PHONE: 7145051800 MAIL ADDRESS: STREET 1: 6900 E 47TH AVE STREET 2: STE 200 CITY: DENVER STATE: CO ZIP: 80216 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-KSB [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the Fiscal Year ended: December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _______ to _______ Commission File No. 1-13852 CET ENVIRONMENTAL SERVICES, INC. (Exact Name of Small Business Issuer as Specified in its Charter) California 33-0285964 - ---------------------------- --------------------- (State Or Other Jurisdiction (I.R.S. Employer Of Incorporation Or Identification Number) organization) 7670 South Vaughn Court, Ste. 130, Englewood, Colorado 80112 ------------------------------------------------------------ (Address of Principal Executive Offices, Including Zip Code) Issuer's telephone number, including area code: (303) 708-1360 Securities registered pursuant to Section 12(b) of the Act: Common Stock Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 ----- As of March 24, 1997, 5,798,585 Shares of the Registrant's Common Stock were outstanding. The aggregate market value of voting stock held by nonaffiliates of the Registrant was approximately $13,100,000. Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. / / State Issuer's revenues for its most recent fiscal year: $54,918,520 Documents incorporated by reference: Proxy Statement for Annual Meeting of Shareholders. PART I ITEM 1. DESCRIPTION OF BUSINESS. THE COMPANY The Company was incorporated in February 1988 under the name "Thorne Environmental, Inc." to conduct business in environmental consulting, engineering, remediation and construction. The Company's initial growth resulted from its successful performance of emergency response cleanup services in certain western states and the Trust Territory of the Pacific Islands for the U.S. Government. The Company has since developed a broad range of expertise in non-proprietary technology-based environmental remediation and water treatment techniques for both the public and private sectors throughout North and South America and the Trust Territory of the Pacific Islands. The Company was purchased by its existing majority shareholders in November 1991, and for the last five years has engaged in a program of expansion through internal client development and add-on contracts, the acquisition of personnel and assets in desirable geographic locations, and the acquisition of smaller companies involved with target growth technologies. The Company has built a large backlog of government work through the award of several multi-year contracts with the Department of Defense, Department of Energy and the Environmental Protection Agency. The Company has achieved and maintains a balance between its commercial and government sector business through an aggressive industrial marketing strategy. To date, the Company has performed remediation services for both public and private sector customers at more than 500 sites. The Company's strategy has been to distinguish itself in the market by providing full service environmental contracting, municipal and industrial water and wastewater treatment, and emergency response services. Through several major government contracts and a diversified commercial client base, the Company provides turnkey waste management for a complete range of water, soil, and air pollution issues. The Company's personnel have developed expertise in a broad range of remediation techniques such as bioremediation, bioventing, vapor extraction, gas/air sparging, thermal desorption, soil washing and groundwater remediation systems. The Company also offers a broad range of services in support of municipal and industrial water and wastewater treatment, military base closures, and other operations with significant environmental components. The Company believes it has gained a solid reputation for promptly providing cost effective and innovative remediation solutions. In November 1996, the Company relocated its corporate headquarters to Englewood, Colorado from Tustin, California to be more centrally located for its expanding business. The Company also maintains offices in Tustin, California; Richmond, California; Portland, Oregon; Edmonds, Washington; Denver, Colorado; Phoenix, Arizona; Pasadena, Texas; New Orleans, Louisiana; Jackson, Mississippi; Mobile, Alabama; and Atlanta, Georgia. In July, 1995, the Company completed an initial public offering of 1,200,000 shares of its Common Stock, and in August 1995, sold an additional 180,000 shares pursuant to an overallotment option. The net proceeds to the Company from the public offering were approximately $5,800,000. Concurrent with IPO, the Company became listed on the American Stock Exchange under the call letters "ENV." 2 On November 10, 1995, the Company acquired all of the outstanding stock of En-Tech, Inc., a Colorado corporation ("En-Tech"), doing business as Environmental Technologies, Inc., in exchange for 35,769 shares of the Company's Common Stock. En-Tech is engaged in the design, construction, and operation of industrial wastewater and water treatment facilities, and provides services in both the public and private sectors. En-Tech was merged into the Company effective March 15, 1996. In December 1996, the Company commenced a Private Placement Offering of Common Stock. This offering was completed in January 1997, and resulted in the issuance of 729,248 shares with net proceeds to the Company totalling $2,053,562. The Company has committed to use its best efforts to register these shares for resale prior to December 31, 1997. In conjunction with the offering, warrants for an additional 72,925 shares of Common Stock were issued as partial compensation for underwriting services. These warrants are exercisable at a price of $3.60 per share for five years from the date of the offering. THE ENVIRONMENTAL REMEDIATION INDUSTRY Environmental Business International, Inc. ("EBI") estimated that the total United States environmental services industry would generate revenues during 1996 in excess of $90 billionand that the remediation industry would account for approximately $8.5 billion of such estimated revenue Driven largely by legislation passed during the late 1970s and early 1980s in response to widespread public concern regarding clean air and water, the environmental remediation services business has grown rapidly during the past decade. The Company is involved primarily in the remediation segment of the environmental services industry that is focused on cleanup of existing environmental problems. Arising in response to the 1980 CERCLA ("Superfund") legislation, the remediation services business grew quickly. A study by the Waste Management and Education Research and Educational Institute at the University of Tennessee, Knoxville, has estimated the total cost of cleaning up America's worst hazardous toxic waste sites as high as $750 billion in 1990 dollars. This revenue is divided among six major regulation-driven sectors, including Superfund (federally funded) programs, state-funded programs, federal facilities programs (primarily Department of Energy and Department of Defense), UST removals, private remediation programs and hazardous waste management facility corrective actions. Federal facilities cleanup programs have become an increasingly important sector of the business as a result of active military base and other facilities closure. Since 1994, relaxing cleanup regulations and pressure to create uses for contaminated and idle properties has driven the rapid growth of industrial redevelopment or "Brownfield" site remediation programs. The term "Brownfield" comes from an EOA sponsored program to study the redevelopment of "abandoned, idled, or underused industrial facilities where expansion or redevelopment is complicated by real or perceived environmental contamination" (U.S. EPA). The exact number of Brownfield sites is unclear; however, their existence and a governmental effort to facilitate their cleanup have created an opportunity for full service remediation as well as financial participation in the redevelopments. 3 The remediation business consists of three phases: site assessment, remediation program design and the actual site remediation. The first phase is largely investigative and can involve substantial chemical analysis to understand the nature and extent of the problem. The design phase involves detailed engineering to develop the optimal solution for cleaning the site. The third phase is the true implementation of the site remediation plan and involves various on-site treatment procedures for contaminated materials or the excavation and containment or off-site transportation of toxic materials. The Company provides an extensive full-service offering in all phases of contaminated site remediation. Innovative on-site remediation technologies are in high demand to provide an alternative to off-site disposal of hazardous waste. On-site technologies such as bioremediation, bioventing, vapor extraction, gas/air sparging, low temperature thermal desorption, chemical fixation and soil washing are gaining wide-spread regulatory acceptance. The Company strives to utilize these remediation techniques more efficiently than its competitors. Responding to emergency spills or leaks of contaminants by petroleum companies, by state or federal agencies or commercial treaters and haulers of hazardous materials is another important segment of the environmental remediation services industry. Emergency situations can involve the use of various containment and treatment techniques. Providers of these services must be able to handle these sorts of problems on a stand-by basis, due to public concerns and publicity regarding hazardous material spills. The federal government routinely contracts with private parties to maintain fast response capabilities to deal with these sorts of problems. ORGANIZATION OF THE COMPANY The Company is organized by function, with most remediation projects requiring a multi-disciplinary approach that involves more than one department. The Company utilizes the following resources to provide turnkey environmental remediation services to its customers: o Registered engineers, geologists and earth scientists for performing investigations and remediation feasibility studies. o In-house laboratory facilities for evaluating water treatment techniques, numerous remedial technologies, monitoring ongoing projects, and accelerating remediation. o Engineers, earth scientists and construction managers to design remediation and water/wastewater treatment systems from the conceptual stage through final design. o A team of certified water treatment system operators to provide design, construction, consultation and operation for municipal, industrial, and mining wastewater treatment. o Manpower and equipment for performing site preparation such as excavation, grading, berming and hauling soil; removal of obstacles, i.e., drums, transformers, USTs and piping; and dismantling ASTs. 4 o Manpower and equipment for erecting or installing remediation equipment, support buildings and enclosures for remediation of contaminated soil, water, sludge or sediment. SERVICES AND PRODUCTS PROVIDED BY THE COMPANY The Company provides full turnkey services for environmental remediation of hazardous and toxic waste on a planned and emergency basis. By offering turnkey services, the Company believes it enjoys a competitive advantage in soliciting new customers, as well as in obtaining follow-on contracts that may be tangential or unrelated to the original scope of work. Customers contractually engage the Company to accomplish some or all of the following tasks: o Phase I Site Assessments o Site Characterizations o Remedial Investigations/Feasibility Studies o Interim Remedial Management Programs o Health Risk Assessments o Remedial Action Plans o Remedial Design and Construction o Underground Storage Tank Management and Removal o Regulatory Agency Coordination and Maintenance o Remediation System Operation and Maintenance o Facility Decontamination, Demolition and Site Restoration o Emergency Response Cleanup Services REMEDIATION SERVICES. The Company believes it has a solid reputation for responsiveness and technical excellence in providing turnkey remediation services such as design, construction, operation and maintenance for a variety of innovative technologies, including: o Bioremediation/Bioventing o Vapor Extraction o Gas/Air Sparging o Thermal Desorption (the Company owns and operates a TD system that is permitted in several states o Chemical Fixation o Soil Washing 5 o Groundwater Remediation Systems - Ex Situ o Free Product Extraction o Activated Carbon Adsorption o Air Stripping o Advanced Oxidation Technologies (Ultraviolet and Ozone) - In Situ o Gas/Air Sparging o Bioremediation o Physical/Chemical Treatment The Company does not promote a single technology, but recommends the remediation methods that provide the most cost-effective and timely mitigation. FACILITY CONSTRUCTION, MAINTENANCE AND CLOSURE SERVICES. In addition to remediation of soil and groundwater, the Company provides services related to facilities that have contaminated surrounding areas or have the potential to do so. The Company has completed a variety of projects related to construction, maintenance and closure/site restoration of facilities including: o Mechanical Maintenance and Construction o Facility Decontamination and Demolition o Waste Area Closures o Drum Removals o Lab Packing and Waste Services o Excavation, Transport and Disposal of Waste WATER AND WASTEWATER TREATMENT. The Company has gained a vast and comprehensive body of experience in performing a variety of traditional and innovative water and wastewater treatment services. These services range from laboratory treatability studies to construction management and from conceptual design to operation and maintenance. The following treatment technologies are currently being used successfully by Company personnel in the performance of municipal and industrial wastewater treatment projects: - Filtration - Ultraviolet Treatment - Chemical Precipitation - Dissolved Air - Reverse Osmosis - Recirculated Air - Ion Exchange - Activated Sludge 6 The Company provides water and wastewater treatment services to both public and private sector clients in the industrial, mining, municipal, and manufacturing markets. The key water/wastewater services provided are: FACILITY DESIGN AND CONSTRUCTION. The Company's process and mechanical engineers have decades of experience in the planning, design, and construction of water and wastewater treatment facilities. Facilities are designed to minimize operating costs through the use of such techniques as energy efficient low-pressure air systems, ergonomic treatment building design, and rotating equipment optimized for energy consumption. The Company employs state of the art construction management techniques to efficiently construct water and wastewater treatment plants with its own work forces. FACILITY OPERATION AND MAINTENANCE SERVICES. The Company provides cost effective operation and maintenance services that are customized to meet the needs of specific clients. All operations contracts include the development of site-specific preventive maintenance programs and standard operating procedures. All operators have routine equipment, maintenance skills, and are supported by a staff of mechanics who perform major maintenance of equipment, including rebuilds. LAB CAPABILITIES. The Company has an in-house laboratory designed and certified to meet the needs of our water and wastewater treatment clientele. In addition to a complete battery of wet chemical and bacteriological testing, the lab is equipped to conduct treatability studies for water and wastewater treatment processes and pilot scale treatment plant investigations. PROJECT FINANCING AND CONCESSION AGREEMENTS. The Company offers clients a comprehensive concession service that includes the highest quality facility design, construction, financing, and operational services. With today's increasingly stringent regulatory environment, and the need for more sophisticated treatment processes, the concession approach allows clients to place their water and wastewater treatment responsibilites in the hands of the Company's qualified team of professionals. OPERATION AND MAINTENANCE SERVICES. Although a treatment process may be properly designed and constructed, successful remediation or water/wastewater treatment depend upon system operation and maintenance by trained, experienced staff. The Company provides not only the equipment, but services it on a long-term basis to see the remediation program through to completion. Most of the Company's remediation systems are installed with remote monitoring equipment so that the system can be efficiently monitored from a central location with operating information obtained and stored for later reference. The systems are serviced by in-house technicians and engineers. To control costs, visits to the site are made to perform preventive maintenance and to take quality assurance samples. Integral to successful system operation and maintenance of treatment systems, and ultimately the success of remediation, is system optimization which provides an engineering analysis of the system's performance. The Company provides periodic evaluations of system operating parameters to ensure the original design is performing to specification. If the monitoring results do not indicate that the desired result is occurring, the system is further analyzed to determine the problem and decide how to maximize performance. 7 CUSTOMERS The Company's customers include federal, state and local government agencies and commercial enterprises including Fortune 500 companies. The following is a representative list of the Company's past and present customers: PETROLEUM INDUSTRY Texaco Exxon Unocal LASMO Oil and Gas, Inc. Tesoro Enron Oil Trading and Transportation Ultramar FINANCIAL First Interstate Bank Bank of America Seafirst Bank Bank One Wells Fargo Bank Principal Financial Group CHEMICAL, MANUFACTURING, DISTRIBUTING Monsanto Chemical Fleming Georgia Pacific Pacific Gas & Electric Hewlett-Packard Certified Grocers of California, Ltd. GOVERNMENT (FEDERAL AND STATE) U.S. EPA Oregon Department of Environmental Quality U.S. Corps of Engineers Colorado Department of Health U.S. Navy Missouri Department of Natural Resources U.S. Dept. of Energy Arizona Department of Environmental Quality The Company is the prime contractor for a six-year, $75 million Fixed Rate, Indefinite Quantity, Cost Plus Fixed Fee, Cost Plus Award Fee contract for the EPA to provide emergency response cleanup services ("ERCS") in EPA Regions IX and X, which include California, Hawaii, Nevada, Arizona, Washington, Oregon, Idaho, Alaska, Guam, American Samoa, Saipan and the Trust Territory of the Pacific Islands. Under the contract, which began March 1, 1991, the Company has received over 120 delivery orders to provide ERCS for oil, petroleum and hazardous substance releases in accordance with the provisions of the federal Clean Water Act ("CWA"), RCRA and Superfund legislation. On December 20, 1996, the Company was notified by EPA of its selection as the successful bidder for the Emergency and Rapid Response Services (ERRS) West contract. This contract calls for the provision of similar services as the ERCS contract and covers EPA Regions VI, VIII and IX. It runs for five years and was originally estimated at $250 million. Subsequent to award, the Company was notified by EPA that the estimated contract amount has been increased to $292 million. The Company is currently awaiting notification on results from its bid for ERRS contracts in EPA Regions IV and X. The Company also provides similar emergency response services to other governmental and commercial clients under various contracts on an as-needed basis. 8 The ERRS West Contract, like most of the Company's other government contracts, is not a binding agreement requiring the performance of work by the Company and payment by the government. This occurs only when the government issues work orders under the contract. Management believes, based on its prior experience with government contracts, that the Company will receive work orders for a substantial portion if not the full amount of the contract during the life of the contract, or extensions thereof. However, the possibility always exists that the government will terminate work under the contract at any time. The Company is a prime contractor on a three year, $25 million Pre-placed Remedial Action Contract (PRAC) with the Corps of Engineers, Omaha District. Under this contract, the Company is providing remedial actions at hazardous waste sites within the District's Midwest region. Delivery orders are in the planning stages. The Company is a Prime Contractor for the McClellan Environmental Technologies Remediation Implementation Contract (METRIC). The contract has a 5-year ordering period and a potential program value of $19 million. The METRIC program, sponsored by the United States Air Force, has been developed to repair environmental damage at various installations and to prevent further environmental degradation at these installations. Under this contract, the Company will perform work primarily at McClellan Air Force Base, near Sacramento, California, and its satellite facilities. Individual contracts with customers typically have an award value of $25,000 to $100,000 for the performance of specific tasks, and from $125,000 to $7,000,000 for comprehensive turnkey services. Geographically, the Company provides services to customers throughout the western and southeastern United States and the Trust Territory of the Pacific Islands. In 1996, the Company opened an office in Brazil to pursue the growing water and wastewater market. The Company has Master Service Agreements with LASMO Oil and Gas, Inc., Texaco, Unocal, Tesoro, Monsanto, Bank of America and Seafirst Bank as well as emergency response contracts with the State of Arizona, State of Missouri, Ryder Trucks, Yellow Freight Lines, Burlington Northern Railroad, Exxon, U.S. Coast Guard, United Parcel Service, Norfolk and Southern Railroad, Simplot and Cenex. Master Service Agreements and the emergency response contracts set forth the terms and conditions pursuant to which the Company would provide services in the future when needed or requested pursuant to a purchase order or request for services. BUSINESS STRATEGY The Company plans to capitalize on the following trends: o On-site remediation is increasing, especially at large sites. Public opposition and regulatory resistance to incineration and landfilling will enhance the prospects for bioremediation, vapor extraction, thermal desorption and other innovative on-site technologies. o Privatization of drinking water and sewage treatment systems in the U.S. and internationally will provide a large and expanding opportunity throughout the decade and well into the next century. 9 o Remediation at active industrial sites under the RCRA corrective action program represents an important private sector segment in an early stage of development. o Most government contracts require a defined percentage of the work be subcontracted to small business enterprise companies ("SBEs"), typically between 20 and 60 percent. The Company qualifies as an SBE under Standard Industrial Classification Code 8744, Environmental Remediation Services, by having less than 500 employees. The Company's strategy to capitalize on these trends emphasizes the following key elements: DIVERSIFICATION THROUGH CONTROLLED EXPANSION. The Company seeks controlled growth and diversification by providing its services to additional industries and expansion into new geographical territories including Latin America. Management has identified several areas of interest for expansion including additional work in the areas of emergency response service to the U.S. Government, mining facility decommissioning and reclamation, and privatization of water treatment facilities throughout North and South America. MIXTURE OF PUBLIC AND PRIVATE SECTOR WORK. The Company seeks to maintain a mix of government projects and private sector projects. Government projects can offer the advantage of multi-year scope of work but generally have lower gross margins. Private sector projects tend to have shorter time frames but offer opportunities for greater gross margins. Management plans to continue developing business opportunities in both sectors and would like to keep a balance between EPA and non-EPA work. (See "MANAGEMENT'S DISCUSSION AND ANALYSIS.") EMPHASIS ON RECURRING REVENUE. The Company seeks to expand its base of recurring revenue sources in order to mitigate the cyclical nature of the environmental remediation services industry. The Company is on appropriate approved-contractor lists with its major governmental customers and largest corporate customers whereby the Company is invited to bid on future environmental engineering/remediation projects. Inclusion on such lists is a result of the Company's having completed prior contracts to the satisfaction of these customers. COMMITMENT TO QUALITY. Management believes that the long-term success of the Company depends upon its reputation with customers and government regulators for performing top quality, turnkey environmental remediation services. The Company must continue to distinguish itself with private and government sector customers by maintaining competence in various state-of-the-art technology based remediation alternatives, by efficient and understandable documentation on accounting systems, and by efficient and effective job site performance. PROFESSIONAL MARKETING AND MANAGEMENT. The Company is committed to maintaining a professional marketing staff that understands the needs and requirements of its various customers, that can accurately evaluate requests for proposals and invitations to bid and that responds in a timely manner with high quality comprehensive formal proposals. It is critical that contractors understand the intricacies of the detailed and time-consuming process associated with bidding and managing projects for the federal government. The Company utilizes non-proprietary specialized software for job cost accounting and governmental contracts to assist with both bidding and managing projects. 10 STABLE WORK FORCE. The Company strives to maintain a stable work force of skilled professionals (engineers, etc.), professional managers (executive and supervisory levels), dedicated administrative personnel (accounting, contract administration, etc.), as well as trained and experienced laborers (transportation, construction and remediation). The Company seeks to attract and retain such employees by providing fair compensation, cash bonus incentives and a dynamic work environment. The Company maintains a comprehensive program for providing health and safety training related to hazardous material exposure, in full compliance with the highest standards set forth by federal and other applicable regulatory agencies. Management believes that the Company's stable and experienced work force has contributed, and will continue to contribute, to the Company's excellent safety record, which reduces insurance costs and should make doing business with the Company more inviting for current and prospective customers. OWNERSHIP OF EQUIPMENT. The Company attempts to purchase specialized emergency response and remediation equipment, thereby providing the Company with key business advantages, including reduced operating costs, greater flexibility in scheduling the use of resources (equipment, personnel, etc.) and greater reliability in meeting contractually defined performance timetables and deadlines. The Company typically rents non-specialized equipment such as backhoes and excavators. MARKETING The Company has a dedicated marketing and sales staff of approximately 20 people, including sales professionals, proposal writers, technical editors, and project estimators. A significant portion of new business is derived from current customers seeking services for additional sites and new needs. The Company has developed ongoing relations with a broad range of customers in various industries and geographical sites. The Company has segregated its marketing efforts for the public and private sectors. The public sector proposal effort is managed by a Government Marketing Specialist with assistance from the Marketing Services Group. The Company pursues federal contracts which range from $5 to $70 million annually, as a prime contractor, especially if they are designated for SBEs. On larger opportunities, unless the Company is uniquely qualified such as with EPA work, the Company establishes teaming agreements with large engineering/construction firms that provide specific contract percentages if awarded. The marketing organization for the commercial business is primarily decentralized. Sales leads and customer relationships are developed on a regional basis by the Regional Manager, Project Manager or Business Development Manager. The Company's contracts are primarily obtained through competitive bidding and through negotiations with long-standing customers. The Company is typically invited to bid on projects undertaken by recurring customers who maintain pre-qualified contractor bid lists. Bidding activity, backlog and revenue resulting from the award of contracts to the Company vary significantly from period to period. 11 COMPETITION The environmental industry in the United States has developed rapidly since the passage of RCRA in 1976 and is highly competitive. The industry today is highly fragmented, with numerous small and medium sized companies serving niche markets according to geography, industry, media (air, water, soil, etc.) and technological specialization (bioremediation, etc.). Because the Company operates in many sectors of the environmental industry, the Company can adapt to changes in the marketplace by allocating its resources to the industry sector in which the business opportunities exist. Management believes that the keys to success in the industry today are service and capabilities. The Company will continue to focus on the application of new technology as well as innovative applications of existing technologies to solve complex problems. The Company also plans to continue providing quality environmental remediation services to its customers. Management believes that the primary factors of competition are price, technological capabilities, reputation for quality and safety, relevant experience, availability of machinery and equipment, financial strength, knowledge of local markets and conditions and estimating abilities. Management believes that the Company has competed and will continue to compete favorably on the basis of the foregoing factors. However, many of the Company's competitors have financial resources and facilities far greater than that of the Company. Additionally, at any time and from time to time the Company may face competition from new entrants into the industry. The Company may also face competition from technologies that may be introduced in the future, and there can be no assurance that the Company will be successful in meeting the challenges which will be posed by its competition in the future. GOVERNMENT REGULATION The Company is presently regulated by a myriad of federal, state and local environmental and transportation regulatory agencies, including but not limited to the EPA, which regulates the generation and disposal of hazardous waste; the U.S. Department of Labor, which sets safety and training standards for workers; the U.S. Department of Transportation, which regulates transportation of hazardous materials and hazardous waste; and similar state and local agencies. The need for governments and business to comply with the complex scheme of federal and state regulations governing their operations is the market in which the Company operates, although the Company itself must operate under and in conformance with applicable federal and state laws and regulations. The Company attempts to pass the cost of compliance on to the customer through the prices paid by customers for the Company's services. ENVIRONMENTAL LAWS Most environmental laws and regulations are promulgated by the U.S. Congress and federal departments and agencies. For example, the National Environmental Policy Act compels federal governmental agencies at all levels to make decisions with environmental consequences in mind. The EPA and the U.S. Occupational Safety and Health Administration ("OSHA") are responsible for protecting and monitoring certain natural resources (such as air, water and soil) and working conditions. These laws and regulations establish a comprehensive regulatory 12 framework consisting of permitting processes, systems construction, monitoring and reporting procedures, and administrative, civil and criminal enforcement mechanisms. Many of the federal laws and regulations contemplate enforcement by state agencies and adoption by the states of similar environmental laws and regulations which must meet minimum federal requirements. In areas of environmental law where federal regulation is silent, the states may adopt their own environmental laws. As an example, some states monitor the transfer of real estate with potential environmental contamination by requiring the preparation of environmental assessments and disclosures of the findings of such assessments or the issuance of pre-transfer disclosure statements. Some states have also provided an environmental audit privilege whereby land owners undertaking such audits and disclosing the findings to the state will not be penalized for violations if they clean up the property. Local governments such as counties and municipalities may also enact and enforce environmental laws that address local concerns which may be more stringent than applicable state laws. The Company's ability to assist customers to comply with these environmental laws and regulations forms the basis for the current and future environmental consulting, engineering, remediation, laboratory and other services provided by the Company. Enforcement of such laws and regulations also leads to business for the Company. For example, the EPA has promulgated regulations that require the registration and upgrading of USTs that contain liquid petroleum or hazardous substances, and the reporting of leaks and cleanup of contamination from those USTs. The UST regulations have in turn been adopted by the states in forms no less strict than the federal regulations. To encourage compliance with UST regulations, some states have passed laws that provide for the creation of a fund to cover the costs of cleanup but condition access to the fund or the amount of the costs for which an owner can obtain fund reimbursement on the proper registration of the USTs or compliance with other regulatory requirements. The federal laws and regulations described below constitute the major actions that have caused industry growth in the consulting, engineering and remediation and analytical laboratory service industries. COMPREHENSIVE ENVIRONMENTAL RESPONSE, COMPENSATION AND LIABILITY ACT OF 1980 ("CERCLA"). This legislation, as amended by the Superfund Amendments and Reauthorization Act of 1986, established the Superfund program to identify and clean up existing contaminated hazardous waste sites and other releases of hazardous substances into the environment. CERCLA in most instances imposes strict joint and several liability on certain hazardous substance generators, transporters and disposal facility owners and operators for the costs of removal or remedial action, other necessary response costs, damages for injury, destruction or loss of natural resources, and the costs of any health effects study. While federal funds of approximately $8.5 billion exist to pay for the cleanup, CERCLA gives the EPA authorization to compel private parties to undertake the cleanup and enforcement incentives including the imposition of penalties and punitive damages. Resource Conservation and Recovery Act of 1976. RCRA, as amended by the Hazardous and Solid Waste Amendments of 1984 ("HSWA"), provides for the regulation of hazardous waste from the time of generation to its ultimate disposal as well as the regulation of persons engaged in 13 generation, handling, transportation, treatment, storage and disposal of hazardous waste. Hydrocarbon-based hazardous waste as defined by RCRA can include leaked/spilled crude oil, refined oil, gasoline, kerosene and industrial solvents (used, for example, in the transportation and manufacturing industries). Hazardous waste also includes the by-products of virtually any business, including the production of plastics, pesticides, fertilizers, soaps, medicines, explosives, etc. These wastes can contain heavy metals, organic chemicals, dioxin, PCBs, cyanide and other toxic substances. Regulations have been issued pursuant to RCRA in the following areas, among others: permitting assistance, remediation of environmental contamination associated with USTs, municipal solid waste disposal and land disposal of hazardous waste. HSWA has increased the number of hazardous waste generators subject to RCRA. HSWA also imposes land disposal restrictions on certain listed hazardous wastes which do not meet specified treatment standards, prescribes more stringent standards for hazardous waste disposal sites, sets standards for USTs, and provides for corrective action at or near sites of waste management units. EPA UST REGULATIONS. The EPA has mandated that USTs that are used to store gasoline, diesel fuel, fuel oil, waste oil and hazardous materials be registered with the appropriate state regulatory agency, designed or upgraded to meet construction and operational standards and monitored to insure against groundwater and soil contamination from leaking. Owners and operators are further required to report leaks and undertake appropriate corrective action, including testing and monitoring to identify the extent of the contamination, removal and disposal of contaminated soil, or on-site treatment of contaminated soil or groundwater. The EPA has delegated the administration of UST regulations to state agencies. To assist the remediation process when leaking USTs are identified, many state legislatures have created reimbursement programs funded by gasoline taxes or other taxes and fees. Another significant segment of the environmental industry results from EPA requirements for upgrading or eliminating storage tanks. RCRA mandates that by December 31, 1998, every single-walled UST in the United States be removed and replaced with a double-walled tank. Any environmental danger to the soil or water caused by leakage of a UST must also be remediated. According to the Environmental Business Report published by BTI Consulting Group, Inc., approximately 2,200,000 USTs containing petroleum products or hazardous chemicals are located in the United States. Over 1.6 million of these tanks are subject to federal regulations, and approximately 91 percent of those contain petroleum products. In order to comply with the December 1998 deadline, approximately 250,000 tanks must be removed each year through 1998. However, the greatest number of USTs replaced to date in a calendar year was approximately 80,000 during 1989. Thus, the Company anticipates that UST-related business opportunities will increase each year through 1998, and that a substantial number of UST owners then in violation of EPA mandates will provide business opportunities well into the start of the next decade. Management believes that the Company is well positioned in the niche market of removing and replacing USTs and performing remediation and construction services required in conjunction with UST replacement. CLEAN WATER ACT ("CWA"). The CWA established a system of standards, permits and enforcement procedures for the discharge of pollutants into navigable waters from industrial, municipal and other wastewater sources. Key areas for which regulations have been issued or are proposed include industrial wastewater pretreatment, surface water toxic control, wastewater 14 sludge, disposal and storm water discharges. The CWA requires, under certain circumstances, pretreatment of industrial wastewater before discharge into municipal treatment facilities. These enforcement efforts by the EPA will prompt facility upgrading and control of industrial discharges. The EPA and delegated state agencies are placing some of the non-complying communities under enforcement schedules. In cases of noncompliance, the EPA may assess administrative penalties and may sue for court-ordered compliance and penalties. Some public funding is available to assist municipalities in complying with treatment requirements. SAFE DRINKING WATER ACT ("SDWA"). Under the SDWA and its subsequent reauthorization, the EPA is empowered to set drinking water standards for public water systems in the United States. The SDWA requires that the EPA set maximum permissible contamination levels for over 80 substances and also requires the EPA to establish a list every three years of contaminants that may cause adverse health effects and may require regulation. Enforcement responsibility is placed on the states and includes water supply systems monitoring. The SDWA also requires that the EPA set criteria for the use of treatment techniques including when filtration should be used for surface water supplies and when to require utilities to disinfect their water. The EPA regulations under the SDWA are expected to result in significant expenditures by public water systems for evaluation and, ultimately, for upgrading of many facilities. Bolstering federal laws are stringent state laws, such as California's Safe Drinking Water and Toxic Enforcement Act of 1986 ("Prop 65"), which took full legal effect in 1992. To cite just one facet of Prop 65, California's drinking water must not have concentrations of more than one part per billion of benzene. However, one tablespoon of gasoline contains enough benzene to render 50,000 gallons of water undrinkable by California's standards. To place the problem within a commercial context, an estimated one in four gas stations has a UST that is leaking, and a single leak can result in thousands of gallons of benzene-rich gasoline leaking into the watertable. OSHA AND OSHA REFORM ACT. OSHA has promulgated various regulations setting forth standards for disclosure of health hazards in the work place and for response thereto. The Hazard Communication Standard, for example, requires manufacturers and importers of chemicals to assess the hazards of their products and disclose the same through material data safety sheets and label warnings. In 1990, in an effort in part to create a self-funding administration, Congress increased the ceiling for certain OSHA-imposed penalties. POTENTIAL LIABILITY AND INSURANCE The Company maintains quality assurance and quality control programs to reduce the risk of damage to persons and property. However, in providing environmental remediation services to the Company's customers, the Company faces substantial potential liability for environmental damage, personal injury, property damage, economic losses and fines and costs imposed by regulatory agencies. Furthermore, it is possible that one or more of the Company's customers may assert a claim against the Company for negligent performance of services. The Company's potential environmental liability arises, in part, because some of its services involve the cleanup of petroleum products and other hazardous substances for its customers. The scope of liability under existing law for environmental damage is potentially very broad and could apply to the Company in a number of ways. For example, the Company may be exposed to liability under CERCLA when it conducts a cleanup operation that results in a release 15 of hazardous substances, or when it arranges for disposal of such substances. Other liabilities may arise if the Company creates or exacerbates a contamination problem through errors or omissions in its cleanup work, potentially giving rise to, among other things, tort actions for resulting damages and Superfund liability for any resulting cleanup. Finally, it is possible that one or more of the Company's customers will assert a claim against the Company for an allegedly incomplete or inadequate cleanup. Many state and federal environmental laws apply to the Company's activities, and the potential for liability exists depending on the circumstances and substances involved in each cleanup operation. Moreover, the law in this area is developing rapidly and is thus subject to considerable uncertainty. The Company has had no claim made against it by governmental agencies or third parties under environmental laws or regulations. The Company has had one claim made by a former customer related to the design of a remediation project, which has been settled. It has not established any reserves for potential liabilities as management of the Company, based on advice of counsel, believes that the Company will be successful in its defense of the claims. The Company maintains comprehensive general liability insurance and worker's compensation insurance that provide $5 million of coverage each. In addition, the Company maintains pollution liability and errors and omissions insurance that provides $2 million of coverage each. Because there are various exclusions and retentions under the insurance policies described above, not all liabilities that may be incurred by the Company are likely to be covered by insurance. In addition, certain of the policies are "claims made" policies which only cover claims made during the term of the policy. If a policy terminates and retroactive coverage is not obtained, a claim subsequently made, even a claim based on events or acts which occurred during the term of the policy, might not be covered by the policy. In the event the Company expands its services into a new market, no assurance can be given that the Company will be able to obtain insurance coverage for such activities or, if insurance is obtained, that the dollar amount of any liabilities incurred in connection with the performance of such services will not exceed policy limits. The market for liability insurance has been severely constrained in the past several years, due in part to high losses experienced by the insurance industry from environmental impairment liability claims, including claims associated with hazardous materials and toxic wastes. Consequently, the available insurance coverage for enterprises such as the Company has been reduced, eliminated entirely or priced beyond the reach of many companies. To date, the Company has been able to obtain any insurance required by a customer. However, there can be no assurance that the Company will be able to maintain adequate liability insurance in the future. BONDING REQUIREMENTS Commercial remediation projects, as well as federal, state and municipal projects, often require contractors to post both performance and payment bonds at the execution of a contract. Performance bonds guarantee that the project will be completed and payment bonds guarantee that vendors will be paid for equipment and other purchases. Contractors without adequate bonding may be ineligible to bid or negotiate on many projects. The Company has frequently been required to obtain such bonds and it should be assumed that the Company will continue to be 16 required to obtain such bonds in the future, particularly with government contracts. The Company obtains required bonds on a case-by-case basis as needed and has not experienced any problems in obtaining necessary bonds. The Company could experience such difficulties in the future if the total amount of the bonds then outstanding against the Company exceeds the limits imposed by bonding companies based on the financial condition of the Company at the time. Bonds typically cost between 1 and 3 percent of the cost of a project. To date, no payments have been made by any bonding company for bonds issued for the Company. EMPLOYEES The Company presently employs approximately 200 persons full time and 50 part time at its 12 offices, including 4 people who are officers of the Company. The Company's employees are not represented by a labor union or covered by a collective bargaining agreement, and the Company believes it has good relations with its employees. The Company typically hires temporary workers on location to staff certain projects. While all of the Company's jobs are performed under the supervision and direction of the Company's supervisors and foremen, and the Company attempts to utilize as many of the Company's full-time laborers as possible to staff jobs, the location and other factors affecting jobs performed away from the immediate vicinity of the Company's permanent offices result in the Company occasionally hiring temporary workers on site. The Company carefully reviews the training and qualifications of all temporary workers hired to assure that all such personnel are qualified to perform the work in question. However, due to the temporary nature of such employment, there is no assurance that all such temporary workers will perform at levels acceptable to the Company and its customers. The operations of the Company are substantially dependent upon its executive officers. The Company has no employment contracts with these persons and the loss of their services could have a material adverse effect on the Company. The Company's further success will also depend significantly on its ability to attract and retain additional skilled personnel, including highly trained technical personnel, project managers and supervisors. The Company believes it currently has adequate qualified supervisory personnel, but there is no assurance that experienced and qualified management level personnel will be available to the Company in the future to fill positions as needed. ITEM 2. DESCRIPTION OF PROPERTY. The Company's headquarters and administrative facilities are located at 7670 S. Vaughn Court, Ste. 130, Englewood, Colorado, in approximately 4,600 square feet of leased office space. The lease expires in July, 1998. The Company's corporate and administrative functions are conducted from these facilities. The Company's remediation services are conducted from the following spaces: CURRENT SQ. FT LEASE EXPIRATION MONTHLY RENT --------- ---------------------- ------------- 14761 Bentley Circle Tustin, California...... 18,490 April 14, 1997* $6,700 17 120 West Dayton Street, Suite A-7 Edmonds, Washington...................... 6,910 December 31, 1997* $7,198 150 West Dayton Street Edmonds, Washington...................... 5,000 February 28, 1998* $2,522 3033 Richmond Parkway, Suite 300 Richmond, California..................... 7,664 April 30, 2001 $6,438 6900 E. 47th Avenue Drive, Suite 200 Denver, Colorado......................... 11,051 July 31, 1998 $2,993 525 South Madison Tempe, Arizona........................... 5,014 February 28, 1998 $3,150 7670 S. Vaughn Court, Ste. 130 Englewood, Colorado...................... 4,600 July 31, 1998 $4,622 5275, 5251, & 5315 NW St. Helens Road Portland, Oregon......................... 3,000 January 6, 1999 $3,500 150 Noel Street Mobile, Alabama.......................... 20,000 April 30, 1997* $2,950 13120 Carrere Court New Orleans, Louisiana................... 13,520 April 14, 1998* $3,500 3222 Pasadena Freeway Pasadena, Texas.......................... 2,755 May 31, 2001 $4,375 275-A Industrial Drive Jackson, Mississippi...................... 11,325 October 31, 1998* $3,080 1401 Business Center Drive Conyers, Georgia 30207.................. 5,000 June 30, 1997 $1,540 - ------------------------ * Contains an option to renew or extend the lease. ITEM 3. LEGAL PROCEEDINGS. Except as set forth below, the Company is not a party to any material legal proceedings which are pending before any court, administrative agency or other tribunal. Further, the Company is not aware of any material litigation which is threatened against it in any court, administrative agency or other tribunal. Management believes that no pending litigation in which the Company is named as a defendant is likely to have a material adverse effect on the Company's financial position or results of operations. 18 On February 12, 1997, LMU & Company ("LMU") filed suit against the Company alleging that LMU was entitled to cash compensation of up to $25,000 and warrants to purchase 100,000 shares of Common Stock of the Company at an exercise price based on the market price on or about November 1, 1996, for services rendered in conjunction with the development of the Private Placement equity offering which completed in January, 1997. The Company is currently in settlement discussions with the plaintiff. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Company's security holders during the fourth quarter of the period covered by this report. 19 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. (a) PRINCIPAL MARKET OR MARKETS. Since July 18, 1995, the Company's Common Stock has been listed on the American Stock Exchange ("AMEX") under the symbol "ENV". The following table sets forth the high and low sale prices for the Company's Common Stock as reported on the AMEX for the periods indicated: QUARTER ENDED HIGH LOW ------------------------- --------- --------- September 30, 1995....... $ 7.25 $ 4.75 December 31, 1995........ $ 9.50 $ 7.0625 March 31, 1996........... $ 11.625 $ 9.00 June 30, 1996............ $ 13.375 $ 9.50 September 30, 1996....... $ 9.875 $ 5.375 December 31, 1996........ $ 7.50 $ 3.8125 (b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK. The number of record holders of the Company's common stock at March 21, 1997, was 124. This does not include those shareholders who hold their shares in street name. (c) DIVIDENDS. The Board of Directors does not anticipate paying cash dividends on the Company's Common Stock in the foreseeable future as it intends to retain future earnings to finance the growth of the business. The payment of future cash dividends will depend on such factors as earnings levels, anticipated capital requirements, the operating and financial conditions of the Company and other factors deemed relevant by the Board of Directors. The California Corporations Code provides that a corporation may not pay dividends if the corporation is, or as a result of the distribution would be, likely to be unable to meet its liabilities as they mature. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS. The following discussion is intended to provide an analysis of the Company's financial condition and results of operations and should be read in conjunction with the Company's financial statements and notes thereto contained elsewhere herein. GENERAL The Company provides comprehensive environmental remediation services of hazardous and toxic waste on a planned and emergency basis to both government and private sector customers. It also provides water and wastewater treatment facilities and services to municipal and industrial clients. The Company has provided these services from its Southern California and Seattle area offices since the Company was acquired by current management on November 29, 1991. Offices in metro San Francisco and Portland were established in 1993; offices in Phoenix, Denver and St. Louis were opened in 1994; offices in Houston, New Orleans, Jackson, Mobile, Atlanta and Georgetown, Colorado were opened in 1995; and offices in Birmingham, Kansas City, Tucson and Campinas, Brazil were opened in 1996. In late 1996, the corporate offices of the Company were moved to Englewood, Colorado from Tustin, California. 20 STATISTICAL ANALYSIS OF RESULTS OF OPERATIONS The following table presents, for the periods indicated, the percentage relationship which certain items of the Company's statements of income bear to project revenue and the percentage increase or (decrease) in the dollar amount of such items:
RELATIONSHIP PERCENTAGE TO PROJECT REVENUE PERIOD TO ------------------------------- PERIOD CHANGE YEAR ENDED DECEMBER 31, -------------------- ------------------------------- 1996 VS. 1995 VS. 1996 1995 1994 1995 1994 --------- --------- --------- --------- --------- Project Revenue.................................... 100.0% 100.0% 100.0% 14.7% 103.7% Project Costs: Direct .......................................... 79.5 71.7 75.1 27.1 95.6 Indirect......................................... 14.9 14.7 10.1 16.1 187.2 --------- --------- --------- --------- --------- Gross Profit (Loss)................................ 5.6 13.6 14.8 (52.5) 87.5 Other Operating Expenses (Income): Selling ......................................... 5.6 3.6 4.6 77.5 57.9 General and Administrative....................... 5.8 4.3 4.2 53.0 122.6 Amortization of excess of acquired net assets in excess of cost.................. 0.0 (0.7) (1.6) (100.0) (8.3) --------- --------- --------- --------- --------- Operating Income (Loss)............................ (5.8) 6.3 7.6 (205.4) 66.1 Other Income (Expense)............................. (1.7) (0.7) (0.6) (185.7) 89.4 --------- --------- --------- --------- --------- Income (Loss) before taxes on income............... (7.5) 5.6 7.0 (252.3) 64.0 Taxes on Income.................................... (0.7) 1.4 0.1 (152.0) 3691.2 --------- --------- --------- --------- --------- Net Income (Loss).................................. (6.8%) 4.3% 6.9% (284.6%) 25.3% --------- --------- --------- --------- --------- Pro forma information (Note 1): Historical earnings before income taxes.......... -- 5.6% 7.0% -- 64.0% Pro forma income taxes........................... -- 2.3 1.7 -- 114.2 Pro forma net income............................. -- 3.8 5.3 -- 47.2
- ------------------------ Note 1 From January 1, 1994 to June 14, 1995, income taxes on net earnings were payable personally by the stockholders pursuant to an election under Subchapter S of the Internal Revenue Code not to have the Company taxed as a corporation. However, the Company was liable for state franchise taxes at a rate of 1.5 percent on its net income. Pro forma financial information is presented to show the effects on 1995 and 1994 financial information had the Company not been treated as an S Corporation for income tax purposes. Effective June 15, 1995, the Company terminated its Subchapter S election and began to be taxed as a Subchapter C Corporation. 21 The Company's revenues continued to grow in 1996, but at a much slower rate. Total revenues increased 14.7 percent from 1995 to 1996 compared to 103.7 percent from 1994 to 1995. In the past two years, the Company has accomplished its goal of increasing the proportion of non-EPA work (in 1994 EPA contract work accounted for 67 percent of revenues). With the award of the EPA ERRS contract, the proportion of non-EPA work will most likely reduce in 1997. However, the Company's goal is to maintain an equal distribution of revenues from government contracts and commercial contracts to produce a solid continuity of revenues, while optimizing margins. The Company has performed services for over 500 commercial customers. The following table sets forth the percentages of the Company's revenues attributable to the EPA vs. other non-EPA public and private sector customers: YEAR ENDED DECEMBER 31 -------------------------------------------------- 1996 1995 ------------------------ ----------------------- Non-EPA............. $ 44,065,990 80.2% $ 34,959,345 73.0% EPA................. $ 10,852,530 19.8% $ 12,912,627 27.0% ------------- --------- ------------- --------- Total............... $ 54,918,520 100.0% $ 47,871,972 100.0% ------------- --------- ------------- --------- Direct costs as a percentage of revenues increased significantly from 72.1 percent in 1995 to 79.5 percent in 1996. This increase was due to a variety of factors: o Increased competition, which results in tighter bidding. o Cost overruns on certain projects. o Additional work performed without obtaining formal change orders. o The write-down in the fourth quarter of $761,811 in revenue related to a specific phase of work performed on a $13 million project involving clean-up of a major chemical fire. Because there were multiple entities involved on the client side, the authorization for this phase of work was not fully documented. Management believes that the work product for this phase is important to the ongoing litigation related to the fire and that there is reasonable likelihood of collecting a substantial portion of this amount. All other amounts related to the project have been collected. Indirect expenses increased from $7,039,432 (14.7% of revenues) in 1995 to $8,175,951 (14.9% of revenues) in 1996. This increase was due primarily to the inclusion of a full year's cost in 1996 for offices opened in mid-1995, and the opening of additional offices in 1996. The combined increase in direct and indirect operating costs caused gross profit to decline from 13.6 percent of revenues in 1995 to 5.6 percent in 1996. Much of this decline is attributable to the efforts undertaken to win the new EPA work. Several of the offices opened in 1995 and 1996 were specifically related to qualifying for that work. Since the award was delayed for one year, significant extra costs were incurred. Nevertheless, in response to this decline, the Company has taken the following corrective actions: 22 o Closed unprofitable offices in Birmingham, Georgetown, Kansas City, St. Louis and Tucson. o Restructured employee benefit programs to reduce cost. o Reduced staff and realigned personnel classifications to better control indirect labor costs. o Hired a new Chief Financial Officer with significant industry experience and further enhanced financial management staff in conjunction with the move of the corporate office. o Implemented revised processes and controls for contracts administration, revenue recognition, billing and collection, and accounts payable. o Initiated an analysis of pricing and bidding procedures to ensure new projects are bid with adequate margins. These actions are projected to significantly reduce overhead and improve project performance, but are not expected to have any material impact on the Company's ability to perform current projects or obtain new work. Selling expenses increased from 3.6 percent of revenue in 1995 to 5.6 percent of revenue in 1996. This increase is the result of Management's commitment to a formal sales/bid and proposal staff and the increase in salaries and benefits primarily resulting from the addition of personnel. The dedicated sales staff increased from 9 to 20 persons during 1995, with 1996 results reflecting a full year of these personnel costs. Approximately 50% of the costs in 1996 were related to the development of specific bids and proposals, both public and private sector. General and administrative expenses increased from 4.3 percent of revenues in 1995 to 5.8 percent of revenues in 1996. Contributors to this increase included higher insurance costs, additional financial management personnel, move of the corporate office and an increase in the allowance for doubtful accounts of approximately $400,000. Amortization of acquired net assets in excess of cost was $337,437 in 1995 ($0 in 1996). The acquired net assets in excess of cost was created when the estimated fair value of net assets purchased exceeded the purchase price by approximately $1,472,000 when the Company was acquired by current management on November 29, 1991. The acquired net assets in excess of cost were amortized over a four-year period beginning December 1, 1991, and ending on November 30, 1995. The four-year period for amortization was selected because it matched the term of the contract with the EPA. Interest expense (net) increased from $326,331 in 1995 to $627,537 in 1996, due primarily to increased borrowing. The increased borrowings were necessary because of greater working capital needs due to the Company's expansion into new geographic areas, the growth in the Company's business, and a tightened cash flow in the last half of the year. Until June 15, 1995, the Company was a Subchapter S Corporation as defined by the Internal Revenue Service and substantially all taxes were paid by the shareholders. However, the Company has traditionally made distributions of cash to its shareholders in approximately the 23 amount of such shareholders' tax liabilities related to the income of the Company. On June 15, 1995, the Company made a revocation of its Subchapter S Corporation status and accordingly is now subject to the tax laws and rates applicable to a Subchapter C Corporation. Distributions of $927,101 were paid to the Company's shareholders prior to the termination of the Company's Subchapter "S" tax status. Immediately following these distributions, the shareholders loaned $357,865 to the Company, and these loans were repaid from the proceeds of the Company's initial public offering in July 1995. At the date of the revocation of the "S" status, there were no net operating loss carryforwards available to be carried forward to any subsequent period. Additionally, at the date of the revocation, any prior earnings of the S Corporation not previously distributed will be reclassified from retained earnings to paid-in capital accounts. A special grace period of one year will exist whereby these undistributed S Corporation earnings could be distributed to the S Corporation shareholders in a tax-free manner. In 1996, the Company was able to carryback losses equivalent to 1995 profits for federal tax purposes, resulting in a federal tax benefit of $353,878 for 1996. This carryback does not apply for state income taxes, but there will be amounts available as loss carryforward for both federal and state tax purposes in 1997. BONDING The amount of bonding capacity offered by sureties is a function of the financial health of the company requesting the bond. At March 1997, the bonding capacity for the Company was $25 million. LIQUIDITY AND CAPITAL RESOURCES Capital resources are used primarily to fund the acquisition of capital equipment and increase working capital needed to support continued expansion of the Company's operations. Historically, the Company has been under-capitalized, attempting to meet cash requirements through funds generated from operations, together with funds borrowed under installment and term loans. DEBT. In February 1994, as amended in March 1995, the Company entered into a credit arrangement with Comerica whereby Comerica provided a credit line to the Company. Borrowings are based on 75 percent of certain eligible accounts receivable, plus certain adjustments, up to $4,000,000. The credit line was collateralized by all assets of the Company and personally guaranteed by the shareholders of the Company. Interest accrued at Comerica's base rate plus 1.5 percent, payable monthly. On October 14, 1994, the Company borrowed $380,000 from Comerica, with interest payable monthly at Comerica's base rate plus 2.0 percent. The monthly payment is $7,917. The loan is collateralized by certain fixed assets of the Company. In 1995, the Company borrowed $300,000, in loan amounts of $195,000 and $105,000, from Comercia, with interest payable monthly at Comerica's base rate plus 2.0 percent. The monthly payments are $4,062 and $2,187, respectively. The loans are collateralized by certain fixed assets of the Company. The combined amount of these loans was refinanced in March, 1996 as described below. In January 1995, the Company borrowed $550,000 from the Birnie Children's Trust No. I (the "Birnie Trust") at the interest rate of 2 percent per month, due and payable monthly. The 24 wife of Steven H. Davis, President of the Company, is a beneficiary of the Birnie Trust. The Company has borrowed funds from the Birnie Trust at various times in order to meet its working capital requirements. These borrowings have allowed the Company to grow at the rate it has in the past. The Company believes that the cash from operations and borrowings under the existing or future lines of credit will be sufficient to fund future growth. However, the Company believes the Birnie Trust could be a source of funds in the future, if necessary. The Company repaid $350,000 of this loan with proceeds of the Company's initial public offering which closed during July 1995. The remaining $200,000 was invested into the subordinated notes described in the following paragraph. In February 1995, the Board of Directors determined to issue Subordinated Notes, coupled with warrants to purchase shares of common stock at an exercise price of $1.20 per share which can be exercised on or before December 31, 1996. The Subordinated Notes were offered on a selective, privately arranged basis, and bear interest at ten percent per annum, payable monthly, and are subordinated to senior commercial or institutional lending indebtedness. Each $10,000 face value note purchaser received a warrant to purchase 1,312 shares of the Company's common stock. The notes are secured by a second lien on the Company's accounts receivable and contracts in progress and were due and payable on March 1, 1996. The Company received subscriptions for $890,000 of these notes. Relatives of officers of the Company accounted for $680,000 of such subscriptions. One of the notes in the amount of $80,000 was paid off during August 1995. During December 1995, all nineteen of the investors exercised their warrants to purchase a total of 116,768 shares of common stock. Eighteen of the investors exchanged a total of $127,575 of the outstanding Subordinated Notes and one investor paid $12,600 in cash to exercise his warrants. A total amount of $210,625 of the remaining balance of $682,425 of the Subordinated Notes was paid off at maturity and the remaining balance of $471,800 was rolled over into new notes due in one year with interest payable monthly at 10 percent per annum. On July 24, 1996, the Company borrowed an additional $200,000 from the Birnie Trust under a Promissory Note payable in one year at 10% interest. On March 1, 1997, the notes totaling $671,800 were extended to February 28, 1998. During December 1995, the Company financed two purchases of equipment through Comerica for $74,774 and $354,297. These loans are payable in 36 monthly installments of $2,378 and $11,267 including interest at nine percent commencing December 30, 1995 and January 30, 1996, respectively. As of December 31, 1996, the combined balance due on these loans was $296,675. In March, 1996, the Company established a line of credit facility with Union Bank of California, N.A. (the "Bank") to replace the Comerica facility. This line provides up to $6,000,000 of available credit to the Company based upon a percentage (75%) of eligible receivables (as defined in the loan agreement). Interest is payable monthly at the Bank's adjusted LIBOR Rate plus 2% or the Bank's Reference Rate, at the option of the Company. The line of credit facility has an expiration date of May 1, 1997. In addition, the Company borrowed $124,940 from the Bank for the purchase of equipment. Interest will be payable monthly at the Bank's adjusted LIBOR Rate plus 2.25% or at the Bank's Reference Rate plus .25%, at the option of the Company. This bank also loaned the Company $600,000 to pay off equipment loans at the former bank. Interest will be payable monthly at the Bank's Reference Rate plus .25%. 25 The Company has been notified by the Bank that the Company is in breach of certain loan covenants relating to the three Company loans from the Bank under which, as of December 31, 1996, the Company had borrowed an aggregate of approximately $4,776,000. The Company is not in default with respect to any loan payments due to the Bank. The breached covenants relate to the ratio of the Company's liabilities to its tangible net worth, the maintenance of a minimum net worth, and the maintenance of profitable operations. The Bank notified the company that no further funds would be loaned while the Company is in breach of covenants. The Company has entered into an agreement with the Bank whereby the Bank has agreed to forebear from taking any action against the Company based upon the breached covenants as long as the Company does not default on any payment due to the Bank or otherwise breaches any of the other terms of the forbearance agreement. Under the terms of the forbearance agreement, in addition to regular interest payments, the Company has made payments of $500,000 on January 10, 1997; $250,000 on February 15, 1997; $169,244 on February 26, 1997; and $250,000 on March 15, 1997. An additional $250,000 is due on April 15, 1997 with the balance of the loan repaid not later than May 1, 1997. These payments are personally guaranteed by certain of the officers and directors of the Company. The forbearance agreement has also increased the interest rate on the line of credit to the Bank's Reference Rate plus 1. 5%. If the Company does not comply with the forbearance agreement, the Bank could declare the loans in default and could proceed to foreclose on the collateral securing the loans, which consists of all the Company's accounts receivable, inventory, equipment, and other assets. Any such actions by the Bank would have a material adverse impact upon the Company. Management intends to fully comply with the forbearance agreement and believes that they will be able to secure enough funds through operations or by obtaining additional financing sufficient to pay all amounts due the Bank within the required time frame. On March 25, 1997, the Company accepted a proposal (out of three proposals received) from another bank to replace the Union Bank facility with a line of credit of $9,000,000 and equipment term loan of $1,000,000. This proposal is contingent upon due diligence and approval of the bank's credit committee. On November 8, 1996, the Company borrowed $545,000 from Signal Hill Petroleum under a Promissory Note payable in 30 days at 10% interest per annum. This note was extended to January 15, 1997, then repaid in the amount of $300,000 on January 15, 1997, and $250,129 (including accrued interest) on February 27, 1997. The Company has also financed vehicles and equipment using long term capital leases from various entities. As of December 31, 1996, the combined balance due on these leases was $1,204,457. During 1996, the Company increased its available cash by $1,410,346. Cash flow provided by operations was $1,057,486 as the Company experienced a significant decrease in accounts receivable. This was compared to cash flow used in operations of $4,284,087 in 1995. During 1996, net cash used in investing activities was $1,457,777 compared to $2,777,630 in 1995. This was due to reduced equipment purchases. Cash flow provided by financing activities was $1,810,637 in 1996, compared to $7,106,417 in 1995 which included the receipt of $5,763,679 from the Company's initial public offering. 26 As of December 31, 1996, the Company had working capital of $3,302,299 compared to working capital of $8,323,783 at December 31, 1995. The change was primarily due to the decrease in accounts receivable. Management believes that funds provided from operations, the new lines of credit and the sale of stock in January 1997 (as described below) will be sufficient to fund the Company's immediate needs for working capital. CAPITAL COMMITMENTS. The Company has entered into leases for its existing facilities with such leases expiring at various dates through 1998. Monthly rentals currently are approximately $51,000 in the aggregate. Management anticipates that capital expenditures in the foreseeable future will be at similar levels to 1996, and will be funded from working capital and equipment leases. In December, 1996, the Company commenced a Private Placement Offering of Common Stock. This offering was completed in January 1997, and resulted in the issuance of 729,248 shares with net proceeds to the Company totalling $2,053,562. The shares issued pursuant to this offering are currently classified as "restricted securities" as such term is defined in Rule 144 of the Securities Act of 1933. The Company has committed to use its best efforts to register these shares for resale prior to December 31, 1997. In conjunction with the offering, warrants for an additional 72,925 shares of Common Stock were issued as partial compensation for underwriting services. These warrants are exercisable at a price of $3.60 per share for five years from the date of the offering. ITEM 7. FINANCIAL STATEMENTS. Please see pages F-1 through F-22. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 27 PART III ITEM 9. 10, 11 AND 12. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by these Items is incorporated herein by reference to the company's definitive proxy Statement relating to the Annual Meeting of Shareholders to be held May 15, 1997. 28 PART IV ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits.
EXHIBIT SEQUENTIAL NUMBER DESCRIPTION LOCATION PAGE NO. - ----------- --------------------------------------------- --------------------------------------------- --------------- 3.1 Amended and RestatedArticles of Incorporation Incorporated by reference to Exhibit 3.1 to -- the Company's Form SB-2 Registration Statement No. 33-91602 3.2 Bylaws Incorporated by reference to Exhibit 3.2 to -- the Company's Form SB-2 Registration Statement No. 33-91602 10.1 Incentive Stock Option Plan Incorporated by reference to Exhibit 10.1 to -- the Company's Form SB-2 Registration Statement No. 33-91602 10.2 Form of Incentive Stock Option Agreement Incorporated by reference to Exhibit 10.2 to -- the Company's Form SB-2 Registration Statement No. 33-91602 10.3 Loan Documents Between Comerica Bank and the Incorporated by reference to Exhibit 10.3 to -- Company the Company's Form SB-2 Registration Statement No. 33-91602 10.4 Award/Contract No. 68-W1-0012 Between the Incorporated by reference to Exhibit 10.4 to -- Company and the EOA (unredacted) the Company's Form SB-2. Registration Statement No. 33-91602 23 Consent of Grant Thornton LLP Filed herewith electronically -- 27 Financial Data Schedule Filed herewith electronically --
(b) Reports on Form 8-K. During the last quarter of the period covered by this Report, the Company did not file any Reports of Form 8-K. 29 [Grant Thornton Letterhead] REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors CET Environmental Services, Inc. We have audited the accompanying balance sheets of CET Environmental Services, Inc. as of December 31, 1996 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above, present fairly, in all material respects, the financial position of CET Environmental Services, Inc. as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the years then ended, in conformity with generally accepted accounting principles. /s/GRANT THORNTON LLP Denver, Colorado March 25, 1997 F-1 CET Environmental Services, Inc. BALANCE SHEETS December 31, ASSETS
1996 1995 ------------ ------------ CURRENT ASSETS Cash...................................... $ 1,887,001 $ 476,655 Accounts receivable, less allowance for doubtful accounts; $538,087 in 1996 and $135,404 in 1995........................ 7,454,393 13,356,823 Contracts in process...................... 6,656,862 6,213,490 Income tax receivable..................... 1,282,778 -- Due from related party.................... 158,010 -- Other receivables......................... 199,016 146,531 Inventories............................... 171,642 256,140 Prepaid expenses.......................... 613,770 506,240 Deferred income tax asset................. -- 289,330 ------------ ------------ Total current assets.................... 18,423,472 21,245,209 ------------ ------------ EQUIPMENT AND IMPROVEMENTS Field equipment and vehicles.............. 5,672,638 4,061,144 Office furniture, equipment and leasehold improvements.................. 1,591,910 1,204,474 ------------ ------------ 7,264,548 5,265,618 Less allwoance for depreciation and amortization........................ (2,378,260) (1,281,716) ------------ ------------ Equipment and improvements--net......... 4,886,288 3,983,902 GOODWILL.................................... 352,644 373,061 DEPOSITS.................................... 132,913 105,679 ------------ ------------ $ 23,795,317 $ 25,707,851 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these statements. F-2 CET Environmental Services, Inc. BALANCE SHEETS - CONTINUED December 31, LIABILITIES AND STOCKHOLDERS' EQUITY
1996 1995 ------------ ------------ CURRENT LIABILITIES Note payable--line of credit.............. $ 4,200,650 $ 2,424,836 Loan from shareholder..................... 545,000 -- Acounts payable........................... 7,758,668 7,857,824 Accrued expenses.......................... 1,156,858 1,730,853 Income taxes payable...................... -- 372,162 Current obligations under capital leases.. 329,934 208,248 Current portion of long-term debt......... 1,130,063 327,503 ------------ ------------ Total current liabilities............... 15,121,173 12,921,426 DEFERRED INCOME TAXES....................... -- 37,282 OBLIGATONS UNDER CAPITAL LEASES............. 874,523 661,697 NOTES PAYABLE TO RELATED PARTIES............ 671,800 682,425 LONG-TERM DEBT.............................. 153,848 694,953 COMMITMENTS AND CONTINGENT LIABILITIES...... -- -- STOCKHOLDERS' EQUITY Common stock (no par value)--authorized 20,000,000 shares; issued and outstanding, 5,066,537 shares........... 6,165,977 6,165,977 Paid-in capital........................... 555,530 535,175 Retained earnings......................... 252,466 4,008,916 ------------ ------------ Total stockholders' equity.............. 6,973,973 10,710,068 ------------ ------------ $ 23,795,317 $ 25,707,851 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these statements. F-3 Ch Environmental Services Inc. STATEMENTS OF OPERATIONS Year Ended December 31,
1996 1995 ------------- ------------- PROJECT REVENUE.................................................................... $ 54,918,520 $ 47,871,972 PROJECT COSTS Direct........................................................................... 43,660,435 34,343,855 Indirect......................................................................... 8,175,951 7,039,432 ------------- ------------- 51,836,386 41,383,287 ------------- ------------- Gross profit................................................................... 3,082,134 6,488,685 ------------- ------------- OTHER OPERATING EXPENSES (INCOME) Selling.......................................................................... 3,101,197 1,747,298 General and administrative....................................................... 3,158,707 2,064,848 Amortization of excess of acquired net asset in excess of cost................... -- (337,437) ------------- ------------- 6,259,904 3,474,709 ------------- ------------- Operating income (loss)........................................................ (3,177,770) 3,013,976 ------------- ------------- OTHER INCOME (EXPENSE) Interest expense, net............................................................ (627,537) (326,331) Other income (expense)........................................................... (292,998) 4,144 ------------- ------------- (920,535) (322,187) ------------- ------------- Income (loss) before taxes on income........................................... (4,098,305) 2,691,789 (Benefit) taxes on income...................................................... (341,855) 656,792 ------------- ------------- NET INCOME (LOSS)............................................................ $ (3,756,450) $ 2,034,997 ------------- ------------- ------------- ------------- Weighted average number of shares outstanding...................................... 5,066,537 4,113,725 Net income per common share...................................................... $ (0.74) ------------- ------------- Pro forma Information (Note B) Historical earnings before income taxes.......................................... $ -- $ 2,691,789 Pro forma income taxes........................................................... 882,538 ------------- ------------- Pro forma net income............................................................. $ -- $ 1,809,251 ------------- ------------- ------------- ------------- Pro forma net income per common share............................................ $ -- $ 0.44 ------------- ------------- ------------- -------------
The accompanying notes are an integral part of these statements. F-4 CET Environmental Services, Inc. STATEMENT OF STOCKHOLDERS' EQUITY Years Ended December 31, 1996 And 1995
COMMON STOCK TOTAL -------------------- PAID-IN RETAINED STOCKHOLDERS' SHARES AMOUNT CAPITAL EARNINGS EQUITY --------- --------- --------- --------- ------------ Balance at January 1, 1995.................................... 3,534,000 $ 12,123 $ -- $3,399,599 $3,411,722 Distributions paid............................................ -- -- -- (927,101) (927,101) Undistributed S Corp. earnings................................ -- -- 498,579 (498,579) -- Initial public offering of common stock....................... 1,380,000 5,763,679 -- -- 5,763,679 Shares issued for acquisition of En-Tech, Inc................. 35,769 250,000 -- -- 250,000 Exercise of stock purchase warrants by holders of sub-ordinated promissory notes.............................. 116,768 140,175 -- -- 140,175 Issuance of stock options at exercise price below market value -- -- 36,596 -- 36,596 Net income for the year....................................... -- -- -- 2,034,997 2,034,997 --------- --------- --------- --------- ------------ Balance at December 31, 1995.................................. 5,066,537 6,165,977 535,175 4,008,916 10,710,068 Issuance of stock options at exercise price below market value -- -- 20,355 -- 20,355 Net income (loss) for the year................................ -- -- -- (3,756,450) (3,756,450) --------- --------- --------- --------- ------------ Balance at December 31, 1996.................................. 5,066,537 $6,165,977 $ 555,530 $ 252,466 $6,973,973 --------- --------- --------- --------- ------------
The accompanying notes are an integral part of this statement. F-5 CET Environmental Services, Inc. STATEMENT OF CASH FLOWS Year Ended December 31, 1996 And 1995
1996 1995 ------------- ------------- Increase (decrease) in cash CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)................................................................. $ (3,756,450) $ 2,034,997 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization................................................... 1,252,781 761,840 Amortization of excess of acquired net assets in excess of cost................. -- (337,437) Provision for bad debts......................................................... 402,683 71,441 Deferred income taxes........................................................... 252,048 (250,756) Loss on sale of equipment....................................................... 13,304 18,842 Employee stock option plan...................................................... 20,355 36,596 Changes in operating assets and liabilities: (Increase) decrease in accounts receivable.................................... 5,499,747 (10,543,941) Increase in contracts in process.............................................. (443,372) (3,253,311) Increase in due from related party............................................ (158,010) -- Increase in income tax & other receivables.................................... (1,335,263) (92,791) Increase in prepaid expenses.................................................. (107,530) (415,462) (Increase) decrease in inventory and deposits................................. 50,210 (200,163) Increase (decrease) in accounts payable....................................... (99,156) 6,220,408 Increase (decrease) in accrued expenses and income taxes...................... (533,861) 1,665,650 ------------- ------------- Net cash (used in) provided by operating activities......................... 1,057,486 (4,284,087) ------------- ------------- INVESTING ACTIVITIES: Purchase of equipment............................................................. (1,523,418) (2,779,478) Proceeds from sale of equipment................................................... 65,641 1,848 ------------- ------------- Net cash used in investing activities....................................... (1,457,777) (2,777,630) ------------- ------------- FINANCING ACTIVITIES: Proceeds from issuance of long-term debt.......................................... 766,751 727,254 Payments on long-term debt........................................................ (917,592) (222,466) Payments on capital leases........................................................ (348,711) (134,185) Proceeds from credit line loan--net of payments................................... 1,775,814 1,076,636 Borrowings from related party trust fund.......................................... 200,000 550,000 Payments on related party trust fund.............................................. -- (350,000) Proceeds from issuance of stock................................................... -- 5,763,679 Distributions paid................................................................ -- (927,101) Proceeds from loans from shareholders............................................. 545,000 357,865 Payments on loans from shareholders............................................... -- (357,865) Proceeds from exercise of stock purchase warrants................................. $ -- $ 12,600 Proceeds from issuance of subordinated notes payable.............................. -- 690,000 Payments on subordinated notes payable............................................ (210,625) (80,000) ------------- ------------- Net cash provided by financing activities................................... 1,810,637 7,106,417 ------------- -------------
The accompanying notes are an integral part of these statements. F-6 CET Environmental Services, Inc. STATEMENT OF CASH FLOWS-CONTINUED Year Ended December 31, 1996 And 1995
1996 1995 ------------- ------------- INCREASE IN CASH.................................................................... $ 1,410,346 $ 44,700 Cash at beginning of year........................................................... 476,655 431,955 ------------- ------------- Cash at end of year................................................................. $ 1,887,001 $ 476,655 ------------- ------------- ------------- ------------- Supplemental disclosures to cash flow information: Cash paid during the year Interest........................................................................ $ 485,951 $ 282,230 Income taxes.................................................................... $ 656,900 $ 518,757 Noncash investing and financing activities: Acquisition of business Fair value of tangible and intangible assets acquired........................... $ -- $ 500,047 Liabilities assumed or incurred................................................. -- 250,047 ------------- ------------- Fair value of common stock paid as consideration................................ $ -- $ 250,000 ------------- ------------- ------------- ------------- Reduction of subordinated notes payable as a result of the exercise of related stock purchase warrants......................................................... $ -- $ 127,575 Capital lease and financing obligations incurred for equipment.................... $ 683,223 $ 837,000 Conversion of remaining portion of related party note payable to a subordinated note payable.................................................................... $ -- $ 200,000 Issuance of note payable for financing of insurance premiums...................... $ 412,296 $ --
The accompanying notes are an integral part of these statements. F-7 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE A--ORGANIZATION AND DESCRIPTION OF COMPANY CET Environmental Services, Inc. (the "Company") was incorporated on February 9, 1988 under the laws of the State of California. On November 29, 1991 ("Acquisition Date"), Environmental Operations, Inc., purchased 100% of the Company's outstanding stock from Consolidated Environmental Technologies, Inc. In August 1992, Environmental Operations, Inc. was merged into CET Environmental Services, Inc. The Company provides a variety of consulting and technical services to resolve environmental and health risk problems in the air, water and soil. The Company has developed a broad range of expertise in non-proprietary technology-based environmental remediation and water treatment techniques for both the public and private sectors throughout North and South America and the Trust Territory of the Pacific Islands. NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CASH For purposes of the statement of cash flows, the Company considers all highly liquid cash investments with an original maturity of three months or less to be cash. CONTRACTS A majority of the Company's revenues are generated from time-and-material contracts whereby the Company provides services, as prescribed under the various contracts, for a specified fixed hourly rate for each type of labor hour and receives reimbursement for material, inventories and subcontractor costs. Many of the contracts also have a fixed mark-up to be applied to material, inventories and subcontract costs. In addition, many of the time and material contracts have a stated maximum contract price which can not be exceeded without an authorized change order. Revenues are recorded on contracts based upon the labor hours and costs incurred. Provision for losses on uncompleted contracts are made in the period in which such losses are determined. Claims are recorded in revenue when received. Contracts in process consists of the accumulated unbilled labor at contracted rates, material, subcontractor costs and other direct job costs and award fees related to projects in process. F-8 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED INVENTORIES Inventories consist of various supplies and materials used in the performance of the services related to the Company's projects and are stated at the lower of cost or market. EQUIPMENT AND IMPROVEMENTS Equipment and improvements are recorded at cost. Depreciation and amortization are provided on a straight-line method over the estimated useful lives of the respective assets, usually between 3 to 7 years. GOODWILL The excess of the purchase price over the estimated fair values of the assets acquired less the liabilities assumed, from the Company's November 1995 purchase of En-Tech, Inc. was recorded as goodwill. Such goodwill is being amortized over a fifteen-year period using the straight-line method. The Company evaluates its goodwill annually to determine potential impairment by comparing the carrying value to the undiscounted estimated expected future cash flows of the related assets. ACQUIRED NET ASSETS IN EXCESS OF COST The acquisition of the Company by Environmental Operations, Inc. on November 29, 1991 (see Note A), was accounted for as a purchase. The estimated fair value of net assets purchased exceeded the purchase price by approximately $1,472,000 (after a reduction of all long-term assets to zero). The acquired net assets in excess of cost was amortized over a four-year period beginning December 1, 1991. The amount was fully amortized at December 31, 1995. INCOME TAXES The Company accounts for income taxes on the liability method which requires that deferred tax assets and liabilities be recorded for expense and income items that are recognized in different periods for financial and income tax reporting purposes. From January 1, 1994 to June 14, 1995, income taxes on net earnings were payable personally by the stockholders pursuant to an election under Subchapter S of the Internal Revenue Code not to have the Company taxed as a corporation. However, the Company was liable for state franchise taxes at a rate of 1.5 percent on its net income. Pro forma financial information is presented to show the effects on 1995 financial information had the Company not been treated as an S Corporation for income tax purposes. Effective June 15, 1995, the Company terminated its Subchapter S election and began to be taxed as a Subchapter C corporation. F-9 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED STOCK SPLIT AND EARNINGS PER SHARE Earnings per share has been computed based upon the weighted average number of shares outstanding and equivalent shares outstanding during the year. Equivalent shares relate to shares issuable upon the exercise of stock options and warrants. On March 1, 1995, the Board of Directors of the Company approved a resolution which increased the number of authorized shares from 10,000,000 shares to 20,000,000 shares. Additionally, a stock split was approved which converted each issued and outstanding share into 291.5 shares. All share and per share data have been retroactively restated to give effect to this stock split. ESTIMATED FAIR VALUE INFORMATION Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosure about Fair Value of Financial Instruments" requires disclosure of the estimated fair value of an entity's financial instrument assets and liabilities, as defined, regardless of whether recognized in the financial statements of the reporting entity. The fair value information does not purport to represent the aggregate net fair value of the Company. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash: The carrying amount approximates fair value due to the short-term maturity. Note Payable--Line of Credit: The carrying amount approximates fair value as the line of credit has a variable interest rate which is considered to approximate the market rate. Loan from shareholder: The carrying amount approximates the fair value because of the short terms to maturity of the notes (within 3 months). Long-Term Debt / Obligations Under Capital Leases: The carrying value approximates fair value as the interest rate at December 31, 1996 and 1995 is considered to approximate the market rate. Notes Payable to Related Parties: The carrying value approximates fair value as the interest rate at December 31, 1996 and 1995 is considered to approximate the market rate. RECLASSIFICATIONS Certain financial statement reclassifications have been made in 1995 to conform with presentations used in 1996. F-10 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE C--CONTRACTS IN PROCESS Contracts in process consists of the following at December 31:
1996 1995 ---------- ------------ Government--EPA contracts.......................................... $ 648,973 $ 832,468 Commercial contracts............................................... 6,007,889 5,209,500 Award Fees/Project Management--EPA contracts....................... -- 171,522 ---------- ------------ Totals.......................................................... 6,656,862 $ 6,213,490 ---------- ------------ ---------- ------------
The Environmental Protection Agency (EPA) awards the Company an award fee for work performed based upon a percentage of sub-contract and material costs incurred plus a percentage of program management fees billed. NOTE D--SIGNIFICANT CUSTOMERS A significant portion of the Company's business is from a contract entered into in March 1991, with the Environmental Protection Agency (EPA). A new contract was awarded by the EPA in December 1996 with estimated maximum revenues of $292,000,000 over five years. As of December 31, 1996 and 1995, the net balance of accounts receivable from the EPA was $2,256,448 and $2,610,539, respectively. Revenues from the EPA in 1996 and 1995 amounted to approximately $10.9 million and $12.9 million, respectively. NOTE E--RELATED PARTY TRANSACTIONS In order to meet short term operating needs, the Company, from time to time borrows funds on a short term basis from affiliates of the Company or from a trust fund of a relative of the President. On November 8, 1996, the Company borrowed $545,000 from Signal Hill Petroleum, a company controlled by Craig C. Barto, one of the Company's directors, pursuant to a 30 day note which bears interest at 10% per annum. The due date on the note was extended to January 15, 1997. The Company also borrowed $671,800, which includes subordinated notes of $471,800 (see Notes G and H), from relatives of Steven H. Davis, President, pursuant to one year notes which bear interest at the rate of 10% per annum. These notes are due February 28, 1998. The Company intends to repay these loans from revenues when sufficient funds are available. Interest expense attributable to these related party borrowings amounted to $55,898 and $44,696 for 1996 and 1995, respectively. F-11 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE E--RELATED PARTY TRANSACTIONS--CONTINUED A director and 12.1% owner of the Company is a 50% owner in Signal Hill Petroleum, Inc., Paramount Petroleum Corp. and Fletcher Oil. The Company provided services to these companies during the years ended December 31, 1996 and 1995 for fees amounting to approximately $340,000 and $293,000, respectively. On April 30, 1996, the Company loaned $105,764 to an officer and director of the Company pursuant to a demand note which bears interest at the rate of 8.25% per annum. Interest is payable monthly and principal is due on demand. Throughout 1996, the Company made additional advances to this individual bringing the total amount due to $158,010 at December 31, 1996. In March and April 1995, the Company issued debt securities in a private offering totaling $890,000 of which $680,000 were issued to investors related to Company management (see Note H). NOTE F--CAPITAL LEASES Vehicles and equipment recorded under capital leases consist of the following at December 31:
1996 1995 ------------ ---------- Vehicles........................................................... $ 1,497,407 $ 882,347 Equipment.......................................................... 272,151 239,117 ------------ ---------- 1,769,558 1,121,464 Less accumulated depreciation...................................... (465,228) (167,474) ------------ ---------- Totals......................................................... $ 1,504,330 $ 953,990 ------------ ---------- ------------ ----------
The following is a schedule by year of the future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31:
1996 ------------ 1997....................................................... $ 471,092 1998....................................................... 427,256 1999....................................................... 377,575 2000....................................................... 265,251 2001....................................................... 35,337 --------- Total minimum lease payments................................. 1,576,511 Less amounts representing estimated executory costs (taxes).. 120,977 --------- Net minimum lease payments................................... 1,455,534 Less amount representing interest............................ 251,077 --------- Present value of net minimum lease payments.................. $ 1,204,457 ---------
F-12 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE F--CAPITAL LEASES--CONTINUED Current portion............................................ 329,934 Noncurrent portion......................................... 874,523 --------- $1,204,457 --------- ---------
NOTE G--LINE OF CREDIT AND LONG-TERM DEBT The Company has a line of credit facility with Union Bank of California, N.A. (the "Bank") which provides up to $6,000,000 of available credit to the Company based upon a percentage (75%) of eligible receivables (as defined in the loan agreement). Interest is payable monthly at the Bank's adjusted LIBOR-Rate plus 2% or the Bank's Reference Rate, at the option of the Company. The line of credit facility has an expiration date of May 1, 1997. In addition, the Company borrowed $124,940 from the Bank for the purchase of equipment. Interest is be payable monthly at the Bank's adjusted LIBOR-Rate plus 2.25% or at the Bank's Reference Rate plus .25%, at the option of the Company. This Bank also loaned the Company $600,000 to pay off equipment loans at the former bank. Interest is payable monthly at the Bank's Reference Rate plus .25%. The Company has been notified by the Bank that the Company is in breach of certain loan covenants relating to the three Company loans from the Bank under which, as of December 31, 1996, the Company had borrowed an aggregate of approximately $4,776,000. The Company is not in default with respect to any loan payments due to the Bank. The breached covenants relate to the ratio of the Company's liabilities to its tangible net worth, the maintenance of a minimum net worth, and the maintenance of profitable operations. The Bank notified the Company that no further funds would be loaned while the Company is in breach of these covenants. The Company has entered into an agreement with the Bank whereby the Bank has agreed to forebear from taking any action against the Company based upon the breached covenants as long as the Company does not default on any payment due to the Bank or otherwise breach any of the other terms of the forbearance agreement. Under the terms of the forbearance agreement, in addition to regular interest payments the Company has made a payment of $500,000 on January 10, 1997, and then made payments of $250,000 each on January 31, 1997, February 15, 1997 and March 15, 1997 with a required payment of $250,000 on April 15, 1997. The Company made an additional payment of $170,000 in January 1997. The balance on the loan shall be repaid not later than May 1, 1997. These payments are personally guaranteed by certain of the officers and directors of the Company. If the Company does not comply with the forbearance agreement, the Bank could declare the loans in default and could proceed to foreclose on the collateral securing the loans which consists of all the Company's accounts receivable, inventory, equipment, and other assets. Any such actions by the Banks would have a material adverse impact upon the Company. Management intends to fully comply with the forbearance agreement and believes that they will be able to secure enough funds through operations and by obtaining additional financing sufficient to pay all amounts due the Bank within the required time frame. F-13 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE G--LINE OF CREDIT AND LONG-TERM DEBT--CONTINUED Long-term debt consists of the following at December 31:
1996 1995 --------- ---------- Note payable to bank, collateralized by equipment, payable in 48 monthly installments of $7,917 plus accrued interest at the bank's base rate plus 2%. Paid in 1996. $ -- $ 267,667 Note payable to bank, collateralized by equipment, payable in 48 monthly installments of $2,187 plus accrued interest at the bank's base rate plus 2%. Paid in 1996. -- 89,687 Note payable to bank, collateralized by equipment, payable in 48 monthly installments of $4,062 plus accrued interest at the bank's base rate plus 2%. Paid in 1996. -- 170,625 Note payable to bank, collateralized by equipment, payable in 36 monthly installments of $2,378 including interest at 9%, beginning December 30, 1995. 49,859 72,957 Note payable to bank, collateralized by equipment, payable in 36 monthly installments of $11,267 including interest at 9%, beginning January 30, 1996. 246,816 354,297 Eight installment notes payable to a bank and finance companies, collateralized by vehicles, payable in monthly installments ranging from $182 to $713 including interest ranging from 9.75% to 18%. Paid in 1996. -- 67,223 Note payable to a bank, collateralized by equipment, payable in monthly installments of $16,667 including interest at 8.5%, due May 1, 1997. 450,000 -- Note payable to a bank collateralized by equipment, due May 1, 1997, interest at 8.25%. 124,940 --
F-14 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE G--LINE OF CREDIT AND LONG-TERM DEBT--CONTINUED
1996 1995 ---------- ---------- Note payable for annual insurance premium, interest at 4.98%, with monthly payments of $43,531, due June 15, 1997......................... 412,296 -- --------- --------- 1,283,911 1,022,456 Less current portion................................................................... 1,130,063 327,503 --------- --------- $ 153,848 $ 694,953 --------- ---------
Scheduled future maturities of these notes for the years ending December 31 are as follows: 1997................................................ $1,130,063 1998................................................ 153,848 --------- $1,283,911 ---------
Related party debt consists of the following at December 31:
1996 1995 --------- -------------- Loan from shareholder, uncollateralized, due January 15, 1997, interest at 10% (see Note E).................................. 545,000 -- Note payable to related party, uncollateralized, due February 28, 1998, interest at 10% (see Note E)..................... 200,000 -- Subordinated notes payable to related parties, due February 28, 1998, interest at 10% (see Notes E and H).............. 471,800 682,425 --------- ------- 1,216,800 682,425 Less current portion.................................................... 545,000 -- --------- ------- $ 671,800 $ 682,425 --------- -------
NOTE H--SUBORDINATED NOTES PAYABLE In March and April 1995, the Company issued debt securities in a private offering pursuant to which it raised $890,000. In exchange for each $10,000 invested, the nineteen investors were given a warrant to acquire approximately 1,312 shares of common stock at approximately $1.20 per share, to be exercised on F-15 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE H--SUBORDINATED NOTES PAYABLE--CONTINUED or before December 31, 1996, for an aggregate of 116,768 shares, and a subordinated note for the amount invested. The subordinated notes bore interest at ten percent per annum payable on the first day of each month commencing on April 1, 1995. The subordinated notes are redeemable by the Company at any time upon 60 days' notice to the holders and have a maturity date of March 1, 1996. Holders of the subordinated notes have a security interest in the Company's accounts receivable and contracts in progress that is subordinate to holders of the senior indebtedness. Investors holding subordinated notes in the aggregate amount of $680,000 are related to Company management. In August 1995, one subordinated note in the amount of $80,000 was paid off. During December 1995, all nineteen of the investors exercised their warrants to purchase a total of 116,768 shares of common stock. Eighteen of the investors exchanged a total of $127,575 of the outstanding subordinated notes and one investor paid $12,600 in cash to exercise his warrants. Interest of approximately $60,000 was paid to the holders of these subordinated notes during 1995. On March 1, 1996, $210,625 of the remaining balance of $682,425 of the subordinated notes was paid off. The remaining $471,800 was rolled over into new notes payable February 28, 1998 with interest payable monthly at ten percent per annum. Interest of $39,316 was paid to the holders of these notes during 1996. NOTE I--TAXES ON INCOME The provision (benefit) for taxes on income includes the following for the year ended December 31:
1996 1995 ----------- ---------- CURRENT Federal............................................. $ (569,268) $ 732,205 State............................................... (24,635) 176,635 ---------- --------- (593,903) 908,840 ---------- --------- DEFERRED Federal............................................. 215,390 (215,390) State............................................... 36,658 (36,658) ---------- --------- 252,048 (252,048) ---------- --------- TOTAL....................................................... $ (341,855) $ 656,792 ---------- ---------
A reconciliation between the expected federal income tax expense computed by applying the Federal statutory rate to income before income taxes and the actual provision (benefit) for taxes on income for the year ended December 31 is as follows: F-16 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE I TAXES ON INCOME--CONTINUED
1996 1995 ------------- ------------ Provision (benefit) for income taxes at statutory rate....... $ (1,598,400) $ 1,076,715 Change in valuation reserve.................................. 1,076,366 -- Stock options................................................ 8,142 14,638 Purchase accounting effects Negative goodwill................ -- (134,975) S Corporation earnings....................................... -- (225,746) Other........................................................ 172,037 (73,840) ------------- ------------ $ (341,855) $ 656,792 ------------- ------------
Deferred tax assets and liabilities consist of the following at December 31:
1996 1995 ----------- ---------- Net deferred tax asset Accrued salary expense................................... $ 85,704 $ 154,203 Allowance for doubtful accounts.......................... 198,661 58,223 NOL carryforward......................................... 870,209 -- Other.................................................... (78,208) 76,904 --------- -------- 1,076,366 289,330 --------- -------- Valuation reserve........................................ (1,076,366) -- --------- -------- $ -- $ 289,330 Deferred tax liability depreciation and amortization......... $ -- $ (37,282) --------- --------
Realization of the deferred tax asset depends on achieving a certain minimum level of future taxable income and although management currently believes that the achievement of the required future taxable income is more likely than not, it is reasonably possible that this belief could change in the near term, resulting in an adjustment to the valuation allowance. The Company has net operating loss carryforwards for tax purposes of $2,231,304 which expire in 2011. NOTE J--COMMITMENTS AND CONTINGENCIES The Company is obligated under certain operating leases for its facilities. The leases expire at various dates through 2001, with appropriate rentals as set forth below. Some leases also provide for payments of taxes and certain common area costs and expenses. F-17 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE J--COMMITMENTS AND CONTINGENCIES--CONTINUED The following is a summary at December 31, 1996, of the future minimum rents due under noncancellable operating leases:
YEAR ENDING DECEMBER 31, ------------ 1997...................................... $ 634,933 1998...................................... 308,151 1999...................................... 170,717 2000...................................... 151,825 2001...................................... 49,412 ---------- Total..................................... $1,315,038 ----------
Total rent expense under operating leases for the years ended December 31, 1996 and 1995 was approximately $892,700 and $492,400, respectively. Although the Company is involved in litigation in the normal course of its business, management believes that no pending litigation in which the Company is named as a defendant is likely to have a materially adverse effect on the Company's financial position or results of operations. NOTE K--STOCKHOLDERS' EQUITY A reclassification of $498,579 from retained earnings to paid-in capital was made which represented the approximate balance in the Company's S corporation accumulated adjustment account which had not been distributed to shareholders as of June 15, 1995 (date of termination of the Company's S corporation status, see Note B). In June 1995, the Company distributed an aggregate of $927,101 to certain shareholders, which aggregate amount is approximately the amount of the tax liabilities of such shareholders resulting from the Company's former Subchapter "S" tax status. The primary source of funds for such distribution was the proceeds from the sale of the Subordinated Notes (Note H). Immediately after such distribution, these same shareholders loaned an aggregate of $357,865 to the Company. Such shareholder loans bore interest at 10% and were repaid out of the proceeds of the Company's initial public offering in July 1995. In July 1995, the Company completed an initial public offering of 1,200,000 shares of its common stock, and in August 1995, sold an additional 180,000 shares pursuant to an over-allotment option. The net proceeds to the Company from the public offering was approximately $5,800,000. In connection with this offering, the Company issued a warrant to the representatives of the underwriters in this offering to purchase up to 120,000 shares of the Company's common stock at $6.00 per share (the F-18 NOTE K -STOCKHOLDERS' EQUITY--Continued "Representatives' Warrant"). The Representatives' Warrant is entitled to the benefit of adjustments in the purchase price and in the number of shares of common stock and/or other securities deliverable upon the exercise thereof in the event of a stock dividend, stock split, reclassification, reorganization, consolidation or merger and may be exercised at any time during the four-year period commencing on July 18, 1996. The Representatives' Warrant is restricted from sale, transfer, assignment, or hypothecation until July 18, 1996, except to officers or partners of the underwriters and members of the selling group or their officers and directors. On November 10, 1995, the Company acquired all of the outstanding stock of En-Tech, Inc., a Colorado corporation ("En-Tech"), doing business as Environmental Technologies, Inc., in exchange for 35,769 shares of the Company's common stock. En-Tech was engaged in the design, construction, and operation of industrial wastewater and water treatment facilities, and provided services in both the public and private sectors. This acquisition was accounted for as a purchase and, accordingly, En-Tech's assets, liabilities and results of operations were included in the December 31, 1995 balance sheet and statement of income since the date of acquisition. En-Tech was merged into the Company effective March 15, 1996. On February 9, 1996, the Company filed a registration statement on Form SB-2 to register 402,537 shares of common stock for resale by certain shareholders ("Selling Shareholders"), which shares have been "restricted securities" as defined in Rule 144 under the Securities Act of 1933. None of the proceeds from the sale of the common stock by the Selling Shareholders were received by the Company. NOTE L--PROFIT SHARING AND 401(K) PLAN The Company maintains a Profit Sharing and 401(K) Plan, which has been in effect since January 1, 1990. All classes of employees meeting the participation requirements are eligible to participate in the Plan. Company contributions to the profit sharing plan are discretionary. The Company does, however, make a matching contribution in the amount of 25% of the first 6% of all elective deferrals. The Company contributed $83,738 and $50,304 for the years ended December 31, 1996 and 1995, respectively. NOTE M--STOCK OPTIONS On March 1, 1995, the Company adopted an Incentive Stock Option Plan (the "Plan") for key personnel. A total of 550,000 shares of the Company's common stock are reserved for issuance pursuant to the exercise of stock options (the "Options") which may be granted to full-time employees of the Company. The Plan is administered by the Board of Directors. In addition to determining who will be granted Options, the Board of Directors has the authority and discretion to determine when Options will be granted and the number of Options to be granted. The Board of Directors may grant Options intended to qualify for special treatment under the Internal Revenue Code F-19 NOTE M--STOCK OPTIONS-- Continued of 1986, as amended ("Incentive Stock Options") and may determine when each Option becomes exercisable, the duration of the exercise period for Options and the form of the instruments evidencing Options granted under the Plan. The maximum aggregate fair market value (determined as of the date of grant) of the shares as to which the Incentive Stock Options become exercisable for the first time during any calendar year may not exceed $100,000. The Plan provides that the purchase price per share for each Incentive Stock Option on the date of grant may not be less than 100 percent of the fair market value of the Company's common stock on the date of grant. However, any Option granted under the Plan to a person owning more than 10 percent of the Company's common stock shall be at a price of at least 110 percent of such fair market value. The Plan is accounted for under APB Opinion 25 and related interpretations. The options generally have a term of 10 years when issued and vest over 3-5 years. Had compensation cost for the Plan been determined based on the fair value of the options at the grant date consistent with the method of Statement of Financial Accounting Standards 123, "Accounting for Stock-Based Compensation", the Company's net income (loss) and earnings (loss) per common share would have been:
1996 1995 ------------- ------------ Net income (loss) As reported.................................... $ (3,756,450) $ 1,809,251 Pro forma...................................... (3,854,017) 1,781,220 Earnings (loss) per common share As reported.................................... $ (0.74) $ 0.44 Pro forma...................................... (0.76) 0.43
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions for grants used in 1996 and 1995: no expected dividends; expected volatility of 50%; risk-free interest rate of 5.5%; and expected lives of 6 years. A summary of the status of the Plan follows:
AVERAGE PRICE PER SHARES SHARE --------- ----------- Outstanding at January 1, 1995...................................... -- Granted............................................................. 181,000 $ 3.50 Exercised........................................................... --
F-20 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE M--STOCK OPTIONS--CONTINUED Canceled........................................................... (5,000) $ 3.50 --------- --------- Outstanding at December 31, 1995................................... 176,000 $ 3.50 --------- --------- Total exercisable at December 31, 1995............................. 10,000 $ 3.50 --------- --------- Outstanding at January 1, 1996..................................... 176,000 $ 3.50 Granted............................................................ 150,000 $ 6.89 Exercised.......................................................... -- Canceled........................................................... (112,000) $ 4.83 --------- --------- Outstanding at December 31, 1996................................... 214,000 $ 5.60 --------- --------- Total exercisable at December 31, 1996............................. 41,600 $ 3.92 --------- ---------
In May 1995, options for 181,000 shares of common stock were granted under the Plan of which options for 90,500 shares will vest only upon the occurrence of certain circumstances. On December 31, 1995, 13,500 of such remaining options were granted as events upon which these options were contingent occurred. The Company recorded compensation expense of $20,355 and $36,596 in 1996 and 1995 respectively, relating to these options. Compensation expense of $22,361 will be recorded in future periods as these options vest over a five-year period commencing December 31, 1996. NOTE N--DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS All of the Company's financial instruments are held for purposes other than trading. The carrying amounts in the table below are the amounts at which the financial instruments are reported in the financial statements. The estimated fair values of the Company's financial instruments at December 31, 1996 and 1995 are as follows: 1996 ------- Carrying Amount Estimated Fair Value --------------- -------------------- Cash............................ $ 1,887,001 $ 1,887,001 Note payable-line of credit..... 4,200,650 4,200,650 Loan from shareholder........... 545,000 545,000 Long-term debt.................. 1,348,340 1,348,340 Capitalized lease obligations... 1,204,457 1,204,457 Notes payable to related parties 671,800 671,800 F-21 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS - CONTINUED December 31, 1996 and 1995 NOTE N--DISCLOSURE ABOPUT FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued 1995 ------- Carrying Amount Estimated Fair Value --------------- -------------------- Cash............................ $ 476,644 $ 476,655 Note payable--line of credit..... 2,424,836 2,424,836 Long-term debt.................. 1,022,456 1,012,509 Notes payable to related parties 682,425 682,425 Capitalized lease obligations... 869,945 869,945 NOTE O--FOURTH QUARTER ADJUSTMENTS During the fourth quarter of the year ended December[nb]31, 1996, the Company wrote off accounts receivable, recorded as a reduction of revenues, approximately $731,500. This adjustment was considered necessary due to the age of the receivable which resulted from disputed amounts arising from contract changes. NOTE P--SUBSEQUENT EVENT In January[nb]1997, the Company completed a private offering of 729,248 shares of its common stock. The net proceeds to the Company from this offering were approximately $2,060,000. In connection with this offering, the Company issued a warrant to the representatives of the underwriters in this offering to purchase up to 10% of the number of shares sold in the offering of the Company's common stock. The purchase price of such was warrants was $100 and the exercise price under such warrants is $3.60 per share. The warrant may be exercised in whole or in part at any time or from time to time until the expiration date of December 31, 2001. F-22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. CET ENVIRONMENTAL SERVICES, INC. DATED: APRIL 10, 1997 BY /S/ STEVEN H. DAVIS ----------------------------------------- Steven H. Davis PRESIDENT AND CHIEF EXECUTIVE OFFICER Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the date indicated. SIGNATURE CAPACITY DATE - ------------------------------ --------------------------- ------------------- /s/ STEVEN H. DAVIS President, Chief Executive - ------------------------------ Officer and Director April 10, 1997 Steven H. Davis Executive Vice President April 10, 1997 /s/ RICK C. TOWNSEND and Chief Financial - ------------------------------ Officer (Principal Rick C. Townsend Accounting Officer) /s/ CRAIG C. BARTO Director April 10, 1997 - ------------------------------ Craig C. Barto /s/ ROBERT S. COLDREN Director April 10, 1997 - ------------------------------ Robert S. Coldren Executive Vice President, April 10, 1997 /s/ DOUGLAS W. COTTON Chief Operating Officer, - ------------------------------ Secretary and Director Douglas W. Cotton /s/ JOHN G. L. HOPKINS Senior Vice President April 10, 1997 - ------------------------------ and Director John G. L. Hopkins /s/ ROBERT A. TAYLOR Director April 10, 1997 - ------------------------------ Robert A. Taylor EX-23 2 EXHIBIT 23 - CONSENT OF CPAS CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our reports dated March 25, 1997, accompanying the financial statements incorporated by reference or included in the Annual Report of CET Environmental Services, Inc. (the Company) on Form 10-KSB for the year ended December 31, 1996. We consent to the incorporation by reference in the Company's Registration Statement on Form S-8 of the aforementioned reports. GRANT THORNTON LLP Denver, Colorado March 25, 1997 EX-27 3 EXHIBIT 27 - FDS
5 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1,887,001 0 7,992,480 538,087 6,828,504 18,423,472 7,264,548 2,378,260 23,795,317 15,121,173 1,028,371 0 0 6,165,977 807,996 23,795,317 0 54,918,520 0 51,836,386 6,254,702 298,200 627,537 (4,098,305) (341,855) (3,756,450) 0 0 0 (3,756,450) (0.74) (0.74)
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