-----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, BCKM5J5KROSkpPY9tHXpbY1JYnQrmAQSVhFX7kUqtBOcSADo386ThXZz/fIHT28G EKn/LKOLuiEuPY39N2CseA== 0000948830-98-000098.txt : 19980504 0000948830-98-000098.hdr.sgml : 19980504 ACCESSION NUMBER: 0000948830-98-000098 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980430 SROS: NASD 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/A SEC ACT: SEC FILE NUMBER: 033-91602 FILM NUMBER: 98606444 BUSINESS ADDRESS: STREET 1: 7670 SOUTH VAUGHN CT STREET 2: SUITE 130 CITY: ENGLEWOOD STATE: CO ZIP: 80112 BUSINESS PHONE: 7145051800 MAIL ADDRESS: STREET 1: 6900 E 47TH AVE STREET 2: STE 200 CITY: DENVER STATE: CO ZIP: 80216 10-K/A 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A AMENDMENT NO. 1 [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, 1997 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 Registrant as Specified in its Charter) CALIFORNIA 33-0285964 - ------------------------------------------------------------------------------ (State or Other Jurisdiction of (I.R.S. Employer Identification Number) Incorporation or 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 19, 1998, 5,809,485 Shares of the Registrant's Common Stock were outstanding. The aggregate market value of voting stock held by nonaffiliates of the Registrant was approximately $15,900,000. Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K 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-K or any amendment to this Form 10-K. [] Documents incorporated by reference: None. PART I ITEM 1. 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 six 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 backlog in excess of $300 million of government work through the award of several multi-year contracts with the Environmental Protection Agency, the Department of Defense, and the Department of Transportation. 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 variety 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 and treatment 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; and Mobile, Alabama. 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 the IPO, the Company became listed on the American Stock Exchange under the symbol "ENV." In November 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 -2- 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 totaling $2,035,662. The Common Stock sold via this offering was registered for resale under an S-3 Registration which was effective January 7, 1998. 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. In August 1997, the Company acquired all of the outstanding stock of Water Quality Management Corporation, a Colorado corporation ("WQM"), in a cash transaction. WQM is engaged in the operation and maintenance of municipal and industrial water and wastewater treatment facilities. WQM is operated as a wholly owned subsidiary of the Company. In January 1998, the Company acquired all of the outstanding stock of H2O Construction and Maintenance, Inc. a Colorado corporation ("H2O"), for cash and notes. H2O is engaged in the construction, operation and maintenance of water and wastewater treatment, collection and distribution facilities. H2O provides services to both public and private sector clients. H2O is currently operated as a wholly owned subsidiary of the Company, but it is planned to be merged into WQM during 1998. THE ENVIRONMENTAL REMEDIATION INDUSTRY Various analysts have recently estimated that the total United States environmental services industry generates revenues of $180-200 billion per year. ENVIRONMENTAL BUSINESS JOURNAL has indicated that the remediation industry accounted for approximately $6.1 billion of revenue in 1997. Driven largely by legislation passed during the late 1970's and early 1980's in response to widespread public concern regarding clean air and water, the environmental services business has expanded rapidly during the past decade. The Company is involved primarily in the remediation segment of the industry, which 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 facility closures. Since 1994, increased pressure to create uses for contaminated and idle properties has driven a rise in industrial redevelopment or "Brownfield" site remediation programs. The term "Brownfield" comes from an EPA sponsored program to study the redevelopment of "abandoned, idled, or underused industrial -3- 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. 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. THE WATER TREATMENT INDUSTRY According to Merrill Lynch in its GLOBAL WATER INDUSTRY OUTLOOK dated October 1, 1997, the global water treatment market is currently estimated in excess of $300 billion and expected to exceed $400 billion by the turn of the century. There is an overwhelming percentage of the population, both domestically and internationally, who are either consuming impure water or directly dumping sewage. There are 45 million people in the U.S. and 40% of the world's population drinking contaminated water. Ninety percent of the world's population dumps raw sewage. The water treatment industry is experiencing various trends, including concurrent substantial growth and consolidation. These trends include: - - CONSOLIDATION: There are currently 50,000 companies in the U.S. providing services, equipment and supplies to the industry, allowing substantial opportunity for consolidation through merger and acquisition. - - TURN KEY FIRMS: Clients are looking for firms which can supply "cradle to grave" services to solve their water treatment problems. Total solution companies are generally providing these services by acquiring specialty companies and combining the multiple services under one umbrella. Customer needs are driving the consolidation process. -4- - - PRIVATIZATION/CONTRACT OPERATIONS: Through favorable changes in IRS regulations, the privatization market is beginning to accelerate in the U.S. New rules allow for 30-year operations contracts (instead of the previous 5-year contracts) in conjunction with tax exempt financing. This is a critical driver in the marketplace. - - DETERIORATING INFRASTRUCTURE: Many municipal wastewater treatment facilit- ies in the U.S. were constructed in the late 60's and early 70's using fed- eral grant monies. These facilities are coming to the end of their useful lives, but there are no longer any grant programs. This is driving the move to public/private partnerships for financing and operating new facilities. - - GLOBALIZATION: Increased industrialization in emerging economies is driv- ing the need for water/wastewater treatment. Many do not have adequate water supplies which makes this process even more important. European and American firms overwhelmingly lead in the developed technologies for these services. - - RISING WATER/WASTEWATER RATES: The supply of water has actually decreased slightly over the past decades due to the loss of replenishment into avail- able resources and pollution of fresh water supplies. Population growth and economic demand has further pushed up the value of existing supplies. This increased cost of water is driving the market for reuse and recycling of these supplies, increasing the number and type of treatment opportunities. - - INDUSTRIAL WATER: The need for ultrapure process water in the power, mining, semiconductor, pharmaceutical, food processing and other industries is expected to double over the next six years. Advanced manufacturing techniques are driving this increase. This current market is $9 billion and is expected to reach $15 billion by the year 2000. - - INDUSTRIAL WASTEWATER: Regulatory pressures are driving industrial firms to upgrade wastewater treatment and pre-treatment facilities. Because the operation and compliance reporting for these facilities is complex and not part of their core business, more industrial firms are outsourcing for these services. ORGANIZATION OF THE COMPANY The Company is organized into three primary business lines: industrial services, which includes in-plant maintenance, environmental remediation and emergency response; federal government programs; and water/wastewater services. This is overlaid with a geographic structure in which each office is able to provide manpower and equipment to support projects in each of the business lines. The Company utilizes the following resources to provide turnkey services to its customers: - Registered engineers, geologists and earth scientists for performing investigations and remediation feasibility studies. - In-house laboratory facilities for evaluating water treatment techniques, numerous remedial technologies, monitoring ongoing projects, and accelerating remediation. - Engineers, earth scientists and construction managers to design remedia- tion and water/wastewater treatment systems from the conceptual stage through final design. -5- - A team of certified water treatment system operators to provide design, construction, consultation and operation for municipal, industrial, and mining wastewater treatment. - 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. - 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, and for water/wastewater treatment, collection and distribution facilities. This can include assessment and characterization studies, conceptual design, detail design, construction and installation, and operation and maintenance. 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. REMEDIATION SERVICES. The Company believes it has a solid reputation for responsiveness and technical excellence in providing turnkey remediation services, utilizing a variety of innovative technologies. 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: - Mechanical Maintenance and Construction - Facility Decontamination and Demolition - Waste Area Closures - Drum Removals - Lab Packing and Waste Services - Excavation, Transport and Disposal of Waste - Remote System Monitoring - System Optimization WATER AND WASTEWATER TREATMENT. The Company has gained a comprehensive body of experience in performing a variety of traditional and innovative water and wastewater treatment services. The following treatment technologies are currently being used successfully by the Company in the performance of municipal and industrial wastewater treatment projects: X Filtration X Ultraviolet Treatment X Chemical Precipitation X Dissolved Air X Reverse Osmosis X Recirculated Air X Ion Exchange X Activated Sludge The Company has full turnkey capability for treatment plants, collection and distribution systems, and ancillary facilities. The key water/wastewater services provided to both public and private sector clients include: -6- FACILITY DESIGN AND CONSTRUCTION. 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 utilizes automated design tools and incorporates ongoing constructability and operability revenues to ensure a highly efficient facility. The Company employs state of the art construction management techniques to efficiently construct facilities 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. The Company is also capable of performing non-disruptive, in situ pipeline leak detection and repair. LAB CAPABILITIES. The Company has an in-house laboratory designed and certified to meet the needs of 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 responsibilities in the hands of the Company's qualified team of professionals. 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 Coastal Arco FINANCIAL First Interstate Bank Bank of America Seafirst Bank Bank One Wells Fargo Bank Principal Financial Group MANUFACTURING AND PROCESSING Monsanto Chemical ConAgra Georgia Pacific Pacific Gas & Electric Hewlett-Packard Intel GOVERNMENT (FEDERAL AND STATE) U.S. EPA Oregon Dept. of Environmental Quality U.S. Army Corps of Engineers Colorado Dept. of Health U.S. Dept. of Transportation Missouri Dept. of Natural Resources U.S. Dept. of Energy Arizona Dept. of Environmental Quality -7- The Company was 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 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. In December 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 is estimated at $292 million. The Company has received in excess of 90 delivery orders with an approximate contract amount of $33 million to date under this contract. In September 1997, the Company was selected as the successful bidder for the ERRS contract in Region X. This contract also runs for five years and is estimated at $42 million. To date, the Company has received seven delivery orders with an approximate contract amount of $5 million under this contract. The ERRS contracts, like most of the Company's other government contracts, are "basic ordering documents," not binding agreements requiring the performance of work by the Company and payment by the government. This occurs only when the government issues delivery orders under the contract. Management believes, based on its prior experience with government contracts, that the Company will receive delivery 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. In 1997 the Company was issued two delivery orders valued at approximately $11 million. 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. The Company has Master Service Agreements or emergency response contracts with approximately 100 clients. These include ABF Freight, Arco Chemical, Bank of America, Burlington Northern, Conoco, Exxon, Georgia Pacific, Monsanto, Ryder Truck, Texaco, U.S. Coast Guard and United Parcel Service. Master Service -8- 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: - 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. - Privatization and outsourcing of drinking water and sewage treatment systems in the U.S. and internationally will provide a large and expanding opportunity well into the next century. - Remediation at active industrial sites under the RCRA corrective action program represents an important private sector segment in an early stage of development. - 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 by broadening the mix of related services performed for each client. Management has identified several areas of interest for expansion including additional work in the areas of base closure services to the U.S. Government, in plant services for industrial clients, 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 reasonable 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 large 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. The Company also intends to increase the number of operations and maintenance contracts, both for water/wastewater facilities and industrial services. These contracts are generally longer term, providing a more sustainable revenue base. -9- 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 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 and treatment alternatives, and by efficient and effective job site performance. PROFESSIONAL MARKETING AND MANAGEMENT. The Company is committed to maintaining a professional marketing and project management 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. This includes understanding 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 government contracts to assist with both bidding and managing projects. STABLE WORK FORCE. The Company strives to maintain a stable, dedicated work force of experienced professionals, managers, administrative personnel, and trained operators and laborers. The Company seeks to attract and retain such employees by providing fair compensation, 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 experienced work force will continue to contribute to the Company's excellent safety record, reducing insurance costs and increasing customer satisfaction. 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 on a centralized basis. The Company pursues federal contracts which range from $5 million to $70 million annually. On larger opportunities, the Company may establish teaming agreements with large engineering/construction firms to enhance the chances for award. 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 Managers or the 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 -10- 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. 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 high quality 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 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 framework -11- 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. 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, such as EPA mandated registration and upgrade of USTs, also leads to business for the Company. The federal laws and regulations described below constitute the major actions that have caused industry growth in the environmental and water/wastewater 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. 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"). This legislation, 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 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. 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. -12- 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. The Company anticipates that UST-related business opportunities will be substantial in 1998, and that a significant number of UST owners will not meet the deadline, providing further opportunities for several years. 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. The CWA requires, under certain circumstances, pretreatment of industrial wastewater before discharge into municipal treatment facilities. The EPA and delegated state agencies are also placing some non-complying municipalities under enforcement schedules. These regulations are creating the need for the upgrade or construction of new treatment facilities by both industrial and municipal entities. 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, quality control, health and safety 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 -13- 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 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. The Company is not aware of any pending litigation of this nature, and has not established any reserves for potential liabilities. 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 will necessarily 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 at times, 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 may be 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 -14- 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 required to obtain such bonds in the future. 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 its total amount of bonds outstanding exceeds the limits imposed by bonding companies based on the financial condition of the Company at any given time. Bonds typically cost between 1% and 3% 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 150 part time at its 11 offices, including four Company officers. 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. While all of the Company's projects 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 regular laborers as possible to staff projects, the location and other factors affecting projects 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 PROPERTIES. 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 services are conducted from the following spaces: -15- CURRENT LEASE MONTHLY SQ. FT EXPIRATION RENT - ------------------------------------------------------------------------------ 14761 BENTLEY CIRCLE TUSTIN, CALIFORNIA 18,490 April 14, 1999 10,169.50 - ------------------------------------------------------------------------------ 150 WEST DAYTON STREET EDMONDS, WASHINGTON 5,000 April 30, 1998 3,548.04 - ------------------------------------------------------------------------------ 170 WEST DAYTON, STE. 106A EDMONDS, WASHINGTON (NEW OFFICE LOCATION RENT TO COMMENCE MAY 1, 1998) 6,920 March 31, 2001* 8,073.00 - ------------------------------------------------------------------------------ 170 WEST DAYTON, STE. 106 B-D EDMONDS, WASHINGTON (NEW WAREHOUSE SPACE) RENT COMMENCED MARCH 1, 1998 5,568 March 31, 2001* 3,062.40 - ------------------------------------------------------------------------------ 3033 RICHMOND PARKWAY, STE. 300 RICHMOND, CALIFORNIA 7,664 April 30, 2001 6,438.00 - ------------------------------------------------------------------------------ 6900 E. 47TH AVENUE DRIVE, SUITE 200 DENVER, COLORADO 11,051 July 31, 1998 2,993.00 - ------------------------------------------------------------------------------ 525 SOUTH MADISON TEMPE, ARIZONA 3,254 August 31, 1998 1,952.00 - ------------------------------------------------------------------------------ 7670 S. VAUGHN COURT, STE. 130 ENGLEWOOD, COLORADO 4,600 July 31, 1998 4,622.00 - ------------------------------------------------------------------------------ 5275, 5251, & 5315 NW ST. HELENS ROAD PORTLAND, OREGON 3,000 January 6, 1999 3,500.00 - ------------------------------------------------------------------------------ 150 NOEL STREET MOBILE, ALABAMA 20,000 April 30, 2000 3,275.00 - ------------------------------------------------------------------------------ 13120 CARRERE COURT NEW ORLEANS, LOUISIANA 13,520 April 14, 2001* 3,771.21 - ------------------------------------------------------------------------------ 3222 PASADENA FREEWAY PASADENA, TEXAS 2,755 May 31, 2001 4,375.00 - ------------------------------------------------------------------------------ 275-A INDUSTRIAL DRIVE JACKSON, MISSISSIPPI 11,325 October 31, 3,080.00 1998* - ------------------------------------------------------------------------------ *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 -16- a defendant is likely to have a material adverse effect on the Company's financial position or results of operations. On February 13, 1998, the Company filed suit in the United States District Court for the District of Oregon against Road Runner Oil, Inc. and Bernard J. Roscoe, alleging breach of contract for non-payment of services performed by the Company at an oil field in Roosevelt, Utah. The amount of unpaid invoices, including interest and collection costs, is approximately $1.8 million. The Company has also filed liens on all equipment at the site and on the mineral rights related to the oil field. Management believes that it has clear cause of action, and that between Road Runner and Mr. Roscoe, guarantor of the contract, there are ample assets to satisfy the claim. On February 27, 1998, the Company was granted a pre-judgment writ of attachment on certain equipment provided to Road Runner by the Company. The estimated value of this equipment is $700,000. 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. -17- 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 ----------------------------------------------------------- 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 ----------------------------------------------------------- March 31, 1997 7.875 5.00 ----------------------------------------------------------- June 30, 1997 5.625 4.25 ----------------------------------------------------------- September 30, 1997 6.9375 5.125 ----------------------------------------------------------- December 31, 1997 7.8125 6.00 (b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK. The number of record holders of the Company's common stock at March 21, 1998, was 88. 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 likely be, unable to meet its liabilities as they mature. ITEM 6. SELECTED FINANCIAL DATA. The following selected financial information for the years ended December 31, 1997, 1996, 1995, 1994, and 1993 is derived from financial statements of the Company audited by Grant Thornton LLP, independent certified public accountants. -18- Balance Sheet Data:
- ---------------------------------------------------------------------------------------- AT DECEMBER 31, - ---------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 - ---------------------------------------------------------------------------------------- CURRENT ASSETS $25,089,253 $18,423,472 $21,245,209 $6,478,993 $5,855,163 - ---------------------------------------------------------------------------------------- TOTAL ASSETS 29,882,811 23,795,317 25,707,851 7,591,699 6,406,740 - ---------------------------------------------------------------------------------------- CURRENT LIABILITIES 12,970,393 15,121,173 12,921,426 3,461,813 3,690,851 - ---------------------------------------------------------------------------------------- WORKING CAPITAL (DEFICIT) 12,118,860 3,302,299 8,323,783 3,017,180 2,164,312 - ---------------------------------------------------------------------------------------- LONG TERM DEBT 8,203,701 1,700,171 2,076,357 380,727 44,845 - ---------------------------------------------------------------------------------------- TOTAL LIABILITIES 21,174,094 16,821,344 14,997,783 4,179,977 4,421,245 - ---------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY 8,708,717 6,973,973 10,710,068 3,411,722 1,965,495 - ---------------------------------------------------------------------------------------- Statement of Income Data: - ------------------------------------------------------------------------------------------ FOR THE YEARS ENDED DECEMBER 31, - ------------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------ REVENUES $54,169,753 $54,918,520 $47,871,972 $23,506,066 $17,399,068 - ------------------------------------------------------------------------------------------ OPERATING EXPENSES 54,046,462 58,096,290 44,857,996 21,717,086 15,790,125 - ------------------------------------------------------------------------------------------ NET INCOME (LOSS) FROM CONTINUING OPERATIONS (347,291) (3,756,450) 2,034,997 1,623,804 1,547,501 - ------------------------------------------------------------------------------------------ NET INCOME (LOSS) FROM CONTINUING OPERATIONS PER COMMON SHARE (0.06) (0.74) 0.49 0.44 0.42 - ------------------------------------------------------------------------------------------ WEIGHTED AVERAGE SHARES 5,785,264 5,066,537 4,113,725 3,676,830 3,675,764 - ------------------------------------------------------------------------------------------ CASH DIVIDENDS PER COMMON SHARE -0- -0- -0- -0- -0- - ------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 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. -19- 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 provides these services from its offices in: Denver, Colorado; Houston, Texas; Jackson, Mississippi; Mobile, Alabama; New Orleans, Louisiana; Phoenix, Arizona; Portland, Oregon; Richmond, California; Seattle, Washington; and Tustin, California. In late 1996, the corporate offices of the Company were moved to Englewood, Colorado from Tustin, California. 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:
PERCENTAGE RELATIONSHIP TO PROJECT REVENUE PERIOD TO PERIOD YEAR ENDED CHANGE ------------------------------- ------------------- 1997 1996 VS. VS. 1997 1996 1995 1996 1995 ------ ------ ------ ------ ------- Project Revenue 100.0% 100.0% 100.0% (1.4%) 14.7% Project Costs: Direct 79.9 79.5 71.7 (0.9) 27.1 Indirect 10.6 14.9 14.7 (29.6) 16.1 - ----------------------------------------------------------------------------------- Gross Profit (Loss) 9.5 5.6 13.6 66.5 (52.5) Other Operating Expenses (Income): Selling 3.8 5.6 3.7 (33.3) 77.5 General Admin- istrative 5.4 5.8 4.3 (7.0) 53.0 Amortization of Excess of Ac- quired Net Assets in Ex- cess of Cost 0.0 0.0 (0.7) - (100.0) - ---------------------------------------------------------------------------------- Operating Income (Loss) 0.3 (5.8) 6.3 103.9 (205.4) Other Income (Expense) (1.1) (1.7) (0.7) (36.5) (185.7) - ---------------------------------------------------------------------------------- Income (Loss) Before Taxes on Income (0.8) (7.5) 5.6 88.8 (252.3) Taxes on Income (0.2) (0.7) 1.4 66.8 (152.0) - ----------------------------------------------------------------------------------- Net Income (Loss) (0.6%) (6.8%) 4.2% 90.8% (284.6%) - ----------------------------------------------------------------------------------- -20- Pro Forma Information (Note 1): Historical Earn- ings Before Income Taxes -- -- 5.6% -- -- Pro Forma Income Taxes -- -- 1.8% -- -- Pro Forma Net Income -- -- 3.8% -- --
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 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. The Company experienced a slight decrease in revenues (1.4%) from 1996 to 1997, compared to a 14.7% increase from 1995 to 1996. As expected with the award of the EPA ERRS contracts, the proportion of non-EPA work was reduced in 1997 from 80.2% to 61.2% of total revenue. The Company's goal is to maintain a relatively equal distribution of revenues from government contracts and commercial contracts to produce a solid continuity of revenues, while optimizing margins. The following table sets forth the percentages of the Company's revenues attributable to the EPA vs. non-EPA public and private sector customers: YEAR ENDED DECEMBER 31, - ------------------------------------------------------------------------------ 1997 1996 1995 ----------------- ------------------ ----------------- Non-EPA $33,125,032 61.2% $44,065,990 80.2% $34,959,345 73.0% EPA $21,044,721 38.8% $10,852,530 19.8% $12,912,627 27.0% ----------------- ----------------- ----------------- Total $54,169,753 100.0% $54,918,520 100.0% $47,871,972 100.0% ================= ================= ================= Direct costs as a percentage of revenues remained relatively constant at 79.9% compared to 79.5% in 1996. Indirect expenses decreased significantly from $8,175,951 (14.9% of revenues) in 1996 to $5,752,064 (10.6% of revenues) in 1997. This decrease in indirect operating costs caused gross profit to increase from 5.6% of revenues in 1996 to 9.5% in 1997. The decrease in indirect operating costs were a result of the Company taking the following corrective actions: - Closed unprofitable offices in Atlanta, Birmingham, Georgetown, Kansas City, St. Louis and Tucson. - Reduced staff and realigned personnel classifications to better control indirect labor costs. - Restructured employee benefit programs to reduce cost. -21- - Hired new key financial management staff with significant industry experience. - Implemented revised processes and controls for contracts administration, revenue recognition, billing and collection, and accounts payable. These actions have significantly reduced overhead, but have not had any material impact on the Company's ability to perform current projects or obtain new work. Selling expenses also decreased significantly from $3,101,197 (5.6% of revenue) in 1996 to $2,070,130 (3.8% of revenue) in 1997. This decrease is the result of some reduction of the sales and proposal staff, and the refocusing of commercial sales efforts out to the regional offices. The Company also implemented a sales commission program, reducing the fixed salary component of sales costs. The changes have not impacted the Company's ability to continue to win new work in both the government and commercial sectors. General and administrative expenses decreased slightly from $3,158,707 (5.8% of revenue) in 1996 to $2,937,762 (5.4% of revenue) in 1997. This decrease was due primarily to lower insurance costs. Amortization of acquired net assets in excess of cost of $337,437 in 1995 resulted from the estimated fair value of net assets purchased exceeding the purchase price 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. Interest expense (net) increased from $627,537 in 1996 to $704,575 in 1997, due primarily to increased borrowing. The increased borrowings were necessary because of the build up of accounts receivable and contracts in process as revenues grew in the second half of the year. In 1996, the Company was able to carryback losses equivalent to 1995 profits for federal tax purposes, resulting in a federal tax benefit of $341,855 for 1996 and $113,547 in 1997. There amount of loss carryforward available for federal tax purposes in 1998 is approximately $2.3 million. 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 traditionally made distributions of cash to its shareholders in approximately the 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. 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 were reclassified from retained earnings to paid-in capital accounts. In summary, the Company undertook a variety of corrective actions as described above beginning in late 1996. These have resulted in significant improvement to financial performance in the second half of 1997. Both revenues and net income were up markedly in the second half of 1997 as compared to both the second half of 1996 and the first half of 1997, as reflected in the following table: -22- JULY-DECEMBER JANUARY-JUNE JULY-DECEMBER 1996 1997 1997 - ---------------------------------------------------------------------------- REVENUE $27,904,819 $20,111,396 $34,058,357 - ---------------------------------------------------------------------------- NET INCOME (LOSS) $(3,788,581) $(1,421,492) $1,074,201 BONDING The amount of bonding capacity offered by sureties is a function of the financial health of the company requesting the bond. At March 1998, the bonding capacity for the Company was in excess of $25 million. LIQUIDITY AND CAPITAL RESOURCES Working capital increased by $8,816,561 from $3,302,299 at December 31, 1996 to $12,118,860 at December 31, 1997. The current ratio increased in the same period from 1.22 to 1.93. Current assets increased by $6,665,781 primarily from increases in accounts receivable - net ($2,588,123) and contracts in process ($6,687,357) due to significantly higher revenues in the second half of 1997 ($34,058,357) compared to the second half of 1996 ($27,904,819). This was partially offset by reductions in cash of $1,543,123 and income tax receivable of $1,262,436. The Company also increased working capital through a private placement of common stock as described below. Current liabilities decreased by $2,150,780. This was due to a reduction in the current portion of debt of $5,264,496 which was partially offset by an increase in accounts payable and accrued expenses of $3,113,716. Equipment and improvements (net) decreased by $1,079,924 due to an excess of depreciation over capital expenditures, which were relatively low at approximately $450,000. Goodwill increased by $156,584. This was the result of acquiring WQM. The acquisition was treated as a purchase, with resultant goodwill of $174,877. WQM is currently maintained as a wholly owned subsidiary and consolidated accordingly. Deposits and other assets increased by $345,053. This was due to deposits made on custom remediation equipment delivered in early 1998. Capital resources are used primarily to fund the acquisition of capital equipment and provide 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 revolving 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 of $4 million to the Company. 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 on a term basis, with interest at Comerica's base rate plus 2.0 percent. The loan is collateralized by certain fixed assets of the Company. In 1995, the Company -23- borrowed an additional $300,000, in loan amounts of $195,000 and $105,000, from Comerica also on a term basis, with interest payable monthly at Comerica's base rate plus 2.0 percent. These loans were 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 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. 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 Company issued Subordinated Notes, coupled with warrants to purchase shares of common stock at an exercise price of $1.20 per share which could be exercised on or before December 31, 1996. The Subordinated Notes were offered on a selective, privately arranged basis, and bore interest at ten percent per annum, payable monthly, and were 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 were 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 which with extensions are now due on February 28, 1999 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. This note was also extended to February 28, 1999. 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, 1997, the combined balance due on these loans was $142,847. 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 provided up to $6,000,000 of credit to the Company based upon a percentage (75%) of eligible receivables. In addition, the Company borrowed $124,940 from the Bank for the purchase of equipment. This bank also loaned the Company $600,000 to pay off term loans at Comerica. Interest was payable monthly at the Bank's Reference Rate plus .25%. 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. -24- On May 30, 1997 the Company entered into a new financing agreement with National Bank of Canada. This agreement is comprised of a line of credit of $9,000,000 based upon a percentage (80%) of qualifying receivables, and an equipment term loan of $1,000,000. The $9,000,000 line provides that up to $1,000,000 can be used for capital expenditures. Interest is payable monthly at the Bank's Reference Rate plus .25%. This rate may be adjusted up or down an additional .25% depending upon the Company's profitability. Upon execution of the new loan agreement, proceeds of $3,108,390 were used to pay off all outstanding indebtedness to Union Bank. As of December 31, 1997, the balance owed on the new line of credit was $6,198,631 and on the equipment loan was $950,000. The Company has also financed vehicles and equipment using long term capital leases from various entities. As of December 31, 1997, the combined balance due on these leases was $877,227. Management believes that funds provided from operations, the new line 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. During 1997, the Company decreased its available cash by $1,543,123. Net cash used in operations was $3,958,059 which was largely caused by the significant increase in accounts receivable and contracts in progress due to the high level of revenues in the third and fourth quarters. This increase was partially funded by a corresponding increase in accounts payable and accrued expenses. Cash used in investing activities was $649,745. This was comprised of $462,947 for capital expenditures and $186,798 for the purchase of Water Quality Management Corporation. Net cash provided by financing activities was $3,064,681. This was primarily from net proceeds of the private placement of common stock of $2,035,662 and a net increase on the line of credit of $1,997,981. These were partially offset by payments on capital leases of $327,230 and payoff of the short term shareholder loan from Signal Hill Petroleum Inc. of $545,000. 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 totaling $2,035,662. The shares issued pursuant to this offering were classified as "restricted securities" as such term is defined in Rule 144 of the Securities Act of 1933. The Company completed an S-3 registration of these shares for resale which was effective January 7, 1998. 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. CAPITAL COMMITMENTS. The Company has entered into leases for its Existing facilities with such leases expiring at various dates through 2001. Monthly rentals currently are approximately $58,900 in the aggregate. Management anticipates that capital expenditures will increase in 1998 and will be funded from working capital, term loans and equipment leases. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not Applicable. -25- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Please see pages F-1 through F-22. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The Directors and Executive Officers of the Company are as follows: Name Age Positions and Offices Held - ----------------- --- ---------------------------------------------- Steven H. Davis 44 Chief Executive Officer, President and Director Douglas W. Cotton 47 Executive Vice President, Chief Operating Officer, Secretary and Director Craig C. Barto 39 Director Robert A. Taylor 52 Director Rick C. Townsend 47 Executive Vice President, Chief Financial Officer, Secretary and Director John G.L. Hopkins 50 Senior Vice President - Federal Programs and Director There is no family relationship between any Director or Executive Officer of the Company. The Company has no Nominating Committee, but does have an Audit Committee, an Executive Committee and a Compensation Committee. The Audit Committee presently consists of Craig C. Barto and Robert A. Taylor. The Audit Committee reviews financial statements and data with the Company's independent accountants before the information and data are released to the public. The Executive Committee consists of Steven H. Davis, John G.L. Hopkins, Douglas W. Cotton and Rick C. Townsend. The Executive Committee has authority, during the intervals between the meetings of the Board of Directors, in the management of the business and affairs of the Company not contrary to the specific direction of the Board of Directors and except as provided by the Company's Bylaws. The Compensation Committee presently consists of Craig C. Barto and Robert A. Taylor. The Compensation Committee reviews compensation matters relating to the Executive Officers of the Company and makes recommendations to the Board of Directors, and administers the Company's Incentive Stock Option Plan. -26- Rick C. Townsend currently serves as an advisor to the Audit Committee, and Steven H. Davis serves as an advisor to the Compensation Committee. Set forth below are the names of all directors, nominees for director and executive officers of the Company, all positions and offices with the Company held by each such person, the period during which he has served as such, and the principal occupations and employment of such persons during at least the last five years: STEVEN H. DAVIS has served as the Company's Chief Executive Officer, President and a Director since 1991. Prior to that time he was operating partner of Lincoln Property Company which developed over 3 million square feet of buildings in California, Nevada and Colorado. He has almost 20 years of experience in construction, financing and developing industrial real estate. Mr. Davis graduated from Brown University with an emphasis in Economics and obtained an MBA from the University of Southern California. As President, Mr. Davis manages the Company's business affairs and has been instrumental in securing financing, negotiating bonding agreements, projecting and analyzing the feasibility of expansion, mergers and acquisitions, and formulating business relationships with customers, financial entities and the legal community. CRAIG C. BARTO has been a Director of the Company since 1991. He is also the President and Chairman of the Board of Directors of Signal Hill Petroleum, Inc., Barto/Signal Petroleum, Inc., Signal Hill Operating, Inc., and Signal Oil and Refining, Inc., which operate businesses such as Paramount and Fletcher oil refineries. A graduate of UCLA with a degree in Economics, Mr. Barto was instrumental in the growth of the Signal Hill Petroleum companies in the oil business in 1979 with the reclamation of a marginal operation in the West Newport Oil Field in Orange County, California. In addition to the oil and gas operations, Mr. Barto is also responsible for the commercial and residential development of over 100 acres of some of the last undeveloped hilltop property in Southern California. DOUGLAS W. COTTON has served as the Company's Executive Vice President and a Director since 1991 and is responsible for all aspects of the Company's operations in the Southwest, and provides guidance for marketing and sales to commercial clients nationwide. He was appointed Chief Operating Officer in October, 1996. Prior to joining the Company, Mr. Cotton served as Vice President of Ecova Corporation and worked for 13 years at IT Corporation where he held various positions culminating in serving as General Manager for the Gulf Coast Region. He has more than 20 years of experience managing on-site biological, chemical and physical remediation of hazardous wastes in sludge, soil and groundwater using a variety of innovative technologies. His knowledge of the industry has been gained at more than 100 remediation projects ranging from $100,000 to $45 million, including Superfund sites, emergency response cleanups and large excavation/on-site treatment projects. ROBERT A. TAYLOR has been a Director of the Company since 1996. He is a veterinarian and manages the Alameda East Veterinary Hospital in Denver, Colorado which he started in 1971. Currently, Alameda East Veterinary Hospital employs 55 persons and provides a small animal practice specializing in orthopedic and rehabilitation services. Dr. Taylor received a B.S. degree in Animal Science from Texas A&M University in 1969, a D.V.M. degree from Texas A&M University in 1970, and a M.S. degree in Veterinary Surgery from Colorado State University in 1978. RICK C. TOWNSEND has been Executive Vice President and Chief Financial Officer of the Company since November 1996, a Director since May 1997, and -27- Secretary since January 1998. From 1992 until October 1996, Mr. Townsend held the position of Vice President and Chief Financial Officer for the international operations of CH2M HILL, a major environmental consulting and engineering firm. In that role, Mr. Townsend managed all financial and administrative affairs for the unit. He also assisted in securing financing for international environmental and infrastructure projects, including water and wastewater treatment systems in Brazil and Canada. From 1990 until 1992, Mr. Townsend served as Vice President for The Futures Corporation, a business development and management services company. From 1974 until 1988, Mr. Townsend was employed by Morrison Knudsen Corporation where he held several positions including General Director and Group Business Manager of Morrison Knudsen Technologies. In these positions, he was exposed to several business sectors relevant to the Company's environmental contracting operations. Mr. Townsend received a degree in Economics from the University of California at Los Angeles in 1973. JOHN G.L. HOPKINS served as the Company's Senior Vice President-Federal Programs since 1990 and as a Director since 1991. Mr. Hopkins has advised the Company that his term as a Director will end at the next Annual Meeting of Shareholders and that effective July 1, 1998, he will retire as an officer. He has agreed to continue to provide services to the Company on a consulting basis, as needed. From 1990 to October 1996, he was also Chief Operating Officer. Since October 1996 he has been Senior Vice President - Federal Programs. With more than 20 years of experience in managing large-scale hazardous waste remediation projects, Mr. Hopkins is presently responsible for the Company's operations in the Northwest and all Federal government programs. Previously, he held senior management positions with Hydro-Search, Inc., Riedel Environmental Services, Inc. and IT Corporation. Mr. Hopkins has managed more than 500 remedial action projects in 24 states and has negotiated and managed three large multi-year indefinite delivery contracts with the EPA totaling more than $350 million. Mr. Hopkins graduated from the University of Southern California in 1973 with a Bachelor of Science degree in Chemistry and Biological Sciences. His publications include work involving sampling protocols and emergency response. The Company's executive officers hold office until the next annual meeting of directors of the Company, which currently is scheduled for June 2, 1998. There are no known arrangements or understandings between any director or executive officer and any other person pursuant to which any of the above- named executive officers or directors was selected as an officer or director of the Company. SECTION 16(A) BENEFICIAL REPORTING COMPLIANCE Based solely on a review of Forms 3 and 4 and amendments thereto furnished to the Company during its most recent fiscal year, and Forms 5 and amendments thereto furnished to the Company with respect to its most recent fiscal year and certain written representations, four persons who were officers and directors of the Company failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal year. Steven H. Davis and John G. L. Hopkins each filed two late reports each of which reported one transaction; Douglas W. Cotton filed two late reports which reported a total of four transactions; and Craig C. Barto filed one late report reporting one transaction. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth information concerning the compensation received for services rendered in all capacities to the Company for the years ended December 31, 1997, 1996 and 1995, by the Company's President and each other executive officer whose compensation exceeded $100,000 during such years. -28- SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION --------------------------------- ANNUAL COMPENSATION AWARDS PAYOUTS ------------------------------ ----------------- --------------- SECURI- TIES OTHER UNDERLY- ANNUAL RE- ING ALL COMPEN- STRICTED OPTIONS/ OTHER NAME AND PRINCIPAL SATION STOCK SARs LTIP COMPEN- POSITION YEAR SALARY BONUS AWARD(S) (NUMBER) PAYOUTS SATION - ------------------ ---- ------ ----- ------ -------- -------- ------- ------- Steven H. Davis, 1997 $ 84,907 $ 0 $1,003 0 0 0 $0 Chief Executive 1996 $ 79,150 $ 0 $ 951 0 0 0 $0 Officer 1995 $126,160 $ 0 $1,027 0 0 0 $0 John G.L. Hopkins, 1997 $123,183 $ 0 $ 0 0 0 0 $0 Senior Vice Presi- 1996 $125,000 $ 0 $ 0 0 0 0 $0 dent - Federal 1995 $124,923 $ 0 $ 0 0 0 0 $0 Programs Douglas W. Cotton, 1997 $ 32,147 $ 0 $ 425 0 0 0 $0 Executive Vice 1996 $ 63,831 $ 0 $1,038 0 0 0 $0 President and 1995 $124,000 $5,652 $1,873 0 0 0 $0 Chief Operating Officer Rick C. Townsend, 1997 $125,587 $ 0 $ 958 0 0 0 $0 Chief Financial 1996 $ 16,827 $ 0 $ 0 0 60,000 0 $0 Officer _______________ Includes matching 401K contributions by the Company and automobile expenses.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES SECURITIES UNDERLYING VALUE OF UNEXER- SHARES UNEXERCISED CISED IN-THE ACQUIRED OPTIONS MONEY OPTIONS/ ON SARs AT FY-END SARs AT FY-END EXERCISE VALUE EXERCISABLE/ EXERCISABLE/ NAME (NUMBER) REALIZED UNEXERCISABLE UNEXERCISABLE ---- -------- -------- -------------- --------------- Steven H. Davis -0- -0- 0/0 $0 / $0 John G. L. Hopkins -0- -0- 0/0 $0 / $0 Douglas W. Cotton -0- -0- 0/0 $0 / $0 Rick C. Townsend -0- -0- 20,000/40,000 $53,750/$107,500 -29- The Company has no formal employment agreements with any of its Executive Officers. The Company does have a letter agreement with Rick C. Townsend, the Company's Chief Financial Officer, regarding his employment which provides that he is to receive an annual salary of $125,000 and bonuses based on certain net profit levels achieved by the Company. Either the Company or Mr. Townsend may terminate his employment without notice. However, Mr. Townsend is entitled to six months' severance pay on termination by the Company. 401K PLAN The Company has a Non-standardized Cash or Deferred Profit Sharing Plan pursuant to which all eligible employees may contribute a portion of their income. Company contributions to the Profit Sharing Plan are discretionary. The Company does, however, make a matching contribution in the amount of 25 percent of the first six percent of all elective deferrals. STOCK OPTION PLAN On March 1, 1995, the Company adopted an Incentive Stock Option Plan (the "Plan") for key personnel. A total of 550,000 shares of 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 currently 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 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 Board of Directors may adopt, amend and rescind such rules and regulations as in its opinion may be advisable for the administration of the Plan. The Board of Directors may also construe the Plan and the provisions in the instruments evidencing the Options granted under the Plan and make all other determinations deemed necessary or advisable for the administration of the Plan. The Board of Directors has broad discretion to determine the number of shares with respect to which Options may be granted to participants. 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 Common Stock on the date of grant. However, any Option granted under the Plan to a person owning more than 10 percent of the Common Stock shall be at a price of at least 110 percent of such fair market value. During May 1995, options for 181,000 shares of Common Stock had been granted under the Plan, at an exercise price of $3.50 per share, of which options for 90,500 shares will vest over a five-year period commencing May 1, 1996 and the remaining options for 90,500 shares will vest over a five-year period only upon the occurrence of certain circumstances. On December 31, 1995, 13,500 of such remaining options were granted and immediately vested for two employees terminated in October, 1995. The Company recorded compensation expense of $20,356 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. On January 1, 1996, it was determined that the contingent events did occur as to 33,000 of the remaining shares, with vesting thus commencing one year later. The remaining options totaling 44,000 shares of those originally granted in May, 1995, were cancelled because the events upon which they were contingent did not occur. -30- Options to purchase 5,000 shares of common stock at $3.50 per share, granted in May 1995, were canceled prior to December 31, 1995, due to the termination of the employment of one employee. Prior to January 1, 1996, no options were granted to any executive officer of the Company except Kathleen V. Dunlap, a former Treasurer and Chief Financial Officer. Ms. Dunlap received options for 20,000 shares in the aggregate, as part of the original 181,000 shares. The vesting on all 20,000 shares was accelerated to May 15, 1996 related to Ms. Dunlap's termination due to a terminal illness. On January 8, 1996, the Board of Directors granted options to seven employees to purchase an aggregate of 45,000 shares. Options as to 30,000 shares vest over a five-year period commencing on the date of grant and are exercisable at $9.00 per share until 10 years after the date of grant. Options as to 10,000 shares vest over a five-year period commencing on April 10, 1997. The Options as to the remaining 5,000 shares were issued to an employee who is the wife of Douglas W. Cotton, an Officer and Director of the Company, and vest 20% immediately with the remainder vesting over a four-year period commencing on the date of grant and are exercisable at $9.90 per share until five years after the date of grant. On February 29, 1996, options to purchase 10,000 shares granted on January 8, 1996, with an exercise price of $9.00 per share were cancelled upon the termination of an employee. On February 21, 1996, the Board of Directors granted options to an employee to purchase up to 5,000 shares of Common Stock. These options vest over a five-year period commencing on the date of grant and are exercisable at $9.70 per share until ten years after the date of grant. On May 1, 1996, the Board of Directors granted an option to Keith Conti, who was then the Company's principal financial officer, to purchase 10,000 shares of Common Stock at $10.625 per share. On March 28, 1997, these options were cancelled in conjunction with the termination of Mr. Conti's employment. On May 14, 1996, the Board of Directors granted options to seven employees to purchase an aggregate of 22,500 shares of Common Stock at $11.875 per share. These options vest over a five year period commencing on the date of grant, and are exercisable until ten years after the date of grant. On November 14, 1996, the Board of Directors granted an option to Rick C. Townsend, the Company's Executive Vice President and Chief Financial Officer to purchase 60,000 shares of Common Stock at $4.25 per share. This option vests as to 20,000 shares on each anniversary of the date of grant and expires on November 4, 2001. On December 2, 1996, the Board of Directors granted an option to an employee to purchase 7,500 shares of Common Stock at $5.00 per share. This option vests as to 1,875 shares on each anniversary of the date of grant and expires on December 2, 2001. On December 5, 1997, the Board of Directors granted options to ten employees to purchase an aggregate of 72,500 shares of Common Stock at prices ranging from $7.00 to $7.70 per share. The options vest over periods of five to six years and expire ten years after the date of grant. In connection with these grants, options to purchase 40,000 shares at an average exercise price of $10.01 per share were cancelled. On August 13, 1996, the Company filed a registration statement on Form S-8 to register the 550,000 shares of the Company's Common Stock reserved for the Company's Incentive Stock Option Plan. -31- During 1997, unvested options totaling an aggregate amount of 25,200 shares with an average exercise price of $8.30 were cancelled due to the termination of five employees. In addition, vested options totaling 5,200 shares with an average exercise price of $5.09 were cancelled due to the termination of five employees who did not exercise their options prior to the expiration date stipulated in the option agreement. As of December 31, 1997, options for 80,325 shares were exercisable at prices ranging from $3.50 to $11.88 per share. If an optionee ceases to be employed by the Company for any reason other than death or disability, the optionee may exercise all Options within three months following such cessation to the extent exercisable on the date of cessation. If an optionee dies while employed by the Company, or during the three-month period following termination of the optionee's employment, or if the optionee becomes disabled, the optionee's Options, unless previously terminated, may be exercised, whether or not otherwise exercisable, by the optionee or his legal representative or the person who acquires the Options by bequest or inheritance at any time within one year following the date of death or disability of the optionee. An Option granted under the Plan is not transferable by the optionee other than by will or by the laws of descent and distribution and, during the lifetime of the optionee, may be exercised only by the optionee, his guardian or legal representative. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation", which requires entities to calculate the fair value of stock awards granted to employees. This statement provides entities with the option of either electing to expense the fair value of employee stock-based compensation or continuing to recognize compensation expense under existing accounting pronouncements and to provide proforma disclosures of net income and, if presented, income per share, as if the above-mentioned fair market value method of accounting was used in determining compensation expense. Additionally, the statement requires that all equity awards granted to nonemployees such as suppliers of goods and services be recognized based on fair value. The Company has elected the proforma method of disclosure. Under this method, 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 1997 and 1996: no expected dividends; expected volatility of 74.77%; risk free interest rate of 6.07%; and expected lives of five years. Using these assumptions, the Company's net income(loss) and earnings(loss) per common share would have been: 1997 1996 Net income(loss) --------- ----------- As reported $(347,291) $(3,756,450) Pro Forma (495,586) (3,854,017) Earnings(loss) per common share As reported $ (0.06) $ (0.74) Pro Forma (0.09) (0.76) -32- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth the number and percentage of shares of the Company's no par value common stock owned beneficially, as of April 10, 1998, by any person, who is known to the Company to be the beneficial owner of 5% or more of such common stock, and, in addition, by each Director of the Company, and by all Directors and Officers of the Company as a group. Information as to beneficial ownership is based upon statements furnished to the Company by such persons. NAME AND ADDRESS AMOUNT AND NATURE OF PERCENT OF BENEFICIAL OWNERS BENEFICIAL OWNERSHIP OF CLASS - ------------------------ -------------------- -------- Craig C. Barto 703,554 12.1% 2440 Bayshore Drive Newport Beach, CA 92663 Douglas W. Cotton 635,314 (1) 11.0% Four Bowditch Irvine, CA 92720 Steven H. Davis 1,262,563 (2) 21.7% 7625 S. Yampa Street Aurora, CO 80016 John G. L. Hopkins 550,125 9.5% 120 West Dayton #A-7 Edmonds, WA 98020 Robert A. Taylor 10,496 0.2% 9870 East Alameda Denver, CO 80231 Rick C. Townsend 20,000 (3) 0.3% 10816 Eagle Crest Court Parker, CO 80134 All directors and executive 3,182,052 54.6% officers as a group (6 persons) __________________ (1) Includes 1,000 shares underlying stock options exercisable within 60 days held by Mr. Cotton's wife. (2) Includes 1,000 shares held by the wife of Mr. Davis. Also includes 73,656 shares held by relatives of Mr. Davis of which he disclaims beneficial ownership. (3) Represents shares underlying stock options exercisable within 60 days held by Mr. Townsend. There are no known agreements, the operation of which may at a subsequent date result in a change in control of the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Since July 1992, the Company has relied upon financing from the Birnie Trust. The mother-in-law of Steven Davis, the Company's President, is trustee of the Birnie Trust and Mr. Davis' wife is a beneficiary. The Company has borrowed -33- funds from the Birnie Trust pursuant to promissory notes due and payable on demand with the interest payable monthly. The Birnie Trust is also an investor in the Company's private offering of debt securities, described below. The total borrowings since July 1, 1992, were $2,269,000. However, the maximum principal amount outstanding at any one time was $671,800. In 1997 and 1996, the Company provided services to Signal Hill Petroleum, Inc., Paramount Petroleum and Fletcher Oil in the aggregate amount of approximately $835,000 and $340,000, respectively. These services include remediation services, ground water monitoring and site investigations for existing properties and environmental assessments in relation to property acquisition. Mr. Barto, Chairman of the Company, is a 50 percent owner of these businesses. 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 19 investors were given a warrant to acquire approximately 1,312 shares of Common Stock at approximately $1.20 per share, for an aggregate of 116,768 shares, and a Subordinated Note for the amount invested. The promissory notes were due on March 1, 1996, with interest of 10 percent per annum payable on the first day of each month commencing on April 1, 1995. Investors who held Subordinated Notes in the aggregate amount of $680,000 are related to Company management. The Birnie Trust held $400,000 of such Subordinated Notes and other relatives of Mr. Davis held $230,000 of such Subordinated Notes. A relative of Mr. Cotton held $50,000 of such Subordinated Notes. During August 1995, one of the Subordinated Notes in the principal amount of $80,000 was repaid. During November and December 1995, the 19 investors exercised their warrants to purchase a total of 116,768 shares of Common Stock. Eighteen (18) of the investors converted a total of $127,575 of the outstanding Subordinated Notes and one investor paid $12,600 in cash to exercise his warrant. On March 1, 1996, the remaining balances were repaid on all Subordinated Notes except for $471,800 (comprised of a $337,000 Note held by the Birnie Trust and $134,800 of Notes held by relatives of Mr. Davis) which was rolled over into new Notes, payable in one year with interest due monthly at ten 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 December 31, 1997, the Promissory Notes to the Birnie Trust totaling $537,000 and to the relatives of Mr. Davis totaling $134,800 were extended to February 28, 1999. On April 30, 1996, the Company loaned $105,764.38 to John G. L. Hopkins, 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. Since that date, several additional advances have been made to Mr. Hopkins bringing the total amount of the loan to Mr. Hopkins to approximately $148,000 (excluding accrued interest) as of December 31, 1996. On February 27, 1997, these loans were repaid in full by Mr. Hopkins. During 1997, the Company made additional advances to Mr. Hopkins and the balance due at December 31, 1997, was $100,010. Interest is payable monthly, and principal is due on demand. In order to meet short-term operating needs, the Company from time to time borrows money from affiliates of the Company. 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, then repaid in the amount of $300,000 on January 15, 1997, and $250,129 (including accrued interest) on February 27, 1997. -34- All of these transactions were approved by the Board of Directors and were made on terms as fair and reasonable to the Company as those that could be obtained from non-affiliated third parties. Any future transactions between the Company and its officers, directors, employees and affiliates that are outside the scope of the Company's employment relationship with such persons will be subject to the approval of a majority of the disinterested members of the Board of Directors based upon a determination that the terms are at least as favorable to the Company as those that could be obtained from unrelated parties. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. The following financial statements are filed herewith: PAGES Report of Independent Certified Public Accountants F-1 Consolidated Balance Sheets F-2 - F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Stockholders' Equity F-5 Consolidated Statements of Cash Flows F-6 - F-7 Notes to Consolidated Financial Statements F-8 - F-22 2. No financial statement schedules are required to be filed. 3. EXHIBITS. THE FOLLOWING EXHIBITS ARE FILED HEREWITH: EXHIBIT NUMBER DESCRIPTION LOCATION - ------------------------------------------------------------------------------- 3.1 Amended and Restated Articles Incorporated by reference to of Incorporation 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 Incorporated by reference to Agreement Exhibit 10.2 to the Company's Form SB-2 Registration Statement No. 33-91602 10.3 Loan Documents Between National Previously filed Bank of Canada and the Company 21 Subsidiaries of the Registrant Previously filed 23 Consent of Grant Thornton LLP Filed herewith electronically 27 Financial Data Schedule Previously filed (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. -35- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Amendment to be signed on its behalf by the undersigned, thereunto duly authorized. CET ENVIRONMENTAL SERVICES, INC. Dated: April 30, 1998 By /s/ Steven H. Davis Steven H. Davis President and Chief Executive Officer -36- 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, 1997 and 1996, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period then ended, in conformity with generally accepted accounting principles. /s/ Grant Thornton LLP GRANT THORNTON LLP Denver, Colorado March 6, 1998 F-1 CET Environmental Services, Inc. BALANCE SHEETS December 31, ASSETS 1997 1996 ----------- ----------- CURRENT ASSETS Cash $ 343,878 $ 1,887,001 Accounts receivable, less allowance for doubtful accounts; $642,097 in 1997 and $538,087 in 1996 10,042,516 7,454,393 Contracts in process 13,344,219 6,656,862 Retention receivable 268,949 - Income tax receivable 20,342 1,282,778 Due from related party 100,010 158,010 Other receivables 154,838 199,016 Inventories 248,417 171,642 Prepaid expenses 566,084 613,770 ----------- ----------- Total current assets 25,089,253 18,423,472 ----------- ----------- EQUIPMENT AND IMPROVEMENTS Field equipment and vehicles 5,931,499 5,672,638 Office furniture, equipment and leasehold improvements 1,795,996 1,591,910 ----------- ----------- 7,727,495 7,264,548 Less allowance for depreciation and amortization (3,921,131) (2,378,260) ----------- ----------- Equipment and improvements - net 3,806,364 4,886,288 GOODWILL, net of accumulated amortization of $57,684 in 1997 and $27,471 in 1996 509,228 352,644 DEPOSITS 477,966 132,913 ----------- ----------- $29,882,811 $23,795,317 ----------- ----------- ----------- ----------- The accompanying notes are an integral part of these statements. F-2 LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996 ----------- ----------- CURRENT LIABILITIES Note payable - line of credit $ - $ 4,200,650 Loan from shareholder - 545,000 Accounts payable 8,974,502 7,758,668 Accrued expenses 3,054,740 1,156,858 Current obligations under capital leases 293,957 329,934 Current portion of long-term debt 647,194 1,130,063 ----------- ----------- Total current liabilities 12,970,393 15,121,173 DEFERRED INCOME TAXES - - OBLIGATIONS UNDER CAPITAL LEASES 583,270 874,523 LINE OF CREDIT 6,198,631 - NOTES PAYABLE TO RELATED PARTIES 671,800 671,800 LONG-TERM DEBT 750,000 153,848 COMMITMENTS AND CONTINGENT LIABILITIES - - STOCKHOLDERS' EQUITY Common stock (no par value) - authorized 20,000,000 shares; 5,805,485 and 5,066,537 shares issued and outstanding at December 31, 1997 and 1996, respectively 8,235,589 6,165,977 Paid-in capital 567,953 555,530 Retained earnings (accumulated deficit) (94,825) 252,466 ----------- ----------- Total stockholders' equity 8,708,717 6,973,973 ----------- ----------- $29,882,811 $23,795,317 ----------- ----------- ----------- ----------- F-3 CET Environmental Services, Inc. STATEMENTS OF OPERATIONS Years ended December 31, 1997 1996 1995 ----------- ----------- ----------- PROJECT REVENUE $54,169,753 $54,918,520 $47,871,972 PROJECT COSTS Direct 43,286,506 43,660,435 34,343,855 Indirect 5,752,064 8,175,951 7,039,432 ----------- ----------- ----------- 49,038,570 51,836,386 41,383,287 ----------- ----------- ----------- Gross profit 5,131,183 3,082,134 6,488,685 ----------- ----------- ----------- OTHER OPERATING EXPENSES (INCOME) Selling 2,070,130 3,101,197 1,747,298 General and administrative 2,937,762 3,158,707 2,064,848 Amortization of excess of acquired net assets in excess of cost - - (337,437) ----------- ----------- ----------- 5,007,892 6,259,904 3,474,709 ----------- ----------- ----------- Operating income (loss) 123,291 (3,177,770) 3,013,976 ----------- ----------- ----------- OTHER INCOME (EXPENSE) Interest expense, net (704,575) (627,537) (326,331) Other income (expense) 120,446 (292,998) 4,144 ----------- ----------- ----------- (584,129) (920,535) (322,187) ----------- ----------- ----------- Income (loss) before taxes on income (460,838) (4,098,305) 2,691,789 (Benefit) taxes on income (113,547) (341,855) 656,792 ----------- ----------- ----------- NET INCOME (LOSS) $ (347,291) $(3,756,450) $ 2,034,997 =========== =========== =========== Weighted average number of shares outstanding 5,785,264 5,066,537 4,113,725 Net income (loss) per common share $ (0.06) $ (0.74) $ 0.49 =========== =========== =========== 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. STATEMENTS OF STOCKHOLDERS' EQUITY Years ended December 31, 1997, 1996 and 1995
RETAINED COMMON STOCK EARNINGS TOTAL --------------------- PAID-IN (ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT) 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 (loss) 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 Shares issued in private placement 729,248 2,035,662 - - 2,035,662 Exercise of stock options 9,700 33,950 - - 33,950 Issuance of stock options at exercise price below market value - - 12,423 - 12,423 Net income (loss) for the year - - - (347,291) (347,291) --------- ---------- -------- ----------- ----------- Balance at December 31, 1997 5,805,485 $8,235,589 $567,953 $ (94,825) $ 8,708,717 ========= ========== ======== ========== ===========
The accompanying notes are an integral part of these statements. F-5 CET Environmental Services, Inc. STATEMENTS OF CASH FLOWS Years ended December 31,
1997 1996 1995 ---------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (347,291) $(3,756,450) $ 2,034,997 Adjustments to reconcile net income to net cash net cash (used in) provided by operating activities: Depreciation and amortization 1,573,085 1,252,781 761,840 Amortization of excess of acquired net assets in excess of cost - - (337,437) Provision for bad debts 104,010 402,683 71,441 Deferred income taxes - 252,048 (250,756) Loss on sale of equipment - 13,304 18,842 Employee stock option plan 12,423 20,355 36,596 Changes in operating assets and liabilities: (Increase) decrease in accounts receivable (2,692,133) 5,499,747 (10,543,941) Increase in contracts in process (6,687,357) (443,372) (3,253,311) Decrease (increase) in income tax and other receivables 1,037,665 (1,335,263) (92,791) Decrease (increase) in prepaid expenses 47,686 (107,530) (415,462) (Increase) decrease in inventory and deposits (421,828) 50,210 (200,163) Increase (decrease) in accounts payable 1,215,834 (99,156) 6,220,408 Increase (decrease) in accrued expenses and income taxes 2,199,847 (533,861) 1,665,650 ----------- ---------- ---------- Net cash (used in) provided by operating activities (3,958,059) 1,215,496 (4,284,087) ----------- ---------- ---------- INVESTING ACTIVITIES: Purchase of equipment (462,947) (1,523,418) (2,779,478) Proceeds from sale of equipment - 65,641 1,848 Net purchase of subsidiary (186,798) - - ----------- ---------- ---------- Net cash used in investing activities (649,745) (1,457,777) (2,777,630) ----------- ---------- ---------- FINANCING ACTIVITIES: Proceeds from issuance of long-term debt 1,286,476 766,751 727,254 Payments on long-term debt (1,475,158) (917,592) (222,466) Payments on capital leases (327,230) (348,711) (134,185) Proceeds from credit line loan - net of payments 1,997,981 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 2,035,662 - 5,763,679 Proceeds from exercise of stock options 33,950 - (927,101) Proceeds from loans from shareholders - 545,000 357,865 Payments on loans from shareholders (545,000) - (357,865) Net payments from related party 58,000 (158,010) -
The accompanying notes are an integral part of these statements. F-6 CET Environmental Services, Inc. STATEMENT OF CASH FLOWS (CONTINUED) Years ended December 31,
1997 1996 1995 ---------- ---------- ---------- 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 3,064,681 1,652,627 7,106,417 ---------- ---------- ---------- DECREASE (INCREASE) IN CASH (1,543,123) 1,410,346 44,700 Cash at beginning of year 1,887,001 476,655 431,955 ---------- ---------- ---------- Cash at end of year $ 343,878 $1,887,001 $ 476,655 ========== ========== ========== Supplemental disclosures of cash flow information: Cash paid during the year Interest $ 717,980 $ 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 $ 301,965 $ 412,296 $ - ========== ========== ==========
The accompanying notes are an integral part of these statements. F-7 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS December 31, 1997 AND 1996 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 (the 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 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 revenue is 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. Revenue is 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 and indirect job costs and award fees related to projects in process. 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 three to seven years. Leasehold improvements are amortized over the lives of the respective leases or the service lives of the improvements, whichever is shorter. F-8 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) GOODWILL Goodwill is the excess of cost over the fair value of net assets acquired, and 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. 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. F-9 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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, 1997 and 1996 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, 1997 and 1996 is considered to approximate the market rate. 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 revenue and expenses during the reporting period. Actual results could differ from those estimates. IMPAIRMENT OF LONG-LIVED ASSETS In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF (SFAS 121). SFAS 121 requires that long-lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows (undiscounted and without interest) is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of that loss would be based on the fair value of the asset. SFAS 121 also generally requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of the carrying amount or the fair value, less cost to sell. SFAS 121 is effective for the Company's 1997 fiscal year-end. Any impairment provisions recognized in accordance with SFAS 121 are permanent and may not be restored in the future. No impairment expense was recognized in the years ended December 31, 1997 and 1996. LOSS PER COMMON SHARE The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 128, EARNINGS PER SHARE (SFAS 128). F-10 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SFAS 128 requires the presentation of basic earnings per share (EPS) and, for companies with potentially dilutive securities such as convertible debt, options and warrants, diluted EPS. EPS is computed in accordance with SFAS 128 by dividing net income by the weighted average number of shares outstanding during the period. All outstanding securities at the end of 1997 which could be converted into common shares are anti-dilutive (see note M). Therefore, the basic and diluted EPS are the same. There is no impact on EPS for prior years as a result of the adoption of SFAS 128. RECLASSIFICATIONS Certain financial statement reclassifications have been made in 1995 and 1996 to conform with presentations used in 1997. NOTE C -- CONTRACTS IN PROCESS Contracts in process consists of the following at December 31: 1997 1996 ----------- ---------- Government - EPA contracts $ 3,801,853 $ 648,973 Non-EPA contracts 9,542,366 6,007,889 ----------- ---------- Total $13,344,219 $6,656,862 =========== ========== 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 EPA. A new contract was awarded by the EPA in December 1996, with estimated maximum revenue of $292,000,000 over five years. As of December 31, 1997 and 1996, the net balance of accounts receivable from the EPA was $3,943,761 and $2,256,448, respectively. Revenue from the EPA in 1997 and 1996 amounted to approximately $21 million and $10.9 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; this note was paid in 1997. The Company also borrowed $671,800, which includes subordinated notes of $671,800 (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, 1999. The Company intends to repay these loans from revenue when sufficient funds are available. Interest expense attributable to these related party borrowings amounted to $73,544 and $55,898 for 1997 and 1996, respectively. F-10 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, 1997 and 1996 for fees amounting to approximately $835,000 and $340,000, respectively. The Company periodically makes advances to a officer and director of the Company. The balance due was $100,010 and $158,010 at December 31, 1997 and 1996, respectively. Interest is payable monthly at 10% per annum, and principal is due on demand. 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: 1997 1996 ---------- ---------- Vehicles $1,497,407 $1,497,407 Equipment 272,679 272,151 ---------- ---------- 1,770,086 1,769,558 Less accumulated depreciation (806,148) (465,228) ---------- ---------- Total $ 963,938 $1,304,330 ========== ========== 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, 1997: 1998 $ 422,258 1999 386,060 2000 253,612 2001 29,172 ---------- Total minimum lease payments 1,091,102 Less amounts representing estimated executory costs (taxes) 61,585 ---------- Net minimum lease payments 1,029,517 Less amount representing interest 152,290 ---------- Present value of net minimum lease payments $ 877,227 Current portion $ 293,957 Noncurrent portion 583,270 ---------- $ 877,227 ========== F-11 NOTE G -- LINE OF CREDIT AND LONG-TERM DEBT The Company has a line of credit facility with National Bank of Canada (the "Bank") which provides up to $9,000,000 of available credit to the Company based upon a percentage (80%) of eligible receivables (as defined in the loan agreement). Interest is payable monthly at the Bank's Reference Rate plus .25% (9% at December 31, 1997). The line of credit facility has an expiration date of May 30, 1999. In addition, the Company borrowed $1,000,000 from the Bank under a term loan. Interest is payable monthly at the Bank's Reference Rate plus .25% (9% at December 31, 1997). The Company also has a stand-by letter of credit available at the Bank in the amount of $1,000,000. As of December 31, 1997, the Company was technically in breach of a loan covenant with respect to maintaining profitable operations related to borrowings of $7,148,631. Subsequently the loan agreement was amended to delete the profitability covenant for 1997. Long-term debt consists of the following at December 31: 1997 1996 ---------- ---------- Note payable to bank, collateralized by equipment, payable in 36 monthly installments of $2,378 including interest at 9%, beginning December 30, 1995 $ 24,007 $ 49,859 Note payable to bank, collateralized by equipment, payable in 36 monthly installments of $11,267 including interest at 9%, beginning January 30, 1996 118,840 246,816 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 Note payable for annual insurance premium, interest at 5.73%, with monthly payments of $43,531, due June 30, 1998 304,347 412,296 Note payable to a bank, collateralized by equipment, payable in monthly installments of $16,667 including interest at 9%, balance due May 30, 1999 950,000 - ---------- ---------- 1,397,194 1,283,911 Less current portion 647,194 1,130,063 ---------- ---------- $ 750,000 $ 153,848 ========== ========== Scheduled future maturities of these notes for the years ending December 31 are as follows: 1998 $ 647,194 1999 750,000 ---------- $1,397,194 ========== F-12 NOTE G -- LINE OF CREDIT AND LONG-TERM DEBT (CONTINUED) Related party debt consists of the following at December 31: 1997 1996 -------- ---------- 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, 1999, interest at 10% (see notes E and H) 671,800 471,800 -------- ---------- 671,800 1,216,800 Less current portion - 545,000 -------- ---------- $671,800 $ 671,800 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 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 had a maturity date of March 1, 1996. Holders of the subordinated notes had a security interest in the Company's accounts receivable and contracts in progress that was 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, with interest payable monthly at ten percent per annum. Interest of $47,180 and $39,316 was paid to the holders of these notes during 1997 and 1996, respectively. NOTE I -- TAXES ON INCOME The provision (benefit) for taxes on income includes the following for the year ended December 31: F-13 NOTE I -- TAXES ON INCOME (CONTINUED) 1997 1996 --------- --------- CURRENT Federal $ (20,342) $(569,268) State - (24,635) --------- --------- (20,342) (593,903) --------- --------- DEFERRED Federal (79,650) 215,390 State (13,555) 36,658 --------- --------- (93,205) 252,048 --------- --------- Total $(113,547) $(341,855) ========= ========= 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: 1997 1996 --------- ----------- Provision (benefit) for income taxes at statutory rate $(180,000) $(1,598,400) Change in valuation reserve 102,134 1,076,366 Stock options 6,900 8,142 Other 13,342 172,037 Change in prior year estimate of tax refund (55,923) - --------- ----------- $(113,547) $ (341,855) ========= =========== Deferred tax assets and liabilities consist of the following at December 31: 1997 1996 ----------- ---------- Accrued salary expense $ 81,900 $ 85,704 Allowance for doubtful accounts 227,000 198,661 NOL carryforward 907,700 870,209 Other (38,100) (78,208) ----------- ---------- 1,178,500 1,076,366 Valuation reserve (1,178,500) (1,076,366) ----------- ---------- $ - $ - =========== ========== Deferred tax liability depreciation and amortization $ - $ (37,282) =========== ========== F-16 NOTE I -- TAXES ON INCOME (CONTINUED) Realization of the deferred tax asset depends on achieving future taxable income. The Company incurred losses in the last two years and does not consider it likely that the Company will realize the benefit of the deferred tax asset and, accordingly, has recorded a valuation allowance equal to the deferred tax asset. The Company has net operating loss carryforwards for tax purposes of approximately $2,300,000, which expire in 2012. 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. The following is a summary at December 31, 1997, of the future minimum rents due under noncancelable operating leases: Year ending December 31, 1998 $ 475,897 1999 221,975 2000 178,250 2001 63,792 --------- Total $ 939,914 ========= Total rent expense under operating leases for the years ended December 31, 1997, 1996, and 1995, was approximately $723,900, $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. F-17 NOTE K -- STOCKHOLDERS' EQUITY (CONTINUED) 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 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. In January 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 $2,035,000. 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 warrant was $100 and the exercise price under such warrants is $3.60 per share. The warrants may be exercised in whole or in part at any time or from time to time until the expiration date of December 31, 2001. The Company also issued warrants to purchase 100,000 shares of common stock at $4.25 per share to a management services firm as consideration for its assistance on the private offering. The warrants may be exercised from July 1, 1998 through December 31, 1999. These warrants are considered stock issuance costs, with a value of approximately $235,000 based on the fair value at the grant date as required by Financial Accounting Standards 123. F-18 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 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 $65,206 and $83,738 for the years ended December 31, 1997 and 1996, 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 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 three to five 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: 1997 1996 --------- ----------- Net income (loss) As reported $(347,291) $(3,756,450) Pro forma (495,586) (3,854,017) Earnings (loss) per common share As reported $(0.06) $(0.74) Pro forma (0.09) (0.76) 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 1997 and 1996: no expected dividends; expected volatility of 74.77%; risk-free interest rate of 6.07%; and expected lives of five years. F-19 NOTE M -- STOCK OPTIONS (CONTINUED) A summary of the status of the Plan follows: Average price Shares per share --------- ------------- Outstanding at January 1, 1995 Granted 181,000 $3.50 Exercised - Canceled (5,000) $3.50 -------- ----- Outstanding at December 31, 1995 176,000 $3.50 -------- ----- Total exercisable shares 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 ======== ===== Outstanding at January 1, 1997 214,000 $5.60 Granted 96,900 $7.00 Exercised (9,700) $3.50 Canceled (70,400) $9.04 -------- ----- Outstanding at December 31, 1997 230,800 $5.10 -------- ----- Total exercisable at December 31, 1997 80,375 $4.27 ======== ===== WEIGHTED AVERAGE RANGE OPTIONS PROCEEDS EXERCISE PRICE ------------- ------- -------- ---------------- Exercisable at December 31, 1997 $3.50 - 4.25 46,500 $162,750 $ 3.50 4.26 - 7.00 33,375 174,885 5.24 7.01 - 11.88 500 5,940 11.88 ------ -------- ------ 80,375 $343,575 $ 4.27 ====== ======== ====== The following information applies to options outstanding at December 31, 1997: WEIGHTED AVERAGE RANGE OF OPTIONS WEIGHTED AVERAGE REMAINING EXERCISABLE PRICES OUTSTANDING EXERCISE PRICE CONTRACTUAL LIFE ------------------ ----------- ---------------- ---------------- $3.50 - 4.25 90,300 $ 3.84 6 years 4.26 - 7.00 140,000 5.71 9 years 7.01 - 11.88 500 11.55 8 years F-20 NOTE M -- STOCK OPTIONS (CONTINUED) 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 $12,423 and $20,355 in 1997 and 1996, respectively, relating to these options. Compensation expense of $10,311 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, 1997 and 1996, are as follows: CARRYING ESTIMATED 1997 AMOUNT FAIR VALUE ---------------------------------- ---------- ----------- Cash $ 343,878 $ 343,878 Due from related party 100,010 100,010 Other receivables 154,838 154,838 Note payable - line of credit 6,198,631 6,198,631 Long-term debt 1,397,194 1,397,194 Capitalized lease obligations 877,227 877,227 Notes payable to related parties 671,800 671,800 CARRYING ESTIMATED 1996 AMOUNT FAIR VALUE ---------------------------------- ---------- ----------- Cash $1,887,001 $1,887,001 Due from related party 158,010 158,010 Other receivables 199,016 199,016 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 NOTE O -- FOURTH QUARTER ADJUSTMENTS During the fourth quarter of the year ended December 31, 1997, the Company recorded a reduction of revenue of $370,457 related to change in the estimated margin for a contract. This adjustment was considered necessary to reflect the margin actually achieved on the project. F-21 EX-23 2 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our reports dated March 6, 1998, accompanying the financial statements incorporated by reference or included in the Annual Report of CET Environmental Services, Inc. (the "Company") on Form 10-K for the year ended December 31, 1997. We consent to the incorporation by reference in the Company's Registration Statement on Form S-8 of the aforementioned reports. /s/ Grant Thornton LLP GRANT THORNTON LLP Denver, Colorado March 6, 1998 -----END PRIVACY-ENHANCED MESSAGE-----