-----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, WSpC5gWGvTWDKI8PGLSUYY/5ZYojIszqOf4cmhl7xvBjmhIpk6bXDw8O8O8iEjs2 LwMDEJ5tdEpkTni75ipGvA== 0001047469-98-014778.txt : 19980415 0001047469-98-014778.hdr.sgml : 19980415 ACCESSION NUMBER: 0001047469-98-014778 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980414 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: CET ENVIRONMENTAL SERVICES INC CENTRAL INDEX KEY: 0000944627 STANDARD INDUSTRIAL CLASSIFICATION: HAZARDOUS WASTE MANAGEMENT [4955] IRS NUMBER: 330285964 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 033-91602 FILM NUMBER: 98592729 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 1 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [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: PROXY STATEMENT FOR ANNUAL MEETING OF SHAREHOLDERS. 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 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. 2 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 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. 3 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. - 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 facilities in the U.S. were constructed in the late 60's and early 70's using federal 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 driving 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 available 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 4 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 remediation and water/wastewater treatment systems from the conceptual stage through final design. - 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. 5 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: 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 6 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 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 7 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 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. 8 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. 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. 9 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 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 10 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 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 11 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. 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. 12 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 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. 13 BONDING REQUIREMENTS Commercial remediation projects, as well as federal, state and municipal projects, often require contractors to post both performance and payment bonds at the execution of a contract. Performance bonds guarantee that the project will be completed and payment bonds guarantee that vendors will be paid for equipment and other purchases. Contractors without adequate bonding may be ineligible to bid or negotiate on many projects. The Company has frequently been required to obtain such bonds and it should be assumed that the Company will continue to be 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. 14 The Company's services are conducted from the following spaces:
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 a defendant is likely to have a material adverse effect on the Company's financial position or results of operations. 15 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. 16 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. 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 - ----------------------------------------------------------------------------------------------------------------------------------- 17 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. 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: 18
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 Administrative 5.4 5.8 4.3 (7.0) 53.0 Amortization of Excess of Acquired Net Assets in Excess 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%) - ----------------------------------------------------------------------------------------------------------------------------------- Pro Forma Information (Note 1): Historical Earnings Before -- -- 5.6% -- -- Income Taxes 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. 19 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. - 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. 20 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:
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 21 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 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 22 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. 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. 23 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. 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. 24 PART III ITEM 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by these Items is incorporated herein by reference to the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held May 26, 1998. 25 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 Filed herewith Bank of Canada and the Company electronically. 21 Subsidiaries of the Registrant Filed herewith electronically 23 Consent of Grant Thornton LLP Filed herewith electronically 27 Financial Data Schedule Filed herewith electronically
(b) REPORTS ON FORM 8-K. During the last quarter of the period covered by this Report, the Company did not file any Reports of Form 8-K. 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. CET ENVIRONMENTAL SERVICES, INC. Dated: April 9, 1998 By /S/ ------------------------------------- Steven H. Davis President and Chief Executive Officer Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the date indicated. Signature Capacity Date --------- -------- ---- /S/ President, Chief April 9, 1998 ----------------------------------- Executive Officer Steven H. Davis and Director /S/ Executive Vice April 9, 1998 ----------------------------------- President, Chief Rick C. Townsend Financial Officer, Secretary and Director (Principal Accounting Officer) /S/ Director April 9, 1998 ----------------------------------- Craig C. Barto /S/ Executive Vice April 9, 1998 ----------------------------------- President, Chief Douglas W. Cotton Operating Officer and Director /S/ Senior Vice President April 9, 1998 ----------------------------------- and Director John G. L. Hopkins /S/ Director April 9, 1998 ----------------------------------- Robert A. Taylor 27 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. 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 (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 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1997 and 1996 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. F-9 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ESTIMATED FAIR VALUE INFORMATION Statement of Financial Accounting Standards ("SFAS") No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, requires disclosure of the estimated fair value of an entity's financial instrument assets and liabilities, as defined, regardless of whether recognized in the financial statements of the reporting entity. The fair value information does not purport to represent the aggregate net fair value of the Company. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: CASH: The carrying amount approximates fair value due to the short-term maturity. NOTE PAYABLE - LINE OF CREDIT: The carrying amount approximates fair value as the line of credit has a variable interest rate which is considered to approximate the market rate. LOAN FROM SHAREHOLDER: The carrying amount approximates the fair value because of the short terms to maturity of the notes (within 3 months). LONG-TERM DEBT / OBLIGATIONS UNDER CAPITAL LEASES: The carrying value approximates fair value as the interest rate at December 31, 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 F-10 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) IMPAIRMENT OF LONG-LIVED ASSETS (Continued) 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). 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. F-11 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. 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 ---------- ---------- ---------- ----------
F-12 NOTE F -- CAPITAL LEASES (CONTINUED) 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 ---------- ----------
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. F-13 NOTE G -- LINE OF CREDIT AND LONG-TERM DEBT (CONTINUED) 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-14 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. F-15 NOTE I -- TAXES ON INCOME The provision (benefit) for taxes on income includes the following for the year ended December 31:
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). F-17 NOTE K -- STOCKHOLDERS' EQUITY (CONTINUED) In June 1995, the Company distributed an aggregate of $927,101 to certain shareholders, which aggregate amount is approximately the amount of the tax liabilities of such shareholders resulting from the Company's former Subchapter "S" tax status. The primary source of funds for such distribution was the proceeds from the sale of the Subordinated Notes (note H). Immediately after such distribution, these same shareholders loaned an aggregate of $357,865 to the Company. Such shareholder loans bore interest at 10% and were repaid out of the proceeds of the Company's initial public offering in July 1995. In July 1995, the Company completed an initial public offering of 1,200,000 shares of its common stock, and in August 1995, sold an additional 180,000 shares pursuant to an over-allotment option. The net proceeds to the Company from the public offering was approximately $5,800,000. In connection with this offering, the Company issued a warrant to the representatives of the underwriters in this offering to purchase up to 120,000 shares of the Company's common stock at $6.00 per share (the 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. F-18 NOTE K -- STOCKHOLDERS' EQUITY (CONTINUED) 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. 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. F-19 NOTE M -- STOCK OPTIONS (CONTINUED) 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. 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 -------- ----- -------- -----
F-20 NOTE M -- STOCK OPTIONS (CONTINUED)
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
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. F-21 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-22 EX-10.3 2 EXHIBIT 10.3 LOAN AND SECURITY AGREEMENT THIS AGREEMENT made this 29th day of May, 1997 by and between NATIONAL BANK OF CANADA, a Canadian chartered bank ("Lender"), with an address at One Tabor Center, 1200 Seventeenth Street, Suite 2760, Denver, Colorado 80202, and CET ENVIRONMENTAL SERVICES, INC., a California corporation, with an address at 7670 South Vaughn Court, Suite 130, Englewood, Colorado 80112 ("Borrower"). WITNESSETH: WHEREAS, the parties wish to provide for the terms and conditions upon which Loans may be made, and Letters of Credit may be issued, for the account of Borrower; NOW, THEREFORE, in consideration of any Loans made and/or Letters of Credit issued for the account of Borrower, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged by Borrower, the parties agree as follows: 1. DEFINITIONS. (a) "Acceptable Equipment" shall mean Equipment owned or to be acquired by Borrower and used by Borrower in the ordinary course of business in which Lender shall have a valid, perfected, first priority security interest subject to no other lien, encumbrance or security interest and which is otherwise acceptable to Lender. (b) "Account," "Account Debtor," "Chattel Paper," "Documents," "Equipment," "General Intangibles," "Goods," "Instruments" and "Inventory" shall have the respective meanings assigned to such terms, as of the date of this Agreement, in the Colorado Uniform Commercial Code. (c) "Affiliate" shall mean any Person directly or indirectly controlling, controlled by or under common control with another Person. (d) "Agreement" shall mean this Loan and Security Agreement, any exhibits or schedules hereto, any concurrent or subsequent riders hereto and any extensions, supplements, amendments or modifications hereto. (e) "Blocked Account" shall have the meaning specified in Section 8 hereof. (f) "Closing" shall mean satisfaction of the conditions precedent in Section 4 below and closing of the transactions contemplated by the Agreement. (g) "Collateral" shall mean all of the property of Borrower described in Section 5 hereof, together with all other real or personal property of Borrower now or hereafter pledged to Lender to secure repayment of any of the Liabilities, including, without limitation, all Accounts, Inventory, General Intangibles and Equipment of Borrower. (h) "Collateral Report" shall have the meaning specified in Section 9 hereof. (i) "Eligible Accounts" shall mean those Accounts of Borrower which are unpaid less than ninety (90) days from invoice date, and which Lender, in its sole discretion, determines to be eligible. Eligible Accounts may, at Lender's option, include up to $625,000 of bonded accounts. Without limiting Lender's discretion, unless otherwise agreed by Lender, the following Accounts of Borrower are not Eligible Accounts: (i) all Accounts owing by a single Account Debtor, including currently scheduled Accounts, if twenty-five percent (25%) or more of the balance owing by such Account Debtor to Borrower is ineligible under clauses (iv) or (v) below; (ii) Accounts with respect to which the Account Debtor is an officer, director, employee, Subsidiary or Affiliate of Borrower; (iii) Accounts with respect to which the Account Debtor is not a resident of the United States unless the Account Debtor has supplied Borrower with an irrevocable letter of credit, in form and substance satisfactory to Lender, issued by a U.S. financial institution satisfactory to Lender, to cover the full amount of such Account, and such letter of credit is assigned and delivered to Lender; (iv) Accounts in dispute or with respect to which the Account Debtor has asserted a counterclaim or has asserted a right of setoff; (v) Accounts with respect to which the prospect of payment or performance by the Account Debtor is or will be impaired, as determined by Lender in the exercise of its sole discretion; (vi) Accounts with respect to which Lender does not have a first and valid fully perfected security interest; (vii) Accounts with respect to which the Account Debtor is the subject of bankruptcy or a similar insolvency proceeding or has made an assignment for the benefit of creditors or whose assets have been conveyed to a receiver or trustee; (viii) Accounts with respect to which the Account Debtor's obligation to pay the Account is conditional upon the Account Debtor's approval or is otherwise subject to any prepurchase obligation or return right, as with sales made on a bill-and-hold, guaranteed sale, sale-or-return, sale on approval or consignment basis; (ix) Accounts to the extent that the Account Debtor's indebtedness to Borrower exceeds a credit limit determined by Lender in Lender's discretion; (x) Accounts with respect to which the Account Debtor is located in New Jersey or Minnesota unless Borrower (a) with respect to each such state, has received a certificate of authority to do business and is in good standing in such state, or (b) has filed a Notice of Business Activities Report with the New Jersey Division of Taxation or the Minnesota Department of Revenue, as applicable, for the then current year; (xi) Accounts which arise out of sales not made in the ordinary course of Borrower's business; (xii) Accounts with respect to which the Account Debtor has returned to Borrower any portion of the Inventory the sale of which gave rise to such Accounts; and (xiii) Accounts with respect to which any document or agreement executed or delivered in connection therewith, or any procedure used in connection with any such document or agreement, fails in any material respect to comply with the requirements of applicable law. (j) "Eligible Unbilled Accounts" shall mean those Eligible Accounts with respect to which the work giving rise to such Eligible Account was completed within the last thirty days but for which no invoice has yet been issued. -2- (k) "Equipment Loan" or "Equipment Loans" means all advances made by Lender to Borrower pursuant to paragraph 2(b) below. (l) "Equipment Value" shall mean, at any time, up to eighty percent (80%) of the cost as determined by Lender in its sole discretion of new Acceptable Equipment (less any costs for installation, transportation, and tooling) purchased or being purchased by Borrower. (m) "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. (n) "Event of Default" shall have the meaning specified in Section 13 hereof. (o) "Indemnified Party" shall have the meaning specified in Section 15 hereof. (p) "Letter of Credit Issuer" shall mean Lender or its designee. (q) "Letters of Credit" shall mean any Letter of Credit which shall now or hereafter be issued by the Letter of Credit Issuer at the request and for the account of Borrower pursuant to the terms of this Agreement. (r) "Liabilities" shall mean any and all obligations, liabilities and indebtedness of Borrower to Lender or to any Affiliate of Lender of any and every kind and nature, howsoever created, arising or evidenced and howsoever owned, held or acquired, whether now or hereafter existing, whether now due or to become due, whether primary, secondary, direct, indirect, absolute, contingent or otherwise (including, without limitation, obligations of performance), whether several, joint or joint and several, and whether arising or existing under written or oral agreement or by operation of law, including, without limitation, all obligations for payment of the Loans and for payment of the reimbursement obligations under paragraph 2(c) with respect to the Letters of Credit. (s) "Loans" shall mean all advances made by Lender to Borrower pursuant to Section 2 and shall refer collectively to the Revolving Loans, Equipment Loans and the Term Loans. (t) "Maturity Date" shall mean the earliest to occur of the following: (i) November 30, 1998, and (ii) the date the Liabilities are accelerated pursuant to Section 14 hereof. (u) "Maximum Loan Availability" shall mean (a) the lesser of Nine Million Dollars ($9,000,000) or Revolving Loan Availability minus (b) the outstanding principal amount of all Equipment Loans minus (c) the aggregate undrawn face amount of all Letters of Credit. (v) "Obligor" shall mean Borrower and each Person who is or shall become primarily or secondarily liable for any of the Liabilities. -3- (w) "Other Agreements" shall mean all agreements, instruments and documents, including, without limitation, guaranties, mortgages, trust deeds, pledges, powers of attorney, consents, assignments, security agreements, intercreditor agreements, financing statements and all other writings heretofore, now or from time to time hereafter executed by or on behalf of Borrower or any other Person and delivered to Lender or to any Affiliate of Lender in connection with the Liabilities or the transactions contemplated hereby. (x) "Permitted Liens" shall mean (i) statutory liens of landlords, carriers, warehousemen, mechanics, materialmen or suppliers incurred in the ordinary course of business and securing amounts not yet due or declared to be due by the claimant thereunder, (ii) liens or security interests in favor of Lender, (iii) zoning restrictions and easements, licenses, covenants and other restrictions affecting the use of real property that do not individually or in the aggregate have a material adverse effect on Borrower's ability to use such real property for its intended purpose in connection with Borrower's business, and (iv) the liens set forth on EXHIBIT B. (y) "Person" shall mean any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity, party or foreign or United States government (whether federal, state, county, city, municipal or otherwise), including, without limitation, any instrumentality, division, agency, body or department thereof. (z) "Plan" shall mean any employee benefit plan defined in Section 3(3) of ERISA, including any multiemployer plan or any employee welfare benefit plan which is maintained or has been maintained pursuant to a collective bargaining agreement to which two or more unrelated employers contribute and in respect of which Borrower is an "employer" as defined in Section 3(5) of ERISA. (aa) "Reference Rate" shall mean the rate of interest publicly announced from time to time by National Bank of Canada at its principal office as its United States (rather than Canadian) prime lending rate. The Reference Rate is a reference rate and does not necessarily represent the lowest or best rate actually charged to any customer. Any change in the Reference Rate shall be effective as of the effective date stated in the announcement by National Bank of Canada of such change. (bb) "Revolving Loan" or "Revolving Loans" shall mean all advances made by Lender to Borrower pursuant to paragraph 2(a) hereof. (cc) "Revolving Loan Availability" shall mean at any time, the sum of the following: (i) up to eighty percent (80%) of the face amount (less maximum discounts, credits and allowances which may be taken by or granted to Account Debtors in connection therewith) then outstanding under existing Eligible Accounts at such time, less such reserves as Lender in its sole discretion elects to establish; and -4- (ii) up to fifty percent (50%) of the face amount (less maximum discounts, credits and allowances which may be taken by or granted to Account Debtors in connection therewith) then outstanding under existing Eligible Unbilled Accounts at such time, less such reserves as Lender in its sole discretion elects to establish. Lender may at any time and from time to time in its sole discretion change the advance percentage as set forth above. (dd) "Subsidiary" shall mean any corporation of which more than fifty percent (50%) of the outstanding capital stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether at the time stock of any other class of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned by Borrower or by any partnership or joint venture of which more than fifty percent (50%) of the outstanding equity interests are at the time, directly or indirectly, owned by Borrower. (ee) "Subordinated Debt" means collectively (i) indebtedness to Dorothy R. Munroe as Trustee of the Dorothy R. Munroe Trust in the amount of $84,250.00 (ii) indebtedness to Dorothy R. Munroe as Trustee for Stephanie Ann Davis in the amount of $16,850.00, (iii) indebtedness to Dorothy R. Munroe as Trustee for Charles Howe Davis in the amount of $16,850.00, (iv) indebtedness to Dorothy R. Munroe as Trustee of Birnie Children's Trust I in the amount of $337,000.00, (v) indebtedness to Dorothy R. Munroe, as the Trustee of the Rempel Family Trust in the amount of $16,850.00, and (vi) indebtedness to Dorothy R. Munroe as Trustee of the Birnie Children's Trust I in the amount of $200,000.00. (ff) "Term Loan" shall have the meaning set forth in paragraph 2(d) below. (gg) "Term Loan Availability" shall mean up to eighty percent (80%) of the acceptable auction value for existing Acceptable Equipment as determined pursuant to an appraisal acceptable to Lender in its sole discretion. 2. LOANS, LETTERS OF CREDIT. (a) Subject to the terms and conditions of this Agreement and the Other Agreements, prior to the Maturity Date, Lender may, in its reasonable discretion, make Revolving Loans to Borrower as Borrower shall from time to time request for general working capital purposes. The aggregate unpaid principal amount of all Revolving Loans outstanding at any one time shall not exceed the Maximum Loan Availability at such time. The Revolving Loan shall be repaid as provided elsewhere in this Agreement. If at any time the outstanding principal balance of the Revolving Loan exceeds the Maximum Loan Availability, Borrower shall immediately, and without the necessity of a demand of Lender, pay to Lender such amount as may be necessary to eliminate such excess. (b) Subject to the terms and conditions of this Agreement and the Other Agreements, prior to the Maturity Date, Lender may, in its reasonable discretion, make -5- Equipment Loans to Borrower as Borrower shall from time to time request to purchase Acceptable Equipment. The maximum amount of each Equipment Loan shall not exceed the lesser of (1) the Equipment Value of the Acceptable Equipment purchased with such Equipment Loan, (2) One Million Dollars ($1,000,000) minus the aggregate unpaid principal amount of all Equipment Loans outstanding on such date and (3) the Maximum Loan Availability minus the outstanding principal amount of all Revolving Loans. Borrower shall make equal monthly principal payments on each Equipment Loan on the first day of each month based on a sixty-month (60) straight line amortization schedule, commencing with the first payment on July 1, 1997, and continuing on the first day of each month thereafter until the Maturity Date at which time the entire outstanding amount of each Equipment Loan shall be due and payable in full. (c) Subject to the terms and conditions of this Agreement and the Other Agreements, prior to the Maturity Date, Lender may, in its reasonable discretion, at Borrower's request, cause Letters of Credit to be issued for the account of Borrower; provided, that the aggregate undrawn face amount of the Letters of Credit shall not at any time exceed the lesser of (i) FIVE HUNDRED THOUSAND DOLLARS ($500,000) and (ii) Maximum Loan Availability. If at any time the outstanding principal balance of the Revolving Loan is zero and Maximum Loan Availability is less than zero, Borrower shall provide cash collateral to Lender in an amount equal to the amount by which Maximum Loan Availability is less than zero to secure any Letters of Credit. The Letters of Credit shall be in form and substance satisfactory to Lender and shall have an expiration date not later than the earlier of (1) twelve (12) months from the date of issuance or (2) the Maturity Date. Borrower authorizes Lender to reimburse the Letter of Credit Issuer for any payments made in respect of the Letters of Credit. Borrower shall reimburse Lender, immediately upon demand, in the amount of any payments made by Lender to the Letter of Credit Issuer or any Person with respect to the Letters of Credit, and until Lender shall have been so reimbursed by Borrower such payments by Lender shall be deemed to be Revolving Loans. In connection with the Letters of Credit, Borrower hereby indemnifies Lender for any payments made by Lender with respect to the Letters of Credit and for any taxes, levies, deductions, charges and costs and expenses incurred by Lender with respect to the Letters of Credit. The Lender will not release any collateral until such time as all Letters of Credit have been canceled. (d) Subject to the terms and conditions of this Agreement and the Other Agreements, Lender shall make a loan to Borrower (the "Term Loan") in an amount equal to the lesser of (A) ONE MILLION DOLLARS ($1,000,000) and (B) Term Loan Availability at the time of the advance of the Term Loan. Borrower shall make equal monthly principal payments on the Term Loan on the first day of each month based on a sixty-month (60) straight line amortization schedule with the first payment commencing on the first day of the month following the advance of the Term Loan, and continuing on the first day of each month thereafter until the Maturity Date at which time the entire unpaid principal balance of the Term Loan shall be due and payable in full. (e) The Loans and all other amounts due to Lender from Borrower shall be due and payable in full on the Maturity Date. -6- 3. FEES AND CHARGES. Borrower shall pay to Lender the following fees: (a) Borrower shall pay to Lender interest on the outstanding principal balance of the Loans monthly in arrears beginning on June 1, 1997, at the per annum rate of one-quarter of one percent (0.25%) plus the Reference Rate. If Borrower's earnings net of extraordinary income for the year ended December 31, 1997 exceed $2,000,000 and the ratio of Borrower's liabilities-to-net worth calculated in accordance with Section 12(q)(iv) below is less than 2.5 to 1 for the fiscal year ending on December 31, 1997, then the interest rate set forth above shall be reduced by one-quarter of one percent (0.25%) to the Reference Rate; effective upon receipt by Lender of audited financial statements acceptable to Lender together with such other information as Lender may require. If Borrower's earnings net of extraordinary income for the year ended December 31, 1997 are less than $1,000,000 then the interest rate set forth above shall be increased by one-quarter of one percent (0.25%) to one-half percent (0.50%) plus the Reference Rate; effective retroactively to the date of this Agreement; provided that if audited financials are not received on or before March 31, 1998, the interest rate shall be increased one-quarter percent effective retroactively to the date of this Agreement until such time as such audited financial statements are received and then shall be adjusted in accordance with the results set forth in such audited financial statements. If the interest rate is increased effective retroactively to the date of this Agreement, Borrower shall, within five days after request by Lender, pay to Lender all additional interest due as a result of the retroactive increase. Following the occurrence of an Event of Default, Borrower shall pay to Lender interest on the outstanding principal balance of the Loans at the per annum rate of two percent (2%) plus the Reference Rate. Interest shall be computed on the basis of a year of three hundred sixty (360) days for the actual number of days elapsed. (b) Borrower shall pay to Lender a letter of credit fee equal to one and one-half percent (1.5%) per annum (computed on the basis of a year of three hundred sixty (360) days for the actual number of days elapsed) of the average undrawn face amount of the Letters of Credit, payable monthly in arrears within 10 days after the end of each month; provided, that following the occurrence of an Event of Default, the letter of credit fee shall increase to three and one-half percent (3.5%) per annum. In addition, Borrower shall pay to Lender all expenses incurred by Lender and the Letter of Credit Issuer in connection with the issuance and negotiation of any Letter of Credit, payable on the date incurred by Lender or the Letter of Credit Issuer. (c) Borrower shall pay to Lender a closing fee equal to TWENTY-FIVE THOUSAND DOLLARS ($25,000.00) at Closing. (d) Borrower shall pay to Lender an audit fee at a rate of FIVE HUNDRED DOLLARS ($500.00) per auditor per day, plus travel and other out-of-pocket expenses, which shall be payable by Borrower upon completion of each audit. (e) Borrower shall pay to Lender a monthly unused fee equal to the (i) product obtained by multiplying (A) one-quarter of one percent (0.25%) per annum (computed on the basis of a year of three hundred sixty (360) days for the actual number of days elapsed) times, -7- (B) the amount by which (i) $10,000,000 exceeds (2) the sum of the average daily outstanding balance of the Loans during each calendar month and the average outstanding face amount of all Letters of Credit during such month, and (ii) dividing such product by 360 and multiplying the results by the number of days in the month. Such unused fee shall be payable monthly in arrears within ten (10) days after the end of each month. (f) If Borrower elects to terminate this Agreement prior to the Maturity Date, but within 365 days after Closing, Borrower will pay Lender an early termination fee equal to the amount obtained by multiplying one-half percent times $10,000,000, which amount shall be payable at the time Borrower terminates this Agreement. (g) It is the intent of the parties that the rate of interest and the other fees and charges to Borrower under this Agreement shall be lawful; therefore, if for any reason the interest or other fees and charges payable under this Agreement are found by a court of competent jurisdiction, in a final determination, to exceed the limit which Lender may lawfully charge Borrower, then the obligation to pay interest and other charges shall automatically be reduced to such limit and, if any amount in excess of such limit shall have been paid, then such amount shall be refunded to Borrower. 4. CONDITIONS OF ADVANCES AND LETTERS OF CREDIT. Without limiting Lender's discretion to make advances hereunder, the making of any advance provided for in this Agreement shall be conditioned upon the following: (a) Lender shall have received, (i) with respect to a request for an advance in connection with the Revolving Loan, by at least twelve o'clock p.m. (12:00 p.m.) Denver time on the day on which such advance is requested to be made hereunder with respect to request for an advance in connection with an Equipment Loan by at least twelve o'clock p.m. (12:00 p.m.) Denver time on the day which is three business days prior to the day on which such advance is requested to be made hereunder, a telephonic request from an officer of Borrower (or any Person authorized by Borrower pursuant to a written list provided to Lender), for an advance in a specific amount, and (ii) with respect to a request for the issuance of a Letter of Credit in connection with the Revolving Loan, at least five days prior to the date such Letter of Credit is requested to be issued, an application for such Letter of Credit executed by an officer of Borrower. In addition, Lender shall also have received all of the schedules and reports required to have been delivered by Borrower pursuant to Section 9 hereof; (b) No Event of Default shall have occurred and be continuing, in no event that with notice, or the passage of time, or both could become an Event of Default shall have occurred; (c) All of the representations and warranties contained in this Agreement and the Other Agreements shall be true and correct as if made on the date the request for an advance or Letter of Credit is made; -8- (d) With respect to any advance of an Equipment Loan, Borrower shall have provided Lender evidence of the Equipment Value of the Acceptable Equipment; (e) Within fifteen days after the making of any prior Equipment Loan, Borrower shall have provided to Lender the information required pursuant to Section 12(t) below; (f) Lender shall have received, in form and substance satisfactory to Lender, all certificates, orders, authorities, consents, affidavits, schedules, instruments, security agreements, financing statements, opinions, mortgages and other documents which are provided for hereunder, or which Lender may at any time request, including without limitation a Subordination Agreement in connection with the Subordinated Debt; (g) With respect to the initial advance of the Loans, Lender shall have satisfactorily completed all due diligence on the Borrower and the collateral which Lender determines is necessary, including, without limitation, field audits and financial review; (h) There shall have been no material adverse change in the condition, financial or otherwise, of Borrower as reasonably determined by Lender; (i) With respect to the initial advance of the Revolving Loan, the amount of Revolving Loan Availability minus the amount of such advance and minus all accounts payable of Borrower in excess of thirty days must be at least $1,000,000; (j) With respect to the advance of the Term Loan, (i) Lender shall have received appraisals acceptable to Lender in its sole discretion in order to determine Term Loan Availability, (ii) Lender shall have received UCC search results from such jurisdictions as Lender may require which must be acceptable to Lender in its sole discretion, (iii) Lender shall have a valid, perfected lien on all vehicles owned by Borrower and (iv) Lender shall have received such other documents and information as Lender may reasonably require; and (k) Lender shall have received such other documents, instruments, agreements or information as Lender may reasonably require. 5. GRANT OF SECURITY INTEREST TO LENDER. As security for the payment or other satisfaction of all Liabilities, Borrower hereby assigns to Lender and grants to Lender a continuing security interest in the following property of Borrower, whether now or hereafter owned, existing, acquired or arising and wherever now or hereafter located: (a) all Accounts and all Goods whose sale, lease or other disposition by Borrower has given rise to Accounts and have been returned to or repossessed or stopped in transit by Borrower; (b) all Chattel Paper, Instruments, Documents and General Intangibles (including, without limitation, all patents, patent applications, trademarks, trademark applications, tradenames, trade secrets, goodwill, copyrights, registrations, licenses, franchises, customer lists, tax refund claims, claims against carriers and shippers, guarantee claims, contracts rights, security interests, security deposits and any rights to indemnification); (c) all Inventory and other Goods, including, without -9- limitation, Equipment, vehicles and fixtures; (d) all deposits and cash and any other property of Borrower now or hereafter in the possession, custody or control of Lender or any agent or any Affiliate of Lender or any participant with Lender in the Loans and/or Letters of Credit for any purpose (whether for safekeeping, deposit, collection, custody, pledge, transmission or otherwise); (e) all mobile goods; (f) Account No. 1018171774 at Norwest Bank Colorado, National Association, and all renewals thereof or substitutions, additions thereto, proceeds therefrom, and all cash and other amounts at any time on deposit therein and all interest and dividends thereon; (g) Account No. 4500148743 at Union Bank of California, N.A., and all renewals thereof or substitutions, additions thereto, proceeds therefrom, and all cash and other amounts at any time on deposit therein and all interest and dividends thereon; and (h) all additions and accessions to, substitutions for, and replacements, products and proceeds of the foregoing property, including, without limitation, proceeds of all insurance policies insuring the foregoing property, and all of Borrower's books and records relating to any of the foregoing and to Borrower's business. 6. PRESERVATION OF COLLATERAL AND PERFECTION OF SECURITY INTERESTS THEREIN. Borrower shall, at Lender's request, at any time and from time to time, execute and deliver to Lender such financing statements, documents and other agreements and instruments (and pay the cost of filing or recording the same in all public offices deemed necessary or desirable by Lender) and do such other acts and things as Lender may deem necessary or desirable in order to establish and maintain a valid, attached and perfected security interest in the Collateral in favor of Lender (free and clear of all other liens, claims and rights of third parties whatsoever, whether voluntarily or involuntarily created, except Permitted Liens) to secure payment of the Liabilities, and in order to facilitate the collection of the Collateral. Borrower irrevocably hereby makes, constitutes and appoints Lender (and all Persons designated by Lender for that purpose) as Borrower's true and lawful attorney and agent-in-fact to execute such financing statements, documents and other agreements and instruments and do such other acts and things as may be necessary to preserve and perfect Lender's security interest in the Collateral. Borrower further agrees that a carbon, photographic, photostatic or other reproduction of this Agreement or of a financing statement shall be sufficient as a financing statement. 7. CAPITAL ADEQUACY. If Lender shall reasonably determine that the application or adoption of any law, rule, regulation, directive, interpretation, treaty or guideline regarding capital adequacy, or any change therein or in the interpretation or administration thereof, whether or not having the force of law, increases the amount of capital required or expected to be maintained by Lender or any Person controlling, directly or indirectly, Lender, and such increase is based upon the existence of Lender's obligations hereunder and other commitments of this type, then from time to time, within thirty (30) days after demand from Lender, Borrower shall pay to Lender such amount or amounts as will compensate Lender or such controlling Person, as the case may be, for such increased capital requirement. The determination of any amount to be paid by Borrower under this Section 7 shall take into consideration the policies of Lender or any Person controlling Lender with respect to capital adequacy and shall be based upon any reasonable averaging, attribution and allocation methods selected by Lender. A certificate of Lender setting forth the amount or amounts as shall be -10- necessary to compensate Lender as specified in this Section 7 shall be delivered to Borrower and shall be conclusive in the absence of manifest error. If Lender invokes its rights under this Section 7, the Borrower shall have the right, in lieu of making such payment to the Lender, to terminate this Agreement without payment of any fees that would otherwise be payable under Section 3(f) hereof, by giving the Lender written notice of such election within thirty (30) days of demand by the Lender for payment and within thirty (30) days after giving such notice, making payment of the Liabilities in full and causing the Letters of Credit to be canceled and fully terminated. 8. COLLECTIONS. (a) Borrower shall establish an account (the "Blocked Account") in Borrower's name with a financial institution acceptable to Lender, into which Borrower will immediately deposit all payments received by Borrower with respect to Accounts and other Collateral in the identical form in which such payments were made, whether by cash or check. If Borrower, any Affiliate or Subsidiary of Borrower, or any shareholder, officer, director, employee or agent of Borrower or any Affiliate or Subsidiary of Borrower, or any other Person acting for or in concert with Borrower shall receive any monies, checks, notes, drafts or other payments relating to or as proceeds of Accounts or other Collateral, Borrower and each such Person shall receive all such items in trust for, and as the sole and exclusive property of, Lender and, immediately upon receipt thereof, shall remit the same (or cause the same to be remitted) in kind to the Blocked Account. The financial institution with which the Blocked Account is established shall acknowledge and agree, in a manner satisfactory to Lender, that the amounts on deposit in such Blocked Account are the sole and exclusive property of Lender, that such financial institution has no right to setoff against the Blocked Account, and that such financial institution shall by ACH transfer, wire transfer, or otherwise transfer in immediately available funds in a manner satisfactory to Lender, funds deposited in the Blocked Account on a daily basis as such funds are collected, to Lender. Lender shall, two (2) business days after receipt by Lender of immediately available funds, apply the whole or any part of such collections or proceeds against the Liabilities in such order as Lender shall determine in its sole discretion. Borrower agrees that all payments deposited to such Blocked Account or otherwise received by Lender, whether in respect of the Accounts or as proceeds of other Collateral or otherwise, will be applied on account of the Liabilities in accordance with the terms of this Agreement. All checks, drafts, instruments and other items of payment or proceeds of Collateral shall be endorsed by Borrower to Lender, and, if that endorsement of any such item shall not be made for any reason, Lender is hereby irrevocably authorized to endorse the same on Borrower's behalf. For the purpose of this paragraph, Borrower irrevocably hereby makes, constitutes and appoints Lender (and all Persons designated by Lender for that purpose) as Borrower's true and lawful attorney and agent-in-fact (i) to endorse Borrower's name upon said items of payment and/or proceeds of Collateral and upon any Chattel Paper, document, instrument, invoice or similar document or agreement relating to any Account of Borrower or goods pertaining thereto; (ii) to take control in any manner of any item of payment or proceeds thereof; and (iii) if an Event of Default occurs and is continuing, to have access to any lock box or postal box into which any of Borrower's mail is deposited, and open and process all mail addressed to Borrower and deposited therein; provided, however, that all such mail and contents thereof that do not constitute -11- Collateral shall be forwarded to the Borrower at its chief executive office in a timely fashion; and provided further that any mail sent to the Borrower from its attorneys or accountants shall be forwarded unopened to the Borrower. (b) Lender may, at any time and from time to time after the occurrence and during the continuance of an Event of Default, whether before or after notification to any Account Debtor and whether before or after the maturity of any of the Liabilities, (i) enforce collection of any of Borrower's Accounts or contract rights by suit or otherwise; (ii) exercise all of Borrower's rights and remedies with respect to proceedings brought to collect any Accounts; (iii) surrender, release or exchange all or any part of any Accounts, or compromise or extend or renew for any period (whether or not longer than the original period) any indebtedness thereunder; (iv) sell or assign any Account of Borrower upon such terms, for such amount and at such time or times as Lender deems advisable; (v) prepare, file and sign Borrower's name on any proof of claim in bankruptcy or other similar document against any Account Debtor; and (vi) do all other acts and things which are necessary, in Lender's sole discretion, to fulfill Borrower's obligations under this Agreement and to allow Lender to collect the Accounts. In addition to any other provision hereof, Lender may at any time after the occurrence of an Event of Default, at Borrower's expense, notify any parties obligated on any of the Accounts to make payment directly to Lender of any amounts due or to become due thereunder. (c) Lender, in its sole discretion, without waiving or releasing any obligation, liability or duty of Borrower under this Agreement or the other Agreements or any Event of Default, may at any time or times hereafter, but shall not be obligated to, pay, acquire or accept an assignment of any security interest, lien, encumbrance or claim asserted by any Person in, upon or against the Collateral; provided, however, that so long as no Event of Default has occurred and is continuing, Lender shall first notify the Borrower of such lien and allow ten (10) business days for the Borrower to pay or otherwise settle such lien. All sums paid by Lender in respect thereof and all costs, fees and expenses, including, without limitation, reasonable attorneys' fees, all court costs and all other charges relating thereto incurred by Lender shall constitute Revolving Loans, payable by Borrower to Lender on demand and, until paid, shall bear interest at the rate then applicable to Loans hereunder. (d) Immediately upon Borrower's receipt of any portion of the Collateral evidenced by an agreement, Instrument or Document, including, without limitation, any Chattel Paper, Borrower shall deliver the original thereof to Lender together with an appropriate endorsement or other specific evidence of assignment thereof to Lender (in form and substance acceptable to Lender). If an endorsement or assignment of any such items shall not be made for any reason, Lender is hereby irrevocably authorized, as Borrower's attorney and agent-in-fact, to endorse or assign the same on Borrower's behalf. 9. SCHEDULES AND REPORTS. (a) Borrower shall deliver to Lender, on a monthly basis, a collateral report (the "Collateral Report") describing the aging of the Accounts, all Eligible Accounts created or acquired by Borrower subsequent to the immediately preceding Collateral Report, information in -12- connection with any Account which has ceased to be an Eligible Account since the most recent Collateral Report, and information on all amounts collected by Borrower on Accounts subsequent to the immediately preceding Collateral Report; provided that (i) Lender reserves the right to require such report on a weekly or more frequent basis at any time requested by Lender and (ii) such report shall be required on a weekly basis at all times after the Maximum Loan Availability decreases below $1,000,000.00 unless otherwise agreed by Lender. The Collateral Reports shall contain such additional information as Lender shall require. Borrower shall also furnish copies of any other reports or information concerning the Accounts and Inventory included, described or referred to in the Collateral Reports, including, without limitation, but only if specifically requested by Lender, copies of all invoices prepared in connection with Accounts. Lender, through its officers, employees or agents, shall have the right, at any time and from time to time in Lender's name, in the name of a nominee of Lender or in Borrower's name, to verify the validity, amount or any other matter relating to any of the Accounts, by mail, telephone, telegraph or otherwise. Borrower shall reimburse Lender, on demand, for all costs, fees and expenses incurred by Lender in this regard. (b) Without limiting the generality of the foregoing, Borrower shall deliver to Lender, at lease once a month (or more frequently when requested by Lender), a report with respect to Borrower's Accounts and Inventory reconciling the information described in paragraph 9(a) for such month. (c) All schedules, certificates, reports, and assignments and other items delivered by Borrower to Lender hereunder shall be executed by an authorized representative of Borrower and shall be in such form and contain such information as Lender shall specify. 10. TERMINATION. This Agreement shall be in effect until the Maturity Date. The security interests and liens created under this Agreement and the Other Agreements shall survive such maturity until the Letters of Credit have been terminated and canceled and the payment of the other Liabilities has become indefeasible. At such time as Borrower has repaid all of the Liabilities and this Agreement has terminated, Borrower shall deliver to Lender a release, in form and substance satisfactory to Lender, of all obligations and liabilities of Lender and its officers, directors, employees, agents and Affiliates to Borrower and Lender shall deliver to Borrower a similar release of all claims other than those intended to survive repayment of the Loans. Without limiting the generality of the foregoing, Borrower and Lender agree that the provisions of Section 15 are intended to survive repayment of the Loans and shall not be released. 11. REPRESENTATIONS, WARRANTIES AND COVENANTS. Borrower hereby represents, warrants and covenants that: (a) the financial statements delivered or to be delivered by Borrower to Lender at or prior to the date of this Agreement and at all times subsequent thereto accurately reflect the financial condition of Borrower, and there has been no adverse change in the financial condition, the operations or any other status of Borrower since the date of the financial statements delivered to Lender most recently prior to the date of this Agreement; -13- (b) the office where Borrower keeps its books, records and accounts (or copies thereof) concerning the Collateral and Borrower's principal place of business is the location set forth in the introduction on page 1; all of Borrower's other places of business and locations of Collateral or locations where Borrower maintains any offices or conducts any business are as set forth in EXHIBIT A; Borrower shall promptly (but in no event less than ten (10) days prior thereto) advise Lender in writing of the proposed opening or establishment of any new office, place of business or location at which Borrower conducts business, the closing of any existing place of business, any change in the location of Borrower's books, records and accounts (or copies thereof) or the opening or closing of any post office box of Borrower; (c) the Collateral, including, without limitation, the Equipment is and shall be based, only at the addresses set forth on the first page of this Agreement or on Schedule 1 of EXHIBIT A; (d) if any of the Collateral consists of Goods of a type normally used in more than one state, whether or not actually so used, Borrower shall immediately give written notice to Lender of any use of any such Goods in any state other than a state in which Borrower has previously advised Lender such Goods shall be used, and such Goods shall not, unless Lender shall otherwise consent in writing, be used outside of the continental United States; (e) each Account which Borrower shall, expressly or by implication, request Lender to classify as an Eligible Account or Eligible Unbilled Account, respectively, shall, as of the time when such request is made, conform in all respects to the requirements of such classification as set forth in the respective definitions of "Eligible Account" and "Eligible Unbilled Account" as set forth herein and as otherwise established by Lender from time to time, and Borrower shall promptly notify Lender in writing if any such Eligible Account or Eligible Unbilled Account shall subsequently become ineligible; (f) Borrower is and shall at all times be the lawful owner of its property now purportedly owned or hereafter purportedly acquired by Borrower (including without limitation the Collateral), free from all liens, claims, security interests and encumbrances whatsoever, whether voluntarily or involuntarily created and whether or not perfected, other than the Permitted Liens; (g) Borrower has the right and power and is duly authorized and empowered to enter into, execute and deliver this Agreement and the Other Agreements and perform its obligations hereunder and thereunder; Borrower's execution, delivery and performance of this Agreement and the Other Agreements does not and shall not conflict with the provisions of any statute, regulation, ordinance or rule of law, or any agreement, contract or other document which may now or hereafter be binding on Borrower, and Borrower's execution, delivery and performance of this Agreement and the Other Agreements shall not result in the imposition of any lien or other encumbrance upon any of the Borrower's property under any existing indenture, mortgage, deed of trust, loan or credit agreement or other agreement or instrument by which Borrower or any of its property may be bound or affected; -14- (h) there are no actions or proceedings which are pending or threatened against Borrower which might result in any material adverse change in its financial condition or materially adversely affect Borrower's property and Borrower shall, promptly upon becoming aware of any such pending or threatened action or proceeding, give written notice thereof to Lender; (i) Borrower has obtained all licenses, authorizations, approvals, and permits, the lack of which would have a material adverse effect on the operation of its business, and Borrower is and shall remain in compliance in all material respects with all applicable federal, state, local and foreign statutes, orders, regulations, rules and ordinances, the failure to comply with which could reasonably be expected to have a material adverse effect on its business, property, assets, operations or condition, financial or otherwise; (j) all written information now, heretofore or hereafter furnished by Borrower to Lender is and shall be true and correct as of the date with respect to which such information was or is furnished; (k) Borrower is not conducting, permitting or suffering to be conducted, nor shall it conduct, permit or suffer to be conducted, any activities or transactions with any Affiliate of Borrower; provided, however, that Borrower may enter into transactions with Affiliates of Borrower in the ordinary course of business pursuant to terms that are no less favorable to Borrower than the terms upon which such transfers or transactions would have been made had they been made to or with a Person that is not an Affiliate of Borrower and, in connection therewith, may transfer cash or property to Affiliates of Borrower for fair value; (l) Borrower's name has always been as set forth on the first page of this Agreement and Borrower uses no tradenames or division names in the operation of its business, except as set forth on EXHIBIT A; Borrower shall notify Lender in writing within ten (10) days of the change of its name or the use of any tradenames or division names not previously disclosed to Lender in writing; (m) with respect to Borrower's Equipment: (i) Borrower has good and indefeasible and merchantable title to and ownership of all Equipment that it purports to own, including, without limitation, the Equipment described or listed on the schedule of Equipment delivered to Lender concurrently with this Agreement and any Equipment with respect to which Lender makes an Equipment Loan; (ii) Borrower shall keep and maintain the Equipment in good operating condition and repair and shall make all necessary replacements thereof and renewals thereto so that the value and operating efficiency thereof shall at all times be preserved and maintained; (iii) Borrower shall not permit any such items to become a fixture to real estate or an accession to other personal property; and (iv) Borrower, immediately on demand by Lender, shall deliver to Lender any and all evidence of ownership of, including, without limitation, certificates of title and applications of title to, any of the Equipment; -15- (n) this Agreement and the Other Agreements to which Borrower is a party are the legal, valid and binding obligations of Borrower and are enforceable against Borrower in accordance with their respective terms; (o) Borrower is solvent, is able to pay its debts as they become due and has capital sufficient to carry on its business, now owns property having a value both at fair valuation and at present fair saleable value greater than the amount required to pay its debts, and will not be rendered insolvent by the execution and delivery of this Agreement or any of the Other Agreements or by completion of the transactions contemplated hereunder or thereunder; (p) Borrower is not now obligated, nor shall it create, incur, assume or become obligated (directly or indirectly), for any loans or other indebtedness for borrowed money other than the Loans, except that Borrower may (i) borrow money from a Person other than Lender on an unsecured and subordinated basis if a subordination agreement in favor of Lender and in form and substance satisfactory to Lender is executed and delivered to Lender relative thereto; (ii) borrow money from a Person other than Lender on a secured and unsubordinated basis provided that such secured and unsubordinated indebtedness is incurred to purchase equipment and the amount of such indebtedness incurred after the date hereof and outstanding at any one time does not exceed $100,000; (iii) maintain the Subordinated Debt and any other present indebtedness to any Person which is set forth on EXHIBIT C; (iv) incur unsecured indebtedness to trade creditors in the ordinary course of Borrower's business; and (v) other than financing of insurance premiums in the ordinary course of Borrower's business. (q) Borrower does not own any margin securities, and none of the proceeds of the Loans hereunder shall be used for the purpose of purchasing or carrying any margin securities or for the purpose of reducing or retiring any indebtedness which was originally incurred to purchase any margin securities or for any other purpose not permitted by Regulation G or Regulation U of the Board of Governors of the Federal Reserve System as in effect from time to time; (r) Other than as set forth on EXHIBIT A, Borrower has no Subsidiaries or divisions, nor is Borrower engaged in any joint venture or partnership with any other Person; (s) Borrower is duly organized and in good standing in its state of organization and Borrower is duly qualified and in good standing in all states where the nature and extent of the business transacted by it or the ownership of its assets makes such qualification necessary; (t) Borrower is not in default under any material contract, lease or commitment to which it is a party or by which it is bound, nor does Borrower know of any dispute regarding any contract, lease or commitment which is material to the continued financial success and well-being of Borrower; (u) there are no controversies pending or threatened between Borrower and any of its employees, other than employee grievances arising in the ordinary course of business -16- which are not, in the aggregate, material to the continued financial success and well-being of Borrower, and Borrower is in compliance in all material respects with all federal and state laws respecting employment and employment terms, conditions and practices; and (v) Borrower possesses, and shall continue to possess, adequate licenses, patents, patent applications, copyrights, service marks, trademarks, trademark applications, tradestyles and tradenames to continue to conduct its business as heretofore conducted by it. (w) Exhibit D attached hereto contains a complete list of all vehicles owned by Borrower and a complete and accurate list of the state in which each such vehicle is titled. (x) Except as otherwise disclosed in writing to and approved by Lender, in connection with each request for an advance hereunder, Borrower represents and warrants that in connection with each Eligible Account, (i) the contract giving rise to such Eligible Account is in full force and effect, (ii) all work covered by the invoice giving rise to such Eligible Account was performed in full compliance with all requirements of law and the contract, (iii) the invoice giving rise to the Eligible Account was prepared in compliance with all requirements of the contract and accurately reflects both the work to which it relates and the amounts payable under the contract, (iv) the invoice giving rise to such Eligible Account was presented for payment in compliance with all requirements of the contract and all amounts evidenced by such invoice are due under the contract and do not exceed the amount properly due and payable under the contract and (v) no party under any contract giving rise to any Eligible Account has requested that any audit be conducted in connection with such contract nor has any such party requested any retroactive adjustments of any amounts previously invoiced in connection with any such contract. (y) All of the information set forth in the Representation and Warranty Certificate, dated May 14, 1997, and delivered to Lender is true and correct. Borrower and Lender agree that all of the representations and warranties set forth in EXHIBIT A attached hereto are incorporated herein and made a part hereof by this reference just as if such representations and warranties were set forth in this Section 11. Borrower represents, warrants and covenants to Lender that all representations, warranties and covenants of Borrower contained in this Agreement (whether appearing in EXHIBIT A, Sections 11 or 12 hereof or elsewhere) shall be true at the time of Borrower's execution of this Agreement, shall survive the execution, delivery and acceptance hereof by the parties hereto and the closing of the transactions described herein or related hereto, shall remain true until the repayment in full of all of the Liabilities and termination of this Agreement, and shall be remade by Borrower at the time each Loan is made or Letters of Credit issued pursuant to this Agreement. 12. ADDITIONAL COVENANTS OF BORROWER. Until payment or satisfaction in full of all Liabilities and termination of this Agreement, unless Borrower obtains Lender's prior written consent waiving or modifying any of Borrower's covenants hereunder in any specific instance, Borrower agrees as follows: -17- (a) Borrower shall at all times keep accurate and complete books, records and accounts with respect to all of Borrower's business activities, in accordance with sound accounting practices and generally accepted accounting principles consistently applied, and shall keep such books, records and accounts, and any copies thereof, only at the addresses indicated for such purpose on EXHIBIT A; (b) Borrower agrees to deliver to Lender the following financial information, all of which shall be prepared in accordance with generally accepted accounting principles consistently applied: (i) no later than forty-five (45) days after each calendar month, copies of internally prepared financial statements, including, without limitation, balance sheets and statements of income, certified by the Chief Financial Officer of Borrower; (ii) no later than ninety (90) days after the end of each of Borrower's fiscal years, annual financial statements audited by independent certified public accountants selected by Borrower and satisfactory to Lender; (iii) quarterly, within forty-five (45) days after the end of each quarter, a covenant compliance certificate in a form acceptable to Lender confirming Borrower's compliance with the financial covenants set forth in Section 12(s) below, and (iv) such other financial information as Lender shall reasonably request; (c) Borrower shall promptly advise Lender in writing of any material adverse change in business, assets or condition, financial or otherwise, of Borrower, the occurrence of any Event of Default hereunder or the occurrence of any event which, if uncured, will become an Event of Default hereunder after notice or lapse of time (or both); (d) Lender, or any Persons designated by it, shall have the right, at any time, to call at Borrower's places of business at any reasonable times, and, without hindrance or delay, to inspect the Collateral and to inspect, audit, check and make extracts from Borrower's books, records, journals, orders, receipts and any correspondence and other data relating to Borrower's business, the Collateral or any transactions between the parties hereto, and shall have the right to make such verification concerning Borrower's business as Lender may consider reasonable under the circumstances. Borrower shall furnish to Lender such information relevant to Lender's rights under this Agreement as Lender shall at any time and from time to time request. Borrower authorizes Lender to discuss the affairs, finances and business of Borrower with any officers, employees or directors of Borrower or with any Affiliate or the officers, employees or directors of any Affiliate, and to discuss the financial condition of Borrower with Borrower's independent public accountants. Any such discussions shall be without liability to Lender or to Borrower's independent public accountants. Borrower shall pay to Lender all customary fees and out-of-pocket expenses incurred by Lender in the exercise of its rights hereunder, and all of such fees and expenses shall constitute Revolving Loans hereunder, payable on demand and, until paid, shall bear interest at the rate then applicable to Loans hereunder; (e) Borrower shall: (i) keep the Collateral properly housed and shall keep the Collateral insured for the full insurable value thereof against loss or damage by fire, theft, explosion, sprinklers, collision (in the case of motor vehicles) and such other risks -18- as are customarily insured against by Persons engaged in businesses similar to that of Borrower with such companies, in such amounts and under policies in such form as shall be satisfactory to Lender. At the request of Lender, original (or certified) copies of such policies of insurance shall be delivered to Lender, together with evidence of payment of all premiums therefor, and shall contain an endorsement, in form and substance acceptable to Lender, showing loss under such insurance policies payable to Lender. Such endorsement, or an independent instrument furnished to Lender, shall provide that the insurance company shall give Lender at least thirty (30) days written notice before any such policy of insurance is altered or cancelled and that no act, whether willful or negligent, or default of Borrower or any other Person shall affect the right of Lender to recover under such policy of insurance in case of loss or damage. Borrower hereby directs all insurers under such policies of insurance to pay all proceeds payable thereunder directly to Lender and all proceeds received by Lender may be applied to the Liabilities in such order and manner as Lender shall determine. Borrower irrevocably, makes, constitutes and appoints Lender (and all officers, employees or agents designated by Lender) as Borrower's true and lawful attorney (and agent-in-fact) for the purpose of making, settling and adjusting claims under such policies of insurance, endorsing the name of Borrower on any check, draft, instrument or other item of payment for the proceeds of such policies of insurance and making all determinations and decisions with respect to such policies of insurance; and (ii) maintain, at its expense, such public liability and third party property damage insurance as is customary for Persons engaged in businesses similar to that of Borrower with such companies and in such amounts, with such deductibles and under policies in such form as shall be satisfactory to Lender and, at the request of Lender, original (or certified) copies of such policies shall be delivered to Lender, together with evidence of payment of all premiums therefor; each such policy shall contain an endorsement showing Lender as additional insured thereunder and providing that the insurance company shall give Lender at least thirty (30) days written notice before any such policy shall be altered or cancelled. If Borrower at any time or times hereafter shall fail to obtain or maintain any of the policies of insurance required above or to pay any premium in whole or in part relating thereto, then Lender, without waiving or releasing any obligation or default by Borrower hereunder, may (but shall be under no obligation to) obtain and maintain such policies of insurance and pay such premiums and take such other actions with respect thereto as Lender deems advisable. All sums disbursed by Lender in connection with any such actions, including, without limitation, court costs, expenses, other charges relating thereto and reasonable attorneys' fees, shall constitute Revolving Loans hereunder and shall be payable on demand by Borrower to Lender and, until paid, shall bear interest at the rate then applicable to Loans hereunder; -19- (f) Borrower shall not use its property, or any part thereof, in any unlawful business or for any unlawful purpose or use or maintain any of its property in any manner that does or could result in material damage to the environment or a violation of any applicable environmental laws, rules or regulations; shall keep its property in good condition, repair and order; shall permit Lender to examine any of its property at any time; shall not permit its property, or any part thereof, to be levied upon under execution, attachment, distraint or other legal process; shall not grant a security interest in or suffer to exist a lien on any of its property other than the Permitted Liens; shall not sell, lease, transfer or otherwise dispose of any of its property except in the ordinary course of its business; and shall not secrete or abandon any of its property, or remove or permit removal of any of its property from any of the locations listed on Schedule 1 of EXHIBIT A or in any written notice to Lender pursuant to paragraph 10(b) hereof, except for the removal of Inventory sold in the ordinary course of Borrower's business; (g) all monies and other property obtained by Borrower from Lender pursuant to this Agreement will be used solely for business purposes of Borrower; (h) Borrower shall, at the request of Lender, indicate on its records concerning the Collateral a notation, in form satisfactory to Lender, of the security interest of Lender hereunder, and Borrower shall not maintain duplicates or copies of such records at any address other than Borrower's principal place of business set forth on the first page of this Agreement; (i) Borrower shall file all required tax returns and pay all of its taxes when due, including, without limitation, taxes imposed by federal, state or municipal agencies, and shall cause any liens for taxes to be promptly released; provided, that Borrower shall have the right to contest the payment of such taxes in good faith by appropriate proceedings so long as (i) the amount so contested is shown on Borrower's financial statements, (ii) the contesting of any such payment does not give rise to a lien for taxes, (iii) Borrower keeps on deposit with Lender (such deposit to bear interest at a rate reasonably determined by Lender) an amount of money which, in the sole judgment of Lender, is sufficient to pay such taxes and any interest or penalties that may accrue thereon, and (iv) if Borrower fails to prosecute such contest with reasonable diligence, Lender may apply the money so deposited in payment of such taxes. If Borrower fails to pay any such taxes and in the absence of any such contest by Borrower, Lender may (but shall be under no obligation to) advance and pay any sums required to pay any such taxes and/or to secure the release of any lien therefor, and any sums so advanced by Lender shall constitute Revolving Loans hereunder, shall be payable by Borrower to Lender on demand, and, until paid, shall bear interest at the rate then applicable to Loans hereunder; (j) Borrower shall not assume, guarantee or endorse, or otherwise become liable in connection with, the obligations of any Person, except by endorsement of instruments for deposit or collection or similar transactions in the ordinary course of business; (k) Borrower shall not enter into any merger or consolidation, or enter into any transaction outside the ordinary course of Borrower's business, including, without limitation, any purchase, redemption or retirement of any shares of any class of its stock, and any issuance of any shares of, or warrants or other rights to receive or purchase any shares of, any class of its -20- stock; provided, however, that the parties agree that the following transactions, without limitation, shall be deemed to be within the ordinary course of the Borrower's business: (1) the granting of options, and the issuance of stock upon the exercise of such options, pursuant to any stock option plan duly adopted by the Borrower's shareholders; (2) the issuance of common stock upon the exercise of currently outstanding warrants to purchase up to 300,000 shares of such stock; and (3) the future issuance of warrants to purchase up to 100,000 shares of common stock per year, and the issuance of stock upon exercise of such warrants. (l) Borrower shall not declare or pay any dividend or other distribution (whether in cash or in kind) on any class of its stock; (m) After the date of this Agreement, Borrower shall not make any loans or similar advances to any of its officers or any Person related to any such officer; (n) Borrower shall (i) keep in full force and effect any and all plans which may, from time to time, come into existence under ERISA, unless such Plans can be terminated without liability to Borrower; (ii) make contributions to all of the Plans in a timely manner and in a sufficient amount to comply with the requirements of ERISA; (iii) comply with all material requirements of ERISA which relate to Plans (including, without limitation, the minimum funding standards of Section 302 of ERISA); and (iv) notify Lender immediately upon receipt by Borrower of any notice of the institution of any proceeding or other action which may result in the termination of any Plans; (o) Borrower shall not invest in, purchase or otherwise acquire, or contract to invest in, purchase or otherwise acquire, the obligations or stock of any Person, other than direct obligations of the United States; (p) Borrower shall not amend its organizational documents or change its fiscal year; (q) Borrower shall reimburse Lender for all costs and expenses, including, without limitation, legal expenses and reasonable attorneys' fees, incurred by Lender in connection with documentation and consummation of this transaction and any other transactions between Borrower and Lender, including, without limitation, Uniform Commercial Code and other public record searches, lien filings, Federal Express or similar express or messenger delivery, appraisal costs, surveys, title insurance and environmental audit or review costs, and in seeking to administer, collect, protect or enforce any rights in or to the Collateral or incurred by Lender in seeking to collect any Liabilities and to administer, participate, assign and/or enforce any of Lender's rights under this Agreement and the Other Agreements. All such costs, expenses and charges shall constitute Revolving Loans hereunder, shall be payable by Borrower to Lender on demand, and, until paid, shall bear interest at the rate then applicable to Loans hereunder; (r) Borrower at all times shall comply with the following financial covenants: -21- (i) Borrower shall not make or incur any capital expenditures (as such term is defined in accordance with GAAP), exceeding $1,500,000 in the aggregate during any fiscal year (beginning with the fiscal year ending December 31, 1997). (ii) Borrower shall achieve net profit after taxes and before extraordinary gains (as such terms are defined in accordance with GAAP) for each fiscal year of at least $500,000 per fiscal year beginning with the fiscal year ending December 31, 1997. (iii) Borrower shall achieve net profit before extraordinary gains (as such terms are defined in accordance with GAAP) of at least zero ($0) for each fiscal quarter beginning with the fiscal quarter commencing on April 1, 1997. (iv) Total liabilities of Borrower to tangible net worth of Borrower (as such term is defined in accordance with GAAP) shall not exceed 2.50 to 1.0 at any time. (v) Borrower's minimum tangible net worth (as such term is defined in accordance with GAAP) shall not be less than (A) $6,600,000 for the fiscal year ended December 31, 1996 and (B) for each fiscal quarter (calculated at the end of the fiscal quarter), commencing with the fiscal quarter beginning January 1, 1997, $6,600,000 plus 90% of net income after taxes from and after January 1, 1997 plus any additional new equity contributed to Borrower or invested in Borrower after January 1, 1997. The calculation of tangible net worth pursuant to this subsection (v) shall exclude all intangible assets and other similar assets and shall include the Subordinated Debt. (vi) Borrower shall maintain a ratio of earnings before interest and taxes to interest expense (as such terms are defined in accordance with GAAP) of at least 2.0 to 1 for each fiscal quarter, calculated at the end of each fiscal quarter, commencing with the quarter beginning April 1, 1997; (s) Within fifteen days after the making of any Equipment Loan, Borrower shall provide to Lender evidence that the proceeds of such Equipment Loan have been used to acquire Acceptable Equipment, which evidence may include, but shall not be limited to a bill of sale or certificate of title; and (t) Immediately upon request by Lender, Borrower shall take all actions necessary to comply with the Assignment of Claims Act of 1940, as amended. (u) Immediately upon request of Lender, Borrower shall provide a list of each location at which any Equipment or other Collateral is located (which list shall include not only offices but each individual job site) and immediately take all actions required by Lender and execute all UCC Financing Statements required by Lender in order to allow Lender to be fully perfected in each such jurisdiction. -22- 13. DEFAULT. The occurrence of any one or more of the following events shall constitute an "Event of Default" by Borrower hereunder: (a) the failure of any Obligor to pay any of the Liabilities when due; (b) the failure of any Obligor to perform, keep or observe any of the covenants, conditions, promises, agreements or obligations of such obligor under this Agreement or any of the Other Agreements; (c) the failure of any Obligor to perform, keep or observe any of the covenants, conditions, promises, agreements or obligations of such Obligor under any other agreement with any Person if such failure may have a material adverse effect on such Obligor's business property, assets, operations or condition, financial or otherwise; (d) the making or furnishing by any Obligor to Lender of any representation, warranty, certificate, schedule, report or other communication within or in connection with this Agreement or the or the Other Agreements or in connection with any other agreement between such Obligor and Lender, which is untrue or misleading any respect; (e) the making of any levy, seizure or attachment of any of Borrower's property with a fair market value in excess of $100,000 in the aggregate; (f) the commencement of any proceedings in bankruptcy by or against any Obligor or for the liquidation or reorganization of any Obligor, or alleging that such Obligor is insolvent or unable to pay its debts as they mature, or for the readjustment or arrangement of any Obligor's debts, whether under the United States Bankruptcy Code or under any other law, whether state or federal, now or hereafter existing for the relief of debtors, or the commencement of any analogous statutory or non-statutory proceedings involving any Obligor; provided, however, that if such commencement of proceedings against such Obligor is involuntary and such Obligor is contesting such proceedings in good faith, such action shall not constitute an Event of Default unless such proceedings are not dismissed within thirty (30) days after the commencement of such proceedings; (g) the appointment of a receiver or trustee for any Obligor, for any of the Collateral or for any substantial part of any Obligor's assets or the institution of any proceedings for the dissolution, or the full or partial liquidation, of any Obligor which is a corporation or a partnership; provided, however, that if such appointment or commencement of proceedings against such Obligor is involuntary and such Obligor is contesting such proceedings in good faith, such action shall not constitute an Event of Default unless such appointment is not revoked or such proceedings are not dismissed within thirty (30) days after the commencement of such proceedings; (h) the entry of any judgment or order against any Obligor which remains unsatisfied or undischarged and in effect for thirty (30) days after such entry without a stay of enforcement or execution; -23- (i) the death of any Obligor who is a natural Person or the dissolution of any Obligor which is a partnership or corporation; (j) the occurrence of a change of control, direct or indirect, of Borrower; (k) the occurrence of an event of default under, or the revocation or termination of, any agreement, instrument or document executed and delivered by any Person to Lender pursuant to which such Person has guaranteed to Lender the payment of all or any of the Liabilities or has granted Lender a security interest in or lien upon some or all of such Person's real and/or personal property to secure the payment of all or any of the Liabilities; (l) the institution in any court of a criminal proceeding against any Obligor, or the indictment of any Obligor for any crime; or (m) there shall occur a material adverse change, as reasonably determined by Lender, in the condition, financial or otherwise, of the Borrower or the Collateral. References herein to an Event of Default having occurred and be continuing or to the occurrence and continuance of an Event of Default are not intended to and shall not be construed as providing the Borrower any additional cure periods other than those specifically set forth in this Section 13 nor shall Lender be under any obligation to accept any cure from Borrower other than during the cure period specifically set forth in this Section 13 and any agreement to accept any cure by Borrower other than during the cure period specifically set forth in this Section 13 shall be in Lender's sole and absolute discretion. 14. REMEDIES UPON AN EVENT OF DEFAULT. (a) Upon the occurrence of an Event of Default described in paragraph 13(f) hereof, all of Borrower's Liabilities shall immediately and automatically become due and payable, without notice of any kind and upon the occurrence of any other Event of Default, all Liabilities may, at the option of Lender, and without demand, notice or legal process of any kind, be declared, and immediately shall become, due and payable. (b) Upon the occurrence of an Event of Default, Lender may exercise from time to time any rights and remedies available to it under the Uniform Commercial Code and any other applicable law in addition to, and not in lieu of, any rights and remedies expressly granted in this Agreement or in any of the Other Agreements and all of Lender's rights and remedies shall be cumulative and non-exclusive to the extent permitted by law. In particular, but not by way of limitation of the foregoing, Lender may, without notice, demand or legal process of any kind, take possession of any or all of the Collateral (in addition to Collateral of which it already has possession), wherever it may be found, and for that purpose may pursue the same wherever it may be found, and may enter into any of Borrower's premises where any of the Collateral may be, and search for, take possession of, remove, keep and store any of the Collateral until the same shall be sold or otherwise disposed of, and Lender shall have the right to store the same at any of -24- Borrower's premises without cost to Lender. At Lender's request, Borrower shall, at Borrower's expense, assemble the Collateral and make it available to Lender at one or more places to be designated by Lender and reasonably convenient to Lender and Borrower. Borrower recognizes that if Borrower fails to perform, observe or discharge any of its Liabilities under this Agreement or the Other Agreements, no remedy at law will provide adequate relief to Lender, and agrees that Lender shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages. Any notification of intended disposition of any of the Collateral required by law will be deemed reasonably and properly given if given at least ten (10) calendar days before such disposition. Any proceeds of any disposition by Lender of any of the Collateral may be applied by Lender to the payment of expenses in connection with the Collateral, including, without limitation, legal expenses and reasonable attorneys' fees, and any balance of such proceeds may be applied by Lender toward the payment of such of the Liabilities, and in such order of application, as Lender may from time to time elect, including, without limitation, to provide cash collateral to secure the Letters of Credit. 15. INDEMNIFICATION. Borrower agrees to defend (with counsel satisfactory to Lender), protect, indemnify and hold harmless Lender, each Affiliate of Lender, and each of their respective officers, directors, employees, attorneys and agents (each an "Indemnified Party") from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature (including, without limitation, the disbursements and the reasonable fees of counsel for each Indemnified Party in connection with any investigative, administrative or judicial proceeding, whether or not the Indemnified Party shall be designated a party thereto), which may be imposed on, incurred by, or asserted against, any Indemnified Party (whether direct, indirect or consequential and whether based on any federal, state or local laws or regulations, including, without limitation, securities, environmental and commercial laws and regulations, under common law or in equity, or based on contract or otherwise) in any manner relating to or arising out of this Agreement or any Other Agreement, or any act, event or transaction related or attendant thereto, the making and the management of the Loans or any Letters of Credit or the use or intended use of the proceeds of the Loans or any Letters of Credit; provided, however, that Borrower shall not have any obligation hereunder to any Indemnified Party with respect to matters caused by or resulting from the willful misconduct or gross negligence of such Indemnified Party. To the extent that the undertaking to indemnify set forth in the preceding sentence may be unenforceable because it is violative of any law or public policy, Borrower shall satisfy such undertaking to the maximum extent permitted by applicable law. Any liability, obligation, loss, damage, penalty, cost or expense covered by this indemnity shall be paid to each Indemnified Party on demand, and, failing prompt payment, shall, together with interest thereon at the highest rate then applicable to Loans hereunder from the date incurred by each Indemnified Party until paid by Borrower, be added to the Liabilities of Borrower and be secured by the Collateral. The provisions of this Section 15 shall survive the satisfaction and payment of the other Liabilities and the termination of this Agreement. 16. NOTICE. All written notices and other written communications with respect to this Agreement shall be sent by ordinary, certified or overnight mail, by telecopy or delivered in person, and in the case of Lender shall be sent to it at One Tabor Center, 1200 Seventeenth -25- Street, Suite 2760, Denver, Colorado 80202, and in the case of Borrower shall be sent to it at its principal place of business set forth on the first page of this Agreement, Attention: Rick C. Townsend. 17. CHOICE OF GOVERNING LAW; CONSTRUCTION; FORUM SELECTION. This Agreement and the Other Agreements are submitted by Borrower to Lender for Lender's acceptance or rejection as an offer by Borrower to borrow monies from Lender now and from time to time hereafter, and shall not be binding upon Lender or become effective until accepted by lender, in writing. If so accepted by Lender, this Agreement and the Other Agreements shall be deemed to have been made at said place of business. THIS AGREEMENT AND THE OTHER AGREEMENTS SHALL BE GOVERNED AND CONTROLLED BY THE INTERNAL LAWS OF THE STATE OF COLORADO AS TO INTERPRETATION, ENFORCEMENT, VALIDITY, CONSTRUCTION, EFFECT, AND IN ALL OTHER RESPECTS, INCLUDING, WITHOUT LIMITATION, THE LEGALITY OF THE INTEREST RATE AND OTHER CHARGES, BUT EXCLUDING PERFECTION OF THE SECURITY INTERESTS IN THE COLLATERAL, WHICH SHALL BE GOVERNED AND CONTROLLED BY THE LAWS OF THE RELEVANT JURISDICTION. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or remaining provisions of this Agreement. To induce Lender to accept this Agreement, Borrower irrevocably agrees that, subject to Lender's sole and absolute election, ALL ACTIONS OR PROCEEDINGS IN ANY WAY, MANNER OR RESPECT ARISING OUT OF OR FROM OR RELATED TO THIS AGREEMENT, THE OTHER AGREEMENTS OR THE COLLATERAL SHALL BE LITIGATED IN COURTS HAVING SITUS WITHIN THE CITY OF DENVER, STATE OF COLORADO. BORROWER HEREBY CONSENTS AND SUBMITS TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURTS LOCATED WITHIN SAID CITY AND STATE. BORROWER HEREBY WAIVES ANY RIGHT IT MAY HAVE TO TRANSFER OR CHANGE THE VENUE OF ANY LITIGATION BROUGHT AGAINST BORROWER BY LENDER IN ACCORDANCE WITH THIS SECTION. 18. PARTICIPATION; ASSIGNMENT. Lender shall have the right to sell or assign all or any of its rights under this Agreement and the Other Agreements, and/or to offer participation interests therein or to syndicate the Loans, to any Person, without the consent of Borrower; provided Lender retains at least a 50% interest in the Loans. In such event, Borrower shall execute such agreements, instruments and documents as Lender shall request in connection therewith, including, without limitation, agreements, instruments and documents in favor of each assignee and participant. 19. MODIFICATION AND BENEFIT OF AGREEMENT. This Agreement and the Other Agreements may not be modified, altered or amended except by an agreement in writing signed by Borrower and Lender. Borrower may not sell, assign or transfer this -26- Agreement, or the Other Agreement or any portion thereof, including, without limitation, Borrower's rights, titles, interest, remedies, powers or duties thereunder. 20. HEADINGS OF SUBDIVISIONS. The headings of subdivisions in this Agreement are for convenience of reference only, and shall not govern the interpretation of any of the provisions of this Agreement. 21. POWER OF ATTORNEY. Borrower acknowledges and agrees that its appointment of Lender as its attorney and agent-in-fact for the purposes specified in this Agreement is an appointment coupled with an interest and shall be irrevocable until all of the Liabilities are paid in full and this Agreement is terminated. 22. WAIVER OF JURY TRIAL; OTHER WAIVERS. (a) BORROWER HEREBY WAIVES ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING WHICH PERTAINS DIRECTLY OR INDIRECTLY TO THIS AGREEMENT, ANY OF THE OTHER AGREEMENTS, THE LIABILITIES, THE COLLATERAL, ANY ALLEGED TORTIOUS CONDUCT BY BORROWER OR LENDER OR WHICH, IN ANY WAY, DIRECTLY OR INDIRECTLY, ARISES OUT OF OR RELATES TO THE RELATIONSHIP BETWEEN BORROWER AND LENDER. IN NO EVENT SHALL LENDER BE LIABLE FOR LOST PROFITS OR OTHER SPECIAL OR CONSEQUENTIAL DAMAGES. (b) Borrower hereby waives demand, presentment, protest and notice of nonpayment, and further waives the benefit of all valuation, appraisal and exemption laws. (c) BORROWER HEREBY WAIVES ALL RIGHTS TO NOTICE AND HEARING OF ANY KIND PRIOR TO THE EXERCISE BY LENDER OF ITS RIGHTS TO REPOSSESS THE COLLATERAL OF BORROWER WITHOUT JUDICIAL PROCESS OR TO REPLEVY, ATTACH OR LEVY UPON SUCH COLLATERAL WITHOUT PRIOR NOTICE OR HEARING. (d) Lender's failure, at any time or times hereafter, to require strict performance by Borrower of any provision of this Agreement or any of the Other Agreements shall not waive, affect or diminish any right of Lender thereafter to demand strict compliance and performance therewith. Any suspension or waiver by Lender of an Event of Default under this Agreement or any default under any of the Other Agreements shall not suspend, waive or affect any other Event of Default under this Agreement or any other default under any of the Other Agreements, whether the same is prior to subsequent thereto and whether of the same or of a different kind or character. No delay on the part of Lender in the exercise of any right or remedy under this Agreement or any Other Agreement shall preclude other or further exercise thereof or the exercise of any right or remedy. None of the undertakings, agreements, warranties, covenants and representations of Borrower contained in this Agreement or any of the Other Agreements and no Event of Default under this Agreement or default under any of the Other Agreements shall be deemed to have been suspended or waived by Lender unless such suspension or waiver is in -27- writing, signed by a duly authorized officer of Lender and directed to Borrower specifying such suspension or waiver. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the 29th day of May, 1997. NATIONAL BANK OF CANADA, a Canadian chartered bank By /S/ ----------------------------------------------------- Name: Andrew M. Conneen, Jr. Title: Vice President CET ENVIRONMENTAL SERVICES, INC., a California corporation By /S/ ----------------------------------------------------- Name Rick C. Townsend Title: Executive Vice President -28- LIST OF EXHIBITS A - Business and Collateral Locations (Representation and Warranty Certificate) B - Permitted Liens C - Indebtedness D - Owned Vehicles EXHIBIT A BUSINESS AND COLLATERAL LOCATIONS (REPRESENTATION AND WARRANTY CERTIFICATE) ATTACHED EXHIBIT B PERMITTED LIENS
- -------------------------------------------------------------------------------------------------------------- SECURED PARTY FILING OFFICE COLLATERAL FILING FILING NAME DATE NO. - -------------------------------------------------------------------------------------------------------------- RDO Equipment Inc., dba Arizona Secretary Reed Screen-All Model CV- 05/24/96 899361-0 Arizona Industrial of State 40-D Serial No. 1507 Machinery Co. - -------------------------------------------------------------------------------------------------------------- Associates Capital Services Louisiana Central All present and future 07/10/95 08-371206 Corp. Filing Motorola products - -------------------------------------------------------------------------------------------------------------- Power Motive Corporation Colorado Secretary RD40B S/N 40B986 08/29/95 952064813 of State - -------------------------------------------------------------------------------------------------------------- Power Motive Corporation Colorado Secretary WA250 S/N A65514 09/18/96 962069669 of State - -------------------------------------------------------------------------------------------------------------- American Compressor California Secretary 300 CFM @ 7 PSIG 12.2 09/13/93 93185583 Company of State BHP 91.6 dba s/n 8457 SM - -------------------------------------------------------------------------------------------------------------- Bengal Equipment and California Secretary Used JCB Model 505-19 07/14/94 94143540 Tractor Co. of State Loadall - -------------------------------------------------------------------------------------------------------------- Paragon Environmental California Secretary ICON Fluid Bed Solvent 12/02/96 9633760756 Systems, Inc. of State Recovery System - --------------------------------------------------------------------------------------------------------------
EXHIBIT C INDEBTEDNESS ATTACHED EXHIBIT D VEHICLES ATTACHED EX-21 3 EXHIBIT 21 EXHIBIT 21 CET ENVIRONMENTAL SERVICES, INC. SUBSIDIARIES
STATE OF % CET COMPANY INCORPORATION OWNERSHIP - -------------------------------------------------------------------------------- Water Quality Management Corporation Colorado 100% - -------------------------------------------------------------------------------- H2O Construction & Maintenance, Inc. Colorado 100%
EX-23 4 EXHIBIT 23 [LETTERHEAD] REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors CET Environmental Services, Inc. We have audited the accompanying balance sheets of CET Environmental Services, Inc. as of December 31, 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 Denver, Colorado March 6, 1998 EX-27 5 EXHIBIT 27 FDS
5 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 343,878 0 10,953,562 (642,097) 13,344,219 25,089,253 7,727,495 (3,921,131) 29,882,811 12,970,393 2,005,070 0 0 8,235,589 473,128 29,882,811 54,169,753 54,169,753 0 49,038,570 4,887,446 0 704,575 (460,838) (113,547) (347,291) 0 0 0 (347,291) (.06) (.06)
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