-----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, I0ZvnTkTfG7rLZj9si9rh+u3IX7Q2M1/xIERToboC6RK1Y/HEWhy7ZtK3WvF9v3P RGqOTdz90L2bV3az49KsOA== 0001047469-99-015072.txt : 19990416 0001047469-99-015072.hdr.sgml : 19990416 ACCESSION NUMBER: 0001047469-99-015072 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 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: 99595064 BUSINESS ADDRESS: STREET 1: 7670 SOUTH VAUGHN CT STREET 2: SUITE 130 CITY: ENGLEWOOD STATE: CO ZIP: 80112 BUSINESS PHONE: 3037081360 MAIL ADDRESS: STREET 1: 6900 E 47TH AVE STREET 2: STE 200 CITY: DENVER STATE: CO ZIP: 80216 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998 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, 1999, 6.3 million shares of the Registrant's Common Stock were outstanding. The aggregate market value of voting stock held by nonaffiliates of the Registrant was approximately $5.0 million. 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: The information required by Part III is incorporated by reference from the Registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. 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 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 seven 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 $360 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 2,000 sites. The Company's strategy has been to distinguish itself in the market by providing full-service environmental contracting, 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; Sacramento, California; Edmonds, Washington; Denver, Colorado; Pasadena, Texas; San Antonio, Texas; New Orleans, Louisiana; Jackson, Mississippi; and Mobile, Alabama. In July 1995, the Company completed an initial public offering of 1.2 million shares of its Common Stock, and in August 1995, sold an additional 0.2 million shares pursuant to an overallotment option. The net proceeds to the Company from the public offering were approximately $5.8 million. Concurrent with the IPO, the Company became listed on the American Stock Exchange under the symbol "ENV." 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 0.7 million shares with net proceeds to the Company totaling $2.0 million. The Common Stock sold via this offering was registered for resale in a Form S-3 Registration Statement which became effective January 7, 1998. In conjunction 1 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 was 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. As a result of the purchase, H20 was merged with WQM, a wholly owned subsidiary of the Company. In July 1998, the Company engaged Sanders Morris Mundy of Houston, Texas to assist in maximizing shareholder value by exploring acquisition and divestiture strategies. In August 1998, the Company completed a private financing, raising $1.9 million of net proceeds in a placement of convertible preferred stock and warrants. The preferred shares could be converted into shares of the Company's Common Stock at a 15 percent discount to the price of the Common Stock at the time of conversion with a maximum conversion price of $3.35. Three-year warrants to purchase an aggregate of 35,000 shares of the Company's Common Stock at a price of $3.00 per share were also issued. Through January 1999, a total of 430 shares of the preferred securities were converted into 472,803 shares of Common Stock by the holders. The Common Stock issued upon conversion was registered for resale in a Form S-3 Registration Statement which became effective August 13, 1998. In January 1999, the Company negotiated to redeem the remaining 1,570 preferred shares for $1.9 million in cash. In December 1998, the Company sold all of the outstanding stock of WQM and H2O for $12.5 million in cash to AquaSource Services and Technologies, Inc. In addition to the $12.5 million in cash, additional consideration may be paid in 1999 based on the final audit of working capital levels. The Company received $11.3 million of the consideration at the date of purchase with the remaining consideration due ninety days after closing. At December 31, 1998, $2.6 million is included in accounts receivable as the remaining consideration. THE ENVIRONMENTAL 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 1998. 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 2 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 onsite treatment procedures for contaminated materials or the excavation and containment or offsite transportation of toxic materials. The Company provides an extensive full-service offering in all phases of contaminated site remediation. Innovative onsite remediation technologies are in high demand to provide an alternative to offsite disposal of hazardous waste. These technologies have been provided to various Company clients in order to minimize and/or eliminate our clients' cradle-to-grave liability. Onsite 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 use these remediation techniques more efficiently than its competitors. Responding to emergency spills or leaks of contaminants by petroleum and chemical 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 Company has also marketed to transporters, primarily rail carriers, in this market. Regulatory pressures are driving industrial firms to construct or upgrade wastewater treatment and pre-treatments facilities. In addition, the need for ultrapure water in the power, mining, semiconductor, pharmaceutical, food processing, and other industries is expected to double over the next 6 years. Because design, construction, operation, and compliance reporting for water and wastewater treatment systems are 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 facility cleaning, operation, maintenance, construction, closures, and emergency response; environmental remediation; and government programs. 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. 3 The Company uses the following resources to provide turnkey services to its customers: - Registered engineers, geologists, and environmental 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, scientists, and construction managers to design remediation and water/wastewater treatment systems from the conceptual stage through final design. - 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 specialized 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 environmental services for remediation of non-hazardous, hazardous, and toxic waste on a planned and emergency basis, industrial services, water and wastewater treatment. This can include assessment and characterization studies, conceptual design, detail design, construction and installation, decontamination and demolition, 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. INDUSTRIAL SERVICES. The Company provides plant services to industrial clients as an outside contractor, or by offering full- or part-time onsite personnel on a contract basis. These services include: - Tank and sump services - Specialty construction - Plant operation and maintenance - Waste management and removals - Regulatory agency coordination and permitting, regulatory management outsourcing, and compliance audits - Waste area construction/closures - Facility closures - Emergency response ENVIRONMENTAL REMEDIATION SERVICES. The Company provides full-scale turnkey environmental remediation services that range from Phase I environmental assessments and remedial investigation/feasibility studies (RI/FSs) to the design, construction, and operation of remediation systems. The Company does not promote a single technology, but recommends the remediation methods that provide the most cost-effective and timely mitigation. GOVERNMENT PROGRAMS. The Company works with government agencies at all levels: federal, state, county, municipal, and special districts. These contracts are performed with the Company as the 4 prime contractor, a teaming partner, or a subcontractor. The services provided to the government are similar to those provided to the private sector and include emergency response and remediation services. 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 Coastal Corporation Monsanto/Solutia Colonial Pipeline Nalco Chemical ERGON, Inc. Paramount Petroleum LASMO Oil & Gas, Inc. Total Petroleum Marathon Refining Unocal Corporation FINANCIAL/REAL ESTATE Canal Insurance Principal Financial Group Lincoln Property Company Remediation Financial, Inc. MANUFACTURING AND PROCESSING Anheuser Busch Home Base Big 4 Rents Raytheon Missile Systems CAE Electronics Read-Rite Corporation Chiquita Melon Safety-Kleen Coors Schlage Lock Fleming Foods Samsonite Georgia Pacific TRANSPORTATION Burlington Northern Santa Fe Railroad Illinois Central Railroad Central Freightlines Navajo Express CSX Transportation Union Pacific Railroad Highway Transports Yellow Freight ENGINEERING/CONSTRUCTION FIRMS Bechtel Montgomery Watson DeSilva Construction Parsons Engineering Fluor Corporation Stone and Webster Foster Wheeler Tetra Tech UTILITIES Florida Gas Transmission Pacific Gas & Electric Mississippi Power Southern Natural Gas GOVERNMENT (FEDERAL AND STATE) U.S. EPA Colorado Department of Mines U.S. Air Force Contra Costa Water District U.S. Army Corps of Engineers Los Angeles County Metropolitan Transportation
5 U.S. Coast Guard Agency U. S. Department of Transportation Port of Oakland U.S. Navy San Francisco Department of Public Works Alameda County Water District San Francisco Public Utilities Commission City and County of Denver Texas Natural Resource Conservation Commission City of Coachella Texas Railroad Commission
In October 1996 the Company was awarded 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. To date, the Company has been issued 5 delivery orders valued at approximately $2 million. In December 1996, the Company was notified by EPA of its selection as the successful bidder for the Emergency Response and Remedial Response Services (ERRS) West contract. This contract includes performing emergency response and remediation for oil, petroleum, and hazardous substance releases in accordance with the provisions of the federal Clean Water Act ("CWA"), RCRA and Superfund legislation. It covers 15 states and certain U.S. territories in EPA Regions VI, VIII and IX, runs for 5 years, and is estimated at $292 million. The Company has received in excess of 145 delivery orders with an approximate contract amount of $64 million to date under this contract. In September 1997 the Company was selected as the successful bidder for the ERRS contract in Region X which covers four states in the northwest. This contract also runs for 5 years and is estimated at $42 million. To date, the Company has received 13 delivery orders with an approximate contract amount of $7 million under this contract. In June 1997 the Company was awarded a 5-year, $25 million Pre-placed Remedial Action Contract (PRAC) with the U.S. Army Corps of Engineers, Omaha District. Under this contract, the Company is providing remedial actions at hazardous waste sites within the District's Midwest region. To date, the Company has been issued 7 delivery orders valued at approximately $13 million. In May 1998 CET was awarded a Worldwide Full-Service Environmental Remedial Actions (WFSERA) contract by the Air Force Center for Environmental Excellence (AFCEE). The total contract value between 7 contractors is $475 million. This contract has a 5-year ordering period with 3 additional years for performance. To date, CET has been awarded 6 delivery orders valued at approximately $2 million. The ERRS contracts, like most of the Company's other government contracts, are "basic ordering documents," not binding agreements requiring the performance of work by the Company and payment by the government. This occurs only when the government issues delivery orders under the contract. Management believes, based on its prior experience with government contracts, that the Company will receive delivery orders for a substantial portion if not the full amount of the contract during the life of the contract, or extensions thereof. However, the possibility always exists that the government will terminate work under the contract at any time. The Company has Master Service Agreements with approximately 100 clients. These include ABF Freight, Arco Chemical, Burlington Northern, Santa Fe Railroad, CITGO Petroleum, ERGON, Conoco, Georgia Pacific, Monsanto, Nalco Chemical, National Response Corporation, Ryder Truck, 6 Safety-Kleen, Southern Natural Gas, U.S. Coast Guard, and Union Pacific Railroad. Master Service Agreements 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: - Onsite 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 onsite technologies. - 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. - To meet special requirements and budget constraints, industrial facilities are increasingly outsourcing environmental and general maintenance and construction services. The Company is targeting these facilities to perform this work on a contract basis or offering full- or part-time personnel on site. - The U.S. EPA's Brownfields Economic Redevelopment Initiative, various state voluntary cleanup programs, and a maturing of the environmental marketplace have reduced the risk and uncertainty of selling, buying, and financing underutilized or Brownfield sites, creating an opportunity to redevelop prime land that was previously "untouchable" due to contamination. - A shift in emphasis from investigation to remediation, combined with the increasing numbers of military installations being listed for Base Realignment and Closure (BRAC), presents an opportunity for remediation contractors to capitalize on this allocation of federal monies. 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 redevelopment of Brownfield properties. 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.") 7 EMPHASIS ON RECURRING REVENUE. The Company seeks to expand its base of recurring revenue sources 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 industrial services and water/wastewater facilities. 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 jobsite 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 uses 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 10 people, including sales professionals, proposal writers, technical editors, and project estimators. A significant portion of new business is derived from current customers seeking services for additional sites and new needs. The Company has developed ongoing relations with a broad range of customers in various industries and geographical sites. The Company has segregated its marketing efforts for the public and private sectors. The public sector proposal effort is managed on a centralized basis. The Company pursues federal contracts that range from $5.0 million to $70.0 million annually. On larger opportunities, the Company may establish teaming agreements with large engineering/construction firms to enhance the chances for award. 8 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 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 that 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 9 regulations governing their operations is the market in which the Company operates, although the Company itself must operate under and in conformance with applicable federal and state laws and regulations. The Company attempts to pass the cost of compliance on to the customer through the prices paid by customers for the Company's services. ENVIRONMENTAL LAWS Most environmental laws and regulations are promulgated by the U.S. Congress and federal departments and agencies. For example, the National Environmental Policy Act compels federal governmental agencies at all levels to make decisions with environmental consequences in mind. The EPA and the U.S. Occupational Safety and Health Administration ("OSHA") are responsible for protecting and monitoring certain natural resources (such as air, water, and soil) and working conditions. These laws and regulations establish a comprehensive regulatory framework 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 that 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 that 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 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. 10 EPA UST REGULATIONS. The EPA has mandated that USTs that are used to store gasoline, diesel fuel, fuel oil, waste oil and hazardous materials be registered with the appropriate state regulatory agency, designed or upgraded to meet construction and operational standards, and monitored to insure against groundwater and soil contamination from leaking. Owners and operators are further required to report leaks and undertake appropriate corrective action, including testing and monitoring to identify the extent of the contamination, removal and disposal of contaminated soil, or on-site treatment of contaminated soil or groundwater. The EPA has delegated the administration of UST regulations to state agencies. To assist the remediation process when leaking USTs are identified, many state legislatures have created reimbursement programs funded by gasoline taxes or other taxes and fees. RCRA mandated 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's UST-related business opportunities were substantial in 1998. A significant number of UST owners did 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 3 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. 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. 11 POTENTIAL LIABILITY AND INSURANCE The Company maintains quality assurance, quality control, and 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 maintains comprehensive general liability insurance and worker's compensation insurance that provide $10 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 that 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 that occurred during the term of the policy, might not be covered by the policy. In the event the Company expands its services into a new market, no assurance can be given that the Company will be able to obtain insurance coverage for such activities or, if insurance is obtained, that the dollar amount of any liabilities incurred in connection with the performance of such services will not exceed policy limits. The market for liability insurance has been severely constrained at times, due in part to high losses experienced by the insurance industry from environmental impairment liability claims, including claims associated with hazardous materials and toxic wastes. Consequently, the available insurance coverage for enterprises such as the Company may be reduced, eliminated entirely or priced beyond the reach of many companies. To date, the Company has been able to obtain any insurance required by a customer. However, there can be no assurance that the Company will be able to maintain adequate liability insurance in the future. BONDING REQUIREMENTS Commercial remediation projects, as well as federal, state, and municipal projects, often require 12 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 As of March 1999, the Company employed approximately 198 employees' full time and 237 part time at its 10 offices, including five 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 May 1999. The Company's corporate and administrative functions are conducted from these facilities. The Company plans to consolidate its Denver, Colorado locations. Both the Company's headquarters and the Denver Field Office will relocate to 7032 S. Revere Parkway, Englewood, Colorado on May 31, 1999. 13 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 ----------------------------------------------------- ---------- ------------------------ --------------- 170 WEST DAYTON, STE. 106A EDMONDS, WASHINGTON (OFFICE) 6,920 March 31, 2001* 9,008.13 ----------------------------------------------------- ---------- ------------------------ --------------- 170 WEST DAYTON, STE. 106 B-D EDMONDS, WASHINGTON (WAREHOUSE) 5,568 March 31, 2001* 3,763.45 ----------------------------------------------------- ---------- ------------------------ --------------- 3033 RICHMOND PARKWAY, STE. 300 RICHMOND, CALIFORNIA 7,664 April 30, 2001 7,353.61 ----------------------------------------------------- ---------- ------------------------ --------------- 12570 E. 39TH AVENUE DENVER, COLORADO 5,021 May 31, 1999 5,330.00 ----------------------------------------------------- ---------- ------------------------ --------------- 7670 S. VAUGHN COURT, STE. 130 ENGLEWOOD, COLORADO 4,600 May 31, 1999 5,084.20 ----------------------------------------------------- ---------- ------------------------ --------------- 7032 S. REVERE PARKWAY ENGLEWOOD, COLORADO 12,027 May 31, 2004** 11,024.75 ----------------------------------------------------- ---------- ------------------------ --------------- 150 NOEL STREET MOBILE, ALABAMA 20,000 April 30, 2000 3,275.00 ----------------------------------------------------- ---------- ------------------------ --------------- 13120 CARRIERE 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 ----------------------------------------------------- ---------- ------------------------ --------------- 3437 MYRTLEAVENUE, STE. 375 NORTH HIGHLANDS, CALIFORNIA 1,150 Month to Month 736.00 ----------------------------------------------------- ---------- ------------------------ --------------- 100 N. E. LOOP 410, STE. 1200 SAN ANTONIO, TEXAS 150 Month to Month 414.00 ----------------------------------------------------- ---------- ------------------------ --------------- 275-A INDUSTRIAL DRIVE JACKSON, MISSISSIPPI 11,325 August 31, 2003 3,958.44 ---------------------------------------------------------------------------------------------------------
*CONTAINS AN OPTION TO RENEW OR EXTEND THE LEASE. **NEW LEASE COMMENCES JUNE 1, 1999. 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. 14 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 Utah. The amount of unpaid invoices, including interest and collection costs, is approximately $2.1 million. In August 1998 the Oregon court determined that the venue for the United States District Court action should be in Utah, and venue for the action was changed accordingly. Road Runner also filed a claim in this action against the Company for breach of contract seeking unspecified damages. The Company has also filed mechanic's liens on certain equipment at the site and against Road Runner's rights in the oil field. Separate actions have also been filed by the Company in Utah state court and Tribal Court to foreclose these liens. Road Runner has failed to respond timely to these two actions, and the Company is presently seeking a default remedy. The Company has written off this account receivable. The Company performed an emergency response in 1997 for Aqua-Pak, Inc. The Company has initiated a lawsuit in the U.S. District Court for the Southern District of Texas - Houston Division against PTS Properties, Inc., the building owner, Allchem Industries, Inc. and Fertilizers and Chemicals, Ltd., the chemical owners, and Aqua-Pak, Inc. for collection of the outstanding receivable of $400,000. The Company has written off this account receivable. Environmental Chemical Corporation (ECC) has filed for arbitration against the Company for various claims related to a Subcontractor Agreement for Environmental Protection Agency-related work. The Company has booked, in its opinion, sufficient reserves for ECC's claims. The Company is currently under investigation by the Office of the Inspector General (OIG) of the Environmental Protection Agency due to a past suspended audit. To date no claims have been made against the Company arising from this investigation, and subsequent independent audits by the Defense Contract Audit Agency (DCAA) have not been adverse and have not resulted in claims against the Company. The Company is cooperating with the OIG to complete its investigation. 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 quarter ended December 31, 1998. 15 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, 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 -------------------------------- ----------- ---------- March 31, 1998 7.25 5.4375 -------------------------------- ----------- ---------- June 30, 1998 $6.375 2.50 -------------------------------- ----------- ---------- September 30, 1998 2.8125 1.50 -------------------------------- ----------- ---------- December 31, 1998 2.0625 .50
(b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK. The number of record holders of the Company's common stock at March 19, 1999 was 69. This does not include approximately 800 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. (d) SALES OF UNREGISTERED SECURITIES. None 16 ITEM 6. SELECTED FINANCIAL DATA. The following selected financial information for the years ended December 31, 1998, 1997, 1996, 1995, and 1994 is derived from financial statements of the Company audited by Grant Thornton LLP, independent certified public accountants. Balance Sheet Data (in thousands):
---------------------------------------- ----------------------------------------------------------------------- AT DECEMBER 31, ---------------------------------------- ----------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- CURRENT ASSETS $ 26,670 $ 25,089 $ 18,424 $ 21,245 $ 6,479 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- TOTAL ASSETS 30,202 29,883 23,795 25,708 7,592 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- CURRENT LIABILITIES 18,835 12,970 15,121 12,921 3,462 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- WORKING CAPITAL 7,835 12,119 3,303 8,324 3,017 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- LONG TERM DEBT 251 8,204 1,700 2,077 381 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- TOTAL LIABILITIES 19,086 21,174 16,821 14,998 4,180 ---------------------------------------- ------------- -------------- -------------- ------------- ------------- SHAREHOLDERS' EQUITY 11,116 8,709 6,974 10,710 3,412 ---------------------------------------- ------------- -------------- -------------- ------------- -------------
Statement of Operations Data (in thousands, except earnings per share data):
----------------------------------------- ------------------------------------------------------------------------ FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------- ------------------------------------------------------------------------ 1998 1997 1996 1995 1994 ----------------------------------------- --------------- ------------- ------------- ------------- -------------- REVENUES $ 66,497 $ 54,170 $ 54,919 $ 47,872 $ 23,506 ----------------------------------------- --------------- ------------- ------------- ------------- -------------- OPERATING EXPENSES 74,727 54,047 58,096 44,858 21,717 ----------------------------------------- --------------- ------------- ------------- ------------- -------------- NET INCOME (LOSS) FROM CONTINUING OPERATIONS 538 (347) (3,756) 2,035 1,624 ----------------------------------------- --------------- ------------- ------------- ------------- -------------- NET INCOME (LOSS) FROM CONTINUING OPERATIONS PER COMMON SHARE $ 0.09 $ (0.06) $ (0.74) $ 0.49 $ 0.44 ----------------------------------------- --------------- ------------- ------------- ------------- -------------- WEIGHTED AVERAGE SHARES 5,828,537 5,785,264 5,066,537 4,113,725 3,676,830 ----------------------------------------- --------------- ------------- ------------- ------------- -------------- CASH DIVIDENDS PER COMMON SHARE -0- -0- -0- -0- -0- ----------------------------------------- --------------- ------------- ------------- ------------- --------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This Annual Report on Form 10-K contains forward-looking statements (as such term is defined in the private Securities Litigation Reform Act of 1995), and information relating to the Company that is based on beliefs of management of the Company, as well as assumptions made by and information currently available to management of the Company. When used in this Report, the words "estimate," "project," "believe," "anticipate," "intend," "expect," and similar expressions are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events based on currently available information and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. 17 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; San Antonio, Texas; Jackson, Mississippi; Mobile, Alabama; New Orleans, Louisiana; Sacramento, California; Richmond, California; Seattle, Washington; and Tustin, California. In late 1996, the corporate offices of the Company were moved to Englewood, Colorado from Tustin, California. BUSINESS STRATEGY The Company is focused on basic strategies that should lead to improved profitability, specifically to focus on the completion of more profitable contracts, overall direct and indirect cost reductions, and administrative efficiencies. The Company continues to focus on business relationships where it can assure high quality and operate profitably. Cost reduction efforts will continue to focus on improved program management, field consolidation, reduction of corporate expenses, and assessment of field location efficiencies. Delivery of quality service has been and will continue to be closely monitored. While management believes that implementation of this strategy will improve operating performance no assurances can be given as to its ultimate success. Completion of the sale of WQM and H20 in December of 1998 permits management of the Company to focus on operations and strategic alternatives for the Company and to enable the Company to realize its potential in the market for environmental remediation services. In addition, other events that impacted the Company in 1998 or which may impact the Company in the future include a $8.4 million reduction of debt in 1998 thereby reducing future interest expense. Future strategic alternatives currently being considered by the Company include, among others, (i) the pursuit of opportunities in its core environmental remediation business, including acquisition of other companies in its core business or in businesses complimentary to the Company's core business; (ii) expansion of services provided by the Company; and (iii) continued focus on the improvement of contract profitability. 18 RESULTS OF OPERATIONS The following table presents, for the periods indicated, the percentage relationship which certain items of the Company's statements of income bear to project revenue and the percentage increase or (decrease) in the dollar amount of such items:
PERCENTAGE RELATIONSHIP TO PROJECT REVENUE PERIOD TO PERIOD YEAR ENDED CHANGE ---------------------------------------- ---------------------------- 1998 1997 VS. VS. 1998 1997 1996 1997 1996 ------------ ---------- ----------- ------------- ----------- Project Revenue 100.0% 100.0% 100.0% 22.8% (1.4)% Project Costs: Direct 87.7 79.9 79.5 34.7 (0.9) Indirect 10.4 10.4 14.9 22.3 (30.9) -------------------------------------------------------------------------------------------------------------------- Gross profit 1.9 9.7 5.6 (75.3) 69.9 Other operating expense (income): Selling 3.0 3.8 5.6 (3.9) (33.2) General and administrative expense 11.3 5.6 5.8 147.6 (3.6) -------------------------------------------------------------------------------------------------------------------- Operating income (loss) (12.4) 0.3 (5.8) (6,790.2) 103.9 Other income (expense) 13.5 (1.1) (1.7) 1,632.7 36.5 -------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes 1.1 (0.8) (7.5) 256.6 88.8 Income tax (benefit) 0.3 (0.2) (0.7) (260.5) (66.7) -------------------------------------------------------------------------------------------------------------------- Net income (loss) 0.8% (0.6)% (6.8)% 255.3% 90.8% --------------------------------------------------------------------------------------------------------------------
1998 COMPARED TO 1997 PROJECT REVENUE. Project revenues increased 22.8% from $54.2 million in 1997 to $66.5 million in 1998. The increase is due primarily to (i) an increase of $11.9 million in revenue provided by EPA contracts (see table below); (ii) an increase of $2.0 million in revenue provided by WQM; and (iii) an increase resulting from the acquisition of H20 in January 1998 providing for revenues of approximately $1.5 million in 1998. See also, Item 1. Business -"THE COMPANY" and Note C to Company's Consolidated Financial Statements. The Company's goal is to maintain a relatively equal distribution of revenues from government contracts and commercial contracts to produce continuity of revenues, while optimizing margins. 19 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, ------------------------------------------------------------------------------------------- 1998 1997 1996 ---------------------------- ---------------------------- --------------------------- Non-EPA 33,569,412 50.5% $33,125,032 61.2% $44,065,990 80.2% EPA 32,927,870 49.5% $21,044,721 38.8% $10,852,530 19.8% ---------------------------- ---------------------------- --------------------------- Total 66,497,282 100.0% $54,169,753 100.0% $54,918,520 100.0% ---------------------------- ---------------------------- --------------------------- ---------------------------- ---------------------------- ---------------------------
DIRECT COSTS. Direct costs increased from 79.9% of revenue in 1997 to 87.7% of revenue in 1998. The increase is due primarily to cost overruns incurred on the following projects: (i) State of Washington resulting in a negative margin of $0.9 million or 1.3% of revenue in 1998 compared to a negative margin of $0.1 million or 0.1% of revenue in 1997; (ii) Monfort of Colorado, Inc. resulting in a negative margin of $1.3 million or 2.0% of revenue in 1998 compared to a margin of $0.7 million or 1.3% of revenue in 1997; (iii) various revenue adjustments related to closure of certain branch offices resulting in a negative margin of $0.8 million or 1.3% of revenue in 1998 compared to no adjustment in 1997; and (iv) other low margin projects finalized in 1998. INDIRECT COSTS. Indirect costs increased $1.3 million from $5.6 million in 1997 to $6.9 million in 1998. Indirect costs as a percentage of revenue remained constant at 10.4% in 1997 and 1998. Therefore the increase in indirect costs is directly attributable to the increase in revenue described above. GROSS PROFIT. Gross profit decreased $3.9 million from $5.2 million or a gross margin of 9.7% in 1997 to $1.3 million or a gross margin percentage of 1.9% in 1998. The decrease in gross margin results primarily from the increase in direct costs attributable to a decline in contract profitability. SELLING EXPENSE. Selling expense remained relatively constant from 1997 to 1998, while revenue increased 22.8%. Selling expense decreased to 3.0% of revenue 1998 from 3.8% of revenue in 1997. GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased $4.5 million from $3.0 million in 1997 to $7.5 million in 1998. The increase is due primarily to a non-recurring adjustment of $2.4 million to write off amounts due under contracts. See also Item 3. Legal Proceedings. Additionally, non-recurring adjustments of $1.3 million were recorded in 1998 to provide allowances for accounts receivable, contracts in process, and disallowance of cost incurred on government contracts. OPERATING INCOME (LOSS). Operating income decreased $8.3 million from an operating income of $0.1 million in 1997 to an operating loss of $8.2 million in 1998. The decrease in operating income can be attributed primarily to the decrease of $3.9 million gross profit and the increase of $4.5 million in general and administrative expense discussed above. OTHER INCOME (EXPENSE). Other income increased $9.5 million from $0.6 million other expense in 1997 to $8.9 million other income in 1998. The increase is due primarily to a non-recurring gain of $10.2 million on the sale of WQM in December 1998. See also Item 1. Business - "THE COMPANY" and Note C to Company's Consolidated Financial Statements. 20 INCOME TAX EXPENSE (BENEFIT). During 1998 the Company recorded income tax expense of $0.2 million compared to an income tax benefit of $0.1 million in 1997. The 1998 income tax expense is related to the gain on sale of WQM. The 1997 benefit was based on an estimate of 1995 carryback benefits available. NET INCOME (LOSS). Net income for the year ended December 31, 1998 was $0.5 million compared to a net loss of $0.3 million in the year ended December 31, 1997. As discussed above, the improvement in net income is due primarily to the non-recurring gain on sale of business of $10.2 million offset by a decrease in gross profit of $3.9 million and increase in general and administrative expense of $4.5 million. 1997 COMPARED TO 1996 PROJECT REVENUE. The Company experienced a slight decrease in revenues of 1.4% from $54.9 million in 1996 to $54.2 million in 1997. 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 (see table above). The Company's goal continues to be the maintenance of a relatively equal distribution of revenues from government contracts and commercial contracts to produce a solid continuity of revenues, while optimizing margins. DIRECT COSTS. Direct costs decreased slightly from $43.7 million in 1996 to $43.3 million in 1997. Direct costs as a percentage of revenues remained relatively constant at 79.9% compared to 79.5% in 1996 therefore the decrease in direct costs is primarily the result of the change in revenue described above. INDIRECT COSTS. Indirect expenses decreased significantly from $8.2 million or 14.9% of revenues in 1996 to $5.6 million or 10.4% of revenues in 1997. This decrease in indirect operating costs caused gross profit to increase from 5.6% of revenues in 1996 to 9.7% in 1997. The decrease in indirect operating costs were a result of the Company taking the following corrective actions: - Closed unprofitable offices in Portland and Phoenix. - 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. - Implemented revised processes and controls for contract administration, revenue recognition, billing and collection, and accounts payable. SELLING EXPENSES. Selling expenses decreased 33.2% from $3.1 million in 1996 to $2.1 million 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. 21 GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense decreased 3.6% from $3.2 million in 1996 to $3.0 million in 1997. This decrease was due primarily to lower insurance costs. OPERATING INCOME (LOSS). Operating income increased from an operating loss of $3.2 million in 1996 to an operating income of $0.1 million in 1997. As described above, the improvement can be attributed primarily to the increase of $2.2 million gross profit and decrease in selling expenses. INCOME TAX (BENEFIT). In 1996, the Company was able to carryback losses equivalent to 1995 profits for federal tax purposes, resulting in a federal tax benefit of $0.3 million for 1996 and $0.1 million in 1997. NET INCOME (LOSS). Net loss for the year ended December 31, 1997 was $0.3 million compared to a net loss of $3.8 million in the year ended December 31, 1996. As discussed above, the change in net income is due primarily to the $2.2 million improvement in gross profit and the $1.0 million decrease in selling expense. BONDING The amount of bonding capacity offered by sureties is a function of the financial health of the company requesting the bond. At March 1999, the bonding capacity for the Company was in excess of $25.0 million. LIQUIDITY AND CAPITAL RESOURCES The Company's financial position improved from 1997 to 1998. The Company's debt to equity ratio improved to 1.71 in 1998 from 2.43 in 1997. Related to this, the turnover ratio of the combination of accounts receivable and contracts in process improved to 120 days in 1998 from 157 days in 1997. The Company's cash and cash equivalents decreased from $0.3 million at December 31, 1997 to $0.03 million at December 31, 1998. The decrease in cash and cash equivalents is due to cash used by operating activities of $6.2 million, cash provided by investing activities of $9.1 million and cash used in financing activities of $3.2 million. Cash used by operating activities of $6.2 million is due primarily to an increase in accounts receivable and a reduction of current liabilities. Cash provided by investing activities of $9.1 million resulted primarily from the sale of WQM. Cash used in financing activities of $3.2 million resulted primarily from repayment of short-term borrowings. 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. Since January 1995, the Company has borrowed funds from related parties. As of January 1999, all funds have been repaid and the Company does not anticipate borrowing from these sources in the future. 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 $9.0 million based upon a percentage (80%) of qualifying receivables, and an equipment term loan of $1.0 million. The $9.0 million line provides that up to $1.0 million can be used for capital expenditures. Interest is payable monthly at the Bank's 22 Reference Rate plus .25%. This rate may be adjusted up or down an additional .25% depending upon the Company's profitability. The Company used proceeds from the sale of WQM to repay the line of credit, then subsequently borrowed an additional $1.0 million as of December 31, 1998. In January 1999, the Company reduced the maximum available under this financing agreement to $7.5 million. The Company has also financed vehicles and equipment using long term capital leases from various entities. As of December 31, 1998, the combined balance due on these leases was $0.6 million. 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 0.7 million shares with net proceeds to the Company totaling $2.0 million. 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. In August 1998, the Company completed a private financing, raising $1.9 million of net proceeds in a placement of convertible preferred stock and warrants. The preferred shares could be converted into shares of the Company's common stock at a 15 percent discount to the price of the common shares at the time of conversion with a maximum conversion price of $3.35. An aggregate of three-year warrants to purchase 35,000 shares of the Company's common stock at a price of $3.00 per share was also issued. A total of 430 shares of the preferred securities were converted into 472,803 shares of common stock by the holders. In January 1999, the Company negotiated to redeem the remaining 1,570 preferred shares for $1.9 million in cash. In December 1998, the Company sold all of the outstanding stock of WQM for $12.5 million in cash to AquaSource Services and Technologies, Inc. In addition to the $12.5 million in cash, additional consideration may be paid in 1999 based on the final audit of working capital levels. Management believes that funds provided by operations, funds available under the Company's line of credit and available funds from equity financing discussed above will be sufficient to fund the Company's immediate needs for working capital. CAPITAL COMMITMENTS. The Company has entered into leases for its existing facilities with such leases expiring at various dates through 2004. Monthly rentals currently are approximately $57,300 in the aggregate. Management anticipates that capital expenditures will increase in 1999 and will be funded from working capital, term loans and equipment leases. YEAR 2000 COMPLIANCE The Company has assessed the Year 2000 compliance problem and has determined that it has potential for exposure regarding Year 2000 compliance in three areas of its internal and external business activities. These areas include (1) its own internal hardware, software systems, and the telecommunications systems which are utilized to process and provide the Company's accounting, operational information, and communications, (2) the vulnerability of the Company to the failure of other companies to be Year 2000 compliant, and (3) the Year 2000 Compliance efforts of the Environmental Protection Agency (EPA), a significant client of the Company, on its daily tracking & billing system. The following discusses management's assessment and solutions of those risks and the 23 steps that are being taken to minimize them. INTERNAL HARDWARE, SOFTWARE AND TELECOMMUNICATIONS. During the past 9 months, the Company has been and is replacing or adding new equipment to its inventory of network and systems computers. The Company has committed approximately $350,000 for this hardware/software replacement, which has been financed with its cash resources and with lease financing. The hardware includes the Company's organization-wide network systems and servers, telephone systems, and personal computer equipment. The Company will test Year 2000 compliance on this new hardware/software as it is accepted. In addition, the Company has contracted for the replacement of its organization-wide accounting, costing, and management information computer software. This new software will operate the Company's accounting and operational information systems and will be functional for use by all of its regional locations. The Vendor has warranted that the software is Year 2000 compliant. Customization of the software is scheduled, and the staff training will begin 2nd quarter 1999. It is estimated that the system will be installed and functional in the 3rd quarter 1999. The cost of this system is expected to be approximately $250,000 including software, hardware and implementation, and training expenses. The primary purpose of acquiring this system is to provide improved functionality in the area of consolidated financial reporting, financial project controls, Year 2000 compliance, timely cost capturing, and management reporting. In addition, the Company has reviewed its telecommunications systems, analyzed various options, and purchased a new central telecommunication system that will provide increased functionality associated with multiple office communication requirements. The new system is Year 2000 compliant, and installation is scheduled to be complete by June 1, 1999. The estimated costs associated with a new telecommunications system are $33,000. In addition to the above activities, the Company is in the final process of completing a full inventory and assessment of its computer hardware, software, and equipment with embedded devices. It is anticipated that this process will be completed by September 1999. Management intends to identify any remaining remedial efforts that may be required to ensure its internal hardware and software systems are Year 2000 complaint. YEAR 2000 COMPLIANCE OF OTHER COMPANIES. Although the Company expects its internal systems to be Year 2000 compliant, the failure of any of its significant vendors or clients to correct a material Year 2000 problem could result in an interruption in certain normal business activities and operations. To date, the Company has received various inquires from its clients and significant vendors to provide information on Year 2000 compliance or to inform the Company of their Year 2000 compliance. The Company has been responding to these requests and notices. Management is not aware of any claims by any client to provide remedial services under any warranty agreement (stated or implied) for systems it may have provided, nor is it aware of any system that may have been provided that may be in violation of any Year 2000 compliance. To the extent any such claims may be made, the Company intends to address these issues on a case by case basis. The Year 2000 problem is not limited to computer hardware and software. It can affect a multitude of other day-to-day business activities. Any type of equipment with a microchip that stores and processes dates can be affected. The company is diligently identifying and addressing these issues so that its ability to conduct business as usual is not compromised as it moves into the 21st century. The Company is identifying mission-critical business functions that rely upon date-sensitive equipment, software, or hardware. The Company is requesting Year 2000 verification in these areas by performance testing or certifications that use various types of testing for compliance, i.e., century byte, hardware clock rollover, hardware clock leap year, BIOS rollover, BIOS leap year, power-on rollover, and power-on leap year. Due to the general uncertainty inherent in the Year 2000 problem, the Company at this time is unable to completely determine if any adverse impact will be experienced by the Company from 24 other companies' Year 2000 failures. EPA YEAR 2000 COMPLIANCE. The Company has been working with the EPA on their efforts to bring their daily tracking & billing system (RCMS) to Year 2000 compliance. The EPA has been developing a windows-based RCMS, Year 2000 Compliant system to be issued to its Contractors by July 1999. Their efforts are currently in the design testing stage. The Company expects some amount of problems that are inherent to conforming to a new windows-based system. Given the current assurances from the EPA of their compliance, the Company is only anticipating the normal conversion problems. (i.e., DOS-based vs. Windows-based interaction). While the Company may be vulnerable to other companies' Year 2000 compliance failures, the Company is well positioned to minimize the Y2K impact. The Company believes that with the implementation of its new hardware, software, up-grades to our office equipment, and completion of its assessment of vendors and clients, the possibility of significant interruptions of normal operations has been greatly reduced. 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. 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 June 8, 1999. 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. Schedules have been omitted because they are not applicable, are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto. 3. EXHIBITS. The following exhibits are filed herewith:
EXHIBIT NUMBER DESCRIPTION LOCATION ----------------------- ------------------------------------------ ------------------------------------ 3.1 Amended and Restated Articles of Incorporated by reference to 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 Agreement Incorporated by reference to Exhibit 10.2 to the Company's Form SB-2 Registration Statement No. 33-91602 10.3 Loan Documents Between National Bank of Incorporated by reference to Canada and the Company Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
26
EXHIBIT NUMBER DESCRIPTION LOCATION ----------------------- ------------------------------------------ ------------------------------------ 10.4 Amendment to Loan and Security Agreement Filed herewith electronically and Loan Documents between National Bank of Canada and the Registrant 10.5 Second Amendment to Loan and Security Filed herewith electronically Agreement and Loan Documents between National Bank of Canada and the Registrant 10.6 Third Amendment to Loan and Security Filed herewith electronically Agreement and Loan Documents between National Bank of Canada and the Registrant 10.7 Stock Purchase Agreement with AquaSource Incorporated by reference to Services and Technologies, Inc. Exhibit 10.1 to the Company's report on Form 8-K dated December 17, 1998 21 Subsidiaries of the Registrant None. 23 Consent of Grant Thornton LLP Filed herewith electronically 27 Financial Data Schedule Filed herewith electronically
(b) REPORTS ON FORM 8-K. The Company filed a Report on Form 8-K dated December 17, 1998 reporting information under Items 2 and 7 of that form concerning the sale of the Company's WQM subsidiary. 27 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 15, 1999 By /s/ Steven H. Davis ------------------------------- Steven H. Davis President and Chief Executive Officer Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the date indicated.
Signature Capacity Date --------- -------- ---- /s/ Steven H. Davis President (principal financial - ---------------------------------------------------- and accounting officer), Chief April 15, 1999 Steven H. Davis Executive Officer, Secretary and Director /s/ Craig C. Barto Director April 15, 1999 - ---------------------------------------------------- Craig C. Barto /s/ Douglas W. Cotton Executive Vice President, - ---------------------------------------------------- Chief Operating Officer and April 15, 1999 Douglas W. Cotton Director /s/ George Pratt Director April 15, 1999 - ---------------------------------------------------- George Pratt /s/ Robert A. Taylor Director April 15, 1999 - ---------------------------------------------------- Robert A. Taylor
28 CET ENVIRONMENTAL SERVICES, INC. FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS December 31, 1998 and 1997 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors CET Environmental Services, Inc. We have audited the accompanying consolidated balance sheets of CET Environmental Services, Inc. as of December 31, 1998 and 1997, and the related consolidated 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 consolidated financial position of CET Environmental Services, Inc. as of December 31, 1998 and 1997, and the consolidated 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 25, 1999 F-1 CET Environmental Services BALANCE SHEETS December 31,
ASSETS 1998 1997 ------------ ------------ CURRENT ASSETS Cash $ 25,192 $ 343,878 Accounts receivable, less allowance for doubtful accounts; $721,857 in 1998 and $642,097 in 1997 11,781,212 10,042,516 Contracts in process less allowance for doubtful accounts of $284,128 in 1998 and $-0- in 1997 10,154,501 13,344,219 Retention receivable 663,998 268,949 Income tax receivable -- 20,342 Due from related party 124,036 100,010 Other receivables 3,371,828 154,838 Inventories 267,491 248,417 Prepaid expenses 281,935 566,084 ------------ ------------ Total current assets 26,670,193 25,089,253 ------------ ------------ EQUIPMENT AND IMPROVEMENTS Field equipment and vehicles 5,761,481 5,931,499 Office furniture, equipment and leasehold improvements 601,843 1,795,996 ------------ ------------ 6,363,324 7,727,495 Less allowance for depreciation and amortization (2,883,021) (3,921,131) ------------ ------------ Equipment and improvements - net 3,480,303 3,806,364 GOODWILL, net of accumulated amortization of $57,684 in 1997 -- 509,228 DEPOSITS 51,318 477,966 ------------ ------------ $ 30,201,814 $ 29,882,811 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these statements. F-2 LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997 ----------- ------------ CURRENT LIABILITIES Cash overdraft $ 1,936,741 $ -- Accounts payable 11,383,109 8,974,502 Accrued expenses 3,249,019 3,054,740 Current obligations under capital leases 316,798 293,957 Income taxes payable 158,958 -- Current portion of long-term debt 750,000 647,194 Line of credit 1,039,925 -- ----------- ------------ Total current liabilities 18,834,550 12,970,393 OBLIGATIONS UNDER CAPITAL LEASES 250,784 583,270 LINE OF CREDIT -- 6,198,631 NOTES PAYABLE TO RELATED PARTIES -- 671,800 LONG-TERM DEBT -- 750,000 COMMITMENTS AND CONTINGENT LIABILITIES -- -- STOCKHOLDERS' EQUITY Common stock (no par value) - authorized 20,000,000 shares; 6,129,271 and 5,805,485 shares issued and outstanding at December 31, 1998 and 1997, respectively 8,539,716 8,235,589 4% convertible preferred stock (no par value) - authorized 5,000,000 shares; 1,710 and -0- shares issued and outstanding at December 31, 1998 and 1997, respectively 1,589,102 -- Paid-in capital 574,629 567,953 Retained earnings (accumulated deficit) 413,033 (94,825) ----------- ------------ Total stockholders' equity 11,116,480 8,708,717 ----------- ------------ $30,201,814 $ 29,882,811 ----------- ------------ ----------- ------------
The accompanying notes are an integral part of these statements. F-3 CET Environmental Services STATEMENT OF OPERATIONS Years ended December 31,
1998 1997 1996 ------------ ------------ ------------ PROJECT REVENUE $ 66,497,282 $ 54,169,753 $ 54,918,520 PROJECT COSTS Direct 58,298,144 43,286,506 43,660,435 Indirect 6,902,927 5,645,781 8,175,951 ------------ ------------ ------------ 65,201,071 48,932,287 51,836,386 ------------ ------------ ------------ Gross profit 1,296,211 5,237,466 3,082,134 ------------ ------------ ------------ OTHER OPERATING EXPENSES (INCOME) Selling 1,989,584 2,070,130 3,101,197 General and administrative 7,535,966 3,044,045 3,158,707 ------------ ------------ ------------ 9,525,550 5,114,175 6,259,904 ------------ ------------ ------------ Operating income (loss) (8,229,339) 123,291 (3,177,770) ------------ ------------ ------------ OTHER INCOME (EXPENSE) Gain on sale of subsidiary 10,154,028 -- -- Interest expense, net (892,213) (704,575) (627,537) Other income (expense) (310,722) 120,446 (292,998) ------------ ------------ ------------ 8,951,093 (584,129) (920,535) ------------ ------------ ------------ Income (loss) before taxes on income 721,754 (460,838) (4,098,305) (Benefit) taxes on income 183,276 (113,547) (341,855) ------------ ------------ ------------ NET INCOME (LOSS) $ 538,478 $ (347,291) $ (3,756,450) ------------ ------------ ------------ ------------ ------------ ------------ Weighted average number of shares outstanding 5,828,537 5,785,264 5,066,537 Earnings (loss) per common share $ 0.09 $ (0.06) $ (0.74) ------------ ------------ ------------ ------------ ------------ ------------ Earnings (loss) per common share-- assuming dilution $ 0.09 $ (0.06) $ (0.74) ------------ ------------ ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these statements. F-4 CET Environmental Services, Inc. STATEMENTS OF STOCKHOLDER'S EQUITY Years ended December 31, 1998, 1997, and 1996
Retained Common stock Preferred stock earnings Total ----------------------- ----------------------- Paid-in (accumulated stockholders' Shares Amount Shares Amount capital deficit) equity --------- ----------- --------- ----------- --------- ------------ ------------- Balance at January 1, 1996 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 (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 (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 Exercise of stock options and other 6,000 14,000 - - 6,676 - 20,676 Issuance of preferred stock - - 2,000 1,879,229 - - 1,879,229 Conversion of preferred stock 317,786 290,127 (290) (290,127) - - - Dividends on preferred stock - - - - - (30,620) (30,620) Net income for the year - - - - - 538,478 538,478 --------- ----------- --------- ----------- --------- ------------ ------------ Balance at December 31, 1998 6,129,271 $ 8,539,716 1,710 $ 1,589,102 $ 574,629 $ 413,033 $ 11,116,480 --------- ----------- --------- ----------- --------- ------------ ------------ --------- ----------- --------- ----------- --------- ------------ ------------
The accompanying notes are an integral part of these statements. F-5 CET Environmental Services, Inc. STATEMENTS OF CASH FLOWS Years ended December 31,
1998 1997 1996 ------------ ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 538,478 $ (347,291) $(3,756,450) Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 1,453,900 1,573,085 1,252,781 Gain on sale of subsidiary (10,154,028) -- -- Provision for bad debts 333,268 104,010 402,683 Deferred income taxes -- -- 252,048 Loss on sale of equipment 216,007 -- 13,304 Employee stock option plan 6,676 12,423 20,355 Changes in operating assets and liabilities: (Increase) decrease in accounts receivable (3,348,937) (2,692,133) 5,499,747 Decrease (increase) in contracts in process 2,905,590 (6,687,357) (443,372) Decrease (increase) in income tax and other receivables (1,942,137) 1,037,665 (1,335,263) Decrease (increase) in prepaid expenses (370,848) 47,686 (107,530) (Increase) decrease in inventory and deposits 403,074 (421,828) 50,210 Increase (decrease) in accounts payable 3,152,811 1,215,834 (99,156) Increase (decrease) in accrued expenses and income taxes 619,832 2,199,847 (533,861) ------------ ----------- ----------- Net cash (used in) provided by operating activities (6,186,314) (3,958,059) 1,215,496 ------------ ----------- ----------- INVESTING ACTIVITIES: Purchase of equipment (1,381,135) (462,947) (1,523,418) Proceeds from sale of equipment -- -- 65,641 Proceeds from sale of subsidiary 11,250,000 -- -- Net purchase of subsidiary (803,845) (186,798) -- ------------ ----------- ----------- Net cash provided by (used in) investing activities 9,065,020 (649,745) (1,457,777) ------------ ----------- ----------- FINANCING ACTIVITIES: Bank overdraft 1,936,741 -- -- Proceeds from issuance of long-term debt -- 1,286,476 766,751 Payments on long-term debt (754,877) (1,475,158) (917,592) Payments on capital leases (411,359) (327,230) (348,711) Net (payments) proceeds from credit line loan (5,158,706) 1,997,981 1,775,814 Borrowings from related party trust fund -- -- 200,000 Payment of dividends on preferred stock (30,620) -- -- Proceeds from issuance of preferred stock 1,879,229 2,035,662 -- Proceeds from exercise of stock options 14,000 33,950 -- Proceeds from loans from shareholders 500,000 -- 545,000 Payments on loans from shareholders (500,000) (545,000) -- 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. STATEMENTS OF CASH FLOWS Years ended December 31,
1998 1997 1996 ----------- ----------- ----------- Payments on subordinated notes payable $ (671,800) $ -- $ (210,625) ----------- ----------- ----------- Net cash (used in) provided by financing activities (3,197,392) 3,064,681 1,652,627 ----------- ----------- ----------- (DECREASE) INCREASE IN CASH (318,686) (1,543,123) 1,410,346 Cash at beginning of year 343,878 1,887,001 476,655 ----------- ----------- ----------- Cash at end of year $ 25,192 $ 343,878 $ 1,887,001 ----------- ----------- ----------- ----------- ----------- ----------- Supplemental disclosures of cash flow information: Cash paid during the year Interest $ 1,060,211 $ 717,980 $ 485,951 Income taxes -- -- 656,900 Noncash investing and financing activities: Capital lease and financing obligations incurred for equipment $ -- $ -- $ 683,223 ----------- ----------- ----------- ----------- ----------- ----------- Issuance of note payable for financing of insurance premiums $ 485,818 $ 301,965 $ 412,296 ----------- ----------- ----------- ----------- ----------- ----------- Conversion of preferred stock to common $ 290,127 $ -- $ -- ----------- ----------- ----------- ----------- ----------- ----------- Transfer of CIP from deposits to fixed assets $ 368,452 $ -- $ -- ----------- ----------- ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these statements. F-7 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS December 31, 1998, 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, 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. In August 1997, the Company acquired all of the outstanding stock of Water Quality Management Corporation (WQM). WQM was operated as a wholly-owned subsidiary of the Company. WQM was sold in December 1998 (Note C). 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 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 consist 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. F-8 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. 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. 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. 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 AND OTHER RECEIVABLES: The carrying amount approximates fair value due to the short-term maturity. DUE FROM RELATED PARTY: The carrying amount approximates the fair value because it is due on demand. 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. LONG-TERM DEBT / OBLIGATIONS UNDER CAPITAL LEASES: The carrying value approximates fair value as the interest rate at December 31, 1998 and 1997 is considered to approximate the market rate. F-9 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NOTES PAYABLE TO RELATED PARTIES: The carrying value approximates fair value as the interest rate at December 31, 1998 and 1997 is considered to approximate the market rate. USE OF ESTIMATES In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. IMPAIRMENT OF LONG-LIVED ASSETS In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF (SFAS 121). SFAS 121 requires that long-lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows (undiscounted and without interest) is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of that loss would be based on the fair value of the asset. SFAS 121 also generally requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of the carrying amount or the fair value, less cost to sell. SFAS 121 is effective for the Company's 1997 fiscal year-end. Any impairment provisions recognized in accordance with SFAS 121 are permanent and may not be restored in the future. No impairment expense was recognized in the years ended December 31, 1998 and 1997. EARNINGS PER 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. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data): F-10 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
1998 1997 1996 ------- ------- ------- Numerator Net income (loss) $ 539 $ (347) $(3,756) Preferred stock dividends (31) -- -- ------- ------- ------- Numerator for basic earnings per share - income available to common stockholders 508 (347) (3,756) Effect of dilutive securities: Preferred stock dividends -- -- -- ------- ------- ------- Numerator for diluted earnings per share - income available to common stockholders after assumed conversions $ 508 $ (347) $(3,756) ------- ------- ------- ------- ------- ------- Denominator: Denominator for basic earnings per share - weighted average shares outstanding $ 5,829 $ 5,785 $ 5,067 Effect of dilutive securities: Warrants 24 -- -- Convertible preferred stock -- -- -- Stock options 22 -- -- ------- ------- ------- Dilutive potential common shares 46 -- -- Denominator for diluted earnings per share - adjusted weighted average share and assumed conversion $ 5,875 $ 5,785 $ 5,067 ------- ------- ------- ------- ------- ------- Basic earnings per share $ 0.09 $ 0.06 $ 0.74 ------- ------- ------- ------- ------- ------- Diluted earnings per share $ 0.09 $ 0.06 $ 0.74 ------- ------- ------- ------- ------- -------
F-11 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE B -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) In 1998, basic earnings per share data was computed by dividing net income, less preferred stock dividends, by the weighted average number of common shares outstanding during the period. Diluted earnings per share were adjusted for the assumed conversion of potentially dilutive securities including stock options and warrants to purchase common stock. However, dilutive earnings per share computation does not give effect to the assumed conversion of convertible preferred stock as its effect would have been anti-dilutive. In 1997 and 1996, basic earnings per share data was computed by dividing net loss, by weighted average number of common shares outstanding during the period. Diluted earnings per share computations do not give effect to potentially dilutive securities including stock options and warrants as their effect would have been anti-dilutive. Certain financial statement reclassifications have been made in 1996 and 1997 to conform with presentations used in 1998. NOTE C -- SALE OF SUBSIDIARY Effective December 1, 1998, the Company sold all of the outstanding shares of its subsidiary, Water Quality Management Corporation (WQM) for a purchase price of $12,500,000 adjusted for the net working capital of WQM at November 30, 1998. The Company received $11,250,000 at the date of purchase with the remaining consideration due ninety days after closing. At December 31, 1998, $2,598,918 has been included in other receivables as the remaining consideration. NOTE D -- CONTRACTS IN PROCESS Contracts in process consist of the following at December 31:
1998 1997 ----------- ----------- Government - EPA contracts $ 1,971,002 $ 3,801,853 Non-EPA contracts 8,183,499 9,542,366 ----------- ----------- Total $10,154,501 $13,344,219 ----------- ----------- ----------- -----------
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-12 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE E -- SIGNIFICANT CUSTOMERS A significant portion of the Company's business is from contracts 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, 1998 and 1997, the net balance of accounts receivable from the EPA was $8,359,389 and $3,943,761, respectively. Revenue from the EPA in 1998, 1997, and 1996 amounted to approximately $30 million, $21 million, and $10.9 million, respectively. The Company also performs work for the U.S. Army Corps of Engineers that accounted for 10%, 7% and 1% of revenue in 1998, 1997 and 1996, respectively. NOTE F -- 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. The Company borrowed $671,800, which includes subordinated notes of $671,800 (see notes H and I), from relatives of Steven H. Davis, President, pursuant to one-year notes, which bear interest at the rate of 10% per annum. The Company repaid these notes in December 1998. Interest expense attributable to these related party borrowings amounted to $95,761, $73,544, and $55,898 for 1998, 1997, and 1996, respectively. A director and 11.5% 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, 1998, 1997, and 1996 for fees amounting to approximately $273,000, $835,000, and $340,000, respectively. The Company has made advances to a former officer and director of the Company. The balance due was $124,036 and $100,010 at December 31, 1998 and 1997, respectively. Interest is payable monthly at 10% per annum, and principal is due on demand. NOTE G -- CAPITAL LEASES Vehicles and equipment recorded under capital leases consist of the following at December 31:
1998 1997 ----------- ----------- Vehicles $ 1,363,960 $ 1,497,407 Equipment 202,123 272,679 ----------- ----------- 1,566,083 1,770,086 Less accumulated depreciation (751,693) (806,148) ----------- ----------- Total $ 814,390 $ 963,938 ----------- ----------- ----------- -----------
F-13 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE G -- 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, 1998: 1999 $ 382,041 2000 265,031 2001 33,161 --------- Total minimum lease payments 680,233 Less amounts representing estimated executory costs (taxes) (40,310) --------- Net minimum lease payments 639,923 Less amount representing interest (72,341) --------- Present value of net minimum lease payments $ 567,582 --------- --------- Current portion $ 316,798 Noncurrent portion 250,784 --------- $ 567,582 --------- ---------
NOTE H -- 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, including a $500,000 stand-by letter of 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, 1998). The line of credit facility has an expiration date of May 30, 1999. At December 31, 1998, $1,039,925 was outstanding under the agreement. 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, 1998). In January 1999, the Company reduced the maximum available under this financing agreement to $7.5 million comprised of a line of credit of $6.75 million and an equipment term loan of $750,000. Long-term debt consists of the following at December 31:
1998 1997 -------- -------- 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 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 Note payable for annual insurance premium, interest at 5.73%, with monthly payments of $43,531, due June 30, 1998 - 304,347
F-14 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE H -- LINE OF CREDIT AND LONG-TERM DEBT (CONTINUED)
1998 1997 ---------- ---------- Note payable to a bank, collateralized by equipment, payable in monthly installments of $16,667 including interest at 9%, balance due May 30, 1999 750,000 950,000 ---------- ---------- 750,000 1,397,194 Less current portion 750,000 647,194 ---------- ---------- $ - $ 750,000 ---------- ---------- ---------- ----------
Related party debt consists of the following at December 31:
1998 1997 ---------- ---------- Subordinated notes payable to related parties, due February 28, 1999, interest at 10% (see notes F and I) $ - $ 671,800 ---------- ---------- 671,800 Less current portion - - ---------- ---------- $ - $ 671,800 ---------- ---------- ---------- ----------
NOTE I -- 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. On March 1, 1996, the remaining balance of $471,800 was rolled over into new notes, with interest payable monthly at ten percent per annum. Interest of $47,180 and $39,316 was paid to the holders of these notes during 1997 and 1996, respectively. NOTE J -- TAXES ON INCOME The provision (benefit) for taxes on income includes the following for the year ended December 31:
1998 1997 1996 --------- ----------- ----------- CURRENT Federal $ 183,276 $ (20,342) $ (569,268) State - - (24,635) --------- ----------- ----------- $ 183,276 $ (20,342) $ (593,903) --------- ----------- ----------- DEFERRED Federal - (79,650) 215,390 State - (13,555) 36,658 --------- ----------- ----------- - (93,205) 252,048 --------- ----------- ----------- Total $ 183,276 $(113,547) $ (341,855) --------- ----------- ----------- --------- ----------- -----------
F-15 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE J -- TAXES ON INCOME (CONTINUED) 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:
1998 1997 1996 ----------- --------- ----------- Provision (benefit) for income taxes at statutory rate $ 281,484 $(180,000) $(1,598,400) Change in valuation reserve (1,016,400) 102,134 1,076,366 Use of operating loss carry forwards 907,700 -- -- Stock options 2,700 6,900 8,142 Other 32,200 13,342 172,037 Change in prior year estimate (24,408) (55,923) -- ----------- --------- ----------- $ 183,276 $(113,547) $ (341,855) ----------- --------- ----------- ----------- --------- -----------
Deferred tax assets and liabilities consist of the following at December 31:
1998 1997 ----------- ----------- Alternative minimum tax credit $ 202,000 $ - Deferred gain on sale (1,000,900) - Accrued salary expense 211,900 81,900 Allowance for doubtful accounts 377,200 227,000 Other reserves 243,100 - NOL carryforward - 907,700 Other 128,800 (38,100) ----------- ----------- 162,100 1,178,500 Valuation reserve (162,100) (1,178,500) ----------- ----------- $ - $ - ----------- ----------- ----------- -----------
Realization of the deferred tax asset depends on achieving future taxable income. The Company incurred losses in recent 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. NOTE K -- COMMITMENTS AND CONTINGENCIES The Company is obligated under certain operating leases for its facilities. The leases expire at various dates through 2001, with appropriate rentals as set forth below. Some leases also provide for payments of taxes and certain common area costs and expenses. F-16 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE K -- COMMITMENTS AND CONTINGENCIES (CONTINUED) The following is a summary at December 31, 1998, of the future minimum rents due under noncancelable operating leases:
Year ending December 31, 1999 $ 581,578 2000 462,997 2001 134,756 ----------- Total $ 1,179,331 ----------- -----------
Total rent expense under operating leases for the years ended December 31, 1998, 1997, and 1996, was approximately $839,514, $723,900 and $892,700, 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 L -- STOCKHOLDERS' EQUITY On February 9, 1996, the Company filed a registration statement on Form SB-2 to register 402,537 shares of common stock for resale by certain shareholders (Selling Shareholders), which shares have been "restricted securities" as defined in Rule 144 under the Securities Act of 1933. None of the proceeds from the sale of the common stock by the Selling Shareholders were received by the Company. In January 1997, the Company completed a private offering of 729,248 shares of its common stock. The net proceeds to the Company from this offering were approximately $2,035,000. In connection with this offering, the Company issued a warrant to the representatives of the underwriters in this offering to purchase up to 10% of the number of shares sold in the offering of the Company's common stock. The purchase price of such warrant was $100 and the exercise price under such warrants is $3.60 per share. The warrants may be exercised in whole or in part at any time or from time to time until the expiration date of December 31, 2001. The Company also issued warrants to purchase 100,000 shares of common stock at $4.25 per share to a management services firm as consideration for its assistance on the private offering. The warrants may be exercised from July 1, 1998 through December 31, 1999. These warrants are considered stock issuance costs, with a value of approximately $235,000 based on the fair value at the grant date as required by Financial Accounting Standards 123. F-17 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE L -- STOCKHOLDERS' EQUITY (CONTINUED) In July 1998, the Company completed a private placement of 2,000 shares of 4% convertible preferred stock. The net proceeds were approximately $1,879,000. The preferred stock is convertible into shares of common stock based on the stated value of $1,000 per share of preferred stock divided by conversion price on the conversion date. The conversion price is equal to 85% of the lowest closing price of the common stock during the six days immediately preceding the conversion date, not to exceed $3.35. A total of 290 shares of the preferred stock were converted into 317,786 shares of common stock during 1998. The holders of 4% convertible preferred stock are entitled to receive dividends when declared by the Board of Directors, payable in cash or common stock of $40 per share. Such dividends are payable in quarterly installments on March 31, June 30, September 30 and December 31 of each year commencing September 30, 1998. In the event of a voluntary or involuntary dissolution, liquidation or winding up of the Company, the holders of 4% convertible preferred stock are entitled to receive out of the assets of the Company available for distribution, before payment shall be made to holders of common stock, an amount per share equal to $1,000 of such shares and all dividends which have accrued and are unpaid. In connection with this offering, the Company issued warrants to the representatives of the underwriters in this offering to purchase up to 35,000 shares of the Company's common stock at $3.00 per share. The warrants may be exercised during the period commencing July 24, 1999 and ending on December 31, 2001. In January 1999, the Company bought back all the remaining shares of preferred stock for approximately $1,900,000. The warrants issued in connection with the preferred stock remain outstanding. NOTE M -- 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 $82,103, $65,206, and $83,738 for the years ended December 31, 1998, 1997, and 1996, respectively. F-18 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE N -- STOCK OPTIONS On March 1, 1995, the Company adopted an Incentive Stock Option Plan (the Plan) for key personnel. A total of 550,000 shares of the Company's common stock are reserved for issuance pursuant to the exercise of stock options (the Options) which may be granted to full-time employees of the Company. The Plan is administered by the Board of Directors. In addition to determining who will be granted Options, the Board of Directors has the authority and discretion to determine when Options will be granted and the number of Options to be granted. The Board of Directors may grant Options intended to qualify for special treatment under the Internal Revenue Code of 1986, as amended (Incentive Stock Options) and may determine when each Option becomes exercisable, the duration of the exercise period for Options and the form of the instruments evidencing Options granted under the Plan. The maximum aggregate fair market value (determined as of the date of grant) of the shares as to which the Incentive Stock Options become exercisable for the first time during any calendar year may not exceed $100,000. The Plan provides that the purchase price per share for each Incentive Stock Option on the date of grant may not be less than 100 percent of the fair market value of the Company's common stock on the date of grant. However, any Option granted under the Plan to a person owning more than 10 percent of the Company's common stock shall be at a price of at least 110 percent of such fair market value. The Plan is accounted for under APB Opinion 25 and related interpretations. The Options generally have a term of 10 years when issued and vest over three to five years. Had compensation cost for the Plan been determined based on the fair value of the Options at the grant date consistent with the method of Statement of Financial Accounting Standards 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, the Company's net income (loss) and earnings (loss) per common share would have been:
1998 1997 1996 ----------- ----------- ------------- Net income (loss) As reported $ 538,478 $ (347,291) $ (3,756,450) Pro forma 454,233 (495,586) 3,854,017 Earnings (loss) per common share As reported $ 0.09 $ (0.06) $ (0.74) Pro forma 0.08 (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 1998, 1997 and 1996: no expected dividends; expected volatility of 74.77%; risk-free interest rate of 6.07%; and expected lives of five years. F-19 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE N -- STOCK OPTIONS (CONTINUED) A summary of the status of the Plan follows:
Average price Shares per share -------- ------------- 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 -------- -------- -------- -------- Outstanding at January 1, 1998 230,800 $ 5.10 Granted -- $ -- Exercised (4,000) $ 3.50 Canceled (114,700) $ 4.45 -------- -------- Outstanding at December 31, 1998 112,100 $ 5.08 -------- -------- Total exercisable at December 31, 1998 51,950 $ 4.75 -------- -------- -------- --------
Weighted average Range Options Proceeds exercise price ------------ ------------ ------------ ---------------- Exercisable at December 31, 1998 $3.50 - 7.00 51,950 $ 246,950 $ 4.75
F-20 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE N -- STOCK OPTIONS (CONTINUED) The following information applies to options outstanding at December 31, 1998:
Weighted average Range of Options Weighted average remaining exercisable prices outstanding exercise price contractual life ------------------ ----------- ---------------- ----------------- $3.50 - 7.00 112,100 $5.08 6 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 $6,676, $12,423, and $20,355 in 1998, 1997, and 1996, respectively, relating to these options. Compensation expense of $3,172 will be recorded in future periods as these options vest over a five-year period commencing December 31, 1996. NOTE O -- 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, 1998 and 1997, are as follows:
1998 Carrying amount Estimated fair value --------------------------- --------------- -------------------- Cash $ 25,192 $ 25,192 Due from related party 124,036 124,036 Other receivables 3,371,828 3,371,828 Note payable - line of credit 1,039,925 1,039,925 Long-term debt 750,000 750,000 Capitalized lease obligations 567,582 567,582
1997 Carrying amount Estimated 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
F-21 CET Environmental Services, Inc. NOTES TO FINANCIAL STATEMENTS (CONTINUED) December 31, 1998, 1997 and 1996 NOTE P -- FOURTH QUARTER ADJUSTMENTS During the fourth quarter of the year ended December 31, 1998, the Company made the following adjustments: Wrote off specific accounts receivable that were determined to be uncollectible. $ 2,400,000 Increase in allowance for bad debts. 740,000 Increase contract cost for an expected settlement with a subcontractor. 400,000 Wrote off costs of a project in Brazil that was determined not to be feasible. 175,000
F-22 EX-10.4 2 EXHIBIT 10.4 AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LOAN DOCUMENTS THIS AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LOAN DOCUMENTS (this "Amendment"), dated as of August 29, 1997, is between NATIONAL BANK OF CANADA, a Canadian chartered bank ("Lender"), and CET ENVIRONMENTAL SERVICES, INC., a California corporation ("Borrower"). RECITALS A. Lender and Borrower entered into a Loan and Security Agreement dated May 29, 1997 (the "Loan Agreement"), providing for the Revolving Loans, Equipment Loans, Term Loan and Letters of Credit in the aggregate maximum available amount not to exceed $9,000,000. Defined terms used herein and not defined herein shall have the meaning set forth in the Loan Agreement. B. The Loans are secured by the Collateral. C. The Borrower and Lender desire to enter into this Amendment in order to increase the amount of Letters of Credit that may be issued pursuant to the Loan Agreement. AGREEMENT IN CONSIDERATION of the foregoing and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Lender and Borrower agree as follows: 1. AMENDMENT TO LOAN AGREEMENT. In order to increase to the maximum amount of Letters of Credit that may be issued, subsection (i) of Section 2(c) of the Loan Agreement is hereby amended by replacing the phrase "FIVE HUNDRED THOUSAND DOLLARS ($500,000)" with the phrase "ONE MILLION FIVE HUNDRED THOUSAND DOLLARS ($1,500,000)". 2. TERM LOAN ADVANCE. Lender may agree to advance all or a portion of the Term Loan to Borrower prior to Lender having a perfected first priority lien on all vehicles owned by Borrower. However, Lender is not waiving the requirement that Borrower provide Lender a valid, perfected first priority lien on all vehicles owned by Borrower. Accordingly, if Lender elects to make an advance of the Term Loan, Lender hereby agrees that Borrower shall have twenty (20) days following the advance of the Term Loan to deliver to Lender the vehicle titles required pursuant to Section 4(j) of the Loan Agreement and take all other actions required in order to grant Lender a valid perfected first priority lien on all vehicles owned by Borrower. If such vehicle titles have not been delivered to Lender within twenty (20) days after such advance or Borrower fails to take all other actions requested by Lender in order to grant Lender a valid, perfected first priority lien on all vehicles owned by Borrower, such failure shall, at the Lender's option, be an Event of Default under Section 13 of the Loan Agreement. 3. LOAN DOCUMENTS. a. Lender and Borrower agree that any and all notes or other documents executed in connection with the Loans (collectively, the "Loan Documents") are hereby amended to reflect the amendments set forth herein and that no further amendments to any Loan Documents are required to reflect the foregoing. b. All references in any document to the Loan Agreement or any other Loan Document shall refer to the Loan Agreement or such Loan Document as amended pursuant to this Amendment. 4. CONDITIONS PRECEDENT. The obligations of Lender under this Amendment are subject to the satisfaction of the following conditions: a. Borrower shall have executed and delivered this Amendment; and b. No Event of Default or Unmatured Event of Default shall have occurred as of the date hereof. 5. REPRESENTATIONS AND WARRANTIES. Borrower hereby certifies to the Lender that as of the date of this Amendment (taking into consideration the transactions contemplated by this Amendment), all of Borrower's representations and warranties contained in the Loan Agreement and all Loan Documents are true, accurate and complete in all material respects, and no Event of Default or event that with notice or the passage of time or both would constitute an Event of Default has occurred under the Loan Agreement or any Loan Document. Without limiting the generality of the foregoing, Borrower represents and warrants that the execution and delivery of this Amendment has been authorized by all necessary action on the part of Borrower, that the person executing this Amendment on behalf of Borrower is duly authorized to do so and that this Amendment constitutes the legal, valid, binding and enforceable obligation of Borrower. 6. ADDITIONAL DOCUMENTS. Borrower shall execute and deliver to Lender at any time and from time to time such additional amendments to the Loan Agreement and the Loan Documents as the Lender may request to confirm and carry out the transactions contemplated hereby or to confirm, correct and clarify the security for the Loan. 7. CONTINUATION OF THE LOAN AGREEMENT, ETC. Except as specified in this Amendment, the provisions of the Loan Agreement and the Loan Documents shall remain in full force and effect, and if there is a conflict between the terms of this Amendment and those of the Loan Agreement or the Loan Documents, the terms of this Amendment shall control. 2 8. MISCELLANEOUS. a. This Amendment shall be governed by and construed under the laws of the State of Colorado and shall be binding upon and inure to the benefit of the parties hereto and their successors and permissible assigns. b. This Amendment may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument. c. This Amendment and all documents to be executed and delivered hereunder may be delivered in the form of a facsimile copy, subsequently confirmed by delivery of the originally executed document. d. Time is of the essence hereof with respect to the dates, terms and conditions of this Amendment and the documents to be delivered pursuant hereto. e. This Amendment constitutes the entire agreement between Borrower and the Lender concerning the subject matter of this Amendment. This Amendment may not be amended or modified orally, but only by a written agreement executed by Borrower and the Lender and designated as an amendment or modification of the Loan Agreement as amended by this Amendment. f. If any provision of this Amendment shall be held invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions of this Amendment shall not be impaired thereby. g. The section headings herein are for convenience only and shall not affect the construction hereof. h. Execution of this Amendment is not intended to and shall not constitute a waiver by the Lender of any Event of Default. 3 EXECUTED as of the date first set forth above. BORROWER: CET ENVIRONMENTAL SERVICES, INC., a California corporation By: /s/ Rick C. Townsend --------------------------- Rick C. Townsend Executive Vice President LENDER: NATIONAL BANK OF CANADA, a Canadian chartered bank By: /s/ Andrew M. Conneen, Jr. --------------------------- Andrew M. Conneen, Jr. Vice President 4 EX-10.5 3 EXHIBIT 10.5 SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LOAN DOCUMENTS THIS SECOND AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LOAN DOCUMENTS (this "Amendment"), dated as of April 10, 1998, is between NATIONAL BANK OF CANADA, a Canadian chartered bank ("Lender"), and CET ENVIRONMENTAL SERVICES, INC., a California corporation ("Borrower"). RECITALS A. Lender and Borrower entered into a Loan and Security Agreement dated May 29, 1997, as amended by an Amendment to Loan and Security Agreement and Loan Documents dated as of August 29, 1997 (as amended, the "Loan Agreement"), providing for the Revolving Loans, Equipment Loans, a Term Loan and Letters of Credit in the aggregate maximum available amount not to exceed $10,000,000. Defined terms used herein and not defined herein shall have the meaning set forth in the Loan Agreement. B. The Loans are secured by the Collateral. C. The Borrower and Lender desire to enter into this Amendment in order to extend the Maturity Date and in order to make certain other changes to the terms of the Loan Agreement. AGREEMENT IN CONSIDERATION of the foregoing and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Lender and Borrower agree as follows: 1. EXTENSION OF MATURITY DATE. In order to extend the Maturity Date of the Loans, Section 1(t) of the Loan Agreement is hereby revised by substituting the date "May 3O, 1999" for the date "November 30, 1998" in Subsection (i) in the second line of the section. 2. ELIGIBLE UNBILLED ACCOUNTS. Section 1(c)(ii) of the definition of "Revolving Loan Availability" relating to Eligible Unbilled Accounts is amended and restated in its entirety to read as follows: (ii) up to the lesser of (A) 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 Eligible Unbilled Accounts at such time, less such reserves as Lender in its sole discretion elects to establish or (B) $2,500,000. Lender may at any time and from time to time in its sole discretion change the advance percentage as set forth above. 3. NET PROFIT AFTER TAXES. Section 12(r)(ii) of the Loan Agreement regarding net profit after taxes and before extraordinary gains is amended to require Borrower's compliance therewith commencing December 31, 1998 by substituting the date "December 31, 1998" for the date "December 31, 1997" in the last line thereof. 4. LOAN DOCUMENTS. a. Lender and Borrower agree that any and all notes to other documents executed in connection with the Loans (collectively, the "Loan Documents") are hereby amended to reflect the amendments set forth herein and that no further amendments to any Loan Documents are required to reflect the foregoing. b. All references in any document to the Loan Agreement or any other Loan Document shall refer to the Loan Agreement or such Loan Document as amended pursuant to this Amendment. 5. CONDITIONS PRECEDENT. The obligations of Lender under this Amendment are subject to the satisfaction of the following conditions: a. Borrower shall have executed and delivered this Amendment; b. Borrower shall have paid to Lender a modification fee in the amount of $10,000; c. Borrower shall have executed and delivered to Lender and Lender shall have filed with the Environmental Protection Agency a Notice of Assignment complying with the Assignment of Claims Act and acceptable to Lender; and d. No Event of Default or event that with notice or the passage of time, or both, would constitute an Event of Default shall have occurred as of the date hereof. 6. REPRESENTATIONS AND WARRANTIES. Borrower hereby certifies to the Lender that as of the date of this Amendment (taking into consideration the transactions contemplated by this Amendment), all of Borrower's representations and warranties contained in the Loan Agreement and all Loan Documents are true, accurate and complete in all material respects, and no Event of Default or event that with notice or the passage of time or both would constitute an Event of Default has occurred under the Loan Agreement or any Loan Document. Without limiting the generality of the foregoing, Borrower represents and warrants that the execution and delivery of this Amendment has been authorized by all necessary action on the part of Borrower, that the person executing this Amendment on 2 behalf of Borrower is duly authorized to do so and that this Amendment constitutes the legal, valid, binding and enforceable obligation of Borrower. 7. ADDITIONAL DOCUMENTS. Borrower shall execute and deliver to Lender at any time and from time to time such additional amendments to the Loan Agreement and the Loan Documents as the Lender may request to confirm and carry out the transactions contemplated hereby or to confirm, correct and clarify the security for the Loan. 8. CONTINUATION OF THE LOAN AGREEMENT, ETC. Except as specified in this Amendment, the provisions of the Loan Agreement and the Loan Documents shall remain in full force and effect, and if there is a conflict between the terms of this Amendment and those of the Loan Agreement or the Loan Documents, the terms of this Amendment shall control. 9. MISCELLANEOUS. a. This Amendment shall be governed by and construed under the laws of the State of Colorado and shall be binding upon and inure to the benefit of the parties hereto and their successors and permissible assigns. b. This Amendment may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument. c. This Amendment and all documents to be executed and delivered hereunder may be delivered in the form of a facsimile copy, subsequently confirmed by delivery of the originally executed document. d. Time is of the essence hereof with respect to the dates, terms and conditions of this Amendment and the documents to be delivered pursuant hereto. e. This Amendment constitutes the entire agreement between Borrower and the Lender concerning the subject matter of this Amendment. This Amendment may not be amended or modified orally, but only by a written agreement executed by Borrower and the Lender and designated as an amendment or modification of the Loan Agreement as amended by this Amendment. f. If any provision of this Amendment shall be held invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions of this Amendment shall not be impaired thereby. g. The section headings herein are for convenience only and shall not affect the construction hereof. 3 h. Execution of this Amendment is not intended to and shall not constitute a waiver by the Lender of any Event of Default or event that with notice or the passage of time, or both, would constitute an Event of Default. EXECUTED as of the date first set forth above. BORROWER: CET ENVIRONMENTAL SERVICES, INC., a California corporation By: /s/ Rick C. Townsend --------------------------- Rick C. Townsend Executive Vice President LENDER: NATIONAL BANK OF CANADA, a Canadian chartered bank By: /s/ Andrew M. Conneen, Jr. --------------------------- Andrew M. Conneen, Jr. Vice President 4 EX-10.6 4 EXHIBIT 10.6 THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LOAN DOCUMENTS THIS THIRD AMENDMENT TO LOAN AND SECURITY AGREEMENT AND LOAN DOCUMENTS (this "Amendment"), dated as of January __, 1999, is between NATIONAL BANK OF CANADA, a Canadian chartered bank ("Lender"), and CET ENVIRONMENTAL SERVICES, INC., a California corporation ("Borrower"). RECITALS A. Lender and Borrower entered into a Loan and Security Agreement dated May 29, 1997, as amended by an Amendment to Loan and Security Agreement and Loan Documents dated as of August 29, 1997 and as further amended by a Second Amendment to Loan and Security Agreement and Loan Documents dated as of April 10, 1998 (as amended, the "Loan Agreement"), providing for the Revolving Loans, Equipment Loans, a Term Loan and Letters of Credit in the aggregate maximum available amount not to exceed $9,000,000. Defined terms used herein and not defined herein shall have the meaning set forth in the Loan Agreement. B. The Loans are secured by the Collateral. C. The Borrower and Lender desire to enter into this Amendment in order to decrease the Maximum Loan Availability and in order to make certain other changes to the terms of the Loan Agreement. AGREEMENT IN CONSIDERATION of the foregoing and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Lender and Borrower agree as follows: 1. MAXIMUM LOAN AVAILABILITY. In order to decrease the Maximum Loan Availability, Section 1(u) of the Loan Agreement is hereby revised by substituting the phrase "Seven and One-Half Million Dollars ($7,500,000)" for the phrase "Nine Million Dollars ($9,000,000)" in Subsection (a) of the section. 2. WAIVER OF FINANCIAL COVENANT. Lender hereby agrees to waive Borrower's compliance with the covenant set forth in Section 12(r)(iii) of the Loan Agreement (requiring Borrower to achieve a net profit before extraordinary gains of at least zero ($O)) for the fiscal quarter beginning on July 1, 1998 and ending on September 30, 1998. The Lender's waiver set forth herein is specifically limited to the fiscal quarter ended September 30, 1998 and Borrower shall be required to comply with such covenant pursuant to the terms of the Loan Agreement at all times on or after October 1, 1998. 3. SUBORDINATED DEBT. Notwithstanding anything to the contrary in the Loan Agreement, Lender hereby agrees and consents to Borrower repaying off the Subordinated Debt described in the Loan Agreement in an amount not to exceed $672,000, provided that such action does not cause an Event of Default or an event that with notice, the passage of time, or both would constitute an Event of Default. 4. LOAN DOCUMENTS. a. Lender and Borrower agree that any and all notes or other documents executed in connection with the Loans (collectively, the "Loan Documents") are hereby amended to reflect the amendments set forth herein and that no further amendments to any Loan Documents are required to reflect the foregoing. b. All references in any document to the Loan Agreement or any other Loan Document shall refer to the Loan Agreement or such Loan Document as amended pursuant to this Amendment. 5. CONDITIONS PRECEDENT. The obligations of Lender under page 2 (Waiver) and 3 (Subordinated Debt) of this Amendment are subject to the satisfaction of the following conditions: a. Borrower shall have paid to Lender a waiver fee in the amount of $10,000; and b. No Event of Default or event that with notice or the passage of time, or both, would constitute an Event of Default shall have occurred as of the date hereof. 6. REPRESENTATIONS AND WARRANTIES. Borrower hereby certifies to the Lender that as of the date of this Amendment (taking into consideration the transactions contemplated by this Amendment), all of Borrower's representations and warranties contained in the Loan Agreement and all Loan Documents are true, accurate and complete in all material respects, and no Event of Default or event that with notice or the passage of time or both would constitute an Event of Default has occurred under the Loan Agreement or any Loan Document. Without limiting the generality of the foregoing, Borrower represents and warrants that the execution and delivery of this Amendment has been authorized by all necessary action on the part of Borrower, that the person executing this Amendment on behalf of Borrower is duly authorized to do so and that this Amendment constitutes the legal, valid, binding and enforceable obligation of Borrower. 7. ADDITIONAL DOCUMENTS. Borrower shall execute and deliver to Lender at any time and from time to time such additional amendments to the Loan Agreement and the Loan Documents as the Lender may request to confirm and carry out the transactions contemplated hereby or to confirm, correct and clarify the security for the Loan. 2 8. CONTINUATION OF THE LOAN AGREEMENT, ETC. Except as specified in this Amendment, the provisions of the Loan Agreement and the Loan Documents shall remain in full force and effect, and if there is a conflict between the terms of this Amendment and those of the Loan Agreement or the Loan Documents, the terms of this Amendment shall control. 9. MISCELLANEOUS. a. This Amendment shall be governed by and construed under the laws of the State of Colorado and shall be binding upon and inure to the benefit of the parties hereto and their successors and permissible assigns. b. This Amendment may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument. c. This Amendment and all documents to be executed and delivered hereunder may be delivered in the form of a facsimile copy, subsequently confirmed by delivery of the originally executed document. d. Time is of the essence hereof with respect to the dates, terms and conditions of this Amendment and the documents to be delivered pursuant hereto. e. This Amendment constitutes the entire agreement between Borrower and the Lender concerning the subject matter of this Amendment. This Amendment may not be amended or modified orally, but only by a written agreement executed by Borrower and the Lender and designated as an amendment or modification of the Loan Agreement as amended by this Amendment. f. If any provision of this Amendment shall be held invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions of this Amendment shall not be impaired thereby. g. The section headings herein are for convenience only and shall not affect the construction hereof. h. Execution of this Amendment is not intended to and shall not constitute a waiver by the Lender of any Event of Default or event that with notice or the passage of time, or both, would constitute an Event of Default. 3 EXECUTED as of the date first set forth above. BORROWER: CET ENVIRONMENTAL SERVICES, INC., a California corporation By: /s/ Steven H. Davis --------------------------- Name: Steven H. Davis Title: President LENDER: NATIONAL BANK OF CANADA, a Canadian chartered bank By: /s/ Andrew M. Conneen, Jr. --------------------------- Andrew M. Conneen, Jr. Vice President 4 EX-23 5 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our reports dated March 25, 1999, accompanying the consolidated financial statements incorporated by reference or included in the Annual Report of CET Environmental Services, Inc. (the Company) on Form 10-K for the year ended December 31, 1998. We consent to the incorporation by reference in the Company's Registration Statement on Form S-8 of the aforementioned reports. GRANT THORNTON LLP Denver, Colorado April 14, 1999 EX-27 6 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 25 0 27,102 1,006 267 26,670 6,363 2,883 30,202 18,835 251 1,589 0 8,540 988 30,202 66,497 66,497 65,201 65,201 5,858 3,668 892 722 183 538 0 0 0 538 0.09 0.09
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