U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission file no. 000-21325
SYSTEMONE TECHNOLOGIES INC.
(Name of Small Business Issuer in Its Charter)
Florida 65-0226813
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(State of Incorporation) (I.R.S. Employer Identification No.)
8305 N.W. 27th Street
Suite 107
Miami, Florida 33122
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(Address of Registrant's Principal Executive Offices) (Zip Code)
(305) 593-8015
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(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.001 par value and the Common Stock
Purchase Rights attached thereto
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained herein, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in PART III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
State the issuer's revenues for its most recent fiscal year: $17,719,726
The aggregate market value of the Registrant's Common Stock held by
non-affiliates as of March 25, 2003 was $2,845,754 computed by reference to the
closing bid price of the Common Stock as reported on the OTC Electronic Bulletin
Board on such date.
As of March 25, 2003, there were 4,742,923 shares of the Registrant's Common
Stock issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III, Items 9-12, is incorporated by
reference from the Registrant's definitive proxy statement (to be filed within
120 days after the end of the Registrant's fiscal year).
Preliminary Note Regarding Forward Looking Statements
The following items contain certain "forward-looking statements" within the
meaning of section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), which represent the expectations or beliefs of SystemOne
Technologies Inc. (the "Company"), including, but not limited to, statements
concerning (i) trends affecting the Company's financial condition or results of
operations; (ii) the Company's continued growth and operating strategy; and
(iii) trends in governmental regulation. For this purpose, any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the generality of the foregoing,
words such as "may," "will," "expect," "believe," "anticipate," "intend,"
"could," "should," "estimate," "continue," "project," "target," or the negative
or other variations thereof or comparable terminology are intended to identify
forward-looking statements. These statements by their nature involve substantial
risks and uncertainties, certain of which are beyond the Company's control.
Readers are cautioned that any such forward looking statements are not
guarantees of future performance, and that actual results may differ materially
from those projected in the forward looking statements as a result of various
factors. The accompanying information contained herein, including without
limitation the information set forth under the headings "Management's Discussion
and Analysis or Plan of Operation," and "Business," identifies important factors
that could cause such differences. In particular, the Company's performance for
the foreseeable future will be dependent almost completely on the performance of
Safety-Kleen Systems, Inc., a wholly owned subsidiary of Safety-Kleen Corp.
(collectively, "Safety-Kleen"), under the Marketing and Distribution Agreement
that the Company entered into with Safety-Kleen on November 14th, 2000, as
amended and restated as of March 8, 2001 (the "Exclusive Marketing Agreement"),
the acceptance by Safety-Kleen's customers of the Company's products, the
ability of Safety-Kleen to resell or rent the Company's products at attractive
price levels, the ability of Safety-Kleen to properly service the Company's
products the ability of the Company to successfully market and sell its products
in International markets and commercialize new products under development, as
well as other factors more fully described herein. In addition, Safety-Kleen is
currently under reorganization pursuant to Chapter 11 of the federal Bankruptcy
Code and there can be no assurance that Safety-Kleen will be able to continue
its operations as currently conducted or otherwise be in a position to perform
under the Exclusive Marketing Agreement. Safety-Kleen filed a restructuring plan
with the bankruptcy court in November 2002.
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ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
The Company designs, manufactures and sells a full line of patented,
self-contained, recycling industrial parts washers (the "SystemOne(R) Washers"),
for use in the automotive, aviation, marine and general industrial repair
markets. The Company has been awarded eleven patents for its products, which
incorporate innovative, proprietary resource recovery and waste minimization
technologies to distill contaminated solvent and yield pure solvent and a
by-product comparable to used motor oil. The SystemOne(R) Washer integrates a
distillation and recovery process which allows the solvent to be used, treated
and re-used on demand without requiring off-site processing.
The Company was incorporated as Mansur Industries Inc. in November 1990 and, as
a development stage company, devoted substantially all of its resources to
research and development programs related to its full line of self-contained,
recycling industrial parts washers until June 1996. The Company commenced its
planned principal operations in July 1996 and began to generate significant
revenue from product sales in 1997. The Company's operating expenses, however,
increased significantly between 1997 and 2000 in connection with the development
of a national direct marketing and distribution organization, including the
establishment of regional distribution centers and a service fleet. As a result,
the Company could not sustain the cost of this marketing and distribution
organization, and elected to enter into an exclusive marketing agreement as
described below under "Exclusive Marketing Agreement with Safety-Kleen" and
began shipping SystemOne(R) parts washer equipment in January 2001. During 2000,
the Company's operating subsidiary was merged with and into the Company and the
Company changed its name to SystemOne Technologies Inc.
RECENT DEVELOPMENTS
In June 2002, the Company began the process of attaining ISO 9001:2000
certification. ISO 9001:2000 is part of a family of international quality
standards which require the Company to establish and maintain a quality system.
The Company's quality system will include internal quality audits, corrective
and preventive action systems, management review and continual third party
assessments. This quality system is being implemented to ensure maximum customer
satisfaction. The Company expects to be certified by Perry Johnson, Inc., a
training, consulting and implementation firm, in the 2nd quarter of 2003.
In December 2002, the Company completed an exchange of its then outstanding (1)
8.25% Subordinated Convertible Notes due February 23, 2003, and (2) 16%
Promissory Notes due November 30, 2002 for now outstanding (x) 8.25%
Subordinated Convertible Notes due December 31, 2005, (y) 10% Promissory Notes
due December 31, 2005, and (z) warrants to purchase shares of the Company's
common stock, $.001 par value per share at an exercise price of $.01 per share.
See "Liquidity and Capital Resources" for a detailed discussion of the exchange.
The Company entered into an agreement on February 15, 2003 to extend the
maturity from May 30, 2003 to May 30, 2005 of the Company's Senior Revolver (as
defined below).
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EXCLUSIVE MARKETING AGREEMENT WITH SAFETY-KLEEN
On November 14, 2000, the Company entered into the Exclusive Marketing Agreement
with industry leader Safety-Kleen representing a major strategic shift in
direction and focus for the Company. Safety-Kleen had a one time right to
terminate the Exclusive Marketing Agreement, exercisable prior to July 2002, but
chose not to exercise the right. As a result, the initial term of the Exclusive
Marketing Agreement will continue through December 26, 2005, unless terminated
sooner for cause or by mutual agreement. By joining with Safety-Kleen, the
Company united its proprietary breakthrough technologies with the industry
market leader for the past 30 years, providing both companies with significant
competitive advantages. Pursuant to the Exclusive Marketing Agreement, 100% of
the Company's domestic sales of SystemOne(R) Parts Washers are to Safety-Kleen.
Under the Exclusive Marketing Agreement, Safety-Kleen was appointed the
exclusive distributor of SystemOne(R) parts washer equipment in the United
States, Puerto Rico, Canada and Mexico (the "Territory"). Safety-Kleen commenced
marketing the Company's products throughout Safety Kleen's 158 branches across
North America in January 2001. The Company has retained the right to distribute
its equipment outside of the Territory as well as the right, subject to a right
of first offer for Safety-Kleen under certain circumstances, to market newly
developed industrial and commercial parts washers through other distribution
channels.
December 26, 2002 began the third year of the Company's relationship with
Safety-Kleen under the Exclusive Marketing Agreement. For the third year,
Safety-Kleen's minimum annual purchase requirement has increased from 10,000
units (although the Company shipped slightly more units in each prior year) to
12,500 units. In the fourth and fifth years, minimum annual purchases will
increase to 15,000 and 18,000 units, respectively. Approximately 88% of the unit
price payable by Safety-Kleen is due within 30 days after shipment with the
balance payable to the Company in 12 quarterly installments. The price charged
to Safety-Kleen is determined annually based on actual manufacturing costs
incurred during a three month period during the latter part of the previous
year.
Pursuant to the Exclusive Marketing Agreement, Safety-Kleen assumed all service,
maintenance and repair responsibilities for previously sold SystemOne(R) Parts
Washers through the remaining warranty periods. The Company is responsible for
any replacement parts needed for warranty repairs. The Company agreed to pay
Safety-Kleen a total fee of $500,000 for such assumption. The remaining balance
of the $500,000 fee as of December 31, 2002 was $75,000, payable in equal
monthly installments of $25,000 through March 2003. In addition, the Company
will maintain a call center to receive and track certain warranty calls.
RESULTS OF RESTRUCTURING
Operations under the Exclusive Marketing Agreement with Safety-Kleen began
December 26, 2000. At that time, Safety-Kleen became the exclusive distributor
of certain SystemOne(R) parts washer equipment in the Territory and assumed
responsibility for all service, maintenance and repair responsibilities for
previously sold SystemOne(R) parts washers. In connection with the Exclusive
Marketing Agreement, the Company restructured its operations beginning in
November 2000 with a major emphasis on eliminating its national sales and
service infrastructure. The restructuring is complete and the Company
accomplished the following results:
o Closed 57 service centers and terminated all real estate leases for
those centers. The Company currently has no obligation or commitment
with respect to its former service centers.
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o Terminated the employment of approximately 165 employees, including all
sales, service and certain support and administrative personnel other
than 5 regional service managers necessary to support the Safety-Kleen
program. The 5 regional service managers are strategically located
throughout the country and provide technical expertise and training to
Safety-Kleen personnel as needed. In addition, they enable the Company
to maintain accurate and timely communication between Safety-Kleen
branches and the Company's management.
o Subleased all service trucks to Safety-Kleen beginning March 15, 2001
through the termination of the original leases, all of which terminated
by February 28, 2002. The Company currently has no obligation or
commitment with respect to its former fleet of service trucks.
o Transported and consolidated all finished goods, raw material and
service parts inventory from the Company's 57 service centers to the
Company's Miami, Florida facility.
Higher and consistent production levels have allowed the Company to more
efficiently utilize its production facility thereby lowering per unit
manufacturing costs. Additionally, the Exclusive Marketing Agreement requires
Safety-Kleen to purchase 1/12th of each contract year's minimum purchase
commitment per month enabling the Company to maximize manufacturing efficiency
and minimize raw material and finished goods inventory levels.
INDUSTRY AND COMPETITION
Based upon industry research, the Company estimates that domestic expenditures
in connection with industrial parts cleaning machines and services exceed $1.0
billion annually. Industrial parts cleaning machines are used by automotive,
aviation and marine service, repair and rebuilding facilities, gas stations,
transmission shops, parts remanufacturers, machine shops, and general
manufacturing operations of every size and category requiring parts cleaning.
Conventional industrial parts cleaning machines typically remove lubrication
oils from tools and parts through the use of mineral spirit solvents that become
progressively more contaminated and less effective in the cleaning process.
Eventually, the solvent becomes saturated with oil, sludge and other
contaminants and is typically classified as a hazardous waste under federal and
state regulations. Under the most common current practice, the contaminated
solvent must be stored until pick-up, when pure solvent is delivered and the
contaminated solvent is transported to regional refining facilities. This
delivery and off-site recycling program is typically scheduled on 4 to 16 week
cycles. In contrast, the distillation process used in the Company's SystemOne(R)
Washers removes all the contaminants from the solvent within the cleaning unit
itself, minimizing the volume of waste by-product and providing pure solvent to
the customer "on demand", eliminating the need for the costly and potentially
dangerous storage and transportation of hazardous waste. Moreover, the small
amount of waste by-product yielded in the distillation process used in the
SystemOne(R) Washers can typically be recycled or disposed of together with the
customer's used motor oil, which is generally not classified as hazardous waste.
Accordingly, the Company believes that its product line presents an attractive
and economical alternative to users of other technologically outdated,
non-recycling parts cleaning machines because the Company's SystemOne(R) product
line facilitates efficient and economical compliance with environmental
regulations, minimizes waste disposal requirements, reduces insurance costs and
increases worker productivity as a result of enhanced cleaning solution
utilization.
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Industrial parts cleaning machines are used by automotive, aviation and marine
service, repair and rebuilding facilities, gas stations, transmission shops,
parts remanufacturers, machine shops, as well as general manufacturing
operations of every size and category requiring machinery maintenance, service
and repair. Through published industry reports, the Company estimates that
businesses in the United States incur more than $1.0 billion in expenses
annually for commercial and industrial parts cleaning using chemical cleaning
techniques.
The industrial parts cleaning industry is highly competitive and dominated by
Safety-Kleen. The Company believes that Safety-Kleen services a dominant portion
of the parts washing machines currently in use and that no other competitor
accounts for more than 10% of the parts washer market in the United States.
While historically Safety-Kleen has been the Company's primary competitor, by
entering into the Exclusive Marketing Agreement, the Company's general parts
washer product line is now marketed through Safety-Kleen's marketing system
consisting of 158 branches servicing approximately 400,000 customers according
to information provided by Safety-Kleen.
The Company is not aware of any competitor that is currently marketing a
recycling parts washer at comparable pricing to the Company's SystemOne(R)
products. Certain of the Company's target customers have attempted to enhance
the capabilities of their existing industrial parts washers by acquiring stand
alone machines capable of distilling solvent. Although there is a wide variety
of such machinery currently available to the public, the Company believes that
the SystemOne(R) Washers compare favorably with the popular but technologically
outdated, non-recycling products of its competitors on the basis of, among other
things: (i) delivery of pure solvent "on demand"; (ii) lower overall cost; (iii)
reduced time and cost associated with documenting compliance with applicable
environmental and other laws; (iv) reduced safety and environmental risks
associated with competitive machines and services; (v) customer service; and
(vi) difficulty in handling the regulated substances used and/or generated by
competitive machines.
In addition to the industrial parts cleaning industry, the Company will attempt
to access the automotive and industrial painting industry with the release of
the "Slider", its paint and coatings spray gun washer, which is expected in the
second quarter of 2003. The Company has identified two markets within these
industries for which the spray gun washer will be well suited.
The Company estimates there are approximately 42,000 paint and body shops in the
United States currently holding painting permits. Approximately 79% of these
paint and body shops are individually owned small businesses and are single
location operations. Market research indicates that these shops decide whether
to purchase equipment based on recommendations from manufacturer's agents, as
well as three criteria, quality, price and ease of use. The Company's new spray
gun washer has been designed to meet all three criteria.
Pursuant to the Exclusive Marketing Agreement, Safety-Kleen has a right of first
offer to purchase and distribute the "Slider" for the Company and the Company
has notified Safety-Kleen of the commercial availability of the "Slider". If
Safety-Kleen does not elect to purchase and distribute the "Slider," the Company
plans to exploit the paint and body shop market through the use of highly
trained, industry known and accepted manufacturer's agents. The Company has
identified approximately 35,000 original equipment manufacturers (OEM) which
operate in the industrial painting business which are permitted for in-house
spray painting.
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For product & equipment purchasing recommendations, the OEM industrial coatings
market segment relies primarily on established business relationships with a
group of manufacturer's agents that specialize in spray painting equipment
engineering, design, sales, installation & service. The Company plans to utilize
these agents to introduce the Slider to the industrial business segment.
Although the Company has conducted extensive research regarding the potential
market for the Slider, there can be no assurance that this new product will gain
customer acceptance or that the Company's marketing plans will prove to be
successful. Furthermore, the market for spray gun cleaning equipment is
competitive and other manufacturers of such equipment may have greater financial
resources than the Company.
STRATEGY
The Company's strategy is to continue its focus on the research, design,
development, manufacture and sale of its SystemOne(R) Washers. The Company
believes that its products have achieved significant market penetration because
of the technological, economic and environmental advantages of the Company's
products over competitive equipment. The Company plans to place strong emphasis
in 2003 on the following initiatives:
EXPAND PRODUCT LINE. The Company expects to broaden its industrial parts
cleaning product line with the commercial launch of the Slider, the Company's
new paint and coatings spray gun washer, during the second quarter of 2003,
although, as with any new product, unanticipated design or production problems
could delay such introduction. See "Products". The Company has obtained patent
protection, developed prototypes, conducted extensive testing and has begun
production of this new product.
EXPAND INTO INTERNATIONAL MARKETS. The Company believes that opportunities exist
for international sales of the SystemOne(R) product line. The Company is
currently exploring distribution opportunities in international markets through
distribution agreements, although there can be no assurance that the Company
will be able to enter into acceptable international distribution agreements on
profitable terms. The European market, a potential new market for the Company's
product lines, is a highly fragmented market with only one significant operator,
Safety-Kleen Europe Limited (not affiliated with Safety-Kleen Corp.) with
approximately 125,000 installed units throughout Europe. As of the date hereof,
the Company had no international sales.
PRODUCTS
The Company's entire product line is made up of self-contained recycling
industrial cleaning equipment. These products incorporate proprietary waste
minimization technology for which the Company has obtained patent protection.
Except as stated below, all of these products are available for commercial sale.
All of the Company's products utilize technology that (i) provides continuously
recycled cleaning solution during the cleaning process, (ii) eliminates the
necessity for continual replacement and disposal of contaminated cleaning
solution and (iii) facilitates practical and cost effective compliance with
demanding environmental laws and regulations.
SYSTEMONE(R) GENERAL PARTS WASHER was the first of the Company's products to be
available in commercial quantities. The SystemOne(R) General Parts Washer
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provides users with pure mineral spirit solvent "on demand" for parts and tools
cleaning purposes, utilizing a low-temperature vacuum distillation process to
recycle the used solvent within the unit. This process allows the solvent to be
perpetually used and reused without the need for off-site processing, minimizes
the volume of waste by-product and eliminates the need for storage and disposal
of the hazardous waste solvent. The markets for SystemOne(R) General Parts
Washers are automotive, aviation and marine service, repair and rebuilding
facilities, gas stations, transmission shops, parts remanufacturers, machine
shops, and general manufacturing operations of every size and category requiring
small parts cleaning. This product line is currently distributed by Safety-Kleen
under the Exclusive Marketing Agreement.
SYSTEMONE(R) MOBILE WASHER is a mobile telescoping mini-parts washer designed
specifically as an auxiliary unit to the SystemOne(R) General Parts Washer. The
SystemOne(R) Mobile Washer may be placed directly under the automobile being
serviced and provides clean solvent on demand to the user by utilizing the
SystemOne(R) General Parts Washer to distill the contaminated solvents.
SYSTEMONE(R) "SLIDER" SPRAY GUN WASHER, scheduled for commercial introduction in
the second quarter of 2003, the Slider incorporates the Company's
recycling/reclamation capabilities for paint thinner recovery. The target
markets for paint and coatings spray gun washers consist of automotive, aviation
and marine paint shops and all general manufacturing operations that maintain
spray painting and spray on coatings operations. The Company anticipates that
the auto painting industry will represent a substantial market. The SystemOne(R)
Spray Gun Washer facilitates compliance with rigorous environmental disposal
regulations for the paint and coatings industries.
MANUFACTURING AND SUPPLY OF RAW MATERIALS
The Company currently leases a 62,000 square foot facility located in Miami,
Florida which serves as the Company's executive office, manufacturing and
research facility. All of the Company's manufacturing operations, including
design, fabrication, painting and assembly are performed at this facility.
Annual manufacturing capacity of SystemOne(R) Washers at this facility is
approximately 25,000 units on two full shifts, more than sufficient to meet the
Safety-Kleen minimum volume commitment of 18,000 units in the fifth year of the
initial term of the Exclusive Marketing Agreement. The Company currently
manufactures its other products in amounts required for testing, test marketing
and/or commercial production in these manufacturing facilities. The facility is
leased through October 2005 and the lease provides two renewal terms of three
years each, exercisable at the Company's option upon six months prior written
notice. In the second quarter of 2002, the Company was leasing 75,000 square for
its Miami facility and returned approximately 13,000 square feet of idle
capacity to the landlord. Also, in the third quarter of 2002, the Company was
able to negotiate a lower rental rate for the existing 62,000 square feet
leased.
The SystemOne(R) Washers are assembled from raw materials and components all of
which the Company believes are readily obtainable in the United States. The
Company believes that it is not dependent upon any of its current suppliers to
obtain the raw materials and components necessary to assemble and manufacture
SystemOne(R) Washers. The Company currently procures raw materials and
components for its SystemOne(R) Washers from approximately 40 sources.
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MARKETING AND DISTRIBUTION
See "Item 1 Description of Business -- Exclusive Marketing Agreement with
Safety-Kleen" which is incorporated herein by reference for a discussion of the
Company's marketing and distribution of the SystemOne(R) General Parts Washer
within the Territory.
The Company expects that its spray gun washer will be commercially available in
the second quarter of 2003. Pursuant to the Exclusive Marketing Agreement,
Safety-Kleen has a right of first offer, under certain circumstances, to market
the Company's newly developed industrial and commercial parts washers in the
Territory, including the spray gun washer, through its distribution channels. If
Safety-Kleen elects not to exercise its right of first offer and does not market
the spray gun washers for the Company on an exclusive basis, then the Company
plans to instead use established manufacturer's agents. The most promising
markets for distribution of the spray gun washer are paint and body shops and
OEM industrial coating operations. See "Item 1 Description of Business --
Industry and Competition" which is incorporated herein by reference for a
discussion of the market for the Company's parts washers.
PATENTS, TRADEMARKS AND PROPRIETARY TECHNOLOGY
The Company has been awarded 11 United States patents for its product line
including its SystemOne(R) General Parts Washer (four patents), Power Spray
Washer, Spray Gun Washer, Immersion Washer, Floor Washer, MiniDisposer (thermal
oxidizer) and Vapor Recovery System. The Company applies for patents as
appropriate. The Company's patents on its principal product, the SystemOne(R)
General Parts Washer, have terms that commenced September 1994 and continue
through September 2015. The Company currently has three patents pending relating
to the Spray Gun Washer, an Advanced Vapor Recovery System and a parts washer
incorporating Rapid Heat Technology. The Company also holds eight foreign
patents in Canada, Mexico and Japan relating to its SystemOne(R) technologies
and has seven additional foreign patents pending in Europe, Canada, Mexico and
Japan.
The Company believes that patent protection is important to its business. There
can be no assurance as to the breadth or degree of protection which existing or
future patents, if any, may afford the Company, that any patent applications
will result in issued patents, that patents will not be circumvented or
invalidated or that the Company's competitors will not commence marketing
self-contained washers with similar technology. In addition, it is costly to
enforce patent and other intellectual property rights against infringing
parties. In the event the Company's products or processes infringe patents or
proprietary rights of others, the Company may be required to incur costs to
defend such claims, modify the design of its products or obtain a license, any
of which could harm the Company's results of operations.
The Company has received federal trademark registrations with respect to the
mark "SystemOne(R)" and design and Qsol(R) mark and design for the Company's
proprietary solvent formulas.
The Company also relies on trade secrets and proprietary know-how and employs
various methods to protect the concepts, ideas and documentation of its
proprietary information. However, such methods may not afford complete
protection and there can be no assurance that others will not independently
develop such know-how or obtain access to the Company's know-how, concepts,
ideas and documentation. Although the Company has and expects to continue to
have confidentiality agreements with certain employees and vendors, there can be
no assurance that such arrangements will adequately
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protect the Company's trade secrets. Because the Company believes that its
proprietary information is important to its business, failure to protect such
information could have a material adverse effect on the Company.
RESEARCH AND DEVELOPMENT
The Company recognizes that the industrial parts cleaning industry may be
entering a phase of rapid technological change and the Company will seek to
retain what it perceives as its technological superiority over competitors'
products. In this regard, the Company intends to continue to seek means of
refining and improving its SystemOne(R) Washers. In order to keep pace with the
rate of technological change, the Company also intends to devote considerable
resources in time, personnel and funds on research and development for future
products and improvements to existing products. The Company recognizes that many
of its competitors have far greater financial resources than the Company which
may be devoted to research and development and there can be no assurance that
the Company will maintain a technological advantage over its competitors.
Additionally, although there can be no assurance that the Company will develop
new products capable of commercialization, the Company intends to continue its
programs to develop new products, some of which may utilize the Company's
patented products and processes.
Research and development expenditures increased 45% from $221,421 in 2001 to
$320,083 in 2002. The increase is primarily due to upgrading engineering
software and hardware, increased expenditures for materials necessary to develop
equipment and an increase in salaries for the Company's engineers.
The Company's engineering team is currently working on four projects: upgrading
the SystemOne(R) General Parts Washer which includes related plant retooling,
finalizing development of the European model of the SystemOne(R) General Parts
Washer, finalizing development of the SystemOne(R) Spray Gun Washer and
implementing the ISO 9001:2000 quality process.
The Company is currently working on upgrading the SystemOne(R) General Parts
Washer. The upgraded model will feature improved performance and internal
components, a smaller "foot print" that will require less valuable floor space
and allow for easier mobility. To begin production of the upgraded model,
retooling of some of the Company's equipment will be required. The Company plans
to launch this upgraded model in the second quarter of 2003. Costs incurred for
the year ended December 31, 2002 on the upgraded model are approximately $53,000
and the Company estimates that it will incur additional costs of approximately
$82,000 in 2003 to complete the model.
The Company has largely completed the design and development of the European
model of the SystemOne(R) General Parts Washer and it has been field tested in
Europe by two prospective distributors. The Company anticipates commencing
commercial sales of the unit in the second quarter of 2003 provided that an
acceptable distribution agreement can be entered into, of which there can be no
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assurance. Costs incurred for the year ended December 31, 2002 were
approximately $53,000 and the Company estimates that it will incur additional
costs of approximately $54,000 in 2003 to complete final design and production
arrangements.
The Company has completed the design and development of the SystemOne(R) Spray
Gun Washer and it will be field tested in March 2003. The Company also
anticipates commencing commercial sales of the unit in the second quarter of
2003, provided that an acceptable distribution agreement can be entered into.
See "Item 1 Description of Business -- Industry and Competition" which is
incorporated herein by reference for a discussion of the Company's potential
distributors. Costs incurred for the year ended December 31, 2002 related to the
Spray Gun Washer were approximately $160,000 and the Company estimates that it
will incur additional costs of approximately $109,000 in 2003 to complete
testing, final design and production tooling. The Spray Gun Washer utilizes the
same core resource recovery technology as the General Parts Washer and the
Company does not anticipate any significant technological issues although there
can be no assurance that field testing will not reveal unanticipated problems.
The Company began implementation of ISO 9001:2000 during 2002 to attain
certification. ISO 9001:2000 is part of a family of international quality
standards which require the Company to establish and maintain a quality system.
The Company's quality system will include internal quality audits, corrective
and preventive action systems, management review and continual third party
assessments. The Company expects to be certified by Perry Johnson, Inc., a
training, consulting and implementation firm, the 2nd quarter of 2003. Costs
incurred relating to the certification were approximately $53,000 in 2002 and
the Company estimates that the cost to complete the project in 2003 will be
approximately $82,000. This quality system is being implemented to ensure
maximum customer satisfaction, but is not currently required for domestic or
international sales.
GOVERNMENT REGULATION
The Company believes that federal and state laws and regulations have been
instrumental in shaping the industrial parts washing industry. Federal and state
regulations dictate and restrict to varying degrees what types of cleaning
solvents may be utilized, how a solvent may be stored, and the manner in which
contaminated solvents may be generated, handled, transported, recycled and
disposed.
The Company believes that customer demand for its SystemOne(R) Washers is
partially a function of the legal environment in which customers for the
Company's products conduct business; accordingly, the federal and state laws and
regulations discussed below regulate the behavior of the Company's customers.
The Company's SystemOne(R) Washers were designed to help minimize the cost of
complying with existing federal and state environmental laws and regulations.
Any changes, relaxation or repeal of the federal or state laws and regulations
which have shaped the parts washing industry may significantly affect demand for
the Company's products and the Company's competitive position.
REGULATION OF HANDLING AND USE OF SOLVENTS. Federal and state regulations have
restricted the types of solvents that may be utilized in industrial parts
cleaning machines. Stoddard solvents, more commonly known as mineral spirits and
solvent naphtha, are the cleaning solvents typically used in industrial parts
washers. The Company uses mineral spirits with a minimum of 140 degrees
Fahrenheit ignitable limits in its SystemOne(R) Washers. Such mineral spirits do
not exhibit the ignitability characteristic for liquid hazardous wastes as
defined in the Resource Conservation and Recovery Act of 1976, as amended (the
"RCRA"), and the regulations under that statute adopted by the United States
Environmental Protection Agency (the "EPA"). Certain machines sold by the
Company's competitors use mineral spirits with lower ignitable limits, which
may, after use, render such mineral spirits subject to regulation as a hazardous
waste. The Company believes that the ability to recycle the mineral spirits used
in its SystemOne(R) Washers provides a significant economic benefit to the
Company's customers by allowing them to avoid the expenses and potential
liability associated with the disposal of such solvent as a hazardous waste.
11
Federal, state and many local governments have adopted regulations governing the
handling, transportation and disposal of mineral spirit solvents. On the federal
level, under the Hazardous Materials Transportation Act ("HMTA"), the United
States Department of Transportation has promulgated requirements for the
packaging, labeling and transportation of mineral spirits in excess of specified
quantities. Relative to the handling and disposal of mineral spirits, many
states and local governments have established programs requiring the assessment
and remediation of improper discharges of hazardous materials into the
environment. Liability under such programs is possible for improper release of
mineral spirits in violation of applicable standards. Civil penalties and
administrative costs may also be imposed for such violations. The Company's
products do not require the transportation of mineral spirits that necessitate
compliance with HMTA requirements providing significant economic benefits.
REGULATION OF GENERATION, TRANSPORTATION, TREATMENT, STORAGE AND DISPOSAL OF
CONTAMINATED SOLVENTS. The generation, transportation, treatment, storage and
disposal of contaminated solvents is regulated by the federal and state
governments. At the federal level, the RCRA authorized the EPA to develop
specific rules and regulations governing the generation, transportation,
treatment, storage and disposal of hazardous solvent wastes as defined by the
EPA. The Company believes that none of the solvent recycled in SystemOne(R)
Washers when used in accordance with its intended purpose and instructions is
subject to regulation as a "hazardous waste." In contrast, the Company believes
that the mixture of solvent and contaminants which is periodically recovered
from the machines of many of its competitors is subject to regulation as
"hazardous waste."
The Company believes that the ability to manage its residue by-product as used
oil rather than as a hazardous waste is economically attractive to the Company's
customers for a number of reasons. The Company believes that substantially all
of its target equipment users currently have established systems for the
handling, transportation, recycling and/or disposal of used oil. Accordingly,
the classification of the residue as used oil enables the Company's customers to
dispose of or recycle the residue at no significant additional cost and avoid
certain costs associated with establishing and disposing of wastes in compliance
with a hazardous waste disposal system. Even if the residue by-product were
required to be handled, transported, recycled and/or disposed of as a hazardous
waste, the fact that the SystemOne(R) Washers effect a substantial reduction in
the volume of waste product requiring disposal would still serve to
significantly reduce disposal costs.
PRODUCT LIABILITY AND INSURANCE
The Company is subject to potential product liability risks through the use of
its industrial parts cleaning machines. The Company has implemented strict
quality control measures and currently maintains product liability insurance
with respect to such potential liabilities although there can be no assurance
that such insurance would be adequate to cover any particular claim or that
insurance will continue to be available on acceptable terms.
EMPLOYEES
As of February 7, 2003, the Company had a total of 76 full time employees. This
represents a significant reduction in staff from the approximately 242 employees
the Company had prior to restructuring in 2000. This reduction is the direct
consequence of the major corporate wide restructuring resulting from the
Exclusive Marketing Agreement described above. The Company plans to maintain its
current corporate staff of approximately 28 personnel including corporate
12
management, research and development and field product support, and a
manufacturing staff of approximately 48 employees.
ITEM 2. DESCRIPTION OF PROPERTY
The Company maintains its executive offices and its manufacturing and research
and development facilities in a 62,000 square foot building located in Miami,
Florida. The initial term of the lease for this facility expires October 3,
2005. This lease provides for two renewal terms of three years each and is
exercisable at the Company's option upon six months prior written notice. The
Company's annual lease payments are approximately $441,000, subject to an annual
3.0% increase, plus the Company must pay all utility charges and the Company's
proportionate share of the facilities maintenance and operating expenses. The
Company has the right to cancel this lease upon three months' prior written
notice, subject to certain conditions. The Company has also been granted a right
of first refusal with respect to vacant space adjoining these facilities.
All of the Company's manufacturing operations, including design, fabrication,
painting and assembly are performed at this facility. Annual manufacturing
capacity of SystemOne(R) Washers at this facility is approximately 25,000 units
on two full shifts, more than sufficient to meet the Safety-Kleen minimum volume
commitment of 18,000 units in the fifth year of the initial term of the
Exclusive Marketing Agreement. The Company currently manufactures its other
products in amounts required for testing, test marketing and/or commercial
production in these manufacturing facilities.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the
fourth quarter of 2002.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's securities were delisted from the Nasdaq SmallCap Market on May 8,
2001. The Company's securities are now quoted on the OTC Electronic Bulletin
Board under its symbol STEK.OB.
The following table sets forth, for the periods indicated, the high and low bid
quotations for the Common Stock as reported by Nasdaq SmallCap Market through
May 8, 2001 and the OTC Electronic Bulletin Board subsequent to such date. The
Nasdaq SmallCap Market and OTC Electronic Bulletin Board quotations represent
quotations between dealers without adjustment for retail markups, markdowns or
commissions and may not necessarily represent actual transactions.
13
HIGH BID PRICE LOW BID PRICE
-------------- -------------
2002
Fourth Quarter $0.900 $0.600
Third Quarter $1.500 $0.850
Second Quarter $2.080 $1.500
First Quarter $2.300 $2.040
2001
Fourth Quarter $2.850 $1.300
Third Quarter $2.250 $1.200
Second Quarter $2.650 $1.000
First Quarter $2.594 $1.000
As of December 31, 2002, there were 40 holders of record of the Company's Common
Stock. The Company believes that there are in excess of 500 beneficial owners of
the Common Stock. On March 25, 2003, the closing bid price of the Common Stock
was $.60 per share.
To date, the Company has not declared or paid any dividends on its Common Stock.
Pursuant to the terms of the Company's outstanding Convertible Subordinated
Notes, its Senior Revolver (as defined below), the Subordinated Loan Agreement
(as defined below) and outstanding series of preferred stock, the Company may
not declare or pay any dividends or make any other distributions, except
dividends or distributions payable in equity securities. The payment of
dividends, if any, is within the discretion of the Board of Directors and will
depend upon the Company's earnings, its capital requirements and financial
condition, contractual restrictions and other relevant factors. The Board does
not intend to declare any dividends on the Company's common stock in the
foreseeable future, but instead intends to retain future earnings, if any, for
use in the Company's business operations and to make principal and interest
payments on the Company's outstanding indebtedness.
The following table includes the following information as of December 31, 2002
for the Company's Executive Incentive Plan, which is its only equity incentive
compensation plan.
o The number of securities to be issued upon exercise of outstanding
options, warrants and rights (column (a));
o The weighted-average exercise price of the outstanding options,
warrants and rights disclosed (column (b)); and
o Other than securities to be issued upon exercise of the outstanding
options, warrants and rights disclosed in column (a), the number of
securities remaining available for future issuance under the plan.
14
EQUITY COMPENSATION PLAN INFORMATION
Number of Securities to Weighted-average Number of Securities remaining
be issued upon exercise exercise price of available for future issuance under
of outstanding options, outstanding options, equity compensation plans (excluding
warrants and rights warrants and rights securities reflected in column (a))
Column (a) Column (b) Column (c)
--------------------------------- --------------------------- ------------------------ ----------------------------------------
Executive Incentive Plan..... 533,716 $7.77 216,284
--------------------------------- --------------------------- ------------------------ ----------------------------------------
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis should be read in conjunction with the
Company's audited financial statements, including the notes thereto, contained
elsewhere in this report.
GENERAL
The Company was incorporated in November 1990 and, as a development stage
company, devoted substantially all of its resources to research and development
programs related to its full line of self-contained, recycling industrial parts
washers until June 1996. The Company commenced its planned principal operations
in July 1996. The Company first began to generate significant revenue from
product sales in 1997 followed by increased operating expenses between 1997 and
2000 in connection with the development of a national direct marketing and
distribution organization, including the establishment of regional distribution
centers and a service fleet. However, revenue growth did not match the increase
in costs.
Shifting its strategy in late 2000, the Company appointed Safety-Kleen the
exclusive distributor for SystemOne(R) parts washers in the United States,
Puerto Rico, Canada and Mexico (the "Territory") under the Exclusive Marketing
Agreement. This strategic shift has allowed the Company to eliminate its entire
national direct sales and service infrastructure permitting a significant
reduction in the Company's operating expenses. The Company retained five
regional service managers strategically located throughout the country to
provide technical expertise to Saftey-Kleen personnel as needed.
The Company began shipping SystemOne(R) parts washer equipment to Safety-Kleen
in January 2001 and immediately began to benefit from lower manufacturing cost
per unit due to higher production volume as well as lower selling, general and
administrative cost resulting from the elimination of its national direct sales
and service infrastructure. The Company recognized an operating profit of
$405,000 in the first quarter of 2001, its first operating profit in fourteen
quarters. Additionally, the Company has reported eight successive quarters of
operating profitability during 2001 and 2002.
The Company's transition to operating profitability resulted from streamlining
its operations by eliminating substantial selling, general and administrative
costs and reducing its cost of production. The Company's agreement with
Safety-Kleen will remain in effect, unless terminated earlier by mutual
agreement of the parties or as a result of a material breach by one party,
through December, 2005, as a result of Safety-Kleen's decision not to exercise
its one-time right to terminate the Exclusive Marketing Agreement without cause
15
which expired in July 2002. In the fourth quarter of 2002, the Company effected
a restructuring of its outstanding subordinated indebtedness and extended the
mandatory redemption date of its preferred stock. Also in the first quarter of
2003, the Company extended the maturity of its senior revolving credit facility.
See further discussion regarding of the Company's indebtedness and the
restructuring below in "Liquidity and Capital Resources".
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
RESULTS OF OPERATIONS
The Company sold approximately 10,218 SystemOne(R) General Parts Washers during
2002 compared to 10,053 units in 2001. Revenue increased by $674,414, or 4.0%,
to $17,719,726 for the year ended December 31, 2002 from $17,045,312 for the
year ended December 31, 2001. The revenue increase resulted from a price
increase of approximately 3.6% pursuant to the Exclusive Marketing Agreement and
the shipment of an additional 165 equivalent units due to timing of orders
placed and fulfillment of such orders. Sales during 2002 and 2001 were entirely
to Safety-Kleen pursuant to the Exclusive Marketing Agreement.
Gross profit as a percentage of sales was 38.4% and 36.6% for the years ended
December 31, 2002 and 2001, respectively. The increase in gross profit was due
to higher unit costs of units sold in the first quarter of 2001, which were
manufactured during 2000 and a price increase in 2002 of approximately 3.6%
pursuant to the Exclusive Marketing Agreement. These factors were partially
offset by higher material costs, primarily steel, during the year ended December
31, 2002, which adversely impacted gross profit margins by approximately 1.6%.
Selling, general and administrative expenses decreased $870,051 or 23.8% to
$2,780,574 for the year ended December 31, 2002 from $3,650,625 for the
comparable period of 2001. The decrease is primarily attributable to higher
administrative costs incurred during the year ended 2001 in which the Company
was transitioning to operate under the Exclusive Marketing Agreement. Reductions
in expenses incurred in 2002 as compared to 2001 include professional fees of
approximately $244,000, travel expenses of approximately $140,000, communication
expenses of approximately $80,000, taxes, fees and licenses of approximately
$78,000, facility rent of approximately $77,000 and wages and salaries of
approximately $130,000. The reductions in expenses were partially offset by an
increase in health insurance of approximately $61,000 and an increase in
workers' compensation costs of approximately $58,000.
Research and development expenses increased by $98,662 or 44.6% from $221,421
for the year ended December 31, 2001 to $320,083 for the year ended December 31,
2002. The increase is primarily due to upgrading engineering software and
hardware, increased expenditures for supplies necessary to develop new and
enhanced products (see Item 1 -Description of Business - Research and
Development) and an increase in wages for the Company's engineers. For 2003, the
Company expects to expend approximately the same amount as in 2002 with emphasis
on new and enhanced products.
The Company's engineering team is currently working on four projects: upgrading
the SystemOne(R) General Parts Washer which includes related plant retooling,
finalizing development of the European model of the SystemOne(R) General Parts
Washer, finalizing development of the SystemOne(R) Spray Gun Washer and
implementing the ISO 9001:2000 quality process.
16
Restructuring and other charges were related to the plan of restructuring
initiated in the fourth quarter of 2000 related to the Exclusive Marketing
Agreement. Changes in estimates were comparable during 2002 and 2001. The
restructuring is complete as described in footnote 11 of the financial
statements. The remaining reserve as of December 31, 2001 was reversed into
income in the second quarter of 2002.
The Company recognized operating profit of $3,777,878 and $2,464,097 for the
years ended December 31, 2002 and 2001, respectively. The operating profit is
primarily attributable to the overhead reductions resulting from the Company's
restructuring and its sales under the Exclusive Marketing Agreement which began
in the fourth quarter of 2000.
Interest expense decreased $1,579,445 or 33.2% to $3,173,838 for the year ended
December 31, 2002 from $4,753,283 for 2001. The decrease in interest expense was
primarily the result of completing in January 2002 amortization of debt discount
associated with common stock warrants issued to lenders during the third and
fourth quarters of 2000 and an adjustment to accrued interest related to the
Company's debt restructuring in the fourth quarter of 2002 and is partially
offset by increased debt balances at higher interest rates. The Company's debt
instruments bear interest at fixed rates. In the December 2002 note exchange,
certain fixed rate debt instruments were exchanged for notes bearing lower fixed
rates. See "Liquidity and Capital Resources" below.
Interest income increased $220,438 or 149.8% to $367,621 for the year ended
December 31, 2002 from $147,183 for the comparable period of 2001. The increase
is due primarily to the increase in the deferred payment portion of the sales
proceeds resulting from the cumulative increase in units sold under the
Exclusive Marketing Agreement. As more units are sold, the Company expects
interest income and the receivable related to the deferred portion of the sales
price to increase.
Despite current year's net income, the Company has utilized net operating loss
carryforwards to reduce its federal and state tax burden. Based on an evaluation
of available evidence, in view of the Company's significant historical losses,
management believes that it is not yet more likely than not that the deferred
tax assets will be realized, therefore a full valuation reserve is provided.
As a result of the foregoing, the Company recognized net income of $971,661 for
the year ended December 31, 2002 compared to a net loss of $2,142,003 for the
year ended December 31, 2001.
Dividends on preferred stock are paid-in-kind by issuing additional shares of
preferred stock and for the year ended December 31, 2002 were $2,294,366, an
increase of $241,399 or 11.8% compared to paid-in-kind dividends of $2,052,967
for the year ended December 31, 2001. The increase is due to the compounding
effect of paying dividends on additional shares of preferred stock that were
previously issued as paid-in-kind dividends. Dividends also include $173,038
which is the fair market value of the warrants issued in December 2002 to the
holders of the Series D Preferred Stock and the amortization of preferred stock
discounts associated with common stock warrants issued to investors in the
amount of $725,527 and $764,167 for the year ended December 31, 2002 and 2001,
respectively.
The Company's basic and diluted net loss to common shares decreased $2,872,265
or 68.5% to $1,322,705 for 2002 from $4,194,970 for 2001, or a loss per common
share of $.28 for 2002 as compared to $.88 for 2001.
17
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities for the year ended December 31, 2002
increased by $1,948,272 to $1,183,556 compared to net cash used in operating
activities of $764,716 for the prior year. The increase is primarily
attributable to a shift from a net loss of $2,142,003 for the year ended
December 31, 2001 to net income of $971,661 for the year ended December 31,
2002. This source of cash includes depreciation and amortization of $509,834,
amortization of debt issue costs of $354,816 and interest accrued on debt of
$2,114,654 and is partially offset by: (i) an increase in receivables of
$1,109,755, (ii) an increase in inventories of $202,239, (iii) a decrease in
accounts payable and accrued expenses of $943,919 and (iv) a decrease in
warranty accrual of $397,117. The increase in receivables of $1,109,755 relates
primarily to accumulation of the deferred payments which is further discussed in
the following paragraph. The increase in inventories is largely due to a build
up of inventory in preparation for next year's increase in sales from 10,000 to
12,500 equivalent units pursuant to the Exclusive Marketing Agreement. The
decrease in accounts payable and accrued expenses is primarily attributable to
payoff of aged payables. The decrease in warranty accrual of $397,117 is
primarily the result of paying the $500,000 warranty reserve established at the
end of 2000 related to transitioning service, maintenance and repair
responsibilities for previously sold SystemOne Parts Washers through the
remaining warranty periods. The Company paid approximately $305,000 in cash to
Safety Kleen in 2002 in relation to this reserve.
The majority of the sales price payable for each unit sold to Safety-Kleen is
due on net 30 day terms from date of shipment with a portion of the sales price
payable in equal installments over a 12 quarter period. The Company recognizes
revenue at the time of shipment for the entire sales price but applies a
discount to reflect the present value of the 12 quarterly payments utilizing a
discount rate which is currently 14%. In addition, the Company recognizes
imputed interest income over the discount period as the deferred portion of the
purchase price is amortized over the scheduled payment period. At December 31,
2002, $1,346,928 was included in receivables representing the then current
portion of the installment payments and $2,008,818 was due beyond 12 months as
reflected in the balance sheet as Non-current portion of receivables, net of
discount. The Company expects this receivable to grow throughout the term of the
Exclusive Marketing Agreement. Safety-Kleen has generally made its payments in
accordance with the terms of the Exclusive Marketing Agreement and the Company
considers this receivable from Safety-Kleen to be collectable. If the discount
rate were to vary by 100 basis points up or down, the Company's annual pre-tax
income would vary by approximately $36,000.
Net cash used in investing activities for the year ended December 31, 2002 was
$61,348, an increase of $131,741, compared to $70,393 net cash provided during
the prior year. The increase in cash used was due to selling equipment to
Safety-Kleen during 2001 compared to the Company purchasing various pieces of
production equipment during 2002. The Company expects to spend approximately
$50,000 in capital purchases during 2003.
Net cash used in financing activities for the year ended December 31, 2002 was
$675,894, a decrease of $941,185 compared to $265,291 net cash provided by
financing activities during the prior year. The decrease in cash is due to (i)
the Company paying down the Senior Revolver (as defined below) by $80,000 during
2002 compared to the Company drawing on the Senior Revolver by $550,000 during
2001 and (ii) the Company paying approximately $304,000 in professional fees in
connection with the restructuring of certain debt instruments more fully
described below.
At December 31, 2002, the Company had working capital of $2,788,463 and cash and
cash equivalents totaling $505,066, compared to a working capital deficiency of
$3,606,781 and cash and cash equivalents of $58,752 at December 31, 2001. The
18
significant improvement in net working capital is due primarily to the
classification of the Senior Revolver as long term debt and the reduction in
accounts payable and accrued expenses.
The Company is party to a Revolving Credit Loan Agreement (the "Senior
Revolver") with Hansa Finance Limited Liability Company ("Hansa"), which
provides the Company with a $5 million revolving line of credit. Pursuant to the
Senior Revolver, the Company may borrow twice a month up to the Advance Limit.
The Advance Limit is the lesser of $5,000,000 or the sum of the Advance
Supplement (as defined) plus an amount based on the Company's receivables and
inventory. The Advance Supplement is $2,500,000 for the period from April 1,
2001 until maturity. During 2002, the Company paid down the Senior Revolver by
$80,000 and, as of December 31, 2002, there was approximately $330,000 credit
available on the Senior Revolver. On February 15, 2003 the Company and Hansa
agreed to extend the maturity of the Senior Revolver from May 30, 2003 to May
30, 2005.
In 2001, the Company's primary sources of cash were draws against the Senior
Revolver and sales. In 2002, the Company's primary source of cash was from its
operations. The Exclusive Marketing Agreement with Safety-Kleen has an initial
term of five years plus two five-year renewal options and had a termination
right exercisable by Safety-Kleen prior to the third year of the initial term.
Safety-Kleen had until July 29, 2002 to exercise its one-time right to terminate
the Exclusive Marketing Agreement effective January 26, 2003. Safety-Kleen did
not exercise this termination right and, as a result, the initial term of the
Exclusive Marketing Agreement, which runs until December 26, 2005, is not
terminable except for cause or mutual agreement. In its opinion on the
Company's financial statements, included herein, the Company's independent
accountants, BDO Seidman, LLP, noted that the Company is dependent upon its
sales to its single customer, Safety-Kleen.
Safety-Kleen is currently under reorganization pursuant to Chapter 11 of the
federal Bankruptcy Code and there can be no assurance that Safety-Kleen will be
able to continue its operations as currently conducted or otherwise be in a
position to perform under the Exclusive Marketing Agreement. In November 2002,
Safety-Kleen filed a restructuring plan with the bankruptcy court and filed an
amendment to the plan with the bankruptcy court in February 2003.
The Company's material short-term financial commitments are obligations to make
lease payments on the Company's principal executive and manufacturing facility
in Miami, Florida and equipment leases (approximately $39,000 per month),
installment payments for financed manufacturing equipment (approximately $16,000
per month), interest payments on the Company's 8.25% Subordinated Convertible
Notes of which half can be paid by adding such accrued interest to the principal
amount of such notes and half must be paid in cash beginning January 1, 2003
(approximately $151,000 per month), interest under the Secured Notes (as defined
below) which accrues and is due at maturity (approximately $37,000 per month)
and interest payments on the Senior Revolver (up to approximately $54,000 per
month). Dividends on the Company's Series B, Series C, and Series D Convertible
Preferred Stock can be paid by issuance of additional shares.
On December 9, 2002, the Company exchanged (i) all of its then outstanding 8.25%
Subordinated Convertible Notes due February 23, 2003 (the "Old Junior Notes")
for (a) 8.25% Subordinated Convertible Notes due December 31, 2005 in an
aggregate principal amount equal to 50% of the sum of the aggregate principal
amount of the Old Junior Notes plus all interest accrued thereon, bearing
interest which when due may be added at the Company's option to the principal
19
amount of such notes through December 31, 2002 and thereafter shall be paid in
cash ("Partial Cash Pay Notes"), (b) 8.25% Subordinated Convertible Notes due
December 31, 2005 in an aggregate principal amount equal to 50% of the sum of
the aggregate principal amount of the Old Junior Notes plus all interest accrued
thereon, bearing interest which when due may be added to the principal amount
for the life of such notes ("PIK Pay Notes and together with the Partial Cash
Pay Notes, the "Subordinated Convertible Notes"), and (c) Warrants (the "New
Warrants") for the purchase of an aggregate of 750,000 shares of Common Stock at
an exercise price of $.01 per share expiring on December 31, 2005; and (ii) all
of its then outstanding 16% Promissory Notes due November 30, 2002 (the "Old
Secured Notes") for 10% Promissory Notes (the "Secured Notes" and collectively
with the Subordinated Convertible Notes and the New Warrants, the "Current
Securities") due December 31, 2005 in an aggregate principal amount equal to
100% of the sum of the aggregate principal amount of all Old Secured Notes plus
all interest accrued thereon, with interest which when due will be added to the
principal amount for the life of such notes. The estimated fair market value of
the New Warrants at December 9, 2002 was $519,114 and was charged to unamortized
note discount and credited to additional paid-in capital. The discount will be
amortized to interest expense over the term of the Current Securities.
The issuance of the 750,000 warrants to the holders of the Subordinated
Convertible Notes, described above, would have triggered certain anti-dilution
rights pursuant to the Company's outstanding (i) shares of Series D Preferred
Stock, $1.00 per share, (ii) warrants issued May 2, 2000 exercisable for an
aggregate of 571,428 shares of Common Stock, and (iii) warrants issued August 7,
2000 exercisable for an aggregate of 942,858 shares of Common Stock
(collectively, the "Outstanding Warrants"). The holders of the Series D
Preferred Stock and Outstanding Warrants waived their anti-dilution rights in
exchange for warrants for the purchase of an aggregate of 250,000 shares of
Common Stock at an exercise price of $.01 per share expiring on December 31,
2005. The estimated fair market value of these warrants at December 9, 2002 was
$173,038 and was recorded as a dividend and credited to additional paid-in
capital.
In connection with the Exchange, the holders of the Company's outstanding shares
of Preferred Stock agreed to extend the date upon which the Company must redeem
such shares from May 17, 2004 to the earlier of the 90th day after all of the
Subordinated Convertible Notes are paid in full or March 31, 2006.
The Company is required to issue an additional 942,858 warrants to the holders
of its Secured Notes if the Company (i) sells debt or equity securities, or debt
securities convertible into equity securities, or incurs debt with a final
scheduled maturity date more than twelve months after issuance providing gross
cash proceeds to the Company in an amount equal to or greater than the
outstanding principal amount of the Secured Notes or (ii) enters into a merger,
consolidation, sale of all or substantially all of its assets or other business
combination transaction with a party that prior to such transaction owns less
than 25 percent of the voting power of the Company's outstanding equity
securities. The fair market value of the warrants would be charged to operations
should the warrants become issuable.
In September 2002, the Company entered into agreements with its Chief Executive
Officer and President which extended their employment agreements for thirty-six
months expiring on December 31, 2005.
Although the Company believes that it will continue to be able to meet its
operating cash requirements, assuming Safety-Kleen's continued performance, if
none of the outstanding convertible debt and convertible preferred stock is
20
converted to common stock or extended, significant amounts of cash would be
required commencing in the second quarter 2005 to repay long-term debt, accrued
interest and the redeemable preferred stock as follows:
DEBT PLUS INTEREST PREFERRED STOCK TOTAL
------------------- ------------------ -------------------
2003 $ 147,624 $ -- $ 147,624
2004 826 826
2005 35,554,663 35,554,663
2006 23,618,000* 23,618,000
------------------- ------------------ -------------------
Total $ 35,703,113 $ 23,618,000 $ 59,321,113
=================== ================== ===================
---------
* Assuming no pre-payment of Subordinated Convertible Notes.
The Company entered into an agreement on February 15, 2003 to extend the
maturity from May 30, 2003 to May 30, 2005 of the Senior Revolver.
Prior to 2001, the Company suffered recurring losses from operations, primarily
resulting from the significant expenses incurred in the establishment of its
former direct national marketing and distribution organization, and has a net
capital deficiency. Beginning in the first quarter of 2001, the Company
recognized income from operations in each quarter to date. As of December 31,
2002, the Company's accumulated deficit totaled $62,773,311.
RELATED PARTY TRANSACTIONS
All of the outstanding Preferred Stock and Secured Promissory Notes of the
Company are held by Hanseatic Americas LDC and Environmental Opportunities Fund.
The Senior Revolver is held by Hansa Finance LLC. Mr. Kenneth Leung, Chief
Investment Officer of the Environmental Opportunities Fund, the Environmental
Opportunities Fund II, L.P. and the Environmental Opportunities Fund II
(Institutional) L.P., and Mr. Paul A. Biddelman, the President of Hanseatic
Americas LDC and Hansa Finance LLC, are directors of the Company.
CRITICAL ACCOUNTING POLICIES
Note 1 to the financial statements set forth herein includes a summary of the
significant accounting policies and methods used in the preparation of the
Company's financial statements. Management believes the following policies are
critical to an understanding of the Company's financial statements.
21
REVENUE RECOGNITION. The majority of the sales price payable for each unit
purchased by Safety-Kleen, is payable on net 30 day terms from date of shipment
with a portion of the sales price payable in equal installments over a 12
quarter period. The Company recognizes revenue at the time of shipment (F.O.B.
shipping dock) for the entire sales price but applies a discount to reflect the
present value of the 12 quarterly payments utilizing a discount rate which is
currently 14%. This discount rate used is the Company's incremental borrowing
rate which is determined to be the interest rate paid on its Senior Revolver of
14%. In addition, the Company recognizes interest income over the extended
payment period as the deferred portion of the purchase price is amortized over
the scheduled payment period. If the discount rate were to vary by 100 basis
points up or down, the Company's annual income would vary by approximately
$36,000. The collectability of receivables is evaluated routinely and, if deemed
necessary, the Company records an allowance for doubtful accounts. The allowance
for doubtful accounts was $123,287 and $153,666 at December 31, 2002 and 2001,
respectively. Pursuant to the Exclusive Marketing Agreement, the price charged
to Safety-Kleen is determined annually based on the actual manufacturing costs
incurred during a three month period in the latter part of the previous year.
Deferred revenue on the balance sheet relates to extended two-year warranty
contracts purchased by customers and is recognized in income on the
straight-line basis over the terms of each contract.
PRODUCT WARRANTY. The Company generally warrants that its products will be free
of material defects during the three year warranty period. Safety-Kleen assumed
all service, maintenance and repair responsibilities for the Company's installed
base of SystemOne(R) parts washers including units sold before the Exclusive
Marketing Agreement and units sold pursuant to the Exclusive Marketing
Agreement. The Company is responsible for the cost of all parts required for
service during the warranty period for all units sold. For units sold before the
Exclusive Marketing Agreement, the Company agreed to pay Safety-Kleen a total
fee of $500,000 for all warranty service to be performed by Safety-Kleen on
these units. The balance of the $500,000 fee due as of December 31, 2002 is
$75,000 payable $25,000 per month during the first three months of 2003. For
units sold pursuant to the Exclusive Marketing Agreement, Safety-Kleen is
responsible for the cost of all service, maintenance and repair during the
warranty period. The Company accrues estimated standard warranty costs as the
parts washers are sold to customers.
USE OF ESTIMATES. Management of the Company uses estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
NEW ACCOUNTING STANDARDS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 144, "Accounting for
Impairment or Disposal of Long-Lived Assets." The provisions of this Statement
generally are to be applied prospectively. The adoption of SFAS No. 144 on
January 1, 2002 did not materially impact the Company's financial position or
results of operations.
22
During April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Such standard requires any gain or loss on extinguishments of debt
to be presented as a component of continuing operations (unless specific
criteria are met) whereas SFAS No. 4 required that such gains and losses be
classified as an extraordinary item in determining net income. The adoption of
SFAS No. 145 did not materially impact the Company's financial position or
results of operations.
During June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Under SFAS No. 146, a liability related to
an exit or disposal activity (including restructurings) is not recognized until
such liability has actually been incurred whereas under EITF Issue No. 94-3 a
liability was recognized at the time of a commitment to an exit or disposal
plan. The provisions of this standard are effective for disposal activities
initiated after December 31, 2002.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annul financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and are not
expected to have a material effect on the Company's financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure. This statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
also amends the disclosure requirements of SFAS No. 123 to require more
prominent and frequent disclosures in the financials statements about the
effects of stock-based compensation. The transitional guidance and annual
disclosure provisions of this Statement is effective for the December 31, 2002
financial statements. The interim reporting disclosures requirements will be
effective for the Company's March 31, 2003 10-QSB. Because the Company continues
to account for employee stock-based compensation under APB opinion No. 25, the
transitional guidance of SFAS No. 148 has no effect on the financial statements
at this time. However, in the December 31, 2002 financial statements we have
incorporated the enhanced disclosure requirements of SFAS No. 148.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities ("VIE's") created after January 31, 2003, and to VIE's in which an
enterprise obtains an interest after that date. It applies to the first fiscal
23
year or interim period beginning after June 15, 2003, to VIE's in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
FIN 46 applies to public enterprises as of the beginning of the applicable
interim or annual period. The adoption of FIN 46 is not expected to have a
material impact on the Company's consolidated financial position, liquidity, or
results of operations.
ITEM 7. FINANCIAL STATEMENTS
The Financial Statements of the Company required by Form 10-KSB are attached
hereto following Part III of this report commencing on page 35.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Incorporated by reference from the Company's definitive proxy statement to be
filed within 120 days after the end of the Company's fiscal year.
ITEM 10. EXECUTIVE COMPENSATION
Incorporated by reference from the Company's definitive proxy statement to be
filed within 120 days after the end of the Company's fiscal year.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated by reference from the Company's definitive proxy statement to be
filed within 120 days after the end of the Company's fiscal year.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the Company's definitive proxy statement to be
filed within 120 days after the end of the Company's fiscal year.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
EXHIBIT DESCRIPTION
------- -----------
3.1 Amended and Restated Articles of Incorporation of
the Company, as amended to date (incorporated by
reference to Exhibit 3.1 of the Company's
Quarterly Report on Form 10-QSB for the quarter
ended June 30, 2000 (Commission File Number:
000-21325)).
3.2 Bylaws of the Company (incorporated by reference
to Exhibit 3.2 of the Company's Registration
Statement on Form S-1, as amended (No.
333-08657)).
24
EXHIBIT DESCRIPTION
------- -----------
4.1 The rights of holders of shares of the Company's
Common Stock, par value $.001, Series B Preferred
Stock, $1.00 par value per share, Series C
Preferred Stock, $1.00 par value per share and
Series D Preferred Stock, $1.00 par value per
share are set forth in the Company's Amended and
Restated Articles of Incorporation as referenced
in Exhibit 3.1 hereto.
4.2 Certificate for Shares of Common Stock, $.001 par
value per share (incorporated by reference to
Exhibit 4.1 of the Company's Registration
Statement on Form S-1, as amended (No.
333-08657)).
4.3 Certificate for Shares of Series B Preferred
Stock, $1.00 par value per share (incorporated by
reference to Exhibit 4.2 of the Company's Current
Report on Form 8-K filed with the Commission on
May 27, 1999 (Commission File Number: 000-21325)).
4.4 Certificate for Shares of Series C Preferred
Stock, $1.00 par value per share (incorporated by
reference to Exhibit 4.2 of the Company's Current
Report on Form 8-K filed with the Commission on
August 31, 1999 (Commission File Number:
000-21325)).
4.5 Certificate for Shares of Series D Preferred
Stock, $1.00 par value per share (incorporated by
reference to Exhibit 4.2 of the Company's Current
Report on Form 8-K filed with the Commission on
May 15, 2000 (Commission File Number: 000-21325)).
4.6 Form of Warrant dated November 10, 2000
(incorporated by reference to Exhibit 4.7 of the
Company's Annual Report on Form 10-KSB for the
year ended December 31, 2000 (Commission File
Number 000-21325)).
4.7 Form of Warrant dated May 2, 2000 (incorporated by
reference to Exhibit 4.1 of the Company's
Quarterly Report on Form 10-QSB for the quarter
ended June 30, 2000 (Commission File Number
000-21325)).
4.8 1998 Common Stock Purchase Rights Agreement, dated
as of October 1, 1998, between the Company and
Continental Stock Transfer & Trust Company
(incorporated by reference to Exhibit 4.1 of the
Company's Form 8-A12G filed with the Commission on
October 6, 1998 (Commission File Number:
000-21325)), as amended by (i) First Amendment to
Rights Agreement, dated as of May 2, 2000, by and
between the Company and Continental Stock Transfer
and Trust Company. (incorporated by reference to
Exhibit 4.2 of the Company's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 2000
(Commission File Number: 000-21325)), (ii) Second
Amendment to Rights Agreement, dated as of August
7, 2000, by and between the Company and
Continental Stock Transfer and Trust Company.
(incorporated by reference to Exhibit 4.3 of the
Company's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2000 (Commission File
Number: 000-21325)), and (iii) Third Amendment to
Rights Agreement, dated as of November 7, 2000, by
and between the Company and Continental Stock
Transfer and Trust Company. (incorporated by
reference to Exhibit 4.1 of the Company's Form
8-A12G/A filed with the Commission on December 28,
2000 (Commission File Number: 000-21325)).
4.9 Exchange Agreement dated as of December 9, 2002
between the Company and the Holders party thereto
(incorporated by reference to Exhibit 4.1 of the
Company's Current Report on Form 8-K filed with
the Commission on December 13, 2002 (Commission
File Number: 000-21325)).
25
EXHIBIT DESCRIPTION
------- -----------
4.10 Form of 8.25% Subordinated Convertible Note due
December 31, 2005 dated as of December 9, 2002
(partial cash pay) (incorporated by reference to
Exhibit 4.2 of the Company's Current Report on
Form 8-K filed with the Commission on December 13,
2002 (Commission File Number: 000-21325)).
4.11 Form of 8.25% Subordinated Convertible Note due
December 31, 2005 dated as of December 9, 2002
(PIK pay) (incorporated by reference to Exhibit
4.3 of the Company's Current Report on Form 8-K
filed with the Commission on December 13, 2002
(Commission File Number: 000-21325)).
4.12 Form of Warrant for the Purchase of Shares of
Common Stock at an exercise price of $.01 per
share dated as of December 9, 2002 (incorporated
by reference to Exhibit 4.4 of the Company's
Current Report on Form 8-K filed with the
Commission on December 13, 2002 (Commission File
Number: 000-21325)).
4.13 Form of Promissory Note dated as of December 9,
2002 (incorporated by reference to Exhibit 4.5 of
the Company's Current Report on Form 8-K filed
with the Commission on December 13, 2002
(Commission File Number: 000-21325)).
4.14 Waiver Agreement dated as of December 9, 2002, by
and among the Company, Hanseatic Americas LDC,
Environmental Opportunities Fund II, L.P. and
Environmental Opportunities Fund II
(Institutional), L.P. (incorporated by reference
to Exhibit 4.6 of the Company's Current Report on
Form 8-K filed with the Commission on December 13,
2002 (Commission File Number: 000-21325)).
4.15 Letter Agreement dated December 9, 2002, by and
among the Company, Hanseatic Americas LDC,
Environmental Opportunities Fund, L.P.,
Environmental Opportunities Fund II, L.P. and
Environmental Opportunities Fund II
(Institutional), L.P. (Institutional), L.P.
(incorporated by reference to Exhibit 4.7 of the
Company's Current Report on Form 8-K filed with
the Commission on December 13, 2002 (Commission
File Number: 000-21325)).
10.1 Shareholders Agreement, dated May 2, 2000 by and
among the Company and the other parties thereto
(incorporated by reference to Exhibit 10.1 of the
Company's Current Report on Form 8-K filed with
the Commission on May 15, 2000 (Commission File
Number: 000-21325)).
10.2 The Company's Executive Incentive Plan, as amended
to date (incorporated by reference to Annex A of
the Company's Definitive Schedule 14A, filed with
the Commission on June 14, 2000 (Commission File
Number: 000-21325)).
10.3 Form of Indemnification Agreement between the
Company and each of its directors and executive
officers (incorporated by reference to Exhibit
10.3 of the Company's Registration Statement on
Form S-1, as amended (No. 333-08657)).
10.4 Intertek Testing Services Listing, Labeling, and
Follow-up Service Agreement (incorporated by
reference to Exhibit 10.32 of the Company's
Quarterly Report on Form 10-QSB for the quarter
ended June 30, 1997 (Commission File Number
000-21325)).
10.5 Loan Agreement, dated August 7, 2000, by and among
the Company, Environmental Opportunities Fund II,
L.P., Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC
(incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2000 (Commission File
Number: 000-21325)).
26
EXHIBIT DESCRIPTION
------- -----------
10.6 First Amendment to Loan Agreement, dated November
10, 2000, by and among the Company, Environmental
Opportunities Fund II, L.P., Environmental
Opportunities Fund II (Institutional), L.P. and
Hanseatic Americas LDC. (Incorporated by reference
to exhibit 10.6 of the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2000
(Commission File Number: 000-21325)).
10.7 Second Amendment to Loan Agreement, dated November
30, 2000, by and among the Company, Environmental
Opportunities Fund II, L.P., Environmental
Opportunities Fund II (Institutional), L.P. and
Hanseatic Americas LDC (incorporated by reference
to Exhibit 10.7 of the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2000
(Commission File Number 000-21325)).
10.8 Letter Agreement regarding the Loan Agreement,
dated August 7, 2000, by and among the Company,
Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II
(Institutional), L.P., Environmental Opportunities
Fund (Cayman), L.P., Hanseatic Americas LDC, Paul
Mansur and Pierre Mansur (incorporated by
reference to Exhibit 10.3 of the Company's
Quarterly Report on Form 10-QSB for the quarter
ended June 30, 2000 (Commission File Number:
000-21325)).
10.9 Security Agreement, dated August 7, 2000, by and
among the Company, Environmental Opportunities
Fund II, L.P., Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC
(incorporated by reference to Exhibit 10.4 of the
Company's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2000 (Commission File
Number: 000-21325)).
10.10 First Amendment to Security Agreement, dated
November 10, 2000, by and among the Company,
Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC
(incorporated by reference to Exhibit 10.12 of the
Company's Annual Report on Form 10-KSB for the
year ended December 31, 2000 (Commission File
Number 000-21325)).
10.11 Second Amendment to Security Agreement, dated
November 30, 2000, by and among the Company,
Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC
(incorporated by reference to Exhibit 10.13 of the
Company's Annual Report on Form 10-KSB for the
year ended December 31, 2000 (Commission File
Number 000-21325)).
10.12 Second Amended and Restated Marketing and
Distribution Agreement, dated as of March 8, 2001
by and between the Company and Safety-Kleen
Systems, Inc. (incorporated by reference to
Exhibit 10.16 of the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2000
(Commission File Number 000-21325)).
10.13 Revolving Credit Loan Agreement by and between the
Company and Hansa Finance Limited Liability
Company, dated as of November 30, 2000
(incorporated by reference to Exhibit 10.17 of the
Company's Annual Report on Form 10-KSB for the
year ended December 31, 2000 (Commission File
Number 000-21325)).
10.14 Security Agreement by and between the Company and
Hansa Finance Limited Liability Company, dated as
of November 30, 2000 (incorporated by reference to
Exhibit 10.19 of the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2000
(Commission File Number 000-21325)).
10.15 Master Lease Agreement, dated as of December 14,
1997 between the CIT Group/Equipment Financing,
Inc. and the Company. (incorporated by reference
to Exhibit 10.20 of the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2000
(Commission File Number 000-21325)).
27
EXHIBIT DESCRIPTION
------- -----------
10.16 Third Amendment to Loan Agreement, dated February
27, 2002, by and among the Company, Hanseatic
Americas LDC, Environmental Opportunities Fund II,
L.P. and Environmental Opportunities Fund II
(Institutional), L.P. (incorporated by reference
to Exhibit 10.1 of the Company's Current Report on
Form 8-K filed with the Commission on March 1,
2002 (Commission File Number: 000-21325)).
10.17 Letter Agreement dated February 27, 2002, by and
among the Company, Hanseatic Americas LDC,
Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II
(Institutional), L.P., Environmental Opportunities
Fund, L.P. and Environmental Opportunities Fund
(Cayman), L.P. (incorporated by reference to
Exhibit 10.2 of the Company's Current Report on
Form 8-K filed with the Commission on March 1,
2002 (Commission File Number: 000-21325)).
10.18 Letter Agreement dated February 27, 2002, by and
among the Company, Paul I. Mansur, Pierre G.
Mansur, Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P., Environmental
Opportunities Fund II (Institutional), L.P.,
Environmental Opportunities Fund, L.P. and
Environmental Opportunities Fund (Cayman), L.P.
(incorporated by reference to Exhibit 10.3 of the
Company's Current Report on Form 8-K filed with
the Commission on March 1, 2002 (Commission File
Number: 000-21325)).
10.19 Fourth Amendment to Loan Agreement, dated
September 30, 2002, by and among the Company,
Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P. and Environmental
Opportunities Fund II (Institutional), L.P.
(incorporated by reference to Exhibit 10.1 of the
Company's Current Report on Form 8-K filed with
the Commission on September 30, 2002 (Commission
File Number: 000-21325)).
10.20 Employment Agreement between Paul I. Mansur and
the Company dated as of January 1, 2003
(incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-QSB for the
quarter ended September 30, 2002 filed with the
Commission on November 14, 2002 (Commission File
Number: 000-21325)).
10.21 Employment Agreement between Pierre G. Mansur and
the Company dated as of January 1, 2003
(incorporated by reference to Exhibit 10.2 of the
Company's Quarterly Report on Form 10-QSB for the
quarter ended filed with the Commission on
November 14, 2002 (Commission File Number:
000-21325)).
10.22 Fifth Amendment to Loan Agreement, dated as of
December 9, 2002, by and among the Company,
Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P. and Environmental
Opportunities Fund II (Institutional), L.P.
(incorporated by reference to Exhibit 10.1 of the
Company's Current Report on Form 8-K filed with
the Commission on December 13, 2002 (Commission
File Number: 000-21325)).
10.23 Third Amendment to Security Agreement, dated as of
December 9, 2002, by and among the Company,
Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P. and Environmental
Opportunities Fund II (Institutional), L.P.
(incorporated by reference to Exhibit 10.2 of the
Company's Current Report on Form 8-K filed with
the Commission on December 13, 2002 (Commission
File Number: 000-21325)).
28
EXHIBIT DESCRIPTION
------- -----------
10.24 Letter Agreement dated December 9, 2002, by and
among the Company, Hanseatic Americas LDC,
Environmental Opportunities Fund II, L.P. and
Environmental Opportunities Fund II
(Institutional), L.P. (incorporated by reference
to Exhibit 10.2 of the Company's Current Report on
Form 8-K filed with the Commission on December 13,
2002 (Commission File Number: 000-21325)).
10.25 First Amendment to Revolving Credit Loan Agreement
by and between the Company and Hansa Finance
Limited Liability Company, dated as of February
15, 2003 (incorporated by reference to Exhibit
10.1 of the Company's Current Report on Form 8-K
filed with the Commission on March 18, 2003
(Commission File Number: 000-21325)).
10.26 Revolving Credit Note, dated as of February 15,
2003 (incorporated by reference to Exhibit 10.2 of
the Company's Current Report on Form 8-K filed
with the Commission on March 18, 2003 (Commission
File Number: 000-21325)).
23.2 Consent of BDO Seidman, LLP
(B) Reports on Form 8-K
Form 8-K filed with the Securities and Exchange Commission on September
30, 2002.
Form 8-K filed with the Securities and Exchange Commission on December
13, 2002.
ITEM 14. CONTROLS AND PROCEDURES
EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROLS. Within
the 90 days prior to the date of this Annual Report on Form 10-KSB, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures ("Disclosure Controls") and its internal controls and
procedures for financial reporting ("Internal Controls"). This evaluation (the
"Controls Evaluation") was done under the supervision and with the participation
of the Company's management, including its Chief Executive Officer ("CEO") and
Director of Finance and Administration/Principal Financial Officer (PFO).
Rules adopted by the SEC require that in this section of the Annual Report the
Company present the conclusions of its CEO and the PFO about the effectiveness
of the Company's Disclosure Controls and Internal Controls based on and as of
the date of the Controls Evaluation.
CEO AND PFO CERTIFICATIONS. Appearing immediately following the Signatures
section of this Annual Report are "Certifications" of the CEO and the PFO. The
Certifications are required in accord with Section 302 of the Sarbanes-Oxley Act
of 2002 (the "Section 302 Certifications"). This section of the Annual Report is
the information concerning the Controls Evaluation referred to in the Section
302 Certifications and this information should be read in conjunction with the
Section 302 Certifications for a more complete understanding of the topics
presented.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS. Disclosure Controls are procedures
that are designed with the objective of ensuring that information required to be
disclosed in the Company's reports filed under the Securities Exchange Act of
1934 ("Exchange Act"), such as this Annual Report, is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's ("SEC") rules and forms. Disclosure Controls are also
29
designed with the objective of ensuring that such information is accumulated and
communicated to the Company's management, including the CEO and PFO, as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures which are designed with the objective of providing
reasonable assurance that (1) the Company's transactions are properly
authorized, recorded and reported; and (2) the Company's assets are safeguarded
against unauthorized or improper use, to permit the preparation of the Company's
financial statements in conformity with generally accepted accounting
principles.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. The Company's management,
including the CEO and PFO, does not expect that the Company's Disclosure
Controls or its Internal Controls will prevent all errors and all fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
SCOPE OF THE CONTROLS EVALUATION. The CEO/PFO evaluation of the Company's
Disclosure Controls and Internal Controls included a review of the controls'
objectives and design, the controls' implementation by the Company and the
effect of the controls on the information generated for use in this Annual
Report. In the course of the Controls Evaluation, management sought to identify
data errors, controls problems or acts of fraud and to confirm that appropriate
corrective action, including process improvements, were being undertaken. This
type of evaluation will be done on a quarterly basis so that the conclusions
concerning controls effectiveness can be reported in the Company's Quarterly
Reports on Form 10-QSB and Annual Report on Form 10-KSB. The overall goals of
these various review and evaluation activities are to monitor the Company's
Disclosure Controls and Internal Controls and to make modifications as
necessary; the Company's intent in this regard is that the Disclosure Controls
and the Internal Controls will be maintained as dynamic systems that change
(including with improvements and corrections) as conditions warrant.
Among other matters, management sought in its evaluation to determine whether
there were any "significant deficiencies" or "material weaknesses" in the
Company's Internal Controls, or whether the Company had identified any acts of
fraud involving personnel who have a significant role in the Company's Internal
Controls. In the professional auditing literature, "significant deficiencies"
are referred to as "reportable conditions"; these are control issues that could
have a significant adverse effect on the ability to record, process, summarize
and report financial data in the financial statements. A "material weakness" is
30
defined in the auditing literature as a particularly serious reportable
condition where the internal control does not reduce to a relatively low level
the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financial statements and not be detected
within a timely period by employees in the normal course of performing their
assigned functions.
In accordance with SEC requirements, the CEO and PFO note that, since the date
of the Controls Evaluation to the date of this Annual Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
CONCLUSIONS. Based upon the Controls Evaluation, the Company's CEO and PFO have
concluded that, subject to the limitations noted above, our Disclosure Controls
are effective to ensure that material information relating to the Company is
made known to management, including the CEO and PFO, particularly during the
period when the Company's periodic reports are being prepared, and that the
Company's Internal Controls are effective to provide reasonable assurance that
its financial statements are fairly presented in conformity with generally
accepted accounting principles.
31
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
as amended (the "Exchange Act"), the Company has caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
SYSTEMONE TECHNOLOGIES INC.
Dated: March 31, 2003 By: /s/ /s/ Paul I. Mansur
--------------------------------------
Chief Executive Officer
(Principal Executive Officer)
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the Company and in the capacities
and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ Pierre G. Mansur Chairman of the Board and March 31, 2003
----------------------------------------- President; Director
Pierre G. Mansur
/s/ Paul I. Mansur Chief Executive Officer; March 31, 2003
----------------------------------------- Principal Executive Officer;
Paul I. Mansur Director
/s/ Steven M. Healy Director of Finance and March 31, 2003
----------------------------------------- Administration; Principal
Steven M. Healy Financial Accounting Officer
/s/ Kenneth C. Leung Director March 31, 2003
-----------------------------------------
Kenneth C. Leung
/s/ Paul A. Biddelman Director March 31, 2003
-----------------------------------------
Paul A. Biddelman
32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Paul I. Mansur, Chief Executive Officer of SystemOne Technologies Inc.,
certify that:
1. I have reviewed this annual report on Form 10-KSB of SystemOne
Technologies Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 31, 2003
/s/ Paul I. Mansur
-------------------------
Paul I. Mansur
Chief Executive Officer
33
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
I, Steven M. Healy, Director of Finance and Administration (Principal Financial
Officer) of SystemOne Technologies Inc., certify that:
1. I have reviewed this annual report on Form 10-KSB of SystemOne
Technologies Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation Date");
and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 31, 2003
/s/ Steven M. Healy
--------------------------------------
Steven M. Healy
Director of Finance and Administration
(Principal Financial Officer)
34
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
SystemOne Technologies Inc.
Miami, Florida
We have audited the accompanying balance sheets of SystemOne Technologies Inc.
as of December 31, 2002 and 2001 and the related statements of operations,
stockholders' deficit, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit 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.
As described in Note 2, the Company's revenue is dependent on sales to one
customer that is currently operating under Chapter 11 of the U.S. Bankruptcy
code
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SystemOne Technologies Inc. at
December 31, 2002 and 2001, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
/s/ BDO Seidman, LLP
Miami, Florida
February 12, 2003
SYSTEMONE TECHNOLOGIES INC.
BALANCE SHEETS
DECEMBER 31
-------------------------------
2002 2001
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 505,066 $ 58,752
Receivables 2,585,536 2,092,161
Inventories 1,250,802 1,048,563
Prepaid and other assets 384,351 309,015
------------ ------------
Total current assets 4,725,755 3,508,491
Property and equipment, net 1,133,005 1,576,522
Non-current portion of receivables, net of discount 2,008,818 1,362,059
Other assets 316,531 367,427
------------ ------------
Total assets $ 8,184,109 $ 6,814,499
============ ============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses $ 1,252,974 $ 2,196,893
Warranty accrual 435,392 673,018
Deferred revenue 106,814 116,364
Current installments of long-term debt and obligations under capital
leases 142,112 4,128,997
------------ ------------
Total current liabilities 1,937,292 7,115,272
Long-term debt 30,834,546 25,618,239
Warranty accrual, non-current 239,098 398,589
------------ ------------
Total liabilities 33,010,936 33,132,100
------------ ------------
Commitments and contingencies
Redeemable convertible preferred stock, voting, $1.00 par value per share
Authorized 1,500,000 shares, 182,270 issued and outstanding (168,312 in
2001) at liquidation value 18,227,000 16,831,200
Less unamortized discount (1,008,344) (1,733,871)
------------ ------------
Net redeemable convertible preferred stock 17,218,656 15,097,329
------------ ------------
Stockholders' deficit:
Common stock, $0.001 par value per share, authorized 25,000,000 shares,
issued and outstanding 4,742,923 4,743 4,743
Additional paid-in capital 20,723,085 20,030,933
Deficit (62,773,311) (61,450,606)
------------ ------------
Total stockholders' deficit (42,045,483) (41,414,930)
------------ ------------
Total liabilities, redeemable convertible preferred stock and
stockholders' deficit $ 8,184,109 $ 6,814,499
============ ============
See accompanying notes to financial statements.
36
SYSTEMONE TECHNOLOGIES INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER
--------------------------------
2002 2001
------------ ------------
Revenue $ 17,719,726 $ 17,045,312
Cost of goods sold (10,916,191) (10,805,202)
------------ ------------
Gross profit 6,803,535 6,240,110
------------ ------------
Operating expenses:
Selling, general and administrative 2,780,574 3,650,625
Research and development 320,083 221,421
Restructuring and other charges (75,000) (96,033)
------------ ------------
Total operating expenses 3,025,657 3,776,013
------------ ------------
Operating income 3,777,878 2,464,097
------------ ------------
Interest expense (3,173,838) (4,753,283)
Interest income 367,621 147,183
------------ ------------
Interest expense, net (2,806,217) (4,606,100)
------------ ------------
Net income (loss) 971,661 (2,142,003)
------------ ------------
Dividends and accretion of discount on redeemable
convertible preferred stock (2,294,366) (2,052,967)
------------ ------------
Net loss attributable to common shares $ (1,322,705) $ (4,194,970)
============ ============
Basic and diluted net loss per common share $ (0.28) $ (0.88)
============ ============
Weighted average shares outstanding 4,742,923 4,742,923
============ ============
See accompanying notes to financial statements.
37
SYSTEMONE TECHNOLOGIES INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
COMMON STOCK ADDITIONAL TOTAL
------------------------ PAID-IN STOCKHOLDERS'
SHARES PAR CAPITAL DEFICIT DEFICIT
------------ --------- ------------ ------------ ------------
Balance, January 1, 2001 4,742,923 $ 4,743 $ 19,216,577 $(57,255,636) $(38,034,316)
Net loss (2,142,003) (2,142,003)
Beneficial conversion feature on
Series D Preferred Stock 814,356 814,356
Declaration of in-kind preferred
dividends and accretion of
discount on preferred stock (2,052,967) (2,052,967)
------------ --------- ------------ ------------ ------------
Balance, December 31, 2001 4,742,923 4,743 20,030,933 (61,450,606) (41,414,930)
Net income 971,661 971,661
Declaration of in-kind preferred
dividends and accretion of
discount on preferred stock (2,294,366) (2,294,366)
Warrants issued 692,152 692,152
------------ --------- ------------ ------------ ------------
Balance, December 31, 2002 4,742,923 $ 4,743 $ 20,723,085 $(62,773,311) $(42,045,483)
============ ========= ============ ============ ============
See accompanying notes to financial statements.
38
SYSTEMONE TECHNOLOGIES INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31
-------------------------------
2002 2001
----------- -----------
Cash flows from operating activities:
Net income (loss) $ 971,661 $(2,142,003)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 509,834 555,303
Amortization of debt issue costs 354,816 299,523
Loss on sale of fixed assets 889 26,560
Interest accrued on convertible debt and amortization of note discounts 2,114,654 3,833,672
(Recoveries) provision for doubtful accounts (30,379) (115,304)
Changes in operating assets and liabilities:
Receivables (1,109,755) (1,771,250)
Inventories (202,239) 824,492
Prepaid and other assets (75,339) (184,552)
Accounts payable and accrued expenses (943,919) (903,891)
Restructuring and other charges -- (213,266)
Warranty accrual (397,117) (901,450)
Deferred revenue (9,550) (72,550)
----------- -----------
Net cash provided by (used in) operating activities 1,183,556 (764,716)
----------- -----------
Cash flows (used in) provided by investing activities:
Purchase of equipment (61,348) (28,110)
Proceeds from sale of equipment -- 98,503
----------- -----------
Net cash (used in) provided by investing activities (61,348) 70,393
----------- -----------
Cash flows (used in) provided by financing activities:
Payments made for financing costs (303,919) --
(Repayments) proceeds from long-term debt (80,000) 550,000
Repayments of capital lease obligations (291,975) (284,709)
----------- -----------
Net cash (used in) provided by financing activities (675,894) 265,291
----------- -----------
Net increase (decrease) in cash and equivalents 446,314 (429,032)
Cash and equivalents at beginning of year 58,752 487,784
----------- -----------
Cash and equivalents at end of year $ 505,066 $ 58,752
=========== ===========
Supplemental disclosures:
Cash paid for:
Interest $ 690,837 $ 679,887
Taxes $ -- $ --
Non-cash financing and investing activities:
Acquisition of leased equipment through a capital lease $ 5,858 $ --
Beneficial conversion feature on Series D Preferred Stock $ -- $ 814,356
Value of common stock purchase warrants issued in connection with the
Debt restructuring $ 692,152 $ --
In-kind dividends and accretion on redeemable preferred stock $ 2,294,366 $ 2,052,967
See accompanying notes to financial statements.
39
SYSTEMONE TECHNOLOGIES INC.
NOTES TO FINANCIAL STATEMENTS
(1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BUSINESS
SystemOne Technologies Inc. (the "Company") designs, manufactures and sells a
full line of patented, self-contained, recycling industrial parts washers, (the
"SystemOne(R) Washers"), for use in the automotive, aviation, marine and general
industrial repair markets. The Company has been awarded eleven patents for its
products, which incorporate innovative, proprietary resource recovery and waste
minimization technologies to distill contaminated solvent and yield pure solvent
and a by-product comparable to used motor oil. The SystemOne(R) Washer
integrates a distillation and recovery process which allows the solvent to be
used, treated and re-used on demand, without requiring off-site processing. The
Company, which was incorporated as Mansur Industries Inc. in November 1990,
commenced the sale of SystemOne(R) Washers in July 1996 and sold approximately
40,200 total SystemOne units through December 31, 2002.
On November 14, 2000, the Company entered into an exclusive Marketing and
Distribution Agreement, as amended (the "Exclusive Marketing Agreement") with
industry leader Safety-Kleen Systems, Inc., a wholly-owned subsidiary of
Safety-Kleen Corp. (collectively, "Safety-Kleen") representing a major strategic
shift in direction and focus for the Company. Currently, 100% of the Company's
sales of SystemOne(R) Washers are to Safety-Kleen.
Under the Exclusive Marketing Agreement, Safety-Kleen was appointed the
exclusive distributor of certain SystemOne(R) parts washer equipment in the
United States, Canada, Mexico and Puerto Rico (the "Territory"). Safety-Kleen
commenced marketing the Company's products throughout Safety-Kleen's 173
branches across North America in January 2001. The Company has retained the
right to distribute its equipment outside of the Territory as well as the right,
subject to a right of first offer for Safety-Kleen in certain circumstances, to
market newly developed industrial and commercial parts washers through its
distribution channels.
(b) BASIS OF PRESENTATION
Certain amounts in the 2001 financial statements have been reclassified to
conform to the 2002 presentation.
(c) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, demand deposits, and short-term
investments with original maturities of three months or less.
40
(d) ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are customer obligations due under normal trade terms. The
Company performs continuing evaluations of its customer's financial condition
and ability to pay. The Company reserves amounts deemed to be uncollectible in
its allowance for doubtful accounts.
(e) INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method.
(f) PROPERTY, EQUIPMENT AND DEPRECIATION
Property and equipment are stated at cost. Equipment under capital leases is
stated at the present value of minimum lease payments at inception.
Depreciation is calculated using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful life of the asset
or the term of the lease.
(g) REVENUE RECOGNITION
The Company recognizes revenue at the time of shipment (F.O.B. shipping dock)
for the entire sales price. Under the Exclusive Marketing Agreement, the
majority of the sales price payable for each unit purchased by Safety-Kleen is
payable on net 30 day terms from date of shipment with a portion of the sales
price payable in equal installments over a 12 quarter period. The Company
applies a discount to reflect the present value of the 12 quarterly payments
utilizing a discount rate which is currently estimated to be 14%. In addition,
the Company recognizes interest income over the extended payment period as the
deferred portion of the purchase price is amortized over the scheduled payment
period.
Deferred revenue on the balance sheet relates to extended two-year warranty
contracts purchased by customers and is recognized in income on the
straight-line basis over the terms of each contract.
(h) OTHER ASSETS
Debt issue costs associated with the Company's 8.25% Subordinated Convertible
Notes due 2005, 10% Promissory Notes due 2005, and Revolving Credit Loan are
being amortized using the effective interest method over the term of the debt.
During 2002 the Company incurred approximately $304,000 in financing costs in
connection with the debt restructuring. Amortization included in interest
expense for the years ended December 31, 2002 and 2001 was $354,816 and
$299,523, respectively. The balance of unamortized debt issue costs at December
31, 2002 and 2001 was, $316,531 net of accumulated amortization of $112,389 and
$367,427, net of accumulated amortization of $1,151,897, respectively.
41
(i) PRODUCT WARRANTY
The Company generally warrants that its products will be free of material
defects during the three-year warranty period. Safety-Kleen assumed all service,
maintenance and repair responsibilities for the Company's installed base of
SystemOne(R) parts washers including units sold before the Exclusive Marketing
Agreement and units sold pursuant to the Exclusive Marketing Agreement. The
Company is responsible for the cost of all parts required for service during the
warranty period for all units sold. For units sold before the Exclusive
Marketing Agreement, the Company agreed to pay Safety-Kleen a total fee of
$500,000 for all warranty service to be performed by Safety-Kleen on these
units. For units sold pursuant to the Exclusive Marketing Agreement,
Safety-Kleen is responsible for the cost of all service, maintenance and repair
during the warranty period. The Company accrues estimated standard warranty cost
as the parts washers are sold to customers which includes the estimated cost of
parts and the call center. Estimated cost of parts is based on actual parts used
during the previous 6 months and the estimated cost of the call center includes
estimated costs to be incurred during the remaining warranty period.
Warranty accrual activity during the years ended December 31, is as follows:
2002 2001
----------- -----------
Beginning balance $ 1,071,607 $ 1,973,057
Warranty provision 346,406 331,749
Warranty payments (743,523) (1,233,199)
----------- -----------
Ending balance $ 674,490 $ 1,071,607
=========== ===========
The decrease in warranty payments, as shown above, is due to warranty costs
accrued as of January 1, 2001 relating to transitioning service over to
Safety-Kleen pursuant to the Exclusive Marketing Agreement.
(j) FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's long-term debt and redeemable convertible
preferred stock has been estimated by discounting the future cash flows at rates
currently offered to the Company for similar securities of comparable
maturities. The fair values of all other financial instruments are believed to
approximate their carrying amounts.
(k) REDEEMABLE CONVERTIBLE PREFERRED STOCK
The shares of each series of redeemable convertible preferred stock were issued
at discounts from their mandatory redemption values. The carrying amounts of the
preferred stocks are accreted to their redemption values using the straight-line
method, from the date of issuance of each series to the date of mandatory
redemption.
42
(l) RESEARCH AND DEVELOPMENT
Research and development expenses, incurred in connection with engineering
activities related to the development of the European model of the general
parts washer, the spray gun washer and the industrial parts washer, are
expensed as incurred.
(m) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry-forwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. Realization of deferred tax assets
associated with federal and state net operating loss carry-forwards ("NOLs")
is dependent upon generating sufficient taxable income prior to their
expiration. The Company believes that there is a risk that these NOLs may
expire unused and accordingly, has established a valuation reserve against
them in full.
(n) STOCK BASED COMPENSATION
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No.
123." This Statement amends methods of transition for a voluntary change to
the fair value method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of Statement
No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required
for fiscal years ending after December 15, 2002 and are included in the
Notes to Financial Statements.
The Company accounts for stock options issued using the intrinsic value
method and, accordingly, no compensation cost have been recognized for stock
options granted as such options granted had an exercise price greater than
or equal to the market value of the underlying common stock on the date of
the grant. If the Company determined compensation cost based on the fair
value of the options at the grant date, the Company's net loss to common
shares and basic and diluted net loss per common share would have reflected
the pro forma amounts shown below:
2002 2001
----------- -----------
Net loss attributable to common shares, as $(1,322,705) $(4,194,970)
reported
Add: Stock-based employee compensation expense
included in reported net income , net of
related tax effects -- --
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (242,775) (399,625)
----------- -----------
Pro forma net loss $(1,565,480) $(4,594,595)
----------- -----------
Basic loss per common share - as reported $ (.28) $ (.88)
Basic loss per common share - pro forma $ (.33) $ (.97)
43
(o) BASIC AND DILUTED NET LOSS PER SHARE
For the years ended December 31, 2002 and 2001, basic and diluted net loss per
share is computed based on the net loss divided by the weighted-average number
of common shares outstanding of 4,742,923. Diluted loss per share has not been
presented separately, because the effect of the additional shares issuable for
convertible debt, convertible preferred stock, outstanding common stock options
and warrants are anti-dilutive for each year. Common shares issuable in
connection with convertible debt, convertible preferred stock and common stock
options and warrants total 10,240,619 and 8,731,322 shares, respectively, at
December 31, 2002 and 2001.
(p) USE OF ESTIMATES
Management of the Company uses estimates and assumptions relating to the
reporting of assets and liabilities and the disclosure of contingent assets and
liabilities to prepare these financial statements in conformity with generally
accepted accounting principles. Actual results could differ from those
estimates.
(q) RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") 144, "Accounting for
Impairment or Disposal of Long-Lived Assets." The provisions of this Statement
generally are to be applied prospectively. The adoption of SFAS No. 144 on
January 1, 2002 did not materially impact the Company's financial position or
results of operations.
During April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Such standard requires any gain or loss on extinguishments of debt
to be presented as a component of continuing operations (unless specific
criteria are met) whereas SFAS No. 4 required that such gains and losses be
classified as an extraordinary item in determining net income. The adoption of
SFAS No. 145 did not materially impact the Company's financial position or
results of operations.
During June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Under SFAS No. 146, a liability related to
an exit or disposal activity (including restructurings) is not recognized until
44
such liability has actually been incurred whereas under EITF Issue No. 94-3 a
liability was recognized at the time of a commitment to an exit or disposal
plan. The provisions of this standard are effective for disposal activities
initiated after December 31, 2002.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure. This statement provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this Statement
also amends the disclosure requirements of SFAS No. 123 to require more
prominent and frequent disclosures in the financials statements about the
effects of stock-based compensation. The transitional guidance and annual
disclosure provisions of this Statement is effective for the December 31, 2002
financial statements. The interim reporting disclosures requirements will be
effective for the Company's March 31, 2003 10-QSB. Because the Company continues
to account for employee stock-based compensation under APB opinion No. 25, the
transitional guidance of SFAS No. 148 has no effect on the financial statements
at this time. However, in the December 31, 2002 financial statements we have
incorporated the enhanced disclosure requirements of SFAS No. 148.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annul financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002 and are not
expected to have a material effect on the Company's financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (" FIN 46"),
"Consolidation of Variable Interest Entities." FIN 46 clarifies the application
of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities ("VIE's") created after January 31, 2003, and to VIE's in which an
enterprise obtains an interest after that date. It applies in the first fiscal
year or interim period beginning after June 15, 2003, to VIE's in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
FIN 46 applies to public enterprises as of the beginning of the applicable
interim or annual period. The adoption of FIN 46 is not expected to have a
material impact on the Company's consolidated financial position, liquidity, or
results of operations.
(2) LIQUIDITY
As indicated in the accompanying financial statements, the Company's accumulated
deficit totaled $62,773,311 and $61,450,606 at December 31, 2002 and 2001,
respectively. Through November 2000, such deficits primarily resulted from
45
expenses incurred to establish a national direct marketing, distribution and
support organization. As described in note 1(a) above, in November 2000, the
Company entered into the Exclusive Marketing Agreement with Safety-Kleen.
Safety-Kleen is currently operating under Chapter 11 of the US Bankruptcy code.
The Exclusive Marketing Agreement (a) makes Safety-Kleen the exclusive marketer,
distributor and service provider for certain models of the Company's parts
washing equipment in the United States, Puerto Rico, Canada and Mexico (the
"Territory"), and (b) obligates Safety-Kleen to purchase minimum quantities of
the Company's parts washing equipment for each contract year through December
26, 2005. The initial term of the Exclusive Marketing Agreement is five years
ending December 26, 2005 and the Exclusive Marketing Agreement may be extended
for two additional five-year terms subject to the parties reaching an agreement
in writing as to Safety-Kleen's minimum purchase commitments for each contract
year during any renewal term. Safety-Kleen had until July 29, 2002 to exercise
its one-time right to terminate the Exclusive Marketing Agreement effective
January 26, 2003. Safety-Kleen did not exercise this termination right and, as a
result, the initial term of the Exclusive Marketing Agreement is not terminable
except for cause or mutual agreement. The Company retains the rights to sell,
lease, rent and service all of the Company's parts washing equipment outside the
Territory and other product lines within the Territory, subject to Safety-Kleen
right of first offer.
The minimum annual sales under the Exclusive Marketing Agreement escalate from
10,000 equivalent units during each of the first two contract years to 12,500
equivalent units in year three (beginning December 26, 2002), 15,000 equivalent
units in year four (beginning December 26, 2003) and 18,000 equivalent units in
year five (beginning December 26, 2004), at specified prices, including deferred
payments on each unit sold, payable in equal installments.
As a result of restructuring the Company's operations in the fourth quarter of
2000 related to implementing the Exclusive Marketing Agreement with
Safety-Kleen, the Company has reduced expenses and has achieved operating
profitability for the two years ending December 31, 2002. Although the Company
believes that it will continue to be able to meet its operating cash
requirements, assuming Safety-Kleen's continued performance, as described in
notes 7 and 8 below, if none of the outstanding convertible debt and convertible
preferred stock is converted to common stock, significant amounts of cash would
be required, commencing in 2005 to repay long term debt, accrued interest and
the redeemable preferred stock as follows:
DEBT PLUS INTEREST PREFERRED STOCK TOTAL
------------------- ---------------------- -------------------
2003 $ 147,624 $ -- $ 147,624
2004 826 826
2005 35,554,663 35,554,663
2006 -- 23,618,000 * 23,618,000
------------------- ---------------------- -------------------
Total $ 35,703,113 $ 23,618,000 $ 59,321,113
=================== ====================== ===================
-------------
* Assuming no pre-payment of Subordinated Convertible Notes.
46
(3) TRADE RECEIVABLES
Trade receivables consisted of the following at December 31:
2002 2001
----------- -----------
Receivables $ 4,717,641 $ 3,607,886
Less non-current portion of receivables, net of
discount (2,008,818) (1,362,059)
----------- -----------
2,708,823 2,245,827
Less allowance for doubtful accounts (123,287) (153,666)
----------- -----------
$ 2,585,536 $ 2,092,161
=========== ===========
Non-current portion of receivables matures as follows:
2002 2001
----------- -----------
2002 $ -- $ 2,092,161
2003 2,585,536 844,495
2004 1,533,010 674,783
2005 700,582 56,783
2006 36,229 --
----------- -----------
4,855,357 3,668,222
Less discount for imputed interest (261,003) (214,002)
Less current portion (2,585,536) (2,092,161)
----------- -----------
Non-current portion of receivable, net $ 2,008,818 $ 1,362,059
=========== ===========
At December 31, 2002 and 2001, substantially all receivables were with one
customer, Safety-Kleen.
(4) INVENTORIES
Inventories consisted of the following at December 31:
2002 2001
----------- -----------
Raw materials $ 1,048,004 $ 1,019,871
Work in process and finished goods 359,057 187,023
----------- -----------
1,407,061 1,206,894
Less allowance for obsolete inventories (156,259) (158,331)
----------- -----------
$ 1,250,802 $ 1,048,563
=========== ===========
47
(5) PROPERTY AND EQUIPMENT, NET
Property and equipment, net consisted of the following at December 31:
ESTIMATED
USEFUL
2002 2001 LIVES
---------------- --------------- ----------
Furniture and equipment $ 472,276 $ 494,953 5 years
Machinery and equipment 2,728,848 2,670,803 5-10 years
Leasehold improvements 296,921 294,077 3-5 years
---------------- ---------------
3,498,045 3,459,833
Less accumulated depreciation and
amortization (2,365,040) (1,883,311)
---------------- ---------------
$ 1,133,005 $ 1,576,522
================ ===============
Property and equipment under capital leases consisted of the following at
December 31:
2002 2001
----------- -----------
Machinery and equipment $ 794,083 $ 1,344,890
Less accumulated amortization (364,034) (471,238)
----------- -----------
$ 430,049 $ 873,652
=========== ===========
Depreciation expense for the years ended December 31, 2002 and 2001 was $509,834
and $555,303, respectively.
(6) LEASE AGREEMENTS
The Company has a lease obligation for its corporate headquarters that expires
on October 3, 2005. This lease provides two renewal terms of three years each
exercisable at the Company's option upon six months prior written notice. The
Company's annual lease payments under the lease are approximately $441,000
subject to an annual increase of 3 percent, which does not include utilities and
the Company's proportionate share of the facilities maintenance and operating
expenses. Rent expense is being straight lined over the entire lease term.
Total rent expense was $497,439 and $591,169 for the years ended December 31,
2002 and 2001, respectively.
The Company is obligated under capital leases for certain machinery and
equipment that expire at various dates during the next two years.
Future minimum lease payments under non-cancelable operating leases and future
minimum capital lease payments as of December 31, 2002 are as follows:
CAPITAL OPERATING
Year ended December 31: LEASES LEASES
----------- -----------
2003 $ 147,624 $ 494,673
2004 826 487,018
2005 366,625
---------- ----------
Total minimum lease payments 148,450 $1,348,316
========== ==========
48
Less amount representing interest (at rates ranging from 8.15%
to 11.86%) (5,264)
---------
Present value of net minimum capital lease payments $ 143,186
=========
(7) LONG TERM DEBT
Long-term debt and obligations under capital leases consists of the following at
December 31:
2002 2001
------------ ------------
Subordinated Convertible Notes due December 31, 2005 (New Junior
Notes), with interest at 8.25%, including accrued interest $ 22,218,505 $ --
Subordinated Convertible Notes, (Old Junior Notes) with interest
at 8.25%, due February 23, 2003, including accrued interest -- 20,728,874
Revolving credit loan, with interest at 14%, due May 30, 2005 4,670,000 4,750,000
Subordinated Promissory Notes (Secured Notes), with interest at
10% due December 31, 2005, including accrued interest 4,445,374 --
Subordinated Promissory Notes (Old Secured Notes), with interest
at rates ranging from 12% to 16% (16% at December 31, 2001), due
November 30, 2002, including accrued interest -- 3,978,678
Capital leases (note 6) 143,186 429,303
------------ ------------
31,477,065 29,886,855
Less: unamortized discount (500,407) (139,619)
------------ ------------
30,976,658 29,747,236
Current portion (142,112) (4,128,997)
------------ ------------
Long-term portion $ 30,834,546 $ 25,618,239
============ ============
On December 9, 2002, the Company exchanged (i) all of its then outstanding 8.25%
Subordinated Convertible Notes due February 23, 2003 (the "Old Junior Notes")
for (a) 8.25% Subordinated Convertible Notes due December 31, 2005 in an
aggregate principal amount equal to 50% of the sum of the aggregate principal
amount of the Old Junior Notes plus all interest accrued thereon, bearing
interest which when due may be added at the Company's option to the principal
amount of such notes through December 31, 2002 and thereafter shall be paid in
cash ("Partial Cash Pay Notes"), (b) 8.25% Subordinated Convertible Notes due
December 31, 2005 in an aggregate principal amount equal to 50% of the sum of
the aggregate principal amount of the Old Junior Notes plus all interest accrued
thereon, bearing interest which when due may be added to the principal amount
for the life of such notes ("PIK Pay Notes and together with the Partial Cash
Pay Notes, the "Subordinated Convertible Notes"), and (c) Warrants (the "New
Warrants") for the purchase of an aggregate of 750,000 shares of Common Stock at
an exercise price of $.01 per share expiring on December 31, 2005; and (ii) all
of its then outstanding 16% Promissory Notes due November 30, 2002 (the "Old
Secured Notes") for 10% Promissory Notes (the "Secured Notes" and collectively
49
with the Subordinated Convertible Notes and the New Warrants, the "Current
Securities") due December 31, 2005 in an aggregate principal amount equal to
100% of the sum of the aggregate principal amount of all Old Secured Notes plus
all interest accrued thereon, with interest which when due will be added to the
principal amount for the life of such notes. The estimated fair market value of
the New Warrants at December 9, 2002 was $519,114 and was charged to unamortized
note discount and credited to additional paid-in capital. The discount will be
amortized to interest expense over the term of the Current Securities.
The issuance of the 750,000 warrants to the holders of the Subordinated
Convertible Notes, described above, would have triggered certain anti-dilution
rights pursuant to the Company's outstanding (i) shares of Series D Preferred
Stock, $1.00 per share, (ii) warrants issued May 2, 2000 exercisable for an
aggregate of 571,428 shares of Common Stock, and (iii) warrants issued August 7,
2000 exercisable for an aggregate of 942,858 shares of Common Stock
(collectively, the "Outstanding Warrants"). The holders of the Series D
Preferred Stock and Outstanding Warrants waived their anti-dilution rights in
exchange for warrants for the purchase of an aggregate of 250,000 shares of
Common Stock at an exercise price of $.01 per share expiring on December 31,
2005. The estimated fair market value of these warrants at December 9, 2002 was
$173,038 and was recorded as a dividend and credited to additional paid-in
capital.
The Subordinated Convertible Notes are convertible by the holders thereof into
shares of the Company's common stock at a conversion price of $17.00 per share.
The Subordinated Convertible Notes may be redeemed by the Company at a
redemption price of 102% of the principal amount plus any accrued but unpaid
interest. As of December 31, 2002, none of the Company's Subordinated
Convertible Notes has been redeemed.
The Revolving Credit Loan Agreement (the "Senior Revolver") from Hansa Finance
Limited Liability Company ("Hansa") provides the Company with a $5 million
revolving line of credit. In connection with the Senior Revolver, the Company
granted the lender a security interest in substantially all of the Company's
assets, including its intellectual property. Pursuant to the Senior Revolver,
the Company may borrow twice a month up to the Advance Limit. The Advance Limit
is the lesser of $5,000,000 or the sum of the Advance Supplement plus an amount
based on the Company's receivables and inventory. The Advance Supplement was
$3,000,000 through March 31, 2001 and $2,500,000 for the period April 1, 2001
until maturity. As of December 31, 2002, there was approximately $330,000
available on the Senior Revolver. The President of Hansa Finance Limited
Liability Company, Mr. Paul A. Biddelman, is a director of the Company. The
Company and Hansa entered into an agreement on February 15, 2003 to extend the
maturity of the Senior Revolver from May 30, 2003 to May 30, 2005. Interest is
due and payable monthly.
Interest is due and payable on maturity of the Secured Notes. In connection with
the Secured Notes, the Company granted the lenders a security interest in
substantially all of the Company's assets other than its intellectual property.
The security interest is subordinated to the Senior Revolver. Mr. Kenneth
Ch'uan-K'ai Leung, Chief Investment Officer of the Environmental Opportunities
Fund II, L.P. and the Environmental Opportunities Fund II (Institutional), L.P.,
and Mr. Paul A. Biddelman, the President of Hanseatic Americas LDC, which
entities are the holders of 100% of the Secured Notes, are directors of the
Company.
50
In connection with the issuance of the Old Secured Notes, the Company issued the
lenders warrants expiring in August 2005, to purchase an aggregate of up to
942,858 shares of the Company's common stock at an exercise price of $3.50 per
share. The fair value of the warrants, based on the Black-Scholes option-pricing
model, of $2,513,442 was charged to unamortized note discount and credited to
additional paid-in capital. The discount was amortized to interest expense over
the term of the Old Secured Notes and is fully amortized at December 31, 2002.
The Company is required to issue an additional 942,858 warrants to the holders
of its Secured Notes if the Company (i) sells debt or equity securities, or debt
securities convertible into equity securities, or incurs debt with a final
scheduled maturity date more than twelve months after issuance or incurrence
providing gross cash proceeds to the Company in an amount equal to or greater
than the outstanding principal amount of the Secured Notes or (ii) enters into a
merger, consolidation, sale of all or substantially all of its assets or other
business combination transaction with a party that prior to such transaction
owns less than 25 percent of the voting power of the Company's outstanding
equity securities. The fair market value of the warrants would be charged to
operations should the warrants become issuable.
The Senior Revolver and the Secured Notes may be prepaid without penalty. Any
cash proceeds from any new financing or the issuance of stock must be used for
the payment of interest and principal on the Senior Revolver and the Secured
Notes.
Long-term debt matures as follows:
2003 $ 142,112
2004 1,074
2005 31,333,879
-----------------
$ 31,477,065
=================
Assuming the Company (a) continues to defer cash payments of interest on the New
Junior PIK Pay Notes, (b) pays interest currently on the New Junior Partial Cash
Pay Notes (c) accrues interest on the Subordinated Promissory Notes and (d) pays
interest currently on the Senior Revolver, the aggregate amounts payable on the
scheduled maturities would be as follows:
2003 $ 147,624
2004 826
2005 35,554,663
-----------------
$ 35,703,113
=================
The carrying amount of debt, excluding capital leases, was approximately $30.8
million and $29.3 million at December 31, 2002 and 2001, respectively.
Management estimates the fair value of the debt to be $27.4 million and $28.0
million at December 31, 2002 and 2001, respectively.
51
(8) REDEEMABLE CONVERTIBLE PREFERRED STOCK
Shares of redeemable convertible preferred stock (the "Preferred Stock"), stated
at redemption values of $100 per share net of unamortized discount, are
outstanding at December 31 as follows:
2002 2001
------------ ------------
8.25% Series B. Authorized 150,000 shares, issued and
outstanding 67,697 shares (62,439 in 2001) $ 6,769,700 $ 6,243,900
8.00% Series C. Authorized 150,000 shares, issued and
outstanding 89,770 shares (82,997 in 2001) 8,977,000 8,299,700
8.25% Series D. Authorized 150,000 shares, issued and
outstanding 24,803 shares (22,876 in 2001) 2,480,300 2,287,600
------------ ------------
18,227,000 16,831,200
Less unamortized discounts (1,008,344) (1,733,871)
------------ ------------
$ 17,218,656 $ 15,097,329
============ ============
Each series of the Preferred Stock has a Liquidation Value of $100 per share.
The dividend rate payable on all outstanding shares is applied to the
Liquidation Value of each share per annum. Through the second anniversary, as
defined, of the issuance of each series of the Preferred Stock, all dividends
are payable by the issuance of additional shares of the applicable Preferred
Stock valued at the Liquidation Value. Thereafter, all dividends may, at the
option of the Company, be paid either through the issuance of additional shares
of the applicable Preferred Stock, cash or any combination of such Preferred
Stock or cash.
At any time prior to redemption, each holder of Preferred Stock may convert all
or part of such Holder's shares of Preferred Stock into shares of the Company's
common stock at the following conversion prices (in each case subject to
adjustment in certain circumstances):
$4.68 per share for the Series B Preferred Stock
$3.50 per share for the Series C Preferred Stock
$3.50 per share for the Series D Preferred Stock
Until the Mandatory Redemption Date (as defined below), the Company has the
right to redeem any outstanding shares of each series of Preferred Stock at a
redemption price of 102% of the Liquidation Value of the redeemed shares.
The holders of the Preferred Stock are entitled to vote together with the
holders of the Company's Common Stock as a single class on all matters to come
before a vote of the shareholders of the Company. Each share of Preferred Stock
is entitled to the number of votes equal to the number of shares of Common Stock
into which it is then convertible. As amended, the holders have demand
registration rights in certain circumstances.
Pursuant to a Letter Agreement dated December 9, 2002, the holders of all of the
Company's outstanding shares of Preferred Stock agreed to amend the date upon
which the Company is required to redeem the Preferred Stock to the earlier of
(i) the ninetieth day after the date that all of the Subordinated Convertible
Notes shall have been repaid in full, and (ii) March 31, 2006 (such earlier
date, the "Mandatory Redemption Date"), but in no event shall the Mandatory
52
Redemption Date be deemed to occur prior to May 17, 2004. On the Mandatory
Redemption Date, the Company is required to redeem each series of Preferred
Stock outstanding at a redemption price per share equal to the Liquidation Value
plus accrued and unpaid dividends. Assuming the Company continues to issue
dividends on each series of Preferred Stock by issuing additional shares of
Preferred Stock, the aggregate amount redeemable on March 31, 2006 would be
$23,618,000. If on the Mandatory Redemption Date, the Company does not have
sufficient funds to redeem all shares, any available funds will be used to
redeem shares of Preferred Stock on a proportionate basis. If all outstanding
shares of Preferred Stock are not redeemed, the then current conversion price
with respect to any shares not redeemed will be reduced (but not increased) to
the greater of (a) 50% of the then current conversion price, and (b) the closing
price of the Company's common stock as reported by Nasdaq (or such other
principal national exchange on which the common stock is then listed) on the
Mandatory Redemption Date.
The purchasers of the Series D Preferred Stock received warrants on May 2, 2000
which expire in April 2005, to acquire an aggregate of 571,428 shares of the
Company's common stock at an exercise price of $3.50 per share. The fair value
of the warrants, based on the Black-Scholes option-pricing model, of $1,185,644
was charged to unamortized discount and credited to additional paid-in capital.
The discount is being accreted to dividends on the Preferred Stock over the
period to May 2004 which was the original Mandatory Redemption Date prior to the
extension.
In addition, the Series D Preferred Stock warrants created a beneficial
conversion feature in the Series D Preferred Stock which has a value of
$814,356. The value assigned to the beneficial conversion feature is the product
of the value of the common stock at the commitment date and the additional
shares into which the security is convertible and was charged to unamortized
discount and credited to additional paid-in capital. The discount is being
accreted to dividends on the Preferred Stock over the period to May 2004 which
was the original Mandatory Redemption Date prior to the extension.
The issuance of the 750,000 warrants to the holders of Subordinated Convertible
Notes, described in footnote 7, would have triggered certain anti-dilution
rights pursuant to the Company's outstanding (i) shares of Series D Preferred
Stock, $1.00 per share, (ii) warrants issued May 2, 2000 exercisable for an
aggregate of 571,428 shares of Common Stock, and (iii) warrants issued August 7,
2000 exercisable for an aggregate of 942,858 shares of Common Stock
(collectively, the "Outstanding Warrants"). The holders of the Series D
Preferred Stock and Outstanding Warrants waived their anti-dilution rights in
exchange for warrants for the purchase of 250,000 shares of Common Stock at an
exercise price of $.01 per share expiring on December 31, 2005. The fair market
value of these warrants at December 9, 2002 was $173,038 and was recorded as a
dividend and credited to additional paid-in capital.
The carrying amount of the Preferred Stock was approximately $17.2 million and
$15.1 million at December 31, 2002 and 2001, respectively. Management estimates
the fair value of the Company's Preferred Stock to be $15.9 million and $13.1
million at December 31, 2002 and 2001, respectively.
53
On February 27, 2002, the Company and the Lenders entered into a Letter
Agreement, suspending the Company's registration obligations under the Purchase
Agreements for shares of common stock issuable upon conversion of the Series B,
C and D Preferred Stock ("Registrable Shares"). Instead, the Company must
register the Registrable Shares upon notice from holders thereof that they have
a bona fide intent to sell Registrable Shares with a market value of at least
$1,000,000.
(9) STOCKHOLDERS' DEFICIT
In connection with its initial public offering in October 1996, the Company
agreed to sell to the underwriters, for nominal consideration, warrants to
purchase from the Company 100,000 shares of common stock at a price of $9.00 per
share. The warrants were exercisable for a period of four years which ended
September 27, 2001.
In connection with the Exclusive Marketing Agreement with Safety-Kleen, the
Company issued to Safety-Kleen a five-year warrant to purchase up to 1,134,615
shares of the Company's common stock at $3.50 per share. The fair value of the
warrant, based on the Black-Scholes option pricing model, of $2,072,146 was
charged to restructuring and other expense and credited to additional
paid-in-capital in the fourth quarter of 2000.
At December 31, 2002, an aggregate of 9,706,903 shares of common stock could
potentially be issued pursuant to provisions of warrants, convertible preferred
stock and convertible debt at amounts per share ranging from $3.50 to $17.00. At
December 31, 2001, an aggregate of 8,227,356 shares of common stock could
potentially be issued pursuant to provisions of warrants, convertible preferred
stock and convertible debt at amounts per share ranging from $3.50 to $17.00.
At December 31, 2002 the Company had 4,742,923 Common Stock purchase rights (the
"Rights") outstanding which expire on September 30, 2008. The Rights contain
provisions to protect shareholders in the event of an unsolicited attempt to
acquire the Company that is not believed by the board of directors to be in the
best interest of shareholders. The Rights are evidenced by the certificates for
common stock, are subject to anti-dilution provisions and are not exercisable,
transferable or exchangeable apart from the Common Stock until 10 days after an
Acquiring Person, as defined, acquires beneficial ownership of 15% or more, or,
in the case of an Adverse Person, as defined, 10% or more of the Company's
Common Stock. The Rights entitle the holder, except such an Acquiring Person or
Adverse Person to buy that number of shares of Common Stock of the Company which
at the time of such acquisition would have a market value of two times the
exercise price of the Right. The Rights have no voting rights and are
redeemable, at the option of the Company, at a price of $0.001 per Right prior
to the acquisition by an Acquiring Person of 15% or more of the Company's Common
Stock.
(10) STOCK-BASED COMPENSATION
The Company has an executive incentive compensation plan (the "Plan") pursuant
to which the Company's board of directors may grant stock options to officers
54
and key employees. Pursuant to an amendment approved by the Company's
shareholders during 2000, stock options to purchase up to 750,000 shares of
common stock may be granted under the Plan. Stock options are granted with an
exercise price equal to the stock's fair market value at the date of grant
subject to a minimum exercise price of $2.50 per share. All stock options have a
seven-year term and vest and become exercisable over a three-year period from
the date of grant.
At December 31, 2002, there were 216,284 additional shares available for grant
under the Plan. Per share weighted-average fair value on the date of grant of
stock options granted during 2002 and 2001 was $1.17 and $1.72, respectively,
using the Black-Scholes option-pricing model with the following assumptions:
2002-expected dividend yield of zero percent, risk-free interest rate of 4.78
percent, expected life of seven years and a volatility of 86.6 percent;
2001-expected dividend yield of zero percent, risk-free interest of 5.48
percent, expected life of seven years and a volatility rate of 127.6 percent.
Stock-option activity during the periods indicated was as follows
WEIGHTED
AVERAGE
NUMBER OF SHARES EXERCISE PRICE
-------------------- --------------
Balance at December 31, 2000 391,924 $10.01
Granted 168,574 3.50
Exercised -- --
Forfeited (56,532) 6.58
Expired -- --
-----------
Balance at December 31, 2001 503,966 8.22
Granted 108,500 2.50
Exercised
Forfeited (11,000) 2.77
Expired (67,750) 3.50
-----------
Balance at December 31, 2002 533,716 7.77
===========
Stock options consisted of the following at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ ----------------------------
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
AVERAGE REMAINING AVERAGE
RANGE OF EXERCISE ESTIMATED EXERCISE
EXERCISE PRICE NUMBER PRICE LIFE NUMBER PRICE
--------------------------------------------------------------------------- -----------------------------
$2.50 to $8.8125 385,006 4.64 4.6 166,547 6.29
$13.125 to $19.50 148,710 15.87 1.7 148,710 15.87
55
At December 31, 2002 and 2001, the number of options exercisable was 315,257 and
243,005, respectively, and the weighted-average exercise prices of those options
were $10.81 and $12.24, respectively.
(11) RESTRUCTURING AND OTHER CHARGES
As described in note 1(a), the Company initiated a significant restructuring
program in connection with the Exclusive Marketing Agreement. The restructuring
was completed in 2001. A summary of restructuring and other non-recurring
charges (reductions) is as follows:
2002 2001
--------- ---------
Reversal of restructuring accrual $ (75,000) --
Reversal of additional warranty costs for outsourcing services to
Safety-Kleen -- $(194,458)
Employee severance and facility closing
-- 98,425
--------- ---------
$ (75,000) $ (96,033)
========= =========
The restructuring accrual at December 31, 2001 and 2002 was $75,000 and $0
respectively.
(12) INCOME TAXES
There is no current or deferred tax expense for the years ended December 31,
2002 and 2001.
The actual income tax expense differs from the expected income tax effect
(computed by applying the U.S. federal corporate tax rate of 34 percent to loss
before income taxes) for the years ended December 31, 2002 and 2001 as follows:
2002 2001
----------- -----------
Computed "expected" income tax expense (benefit) $ 330,366 $ (728,281)
State income tax benefit, net of U.S. federal income tax
benefit 35,448 (77,628)
Change in valuation allowance 211,236 (137,685)
Other (577,050) 943,594
----------- -----------
Income tax expense $ -- $ --
----------- -----------
During the year ended December 31, 2002, the Company utilized net operating loss
carry-forwards of approximately $628,000 to reduce its federal and state taxes.
56
Temporary differences between financial statement carrying amounts and tax basis
of assets and liabilities that give rise to significant portions of the deferred
tax assets and liabilities as of December 31, 2002 and 2001 are as follows:
2002 2001
------------ ------------
Deferred tax assets:
Net operating loss $ 21,681,222 $ 21,169,216
Deferred revenue 40,194 43,788
Warranty 234,996 403,246
Research and development 204,166 325,427
Inventory reserve 58,801 59,580
Inventory 3,306 158,954
Debt issue costs 14,898 15,992
Bad debt reserve 46,393 57,825
Accrued expenses 238,294 178,675
Patent 43,955 344,872
------------ ------------
Total gross deferred tax assets 22,566,225 22,757,575
Less valuation allowance (22,464,056) (22,252,820)
------------ ------------
Net deferred tax asset 102,169 504,755
------------ ------------
Deferred tax liabilities:
Depreciation 102,169 278,631
Original issue discount -- 226,124
------------ ------------
Total gross deferred tax liabilities 102,169 504,755
------------ ------------
Deferred tax assets, net $ -- $ --
------------ ------------
At December 31, 2002, the Company had net operating loss carry-forwards of
$57,616,855, which expire beginning in the year 2012 through 2021.
Realization of the benefits related to the net operating loss carryforwards may
be limited in any one year due to IRS Code Section 382, change of ownership.
57
EXHIBITS
EXHIBIT DESCRIPTION
------- -----------
23.2 Consent of BDO Seidman, LLP
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
58