ITEM 1. BUSINESS:
General:
The Company is engaged in the business of providing specialized industrial cleaning and other services to divisions and facilities of Fortune 500 companies and other substantial businesses engaged in heavy industry. Such services generally involve the removal of industrial grime, deposits, wastes, encrustations or coatings from equipment and facilities. The Company's principal customers are in the chemical, plastics, power generation, petroleum refining and primary metals businesses. The Company's industrial cleaning methods include, in addition to the use of waterblasting, vacuuming, and other more conventional procedures, the application of ultra-high pressure ("UHP") waterjetting and cutting methods.
Industrial Cleaning Services:
Until 1984 the only technologies used by the Company in providing commercial and industrial cleaning services were vacuum (wet and dry) and conventional water blast cleaning techniques. These conventional methods of service are still provided by the Company. The market applications for the Company's conventional method services in industrial cleaning are many and varied, and include removing materials and deposits from items such as heat exchangers, boilers, condensers, building surfaces, vats, slabs and molds. The Company also provides sewer cleaning, pipe inspection and other services for its customers. See "Item 1 - Business-Company Operations". Such other services are essentially incidental to the Company's business and are not deemed material to its future operations. See Item 1 - Business-Company Operations-Revenue by Service Line".
Industrial vacuuming removes industrial waste and debris, and retrieves salvageable materials, using truck mounted equipment to vacuum up the designated waste. Most of the Company's vacuum equipment can be used in either a wet or dry medium, but the Company also uses equipment that only has a wet application. The Company uses both commercially available equipment and internally designed and fabricated equipment in the performance of industrial vacuum cleaning activities. The Company's vacuum equipment can be used to clean underground lines, pipes, storm drains and sewers, as well as to meet the demands of other cleaning applications. In performing its conventional vacuum cleaning services, the vacuumed material is either transported by the Company for disposal on-site at the customer's location, or is transferred by the Company on-site into barrels, bins or other storage vessels supplied by the customer, for disposal by the customer.
In 1984, to overcome the limitations of conventional technologies, the Company began providing UHP waterjetting services. Although pressurized water cleaning equipment for use in industrial cleaning, construction, mining and other applications is commercially available, the UHP equipment used by the Company is designed and fabricated by the Company. The Company has been able to enhance and modify its UHP equipment since its first introduction. In 1991, the Company purchased certain patents and know-how related to equipment designs, UHP waterjet guns and other technologies. See "Item 1 - Business-Proprietary Technology, Patents Trademarks and Equipment".
Benefits from the application of UHP technology include (1) the use of a very low volume of water, (2) the uniform cleaning of a material from a surface, (3) the minimization of surface damage or degradation, (4) the decrease of environmental and health/safety impacts through the reduction or absence of dust, fumes, sand, solvents or chemicals and other by-products requiring disposal, (5) the reduced volume of residue or waste product (including water)
clean-up, (6) the elimination of many safety hazards associated with conventional methods and the need for "hot work" permits (i.e., UHP waterjetting is a non-spark generating activity), and (7) the elimination of airborne contaminants, reducing preparatory activities (covering surrounding areas) and clean-up times, which yields increased productivity.
With the addition of an abrasive material into the water stream, the Company's UHP equipment can also cut virtually any material. This technique is used where heat or open flames would damage the material being cut or create a safety hazard. Most of the UHP cutting services involve gas pipelines, storage tanks and regenerator heads in the refining industry.
Advantages of UHP technology could become more pronounced in the future as the result of certain actions taken by environmental regulatory agencies which are expected to restrict the use of conventional cleaning methods. In 1989, the Occupational Safety and Health Administration ("OSHA") promulgated regulations which significantly reduce allowable exposure levels to crystalline silica for employees of United States companies, which inhibits the use of sandblasting in industrial cleaning and facilities maintenance applications. Sandblasting is not favored by many of the Company's customers because of the dispersion of particulates into the air, its effect on machinery and equipment, and the necessity of transporting and disposing of the sand waste thereafter. Additionally, the institution of increasingly stringent environmental regulations governing the generation and disposal of all forms of industrial waste, both hazardous and non-hazardous, will impose significant additional costs on most conventional industrial cleaning services. The inherent cost advantages afforded by the absence of particulate and other residue by-products should enhance the future market demand for UHP services such as those provided by the Company. See "Item 1 - Business-Environmental Standards and Government Regulations".
Service Procedures:
Generally, the Company performs its services at customer facilities using truck-mounted equipment. Teams of two or more persons operate the Company's equipment. The Company's employees extend pipe and/or hose, as well as additional equipment, from the truck into the customer's tank, container, paint stack, boiler or other area to be cleaned.
The Company has also installed stationary, electrically powered UHP and conventional waterblast units at some customer facilities. These permanent installations, utilized where repetitive day-to-day cleaning is required, have enhanced the Company's service capabilities while reducing customer down time and overall cleaning cost.
In connection with the use of vacuuming and other conventional technologies, the waste material is conveyed into the equipment's own holding tank, or a Company or customer-owned and controlled roll-off container, for transportation by the customer to a proper customer-designated disposal location, generally on-site at the customer's facility.
In providing UHP waterjetting services, the Company's cleaning system either (1) captures all water, waste and residue produced, which permits pre-treating of such materials in accordance with local requirements prior to discharge into the available sewer system, or (2) allows direct untreated sewer discharge of such resultant waste material. Whether or not such waste material is pre-treated depends upon the nature of the materials to be removed in the cleaning process (as disclosed to the Company by the customer), the nature of
any cleaning additives and other materials used by the Company itself, and local regulations.
Company Operations:
The Company's sales from its primary service lines in dollar amounts and by percentage were as follows:
Year ended June 30 1997 1996 1995 -------- -------- -------- Dollars (in thousands): UHP $ 11,629 $ 9,882 $ 9,329 Vacuum 5,947 6,788 8,450 Waterblasting 4,135 3,958 4,763 Other 1,377 1,247 1,689 -------- -------- -------- Total $ 23,088 $ 21,875 $ 24,231 ======== ======== ======== Percentage: UHP 50.4% 45.2% 38.5% Vacuum 25.8% 31.0% 34.9% Waterblasting 17.9% 18.1% 19.6% Other 5.9% 5.7% 7.0% -------- -------- -------- Total 100.0% 100.0% 100.0% ======== ======== ========
The Company does not depend upon any one customer for sales of its services. During the fiscal year ended June 30, 1997, the Company had sales to approximately 400 different customers. Various plants of E.I. DuPont (which make independent purchasing decisions) made up 13% of Fiscal 1997 net sales. Four other customers each accounted for 6% of Fiscal 1997 net sales.
The Company does not depend upon a limited number of suppliers for the conduct of its business. The loss of any one of its suppliers would not have a material adverse effect on the Company's business.
The Company currently services clients through a number of branch offices and customer site facilities located throughout the United States and Puerto Rico. The branch office locations are facilities at which the Company houses equipment and maintains an administrative staff. Each location is equipped to perform minor equipment maintenance. The Company has mechanics, machinists and facilities to perform major equipment maintenance at its headquarters facility. The customer-site facilities are trailers and equipment at customer locations used by the Company to service that customer and the surrounding area.
While the Company has some long-term commitments from customers for the provision of services, most frequently orders for services are received on a job-by-job basis. In certain instances the Company maintains equipment at the locations of customers which have issued "blanket orders" to the Company for the provision of services over an extended period. Such blanket orders do not obligate the customer to purchase a specified dollar amount of services. Blanket orders permit the Company to be contacted to perform services when needed. Such blanket orders, in combination with the location of the Company's equipment, allows the Company to expedite its response to a particular customer's needs and to obtain a potential competitive advantage. The Company provides its services primarily at prescribed rates or based upon competitive bidding and in some
cases through direct negotiation with the customer. Due to the nature of its business, there are relatively few pre-scheduled or contracted service calls. Most services are performed on an emergency basis or upon less than two weeks advance notice. Accordingly, the Company does not have any significant backlog of service orders. Management of the Company does not consider backlog size to be an important indicator of future performance.
The Company's management knows of no significant seasonal influences related to the provision of its services.
The Company does not provide a separate guaranty or warranty to customers for the services it provides. Due to the size and type of customers serviced, the Company does not generally experience significant delays or other problems in collecting its accounts receivable. Standard payment terms average 60 days. The Company's average days sales outstanding in Fiscal 1997 were 77.
Insurance:
Much of the work performed by the Company is pursuant to contracts that require the Company to indemnify the customer for injury or damage occurring on the work site. The terms of such indemnity agreements vary, but generally they provide that the Company is required to indemnify the customer for losses resulting from or incurred in connection with performance by the Company of its services whether or not the Company has been negligent. Liability for such indemnification claims is generally covered by the Company's insurance policies.
Although the Company believes that its insurance coverage is generally consistent with industry practice, there are exclusions from the Company's insurance coverage for matters of environmental pollution and other types of environmental damage claims. An uninsured or partially insured claim, if successful and of sufficient magnitude, could have a material adverse effect on the Company or its financial condition.
Competition:
The market for industrial cleaning services is fragmented. There are many competitors, no one of which is believed to hold a substantial market share. The Company competes with a number of companies in substantially all of the regions in which it operates. Many of these competitors are local operations servicing a limited geographic area. There are, however, a few large national and regional competitors that have significantly greater resources than the Company. In recent years there has been a trend toward consolidation in the industrial cleaning industry. In 1997 Allwaste Inc., one of the Company's national competitors, was acquired by Phillips Environmental Ltd, a Canadian service company. Other significant national competitors include C.H. Heist Corp., Hydro-Chem Industrial Services, and Rust International, an engineering, construction and environmental cleanup firm controlled by WMX Technologies, Inc.
The Company's principal competitive advantages are the quality of the equipment that it uses, its ability to provide quick response times to customer needs, its safety record, its reputation for competent and professional performance, and the training and mobility of its service force. Another important competitive advantage is the Company's UHP proprietary technology and equipment. See "Item 1 - Business - Proprietary Technology, Patents, Trademarks and Equipment".
The Company relies heavily on repeat customers, and uses both the written and verbal referrals of its satisfied customers to help generate new customers. Many of the Company's customers or prospective customers have a qualification procedure for becoming an approved bidder or vendor based upon the satisfaction of particular performance and safety standards set by the customer. Such customers often maintain a list of vendors meeting such standards and award contracts for individual jobs only to such vendors. The Company continuously monitors and attempts to improve the quality of service it provides, and this process is intended to help the Company maintain standards of performance which are acceptable to its customers. The headquarters and Canton, Ohio facilities of the Company received certification to the International Standard of ISO 9002 in July 1997. The Company is among the first within its industry to receive registration to ISO 9002. The Company believes that its relationships with its customers have been good.
Proprietary Technology, Patents, Trademarks and Equipment:
The Company holds four patents expiring in 2004, 2005, and 2013 with respect to tooling and equipment used in connection with its pressurized water technology. The Company also is the licensee under an exclusive patent license, granted by the University of Missouri, involving a certain waterjet cleaning tool and deposit removal process. The patent being licensed to the Company terminates in 2000. In June 1991, the Company purchased two of these patents, the patent license, certain UHP tools, equipment, know-how, and technology and documentation related to those tools and equipment, a trademark for the term "Water Laser", and all new related inventions hereinafter developed by the sellers of the technology. The patents, license, and know-how relate to UHP technology applicable to industrial cleaning. The acquisition provides the Company with the potential power to foreclose third parties from the use of such patent technology. In connection with the purchase of the above technologies and patents, the Company also received from the sellers an agreement not to engage in any business involving the development, testing, manufacturing or use of any technology, tools, equipment, designs or patents which use water or UHP water as any part of its operation.
The Company has developed a great deal of proprietary technology and know-how which it uses in connection with its provision of industrial cleaning services to customers. The Company continues to develop new and proprietary technology related to its UHP technology and other services, and has additional patents pending.
Most of the technology and the equipment used in providing conventional vacuum and waterblasting services are readily available in the industry. The UHP waterjetting services provided by the Company result from the Company's proprietary technologies, as well as its self-designed and constructed equipment, tools and accessories. These technologies include not only the techniques used by its service personnel in physically providing services, but also the design of the component parts of the equipment used by the Company in providing the services. Although certain basic pieces of equipment are readily available (e.g., diesel and electrical motors, vehicular chassis, etc.), the design of other components assembled into the Company's UHP waterjetting equipment is proprietary to the Company. Such components are fabricated in the Company's machine shops and assembled into finished pieces of equipment at the Company's headquarters facility.
All of the Company's employees sign confidentiality agreements which obligate them to protect the Company's proprietary technology and know-how from unauthorized use and disclosure, and otherwise to treat such information as confidential. Management of the Company believes that with respect to certain of
its know-how and design improvements, even if such processes or products were patentable, any patent protection which could be obtained would not be as beneficial to the Company as the continued maintenance of such proprietary information as confidential material whenever possible.
The Company's name and logos have been registered as service marks with the United States Patent and Trademark Office.
The Company does not operate under any licenses or franchises granted by third parties, other than the University of Missouri patent license. The Company has not granted any right to others in connection with sale or use of its own technology.
Environmental Standards and Government Regulations:
The Company's operations are subject to numerous rules and regulations at the federal, state and local levels. The Company believes that it is in substantial compliance with the various rules and regulations. The Company has not experienced any significant regulatory problems.
All of the Company's operations are subject to regulations issued by the United States Department of Labor under the Occupational Safety and Health Act ("OSHA"). Additionally, some of the Company's operations are subject to the provisions of the Federal Mine Safety and Health Act of 1977. These regulations have strict requirements for protecting employees involved with any materials that are classified as hazardous. Violations of these rules can result in fines.
The Company does not believe that its current activities are subject to the duties pertaining to hazardous waste treatment, storage or disposal facilities, nor those duties pertaining to hazardous waste generators or transporters.
In the event the Company performs a cleaning operation involving the disposal of a waste that would be defined as hazardous under RCRA, the Company could also be classified as a "generator" of hazardous waste, and therefore responsible for manifesting and transporting all such waste to permitted treatment, storage or disposal facilities in accordance with RCRA. As a generator, the Company could be potentially liable under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), also known as the Superfund Act. To the Company's knowledge, none of the sites at which the Company performs services have been designated as Superfund sites. Moreover, to the Company's knowledge, it has not sent any hazardous substances or wastes to any site that has been designated as a Superfund site. Many states have implemented environmental guidelines similar in nature to RCRA and CERCLA.
On the local level, rules and regulations exist and are being promulgated to govern the discharge of wastewater into sewer systems. These rules can vary widely by locale. The Company has developed systems that permit it to comply with these regulations, when applicable. Future changes in such rules and regulations could have a significant impact on the Company in that additional capital expenditures might be required. However, the more intensified regulation also serves to foreclose potential new entrants with little or no experience in industrial cleaning services, as well as those lacking adequate capital.
The Company believes that it has obtained the permits and licenses required to perform its business and believes that it is in substantial compliance with all federal, state and local laws and regulations governing its business. To date, the Company has not been subject to any significant fines,
penalties or other liabilities under such laws and regulations. However, no assurance can be given that future changes in such law, and regulations, or interpretations thereof, will not have an adverse impact on the Company's operations.
The Company's general liability insurance is subject to a pollution exclusion endorsement. Such exclusion is generally found in the majority of general liability policies. The Company does not maintain environmental impairment liability insurance. Thus a claim for damages against the Company that involves pollution or environmental impairment will not be covered by insurance, and, depending on the size of the claim, may have a material adverse effect upon the business and operations of the Company. See "Item 1 - Business-Insurance".
Employees:
As of September 1, 1997, the Company employed 350 full time employees. Due to the nature of the services provided (i.e., primarily on a job-by-job basis), the number of Company employees is subject to fluctuation. No employees are currently covered by collective bargaining agreements. The Company believes that its relations with its employees are good.
ITEM 2.
ITEM 2. PROPERTIES:
The Company's headquarters facility in Canal Fulton, Ohio is comprised of two buildings: a 15,962 square foot office, equipment warehouse and machine shop facility which is leased from a former Chairman and CEO and his wife, and an 8,750 square foot office, machine shop, and service dispatch facility which is owned by the Company.
The headquarters facility lease is for a term ending on October 31, 1997, and is renewable for one three-year term at the Company's option (subject to negotiation of the monthly lease payments). The Company has an option to purchase this facility for a fixed amount anytime during the lease term.
The Company leases the other facilities used in its business under short-term leases, generally one to three years. Management does not anticipate any material problems in negotiating extensions of these existing arrangements. If necessary, management believes that it would be able to obtain adequate alternate facilities on terms acceptable to the Company.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS:
As previously reported, the Company initiated litigation in 1993 against certain former officers and directors in the United States District Court for the Northern District of Ohio, Eastern Division. This litigation was resolved on terms favorable to the Company in December 1996, after the trial had commenced. All claims between the Company and the former officers and directors have now been resolved.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
No matters were submitted to a vote of security holders during the fourth quarter of the year ended June 30, 1997.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS:
The Company's Common Stock trades on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol: VALE. The following table sets forth the high and low sale prices for the periods indicated. High Low ---- --- Fiscal 1996: July 1, 1995 - September 30, 1995 3 5/8 15/16 October 1, 1995 - December 31, 1995 2 3/8 1 January 1, 1996 - March 31, 1996 1 5/16 1 April 1, 1996 - June 30, 1996 1 9/16 7/8 Fiscal 1997: July 1, 1996 - September 30, 1996 1 3/16 11/16 October 1, 1996 - December 31, 1996 1 7/16 15/16 January 1, 1997 - March 31, 1997 1 9/16 15/16 April 1, 1997 - June 30, 1997 1 11/16 7/8
No dividends have been declared on the Common Stock since the inception of the Company, and the Company does not anticipate paying any cash dividend in the foreseeable future. In addition, the Company is restricted from paying dividends on its Common Stock under its credit agreement with its majority stockholder.
Based on information furnished by certain brokerage firms that are record holders of the Company's Common Stock, the Company has in excess of 800 beneficial owners of its Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA:
Dollars in thousands, except per share data: 1997 1996 1995 1994 1993(1) -------- -------- -------- -------- -------- Sales $23,088 $21,875 $24,231 $27,494 $29,098 Gross profit 8,559 6,853 8,562 6,291 4,093 Selling, general and administrative expenses 7,268 7,254 7,155 8,830 10,708 Litigation settlements and related fees (752) 1,351 3,803 Restructuring charges 3,548 2,999 Interest expense 592 572 895 1,506 1,118 Net income (loss) 1,451 (973) 512 (8,539) (14,535) Income (loss) per common share (2) .13 (.16) .02 (1.31) (2.91) Total assets 14,568 15,123 15,704 19,740 27,323 Total long-term debt 7,235 7,021 5,858 10,194 9,596 Total stockholders' equity 4,437 4,031 5,412 (251) 4,260
(1) The year ended June 30, 1993 has been restated to reflect the combined operations with BMW Industrial Services, Inc., which was acquired in Fiscal 1993 and has been accounted for as a pooling of interests.
(2) Income (loss) per common share in 1996 and 1995 have been restated from amounts previously reported to include the effects of the preferred stock dividend requirements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Report.
Results of Operations - 1997 compared to 1996:
Sales increased 5.5% in the fiscal year ended June 30, 1997 from 1996. A shift in sales from vacuum services to UHP waterjetting services continued from the prior year. UHP sales increased 18% in 1997 from 1996, and represented 50% of total sales. In 1996, UHP services represented 45% of total sales. Sales of vacuum services decreased by 12% and went from 31% of total sales in 1996 to 26% in 1997. Sales of waterblasting services, the Company's other major service line, increased 5% in 1997 from 1996 and represented 18% of total sales in both years.
The shift in sales from vacuum services to UHP waterjetting services was expected. Competition in the vacuum services area has increased steadily in recent years. There has been consolidation in the industry and some competitors, including some larger than the Company, have lowered rates to gain market share. The Company has generally chosen not to compete on price and has emphasized its UHP waterjetting service line, where management believes it has a clear technological advantage.
Sales of UHP waterjetting services were also aided in 1997 by new applications for the Company's technology in the hazardous materials abatement industry. The Company had sales of $1.2 million in this area in 1997, compared to less than $400,000 in 1996. The Company expects sales of UHP waterjetting services to this industry to continue to increase in Fiscal 1998.
The Company's gross margin in 1997 increased to 37% of sales, from 31% in the prior year. Increased sales of the UHP waterjetting service line caused part of this improvement. Lower equipment repair costs resulting from increased emphasis on preventive maintenance also contributed. Lower equipment depreciation costs spread over higher revenues also helped to increase the gross margin percentage.
Selling, general and administrative expenses increased by .2% in 1997 over the prior year, and represented 31% of sales in 1997 and 33% in 1996. Interest expense increased 4% in 1997 from 1996, and represented 3% of sales in both years.
Net income in 1997 was increased by a one-time gain on settlement of litigation of $752,000, or $.09 per common share.
Results of Operations - 1996 compared to 1995:
The Company's sales decreased by 10% in 1996 from the prior year. The decrease was primarily in sales of vacuum and waterblasting services. Together, these services decreased by 19% in 1996, and represented 49% of total sales. In 1995 these service lines accounted for 55% of total sales. The Company also exited several minor service lines during the year.
Competition in vacuum and waterblasting services is increasing. Several competitors, which are larger and have greater resources than the Company, have recently reduced rates in an attempt to gain market share, particularly in the Gulf Coast region. The Company has generally chosen not to compete on price and has emphasized its UHP waterjetting service line, where management believes it
has a clear technological advantage. Sales of the UHP waterjetting service line, which is the Company's most profitable, increased 6% in 1996 from 1995, and represented 45% of total sales compared to 38% in the prior year.
The Company plans to continue emphasizing UHP waterjetting services, and is continually developing new applications and tooling for this technology. One area that seems very promising is removal of some types of hazardous coatings containing asbestos and lead. UHP waterjetting is a new technology to the abatement industry, and the Company anticipates significant future revenues from it. The Company does not plan to become an abatement contractor. Instead, it will supply equipment and expertise to abatement contractors to increase their productivity.
The Company's gross margin dropped to 31% of sales in 1996 from 35% in 1995. The drop was primarily caused by changes in the estimated useful lives of certain equipment, which had the net effect of increasing depreciation expense in 1996 by $525,000, or 2.4 % of sales. The drop in sales also contributed to the decreased gross margin percentage due to the effect of spreading fixed costs (primarily depreciation) over a smaller revenue base.
Selling, general and administrative expenses increased by 1.4% in 1996 from the prior year. Due to lower revenues, these expenses amounted to 33% of sales in 1996, compared to 29% in 1995. Interest expense decreased by 36% in 1996 from 1995, due to refinancing under more favorable terms, conversion of debt to equity, and positive cash flows from operations that were used to pay down debt.
Quarterly Operating Results (unaudited):
The following table presents certain unaudited consolidated quarterly operating information for the Company and includes all adjustments considered necessary for a fair presentation of such information for the interim periods.
Three Months Ended (In thousands, except per share data) 9/30/95 12/31/95 3/31/96 6/30/96 9/30/96 12/31/96 3/31/97 6/30/97 ------- -------- ------- ------- ------- -------- ------- ------- Sales $5,888 $5,611 $4,590 $5,786 $6,275 $5,133 $5,321 $6,359 Gross profit 2,046 1,934 963 1,910 2,367 1,727 2,138 2,327 Net income (loss) 131 41 (1,123) (22) 250 437 305 459 Income (loss) per common share $ .00 $ (.01) $ (.14) $ (.01) $ .02 $ .04 $ .03 $ .04
A significant drop in revenues for the quarter ended March 31, 1996 caused the net loss in that period. Gross profit as a percentage of sales for that quarter also dropped significantly because fixed costs, such as equipment depreciation, were spread over a lower revenue base.
Net income in the quarter ended December 31, 1996 was increased by $752,000, or $.09 per common share, by a one-time gain on settlement of litigation.
Quarterly income (loss) per common share above have been restated from amounts previously reported to include the effects of preferred stock dividend requirements.
Liquidity and Capital Resources:
Working capital increased from $1.3 million at June 30, 1996 to $3.6 million at June 30, 1997. Most of the 1997 increase was due to cash generated
from operations. Cash generated from operations totaled $2.6 million in 1997, compared to $600,000 in 1996. The improvement in the Company's results of operations, going from a loss of $973,000 in 1996 to net income of $1,451,000 in 1997, accounted for most of the improvement in cash generated from operations.
Additions to property and equipment were $1.7 million in 1997, compared to $2.5 million in 1996. Additions to property and equipment in 1995 were $1.3 million. All 1997 and 1996 additions were financed through operations or borrowings from the Company's revolving line of credit, which expires in July 2000. The Company anticipates spending more on additions to property and equipment in Fiscal 1998 than in 1997, but expects that total additions to property and equipment in 1998 should not exceed depreciation expense in that year.
Financing activities used $1 million of cash in 1997, compared with providing $1.7 million in 1996. The Company purchased 500,000 shares of its common stock in Fiscal 1997 in accordance with a share purchase program announced in August 1996, for a total cost of $564,000. This expenditure, along with payment of preferred stock dividends of $385,000, accounted for the 1997 use of cash. The Company does not expect to purchase additional common shares in Fiscal 1998.
During 1997 the Company negotiated an extension of its credit agreement with its majority stockholder and its bank line of revolving credit. The existing arrangements were extended two years, to July 2000. The Company had $1 million of credit available under these agreements on June 30, 1997. The Company expects to have adequate cash flows from operations to meet all obligations in Fiscal 1998, as well as to provide for all necessary capital expenditures.
Accounting Standards:
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share"("SFAS No. 128"). SFAS No. 128 modifies the manner in which an entity computes, presents and discloses its earnings per share. The Company is required to adopt the provisions of SFAS No. 128 beginning in the quarter ended December 31, 1997. The adoption of SFAS No. 128 is not expected to have a significant impact on the Company's computation and presentation of earnings per share.
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 established standards for reporting and display of comprehensive income and its components. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997 and is not expected to have a significant impact on the consolidated financial statements of the Company.
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 129, "Disclosure of Information about Capital Structure" ("SFAS No. 129") and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 129 will be effective for the Fiscal year ending June 30, 1998 and SFAS No. 131 will be effective for the fiscal year ending June 30, 1999. As the adoption of SFAS No. 129 and SFAS No. 131 require only additional disclosures, there will be no effect on the Company's consolidated financial position or results of operations or cash flows.
Forward looking statements:
Forward-looking statements in this Form 10-K are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially form those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Potential risks and uncertainties include, but are not limited to, general business and economic conditions; the financial strength of the various industries the Company serves, the competitive pricing environment of the industrial cleaning service industry, the cost and effectiveness of planned marketing campaigns, and the success of the Company to continue to develop new applications and markets for its technology.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
The required financial statements of the Registrant are set forth immediately following the signature page to this registration statement. See "Item 14 - Exhibits, Financial Statements, Schedules and Reports on Form 8-K", for index to the financial statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:
The information required by this item is set forth under the captions "Election of Directors" and "Executive Compensation" of the registrant's definitive proxy statement, and incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION:
The information required by this item is set forth under the caption "Executive Compensation" of the registrant's definitive proxy statement, and incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:
The information required by this item is set forth under the caption "Beneficial Ownership of Voting Securities" of the registrant's definitive proxy statement, and incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:
The information required by this item is set forth under the caption "Executive Compensation" of the registrant's definitive proxy statement, and incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K:
A. (1) Financial Statements Filed:
Valley Systems, Inc. and Subsidiaries:
Report of Independent Accountants.
Consolidated Balance Sheets at June 30, 1997 and 1996.
Consolidated Statements of Income for years ended June 30, 1997, 1996 and 1995.
Consolidated Statements of Stockholders' Equity for the years ended June 30, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the years ended June 30, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
(2) Exhibits:
No. Description of Exhibit - --- ---------------------- 3.1 Restated Certificate of Incorporation of Registrant. (1) 3.2 Certificate of Amendment of Certificate of Incorporation of Registrant. (16) 3.3 By-laws of Registrant (as amended). (16) 4.1 Form of Designation of Rights and Preferences of the Series A Preferred Stock. (1) 4.2 Form of Designation of Rights and Preferences of the Series B Preferred Stock. (1) 4.3 Certificate of Designation of Rights and Preferences of Series C Preferred Stock. (15) 4.4 Specimen Certificate of Common Stock. (1) 4.5 Form of Underwriter's Warrant Agreement. (1) 4.6 1991 Stock Option Plan, and Form of Agreement. (1)(13) 4.7 Warrant Grant Agreement dated June 2, 1994 between the Registrant and Rollins Investment Fund. (14) 10.1 Employment Agreement, dated as of March 13, 1991, between the Registrant and Eugene R. Valentine. (1) 10.2 Business Development Contract between the Registrant and the Aberlyn Group, Inc. dated as of October 1, 1990. (1) 10.3 Agreement and Undertaking dated April 29, 1991 by and among the Registrant, Eugene R. Valentine, Aberlyn Group, Inc., Lawrence Hoffman and Robert M. Rubin. (1) 10.4 Form of Voting Trust Agreement between Eugene R. Valentine and the Aberlyn Group, Inc. (1) 10.5 Letter dated March 15, 1991, to Aberlyn Group, Inc., respecting sale of Common Stock to Consultant in certain events. (1) 10.6 Lease between the Registrant and Eugene R. Valentine and Cynthia J. Valentine dated as of November 1, 1988 as amended in March 1991. (1)
10.7 Securities urchase Agreement dated December 16, 1991 between Rollins Investment Fund ("RIF") and the Registrant. (2) 10.8 Stock Purchase Agreement, dated June 12, 1992, among Eugene R. Valentine, Nicholas J. Pace and Rollins Investment Fund. (3) 10.9 Reorganization Agreement dated July 31, 1992 between Registrant and the stockholders of BMW Industrial Services, Inc., and exhibits thereto. (4) 10.10 Agreement dated July 31, 1992 between Registrant and Power City Industrial Services, Inc. (4) 10.11 Loan Agreement from Rollins Investment Fund to Eugene R. Valentine and Cynthia J. Valentine, dated October 14, 1992. (5) 10.12 Loan Agreement from Eugene R. Valentine to Registrant, dated October 16, 1992. (5) 10.13 Standby and Subordination Agreement from Eugene R. Valentine and Cynthia J. Valentine to Fifth Third Bank. (5) 10.14 Credit and Security Agreement dated December 30, 1991 by and among the Fifth Third Bank, the Registrant, Valley Systems of Ohio, Inc. and Diversified Specialty Enterprises, Inc. (6) 10.15 Lease agreements between Munco Development Company and the Registrant with respect to leases of office space at Crescent Pointe Building, Canton, Ohio. (6) 10.16 Amendment No.1, dated as of November 16, 1992, to the Credit and Security Agreement, dated as of December 31, 1991, by and between Registrant and the Fifth Third Bank. (7) 10.17 Amendment No. 2, dated as of July 20, 1993, to the Credit and Security Agreement, dated as of December 30, 1991, by and betwee the Registrant and the Fifth Third Bank. (8) 10.18 Equipment Lease Agreement and Riders No. 1 & No. 2 by and between the Registrant and Ally Capital Corporation dated December 18, 1992. (9) 10.19 Letter Agreement dated September 9, 1993 between Ally Capital Corporation and the Registrant and Subordination and Security Agreement made as of September 9, 1993 between Ally Capital Corporation and Rollins Investment Fund. (9) 10.20 Loan and Security Agreement, dated as of June 29, 1994 by and between Registrant and Rollins Investment Fund. (15) 10.21 Term Note dated June 29, 1994 from Registrant to Rollins Investment Fund. (15) 10.22 First Amendment to Term Note dated September 2, 1994 by and between Registrant and Rollins Investment Fund. (15) 10.23 First Amendment to Loan and Security Agreement dated March 28, 1995 by and between Registrant and Rollins Investment Fund. (16) 10.24 Second Amendment to Loan and Security Agreement dated November 5, 1996 by and between Registrant and Rollins Investment Fund. (18) 16.1 Letter dated July 8, 1993 from Valley Systems, Inc. to Feldman, Radin & Co., P.C. terminating the auditor's services. (10)
- --------------------------------------------------------------------------------
(1) Hereby incorporated by reference to the filing of the Registrant's Registration Statement on Form S-1 declared effective by the SEC on June 11, 1991.
(2) Hereby incorporated by reference to the filing of the Schedule 13D of Rollins Investment Fund, dated December 20, 1991. (3) Hereby incorporated by reference to the filing of the Schedule 13D of Rollins Investment Fund, dated June 18, 1992. (4) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated August 10, 1992. (5) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated October 30, 1992. (6) Hereby incorporated by reference to the filing of the Registrant's Form 10-K dated November 6, 1992. (7) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated December 21, 1992. (8) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated July 30, 1993. (9) Hereby incorporated by reference to the filing of the Registrant's Form 10-K dated September 24, 1993. (10) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated July 9, 1993. (11) Hereby incorporated by reference to the filing of the Registrant's Form 10-Q dated February 11, 1994. (12) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated June 29, 1994. (13) This is a compensatory plan or arrangement. (14) Hereby incorporated by reference to the filing of the Registrant's Form 8-K dated September 2, 1994. (15) Hereby incorporated by reference to the filing of the Registrant's Form 10-K dated September 26, 1994. (16) Hereby incorporated by reference to the filing of the Registrant's Form 10-K dated September 25, 1995. (17) Hereby incorporated by reference to the filing of the Registrant's Form 10-K dated September 24, 1996. (18) Included as an exhibit in this Form 10-K.
Reports on Form 8-K filed during the three months ended June 30, 1997:
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
VALLEY SYSTEMS, INC.
By: \s\ Ed Strickland President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- \s\ Ed Strickland President and Chief Executive Officer September 22, 1997
\s\ Dennis D. Sheets Vice President, Chief Financial Officer, Treasurer and Secretary September 22, 1997
\s\ Allen O. Kinzer Director September 22, 1997
\s\ Joe M. Young Director September 22, 1997
VALLEY SYSTEMS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page Number
REPORT OF INDEPENDENT ACCOUNTANTS 20
CONSOLIDATED BALANCE SHEETS - June 30, 1997 and 1996 21
CONSOLIDATED STATEMENTS OF INCOME - Years ended June 30, 1997, 1996 and 1995 22
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - Years ended June 30, 1997, 1996 and 1995 23
CONSOLIDATED STATEMENTS OF CASH FLOWS - Years ended June 30, 1997, 1996 and 1995 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 25-32
All schedules are omitted because they are not required under the instructions, are inapplicable, or the information is included elsewhere in the financial statements.
Report of Independent Accountants
To the Stockholders of Valley Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Valley Systems, Inc. and Subsidiaries (the "Company") as of June 30, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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 consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Valley Systems, Inc. and Subsidiaries as of June 30, 1997 and 1996 and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1997, in conformity with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Akron, Ohio August 22, 1997
Valley Systems, Inc. and Subsidiaries Consolidated Balance Sheets June 30, 1997 and 1996
1997 1996 ------------- ------------- ASSETS Current assets: Cash $ 200,093 $ 86,099 Accounts receivable 5,638,350 4,684,719 Prepaid supplies 469,839 443,446 Prepaid expenses 160,772 193,587 ------------- ------------- Total current assets 6,469,054 5,407,851 Property and equipment 7,551,004 9,029,694 Intangible assets 548,000 685,000 ------------- -------------
Total assets $ 14,568,058 $ 15,122,545 ============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 971,611 $ 756,672 Accrued expenses 1,428,834 2,583,966 Current portion of long-term debt 495,929 729,506 ------------- ------------- Total current liabilities 2,896,374 4,070,144 Long-term debt 7,235,120 7,021,200 Commitments and contingencies Stockholders' Equity: Preferred stock, $.10 par value; authorized 2,000,000 shares, issued and outstanding 55,000 5,500 5,500 Common stock, $.01 par value; authorized 12,000,000 shares, issued and outstanding 8,512,073 85,121 85,121 Paid-in capital 26,786,040 26,786,040 Accumulated deficit (21,757,089) (22,726,822) Treasury stock, at cost, 605,456 shares at June 30, 1997 and 105,456 at June 30, 1996 (683,008) (118,638) ------------- ------------- 4,436,564 4,031,201 ------------- ------------- Total liabilities and stockholders' equity $ 14,568,058 $ 15,122,545 ============= =============
The accompanying notes are an integral part of these financial statements.
Valley Systems, Inc. and Subsidiaries Consolidated Statements of Income For the years ended June 30, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Sales $ 23,088,298 $ 21,874,776 $ 24,230,858 Cost of sales 14,529,554 15,021,953 15,668,561 ------------ ------------ ------------ Gross profit 8,558,744 6,852,823 8,562,297 Selling, general and administrative expenses 7,267,973 7,254,467 7,155,585 Interest expense 592,024 571,700 894,583 Gain on settlement of litigation (752,236) - - ------------ ------------ ------------ Income (loss) from operations before income taxes 1,450,983 (973,344) 512,129 Income taxes - - - ------------ ------------ ------------ Net income (loss) $ 1,450,983 $ (973,344) $ 512,129 ============ ============ ============
Net income (loss) per common share $ .13 $ (.16) $ .02 ============ ============ ============ Weighted average shares used in computation 8,203,069 8,490,111 8,532,073 ============ ============ ============
The accompanying notes are an integral part of these financial statements.
Valley Systems, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity For the years ended June 30, 1997, 1996 and 1995
Preferred Common Paid-In Accumulated Treasury Stock(1) Stock(2) Capital Deficit Stock Total -------- ------- ----------- ------------- ---------- ---------- Balance, June 30, 1994 $2,000 $85,121 $21,319,084 $(21,657,517) $ - $ (251,312) Conversion of debt to equity 3,000 2,997,000 3,000,000 Sale of preferred stock 2,500 2,467,956 2,470,456 Net income 512,129 512,129 Series C preferred dividends (319,341) (319,341) ------ ------- ----------- ------------- ---------- ---------- Balance, June 30, 1995 7,500 85,121 26,784,040 (21,464,729) - 5,411,932 Purchase of treasury stock (118,638) (118,638) Retirement of Series B preferred stock (2,000) 2,000 - Net loss (973,344) (973,344) Series C preferred dividends (288,749) (288,749) ------ ------- ----------- ------------- ---------- ---------- Balance, June 30, 1996 5,500 85,121 26,786,040 (22,726,822) (118,638) 4,031,201
Purchase of treasury stock (564,370) (564,370) Net income 1,450,983 1,450,983 Series C preferred dividends (481,250) (481,250) ------ ------- ----------- ------------- ---------- ---------- Balance, June 30, 1997 $5,500 $85,121 $26,786,040 $(21,757,089) $(683,008) $4,436,564 ====== ======= =========== ============= ========== ==========
(1) Share amounts are equivalent to ten times dollar amounts. (2) Share amounts are equivalent to one hundred times dollar amounts.
The accompanying notes are an integral part of these financial statements.
Valley Systems, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the years ended June 30, 1997, 1996 and 1995
1997 1996 1995 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ 1,450,983 $ (973,344) $ 512,129 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 3,138,326 3,516,986 3,229,816 (Gain) loss on disposition of property and equipment (5,784) (6,865) 1,854 (Increase) decrease in assets: Accounts receivable (953,631) (658,313) 232,073 Prepaid supplies (26,393) 16,143 (50,641) Prepaid expenses 32,815 18,922 7,073 Increase (decrease) in liabilities: Accounts payable 214,939 218,840 (323,516) Accrued expenses (1,251,382) (1,531,797) (855,037) ------------ ------------ ------------ Cash provided by operating activities 2,599,873 600,572 2,753,751 ------------ ------------ ------------ Cash flows from investing activities: Additions to property and equipment (1,665,092) (2,547,375) (1,289,083) Proceeds from dispositions of property and equipment 148,240 99,541 684,238 ------------ ------------ ------------ Cash used by investing activities (1,516,852) (2,447,834) (604,845) ------------ ------------ ------------ Cash flows from financing activities: Net borrowings from revolving line of credit 583,403 2,911,279 3,714,981 Payments of other long-term debt (603,060) (702,810) (9,331,833) Proceeds from sale of stock - - 2,470,456 Payments of preferred stock dividends (385,000) (385,000) (223,091) Purchase of treasury stock (564,370) (118,638) - ------------ ------------ ------------ Cash (used) provided by financing activities (969,027) 1,704,831 (3,369,487) ------------ ------------ ------------ Increase (decrease) in cash 113,994 (142,431) (1,220,581) Cash at beginning of year 86,099 228,530 1,449,111 ------------ ------------ ------------ Cash at end of year $ 200,093 $ 86,099 $ 228,530 ============ ============ ============ Cash paid for: Interest $ 592,024 $ 571,700 $ 834,443 Non-cash financing activities: Notes payable converted to preferred stock 3,000,000 Reclassification of payments from former directors and officers 1,017,000 Preferred stock dividends accrued 96,250 96,250
The accompanying notes are an integral part of these financial statements.
Valley Systems, Inc. and Subsidiaries Notes to Consolidated Statements
1. Description of Business:
The Company is engaged in the business of providing specialized industrial cleaning and other services to divisions and facilities of Fortune 500 companies and other substantial businesses engaged in heavy industry. Such services generally involve the removal of industrial grime, deposits, wastes, encrustations and coatings from equipment and facilities. The Company's principal customers are in the chemical, plastics, power generation, petroleum refining and primary metals businesses. The Company's industrial cleaning methods include, in addition to the use of waterblasting, vacuuming and other more conventional procedures, the application of ultra-high pressure ("UHP") waterjetting methods.
2. Summary of Significant Accounting Policies:
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany transactions have been eliminated in the accompanying consolidated financial statements.
Revenue Recognition: Sales and the related cost of sales for services provided are recorded as the services are performed.
Accounts Receivable: The Company's customers are located primarily throughout the United States. The Company monitors potential credit losses and such losses have been within management's expectations. Accounts receivable which become uncollectible are written off against operations at the time they are deemed to be worthless. The total uncollectible accounts charged to operations for the years ended June 30, 1997, 1996 and 1995 were $51,000, $6,000, and $89,000, respectively. The allowance for doubtful accounts was $125,000 at June 30, 1997 and 1996.
Prepaid Supplies: Prepaid supplies consist of items to be used in operations, and are stated at the lower of cost (first in, first out) or market.
Property and Equipment: Property and equipment are stated at cost. The Company uses the straight-line method of depreciation for financial reporting purposes. For income tax purposes, depreciation is computed by either the accelerated or modified cost recovery methods. The estimated useful lives for financial reporting purposes are as follows:
Building and leasehold improvements 3 to 15 years Automobiles and trucks 3 to 7 years Equipment 3 to 7 years
The cost and related accumulated depreciation of assets retired, sold or otherwise disposed of are removed from the accounts and any gain or loss is reflected in the current years' results of operations.
Effective July 1, 1995, the Company revised its estimates of the useful lives of certain machinery and equipment. This change was brought about by a review of machinery and equipment by branch management to better reflect the estimated periods during which such assets will remain in service. The change had the effect of increasing depreciation expense and decreasing net income by approximately $525,000 ($.06 per share) for the year ended June 30, 1996.
Income Taxes: Deferred income taxes are provided to reflect the tax effects of temporary differences between financial and tax reporting, principally related to depreciation.
Intangible Assets: Intangible assets include the cost of certain patents, technology, trademarks, and a non-compete agreement. These items are being amortized to operations on a straight-line basis over 10 years, the period in which the economic benefits are estimated to be realized. Accumulated amortization amounted to $822,000 and $685,000 as of June 30, 1997 and 1996, respectively.
Income (Loss) Per Common Share: Income (loss) per common share is based on the weighted average number of common shares and common share equivalents outstanding during the period after consideration of the preferred stock dividend requirements of $385,000 in 1997 and 1996 and $319,341 in 1995. Common share equivalents include dilutive stock options and warrants using the Treasury Stock method. These items have not been included in computing income (loss) per common share for the three years in the period ended June 30, 1997 since such inclusion would be either anti-dilutive or immaterial. Income (loss) per common share in 1996 and 1995 have been restated from amounts previously reported to include the effects of the preferred stock dividend requirements.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.
Fair Value of Financial Instruments: The carrying values of accounts receivable and short-term borrowings represent reasonable estimates of the fair values of these instruments due to their short maturities. The fair value of long-term debt is estimated by discounting the future cash flows using rates currently available to the Company for debt with similar terms and remaining maturities. The estimated fair values of the long-term debt at June 30, 1997 approximated its carrying values.
New Accounting Pronouncements: During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"). SFAS No. 128 modifies the manner in which an entity computes, presents and discloses its earnings per share. The Company is required to adopt the provisions of SFAS No. 128 beginning in the quarter ended December 31, 1997. The adoption of SFAS No.128 is not expected to have a significant impact on the Company's computation and presentation of earnings per share.
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 established standards for reporting and display of comprehensive income and its components. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997 and is not expected to have a significant impact on the consolidated financial statements of the Company.
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 129, "Disclosure of Information about Capital Structure" ("SFAS No. 129") and Statement of Financial Accounting Standards No.131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 129 will be effective for the fiscal year ending June 30, 1998 and SFAS No. 131 will be effective for the fiscal year ending June 30, 1999. As the adoption of SFAS No. 129 and SFAS No. 131 require only additional disclosures, there will be no effect on the Company's consolidated financial position or results of operations or cash flows.
Reclassifications: Certain amounts in the 1996 consolidated financial statements have been reclassified to conform to the 1997 presentation.
3. Property and Equipment:
Property and equipment consist of the following: 1997 1996 ----------- ----------- Land $ 184,759 $ 182,907 Building and leasehold improvements 580,000 580,000 Automobiles and trucks 9,753,233 11,071,390 Equipment 7,470,264 7,029,931 Equipment in progress and parts 339,293 221,016 ----------- ----------- 18,327,549 19,085,244 Less accumulated depreciation and amortization 10,776,545 10,055,550 ----------- ----------- $ 7,551,004 $ 9,029,694 =========== ===========
Included in property and equipment are assets under capital leases of $2,151,000 and $3,277,000 with related accumulated depreciation of $1,481,000 and $1,743,000 as of June 30, 1997 and 1996, respectively.
The Company incurred repairs and maintenance costs on property and equipment of approximately $1,450,000, $1,850,000 and $2,150,000 for the years ended June 30, 1997, 1996 and 1995, respectively.
4. Accrued Expenses:
Accrued expenses consist of the following: 1997 1996 ----------- ----------- Accrued salaries and bonus $ 819,000 $ 706,000 Accrued payroll taxes, workers compensation insurance and other employee benefits 172,000 357,000 Accrued professional fees 41,000 161,000 Accrued preferred stock dividends 96,250 - Reserve for disputed amounts receivable (see Note 8) - 1,113,000 Other accrued liabilities 300,584 246,966 ----------- ----------- $ 1,428,834 $ 2,583,966 =========== ===========
5. Long-Term Debt:
Long-term debt is comprised of the following: 1997 1996 ----------- ----------- Capitalized leases (A) $ 521,151 $ 1,124,211 Revolving loan - bank (C) 7,209,898 6,626,495 ----------- ----------- 7,731,049 7,750,706 Less: current portion of long-term debt 495,929 729,506 ----------- ----------- $ 7,235,120 $ 7,021,200 =========== ===========
A. Capitalized leases are due in monthly installments ranging from $2,000 to $26,000 and bear interest of 16.4%.
B. The Company has a loan agreement with its majority stockholder, which expires in 2000 and provides a total credit facility to the Company Company as follows:
Through July 1999: $9,000,000 August 1999 through July 2000: $8,000,000
This facility may be utilized by borrowings at .5% over the prime rate (payable quarterly) or, at the Company's option, by having the stockholder provide bank letters of credit which the Company can utilize as collateral for other obligations. The Company reimburses the stockholder for the actual cost of the letters of credit. This loan agreement is collateralized by essentially all assets of the Company. At June 30, 1997, there are no loans outstanding under this facility, and the stockholder has issued $8,280,000 in bank letters of credit, leaving $720,000 of the facility available to the Company.
C. This obligation represents borrowings under a $7,500,000 revolving loan agreement with a bank. The loan bears interest at 1.7% below the prime rate (6.80% at June 30, 1997), payable monthly, and is collateralized by a bank letter of credit provided by the Company's majority shareholder under the loan agreement described in B. above. This revolving loan agreement decreases to $6,500,000 in July 1999 and expires July 2000.
The aggregate maturities on the aforementioned debt are as follows:
Year Ended June 30 1998 $ 495,930 1999 25,222 2000 709,897 2001 6,500,000
6. Income Taxes:
The income tax provision for the three years ended June 30, 1997 is comprised of the following amounts: 1997 1996 1995 ----- ----- ----- Current: Federal $ - $ - $ - ===== ===== =====
Statutory rate 34 % (34)% 34 % Operating loss utilized (34) (34) Operating loss not utilizable 34 ----- ----- ----- Effective rate - % - % - % ===== ===== =====
Deferred federal income taxes reflect the impact for financial statement reporting purposes of temporary differences between the financial statement and tax basis of assets and liabilities. At June 30, 1997 and 1996, the components of the net deferred tax assets and liabilities were as follows: 1997 1996 ----------- ----------- Deferred tax assets: Allowance for doubtful accounts $ 50,000 $ 50,000 Vacation accrual 140,000 132,000 Litigation reserve - 50,000 Sales tax reserve - 55,000 Net operating loss carryforwards 8,026,232 9,919,383 Other 123,253 70,395 ----------- ----------- 8,339,485 10,276,788 Deferred tax liabilities: Basis difference in fixed assets (549,523) (792,832) ----------- ----------- Net deferred tax assets 7,789,962 9,483,946 Valuation allowance (7,789,962) (9,483,946) ----------- ----------- Net deferred taxes recognized $ - $ - =========== ===========
The Company has approximately $20,100,000 of net operating loss carryforwards for future years, which cannot be utilized to create tax refunds. Such amounts begin to expire in the year 2005.
7. Commitments:
The Company has various capital and operating leases in effect for equipment, vehicles and facilities with initial terms ranging from one month to five years with renewal options generally being available. Minimum commitments under all capital and operating leases at June 30, 1997 are as follows:
Capital Operating ----------- ----------- 1998 $ 538,969 $ 103,100 1999 25,542 39,600 2000 - 39,600 2001 - 23,100 ----------- ----------- Total minimum lease payments 564,511 205,400 =========== Less amount representing interest 43,360 ----------- Total present value of capital obligation 521,151 Less current portion 495,929 ----------- Long-term obligation under capital leases $ 25,222 ===========
Operating lease expense amounted to $441,000, $364,000 and $546,000 for the years ended June 30, 1997, 1996 and 1995, respectively.
8. Litigation:
In addition to the matters discussed below, the Company is involved in various litigation arising in the ordinary course of business. Management believes that the ultimate resolution of such litigation will not have a material effect on the Company's operations or financial position.
A. The Company filed a lawsuit in September 1993 against certain of its former directors and officers, as well as other parties. This lawsuit was settled in December 1996.
B. During the fiscal year ended June 30, 1996, the Company determined that amounts contributed to it by two former officers and directors that were previously classified as loans to the Company were not loans. Instead, such contributions were determined to be repayments by the former officers and directors of amounts owed by those officers and directors to the Company at the time the contributions were made. Because the former officers and directors in the lawsuit described above contested this determination, an equal amount was reserved. As a result of the settlement of this lawsuit, the reserve was eliminated in the quarter ended December 31, 1996, resulting in a gain of $752,000 after related expenses of the litigation.
9. Major Customers:
The following table shows the percentage of total sales made to major customers for each fiscal year: 1997 1996 1995 ---- ---- ---- Customer A 13% 14% 10% Customer B 6% 10% 9% Customer C 6% 5% 6% Customer D 6% 5% 5% Customer E 6% * * Customer F * 5% 7% Customer G * 5% 6%
* Customer was less than 5% of total sales for the fiscal year.
10. Stockholders' Equity:
A. At June 30, 1995, there were 20,000 shares of Series B Preferred Stock outstanding. These shares were transferred to the Company in 1996 as part of a settlement of litigation, and were then retired.
B. In September 1994, the Company issued 55,000 shares of Series C Preferred Stock to its majority stockholder, which then transferred them to an affiliate. Each share of the Series C Preferred Stock is entitled to a cumulative annual dividend of $7.00, payable quarterly. The proceeds from the sale of the preferred shares totaled $5.5 million; $3.0 million in the conversion of debt for equity and $2.5 million of cash. The cash proceeds from the transaction were used to retire additional debt and to provide working capital.
11. Stock Options and Warrants:
A. In 1991, the Company adopted a stock option plan. Up to 400,000 shares of common stock may be issued under the plan. Outstanding options on June 30, 1997 were as follows:
Shares ----------------------- Option Price Total Exercisable Expiration Date ------------ -------- ----------- --------------- $3.00 10,000 10,000 2001 $1.50 22,080 23,700 2001 $1.50 46,000 46,000 2002 $1.50 218,200 87,280 2004 $1.50 62,700 - 2006 $1.50 35,000 - 2007 -------- -------- 393,980 166,980 ======== ========
B. In October 1994, the Company issued stock options to its directors to purchase a total of 50,000 shares of its common stock at $1.50 per share. These options can be exercised up to 10,000 shares on or after each of the first five anniversary dates, and expire in October 2004. These options are not part of the stock option plan above. The Company also issued options under the plan to certain employees to purchase a total of 246,200 shares of common stock at $1.50 per share. These options can be exercised up to 20% of the shares on or after each of the first five anniversary dates and expire in 2004.
C. On July 5, 1996, the Company modified options issued under the plan to purchase 34,780 shares of common stock at an original exercise price of $3.00 per share by repricing the options to $1.50 per share. There was no compensation expense recognized related to this modification. The Company also issued options under the plan to certain employees to purchase a total of 64,700 shares of common stock at $1.50 per share. These options can be exercised up to 20% of the shares on or after each of the first five anniversary dates and expire in 2006.
D. In 1997 the Company issued options under the plan to certain employees to purchase a total of 35,000 shares of common stock at $1.50 per share. These options can be exercised up to 20% of the shares on or after each of the first five anniversary dates and expire in 2007.
E. In 1997, 1996 and 1995, respectively, options to purchase 24,000, 18,300 and 28,000 shares of common stock were forfeited.
F. The Company has elected to adopt the "disclosure-only" provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS No. 123"), with no compensation cost recognized for options granted at or above market value. For SFAS No. 123, the fair value of each option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for 1997: (a) risk-free interest rates of 6.40% to 7.04%; (b) no dividend yield in either year; (c) expected terms of 8 years; and (d) volatility of 95%.
If the Company had elected to recognize the compensation cost of its stock option plan based on the fair value of the awards under that plan in accordance with SFAS No. 123, net income would have been reduced to $1,306,346 ($.11 per common share) for the year ended June 30, 1997.
G. At June 30, 1997, warrants to purchase shares of the Company's common stock were outstanding as follows:
Warrant Price Shares Expiration Date -------- ---------- --------------- $ 3.25 10,000 June 1998 $ 3.09 2,314,000 May 2000 $15.00 100,000 September 2001
12. Employee Benefit Plan:
In 1991, the Company adopted a 401(k) plan that covers substantially all employees. The plan is a discretionary plan in that the Company may or may not make contributions to the plan. The Company did not contribute to the plan during the three years ended June 30, 1997.