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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1996
Commission file number 0-21454
ENVIROTEST SYSTEMS CORP.
(Exact name of registrant as specified in its charter)
Delaware 06-0914220
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
Commission file numbers 33-57384-01 and 33-75406-01
ENVIROTEST TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 36-2680300
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
246 Sobrante Way, Sunnyvale, California 94086
(Address of registrants' principal (zip code)
executive offices)
Registrants' telephone number, including area code: (408) 774-6300
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Class A Common Stock, $.01 par value per share, of Envirotest Systems Corp.
Indicate by check mark whether the registrants (1) have filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrants were required to file such reports), and (2) have
been subject to such filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrants' knowledge, in any definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. / /
As of November 30, 1996, 13,204,396 shares of Envirotest Systems Corp.
Class A Common Stock were outstanding, and the aggregate market value (based
upon the last reported sale price on the NASDAQ National Market System on
December 22, 1996) of the shares of Class A Common Stock held by
non-affiliates was approximately $17,989,283 (for purposes of calculating
the preceding amount only, all directors and executive officers of the
registrant are assumed to be affiliates). As of such date, 1,389,749 shares
of Envirotest Systems Corp. Class B Common Stock were outstanding, all of
which were held by affiliates, and 2,026,111 shares of Envirotest Systems
Corp. Class C Common Stock (which do not have ordinary voting rights) were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Envirotest Systems Corp.'s definitive Proxy Statement for
the 1997 annual meeting of its stockholders are incorporated by reference
into Part III of this report, and portions of Envirotest Systems Corp.'s
Registration Statement No. 33-57384 filed on January 25, 1993, Amendments No.
1, No. 2 and No. 3 thereto, filed on March 12, 1993, March 25, 1993 and March
30, 1993, Amendment No. 2 to Envirotest Systems Corp.'s Registration
Statement No. 33-75406 filed on March 8, 1994, Form 10-K for the year ended
September 30, 1993, 1994 and 1995 and Forms 10-Q for the quarterly periods
ended December 31, 1994, and 1995, March 31, 1993, 1994, 1995 and 1996 and
June 30, 1994, 1995 and 1996 are incorporated by reference into Part IV of
this report.
TABLE OF CONTENTS
ITEM DESCRIPTION PAGE
PART I
1. Business ............................................................. 1
2. Properties ........................................................... 29
3. Legal Proceedings .................................................... 30
4. Submission of Matters to a Vote of
Security Holders ................................................... 32
PART II
5. Market for Registrant's Common Equity
and Related Stockholder Matters .................................... 33
6. Selected Financial Data .............................................. 34
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................................ 37
8. Financial Statements and Supplementary Data .......................... 42
9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure ............................. 77
PART III
10. Directors and Executive Officers of the Registrant.................... 78
11. Executive Compensation ............................................... 78
12. Security Ownership of Certain Beneficial
Owners and Management .............................................. 78
13. Certain Relationships and Related Transactions ....................... 78
PART IV
14. Exhibits, Financial Statement Schedules, and
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Reports on Form 8-K ................................................ 78
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PART I
ITEM 1. BUSINESS
ORGANIZATION; ACQUISITION HISTORY
Envirotest Systems Corp., a Delaware Corporation was organized in 1990
for the purpose of acquiring Hamilton Test Systems, Inc. ("HTS") from United
Technologies Corporation in December 1990 . Envirotest Systems Corp.
acquired Envirotest Technologies, Inc., a Delaware corporation ("ETI"),
formerly Systems Control, Inc. ("SC"), in April 1992 from SD-Scicon Plc, a
British subsidiary of Electronic Data Systems . In March 1993, Envirotest
Systems Corp. was merged into HTS, and HTS' name was changed to "Envirotest
Systems Corp." (the "Company" or "Envirotest"). In January 1996, Envirotest
purchased the Washington State subsidiary of SC, all of SC's intellectual
property rights and an option to purchase SC's Indiana vehicle emissions
testing contract and related assets. Envirotest exercised the option in
June 1996.
The Company conducts its operations directly and through its principal
wholly owned subsidiary, ETI, and through Envirotest Wisconsin Inc. and
Systems Controls, Inc.(a Washington corporation). The Company's British
Columbia, Canada operations are conducted through a British Columbia
partnership, Ebco-Hamilton Partners ("EHP"), which is controlled by wholly
owned subsidiaries of the Company.
The Company's principal offices are located at 246 Sobrante Way,
Sunnyvale, California 94086 (telephone (408) 774-6300).
GENERAL
Envirotest is the leading provider of centralized vehicle emissions
testing programs for states and municipalities. These programs are
established in accordance with federal regulations to test motor vehicle
emissions for compliance with air pollution standards. As of December 1,
1996, the Company operated 14 of the 22 currently existing
contractor-operated centralized programs in North America, and in fiscal 1996
performed nearly 11 million of the approximately 16.6 million tests conducted
in these programs. Envirotest is the most experienced operator in the
industry, having performed more than 140 million tests since its inception in
1974. In addition, the Company is the only domestic provider of
contractor-operated centralized testing services outside the United States.
Envirotest provides governmental authorities an all-inclusive service
whereby it designs, constructs, and operates centralized vehicle emissions
programs. In a centralized program, vehicles are inspected in high volume,
test-only facilities, operated either by a private contractor or a
governmental authority. A program network generally consists of 6 or more
facilities, each of which contains multiple testing lanes. In a
decentralized program, vehicles are tested at numerous privately-owned
facilities, such as gas stations and repair shops, which typically also
perform emissions repair work. Some states have considered programs that
contain elements of both a centralized and decentralized program.
The Company's services include: designing a network that provides
convenience to motorists; identifying and procuring adequate inspection
sites; constructing emissions facilities with multiple test lanes; designing
and installing a vehicle emissions inspection system and computer network to
collect and process emissions testing data; and managing and operating the
inspection program using sophisticated software and equipment developed by
the Company.
The Company enters into exclusive, long-term contracts that typically
have an initial term of five to ten years. These contracts may contain
options permitting the governmental authority to extend the contract on
similar terms and conditions for one or more extension periods of one to
three years each.
Envirotest believes that it will continue to be a leading provider of
centralized vehicle testing services because of the experience of its
management and its advanced software and systems integration capabilities.
SIGNIFICANT DEVELOPMENTS
On December 11, 1996, the Company sold its right to receive the two
remaining installment payments totaling $80 million in principal amount (the
"Receivable Assets") due under the General Release and Settlement Agreement
dated December 15, 1995 ("Settlement Agreement"), with the Commonwealth of
Pennsylvania for approximately $79,405,000. The Company retained the right
to receive accrued interest due on the date of closing of approximately
$1,749,000. The interest will be paid on July 31, 1997.
The transaction was effected through a sale of the Receivables Assets
from Envirotest Partners, a Pennsylvania general partnership owned by
Envirotest and ETI, to a newly formed wholly owned subsidiary of the Company,
ES Funding Corp. ("Funding"). Funding, in turn, transferred the Receivables
Assets to an affiliate of a Pennsylvania bank. Funding and Partners provided
certain representations in connection with the transaction, including
representations as to enforceability of the Settlement Agreement against the
Commonwealth, and agreed to repurchase the Receivables Assets if Partners
fails to comply with its obligations under the Settlement Agreement.
The Settlement Agreement requires the Company to use its best efforts to
dispose of the assets it acquired to perform emissions testing services in
Pennsylvania. If the net proceeds received by the Company from the sale of
the assets is less than $55 million, Pennsylvania is obligated to pay the
Company fifty percent of the difference up to $11 million no later than July
31, 1998. The amount of this contingent payment was reduced from $15 million
in an amendment to the Settlement Agreement that permitted the Company to
complete the sale transaction. The Company has retained its right to receive
proceeds upon the sale of the assets.
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In November of 1996, the Company was awarded a contract by the State of
Connecticut to assume responsibility for performing safety inspections of all
vehicles registered in the state for the first time and all vehicles 10 years
old or older undergoing a change of ownership. Under Connecticut law,
motorists are required to obtain a safety inspection of their vehicles upon a
change of ownership. Safety inspections will be performed at 11 of the
Company's stations in 15 specially equipped lanes. Approximately 160,000
vehicles are expected to receive safety inspections each year providing
annual revenues of approximately $2.1 million to the Company. The program
will commence in early 1997.
The Company signed a purchase agreement, dated August 26, 1996 (the
"Agreement"), with MARTA Technologies, Inc. ("MARTA"), a wholly-owned
subsidiary of The Allen Group Inc., to acquire the centralized emissions
testing programs operated by MARTA in the State of Maryland, Jacksonville,
Florida and Cincinnati, Ohio. The current term of the Maryland program
extends through April 1998, during which it is expected to generate revenues
of approximately $9 million. The Jacksonville program extends through March
1998 and is expected to generate annual revenues of $3 million. Effective
August 21, 1996, the Ohio Environmental Protection Agency suspended MARTA's
Cincinnati program, which is scheduled to run through 2005. The suspension
was subsequently found invalid by a court, and resolution of the matter is
pending. Consummation of the transaction contemplated by the Agreement is
subject to completion of due diligence and board approvals.
The Company purchased the Washington State subsidiary of SC, and all of
SC's intellectual property rights on January 30, 1996. The subsidiary has
operated the Washington State vehicle emissions testing program since 1982
and currently performs approximately 1.1 million tests annually. In June
1996, the Company acquired SC's contract with the State of Indiana to perform
vehicle emissions testing services and related program assets. The Indiana
contract has a ten-year term and is scheduled to test approximately 260,000
vehicles annually, starting in January 1997. In addition, all of the key
executives of SC have joined the Company including F. Robert Miller, formerly
President and Chief Executive Officer of SC, who has become President and
Chief Executive Officer of the Company.
INDUSTRY
HISTORY. The vehicle emissions testing industry developed in response
to the Clean Air Act of 1970 (the "Clean Air Act") and subsequent amendments
thereto. In 1974, Arizona became the first state to adopt a
contractor-operated centralized program when it awarded an emissions testing
contract to Envirotest. The Clean Air Act Amendments of 1977 required, for
the first time, the implementation of rudimentary inspection and maintenance
("I/M") programs in certain metropolitan areas and was responsible for the
implementation of I/M programs by the District of Columbia and most of the 35
states that currently have such programs. The 1990 Amendments of the Clean
Air Act classified U.S. metropolitan areas by the degree of air pollution and
required the U.S. Environmental Protection Agency ("EPA") to review and
revise its regulations on I/M
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programs. On November 5, 1992, the EPA adopted regulations (the
"Regulations") that required 179 metropolitan areas in 38 states and the
District of Columbia, with a total of approximately 87 million vehicles, to
have either a basic or enhanced I/M program in place by specified dates. The
number of areas requiring basic and enhanced I/M is continuously updated by
the EPA, and, in February 1995, the EPA published a report indicating that a
total of 179 areas required I/M, 84 areas with approximately 57 million
vehicles requiring enhanced testing programs and 95 areas with approximately
30 million vehicles requiring basic testing programs.
The initial emphasis of the Clean Air Act was to reduce air pollution by
requiring factories and other stationary sources of pollution to incorporate
anti-pollution technologies and by requiring automobile manufacturers to
equip vehicles with emissions control devices. An EPA study, however, has
found that, due to equipment deterioration and improper maintenance, an
average vehicle still emits two to four times the pollutants that it was
designed to emit. Vehicle emissions produce approximately 50% of the ozone
air pollution and nearly all of the carbon monoxide air pollution in
metropolitan areas. The EPA has estimated that enhanced I/M testing is
approximately 10 times more cost-effective in providing emission reductions
than the imposition of additional controls on stationary pollution sources,
and, as a result, has made it an integral part of the EPA's overall effort to
reduce air pollution by ensuring that vehicles meet emissions standards
throughout their useful lives.
Under the Clean Air Act as amended in 1990, and the Regulations, states
that have geographic areas with the worst nonattainment problems must adopt
I/M programs meeting at least the "low enhanced" performance standard and
whose performance, in combination with other air quality improvement programs,
will meet the overall Clean Air Act attainment requirements. This standard
establishes, among other things, the type of network and testing procedures
that must be utilized.
NETWORK TYPES. The EPA has allowed governmental authorities to determine
how best to establish and operate a network of emissions testing facilities,
with the result that two principal types of I/M programs have emerged:
centralized and decentralized. In a centralized I/M program, vehicles are
inspected in high-volume, multi-lane, highly automated test-only facilities,
operated either by private contractors or governmental authorities. These
facilities do not perform any repair work. In decentralized I/M programs,
vehicles are tested at licensed, privately owned facilities, such as gas
stations and repair shops, which typically also perform emissions repair
work. From time to time, some state officials have discussed a third type of
program (generally referred to as a "hybrid" program) containing both
centralized and decentralized components, generally requiring that a
significant percentage of the vehicle population obtain emissions testing in
test-only or centralized facilities, and allowing other vehicle owners the
option of obtaining testing at test-only facilities or at decentralized test
and repair facilities such as gas stations or repair shops.
In the preamble to the Regulations, the EPA stated that decentralized
programs, all of which currently allow emissions testing stations to also
perform repair work ("test-and-repair" programs), give rise to inherent
conflicts of interest that contribute to making them significantly less
effective
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than "test-only" programs. The only test-only programs in use are
provided through centralized networks, such as those operated by the Company.
In the past, the design of I/M programs, and the need for I/M testing
services, was largely driven by statutory and regulatory requirements that
dictated when and where a particular type of I/M program had to be
implemented. The Clean Air Act and the Regulations continue to require basic
and enhanced I/M programs in certain areas, and also establish the type of
network and testing procedures that must be adopted by affected states. The
existing statutory and regulatory requirements have, however, been
supplemented by additional legislative and regulatory enactments that give
states more flexibility in designing their I/M programs.
Today, the impetus for states to adopt centralized, test-only I/M
programs, utilizing the most sophisticated testing methods, is as much the
need to obtain the significant emissions reductions necessary for many states
to meet the health-based clean air standards established by EPA, as it is
specific statutory or regulatory I/M-related requirements. In general,
states may receive significantly greater emission reduction credits (used by
EPA to measure the efficacy of a particular pollution control mechanism
adopted by a state to achieve the applicable standards) for the adoption of a
centralized, test-only I/M system utilizing the most rigorous testing methods.
In November of 1996, EPA announced plans to change the current health
based standards for ozone and particulate pollution to better protect public
health. The proposed new standards would result in a significant increase in
the number of areas that would be classified as non-attainment areas for
these two pollutants. I/M programs will likely be required in many of these
new non-attainment areas to achieve the new standards. Many of the current
non-attainment areas which were able to demonstrate attainment with the use
of a low-enhanced or basic type I/M program may now have to upgrade to the
enhanced I/M programs to meet the new standards. Therefore, the Company
believes that the size of the market opportunities for both centralized and
decentralized enhanced and basic I/M programs will increase if these new more
strict ozone and particulate national ambient air quality standards are
adopted.
CURRENT MARKET SIZE. As of February 1995 (the date of the last EPA
publication containing information on the number of I/M programs), there were
44 I/M programs in operation in 33 states and the District of Columbia,
covering a total of 142 metropolitan areas and testing a total of
approximately 75 million vehicles. Of the currently existing I/M programs,
26 are centralized programs, testing approximately 30 million vehicles on an
annual or biennial basis, and 18 are decentralized programs, testing
approximately 45 million vehicles on an annual or biennial basis. The 1990
Amendments and Regulations require that I/M programs be implemented by
January 1, 1996 in 37 additional metropolitan areas, with a total of
approximately 12 million vehicles on an annual or biennial basis. While it
is possible that certain areas with rural populations may be relieved of the
requirement to implement an I/M program, the Company believes that the states
general desire to achieve the maximum emissions reduction credits possible in
the most efficient manner will be the principal factor influencing program
design decisions in the future.
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MARKET OVERVIEW. The following table identifies, as of December 1996,
the vehicle populations that are currently being tested in a centralized or
decentralized I/M program, the provider of centralized testing services, and
the vehicle populations that are subject to the basic and enhanced (including
low enhanced) testing requirements under the Regulations.
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EPA Classification
Existing Network Data Under Regulations(a)
---------------------------------------- ---------------------
Decentralized Centralized Centralized Basic Enhanced
State Program Program Provider Areas Areas
- -------- ------------- ----------- ----------- ----- --------
(# vehicles, millions) (# vehicles, millions)
Alaska 0.2 0.2
Arizona (opted up
to enhanced) 1.8 Gordon-Darby, Inc. 1.8
California 17.2 7.3 9.9
Colorado 1.8 Envirotest 0.6 1.5
Connecticut 2.0 Envirotest 2.0
Delaware 0.4 State Run 0.4
Florida
Broward/Pinellas 2.2 Gordon-Darby, Inc. 2.2
Dade/Palm Beach 1.9 Envirotest 1.9
Duval (b) 0.5 Marta 0.5
Georgia 1.0 2.0
Idaho 0.1 0.1
Illinois 4.5 Envirotest 4.7
Indiana 0.5 Envirotest 0.5
Kentucky 0.5 0.2
Louisville 0.4 Gordon-Darby, Inc.
Louisiana 0.5 0.2
Maine 0.6
Maryland (b) 1.4 Marta 1.4
Massachusetts 3.9 -- 3.9
Michigan 0.6
Minnesota 0.9 Envirotest 0.9
Missouri 1.2 1.2
Nevada 0.5 0.2 0.6
New Hampshire 0.2 0.6
New Jersey (hybrid
program) 1.0 3.8 State Run 4.8
New Mexico 0.5 0.5
New York 4.4 9.9
North Carolina 1.5 1.5
Ohio 3.5
Cuyahoga County 0.8 Envirotest
Cleveland-Akron 1.0 Envirotest
Dayton-Springfield 0.6 Envirotest
Cincinnati (b) 1.1 Marta
Oregon 0.7 State Run 0.8
Pennsylvania 3.2 5.9
Rhode Island 0.6 0.7
Tennessee
Nashville 0.6 Envirotest 0.6
Memphis 0.2 City Run 0.2
Texas 6.5 3.4 3.1
Utah 0.7 0.8
Vermont 0.1
Virginia 1.0 0.6 1.2
Washington State 1.6 Envirotest 1.6
Washington, D.C. 0.3 District Run 0.3
West Virginia 0.1
Wisconsin 0.9 Envirotest 0.9
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TOTAL 46.0 28.1 30.0 57.0
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(a) The EPA classifies metropolitan areas as basic or enhanced. Information
is provided by state for convenience.
(b) Envirotest has entered into a purchase agreement to acquire the right
to operate each of these programs . The purchase agreement is subject
to completion of due diligence and board approvals.
MARKET GROWTH OPPORTUNITIES. The 1990 Amendments and the Regulations
have resulted in a substantial increase in the size of the market for
contractor-operated centralized testing programs. Since November 1992, 12
states have instituted or contracted for programs involving a total of 15 new
or upgraded existing emissions testing programs, covering approximately 14.1
million vehicles. The Company believes that the most significant growth in
contractor-operated centralized
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programs will occur in metropolitan areas that are required to implement
enhanced testing, especially the 9 states, containing an estimated 47.9
million vehicles, that have not enacted legislation or final I/M regulations
in response to the Regulations, or have enacted legislation for a
contractor-operated centralized program but have not yet announced the
selection of a contractor. This belief is based upon the greater
cost-effectiveness and efficiency of centralized programs over existing
decentralized programs, and the Regulations' use of centralized programs as a
standard for testing. The EPA has estimated that the average cost of an
enhanced test in a centralized program will be substantially less than that
in a decentralized program. In addition, recent efforts to allow states
greater flexibility in designing their programs have resulted in an increased
interest in I/M program ancillary services and on-road testing as states
examine various ways to tailor programs to meet the needs of their local
interests groups and achieve more pollution credits. An example of the
developments in this area is one state that recently selected a contractor to
design, build and operate a data handling system that would connect the
participants in its decentralized program to a central data system; perform a
quality assurance and control program on its decentralized operators; perform
field audits of the participating stations; establish and conduct a public
information program; perform inspector training and station and inspector
licensing; issue waivers, exemptions and extensions to motorists; and manage
the program. All of these services have been performed by the Company either
in its centralized testing or quality assurance programs. The Company
believes that other states will consider the addition of these types of
services and features as part of their future I/M programs.
Additional growth opportunities may result from expansion of existing
centralized programs and privatization of state-run programs in enhanced
areas.
PENDING PROGRAM SELECTION
The Company is currently engaged in negotiations with the State of
Illinois to implement and operate its centralized enhanced I/M program under
a long-term contract. The Company has operated the State's basic program since
May 1986. The Company believes that the negotiations will be completed
during the first quarter of calendar 1997.
EMISSIONS TESTING CONTRACTS
The Company conducts its business under exclusive, long-term contracts
with governmental authorities. Under these contracts, the Company provides
all services needed to design, install, operate, and maintain an I/M program.
These services include: designing a network that provides convenience to
motorists; identifying and procuring adequate inspection sites; constructing
inspection facilities with multiple test lanes; designing and installing a
computer network to provide emission testing data to the appropriate
governmental authority (and, if necessary, to allow access to vehicle
registration data); and operating and maintaining the program. Envirotest's
I/M contracts have an initial term that generally ranges from five to ten
years, and may contain options
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permitting the governmental authority to extend the contract under similar
terms and conditions for one or more extension periods of up to two year
periods under one contract (which can be renewed). A governmental authority
may negotiate renewals or extensions on terms different from those in the
initial contract or expand the program to include additional counties or
services.
The table below describes certain contract terms, operating data, and
fiscal 1996 revenue data for each of the Company's existing emissions
programs.
Commencement Commencement of Stated Current Number of Number of Fiscal 1996
of Initial Current Expiration of Extension Facilities/ Paid Tests in Contract
State/Jurisdiction Contract Contract Current Term Options Lanes Fiscal 1996 Revenues
- ------------------ ------------ ---------------- ------------- ---------- ----------- ------------- ------------
Colorado 1/1/95 1/1/95 12/31/01 None 15/77 855,000 $19,878,000
Connecticut 1/1/83 1/1/95 6/30/02 None 25/87 1,212,290 16,472,000
Florida
- Dade County 4/1/91 4/1/91 3/31/98 Two 1-year 7/31 1,279,000 10,524,000
- Palm Beach County 4/1/91 4/1/91 3/31/98 Two 1-year 5/24 697,000 5,934,000
Illinois 5/1/86 1/1/96 6/30/97 None 22/92 1,552,247 12,013,000
Minnesota 7/1/91 7/1/91 6/30/98 None 9/38 961,625 7,407,000
Ohio 1/1/91 1/1/96 12/31/05 None 31/124 1,166,287 18,625,000
Tennessee 1/1/91 1/1/96 12/31/98 None 11/24 701,717 4,210,000
Wisconsin 4/1/84 12/1/95 11/30/02 None 12/44 744,124 8,682,000
Washington 1/2/82 6/1/93 12/31/99 None 20/84 776,852 6,157,000
British Columbia 9/1/92 9/1/92 8/31/99 None 12/42 646,752 10,147,000
------- ---------- ------------
Totals 169/667 10,592,894 $120,049,000
In December of 1996, the Company was notified that it has been selected
by the City of Anchorage, Alaska to operate its decentralized I/M program
quality assurance and refuse services contract for 1997. This contract is
valued at approximately $270,000.
In November 1996, the Company was awarded a contract by the State of
Connecticut to assume responsibility for performing safety inspections of all
vehicles registered in the state for the first time and all vehicles 10 years
old or older undergoing a change of ownership. Under Connecticut law,
motorists are required to obtain a safety inspection of their vehicles upon a
change of ownership. Safety inspections will be performed at 11 of the
Company's stations in 15 specially equipped lanes. Approximately 160,000
vehicles are expected to receive safety inspections each year providing
annual revenues of $2.1 million to the Company. The program will commence in
early 1997.
For the fiscal year ended September 30, 1996, approximately 96% of the
Company's contract revenues were derived from its 11 emissions testing
contracts with governmental authorities. The Company's five largest
contracts generated approximately 62% of its total contract revenues during
the period, with Colorado accounting for 16%, Ohio for 15%, Connecticut for
13%, Illinois for 10%, and Dade County, Florida for 8%. The termination or
failure to renew any of the Company's significant emissions testing contracts
could have a material adverse effect on the
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Company's financial condition, business, or prospects.
At September 30, 1996, the Company had a revenue backlog of
approximately $660 million for its contracts which extend through 2006,
compared to approximately $724 million at September 30, 1995. Approximately
$140 million of the backlog is expected to be realized during fiscal 1997.
The Company's revenue backlog per contract is calculated by multiplying
(i) the average annual test volume, (ii) the fee per vehicle tested, and
(iii) the remaining number of years in the contract term, excluding optional
extension periods. No assurances can be given that the Company will be able
to fully realize all of its revenue backlog.
The Company believes that, as the incumbent operator in its existing
programs, it generally has a competitive advantage when the programs are
rebid, primarily because the Company has already incurred the costs of
establishing the program network and has gained valuable experience in
operating the program. Each of the Company's emission testing contracts that
allowed for renewal or extension (and as to which the initial term expired)
has been renewed or extended beyond its initial term. There can be no
assurance, however, that existing options to extend contract terms will be
exercised, or that the Company will be awarded a new contract when its
existing I/M contracts are rebid.
The Company's contracts generally set the fee the Company will receive
for each vehicle tested, which is established at the time the contract is
awarded. The Company's fee is based on a number of factors, including the
type of test performed under the program, the vehicle population of a test
area, the number of test lanes installed, and the cost of labor and real
estate. The governmental authority sets the frequency at which vehicles must
be tested, typically annually or biennially, and imposes penalties on
motorists for noncompliance, usually denial or suspension of vehicle
registration. A governmental entity may, during the term of a contract,
request that the Company change the scope of work specified in the contract.
These changes may include an expansion of the geographic area covered by the
contract or program enhancements, and generally result in the negotiation of
an additional fee to be paid to the Company.
Under most of the Company's contracts, the governmental authority has the
right, and in some cases may be obligated, to purchase the Company's program
facilities upon termination of the contract, at a price generally determined
by applying specified criteria set forth in the contract. This price is
usually based on fair market value or book value of, or actual cost to the
Company for, the program sites and facilities, and the Company believes that
such prices would provide the Company adequate consideration for the value of
the assets purchased. The Company's contracts also permit the governmental
authority to terminate the contract for cause, generally after specified
grace periods. Most of these contracts also expressly provide for
termination if the legislation authorizing the I/M program is repealed or if
sufficient funds for the program are not appropriated by the relevant
governmental authority. More than half of the Company's contracts also allow
the
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governmental authority to terminate the contract without cause, upon giving
advance written notice of not less than 30 days. The Company believes that
it is generally entitled, either under the express terms of the contract or
under applicable law, to equitable or reasonable compensation for certain
costs associated with the termination of the contract without cause.
In addition, under most of the Company's I/M contracts, the Company is
required to pay liquidated damages as a penalty for failure to meet specified
start-up dates or performance requirements, in many cases after a specified
grace period. Liquidated damages provisions are customary in emissions
testing contracts. Liquidated damages provisions require payments of up to
$10,000 a day for late system start-up, up to $5,000 per day for inaccurate
reports submitted by the Company, up to ten percent of the fee due to the
Company for the tests performed for submitting incomplete, incorrect, or
illegible reports, or up to $10,000 per day for failing to allow access to
the Company's program facility or emissions testing data. At least one
contract requires the Company to pay the state liquidated damages in the
amount of $1.0 million if the contract is terminated for cause. The Company
is also required to post performance bonds once the contract is awarded.
Those bonds, which range in amount from $100,000 to $1,500,000, protect the
governmental authority for the cost of replacing the existing operator if the
governmental authority terminates the contract for cause prior to expiration.
OTHER I/M PROGRAM CONTRACTS
QUALITY ASSURANCE SERVICES. Envirotest has provided quality assurance
services in the largest and most comprehensive decentralized test-and-repair
system in the United States. Under the contract, the Company employed more
than 15 inspectors to perform trimester audits at the more than 8,700 "smog"
stations. During the audit, the inspectors ensured that the equipment was
properly calibrated, the appropriate testing procedures followed, and the
required paperwork completed. The Company also certified testing personnel
and maintained a current list of the identity and station affiliation of
licensed mechanics. The contract commenced in July 1990 and ended at the end
of September 1996.
REFEREE SERVICES. The Company has a contract with the Municipality of
Anchorage to provide referee services. Under the referee program, the
Company resolves disputes between motorists and private garages, which
conduct emissions tests for the Municipality. This contract commenced in
January 1992, and has been renewed through December 1997.
REMOTE SENSING TECHNOLOGY. In July 1995, the Company's wholly-owned
subsidiary, Remote Sensing Technology, Inc. ("RST") entered into a three year
contract with the State of California to monitor vehicle emissions. RST uses
high speed, high resolution video camera technology and automatic license
plate recognition software to record emissions levels and vehicle
identification information on a color video image of passing vehicles without
the need to stop the vehicles. This technology is designed to measure, from
a road-side location, vehicle emissions from as many as 1,000 vehicles per
hour, and will supplement regular test lane programs. There
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has been increasing interest in this technology, and in the past year RST has
signed contracts to perform pilot programs in New York, Texas and Virginia.
CONTRACT AWARD PROCESS
PRE-BID MARKETING. The Company considers its participation in the
legislative and regulatory authorization process for emission testing
programs to be an important initial step in marketing its services. To
coordinate this effort, the Company's marketing staff divides the United
States into the Northeast, Midwest, Southeast and Western regions. Each
regional manager reports to Envirotest's Vice President of Marketing and is
responsible for monitoring the authorization process in each of the states
and municipalities within a particular region. With the help of legislative
consultants, the Company's marketing staff educates states and municipalities
on the environmental and operational benefits associated with
contractor-operated centralized programs, and attempts to build support for
adoption of such a program among environmental and health organizations as
well as other interested parties that might benefit from implementation of
the most effective I/M program. Once legislation authorizing a centralized
contractor-operated program is enacted, interested parties (including the
Company and its competitors) are often asked to assist the appropriate
governmental authority in drafting the technical aspects of a bid request.
This effort often includes reviewing bid criteria and recommending specified
test programs. Once drafted, the bid request is typically revised several
times as a result of input provided by potential bidders and other interested
members of the public. Generally, the bid request establishes several
convenience factors such as the maximum average waiting time and driving
distance to a testing station, and specifies the technical requirements of
the program.
BID REQUESTS. Typically, bid requests are solicited through either a
"request for proposals" ("RFP") or an "invitation to bid" ("ITB"). In the
more commonly used RFP process, bids are evaluated on the following criteria:
(i) the operating experience, reputation, and financial capability of the
bidder; (ii) the bidder's ability to install and operate a technically
sophisticated testing system in terms of both hardware and software;
(iii) the bidder's ability to integrate testing results with vehicle
registration information in state computer data systems; (iv) the bidder's
ability to provide additional services (such as safety inspections, enhanced
I/M diagnostic tests, and mobile testing); (v) the bidder's ability to meet
specified performance requirements; and (vi) price. Because several factors
are considered in the RFP process, the contract is not necessarily awarded to
the lowest qualified bidder. In the ITB process, the governmental authority
generally conducts a limited review of a bid to determine if it meets a
minimally acceptable technical standard, and generally awards the contract to
the lowest qualified bidder. To date, the Company knows of only four states
that have conducted bids through an ITB process, two of which awarded a
contract to the Company and a third was acquired by the Company. Although no
assurance can be given, the Company believes that the complexity of the
services required for enhanced programs under the Regulations generally will
discourage the use of ITBs in enhanced areas in the future.
BID PREPARATION PROCESS. The Company has developed a sophisticated
network
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optimization model that it uses to design the most efficient program
network for any given region and set of program parameters, which are
detailed in the bid request. These program parameters include: (i) the
expected number of vehicles to be tested annually; (ii) the amount of time
required to conduct an emissions test; (iii) the convenience factors to be
met, such as average waiting time and maximum driving distance to a testing
location; and (iv) the vehicle density of various geographical areas in the
program region. The Company's optimization model assists the Company in
designing a network that provides the greatest convenience and highest
vehicle throughput with the fewest number of testing locations.
As a part of the process of preparing a bid, the Company identifies
particular real estate parcels in a region that meet the criteria contained
in the network optimization model. The Company may secure options prior to
submitting its bid on certain parcels of real estate that it considers to be
important to the construction of an efficient program. The Company has also
developed a sophisticated costing model, which assists the Company in
predicting the engineering, development, construction, and operating costs of
a proposed program. In utilizing the costing model, the Company takes into
account the real estate, construction, labor, equipment, and other costs
which may be particular to a specific geographic region or program.
CONTRACTOR SELECTION. After bid proposals have been received, the
governmental authority will often invite several candidates to make oral
presentations discussing their proposals. The governmental authority then
selects one contractor (the "selected contractor"), and begins negotiating a
contract with respect to the program, usually after a public announcement of
the selection. The principal contract terms are contained in or derived from
the RFP and the proposal submitted by the bidder. The Company has entered
into all such contracts on terms substantially similar to those contained in
its bid, including a test fee no lower than that contained in the bid. There
can be no assurance, however, that the Company will enter into a contract
after becoming the selected contractor with respect to any program.
PROGRAM IMPLEMENTATION. Once the Company and the governmental authority
enter into a contract, the Company begins the process of purchasing or
leasing real estate, constructing the program facilities, and developing and
installing the necessary hardware and software. This process generally takes
six months to two years to complete, depending on the size of the network.
Approximately six months prior to the anticipated commencement of testing,
the Company begins a media campaign to educate the public about the new
program. At the same time, the Company will also begin to hire and train its
workers. Each program is implemented by a start-up team consisting of a
program manager, who is responsible for communicating with the governmental
authority and for managing the Company's operations under the contract,
station managers, who are responsible for the individual operation of each
station, and other support staff. Once implemented, the operation of the
program is also monitored by the Company's senior management on an ongoing
basis.
During the contract term, the Company discusses with the governmental
authority the
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exercise of extension options, if any, or the renewal of the
contract. Depending upon the program's enabling legislation, the
governmental authority may either extend the contract or commence a new
competitive bidding process.
SOFTWARE AND RELATED TESTING EQUIPMENT
The Company has developed sophisticated computer software and hardware
that is essential to the efficient operation of its I/M program facilities.
Central mainframe computers and various peripheral devices located at the
Company's program headquarters monitor each of the Company's inspection lanes
and process and permanently store complete vehicle test histories.
SOFTWARE. The Company believes that its ability to develop
program-specific software for the essential operations of a program are
important to the efficient operation of its testing facilities. The Company
has devoted significant efforts to its development of software systems, which
enable it to conduct highly automated tests and to achieve high throughput
rates. The Company's software has allowed it to automate most of the
important functions of the testing process, including setting the appropriate
emissions standards against which vehicles are tested (these standards vary
by manufacturer, model, and year). The Company's lane operators are prompted
with step-by-step instructions for performing the tests and processing the
results. The Company's expertise in this area is utilized to develop new
software systems for its enhanced programs.
The Company has also developed a system that provides the inspector with
a computer-generated image of the particular vehicle's engine. This image
highlights those areas where pollution control devices are installed in order
to facilitate the inspection of these devices. The system is highly
automated in order to minimize operator input error and can be easily
upgraded to include new operational test standards and procedures.
TESTING EQUIPMENT. Envirotest's computer-managed inspection systems
control the automated inspection of a motor vehicle, based upon identifying
characteristics such as make, model, year, and engine size. The inspection
process is usually divided into multiple test positions that are designed for
specialized functions and are serviced by computers, specialized test
equipment, and associated applications software. The Company also utilizes a
variety of data entry devices such as optical-code and bar-code readers, and
various test equipment such as dynamometers and emissions measurement
systems. The Company chooses from a number of equipment suppliers to meet
the requirements of a specific system design, depending on applicable
specifications and pricing.
Specialized hardware, software and engineering are combined to provide a
highly automated inspection system with a design and operational emphasis on
test data integrity and high-throughput operation. The Company acts as a
systems integrator and does not manufacture any hardware. However,
specialized hardware is designed and engineered as needed.
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ADDITIONAL GROWTH OPPORTUNITIES
The Company offers a variety of program enhancements, including on-road
testing, safety inspection, and vehicle registration services, although
presently there is only a limited market for these services. These program
enhancements offer governmental authorities and motorists the convenience of
multiple vehicle certification services at a single location. Once its
network of emissions testing facilities are in place, the Company is able to
offer these additional services for an additional fee without incurring
significant incremental capital expenditures. The Company anticipates that
the privatization of services traditionally provided by governmental
authorities will increase the market for these services.
ANCILLARY SERVICES. Recent efforts to allow states greater flexibility
in designing their programs has resulted in an increased interest in I/M
program ancillary services and on-road testing as states examine various ways
to add features to their programs and achieve more pollution credits. One
state has recently selected a contractor to design, build and operate a data
handling system that would connect the participants in its decentralized
program to a central data system; perform a quality assurance and control
program on its decentralized operators; perform field audits of the
participating stations; establish and conduct a public information program;
perform inspector training and station and inspector licensing; issue
waivers, exemptions and extensions to motorists; and manage the program. All
of these services are performed by the Company either in its centralized
testing or in quality assurance programs previously operated by the Company.
The Company believes there will be a desire on the part of other states to
consider these types of services and features as part of their I/M program.
ON-ROAD EMISSIONS TESTING: REMOTE SENSING DEVICES. The Regulations
require that programs in enhanced areas conduct on-road emissions tests,
using either remote sensing devices or roadside pullovers, to evaluate the
emissions of at least 0.5% of the vehicle fleet required to be tested or
20,000 vehicles, whichever is less. On-road emissions testing randomly tests
vehicles for compliance with emissions requirements, principally to deter
motorists from tampering with emissions control devices after passing the
mandatory test. The use of the remote sensing device is substantially less
expensive and less disruptive to the consumer than roadside pullovers. The
statutory timetable for implementation of on-road testing is the same as that
for implementation of enhanced I/M programs.
In 1991, Envirotest entered into a Development and Exclusive License
Agreement (the "License Agreement") with the University of Denver and two
University of Denver research scientists pursuant to which the Company
acquired the exclusive right to manufacture and market a remote sensing
device system ("RSD") used to monitor the carbon monoxide, carbon dioxide,
and hydrocarbons emitted from a moving vehicle. The RSD is designed to
measure from a roadside location vehicle emissions from as many as 1,000
vehicles per hour, and photographs the subject vehicle to record its license
plate number. RSD technology is intended to supplement, and not replace,
regular test lane programs, since it is only capable of identifying gross
tailpipe emitters.
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The Company is aware of at least one competitor that currently has in
development a product similar to RSD.
The Company is currently expanding its initial marketing of its RSD
technology, and signed contracts during fiscal 1996 to perform pilot study
programs in New York, Texas and Virginia. The system has been tested
successfully by a number of independent research scientists who have
concluded that it accurately and reliably detects emissions violations. In
addition, the Company is developing several testing enhancements that could
contribute to the commercial utility of the RSD system, some of which are
subject to pending patent applications. Also, the Company has conducted a
review of the fundamental technology of the RSD system and filed for patent
applications or protections that it believes will enhance its competitive
position.
In 1996, EPA issued draft guidance that provides for the possibility of
receiving substantial additional emission reduction credits for those states
that choose to implement significant remote sensing programs covering large
percentages of eligible vehicles. EPA is currently in the process of working
with interested states to help them translate this draft guidance into
specific RSD programs. The Company believes that the results of this effort,
as well as any additional credits that the EPA may assign to utilization of
this technology, will be the principal factors in determining the market for
remote sensing. The Company cannot predict the extent to which the EPA will
assign credits to remote sensing technology or the ultimate size of the
market for this technology.
The Company also believes that the EPA's policy of allowing states
greater flexibility in designing their I/M programs will result in increased
interest in the use of remote sensing technology.
DECENTRALIZED SERVICE PROVIDER. Recent changes to I/M program
legislation have resulted in increased interest in hybrid programs by the
states. Some of the concepts discussed by certain states would require that
vehicles with certain model years be directed to test-only stations, and that
those with different model years be allowed to go to decentralized test and
repair facilities which would be required to purchase new equipment and
submit to increased oversight on the part of the state. The Company has
considered entering the decentralized provider market. This could take any
one of several different forms, including forming a relationship with a third
party having a significant real estate presence in one or more jurisdictions
and operations that attract a significant number of vehicles. Because of its
experience in the vehicle testing business and its technological expertise,
the Company believes that it will have meaningful opportunities in the
decentralized market if it chooses to explore them.
SAFETY INSPECTION SERVICES. The Company believes it is a leader in
safety inspection technology, and currently offers fully-automated safety
inspection services at its testing facilities in Connecticut, and Florida.
The Company has recently signed a contract with the State of Connecticut
significantly expanding its safety inspection services in the State to an
estimated
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160,000 vehicles annually. In addition, the Company has designed
and currently maintains a state-of-the-art turnkey facility for inspection of
New York City taxicabs and limousines. The Company also inspects the taxicab
fleet in the City of Miami on behalf of Dade County. The Company believes
that its existing centralized testing infrastructure, as well as its
expertise in safety inspection testing equipment and procedures put it in a
favorable competitive position if centralized safety inspections are mandated
in the future in states in which it conducts centralized testing. The
National Highway Transportation Safety Administration has stated that it
favors the adoption of periodic safety inspections programs. The recent
award by Connecticut of a safety inspection contract to the Company
demonstrates growing interest on the part of states to be able to provide
their residents with the convenience of safety and emission testing services
in one location.
VEHICLE REGISTRATION SERVICES. The Company has the capability to offer
the convenience of vehicle registration during an emissions testing visit
through the use of its internally-developed software packages to access motor
vehicle records. Wisconsin and certain other states required bidders for
their I/M programs to include a proposal for conducting vehicle registration
services in the emission inspection lanes. Of these states, Wisconsin has
asked the Company to provide registration services at 12 facilities
commencing in the first quarter of calendar 1997. Although no assurances can
be given as to whether other states will include vehicle registration
services in their programs, the Company anticipates that there will be
increasing state interest in the performance of registration services in the
test lanes.
OPPORTUNITIES IN FOREIGN JURISDICTIONS. Although the Company's current
focus is on expansion in domestic markets, management believes that there may
be future opportunities for its services in foreign jurisdictions. The
Company currently operates Canada's only centralized I/M program through its
Canadian subsidiary, Ebco-Hamilton Partners. This program, which operates in
Vancouver, British Columbia, represented the most technologically advanced
emissions testing program in North America prior to the commencement of I/M
240 testing in the United States. The Company is also seeing an emerging
market for safety and BAR90 emission testing services in South and Central
America and Asia-Pacific, and is currently evaluating bid opportunities with
local joint venture partners in several of these areas. In addition, the
Company designed and sold to the Republic of Taiwan a turnkey test system
that is operated by the government to test passenger car and truck emissions.
In November 1994, the Company entered into a contract with Mexico City, Mexico
for the construction of an I/M 240 test lane. In December 1993, Envirotest
entered into a contract with the Government of India to provide four turnkey
heavy duty vehicle emissions and safety lanes in four different cities in the
country. The Company continues to actively monitor developments in mobile
source pollution regulation in foreign jurisdictions, although only a few
countries other than the United States have implemented centralized vehicle
emissions testing. There can be no assurance that foreign jurisdictions will
institute contractor-operated centralized I/M programs, or that the Company
will be awarded I/M contracts by any that may institute such programs.
INTELLECTUAL PROPERTY
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Envirotest has a number of patents, trademarks, and copyrights relating
to the computer hardware and software programs developed for use in its test
lanes. In addition, as mentioned above, the Company has entered into a
License Agreement under which it has the right to manufacture and market RSD,
and, in connection with the acquisition of SC's Washington program, purchased
the right to all intellectual property of SC. Although the Company believes
that its intellectual property rights are important to the marketing of its
services, it does not believe that they are material to its business.
PERSONNEL
As of November 30, 1996, the Company had 3,124 employees, of which
1,079 are full-time and 2,045 are part-time employees. None of the
Company's domestic employees is represented by a labor union. Of the 290
employees employed (through EHP) in the British Columbia program, 270 are
represented by a labor union under the terms of a collective bargaining
agreement that expires on August 31, 1999 (the termination date of the
Company's contract in British Columbia). The Company believes that its
employee relations are satisfactory.
COMPETITION
The market for contractor-operated I/M programs is highly competitive.
Generally, governmental entities consider a number of criteria in selecting a
contractor, including: the operating experience, reputation, and financial
capability of the bidder; the bidder's ability to install and operate a
technically sophisticated testing system in terms of both hardware and
software; the bidder's ability to integrate testing results with vehicle
registration information in state computer data systems; the bidder's ability
to provide supplemental services; the bidder's ability to meet specified
performance requirements; and price. The Company typically competes against
numerous bidders for new or renewal contracts. In addition, the Company also
potentially competes against decentralized program operators when a
governmental authority considers what type of I/M network to adopt.
The Company's principal domestic competitors include Gordon-Darby, Inc.
("Gordon-Darby") and MARTA. Gordon-Darby operates four programs, testing
approximately 3.9 million vehicles per year. MARTA has contracts to operate
three programs, testing approximately 3.0 million vehicles annually, and is
wholly owned by The Allen Group. The Company is engaged in negotiations with
MARTA to acquire its operating programs. The Company also competes with
several other domestic and foreign companies who choose to bid from time to
time on select programs. Also, the Company may compete with test providers in
decentralized markets depending upon the format of any particular program.
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GOVERNMENT REGULATION
The market for the Company's services is substantially dependent upon
state and federal legislation and regulations mandating air pollution
controls and vehicle emissions testing. The availability of new emissions
testing contracts depends largely on the manner by which governmental
authorities choose to implement emissions testing programs to comply with the
Clean Air Act and the regulations thereunder. Specifically, governmental
authorities may, with certain limitations, implement decentralized or state-
run programs, as opposed to centralized contractor-operated programs. State
legislatures and environmental protection and transportation agencies, the
Congress, and the EPA may adopt new, or modify existing laws, regulations,
and policies regarding a wide variety of matters that could, directly or
indirectly, adversely affect the emissions testing industry.
The motor vehicle I/M industry in the United States developed as a
result of the Clean Air Act of 1970, as amended, and EPA regulations
promulgated thereunder. The Clean Air Act has been the driving force behind
the Nation's effort to reduce ambient mobile and stationary source pollution.
THE CLEAN AIR ACT OF 1970. The Clean Air Act required EPA to establish
national ambient air quality standards ("NAAQS") for certain pollutants
(including ground level ozone pollution or "smog") to protect the public
health. Each state was required to develop and adopt a "State Implementation
Plan" or "SIP," to assure that all applicable NAAQS were achieved by the
statutory deadlines, and maintained thereafter. Under the Act, stationary
source polluters were required to incorporate antipollution technologies and
automobile manufacturers were required to equip motor vehicles with new
emissions control devices, in order to reduce the discharge of ambient
pollutants. Although not required by the Clean Air Act, a few states adopted
I/M programs in the early to mid- 1970s in order to ensure that vehicle
emission control devices continued properly to operate, in order to meet
applicable emissions standards. In 1974, Arizona became the first state to
adopt a contractor operated centralized program when it awarded its contract
to Hamilton Test Systems.
THE CLEAN AIR ACT AMENDMENTS OF 1977. The Clean Air Act was amended in
1977, after it had become clear that the NAAQS would not be achieved by the
statutory deadlines in all areas. These amendments required, for the first
time, the implementation of basic I/M programs in metropolitan areas that
could not demonstrate compliance with the applicable NAAQS by 1982. The 1977
Amendments required the implementation of I/M programs by the District of
Columbia and most of the 34 states that currently have such programs. States
were permitted to select the program network type, which historically have
been either centralized or decentralized, and to select the test procedures
to be utilized in the program from among three models approved by the EPA.
THE CLEAN AIR ACT AMENDMENTS OF 1990 AND REGULATIONS ADOPTED THEREUNDER.
By the
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late 1980's it again had become clear that the Clean Air Act's deadlines for
achieving NAAQS would not be met, and the Act was again amended in 1990.
These amendments emphasized the need for effective I/M programs. The 1990
amendments required the EPA to review, revise, and republish its guidance on
I/M programs. This resulted in a thorough review by the EPA of I/M testing
programs and procedures and their effectiveness in ensuring the proper,
continuous operation of vehicle emission control equipment, thus reducing
vehicle emissions. EPA promulgated final regulations governing I/M programs
on November 5, 1992 (the "Regulations").
The 1990 Amendments required, among other things, that the most
seriously polluted metropolitan areas in the United States achieve a 24%
reduction in total vehicle emissions by November 15, 1999. Many areas also
were required to adopt "enhanced" I/M programs.
Under the statute and EPA's Regulations, I/M programs are required in 179
geographic areas, 39 of which did not have any I/M program as of July 1995
(the last date for which EPA date is available). The 1990 Amendments create a
rating scale to indicate the degree of an area's failure to attain the
applicable NAAQS. For ozone, the classifications are "extreme," "severe,"
"serious," "moderate," and "marginal." Under the current ozone NAAQS, 95
non-attainment areas are required to implement programs that meet the "basic"
performance standard established by the Regulations. Programs that meet the
"enhanced" performance standard established by the Regulations will be
required in the 84 areas that: (i) have serious, severe or extreme ozone
non-attainment and urbanized area populations of 200,000 or more; (ii) have
moderate or serious carbon monoxide non-attainment with a design value
exceeding 12.7 parts per million and urbanized area populations of 200,000 or
more; and (iii) have a population of 100,000 or more in the Northeast Ozone
Transport Region (an area covering most of the northeastern United States
from Virginia to Maine).
In September 1995, the EPA adopted an amendment to the Regulations that
created a new "low enhanced" performance standard. The low enhanced standard
is intended to provide greater flexibility for those metropolitan areas that
do not need all the emissions reduction credits from a full enhanced I/M
program to meet the "reasonable further progress" and attainment
requirements. Emission reduction "credits" are used by the EPA to measure the
ability of a particular pollution control mechanism, such as I/M vehicle
testing or stationary-source technologies, to enable a state to meet the
overall air pollution reductions mandated by the 1990 Amendments. The EPA,
however, has maintained that significantly more credits will be awarded to
enhanced programs than to basic programs. To the extent that a state is able
to earn additional credits through a stricter I/M program, it will be
required to earn fewer credits through emissions reductions in other sources,
primarily stationary sources such as factories, thereby potentially
permitting industrial growth that might otherwise have been limited by the
Clean Air Act.
The low enhanced performance standard primarily differs from the high
enhanced
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standard in that it allows for idle testing of all covered vehicles. Under
the high enhanced standard, idle testing is allowable only for pre-1981
vehicles. Vehicle model years beginning with 1986 must meet the I/M 240 test
(described under "Test Procedures") or an equivalent enhanced test. (Vehicles
in model years 1981-1985 must meet two-speed testing under a high enhanced
system). Significantly, the low enhanced performance standard is based upon
a centralized testing network type, as is the high enhanced standard,
although a decentralized, test-and-repair system, with certain additional
features can qualify under the standard. EPA made clear in its September 18,
1995, final rule that the low enhanced standard was designed only for those
areas "which either do not have a major mobile source component to their air
pollution problem or which do not require I/M programs which achieve
substantial reductions in automotive emissions to achieve air quality goals."
NETWORK TYPE. The EPA's performance standards in the Regulations for
basic, low enhanced and enhanced programs were modeled on a centralized
test-only network conducting annual inspections. However, the Regulations
allow governmental entities a limited degree of latitude in designing
alternative programs. Both centralized and decentralized "test-only"
programs are presumed to achieve the applicable performance standards. A
program is defined by the Regulations to be "test-only" if it consists of
stations that only perform official I/M testing (which may include
safety-related inspections) and in which owners and employees of these
stations, or companies owning these stations, are contractually or legally
barred from engaging in motor vehicle repairs or service, motor vehicle parts
sales, and motor vehicle sale and leasing, either directly or indirectly, and
are barred from referring vehicle owners to particular providers of motor
vehicle repair services. A decentralized test and repair program is
permissible in basic areas. In enhanced areas, however, it is acceptable only
if the governmental authority can demonstrate to the EPA that the program,
with required improvements and all other emission reduction programs, is
sufficient to achieve the total amount of emission reductions that is
required to meet the "reasonable further progress and attainment" requirements
of the Clean Air Act. In the preamble to the Regulations, the EPA stated
that it could not accept any of the currently operating decentralized
test-and-repair programs as equally effective as centralized due to their
inherent flaws. (The Regulations also permit the use of a combination of
decentralized test-only and decentralized test-and-repair stations, subject
to the limitations described above applicable to decentralized
test-and-repair stations.)
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In that regard, the Regulations provide that, if a decentralized
test-and-repair program is implemented in either a basic or enhanced area,
the pollution credits awarded to the program will be assumed to be 50% less
for some test procedures, and 75% less for other test procedures, than for
the same tests conducted through centralized or decentralized test-only
programs. This reflects EPA's careful assessment of the inherent problems
associated with test-and-repair networks. However, these discounts for
test-and-repair programs were only rebuttable presumptions and could be
reduced if a state can demonstrate to the satisfaction of the EPA that its
test-and-repair system will exceed the 50% or 75% levels, as applicable,
based upon past performance with the specific test-type and inspection
standards employed.
In any case, EPA's more recent practice has been to depart from the
automatic imposition of these presumptive discounts and, instead consider
carefully all the relevant facts and circumstances in determining how a given
test and repair network is to be scored for air quality credit purposes.
In this respect, EPA's practice was subsequently codified in the
National Highway System Designation Act of 1995 (NHSDA). The NHSDA made two
important changes to EPA's authority regarding the establishment of I/M
programs. In particular, it provided that EPA may no longer require states
to adopt a test only, I/M 240 enhanced inspection and maintenance program as a
means of compliance with the Clean Air Act (although EPA is free to approve
such programs if a state chooses to adopt one). In addition, the NHSDA
provided that EPA may not automatically discount the air emission reduction
credit states receive if they adopt a decentralized, test-and-repair system.
However, the NHSDA affirmed that the burden of proof remains with the
states, and gave states only 120 days after enactment of the statute (in
November, 1995) to submit revisions to the I/M programs in their SIPs. As
part of these submissions, a state must make a good faith estimate of the
actual emissions reductions associated with the proposed I/M system. EPA must
approve proposed programs on an interim basis, granting the full emission
reductions credit claimed by a state, so long as such claims reflect a "good
faith" estimate of the reductions associated with the proposed program. EPA
must grant final approval to the program if, after the statutorily required
18-month interim approval period, the "data collected on the operation of the
state program demonstrates that the credits are appropriate and the revision
is otherwise in compliance with the Clean Air Act." According to EPA, ten
states and the District of Columbia submitted proposals under the NHSDA to
revise their I/M program requirements. These ten states were: Alaska,
California, Georgia, Massachusetts, New Jersey, New York, Pennsylvania,
Texas, Utah, and Virginia.
EPA issued for public comment proposed conditional interim rules in
October 1996, after receiving recommendations on a methodology for reviewing
the SIPS. This methodology includes both a quantitative and qualitative
evaluation of the effectiveness of the programs over both the short term and
long term operation of the programs.
-22-
TESTING PROCEDURES: NEW EMISSIONS TESTS IN ENHANCED AREAS. Today, three
principal types of EPA-approved tests are generally performed: idle,
two-speed idle, and loaded/idle. EPA and state audits have indicated that
the simple idle and the two-speed idle tests used in most I/M programs have
serious shortcomings. These styles of tests worked well for pre-1981,
non-computerized vehicles containing carburetors because typical emission
control problems involved "rich" airfield mixtures that affected idle as well
as cruising emissions. However, today's high tech vehicles are more
effectively tested with procedures that include cycles of acceleration,
deceleration, and cruising under loaded conditions.
The EPA's performance standard for high enhanced programs requires the
implementation of a new, more sophisticated emissions test, called the "I/M
240" transient test (or an equivalent enhanced test approved by EPA), which
is a shorter version of the test procedure used by the federal government to
certify new vehicle compliance with emissions control equipment design
standards. The I/M 240 test, so named because it is estimated to take 240
seconds to perform the test, is conducted on a dynamometer, a treadmill-type
device that simulates actual driving conditions, including periods of
acceleration and deceleration. The I/M 240 test measures tailpipe emissions
more accurately than existing tests. The test is required to be performed on
all 1986 and later model year vehicles for programs with annual testing, and
on all 1984 and later model year vehicles for programs with biennial testing.
The two-speed idle test is permitted to be utilized for 1981 to 1985 model
year vehicles, and the idle test is permitted to be utilized for 1968 to 1981
model year vehicles. Testing must be performed on all 1968 and newer model
year light duty vehicles and light duty trucks rated up to 8,500 pounds gross
vehicle weight.
The Regulations also require enhanced programs to use a pressure check
to identify evaporative emissions leaks in the fuel system and a "purge"
check to ensure that fuel vapors stored in the vehicle evaporative canister
are routed to the engine and burned as fuel. Historically, I/M programs have
been designed to reduce only emissions of volatile organic compounds and
carbon monoxide. The high-tech test procedures required by the EPA, which
are also designed to reduce the levels of nitrogen oxide released into the
air, reflect the EPA's stated belief that reducing these pollutants is
increasingly important to air quality.
To date, most emission testing has been conducted annually. The EPA has
stated, however, that if high-tech tests are used and certain other
conditions are met, it will permit, and is now encouraging states to adopt,
biennial testing in order to reduce the cost to the motorist.
The EPA has stated that it plans to continue to assess alternatives to
the I/M 240 test, some of which may be less costly, such as the Acceleration
Simulation Mode ("ASM") test cycle which is a compromise between previous
steady state load mode testing procedures and the I/M 240. It attempts to
simulate acceleration conditions by applying a higher load to the drive
wheels of
-23-
a vehicle which is intended to simulate the load or strain a vehicle would
experience while accelerating. However, the test is performed under constant
speed conditions of 15 or 25 miles per hour. It is, therefore, a less
accurate test procedure, but the equipment required to perform it is far less
expensive than the I/M 240 test; but is more expensive than that currently
used in decentralized facilities. In a centralized high volume testing
program, where one equipment set may test 20,000 or more vehicles per year,
the cost of the I/M 240 versus the ASM test equipment may amount to less than
$1.00 per test. In decentralized test-only or test-and-repair programs, the
cost differential between the two equipment sets can be substantial because
of the low volume of vehicles tested at these facilities (typically 1,000 per
year).
TESTING PROCEDURES: IN BASIC AREAS. Although the EPA has stated that
states classified by the EPA as basic I/M areas should consider utilizing the
high-tech tests, the performance standard for basic and low enhanced programs
allows states to use the idle test. Testing must be performed on all 1968
and later model year light duty vehicles. States implementing a basic or low
enhanced program are not required to utilize a purge or pressure test, but
they will be required to demonstrate that their programs do not result in an
increase in nitrogen oxide.
IMPLEMENTATION DEADLINES. Basic I/M programs were required to have been
implemented as quickly as possible, with full implementation of decentralized
programs by January 1, 1994 and centralized programs were required to have
been implemented by July 1, 1994. The Regulations mandated that all
requirements related to enhanced I/M programs be implemented by January 1,
1995 subject to certain exceptions allowing for the phase-in of I/M 240
testing. States required to adopt enhanced program were also required to
begin high-tech testing by January 1, 1995, at which time their programs had
to cover at least 30% of the vehicle model years subject to high-tech
testing. All affected vehicles were required to be tested using high-tech
testing by January 1, 1996. Because existing I/M contracts (including all of
the Company's contracts) typically cover only a specified scope of work,
which is almost always patterned on the state emissions testing law in place
at the time the contract was signed, existing I/M contracts that extend
beyond these deadlines for implementing stricter testing standards will have
to be renegotiated to provide for the necessary expansion of equipment and
services to meet the new testing standards.
States failing to submit I/M SIPs, or failing to implement I/M programs
by the prescribed deadlines, are subject to sanction under the Clean Air Act.
Eighteen months after missing a deadline, EPA can impose a construction ban or
withhold federal highway funding from a state. Delay in implementing I/M
programs could also affect states under the federal transportation conformity
rule. The Clean Air Act forbids the federal government from engaging in,
supporting, or providing financial assistance to any activity that does not
conform to an approved SIP. Under the transportation conformity rule,
federally funded highway or transit projects must be consistent with state
air pollution control plans before they can receive federal funding. To date,
the EPA has not exercised its ability to sanction states failing to
-24-
implement I/M programs by the prescribed deadlines. The EPA's stated policy
has been to offer the states additional flexibility in designing their
programs to meet their individual needs, while at the same time encouraging
states to develop effective I/M programs.
EPA'S PROPOSED DECISION TO ADOPT MORE STRINGENT NAAQS. As explained
above, the Clean Air Act's regulatory structure is largely built upon and
driven by the need to achieve and maintain the NAAQS established by EPA for
various pollutants. On November 27, 1996, EPA Administrator Browner signed
notices of a proposed decision that would make the NAAQS for ground level
ozone and particulate matter (PM) significantly more stringent. In
particular, EPA has proposed the following: (1) adding an annual fine
particulate matter standard (PM(2.5) standard) of 15 g/m(3) and a daily
PM(2.5) standard of 50 g/m(3) to the already existing PM(10) standards; (2)
changing the existing ozone ambient standard from a .12ppm, one-hour standard
to a .08 ppm, eight-hour standard based on a three-year average of the annual
third-highest daily eight-hour concentrations; and (3) establishing an
interim policy that would, for the most part, preserve existing standards
during the period following promulgation of the revised standards until those
standards are implemented.
If adopted, these proposed standards would put many additional areas of
the country into nonattainment with the Clean Air Act, and make it more
difficult for areas already classified as nonattainment to meet the NAAQS on
time. At this time estimates vary, but it appears that dozens of areas
classified as attainment or maintenance will be reclassified as nonattainment
if the new standards are adopted. Depending upon the seriousness of their
nonattainment, such areas would likely be required to adopt new measures to
reduce air emissions, such as inspection and maintenance programs.
EPA is under a court order to publish final regulations for PM by June
28, 1997, and EPA has explained that it will issue final regulations for
ozone and PM simultaneously. A public hearing likely will be held in early
January and the anticipated deadline for filing comments is February 18,
1997. Considerable public involvement is expected during the rulemaking
process. Efforts to enlist Congress in preventing the issuance of these
regulations also can be expected. There probably will be congressional
opposition to these proposals, but it is difficult to predict at this time
the breath or depth of this opposition. The Company is unable to predict
whether the regulations revising the NAAQS will be adopted in their current
form or whether any NAAQS regulations will be adopted.
While it is difficult to predict the definitive outcome of any
regulatory process, given the scope of the already existing
attainment-related control programs imposed on existing mobile and stationary
sources, as well as fuel-related regulations, it can reasonably be expected
that the new standards will prompt at least some additional areas to seriously
consider I/M programs, and areas that already have I/M programs to consider
tightening their testing regimes.
-25-
OZONE TRANSPORT ASSESSMENT GROUP. The Clean Air Act required certain
states to submit a plan for the attainment of the ozone NAAQS by November 15,
1994. Many states failed to meet this deadline. As a consequence, EPA
established an alternative planning process allowing the states until
mid-1997 to submit a final attainment plan, based on the results of a two
year assessment to be conducted by the affected states (generally those
located east of the Rocky Mountains) through the Ozone Transport Assessment
Group (OTAG). OTAG was to make recommendations to EPA by the close of 1996
regarding the levels of regional emission reductions needed to eliminate
ozone transport as an obstacle to attainment. It now appears that OTAG will
not meet this deadline, although it expects to make these recommendations
early in 1997.
EPA has determined to begin the process to require the affected states to
take action to obtain the necessary emission reductions. EPA plans to begin
this process in December 1996, and plans to issue a notice of proposed
rulemaking proposing an overall amount of NOx and VOC emission reductions
that each state must achieve. A final "SIP call" notice (indicating how the
SIPs of the affected states will be revised to secure the additional needed
emission reductions) is expected to be issued in summer, 1997.
RECENT CONGRESSIONAL ACTIVITY. Early in the last Congress, which
convened in January, 1995, more than two dozen bills were introduced in both
the House of Representatives and in the Senate that would have revised the
Clean Air Act, and many of these would have been more unfavorable than
current law with respect to the I/M program. These attempts failed, however,
and the Clean Air Act was not reopened in the 104th Congress. It is
impossible to predict at this time whether the 105th Congress will attempt to
revise the Clean Air Act.
The Company is subject to federal, state, local and foreign laws,
regulations and ordinances governing activities or operations that may have
adverse environmental effects. The Company also is generally subject to
environmental laws that impose liability for environmental contamination that
is or comes to be located on properties that are or have been owned or
operated by the Company. From time to time, the Company's operations have
resulted or may result in certain noncompliance with applicable requirements.
The Company believes that it currently conducts its operations in substantial
compliance with all such laws.
Certain sections of this Form 10-K, including "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", contain various forward looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, which represent the
Company's expectations or beliefs concerning future events. The Company
cautions that these statements are further qualified by important factors
that could cause actual results to differ materially from those in the
forward looking statements. The forward looking statements include, without
limitation, statements regarding the commencement of operations for a
particular test site or of a particular program, the number of annual tests,
the types of I/M testing programs to be adopted by states, regulatory and
market changes, the growth in markets in which the Company
-26-
operates, the areas of potential growth that the Company has identified, the
value of contracts, renewals of contracts, expected realizations of backlog,
the success of RSD technology and its utilization in the future, the
Company's success in foreign jurisdictions, and the Company's success as a
decentralized service provider. The Company in the preparation of its
financial statements, also makes various estimates and assumptions that are
forward looking statements. See Note 2 to the "Notes to Consolidated
Financial Statements."
-27-
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth information concerning the executive
officers of the Company as of November 15, 1996:*
Current Position and
Name Age Business Experience
---- --- ----------------------
Chester C. Davenport... 56 Chairman of the Board of Directors since
September 1990; Managing Director of
Georgetown Partners Limited Partnership, a
merchant banking firm ("Georgetown
Partners"), since September 1988; Senior
partner in Washington, D.C. law firm of
Davenport and Seay from 1979 to 1987 and
from 1973 to 1976; Managing General
partner of First City Properties, an
investment partnership, from 1979 to 1985;
Assistant Secretary of Transportation for
Policy and International Affairs from 1977
to 1979.
F. Robert Miller...... 54 President, Chief Executive Officer and
director since 1996; President, Chief
Executive Officer and director of Systems
Control, Inc. and its predecessors from 1987
to 1995.
Raj Modi.............. 44 Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary since
January 1993; Controller from July 1992 to
January 1993; Controller of ETI from
December 1986 to July 1992.
C. Michael Alston..... 38 Vice President, General Counsel and
Secretary since September 1992; Executive
Vice President and General Counsel of
Horne Engineering Services, Inc., an
environmental engineering firm, from March
to September 1992; Attorney at Fulbright &
Jaworski, specializing in corporate and
securities law, from October 1985 to March
1992.
Lawrence H. Taylor..... 52 Vice President of Marketing since January
1994; divisional Vice President of
Marketing and Sales of the Company from
April 1992 to January 1994 and of ETI from
1989 to April 1992.
-28-
Laura E. Baker....... 42 Vice President of Corporate Communications
since January 1996; Vice President of
Corporate Communications of SC from
September 1994 to January 1996; Director
of Corporate Communications from April
1992 to September 1994; Manager of
Marketing Services of SC from 1985 to
April 1992.
Mark D. Frost......... 38 Vice President of Engineering since
January 1996; Vice President of
Engineering of SC from
September 1994 to January 1996; Director of
Engineering of SC from 1985 to September
1994.
Perry J. Ludy......... 46 Vice President of Operations since
February 1996; Vice President of SC from
December 1994 to February 1996; President
of U.S. Auto Glass, Inc. from December
1990 to December 1994.
Richard M. Tucker...... 49 Vice President of Program Development
since January 1996; Vice President of
Program Development of SC from March 1992
to January 1996; Director of International
Marketing of SC from August 1991 to March
1992.
James Burley.......... 48 Vice President of Administration since
July 1996; Human Resources Manager for the
Hughes Research Laboratories from January
1992 to July 1996; Manager of Human
Resources Administration for the Electron
Dynamics Division of Hughes Electronics
from July 1984 to January 1992.
* The employment contract of Ronald M. Lancaster, Executive Vice President,
expired on December 31, 1995, and he is no longer employed by the Company,
and John R. Wallauch, Vice President of Operations, is no longer employed by
the Company.
All officers are elected annually and serve at the discretion of the
Board of Directors.
ITEM 2. PROPERTIES
Envirotest designs, builds and equips its testing sites to meet each
program's specific
-29-
requirements. The Company's testing sites typically range from one to three
acres, depending on the number of testing lanes, specific equipment
requirements, and lot configuration. The Company currently owns 128 testing
stations and leases 48 testing stations totaling in excess of 871,000
square feet. Envirotest also maintains a program headquarters in each of the
states in which it operates. The Company's senior administrative and
marketing staff were relocated from Phoenix, Arizona to Sunnyvale, California
in January 1996, and occupy approximately 21,000 square feet of office space
that are leased by the Company. The Company's engineering staff occupies
40,000 square feet of leased space in Tucson. The Company also has corporate
offices of approximately 3,000 square feet of leased space in Bethesda,
Maryland.
ITEM 3. LEGAL PROCEEDINGS
As previously disclosed, the Company's new contract with the state of
Connecticut began January 1, 1995, with enhanced testing scheduled to begin
on April 3, 1995. Just prior to the startup of enhanced testing,
-30-
the State decided to continue the old testing procedure and phase in the
enhanced testing. Additionally, the Company was unable to build two
facilities, one due to the State's inability to provide the land the contract
required and the other due to the inability to obtain zoning. The State
claimed that it was entitled to be paid for the cost savings to the Company
for not having performed the enhanced test and not having built the
facilities. The Company claimed additional costs incurred when the State
unilaterally changed the test. After unsuccessful settlement negotiations,
the Commissioner of Department of Motor Vehicles rendered a decision on
February 9, 1996 that the Company owed the State $2.4 million plus other non
quantified amounts for 1995 and additional accruing amounts until the
enhanced test was performed and the facilities built. In accordance with the
contract and to protect its rights, the Company appealed the Commissioner's
decision to binding arbitration at the American Arbitration Association. On
May 1, 1996, prior to the appointment of the arbitrators, the State filed a
complaint in the Superior Court at Hartford to enjoin the arbitration from
going forward claiming that the American Arbitration Association had no power
to administer hearings in this matter. The State has taken no further action
on this matter and no hearing date with regard to the State's complaint has
been scheduled.
The Company is a defendant in GRENDELL, ET AL. V. OHIO EPA, ET AL., a
taxpayers class action originally filed on October 3, 1996 in Geauga County
Court of Common Pleas, State of Ohio, and now pending in the U.S. District
Court sitting in Columbus, Ohio. Plaintiffs are political opponents to
Ohio's motor vehicle emission inspection program, known as "E Check," and
seek to enjoin the program and Envirotest's contracts as invalid and void
based on three Ohio constitutional provisions. Plaintiffs principally
challenge Envirotest's statutory right to compensation upon termination or
suspension of E Check by the Ohio legislature. They claim that such a right
"lends" the state's credit to a private company. They also claim that such
right creates a future obligation without a specific appropriation in the
state budget approved for the current biennium. Plaintiffs also challenge
the allocation of inspection fees between Envirotest and Ohio as evidence of
an impermissible "public-private" partnership.
On October 18, 1996, the court transferred the case to the Franklin
County Court of Common Pleas. The Company removed the matter to federal
court on the basis of diversity of citizenship. On December 13, 1996 the
Ohio EPA and Plaintiffs filed motions to dismiss or remand to return the case
to the Ohio state court. The Company believes that it has valid defenses to
the claims contained in the complaint and intends to defend the matter
vigorously.
The Company is a party to various other legal proceedings and claims in
the ordinary course of business. The Company does not believe that the
outcome of any pending matters will materially adversely affect its
consolidated financial position or results of operations.
-31-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of shareholders held on September 24, 1996, the
Company's shareholders approved the following:
a) Election of Richard L. Gelford, Edward Dugger, III, and Robert W.
Kasten, Jr., as the three Class A directors to serve for a term of
one year and until their successors are duly elected and qualified.
The results of the votes were 11,521,418 votes for the proposal and
663,411 votes withheld.
b) Election of Chester C. Davenport, Cleveland A. Christophe, Craig M.
Cogut and F. Robert Miller as the four Class B directors to serve
for a term of one year and until their successors are duly elected
and qualified. The results of the vote were 2,432,060 votes for the
proposal and none withheld.
c) Selection of Coopers & Lybrand L.L.P. as the Company's independent
public accountants for fiscal year 1996. The results of the vote
were 14,442,641 votes for the proposal, 73,783 votes against and
100,465 votes abstain.
d) An amendment to the Company's 1993 Stock Option Plan to increase the
number of shares of Class A Common Stock reserved for issuance
thereunder by 400,000. The results of the vote were 12,387,589 votes
for the proposal, 1,953,812 votes against and 101,915 votes abstain.
Under the Company's Articles of Incorporation, the holders of Class A
Common Stock of the Company are entitled to one vote for each share of Class
A Common Stock so held and holders of the Class B Common Stock are entitled
to 1.75 votes for each votes for each share of Class B Common Stock so held.
-32-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Class A Common Stock, par value $0.01 per share (the "Class A Common
Stock") of Envirotest has traded on the NASDAQ National Market System under
the symbol ENVI since the Company's initial public offering on April 1, 1993.
At November 15, 1996, the Company estimates that it had 282 holders of record
of the Class A Common Stock. A substantial number of the outstanding shares
of the Company's Class A Common Stock are held in nominee name. On December
23, 1996, the last sales price of the Company's Class A Common Stock, as
reported by the NASDAQ National Market System, was $2.50.
The following table sets forth for fiscal 1996 and 1995 the range of
high and low sale prices for the Company's Class A Common Stock as reported
by NASDAQ for the periods indicated. The quotations are derived from data
supplied by NASDAQ Stock Market Inc., and represent prices between dealers
without retail markdowns or commissions and may not necessarily present
actual transactions.
Fiscal 1996 Dec. 31 Mar. 31 June 30 Sept. 30
- ----------- ------- ------- ------- --------
High $4.25 $4.00 $3.125 $3.875
Low $2.25 $2.50 $2.50 $1.625
Fiscal 1995 Dec. 31 Mar. 31 June 30 Sept. 30
- ----------- ------- ------- ------- --------
High $14.5 $6.875 $6.625 $6.375
Low $ 6.5 $4.5 $3.125 $3.0
There is no established public trading market for the Company's Class B
Common Stock, par value $0.01 per share (the "Class B Common Stock") or the
Company's Class C Common Stock, par value $0.01 per share (the "Class C
Common Stock"). The principal difference among the Company's three classes
of stock is voting rights. Each share of Class B Common Stock and Class C
Common Stock are convertible at any time at the option of the holder into an
equal number of shares of Class A Common Stock, subject to certain
limitations in the case of the Class C Common Stock. As of November 15,
1996, the number of record holders of Class B Common Stock was two, and the
number of record holders of Class C Common Stock was one.
The Company has never declared or paid cash dividends on its capital
stock and does not anticipate paying cash dividends in the foreseeable
future. The payment of cash dividends by the Company is restricted by the
terms of the Indentures governing the Company's 9 1/8% Senior Notes due 2001
and 9 5/8% Senior Subordinated Notes due 2003, respectively (in each case
under a formula based upon the consolidated net income of the Company plus
proceeds of equity offerings, and subject to the maintenance of a
consolidated fixed charge coverage ratio of at least 3.0 to 1.0).
-33-
Item 6. SELECTED FINANCIAL DATA
The selected financial data at September 30, 1996, and 1995 and for the
periods ended September 30, 1996, 1995, and 1994, have been derived from, and
should be read in connection with, the audited Consolidated Financial
Statements of the Company, and related notes thereto, included in this
report. The selected consolidated financial data at September 30, 1994, 1993
and 1992 and for the period ended September 30, 1993 and 1992, have been
derived from audited consolidated financial statements of the Company.
The Company has never declared or paid cash dividends on its common stock.
Financial data at September 30, 1992 and for the fiscal year ended
September 30, 1992 and all subsequent financial data, reflect the ETI
acquisition on April 10, 1992.
The following information should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this report.
34
SELECTED FINANCIAL DATA
THE COMPANY
-----------
(Amounts in thousands, Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
except per share and Ended September Ended September Ended September Ended September Ended September
other operating data) 30, 1996 30, 1995 30, 1994 30, 1993 30, 1992(a)
STATEMENT OF OPERATIONS
DATA:
Contact revenues 124,472 $104,757 $96,395 $88,534 $53,301
Gross profit 22,323 31,660 44,343 39,043 23,898
Selling, general and
administrative expenses 21,782 24,911 19,104 13,297 6,319
Amortization expense 3,427 4,017 4,390 3,500 2,389
Reserve for surplus properties - 892 - - -
Non-recurring expense 1,850(e) - - - 2,500(b)
Gain on Pennsylvania settlement (15,307) -
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Income 10,571 1,840 20,849 22,246 12,690
Interest (income) (8,943) (4,318) (6,671) (1,220) (212)
Interest expense 38,940 21,315 23,567 13,370 9,274
Other expense (income) - 63 (26) 446 141
Monthly interest(c) - 284 393 (1,754) (30)
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income
taxes and extraordinary item (19,426) (15,504) 3,586 11,404 3,517
Income tax expenses (benefit) 5,638 (643) 1,412 4,651 (739)
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before (25,064) (14,861) 2,174 6,753 4,256
extraordinary item
Extraordinary item, net - - - (11,411) (1,752)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(25,064) $(14,861) $2,174 $(4,658) $2,504
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per common and
common equivalent share:
Income (loss) before
extraordinary item $(1.51) $(0.93) $0.12 $0.40 $0.32
Net income (loss) $(1.51) $(0.93) $0.12 $(0.28) $0.19
Weighted average common shares
and common equivalent shares 16,552 16,059 17,546 16,714 13,357
Earnings (loss) per common
shares - assuming full dilution
Income (loss) before
extraordinary item $(1.51) $(0.93) $0.12 $0.40 $0.32
Net income (loss) $(1.51) $(0.93) $0.12 $(0.28) $0.19
Weighted average common shares
and common equivalent shares 16,552 16,059 17,546 16,718 13,357
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA:
(AT END OF PERIOD)
Total assets $480,784 $457,273 $418,205 $200,656 $144,485
Long-term debt 420,476 386,906 328,048 129,751 96,937
Stockholders' equity (deficit) 13,154 38,045 52,910 49,470 13,160
OTHER OPERATING DATA:
Number of facilities at end of 169 126 113 112 112
period
35
THE COMPANY
-----------
(Amounts in thousands, Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
except per share and Ended September Ended September Ended September Ended September Ended September
other operating data) 30, 1996 30, 1995 30, 1994 30, 1993 30, 1992(a)
Number of testing lanes at end 667 479 407 405 403
of period
Number of paid tests during 10,592,894 11,042,077 12,342,165 11,525,956 7,489,656(d)
period
- -----------------------------------------------------------------------------------------------------------------------------------
(a) Includes results of operations of ETI from April 10, 1992 (date of
acquisition) to September 30, 1992.
(b) Relates to the cost of closing the headquarters office of ETI in California
in 1992.
(c) Represents the minority stockholder's proportionate share of the operating
income (loss) of Ebco-Hamilton Partners, which operates the British
Columbia program. The minority stockholder's interest was purchased by
the Company on July 24, 1995.
(d) The Company's fiscal 1992 annualized test volume was approximately 11.6
million. The difference between the actual paid tests and annualized paid
tests is due to the acquisition of ETI on April 10, 1992 and the
commencement of the British Columbia program on September 1, 1992.
(e) Relates to the cost of closing the headquarters office in Phoenix,
Arizona in fiscal year 1996.
36
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company conducts its current operations directly and through its
principal wholly owned subsidiaries, Envirotest Technologies, Inc. ("ETI"),
Envirotest Wisconsin, Inc. and Systems Control, Inc., a Washington
corporation. The Company's British Columbia, Canada operations are conducted
through a British Columbia partnership, Ebco-Hamilton Partners ("EHP"), which
is wholly owned by the Company (through its subsidiaries).
RESULTS OF OPERATIONS
FISCAL YEAR ENDED SEPTEMBER 30, 1996 (FISCAL 1996) COMPARED TO FISCAL YEAR
ENDED SEPTEMBER 30, 1995 (FISCAL 1995)
Contract revenues increased to $124.5 million in fiscal 1996 from $104.8
million in fiscal 1995, an increase of $19.7 million or 18.8%. The increase
is primarily attributable to the increase in revenues of $13.0 million
generated from the new contracts with the State of Ohio, $6.4 million from
the Washington State program acquired on January 30, 1996, and $5.0 million
from the Colorado program which commenced in January 1995 and has been
operational for the full year during fiscal 1996, and $2.5 million from the
Connecticut program due to higher fees in the new program which commenced in
January 1995. These increases were partially offset by decreases in revenue
of $2.1 million in the British Columbia program due to an employee strike
during the period, $1.3 million in the Illinois program attributable to the
reduced test fee under the January 1996 contract extension, $2.0 million in
the Minnesota program due to legislature changes during fiscal 1995 exempting
vehicle model years emissions testing, and $1.6 million from the Maryland
program which ceased operations as of December 31, 1994. The Company is
currently engaged in negotiations with the government in British Columbia
pursuant to the terms of its contract to obtain an adjustment in the fees
to offset the loss in revenue experienced during the period of the strike.
Gross profit decreased to $22.3 million in fiscal 1996 from $31.7 million
in 1995, a decrease of $9.4 million, or 29.7%. As a percentage of contract
revenues, gross profit decreased to 17.9% in fiscal 1996 from 30.2% in fiscal
1995, an absolute decrease of 12.3% The decrease in gross profit resulted
from higher than anticipated costs associated with the new Wisconsin and Ohio
programs, decreased revenue in the Minnesota program discussed above and the
absence of contribution from the Maryland program.
37
Selling, general and administrative ("SG&A") expenses decreased to $21.8
million in fiscal 1996 from $24.9 million in fiscal 1995, a decrease of $3.1
million or 12.5%. As a percentage of contract revenues, SG&A expenses
decreased to 17.5% in fiscal 1996 from 23.8% in fiscal 1995 , an absolute
decrease of 6.3%. The decrease in SG&A expenses is primarily due to decreased
marketing expenses and the absence of costs associated with seeking a
resolution of the Pennsylvania contractual issues which were incurred during
fiscal 1995. In addition, the decrease in SG&A as a percentage of
contract revenues is due to the increase in contract revenues discussed above.
Amortization expense decreased to $3.4 million in fiscal 1996 from $4.0
million in fiscal 1995, a decrease of $0.6 million. The decrease is
attributable to expiration of the Maryland program contract and full
amortization of certain other intangible assets.
Consolidation expense was $1.9 million for the fiscal 1996, primarily
representing the costs associated with the closing of the Phoenix Corporate
headquarters.
Gain on Pennsylvania settlement for fiscal 1996 was $15.3 million net of
certain related costs including the write down of related property, plant and
equipment. Gross proceeds were $156 million (including contingent payment up
to $11 million) in accordance with the settlement agreement with Commonwealth
of Pennsylvania.
Income from operations increased to $10.6 million in fiscal 1996 compared
to $1.8 million in fiscal 1995. Income from operations as a percentage of
contract revenues increased to 8.5% in fiscal 1996 compared to 1.7% in fiscal
1995, an absolute increase of 6.8%. The increase is due to the gain on
Pennsylvania settlement, the decrease in selling, general and administrative
expenses, offset by the reduction in the gross profit and consolidation
expense, as discussed above.
Interest expense increased to $38.9 million in fiscal 1996 from $21.3
million in fiscal l995, an increase of $17.6 million. The increase is
primarily attributable to a $13.0 million decrease in capitalized interest as
programs under implementation became operational, and $4.1 million interest
expense on the capital lease and long-term debt issued in June 1995 to
finance the Company's emissions testing network in Ohio.
Interest income increased to $8.9 million in fiscal 1996 from $4.3
million in fiscal 1995, an increase of $4.6 million. The increase is
primarily attributable to the interest income on the funds received and due
from the Pennsylvania settlement.
Minority interest represents the minority partner's proportionate share
of the income of the British Columbia program through July 1995 at which time
the Company, through its wholly owned subsidiary, Envirotest Holdings, Inc.,
purchased the third party interest in the program.
38
Income tax expense was $5.6 million on the pretax loss of $19.4 million
in fiscal 1996 as the Company increased a valuation allowance by $12.8
million, to fully reserve the deferred tax asset. In fiscal 1995, income tax
benefit was $0.6 million on pre-tax loss of $15.5 million which was lower
than the combined federal and state effective tax rate of approximately 39%
as a result of increasing a valuation allowance by $5.4 million to reduce the
deferred tax asset to an amount estimated to be realized. The estimate on the
amount of deferred tax asset to be realized is reviewed quarterly and the
valuation allowance adjusted accordingly.
Net loss was $25.1 million in fiscal 1996 compared to $14.9 million
in fiscal 1995, an increase of $10.2 million.
FISCAL YEAR ENDED SEPTEMBER 30, 1995 (FISCAL 1995) COMPARED TO FISCAL YEAR
ENDED SEPTEMBER 30, 1994 (FISCAL 1994)
Contract revenues increased to $104.8 million in fiscal 1995 from $96.4
million in fiscal 1994, an increase of $8.4 million or 8.7%. This increase
is primarily attributable to the contract revenues contributed by the
Company's Colorado vehicle emissions testing program of $15.3 million which
began operations in January 1995, offset by the decrease of revenue of $6.7
million from the Maryland program which ceased operations as of December 31,
1994.
Gross profit decreased to $31.7 million in fiscal 1995 from $44.3 million
in fiscal 1994, a decrease of $12.6 million or 28.4%. This decrease was
attributable to the decrease in contribution from the Connecticut program due
to higher costs associated with the start-up of the enhanced testing together
with accelerated amortization of deferred charges, the decrease in
contribution from the Maryland program and the absence of contribution from
the Colorado program due to higher than anticipated costs associated with
start-up of the program together with accelerated amortization of deferred
charges. As a percentage of contract revenues, gross profit decreased to
30.2% in fiscal 1995 from 46.0% in fiscal 1994, an absolute decrease of
15.8%. This decrease was primarily attributable to the factors noted above.
The Minnesota state legislature passed a bill, effective July 1995,
exempting vehicles five years and newer from vehicle emissions testing, an
approximate 33% reduction in anticipated test volume. The State negotiated
several changes to the contract with the Company which will result in a
reduction in operating expenses and a larger portion of the test fee
previously paid to the State being paid to the Company.
SG & A expenses increased to $24.9 million in fiscal 1995 from $19.1
million in fiscal 1994, an increase of $5.8 million or 30.4%. As a
percentage of contract revenues, SG & A expenses increased to 23.8% in fiscal
1995 from 19.8% in fiscal 1994, an absolute increase of 4.0%. The dollar
increase in fiscal 1995 was primarily due to incremental expenditures of $4.3
million associated with maintaining the Pennsylvania program assets during
the suspension of
39
operations of the program and costs associated with negotiating a resolution.
These expenditures have been recovered as part of the settlement agreement
reached with the Commonwealth of Pennsylvania after the end of fiscal 1995
and will be reflected in the results of fiscal first quarter 1996. See
"Signficant Developments". Also, the Company incurred additional
administrative costs in order to support the expanded operations resulting
from recent program awards and certain reorganizational changes. The
increase as a percentage of contract revenues in fiscal 1995 was due to the
costs associated with seeking a resolution of the Pennsylvania contractual
issues coupled with the absence of revenues from that program.
Amortization expense decreased to $4.0 million in fiscal 1995 from $4.4
million in fiscal 1994, decrease of $0.4 million. The decrease was
attributable to the Maryland program.
Income from operations decreased to $1.8 million in fiscal 1995 from
$20.8 million in fiscal 1994, a decrease of $19.0 million or 91.3%. Income
from operations as a percentage of contract revenues decreased to 1.8% in
fiscal 1995 compared to 21.6% in fiscal 1994, an absolute decrease of 19.8%.
The decrease was due to the factors discussed above.
Interest expense decreased to $21.3 million in fiscal 1995 from $23.6
million in fiscal 1994, a decrease of $2.3 million. The decrease was
primarily attributable to the increase in capitalized interest expense of
$13.1 million for construction relating to new contracts, offset by increased
interest expense of $10.8 million on the Senior Notes issued in March 1994,
the capital lease and long-term debt issued in June 1995 to finance the
Company's emissions testing network in Ohio and fees for an expired credit
facility. Interest expense of $2.8 million recorded in fiscal 1995 relates
to the Pennsylvania program and was recovered as part of the settlement
agreement reached with the Commonwealth of Pennsylvania after the end of
fiscal 1995 and will be reflected in the results of fiscal first quarter
1996. See "Significant Developments".
Interest income decreased to $4.3 million in fiscal 1995 compared to $6.7
million in fiscal 1994, a decrease of $2.4 million. The decrease was
primarily attributable to decreased cash and cash equivalents and short-term
investments balances as funds are spent on construction and equipment for new
emissions testing facilities, partially offset by increased interest rates.
Minority interest represents the minority partner's proportionate share
of the income and losses of the British Columbia program through July 1995,
at which time the Company, through its wholly owned subsidiary, Envirotest
Holdings, Inc., purchased the third party interest in the program. This
expense amounted to $0.3 million for fiscal 1995 and $0.4 million for fiscal
1994.
Income tax benefit was $0.6 million on pre-tax loss of $15.5 million in
fiscal 1995. The benefit was lower than the combined federal and state
effective tax rate of approximately 39% as a result of increasing a valuation
allowance by $5.4 million to reduce the deferred tax asset to an amount
currently estimated to be realized. This estimate on the amount of deferred
tax asset to be realized is done quarterly and the valuation allowance
adjusted accordingly. Income tax expense
40
was $1.4 million on pre-tax income of $3.6 million in fiscal 1994 based on a
combined federal and state effective tax rate of approximately 39.4%.
Net loss was $14.9 million in fiscal 1995 compared to a net profit of
$2.2 million in fiscal 1994, a decrease of $17.1 million.
The Company incurs significant deferred charges in bringing new emissions
testing programs into operation. These charges are amortized over the
initial twelve month period of operations of these new programs. The Company
expects that its results of operations during any fiscal period that includes
the commencement of a program will be adversely impacted by this accelerated
amortization.
LIQUIDITY, CAPITAL RESOURCES AND COMMITMENTS
Cash and cash equivalents, short-term investments and restricted cash
increased to $82.2 million at September 30, 1996 from $49.9 million at
September 30, 1995. The increase of $32.3 million was primarily a result of
the $69.5 million (including interest) received from the Commonwealth of
Pennsylvania, the proceeds of $17 million from the bonds issued by the
Company's wholly owned subsidiary, Envirotest Wisconsin, Inc., in December
1995 and proceeds of $14.3 million from the bonds issued by the Company in
June 1996 for the Indiana program; partially offset by the expenditure of
$49.7 million for property, plant and equipment primarily relating to the
Ohio, Wisconsin and Indiana programs, cash used in operating activities of
approximately $12.4 million, and the purchase of the Washington State
subsidiary of Systems Control; Inc. (including the assets of SC's Indiana
subsidiary).
The Company's primary uses of cash are the funding of the Company's
capital expenditure requirements, payments on capital and operating leases,
interest payments and other working capital needs. The Company's capital and
operating leases currently require minimum lease payments of approximately
$15.7 million in 1997, decreasing to approximately $14.3 million through 1999
and further decreasing thereafter as certain leases are scheduled to expire.
The Company's capital expenditures include maintenance capital
expenditures for existing
41
facilities, and development and construction expenditures for new emissions
facilities. The Company's development and construction capital expenditures
are dependent on the number of contracts it is awarded, and are only incurred
after the contract has been signed. After signing a contract, the Company may
incur significant development and construction expenditures, which the
Company expects to finance with existing cash resources, internally generated
funds, additional borrowings and alternative financing sources, including
leasing alternatives. It generally takes one to two years after a contract
has been signed for a program to begin operations and generate revenues,
depending on the size of the program.
The Company's principal commitments at September 30, 1996, consist of
capital expenditure requirements for the completion of implementation of the
Indiana program estimated at $5.7 million. Also, in fiscal 1997, the Company
intends to spend approximately $1.2 million on maintenance capital
expenditures.
The Company believes that its existing cash resources including
approximately $79.4 million received by the Company in December 1996 for the
sale of its right to receive the two remaining installments totalling $80
million under the settlement agreement with the Commonwealth of Pennsylvania,
(see "Significant Developments") cash generated from operations and
alternative financing sources, including leasing alternatives, will be
sufficient to complete implementation of the Indiana program and to meet its
liquidity requirements for the foreseeable future.
Accrued expenses and other current liabilities increased to $27.1
million at September 30, 1996 from $13.5 million at September 30, 1995. The
increase was primarily attributable to the accrual of Pennsylvania settlement
reserves totaling $10.1 million which represents reserves for claims and
closing expenses including legal expenses.
RECENT ACCOUNTING PRONOUNCEMENT
Statement of Financial Accounting Standards No. 123 - Accounting for
Stock-Based Compensation will be effective for the Company's 1997 fiscal
year. This statement introduces a fair-value based method of accounting for
stock-based compensation. It encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options and other
equity instruments to employees based on the new fair-value accounting rules.
Companies that choose not to adopt the new fair-value accounting rules will
be required to disclose pro forma net income and earnings per share under the
new method. The Company has not yet determined which method it will adopt.
INFLATION AND INTEREST RATES
While the Company's business is not generally sensitive to inflation,
there can be no assurance that a high rate of inflation in the future would
have an adverse effect on the Company's results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
42
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Envirotest Systems Corp. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Envirotest
Systems Corp. and its Subsidiaries as of September 30, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended September 30, 1996.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Envirotest
Systems Corp. and its Subsidiaries as of September 30, 1996 and 1995, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended September 30, 1996, in conformity with
generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
San Jose, California
December 13, 1996
43
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 1996 and 1995
(AMOUNTS IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)
ASSETS 1996 1995
- ------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 53,104 $ 17,079
Short-term investments 7,991 1,347
Settlement due from Commonwealth of
Pennsylvania 80,000 --
Contract receivables, net of allowance for doubtful accounts
of $449 and $375, respectively 10,969 8,208
Prepaid expenses 2,131 1,967
Deferred income taxes -- 1,376
Other 4,301 1,613
-------- --------
Total current assets 158,496 31,590
Restricted cash 21,108 31,497
Property, plant and equipment, net 192,400 173,507
Assets held under capital leases, net 46,108 27,138
Assets held for sale, net 32,246 5,209
Assets subject to settlement -- 149,629
Intangible assets, net 14,927 17,752
Deferred debt acquisition costs, net of accumulated
amortization of $5,720 and $3,378, respectively 13,159 13,412
Deferred charges, net of accumulated amortization of $7,407
and $3,217, respectively 1,189 3,178
Deferred income taxes -- 4,100
Other 1,151 261
-------- --------
Total assets $480,784 $457,273
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THE CONSOLIDATED FINANCIAL STATEMENTS.
44
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 1996 and 1995
(AMOUNTS IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
- ------------------------------------------------------------------------------
Current liabilities:
Accounts payable $ 3,825 $ 12,742
Accrued interest 1,689 1,499
Accrued expenses and other current liabilities 27,080 13,499
Current portion of capital lease and long-term debt 4,740 1,485
Current portion of other long-term debt 3,880 --
Income taxes payable 674 595
-------- --------
Total current liabilities 41,888 29,820
Senior subordinated debt 125,000 125,000
Senior long-term debt, net of discount of $808 and $989,
respectively 199,192 199,011
Capital lease and long-term debt, net of current portion 58,155 62,895
Other long-term debt, net of current portion 38,129 --
Other 5,266 2,502
-------- --------
Total liabilities 467,630 419,228
-------- --------
Commitments and contingencies (Note 19).
Stockholders' equity:
Common stock, $0.01 per share par value; Class A Common
stock, 40,000,000 shares authorized, 13,204,396 and
12,883,571 shares issued and outstanding at September 30,
1996 and 1995, respectively; Class B Common stock,
5,000,000 shares authorized, 1,389,749 and 1,248,249 shares
issued and outstanding at September 30, 1996 and 1995,
respectively; Class C Common stock, 5,000,000 shares
authorized, 2,026,111 shares issued and outstanding 166 162
Additional paid-in capital 60,172 60,028
Cumulative currency adjustment (96) (121)
Accumulated deficit (41,510) (16,446)
-------- --------
18,732 43,623
Less predecessor carry-over basis (5,578) (5,578)
-------- --------
Total stockholders' equity 13,154 38,045
-------- --------
Total liabilities and stockholders' equity $480,784 $457,273
-------- --------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THE CONSOLIDATED FINANCIAL STATEMENTS.
45
ENVIROTEST SYSTEMS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, 1996, 1995 and 1994
(AMOUNTS IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)
1996 1995 1994
- ------------------------------------------------------------------------------
Contract revenues $ 124,472 $ 104,757 $ 96,395
Costs of services 102,149 73,097 52,052
----------- ----------- -----------
Gross profit 22,323 31,660 44,343
Operating costs and expenses:
General and administrative 18,619 18,683 13,883
Selling 3,163 6,228 5,221
Consolidation expense 1,850
Amortization 3,427 4,017 4,390
Reserve for surplus properties -- 892 --
Gain on Pennsylvania settlement (15,307) -- --
----------- ----------- -----------
Income from operations 10,571 1,840 20,849
Other expense (income):
Interest expense 38,940 21,315 23,567
Interest income (3,259) (4,255) (6,697)
Interest income from Pennsylvania
settlement (5,684) -- --
Minority interest -- 284 393
----------- ----------- -----------
Income (loss) before income taxes (19,426) (15,504) 3,586
Income tax expense (benefit) 5,638 (643) 1,412
----------- ----------- -----------
Net income (loss) $ (25,064) $ (14,861) $ 2,174
----------- ----------- -----------
Earnings (loss) per common and common
equivalent share $ (1.51) $ (0.93) $ 0.12
Weighted average common and common
equivalent shares 16,552,497 16,059,165 17,546,495
----------- ----------- -----------
Earnings (loss) per common share -
assuming full dilution $ (1.51) $ (0.93) $ 0.12
Weighted average common and common
equivalent shares 16,552,497 16,059,165 17,546,495
----------- ----------- -----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THE CONSOLIDATED FINANCIAL STATEMENTS.
46
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended September 30, 1996, 1995 and 1994
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
Additional Cumulative Predecessor
Common Stock Paid-In Currency Accumulated Carry-over
Shares Amount Capital Adjustment Deficit Basis Total
------ ------ ---------- ---------- ------------ ----------- --------
Balances, October 1, 1993 15,891,178 $159 $58,852 $(204) $(3,759) $(5,578) $49,470
Appreciation in warrant value (564) (564)
Exercise of warrants 80,598 1 1,692 1,693
Foreign currency translation
adjustment 137 137
Net income 2,174 2,174
---------- ---- -------- ----- ------- ------- -------
Balances, September 30, 1994 15,971,776 160 59,980 (67) (1,585) (5,578) 52,910
Issuance of common stock
upon exercise of stock
options 186,155 2 48 50
Foreign currency translation
adjustment (54) (54)
Net loss (14,861) (14,861)
---------- ---- ------- ----- -------- -------- -------
Balances, September 30, 1995 16,157,931 162 60,028 (121) (16,446) (5,578) 38,045
Issuance of common stock
upon exercise of stock
options 462,325 4 144 148
Foreign currency translation
adjustment 25 25
Net loss (25,064) (25,064)
---------- ---- ------- ----- -------- -------- -------
Balances, September 30, 1996 16,620,256 $166 $60,172 $(96) $(41,510) $(5,578) $13,154
---------- ---- ------- ----- -------- -------- -------
---------- ---- ------- ----- -------- -------- -------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
47
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, 1996, 1995 and 1994
(AMOUNTS IN THOUSANDS)
1996 1995 1994
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $(25,064) $(14,861) $2,174
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 24,538 16,800 10,612
Amortization of loan discount and
deferred debt acquisition costs 2,516 3,384 1,578
Reserve for surplus properties -- 892 --
Minority interest in net income
of consolidated subsidiary -- 284 393
Gain on sale of property, plant
and equipment and assets held for
sale (114) -- --
Gain on Pennsylvania settlement (15,307) -- --
Deferred taxes 5,476 (863) 681
Other 18 584 --
Changes in assets and liabilities:
Contract receivables (2,511) (11) (686)
Prepaid and other current assets (1,793) (493) (1,507)
Deferred charges (2,200) (5,034) (2,099)
Other long-term assets (813) 514 727
Accounts payable 470 (4,212) 6,492
Accrued interest 190 (5,536) 1,120
Accrued expenses and other
current liabilities 1,358 2,222 1,239
Advances from customers -- -- (712)
Income taxes payable 79 (369) 446
Other long-term liabilities 731 1,178 (159)
-------- ------- -------
Net cash provided by (used in)
operating activities $(12,426) $(5,521) $20,299
-------- ------- -------
-------- ------- -------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
48
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the Years Ended September 30, 1996, 1995 and 1994
(AMOUNTS IN THOUSANDS)
1996 1995 1994
- -------------------------------------------------------------------------------
Cash flows from investing activities:
(Purchase) maturity of short-term
investments $(6,644) $23,199 $(24,546)
Purchases of property, plant and
equipment (49,724) (118,895) (69,350)
Proceeds from sale of property,
plant and equipment 3,835 2,656 --
Proceeds from Pennsylvania settlement 65,000 -- --
Proceeds from sale of Pennsylvania
assets 2,362 -- --
Pennsylvania assets subject to
settlement -- (88,963) --
Payment for purchase of Systems
Control, Inc., net of cash acquired (2,560) -- --
Purchase of minority interest in
consolidated subsidiary -- (1,247) --
Purchase of intangible assets -- -- (6,068)
Other -- 6 (5)
------- -------- --------
Net cash provided by (used in)
investing activities 12,269 (183,244) (99,969)
------- -------- --------
Cash flows from financing activities:
Repayment of senior long-term debt (2,457) -- --
Repayment of capital lease obligations (1,485) (4,751) (469)
Capitalization of loan fees (1,765) (2,749) (9,609)
Proceeds from debt offering 31,345 -- --
Proceeds from issuance of common stock 148 50 --
Proceeds from borrowings of senior
long-term debt -- -- 198,732
Proceeds from capital lease and
long-term debt -- 64,380 --
Decrease (increase) in restricted cash 10,389 (31,497) --
------- -------- --------
Net cash provided by financing activities 36,175 25,433 188,654
------- -------- --------
Effect of exchange rate on cash and
cash equivalents 7 196 137
------- -------- --------
Net increase (decrease) in cash and
cash equivalents 36,025 (163,136) 109,121
Cash and cash equivalents, beginning
of year 17,079 180,215 71,094
------- -------- --------
Cash and cash equivalents, end of year $53,104 17,079 180,215
------- -------- --------
Supplemental cash flow information:
Cash paid for interest and income taxes for the years ended September 30,
1996, 1995 and 1994 was as follows:
Interest net of capitalized interest $38,751 $26,851 $21,184
Income taxes 245 332 299
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
49
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION:
Envirotest Systems Corp. ("Envirotest" or the "Company") markets, installs
and operates centralized vehicle emissions testing programs under contracts
entered into with state and municipal governments within the United States
and a program in British Columbia, Canada. The Company also offers states and
municipalities services in a variety of sophisticated data management and
vehicle identification capabilities.
The Company's services include: designing a network that provides convenience
to motorists, identifying and procuring adequate inspection systems;
constructing emission facilities with multiple test lanes; designing and
installing a vehicle emissions inspection sites and computer network to
collect and process emissions testing data; and managing and operating the
inspection program using computer software and equipment developed by the
Company.
2. SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Envirotest
Systems Corp. and all of its domestic and foreign subsidiary companies. All
material intercompany balances and transactions have been eliminated.
Minority interest in equity of subsidiary represents the minority partner's
proportionate share of the equity of Ebco-Hamilton Partners ("EHP"). At
September 30, 1994, the Company owned 50.0000006% of EHP. On July 24, 1995,
the Company, through its wholly owned subsidiary, Envirotest Holdings Inc.,
purchased the third party interest in Ebco-Hamilton Partners ("EHP"), the
partnership which operates the Company's British Columbia, Canada centralized
vehicle emissions testing program. The purchase price of $1,200 was paid in
cash. The acquisition was accounted for as a purchase. The results of the
acquired interest in EHP have been combined with the results of the Company
since the date of acquisition.
50
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
In January 1996, the Company purchased from Systems Control, Inc. ("SC")
Systems Control, Inc., a State of Washington corporation, and operator of the
State of Washington centralized emissions testing program, intellectual
property of SC and an option to purchase the stock or assets of SC's Indiana
subsidiary. The option was exercised in June 1996 and the Company acquired
the contract with the State of Indiana to operate its centralized emissions
testing contract and the related assets. The total purchase price was
$4,700. If the acquisitions had occurred on October 1, 1995, the Company's
results of operations for the year ended September 30, 1996 would not have
been materially different.
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 reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
For purposes of the Statement of Cash Flows, the Company considers all highly
liquid debt instruments with an original maturity of three months or less to
be cash equivalents. Cash and cash equivalents are stated at cost which
approximates market value. Included in the Company's cash and cash
equivalents are approximately $52,500 and $16,500 primarily in commercial
paper invested through registered broker/dealers at September 30, 1996 and
1995, respectively. The Company intends to hold these investments until
maturity.
51
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
SHORT-TERM INVESTMENTS Short-term investments have an initial maturity of
greater than three months and are carried at cost which approximates market
value. Short term investments of $7,991 as of September 30, 1996, consisted
of commercial papers having the highest rating obtainable from either Moody's
Investor Service, Inc. or Standard & Poor's Corporation Inc. with maturity
dates ranging from December 1996 through February 1997. Short term
investments of $1,347 as of September 30, 1995 consisted of certificates of
deposit with a financial institution, which collateralize letters of credit.
CONTRACT RECEIVABLES
The Company's contract revenues and receivables consist of uncollateralized
amounts due from state, municipal and foreign governments.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. Research
and development expense for the periods ended September 30, 1996, 1995, and
1994 were approximately $44, $33 and $245 respectively, and are included in
general and administrative expenses.
RESTRICTED CASH Restricted cash of $21,108 at September 30, 1996 primarily
consisted of cash collaterals provided to banks for the Company's financing
and performance bonds related to the emissions testing contracts with state
governments. Included in this amount is $6,438, $2,137, $1,700, and $600 cash
collaterals required under credit agreements for the financing of Ohio,
Indiana, Wisconsin, and Washington programs, respectively. Also, $8,651 in
proceeds from bonds issued by the Indiana Development Finance Authority for
the Indiana program which is under construction are being held in trust
pending use of the fund.
PROPERTY, PLANT, EQUIPMENT AND CAPITAL LEASE
Property, plant and equipment are recorded at cost. The capital lease is
recorded at the present value of the future lease principal payments.
Depreciation and amortization are provided on the straight-line method over
the estimated useful lives of the assets as follows:
52
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
Buildings and site improvements 30 years
Machinery and equipment 2-10 years
Leasehold improvements Lease term
Buildings and site improvements are depreciated on a straight line basis over
the estimated useful life, generally 30 years. Quarterly, the Company
prepares an analysis to compare the estimated book value of the buildings,
site improvements and land at the estimated completion date of individual
contracts (assuming certain renewals, if any) to the estimated residual
value. Adjustments to depreciable lives are made accordingly.
It is possible, given the political, legislative and competitive environment
in which the Company operates, that the estimates discussed above could
change and may result in accelerated depreciation charges. Also, the actual
values realized on disposal could differ from the amounts used in estimating
the residual values of these properties.
Interest costs relating to the acquisition and construction of major projects
are capitalized and depreciated over the estimated useful lives of the
related assets. Interest expense capitalized for the years ended September
30, 1996, 1995 and 1994 was $981, $14,027 and $1,533, respectively.
The cost of maintenance and repairs is charged to expense in the year
incurred. Expenditures which increase the useful lives of property and
equipment are capitalized.
When items are retired or disposed of, the cost and accumulated depreciation
are removed from the accounts and any gain or loss is included in income.
INTANGIBLE ASSETS
Intangible assets are amortized on a straight-line basis over their estimated
useful lives as follows:
Goodwill 12 years
Government contracts 12 years
Computer software 5 years
License agreement 10-17 years
Covenants not-to-compete 5 years
53
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
Beneficial ground lease 12 years
Copyrights 12 years
It is the Company's policy to re-evaluate the estimated useful life of each
of its intangible assets on a quarterly basis and may adjust the estimated
useful life accordingly. It is possible, given the political, legislative
and competitive environment in which the Company operates, that the estimates
discussed above could change and may result in accelerated amortization
charges.
DEFERRED DEBT ACQUISITION COSTS
Costs associated with obtaining long-term debt financing have been
capitalized and are amortized over the repayment term of the related debt.
DEFERRED CHARGES
Significant expenses incurred in bringing new emissions testing programs into
operation including, staff recruitment, staff training, public information
and similar pre-operating costs are deferred and amortized over a
twelve-month period commencing with the start of the program operations.
CONTRACT REVENUES
For vehicle emissions inspection contracts, revenue is based upon the fees
that are collectible for the tests that have been performed.
The Company's contract revenues from five major customers, which individually
account for in excess of 10% of the Company's total contract revenue, were
$20,300, $18,700, $17,000, $16,500 and $12,000 for the year ended September
30, 1996; $16,500, $15,300, $14,500, $13,300 and $12,300 for the year ended
September 30, 1995; and $16,100, $13,600, $13,500, $13,400, and $10,300 for
the year ended September 30, 1994.
INCOME TAXES
Deferred tax liabilities and assets are recognized for the expected future
tax consequences of events that have been included in the financial
statements or tax returns. Deferred tax liabilities and assets are determined
based on the difference between the financial statement and tax bases of
assets and liabilities using enacted tax rates in effect for the year in
which the differences are
54
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
expected to reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.
FOREIGN CURRENCY TRANSLATION
The Company has determined that the local currency of its international
subsidiary is the functional currency. In accordance with Statement of
Financial Accounting Standard No. 52, "Foreign Currency Translation", the
assets and liabilities denominated in foreign currency are translated into
U.S. dollars at the current rate of exchange existing at period-end and
revenues and expenses are translated at average monthly exchange rates.
Related translation adjustments are reported as a separate component of
stockholders' equity, whereas, gains or losses resulting from foreign
currency transactions are included in results of operations.
NET INCOME (LOSS) PER COMMON SHARE
Income (loss) per share is based upon the weighted average number of shares
of common stock and common stock equivalents outstanding during the period.
Common stock equivalents are included in the per share calculation where the
effect of their inclusion would be dilutive. The treasury method is used in
computing incremental common stock equivalents which would result from
exercise of outstanding dilutive stock options and warrants.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, other receivables and
accrued liabilities are a reasonable estimate of their fair value due to
their short term nature. The estimated values of the Company's long term debt
and are based on interest rates at September 30, for issues with similar
remaining maturities.
The estimated fair value amounts of the Company's financial instruments have
been determined by the Company, using appropriate market information and
valuation methodologies. Considerable judgment is required to develop the
estimates of fair value, thus, the estimates provided herein are not
necessarily indicative of the amounts that could be realized in a current
market exchange.
The Company calculates the fair value of financial instruments and includes
this additional information in the notes to financial statements when the
fair value is different than the book
55
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
value of those financial instruments. When the fair value is equal to the
book value no additional disclosure is made. The Company uses quoted market
prices whenever available to calculate these fair values. When quoted market
prices are not available, the Company uses standard pricing models for
various types of financial instruments which take into account the present
value of estimated future cash flows. The effect of using different market
assumptions and/or estimation methodologies may be material to the estimated
fair value amounts.
RECENT PRONOUNCEMENTS
During October 1995, the Financial Accounting Standards Board issued
Statement No. 123, "Accounting for Stock-Based Compensation (SFAS No. 123),"
which establishes a fair value based method of accounting for stock-based
compensation plans and requires additional disclosures for those
companies who elect not to adopt the new method of accounting. While the
Company studies the impact of the pronouncement, it continues to account for
employees' stock options under Accounting Principles Board(APB) Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS No. 123 will be
effective for the Company's 1997 fiscal year.
CONCENTRATIONS OF CREDIT RISK As of September 30, 1996, the Company's cash
and cash equivalents and short-term investments, which consist principally of
demand deposits and commercial paper, were on deposit with a number of
commercial banks and an investment house. In addition, receivables include
$80,000 due from the Commonwealth of Pennsylvania. (See Note 6.) The Company
maintains allowances for potential credit losses and such losses have been
within management's expectations. Financial instruments that potentially
subject the Company to concentrations of credit risk principally comprise,
cash and cash equivalents, short-term investments, accounts receivable
(including amounts due from governments due on settlement of contract issues)
and long-term debt.
3. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consisted of the following at September 30,
1996 and 1995:
1996 1995
-------- -------
Property, plant and equipment:
Land $30,805 $24,828
56
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
Buildings and site improvements 96,945 82,334
Machinery and equipment 90,300 53,539
Leasehold improvements 3,792 4,147
-------- --------
221,842 164,848
Construction in progress 10,787 33,398
-------- --------
232,629 198,246
Less accumulated depreciation (40,229) (24,739)
-------- --------
$192,400 $173,507
-------- --------
4. ASSETS HELD UNDER CAPITAL LEASES:
Assets held under capital leases consisted of the following at September 30,
1996 and 1995:
1996 1995
------- -------
Land $ 5,667 $ 3,185
Buildings and site improvements 41,545 6,503
------- -------
47,212 9,688
Construction in progress - 17,504
------- -------
47,212 27,192
Less accumulated amortization (1,104) (54)
------- -------
$46,108 $27,138
------- -------
At September 30, 1995, construction in progress includes $2,467 for land and
$15,037 for buildings and site improvements which are leased assets under
construction, respectively.
5. ASSETS HELD FOR SALE:
Assets held for sale represent property, plant and equipment at testing sites
formerly operated under the Maryland program which terminated December 31,
1994, and 74 sites in Pennsylvania. These properties are currently being
marketed for sale.
At September 30, 1996 and 1995, an estimated loss on sale of properties of
$109,495 and $892 has been recognized. The estimated loss is based on
management's estimates of the amounts
57
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
expected to be realized on the sale of these assets, net of disposal costs.
The amounts the Company will ultimately realize may differ materially from
the amounts assumed in arriving at the estimated loss. $109,402 of the loss
relates to the write down of the Pennsylvania assets. This amount has been
included in the calculation of the Gain on Pennsylvania Settlement (see Note
6).
58
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
Assets held for sale consisted of the following at September 30, 1996 and 1995:
1996 1995
------- ------
Land, buildings and site improvements $30,773 $5,440
Machinery and equipment 2,074 593
------- ------
32,847 6,033
Less accumulated depreciation (601) (824)
------- ------
$32,246 $5,209
------- ------
6. GAIN ON PENNSYLVANIA SETTLEMENT:
Legislation adopted by the Commonwealth of Pennsylvania General Assembly
directed the Pennsylvania Department of Transportation ("PennDOT") to delay
implementation of the Pennsylvania emissions testing program until March 31,
1995, and to design and submit to the federal Environmental Protection Agency
by March 1, 1995, an alternative emissions testing program that consisted of
decentralized test-and-repair facilities or a hybrid of decentralized
test-and-repair and centralized test-only components and that complied with
federal law. On February 28, 1995, the Governor announced an indefinite
suspension of the implementation of any program until the Commonwealth
receives clarification regarding the elements of a testing program that the
federal EPA would find acceptable.
On December 15, 1995, the Company entered into a General Release and
Settlement Agreement ("Agreement") with The Commonwealth of Pennsylvania
which resolves the issues related to the Company's contract with PennDOT.
Under the terms of the Agreement, the Company was paid $25,000 on December
29, 1995 and $40,000 on July 31, 1996 and will be paid $40,000 on each of
July 1997, and 1998 plus interest at 6% from December 15, 1995. In addition,
the Company will sell the assets and retain the proceeds and the Commonwealth
will pay the Company (in July
59
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
1998) 50% of the amount by which the net proceeds from the sale of the
assets (as defined by the Agreement, as amended December 1996) are less than
$55,000 up to a maximum of $11,000 plus interest at 6% from December 15,
1995. Should the net proceeds from the sale of the assets exceed $55,000,
the Company will pay the Commonwealth 75% of the amount by which the net
proceeds exceed $55,000. The Company is of the opinion that sufficient
reserves have been recognized and that upon final disposition of properties
no additional loss will be recognized.
The gain on the Pennsylvania Settlement has been calculated as follows:
Proceeds (excluding contingent payment) $145,000
Property, plant and equipment write down (109,402)
Other assets write down (7,732)
Additional reserves (12,559)
--------
$15,307
On December 11, 1996, the Company sold its right to receive the two remaining
installment payments totaling $80,000 in principal amount under the Agreement
for approximately $79,405. The Company retained the right to receive
accrued interest of approximately $1,749 payable on July 31, 1997.
The transaction was effected through a sale of the Receivables Assets from
Envirotest Partners, a Pennsylvania general partnership owned by Envirotest
and ETI, to a newly formed wholly owned subsidiary of the Company, ES Funding
Corp. ("Funding"). Funding, in turn, transferred the Receivables Assets to
an affiliate of a Pennsylvania bank. Funding and Envirotest Partners
provided certain representations in connection with the transaction,
including representations as to enforceability of the Agreement against the
Commonwealth, and agreed to repurchase the Receivables Assets if Envirotest
Partners fails to comply with its obligations under the Agreement.
60
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
7. INTANGIBLE ASSETS:
Intangible assets consisted of the following at September 30, 1996 and 1995:
1996 1995
------- -------
Government contracts $21,921 $21,294
Covenants not-to-compete 3,988 3,988
Computer software 2,521 2,521
Goodwill 2,415 2,415
License agreement 1,903 1,903
Copyrights 1,000 1,000
Beneficial ground lease - 153
------- -------
33,748 33,274
Less accumulated amortization (18,821) (15,522)
------- -------
$14,927 $17,752
------- -------
8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES:
Accrued expenses and other current liabilities consisted of the following at
September 30, 1996 and 1995:
1996 1995
------- -------
Accrued employee-related expenses $ 5,693 $ 5,134
Accrued real and personal property taxes 2,238 2,077
Pennsylvania settlement and reserves 10,123 -
Accrued interest 1,689 1,499
Corporation relocation reserve 1,500 -
Deferred revenue of Washington program 1,499 -
Other 4,338 4,789
------- -------
$27,080 $13,499
------- -------
Pennsylvania settlement reserves represents reserves for claims related to
construction contract and closing costs of the program.
61
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
9. SENIOR SUBORDINATED DEBT:
Senior subordinated debt consisted of the following at September 30, 1996 and
1995:
1996 1995
-------- --------
Senior Subordinated Notes, due April 1, 2003;
interest at 9 5/8%, payable semi-annually $125,000 $125,000
-------- --------
The Senior Subordinated Notes ("Notes") are not redeemable by the Company
prior to April 1998. Thereafter, the Notes will be redeemable at any time at
the option of the Company, in whole or in part, at the redemption prices
beginning at 103.609% of the principal amount for the period beginning April
1, 1998 and declining ratably to 100% of the principal amount on or after
April 1, 2001 plus accrued or unpaid interest to the date of redemption.
The Notes are unsecured obligations of the Company, subordinated in right of
payment to all Senior Debt (as defined). The Notes carry various covenants,
including a limitation on payment of dividends, incurrence of additional
indebtedness and issuance of disqualified stock (as defined).
As of September 30, 1996 and 1995, the fair value of the Notes, which is
determined based on quoted market price, was $101,875 and $62,500,
respectively.
10. SENIOR LONG-TERM DEBT:
Senior long-term debt consisted of the following at September 30, 1996 and
1995:
1996 1995
-------- --------
Senior Long-Term Notes, due March 15, 2001;
interest at 9 1/8 % (net of discount of $808 and
$989, respectively) $199,192 $199,011
-------- --------
The Senior Notes are not redeemable by the Company prior to March 15, 1998.
Thereafter, the Senior Notes will be redeemable at any time at the option of
the Company, in whole or in part, at
62
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
redemption prices beginning at 103.083% of the principal amount for the
period beginning March 15, 1998 and declining ratably to 100% of the
principal amount on or after March 15, 2000 plus accrued or unpaid interest
to the date of redemption.
The Senior Notes are senior unsecured obligations of the Company, senior in
right of payment to the 9 5/8% Senior Subordinated Notes of the Company. The
Senior Notes carry various covenants, including a limitation on payment of
dividends, incurrence of additional indebtedness and issuance of disqualified
stock (as defined).
As of September 30, 1996 and 1995, the fair value of the Senior Notes, which
is determined based on quoted market price, was $184,000 and $140,000,
respectively.
11. OTHER LONG TERM DEBT
On December 29, 1995, the Company's wholly owned subsidiary, Envirotest
Wisconsin, Inc., issued $17,000 principal amount of notes (the "Notes").
The Notes bear interest at the rate of 7.53% per annum with monthly payments,
including interest, beginning at approximately $230 and increasing to
approximately $340 with maturity on November 30, 2002. The Notes are
collateralized by all assets utilized in the Wisconsin program. At September
30, 1996, the unpaid principal balance is $16,010.
In January 1996, the Company acquired Systems Control, Inc., a Washington
corporation (SC-WA), the operator of the centralized emissions testing
program in the State of Washington. At the time of the acquisition, SC-WA
had debt outstanding under a credit agreement. As of September 30, 1996,
the outstanding balance is $11,654 and bears interest at various rates with
an effective rate of 8.64% at September 30, 1996 and is collateralized by all
real property of the vehicle emissions program in the State of Washington.
This agreement requires monthly payments of approximately $240 with a balloon
payment at maturity on December 31, 1999 of $4,500. This credit agreement
requires a cash collateral amount of $600 as of September 30, 1996 and
through maturity and requires certain covenants related to tangible net
worth, capital ratio, cash flow ratio and distributions of SC-WA be
maintained.
In June 1996, the Company issued $14,345 principal amount of notes for the
Indiana program. The notes bear interest at the rate of 7.82% per annum with
quarterly payments, including
63
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
interest of approximately $540 and mature in 2006. Principal payments begin
June 1997. The notes are collateralized by all assets utilized in the
Indiana program.
The other long-term debt matures as follows:
1997 $3,880
1998 5,289
1999 5,779
2000 9,441
2001 4,510
Thereafter 13,110
-------
Total principal payments 42,009
Less current portion (3,880)
-------
$38,129
-------
-------
12. STOCK OPTIONS:
The Company has adopted a Stock Option Plan (the "Plan") providing for the
grant of options to purchase shares of Class A Common Stock to certain
employees of the Company and its subsidiaries and to Outside Directors (as
defined) on an annual, nondiscretionary basis. The Plan provides for the
grant of options intended to qualify as Incentive Stock Options ("ISOs") as
defined by Section 422 of the Internal Revenue Code and options that do not
qualify as ISOs ("NQSOs"). The exercise price per share for all ISOs
generally may not be less than 100% of the fair market value on the date of
grant. The exercise price per share for NQSOs may be less than, equal to or
greater than the fair market value on the date of grant, but not less than
par value, except that the exercise price for NQSOs granted to Outside
Directors shall be the fair market value on the date of grant. Under the
Plan, such options are exercisable according to a vesting schedule pursuant
to the terms of each Option Agreement. Unless earlier terminated by the
Board of Directors, the Plan will terminate in January 2003, 10 years after
its effective date.
In 1993, pursuant to an agreement for consulting services, a director and
principal stockholder of the Company was granted options to purchase 50,000
shares of Class A Common Stock at an exercise price of $9.75 per share and
50,000 shares at an exercise price of $14.00 per share. Options to purchase
25,000 shares of each of the foregoing options (an aggregate of 50,000)
64
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
vested upon grant, with the remaining options vesting in September 1994. The
unexercised options expire August 31, 1998.
The following table summarizes the status of, and changes in, options granted
during the years ended September 30, 1996, 1995 and 1994:
Shares Under Option Price Per
Option Share
------------ ----------------
Outstanding at October 1, 1993 2,451,305 $0.27 - $16.00
Granted 396,000 $16.00 - $22.00
Exercised - -
Canceled (125,000) $16.00
--------- ---------------
Outstanding at September 30, 1994 2,722,305 $0.27 - $22.00
Granted 457,500 $6.13
Exercised (186,155) $0.27
Canceled and expired (787,000) $15.88 - $22.00
Reissued 454,000 $6.13
--------- ---------------
Outstanding at September 30, 1995 2,660,650 $0.27 - $20.00
Granted 400,000 $2.75 - $2.80
Exercised (462,325) $0.27 - $0.48
Canceled (185,000) $0.27 - $16.00
--------- ---------------
Outstanding at September 30, 1996 2,413,325 $0.27 - $20.00
--------- ---------------
Options exercisable at:
September 30, 1994 1,939,305
September 30, 1995 1,664,150
September 30, 1996 1,505,950
13. STOCKHOLDERS' EQUITY:
Envirotest Systems Corp. was incorporated on August 20, 1990 for the purpose
of purchasing Hamilton Test Systems, Inc. ("HTS"), a wholly owned subsidiary
of United Technologies Corporation (the "Prior Parent"). At the time of the
HTS acquisition, a subsidiary of the Prior Parent had an equity interest in
Envirotest of approximately 23.6% of the outstanding stock.
65
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
Generally Accepted Accounting Principles require that a portion of the equity
participation in Envirotest by the Prior Parent be valued using the
carry-over basis of its equity interest in HTS prior to the acquisition.
Accordingly, a portion of HTS' assets were recorded at the book value of the
Prior Parent. The effect of the predecessor carry-over basis ($5,578) is
reflected as a component of stockholders' equity.
Payment of cash dividends is restricted by the terms of the Indenture
covering the Senior Subordinated Notes (under a formula based upon the
consolidated net income of the Company plus proceeds of equity offerings, and
subject to the maintenance of a certain consolidated fixed charge coverage
ratio).
14. INCOME TAXES:
Income (loss) before income taxes and income tax expense (benefit) for the
years ended September 30, 1996, 1995 and 1994 are shown below:
1996 1995 1994
-------- -------- ------
Income (loss) before income taxes:
Domestic operations $(18,938) $(16,105) $3,165
Foreign operations (488) 601 421
-------- -------- ------
Total (19,426) (15,504) 3,586
-------- -------- ------
Income tax:
Domestic operations:
Current 162 350 592
Deferred 5,161 (1,159) 515
-------- -------- ------
Total domestic 5,323 (809) 1,107
-------- -------- ------
Foreign operations:
Current 152
Deferred 315 166 153
-------- -------- ------
Total foreign 315 166 305
-------- -------- ------
Total $5,638 $(643) $1,412
-------- -------- ------
-------- -------- ------
66
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
The Company's tax expense (benefit) differs from the expense (benefit)
calculated using the statutory federal income tax rate for the following
reasons:
1996 1995 1994
------- ------- ------
Tax expense (benefit) at statutory
federal income tax rate $(6,605) $(5,271) $1,219
Increase (decrease) resulting from:
Goodwill amortization 66 66 66
Nondeductible expenses 179 172 70
Adjustments of the valuation allowance 13,044 5,400 895
State income taxes, net of federal
tax benefit (837) (1,162) (1,021)
Foreign taxes, net of federal
tax benefit (52) 152 138
Other (157) - 45
------ ------ ------
Total income tax expense (benefit) $5,638 $ (643) $1,412
------ ------ ------
The components of deferred tax balances as of September 30, 1996 and 1995 are
as follows:
1996 1995
------ ------
Deferred taxes:
Accrued vacation pay $551 $607
Charitable contributions 372 351
Other liabilities 3,007 1,659
Pennsylvania settlement reserves 2,972 ---
Net operating loss carryforwards 20,268 15,840
Difference between financial reporting
and tax bases of fixed
and intangible assets (7,718) (6,369)
Valuation allowance (19,452) (6,612)
------- ------
Net deferred taxes $0 $5,476
------- ------
67
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
The net change in the valuation allowance for the deferred tax assets of the
Company is as follows:
1996 1995
------ ------
Beginning balance $6,612 $1,212
Adjustment of valuation allowance
due to a reassessment of the
realizability of deferred tax assets 12,840 5,400
------- ------
Ending balance $19,452 $6,612
------- ------
------- ------
At September 30, 1996 the Company had federal net operating loss
carryforwards for federal tax purposes of approximately $46,418. The amounts
expire between 2006 and 2011. The state loss carryforwards vary in amount
and expiration date depending upon the jurisdiction.
15. DEFINED CONTRIBUTION PLAN AND SUPPLEMENTAL RETIREMENT PLAN:
The Company has adopted a defined contribution 401(k) plan (the "Plan")
covering substantially all of its employees. Eligible employees may
contribute up to 16% of base compensation to the Plan. The Company has an
optional matching program where the Company can match 50% of the employee's
first 6% of contribution. Company-matched contributions vest in full after
three years of an employee's credited service to the Company. The Company
also has an option to make additional profit-sharing contributions equal to
2% of the base salary of each Plan participant. Defined contribution expense
for the Company was approximately $696, $586 and $578, for the years ended
September 30, 1996, 1995 and 1994, respectively.
The Company has supplemental employee retirement plans covering six of its
key employees or former employees. The plan benefits for each employee range
from $13 to $100 per year commencing at age 65 for a period of ten years
payable in equal monthly installments. The plans also provide death and
disability benefits in the event of the death or total disability of an
employee while employed by the Company. The Company's policy is to fund the
plan through certain life insurance policies or through the general
unrestricted assets of the Company. Supplemental retirement expense for the
Company was approximately $119, $511 and $118, for the years ended September
30, 1996, 1995 and 1994, respectively.
68
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
16. RELATED PARTY TRANSACTIONS:
In 1993, the Company entered into a three-year agreement for consulting
services with a director and principal stockholder of the Company. The
agreement provides for a base consulting fee of $240 plus expenses annually
for the first year and $120 annually thereafter, as well as the grant of
options. For the years ended September 30, 1996, 1995 and 1994, the Company
expensed $120, $122 and $247, respectively, under this agreement.
As the Company has previously disclosed in its periodic reports filed with
the Securities and Exchange Commission under the Securities and Exchange Act
of 1934, the facilities and assets utilized by the Company in the Cuyahoga
County, Ohio I/M testing program (the "Ohio Assets") and the Tennessee I/M
testing program (the "Tennessee Assets") were leased to the Company pursuant
to separate Sale and leaseback Agreements with Kane Partners, L.P. ("Kane
Partners"). Richard Gelfond, a director of the Company, is Vice President of
the General Partner of Kane Partners and holds a 25% limited partnership
interest in Kane Partners. Chester C. Davenport, Chairman of the Company,
holds a 25% limited partnership interest in Kane Partners. In November 1992,
Kane Partners acquired the underlying leasehold property and the related
rights and obligations from the original lessors of the Ohio and Tennessee
Assets.
The statute and regulations governing Ohio's new I/M 240 test program require
that the land and buildings be owned by a third party having no affiliation
with the operator of the program. The Ohio program is divided into four
separate zones, three of which were subject to competitive bid and, when
awarded, complied with this requirement. The fourth zone, Cuyahoga County,
was subject to an existing contract held by Envirotest at the time contracts
for the other zones were awarded by the State (two of which were awarded to
the Company). As a condition to entering into a new 10 year contract with
Envirotest to conduct I/M 240 vehicle inspections in Cuyahoga County, Ohio
(and not submitting this zone to a competitive bid), the State of Ohio
required Envirotest to comply with its new I/M legislation and caused Kane
Partners to divest its ownership interest in the Ohio Assets. Accordingly,
the third party developer utilized approximately $10,000 of the net proceeds
of the Authority offering described in Note 17 to acquire ownership of the
Ohio Assets that will be utilized in the new Cuyahoga County, Ohio program to
be operated by the Company. As a result, the land and buildings utilized by
the Company under its three Ohio I/M 240 program contracts will be owned by
the developer and leased to the Company.
69
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
In connection with the negotiations related to the Ohio Assets, the Company
agreed to purchase from Kane Partners the Tennessee Assets for $1,800 and one
Ohio test site that will not be utilized in the new test program for $300,
for an aggregate purchase price of $2,100. Although Tennessee Assets and
Ohio Assets have been subject to separate sale and leaseback agreements, the
assets have served as functional security for a financing provided to the
Company in 1990 and were held by Kane Partners since 1992 for the same
purpose. Kane Partners utilized a portion of the aggregate proceeds received
by it from the sale of the Ohio Assets and Tennessee Assets to retire certain
debt obligations held by Chemical Venture Partners and Apollo Advisors, L.P.,
affiliates of which are directors of the Company and beneficially own
approximately 14% and 17%, respectively, of the Company's outstanding Class A
Common Stock. These debt obligations were incurred by Kane Partners in
connection with its initial acquisition of the Ohio Assets and Tennessee
Assets.
In connection with the evaluation and approval of the acquisition of the Ohio
Assets and the Tennessee Assets, and as required by the Senior Notes debt
covenants, a committee of disinterested directors of the Company retained an
independent financial advisor which rendered an opinion stating that (i) the
purchase price paid for the Ohio Assets and Tennessee Assets (collectively,
the "Purchase Price") was fair to the public shareholders of the Company from
a financial point of view, and (ii) the Purchase Price was fair and
reasonable to the Company from a financial point of view and was on financial
terms which are at least as favorable as financial terms which could be
obtained by the Company in a comparable transaction made on an arm's length
basis with persons who are not related persons.
As discussed in Note 17, the Company leased land and facilities in Ohio and
Nashville, Tennessee from Kane Partners during 1994 and 1995. Total lease
expenses under these leases were approximately $1,567 and $2,084 for the
years ended September 30, 1995 and 1994, respectively.
17. CAPITAL LEASE AND LONG-TERM DEBT OBLIGATION:
On June 30, 1995, the Ohio Air Quality Development Authority (Authority)
issued $64,380 of bonds with a 8.1% interest rate to finance the costs of the
acquisition, construction, renovation and equipping of the Company's
emissions testing network in Ohio. The bonds are subject to mandatory sinking
fund redemption and are due December 31, 2005. The land and buildings are
70
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
owned by a developer (the "Developer") and leased to the Company pursuant to
a capital lease. The equipment is owned by the Company. The Developer and
the Company separately have entered into loan agreements with the Authority
under which the payments will provide for timely payment of principal and
interest on the bonds. The Developer and the Company have entered into a
master lease agreement pursuant to which the developer will lease the land
and buildings to the Company. The proceeds are held in trust pending use
of the funds and the unexpended proceeds are reflected on the Company's
balance sheet as restricted cash.
Pursuant to the master lease and loan agreements, all revenues from the
operation of the Ohio emissions testing network are paid into certain
accounts held by the Trustee pursuant to a cash management services
agreement. The excess of revenues from operations over the amount required
to be paid monthly to the Authority under the loan agreements and to the Ohio
Environmental Protection Agency per the contracts will be available to the
Company. The bonds are collateralized by all Ohio program assets.
The future minimum annual payments under the master lease and Company loan
agreement for fiscal years ending September 30, are as follows:
1997 $10,430
1998 9,623
1999 9,617
2000 9,638
2001 9,636
Thereafter 40,894
-------
Total minimum payments 89,838
Amount representing interest (26,943)
-------
Present value of minimum payments 62,895
Less current portion (4,740)
-------
$58,155
-------
71
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
18. OPERATING LEASES:
The Company is obligated under noncancelable operating leases for the
building sites in Vancouver, British Columbia. The Vancouver lease runs for
seven years ending August 31, 1999, with monthly payments averaging
approximately $300. The Company has the option to renew this lease for an
additional seven year period.
As of September 30, 1996, approximate future minimum lease commitments under
noncancelable operating leases are as follows:
1997 $5,225
1998 5,068
1999 4,643
2000 922
2001 711
Thereafter 615
-------
$17,184
-------
Rental expense for the years ended September 30, 1996, 1995 and 1994 was
approximately $4,112, $6,406 and $5,944, respectively, net of sublease income
of approximately $289 and $40 for 1996 and 1995, respectively.
19. COMMITMENTS AND CONTINGENCIES:
The Company's principal commitments at September 30, 1996 consisted of
construction contracts of approximately $4,900 of which $1,800 has already
been incurred for the Indiana program.
72
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
The Company has several performance bonds on its long-term contracts. These
bonds are required by the contracts and vendor agreements in the event the
Company cannot perform and complete the contracts and agreements. In
addition, a bank holds a letter of credit in the amount of $2,400 guaranteed
by the Company in connection with its performance obligations in respect of
the Washington State contract. In the opinion of management, the Company
will be able to fulfill the requirements of the long-term contracts and
leases.
The State of Connecticut has made certain claims stating that the Company
owes the State $2,400 plus accruing amounts for certain cost savings in the
start up of the enhanced testing program in Connecticut. The Company cannot
predict the outcome of this complaint. However, the Company believes that it
has sufficient defense against these claims.
In October 1996, a class action lawsuit was filed asserting the 10 year
contract between Ohio Environmental Protection Agency (OEPA) and the Company
is unconstitutional and, thus, void. The complaint does not request money
damages, except for attorney fees and costs, but seeks to have the Ohio motor
vehicle emission inspection program and the Company's contract enjoined and
declared unconstitutional. Subsequently, the Company filed its motion to
intervene as an additional party defendant in order to protect its interest
in the contract challenged by the plaintiffs' action. The Company believes
that it has valid defenses to the claims contained in the complaint and
intends to defend the matter vigorously.
73
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
The Company is a party to various other legal proceedings and claims in the
ordinary course of business. Although the claims cannot be estimated, in the
opinion of management, the resolution of these matters will not have a
material adverse effect on the Company's consolidated financial position and
results of operations.
20. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The following is a summary of the Company's quarterly results of operations
for the years ended September 30, 1996 and 1995:
1996 QUARTERS ENDED
DEC. 31 MAR. 31 JUN. 30 SEP. 30
- -----------------------------------------------------------------------------
Total contract revenues $28,184 $30,024 $32,556 $33,708
Gross profit 6,292 1,812 7,416 6,803
Net income (loss) 5,588 (16,415) (6,337) (7,900)
Earnings (loss) per common and
common equivalent share $0.32 $(0.99) $(0.38) $(0.46)
Earnings (loss) per common share -
assuming full dilution $0.32 $(0.99) $(0.38) $(0.46)
1995 QUARTERS ENDED
DEC. 31 MAR. 31 JUN. 30 SEP. 30
- -----------------------------------------------------------------------------
Total contract revenues $22,745 $24,149 $29,066 $28,797
Gross profit 9,929 6,849 8,133 6,749
Net loss (211) (1,837) (2,409) (10,404)
Loss per common and common
equivalent share $(0.01) $(0.12) $(0.15) $(0.64)
Loss per common share -
assuming full dilution $(0.01) $(0.12) $(0.15) $(0.64)
21. FOREIGN OPERATIONS:
The Company's contract revenues from its foreign subsidiary, which is located
in Vancouver, British Columbia, Canada were approximately $10,147, $12,285 and
$13,450 for the years ended
74
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
September 30, 1996, 1995 and 1994, respectively, and were earned from a
single customer. Identifiable assets of the foreign subsidiary totaled
approximately $6,913, $5,686 and $6,221 at September 30, 1996, 1995 and 1994,
respectively. The foreign subsidiary had a gross profit of approximately
$572, $1,875 and $2,464 for the years ended September 30, 1996, 1995 and
1994, respectively.
22. SUMMARIZED SEPARATE FINANCIAL INFORMATION:
The Company's consolidated subsidiaries, Envirotest Technologies, Inc.
("ETI"), Remote Sensing Technology, Inc. and Envirotest Partners ("Partners")
are guarantors of the Senior Notes and Notes. The total assets, net equity
and net income of all the subsidiaries not guaranteeing the Senior Notes and
Notes are less than ten percent of the respective amounts reported in the
consolidated financial statements. As required by Rule 3-10(a) of Regulation
S-X, this footnote sets forth the summarized financial information of the
guarantor subsidiaries as of September 30, 1996 and 1995 and for the years
ended September 30, 1996, 1995 and 1994.
In accordance with Staff Accounting Bulletin No. 73, the summarized financial
information reflects the push down of the Company's debt, related interest
expense and allocable debt issue costs associated with the Company's
acquisition of ETI. In addition, as required by Staff Accounting Bulletin
No. 55, the summarized financial information reflects all of the expenses
that the Company incurred on the guarantors' behalf. Except for interest
expense, certain general and administrative expenses and income taxes,
expenses are separately identifiable and therefore, charged directly to the
guarantors. Interest expense is allocated based on the amount of debt
related to the acquisition of ETI; common general and administrative expenses
are allocated based on management's assessment of the actual costs associated
with the guarantors' operations; and income tax expense is provided in the
guarantors' financial data on a separate return basis. Management believes
that the methods used to allocate expenses to the guarantors are reasonable.
75
ENVIROTEST SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
COMBINED SUMMARIZED BALANCE SHEET DATA
SEPTEMBER 30, 1996 AND 1995
1996 1995
- ---------------------------------------------------------------------------
ASSETS
Current assets $ 8,193 $ 5,886
Non-current assets 129,046 250,961
-------- --------
Total assets $137,239 $256,847
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Due to parent $ 18,535 $144,596
Other current liabilities 8,191 10,242
-------- --------
Total current liabilities 26,726 154,838
Non-current liabilities 84,459 80,074
Stockholders' equity 26,054 21,935
-------- --------
Total liabilities and stockholders' equity $137,239 $256,847
-------- --------
COMBINED SUMMARIZED STATEMENTS OF OPERATIONS DATA
FOR THE YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
1996 1995 1994
- ------------------------------------------------------------------------------
Contract revenues $30,743 $45,047 $52,317
Gross profit 20,530 24,379 30,216
Net income 4,114 4,948 10,726
76
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
77
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors is incorporated by reference to the
Company's definitive proxy statement for its 1997 Annual Meeting of
Stockholders (the "1997 Proxy Statement"). Information regarding executive
officers of the Company, included herein under the caption, "Executive
Officers of the Company" in Part I, Item 1 herein, is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Company's 1997 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the Company's 1997 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Company's 1997 Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)1 FINANCIAL STATEMENTS
ENVIROTEST SYSTEMS CORP.
Consolidated Balance Sheets at September 30, 1996 and 1995.
Consolidated Statements of Operations for the years ended September 30,
1996, 1995 and 1994.
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 1996, 1995 and 1994.
Consolidated Statements of Cash Flows for the years ended September 30,
1996, 1995 and
78
1994.
Notes to Consolidated Financial Statements
Report of Independent Accountants.
(a)2 FINANCIAL STATEMENTS SCHEDULES
Schedule II -- Valuation and Qualifying Accounts
Schedules other than that listed above are omitted because they are not
required or are not applicable, or because the information is furnished
elsewhere in the financial statements or the notes thereto.
(a)3 EXHIBITS
3.1 Restated Certificate of Incorporation of Envirotest Systems Corp.
(f)
3.2 First Amended and Restated Bylaws of Envirotest Systems Corp. (j)
3.4 Restated Certificate of Incorporation of Envirotest Technologies,
Inc. (j)
3.5 Restated Bylaws of Envirotest Technologies, Inc. (g)
3.6 Second Amended and Restated Bylaws of Envirotest Systems Corp.
4.1 Indenture, dated as of April 1, 1993, by and among Envirotest
Systems Corp., as issuer, Envirotest Technologies, Inc., as
guarantor, and First Trust National Association, as trustee,
governing the 9 5/8% Senior Subordinated Notes due 2003 of
Envirotest Systems Corp. (f)
4.2 Indenture, dated as of March 15, 1994, by and among Envirotest
Systems Corp., as issuer, Envirotest Technologies, Inc., as
guarantor and First Trust National Association, as trustee,
governing the 9 1/8% Senior Notes due 2001 of Envirotest Systems
Corp. (h)
4.3 First Supplemental Indenture, dated as of March 16, 1994, by and
among Envirotest Systems Corp., as issuer, Envirotest Technologies,
Inc., Remote Sensing Technologies, Inc. and Envirotest Partners, as
guarantors, and First Trust National Association, as trustee,
governing the 9 5/8% Senior Subordinated Notes due 2003 of
Envirotest Systems Corp. (h)
4.4 Second Supplemental Indenture, dated as of May 28, 1994, by and
among Envirotest Systems Corp., as issuer, Envirotest
Technologies, Inc., Remote Sensing
79
Technologies, Inc. and Envirotest Partners, as guarantors, and First
Trust National Association, as trustee, governing the 9 5/8%
Senior Subordinated Notes due 2003 of Envirotest Systems Corp. (j)
4.5 First Supplemental Indenture, dated as of March 15, 1994, by and among
Envirotest Systems Corp., as issuer, Envirotest Technologies, Inc.,
Remote Sensing Technologies, Inc. and Envirotest Partners, as
guarantors, and First Trust National Association, as trustee, governing
the 9 1/8% Senior Notes due 2001 of Envirotest Systems Corp. (j)
4.6 Third Supplemental Indenture, dated as of January 30, 1996, by and
among Envirotest Systems Corp., Envirotest Technologies, Inc., Remote
Sensing Technologies, Inc., Envirotest Partners, Envirotest Acquisition
Co., Systems Control, Inc., as guarantors, and First Trust National
Association, as trustee, governing the 9 5/8% Senior Subordinated Notes
due 2003 of Envirotest Systems Corp. (p)
4.7 Second Supplemental Indenture dated as of January 30, 1996 by and
among, Envirotest Systems Corp., Envirotest Technologies, Inc., Remote
Sensing Technologies, Inc., Envirotest Partners, Envirotest Acquisition
Co., Systems Control, Inc., as guarantors, and First Trust National
Association, as trustee governing the 9 1/8% Senior Notes due, 2001 of
Envirotest Systems Corp. (p)
4.8 Trust Indenture between Indiana Finance Authority and Old National
Trust Company, dated June 1, 1996. (p)
10.1 Amended and Restated Stockholders' Agreement, dated as of
April 10, 1992, by and among Envirotest Systems Corp., Georgetown
Partners Limited Partnership, Gnitrow Ltd., Equico Capital
Corporation, Amoco Venture Capital Company, UNC Ventures II, L.P.,
UNC Ventures, Inc., MESBIC Ventures, Inc., Internationale
Nederlanden (U.S.) Finance Corporation, Skopbank, Apollo Investment
Fund, L.P., Chemical Equity Associates, and each of the individuals
listed on the Schedule of Security holders attached thereto. (a)
10.2 Amendment No. 1 to Amended and Restated Stockholders'
Agreement, dated as of November 10, 1992, by and among Envirotest
Systems Corp. and the Management Stockholders signatory thereto. (a)
10.3 Stock Purchase Agreement, dated January 23, 1992, by and between
Envirotest Systems Corp. and SD-Scicon plc. (a)
10.4 Sale and Leaseback Agreement, dated as of December 14, 1990,
by and between
80
Hamilton Test Systems Ohio, Inc., as Lessor, and
Hamilton Test Systems, Inc., as Lessee. (a)
10.5 Amendment No. 1 to Sale and Leaseback Agreement, dated as of
December 14, 1990, by and between Hamilton Test Systems Ohio, Inc.,
as Lessor, and Hamilton Test Systems, Inc., as Lessee. (a)
10.6 Lease Supplement No. 1, dated December 21, 1990, by and between
Hamilton Test Systems Ohio, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.7 Lease Supplement No. 1, dated February 4, 1991, by and between
Hamilton Test Systems Ohio, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.8 Lease Supplement No. 2, dated March 28, 1991, by and between
Hamilton Test Systems Ohio, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.9 Amendment No. 2 to Sale and Leaseback Agreement, dated as of
July 12, 1991, by and between Hamilton Test Systems Ohio, Inc., as
Lessor, and Hamilton Test Systems, Inc., as Lessee. (a)
10.10 Amendment No. 3 to Sale and Leaseback Agreement, dated as of
April 10, 1992, by and between Hamilton Test Systems Ohio, Inc., as
Lessor, and Hamilton Test Systems, Inc., as Lessee. (a)
10.11 Amendment No. 4 to Sale and Leaseback Agreement, dated as of
November 17, 1992, by and between Kane Partners, L.P., as Lessor,
and Hamilton Test Systems, Inc., as Lessee. (a)
10.12 Sale and Leaseback Agreement, dated as of December 14, 1990,
by and between Hamilton Test Systems Nashville, Inc., as Lessor,
and Hamilton Test Systems, Inc., as Lessee. (a)
10.13 Lease Supplement No. 1, dated February 4, 1991, by and between
Hamilton Test Systems Nashville, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.14 Lease Supplement No. 2, dated March 11, 1991, by and between
Hamilton Test Systems Nashville, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.15 Amendment No. 1 to Sale and Leaseback Agreement, dated as of
July 12, 1991, by and between Hamilton Test Systems Nashville,
Inc., as Lessor, and Hamilton Test Systems, Inc., as Lessee. (a)
81
10.16 Lease Supplement No. 3, dated March 28, 1991, by and between
Hamilton Test Systems Nashville, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.17 Lease Termination, dated as of August , 1991, by and between
Hamilton Test Systems Nashville, Inc., as Lessor, and Hamilton Test
Systems, Inc., as Lessee. (a)
10.18 Amendment No. 2 to Sale and Leaseback Agreement, dated as of
April 10, 1992, by and between Hamilton Test Systems Nashville,
Inc., as Lessor, and Hamilton Test Systems, Inc., as Lessee. (a)
10.19 Supplementary Agreement dated as of July 12, 1991, by and
between Hamilton Test Systems Nashville, Inc., as Lessor, and
Hamilton Test Systems, Inc., as Lessee. (a)
10.20 Ebco-Hamilton Partnership Agreement, dated for reference
August 30, 1991, by and among Ebco Automotive Testing Holdings,
Ltd., Hamilton Test Systems (BC) Ltd., Ebco-Hamilton Test Systems
Ltd., Ebco Industries Ltd. and Hamilton Test Systems, Inc. (a)
10.21 Management Agreement, dated for reference August 30, 1991, by
and between Hamilton Test Systems, Inc. and Ebco-Hamilton Partners.
(a)
10.22 Form of Lease entered into by Ebco-Hamilton Partners and
Intrawest Development Corporation for real estate and improvements
used for program facilities in the British Columbia I/M program.
(a)
10.23 Development and Exclusive License Agreement, dated May 15,
1991, by and among Colorado Seminary (d/b/a the University of
Denver), Systems Control, Inc., Sun Electric Corporation, Donald H.
Stedman, Ph.D and Gary A. Bishop, Ph.D. (a)
10.28 Employment Agreement, dated as of July 1, 1992, by and between
Hamilton Test Systems, Inc. and Ronald M. Lancaster. (a)
10.30 Employment Agreement, dated as of January 1, 1993, by and
between Envirotest Systems Corp. and Chester C. Davenport. (c)
10.32 Supplemental Retirement Plan Agreement, dated as of
September 1, 1991, by and between Hamilton Test Systems, Inc. and
Sylvia C. Edmonds. (a)
10.34 Envirotest Systems Corp. Stock Option Plan, dated as of
January 21, 1993. (d)
10.35 Motor Vehicle Emissions Inspection Maintenance Program
Agreement, dated for
82
reference April 15, 1991, by and between Her
Majesty the Queen in Right of the Province of British Columbia and
Ebco-Hamilton Test Systems Ltd., and Guaranteed by Hamilton Test
Systems, Inc. (a)
10.36 Request for Proposal for the Design, Construction and
Operation of a Motor Vehicle Emissions, Inspection, and Maintenance
Program for the Lower Mainland of British Columbia, dated
September 28, 1990, as revised March 29, 1991. (a)
10.37 Technical Proposal, consisting of Volume IV Design/Operational
Proposal and Volume IV Appendices, submitted by Hamilton Test
Systems, Inc. in cooperation with the Ebco Group, dated
November 30, 1990. (a)
10.38 Motor Vehicle Emissions Inspection and Maintenance Program
Assignment and Assumption Agreement, dated for reference August 30,
1991, by and between Her Majesty the Queen in Right of the Province
of British Columbia and Ebco-Hamilton Test Systems Ltd., as
Assignor, and Ebco-Hamilton Test Systems Ltd., Ebco Automotive
Testing Holdings Ltd. and Hamilton Test Systems (B.C.) Ltd.,
carrying on business as Ebco-Hamilton Partners, as Assignee. (a)
10.39 Guarantee Agreement, dated for reference August 30, 1991, by
and between Hamilton Test Systems, Inc., as Guarantor, and the
Queen in Right of the Province of British Columbia. (a)
10.40 Motor Vehicle Emissions Inspection and Maintenance Program
Amendment No. 1, dated for reference May 15, 1991, by and between
Her Majesty the Queen in Right of the Province of British Columbia
and Ebco-Hamilton Test Systems Ltd., Ebco Automotive Testing
Holdings Ltd. and Hamilton Test Systems (B.C.) Ltd., carrying on
business as Ebco-Hamilton Partners. (a)
10.41 Motor Vehicle Emissions Inspection and Maintenance Program
Amendment No. 2, dated for reference May 31, 1991, by and between
Her Majesty the Queen in Right of the Province of British Columbia
and Ebco-Hamilton Test Systems Ltd., Ebco Automotive Testing
Holdings Ltd. and Hamilton Test Systems (B.C.) Ltd., carrying on
business as Ebco-Hamilton Partners. (a)
10.42 Motor Vehicle Emissions Inspection and Maintenance Program
Amendment No. 3, dated for reference December 13, 1991, by and
between Her Majesty the Queen in Right of the Province of British
Columbia and Ebco-Hamilton Test Systems Ltd., Ebco Automotive
Testing Holdings Ltd. and Hamilton Test Systems (B.C.) Ltd.,
carrying on business as Ebco-Hamilton Partners. (a)
10.43 Motor Vehicle Emissions Inspection and Maintenance Program
Amendment No. 4,
83
dated for reference April 1, 1992, by and between
Her Majesty the Queen in Right of the Province of British Columbia
and Ebco-Hamilton Test Systems Ltd., Ebco Automotive Testing
Holdings Ltd. and Hamilton Test Systems (B.C.) Ltd., carrying on
business as Ebco-Hamilton Partners. (a)
10.44 Contract for the Establishment and Operation of Motor Vehicle
Inspection Program Facilities for the State of Connecticut, dated
as of December 31, 1987, by and between the State of Connecticut
and Hamilton Test Systems, Inc. (a)
10.45 Extension and Modification of Contract between the State of
Connecticut and Hamilton Test Systems, Inc. for the Establishment
and Operation of Motor Vehicle Inspection Program Facilities Dated
December 31, 1987, dated as of May 20, 1992, by and between the
State of Connecticut and Hamilton Test Systems, Inc. (a)
10.46 Change Order to Contract between the State of Connecticut and
Hamilton Test Systems, Inc. for the Establishment and Operation of
Motor Vehicle Inspection Program Facilities Dated December 31,
1987, as Modified by an Extension and Modification Agreement
Effective May 20, 1992, dated as of July 30, 1992, by and between
the State of Connecticut and Hamilton Test Systems, Inc. (a)
10.47 Contract for Motor Vehicle Inspection Program (for Zone
3 -- Palm Beach County), dated as of January 31, 1990, by and
between the State of Florida, the Department of Highway Safety and
Motor Vehicle, and Systems Control, Inc. (Contract No. MO169). (a)
10.48 Request for Proposal No. 3646-89 for the Establishment and
Operation of the Motor Vehicle Inspection Program issued by the
State of Florida. (a)
10.49 Proposal to the Florida Department of Highway Safety and Motor
Vehicles in response to RFP 3646-89 submitted by Systems Control,
Inc. for Zones 3 and 5. (a)
10.50 Amendment No. 1 to the Motor Vehicle Inspection Program
Contract No. MO169, dated February 1, 1990, by and between the
State of Florida, the Department of Highway Safety and Motor
Vehicles, and Systems Control, Inc. (a)
10.51 Contract for Motor Vehicle Inspection Program (for Zone
5 -- Dade County), dated as of January 31, 1990, by and between the
State of Florida, the Department of Highway Safety and Motor
Vehicle, and Systems Control, Inc. (Contract No. MO171). (a)
10.52 Amendment No. 1 to the Motor Vehicle Inspection Program
Contract No. MO171, dated February 1, 1990, by and between the
State of Florida, the Department of
84
Highway Safety and Motor
Vehicle, and Systems Control, Inc. (a)
10.53 Professional Services Agreement, dated October 31, 1990, by
and between the Illinois Environmental Protection Agency and
Systems Control, Inc. (Agency Agreement No. VI-1024). (a)
10.54 Illinois Environmental Protection Agency's Scope of Services
for the Extension of the Vehicle Emission Test Program, dated
October 31, 1990. (a)
10.55 License Agreement, dated October 31, 1990, by and between the
Illinois Environmental Protection Agency and Systems Control, Inc.
(a)
10.56 Technical Proposal for the Extension of the Illinois Vehicle
Emission Test Program submitted by Systems Control, Inc. (a)
10.57 Amendment No. 1 to Professional Services Agreement Number
VI-1024, dated April 8, 1991, by and between the Illinois
Environmental Protection Agency and Systems Control, Inc. (a)
10.58 Amendment No. 2 to Professional Services Agreement Number
VI-1024, dated May 1, 1991, by and between the Illinois
Environmental Protection Agency and Systems Control, Inc. (a)
10.59 Contract-VI-1, dated July 31, 1985, by and between the
Illinois Environmental Protection Agency and Systems Control, Inc.
(a)
10.60 Request for Proposal for the Illinois Motor Vehicle Emissions
Inspection Program, dated January 1985. (a)
10.61 Contract No. DOT-MDE-92-001 for Establishment and Operation of
a Vehicle Emissions Inspection Program, dated as of January 1,
1992, by and between the State of Maryland (the Department of
Transportation, the Motor Vehicle Administration and the Department
of the Environment) and Systems Control, Inc. (a)
10.62 Invitation for Bids for Contract DOT-MDE-88-001, dated May 9,
1988. (a)
10.63 Technical Offer submitted by Systems Control, Inc. to the
State of Maryland, dated June 27, 1988. (a)
10.64 Systems Control, Inc.'s letter to the State of Maryland, dated
June 26, 1991. (a)
85
10.65 General Conditions of the Contract for the Establishment and
Operation of Motor Vehicle Inspection/Maintenance Program for the
State of Minnesota, dated as of July 18, 1990, by and between the
State of Minnesota, acting through the Pollution Control Agency,
and Systems Control, Inc., doing business in Minnesota as Systems
Control Vehicle Testing, Inc. (a)
10.66 Request for Proposal for the Establishment and Operation of
Motor Vehicle Inspection/Maintenance Program for the State of
Minnesota Pollution Control Agency, dated November 20, 1989. (a)
10.67 Proposal submitted by Systems Control, Inc. to the State of
Minnesota Pollution Control Agency in response to the Request for
Proposal. (a)
10.68 Amendment No. 1 to the General Conditions of the Contract for
the Establishment and Operation of Motor Vehicle
Inspection/Maintenance Program for the State of Minnesota, dated as
of June 17, 1991, by and between the State of Minnesota, acting
through the Pollution Control Agency, and Systems Control, Inc.,
doing business in Minnesota as Systems Control Vehicle Testing,
Inc. (a)
10.69 Amendment No. 2 to the General Conditions of the Contract for
the Establishment and Operation of Motor Vehicle
Inspection/Maintenance Program for the State of Minnesota, dated as
of May 15, 1992, by and between the State of Minnesota, acting
through the Pollution Control Agency, and Systems Control, Inc.,
doing business in Minnesota as Systems Control Vehicle Testing,
Inc. (a)
10.70 Term Contract for Establishment and Performance of a Vehicular
Tailpipe Emissions Inspection Program for Cuyahoga County, dated
December 28, 1989, by and between the State of Ohio, the Ohio
Environmental Protection Agency (through the Department of
Administrative Services), and Hamilton Test System, Inc. (Term
Contract No. 680138-GS). (a)
10.71 Ohio Environmental Protection Agency Invitation to Bid for a
Vehicular Emissions Inspection Program for Cuyahoga County (Bid
No.: 680138-GS). (a)
10.72 Letter dated July 5, 1990 from the Ohio Environmental
Protection Agency to Hamilton Test Systems, Inc. (a)
10.73 Contract for Operation of Vehicle Inspection and Maintenance
Program, dated July 1990, by and between the Metropolitan
Government of Nashville and Davidson County and Hamilton Test
Systems, Inc. (a)
10.74 Terms and Specifications to Establish and Operate a Vehicle
Inspection and
86
Maintenance Program for Nashville and Davidson
County. (a)
10.75 Proposal submitted by Hamilton Test Systems, Inc. to the
Metropolitan Government of Nashville and Davidson County. (a)
10.76 Extension of the Contract for the Continued Operation of Motor
Vehicle Emissions Inspection and Maintenance Program Facilities for
the State of Wisconsin, dated as of August 1, 1988, by and between
the State of Wisconsin, the Department of Transportation, and
Hamilton Test Systems, Inc. (a)
10.77 Supplemental Agreement No. 5, dated as of March 23, 1989, by
and between the State of Wisconsin, the Department of
Transportation, and Hamilton Test Systems, Inc. (a)
10.78 Extension and Modification of the Contract for the Continued
Operation of Motor Vehicle Emissions Inspection and Maintenance
Program Facilities for the State of Wisconsin, dated as of
September 1, 1992, by and between the State of Wisconsin, the
Department of Transportation, and Hamilton Test Systems, Inc. (a)
10.79 Contract, dated September 30, 1992, by and between Hamilton
Test Systems, Inc. and the Environmental Protection Agency. (b)
10.80 Amendment No. 1 to Employment Agreement, dated as of
January 1, 1993, by and between Hamilton Test Systems, Inc. and
Ronald M. Lancaster. (c)
10.83 Stockholders' Agreement, dated as of March 30, 1993, by and
among Chester C. Davenport, Sylvia C. Edmonds, Georgetown Partners
Limited Partnership, Chemical Equity Associates, A California
Limited Partnership, TSG Ventures Inc., and the New Class B
Holders. (e)
10.84 Amendment No. 2 to Amended and Restated Stockholders'
Agreement, dated as of March 30, 1993, by and among Envirotest
Systems Corp., Georgetown Partners Limited Partnership,
Kane Partners, L.P., TSG Ventures Inc. (f/k/a/ Equico Capital
Corporation), Amoco Venture Capital Company, UNC Ventures II, L.P.,
UNC Ventures, Inc., MESBIC Ventures, Inc., Internationale
Nederlanden (U.S.) Finance Corporation, Skopbank, Apollo Investment
Fund, L.P., Chemical Equity Associates, and each of the individuals
listed on the Schedule of Securityholders attached thereto. (e)
10.85 Amendment No. 4 to Sale and Leaseback Agreement, dated as of
March 30, 1993, by and between Kane Partners, L.P., as Lessor, and
Hamilton Test Systems, Inc., as Lessee (relating to Tennessee
property). (e)
87
10.86 Amendment No. 5 to Sale and Leaseback Agreement, dated as of
March 30, 1993, by and between Kane Partners, L.P., as Lessor, and
Hamilton Test Systems, Inc., as Lessee (relating to Ohio property).
(e)
10.87 Agreement for Consulting Services, dated as of September 1,
1993, by and between Envirotest Systems Corp. and Cheviot Capital
Advisors Inc. (f)
10.88 Contract for Centralized Emissions Inspection Facilities,
dated November 11, 1993, by and between the Commonwealth of
Pennsylvania, Department of Transportation, and Envirotest/Synterra
Partners. (f)
10.89 Request for Proposal for Pennsylvania's Centralized Vehicle
Inspection/Maintenance (I/M) Program, RFP Number 111142, dated June
21, 1993. (f)
10.90 An Agreement between the Colorado Department of Health, the
Colorado Department of Revenue and Envirotest Systems Corp., dated
February 22, 1994. (g)
10.91 Contract between the State of Connecticut and Envirotest
Systems Corporation for the Establishment and Operation of the
Motor Vehicle Inspection Program Facilities for the State of
Connecticut dated April 15, 1994. (h)
10.92 Contract Between the Department of Environment and
Conservation State of Tennessee and Envirotest Systems Corporation
Dated May 12, 1994. (i)
10.93 State of Ohio Environmental Protection Agency, Contract for
Services with Envirotest Systems Corp., dated October 1994, for
Montgomery, Clark and Greene Counties. (k)
10.94 State of Ohio Environmental Protection Agency, Contract for
Services with Envirotest Systems Corp., dated October 1994, for
Summit, Portage, Medina, Lake, Lorain and Geauga Counties. (k)
10.95 Agreement between the Wisconsin Department of Transportation
and Envirotest Systems Corp. for the establishment and Operation of
Motor Vehicle Emissions Inspection Facilities for the State of
Wisconsin, dated January, 1995. (k)
10.96 Employment Agreement, dated as of February 1, 1995 between
Envirotest Systems Corp. and Ralph E. Reins. (k)
88
10.97 State of Ohio Environmental Protection Agency, Contract for
Services with Envirotest Systems Corp., dated April 25, 1995, for
Cuyahoga County. (l)
10.98 Separation, Release and Waiver Agreement, dated as of May 24,
1995 by and between the Company and William J. Beckham, Jr. (m)
10.99 Agreement with State of California, dated June 1995. (m)
10.100 General Release and Settlement Agreement, dated December 15,
1995 between Envirotest, the Commonwealth of Pennsylvania and the
Pennsylvania Department of Transportation. (n)
10.101 Release of Claim and Dismissal of Litigation before the
Commonwealth Court of the Commonwealth of Pennsylvania, dated
December 18, 1995. (n)
10.102 Contract between Bureau of Automotive Repairs for the State of
California and Remote Sensing Technologies, Inc., dated July
13, 1995. (n)
10.103 Employment Agreement between F. Robert Miller and Envirotest
Systems Corp. dated January 26, 1996. (o)
10.104 Amendment No. 3 to Contract L-90-5140 between the Metropolitan
Government of Nashville and Davidson County and Envirotest
Systems Corp. dated December 19, 1995. (o)
10.105 Amendment No. 6 dated December 21, 1995 to Professional Services
Agreement Number VI-1024 between the State of Illinois
Environmental Protection Agency and Envirotest Technologies,
Inc. (o)
10.106 Agreement between Indiana Department of Environmental Management
and Envirotest Systems Corp. dated June 26, 1996. (p)
10.107 Loan Agreement between Envirotest Systems Corp. and Indiana
Development Finance Authority, dated June 1, 1996. (p)
10.108 Employment Agreement between C. Michael Alston and Envirotest Systems
Corp., effective January 1, 1996.
10.109 Employment Agreement between Raj Modi and Envirotest Systems Corp.,
effective January 1, 1996.
10.110 Employment Agreement between Lawrence Taylor and Envirotest
Systems Corp.,
89
effective January 1, 1996.
10.111 Contract between State of Washington and Envirotest Systems Corp.
10.112 Purchase and Sale Agreement between ES Funding Corporation
and Envirotest Partners, dated November 26, 1996.
10.113 Liquidity Loan Agreement among The Liquidity Lenders, Market Street
Capital Corp., Envirotest Partners and PNC Bank, National
Association, dated November 26, 1996.
10.114 Receivables Purchase Agreement among Market Street Capital Corp., ES
Funding Corporation and PNC Bank, National Association, dated
November 26, 1996.
11. Statement of Computation of Per Share Earnings.
21. Subsidiaries of Envirotest Systems Corp. and Envirotest
Technologies, Inc.
23. Consent of Independent Accountants regarding incorporation by
reference to Registration Statement on Form S-8.
(a) Incorporated by reference to the similarly numbered Exhibits to the
Registrant's Registration Statement on Form S-1 (No. 33-57384)
filed on January 25, 1993.
(b) Incorporated by reference to the similarly numbered Exhibits to
Amendment No. 1 to the Registrant's Registration Statement on
Form S-1 (No. 33-57384) filed on March 12, 1993.
(c) Incorporated by reference to the similarly numbered Exhibits to
Amendment No. 2 to the Registrant's Registration Statement on
Form S-1 (No. 33-57384) filed on March 25, 1993.
(d) Incorporated by reference to the similarly numbered Exhibits to
Amendment No. 3 to the Registrant's Registration Statement on
Form S-1 (No. 33-57384) filed on March 30, 1993.
(e) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1993.
(f) Incorporated by reference to the similarly numbered Exhibits to the
Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 1993, filed on December 29, 1993.
(g) Incorporated by reference to the similarly numbered Exhibits to
Amendment No. 2 to the Registrant's Registration Statement on Form
S-1 (No. 33-75406) filed on March 8, 1994.
(h) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1994.
90
(i) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 1994.
(j) Incorporated by reference to the similarly numbered Exhibits to the
Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 1994, filed on December 29, 1994.
(k) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended December 31,1994.
(l) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1995.
(m) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 1995.
(n) Incorporated by reference to the similarly numbered Exhibits to the
Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 1995, filed on December 29, 1995.
(o) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly report on Form 10-Q for the quarterly
period ended March 31, 1996.
(p) Incorporated by reference to the similarly numbered Exhibits to the
Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 1996.
(b) REPORTS ON FORM 8-K
The registrant filed no reports on Form 8-K during fiscal 1996.
91
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrants have duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Bethesda, State of Maryland, on the 24th day of
December, 1996.
ENVIROTEST TECHNOLOGIES, INC. ENVIROTEST SYSTEMS CORP.
By: /s/ Chester C. Davenport By: /s/ Chester C. Davenport
--------------------------- ---------------------------
Chester C. Davenport Chester C. Davenport
Chairman of the Board of Directors Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
registrants and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
--------- ----- -----
/s/ Chester C. Davenport
- ------------------------- Chairman of the Board December 24, 1996
(Chester C. Davenport) of Directors
/s/ F. Robert Miller
- ------------------------- President, Chief Operating December 23, 1996
(F. Robert Miller) Officer, Director
/s/ Raj Modi
- ------------------------- Vice President, Chief December 24, 1996
(Raj Modi) Financial Officer,
Treasurer and Assistant
Secretary (Principal
Financial and Accounting
Officer)
- -------------------------
(Richard L. Gelfond) Vice Chairman of the December ___, 1996
Board of Directors
/s/ Cleveland Christophe
- -------------------------- Director December 23, 1996
(Cleveland A. Christophe)
- -------------------------- Director December ___, 1996
(Edward Dugger III)
- -------------------------- Director December ___, 1996
(Craig M. Cogut)
92
/s/ Robert W. Kasten Jr.
- ------------------------- Director December 23, 1996
(Robert W. Kasten, Jr.)
93
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Director and Stockholders
Envirotest Systems Corp.
Our report on the consolidated financial statements of Envirotest Systems
Corp. is included on page 43 of this Form 10-K. In connection with our
audits of the financial statements, we have also audited the related
financial statement schedule listed in the index of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
/s/ Coopers & Lybrand L.L.P.
San Jose California
December 13, 1996
94
ENVIROTEST SYSTEMS CORP.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
Beginning Costs and Other Balance at
Classification of Period Expense Accounts Deductions End of Period
SEPTEMBER 30, 1996
Allowance for
doubtful accounts $375 $74 -- -- $449
SEPTEMBER 30, 1995
Allowance for
doubtful accounts $354 $21 -- -- $375
SEPTEMBER 30, 1994
Allowance for
doubtful accounts $250 $104 -- -- $354
95