UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-21953
ENVIRONMENTAL SAFEGUARDS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEVADA 87-042919
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2600 SOUTH LOOP WEST, SUITE 645
HOUSTON, TEXAS 77054
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(713) 641-3838
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
CHECK WHETHER THE ISSUER (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY
SECTION 13 or 15(d) OF THE EXCHANGE ACT DURING THE PAST 12 MONTHS (OR FOR SUCH
SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2)
HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
AT NOVEMBER 9, 2001, APPROXIMATELY 10,112,144 SHARES OF COMMON STOCK, $.001 PAR
VALUE, WERE OUTSTANDING.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE):
Yes [ ] No [X]
ENVIRONMENTAL SAFEGUARDS, INC.
CONTENTS
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheet as of September 30, 2001
(unaudited) and December 31, 2000.
Unaudited Consolidated Condensed Statement of Operations for the
three months and nine months ended September 30, 2001 and 2000.
Unaudited Consolidated Condensed Statement of Cash Flows for the
nine months ended September 30, 2001 and 2000.
Selected Notes to Unaudited Consolidated Condensed Financial
Statements.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
3
ENVIRONMENTAL SAFEGUARDS, INC.
CONSOLIDATED CONDENSED BALANCE SHEET
----------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<Table>
<Caption>
SEPTEMBER 30,
2001 DECEMBER 31,
(UNAUDITED) 2000
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 961 $ 3,068
Accounts receivable 940 1,023
Other current assets 178 105
----------- -----------
Total current assets 2,079 4,196
Property and equipment, net 7,523 8,929
Acquired engineering design and technology, net 1,714 2,019
Other assets 3 9
----------- -----------
Total assets $ 11,319 $ 15,153
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 5,406 $ 2,945
Accounts payable 221 156
Dividends payable 296 225
Accrued interest 620 220
Other accrued liabilities 734 688
Income taxes payable -- 220
----------- -----------
Total current liabilities 7,277 4,454
Long-term debt, net of current portion -- 2,163
Minority interest 2,072 2,872
Stockholders' equity:
Preferred stock; Series B convertible; voting, $.001 par value (aggregate
liquidation value - $2,898); 5,000,000 shares authorized; 2,733,686
shares issued and outstanding 3 3
Preferred stock; Series D convertible, non-voting, cumulative
$.001 par value (aggregate liquidation value $4,000);
400,000 shares authorized, issued and outstanding 1 1
Common stock; $.001 par value; 50,000,000 shares authorized;
10,112,144 shares issued and outstanding 10 10
Additional paid-in capital 14,935 14,935
Accumulated deficit (12,979) (9,285)
----------- -----------
Total stockholders' equity 1,970 5,664
----------- -----------
Total liabilities and stockholders' equity $ 11,319 $ 15,153
=========== ===========
</Table>
The accompanying notes are an integral part of these unaudited
consolidated condensed financial statements.
4
ENVIRONMENTAL SAFEGUARDS, INC.
UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ------------------------
2001 2000 2001 2000
-------- -------- -------- --------
Revenue $ 837 $ 2,271 $ 2,233 $ 9,283
Cost of revenue 933 1,328 2,692 4,934
-------- -------- -------- --------
Gross margin (96) 943 (459) 4,349
Selling, general and administrative
expenses 613 870 1,953 2,818
Amortization of acquired engineering
design and technology 102 102 306 306
Research and development 19 15 54 52
-------- -------- -------- --------
Income (loss) from operations (830) (44) (2,772) 1,173
Other income (expense):
Interest income 4 6 28 20
Interest expense (220) (267) (700) (780)
Other 10 (6) 33 30
-------- -------- -------- --------
Income (loss) before provision for income
taxes and minority interest (1,036) (311) (3,411) 443
Provision for income taxes 102 180 222 1,009
-------- -------- -------- --------
Loss before minority interest (1,138) (491) (3,633) (566)
Minority interest 32 30 209 (534)
-------- -------- -------- --------
Net loss $ (1,106) $ (461) $ (3,424) $ (1,100)
======== ======== ======== ========
Net loss available to common stockholders $ (1,187) $ (575) $ (3,694) $ (1,475)
======== ======== ======== ========
Basic and dilutive loss per common share $ (0.12) $ (0.06) $ (0.37) $ (0.15)
======== ======== ======== ========
Weighted average shares outstanding 10,112 10,112 10,112 10,112
======== ======== ======== ========
</Table>
The accompanying notes are an integral part of these unaudited
consolidated condensed financial statements.
5
ENVIRONMENTAL SAFEGUARDS, INC.
UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
----------
(IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
2001 2000
------- -------
Cash flows from operating activities:
Net loss $(3,424) $(1,100)
Adjustment to reconcile net
loss to net cash provided (used) by
operating activities 2,366 4,010
------- -------
Net cash provided (used) by operating
activities (1,058) 2,910
------- -------
Cash flows from investing activities:
Purchases of property and equipment (181) (136)
------- -------
Cash flows from financing activities:
Payments on long-term debt -- (899)
Distribution to minority owners (669) (1,170)
Dividends on preferred stock (199) (328)
------- -------
Net cash used by financing
activities (868) (2,397)
------- -------
Net increase (decrease) in cash and cash equivalents (2,107) 377
Cash and cash equivalents, beginning of
period 3,068 1,944
------- -------
Cash and cash equivalents, end of period $ 961 $ 2,321
======= =======
</Table>
The accompanying notes are an integral part of these unaudited
consolidated condensed financial statements.
6
SELECTED NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
----------
1. GENERAL
The unaudited consolidated condensed financial statements included herein
have been prepared without audit pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States of America have been condensed or omitted, pursuant to such rules
and regulations. These unaudited consolidated condensed financial
statements should be read in conjunction with the audited consolidated
financial statements and notes thereto of Environmental Safeguards, Inc.
(the "Company") included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2000.
In the opinion of management, the unaudited consolidated condensed
financial information included herein reflect all adjustments, consisting
only of normal, recurring adjustments, which are necessary for a fair
presentation of the Company's financial position, results of operations and
cash flows for the interim periods presented. The results of operations for
the interim periods presented herein are not necessarily indicative of the
results to be expected for a full year or any other interim period.
2. LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has expended a significant portion of its
resources to develop markets and industry awareness of the capabilities of
its indirect thermal desorption remediation and recycling/reclamation
process. The Company's efforts have been focused primarily on hydrocarbon
soil contamination inherent in oil and gas exploration activities. The
Company's efforts to develop markets and produce equipment have required
significant amounts of capital including long-term debt secured by the
Company's ITD units and related ITD technology. The Company has incurred
recurring net losses and has been dependent on revenue from a limited
customer base to provide cash flows. The Company completed its most
significant service contract in December 2000 and is currently exploring
ways to replace the revenue. During the year ended December 31, 2000 and
the nine months ended September 30, 2001, the Company experienced a
tightening of cash reserves and took actions to delay payments on its
senior secured debt. Such delay of principal and interest payments of
approximately $1,233,000 in 2000 would require payment of approximately
$3.9 million of principal and interest payments in 2001. The 2001 debt
payments and expected continuing losses would further strain the Company's
liquidity. In addition, as of September 30, 2001, the Company's current
liabilities exceeded its current assets by $5,198,000. As noted below, the
Company has been unable to make such debt payments thus far. These factors
raise substantial doubt about the Company's ability to continue as a going
concern.
On August 23, 2001, the Company entered into a contract to sell three of
its ITD units to a customer in Mexico. The sale is contingent upon the
customer obtaining financing within one hundred and twenty days from the
execution of the contract. During the interim period before the sale is
consummated, the Company's Mexican subsidiary will operate the ITD units,
which operations are to occur mainly within the fourth quarter of 2001.
Upon receipt of the purchase price for the three ITD units, the Company
will grant to its customer an exclusive license for, and right to use, ITD
technology in Mexico (subject to an existing agreement) and an option to
purchase a fourth ITD unit from the Company. When the financing is obtained
by the customer, the proceeds from the sale of the three units will be used
to pay on the Company's debt. In the event that the customer is unable to
obtain financing within this time period, the Company will operate the ITD
units in Mexico for its customer under a standard services contract.
Effective August 31, 2001, the Company reached an agreement with its
primary lenders and holders of its outstanding preferred stock that
resulted in a deferral of debt payments and dividends until at least
December 31, 2001. This resulted in the Company remaining in compliance
with covenants provided in its senior secured debt agreement and stock
agreements, and provided the Company with increased financial flexibility
to continue its pursuit of new market opportunities (See Note 3). The
Company is currently seeking to obtain service contracts in the markets
that it serves, however, to the extent the Company does not achieve
sustaining profitability and cash flows, the Company may be required to
seek deferral of all remaining current and long-term obligations.
The Company's viability as a going concern is dependent on the continued
restructuring of its obligations and/or capital infusions, the
repositioning of its asset base and the achievement of a sustaining level
of profitability. The accompanying financial statements do not include any
adjustments that might be necessary if the Company is unable to continue as
a going concern.
To the extent the Company's cash reserves and cash flows from operations
are insufficient to meet future cash requirements, the Company will need to
successfully raise additional capital through the sale of additional equity
or the issuance of debt securities. Such financing may not be available on
terms acceptable to the Company or at all. Further, the sale of additional
equity or convertible debt securities may result in dilution to the
Company's stockholders.
Management has evaluated the carrying value of long-lived assets, including
associated intangibles. An evaluation of recoverability is performed by
comparing the estimated future undiscounted cash flows associated with the
asset to the asset's carrying amount to determine if a write-down to market
value or discounted cash flow is required. Given the
7
homogeneous nature and geographic deployment flexibility of such assets,
and based upon a recent evaluation by management, an impairment of the
Company's long-lived assets was not deemed necessary.
3. LONG-TERM DEBT
On August 31, 2001, the Company entered into an agreement (the "Agreement")
with its primary lenders and holders of its outstanding preferred stock
that provided the Company with increased financial flexibility to continue
its pursuit of new market opportunities. The Agreement provided for a
deferral, to December 31, 2001, of all principal and interest payments
(both currently due and previously deferred under agreements dated March
2001 and August 2000) on the Company's senior secured debt. At the end of
the deferral period, based on the Company's involvement in good faith
negotiations for its sale, the sale of a subsidiary, the sale of
substantially all of its assets, or the sale of substantially all assets of
its subsidiaries, all deferrals will be extended to March 31, 2002.
Additionally, the Company has received a continuing deferral of preferred
dividends due in March and September 2001, with a continuing deferral on
the same basis as the senior secured debt. The Agreement was designed to
allow the Company to conserve working capital while strategic plans are
being considered.
4. INCOME TAXES
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The
Company has provided a deferred tax valuation allowance for cumulative net
operating tax losses and foreign tax credit carryforwards to the extent
such net operating losses and foreign tax credit carryforwards may not be
realized. The difference between the federal statutory income tax rate and
the Company's effective income tax rate is primarily attributed to foreign
income taxes and changes in the valuation allowance for deferred tax assets
related to U.S. net operating losses as follows.
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
Federal statutory rate (34)% (34)% (34)% 34%
Foreign income taxes 10 58 7 228
Change in valuation allowance 34 34 34 (34)
---- ---- ---- ----
Effective income tax rate 10% 58% 7% 228%
==== ==== ==== ====
</Table>
As of September 30, 2001, for U.S. federal income tax reporting purposes,
the Company has approximately $9,800,000 of unused net operating losses
("NOLs") available for carryforward to future years. The benefit from
carryforward of such NOLs will expire during the years ended December 31,
2001 to 2020. The benefit from utilization of NOL carryforwards could be
subject to significant limitations in the event of ownership changes in the
Company. As of September 30, 2001, the Company had approximately $834,000
of foreign tax credit carryforwards which can be offset against future
taxable income. The benefit from carryforward of such foreign tax credits
will expire during the years ended December 31, 2002 to 2005.
8
5. EARNINGS (LOSS) PER SHARE
The Company computes basic earnings per share based on the weighted average
number of shares of common stock outstanding for the period, and includes
common stock equivalents outstanding for the computation of diluted
earnings per share. As a result of incurred net losses, for the three
months and nine months ended September 30, 2001 and 2000, all common stock
equivalents have been excluded from the calculation of earnings per share
as their effect is anti-dilutive. In future periods, the calculation of
diluted earnings per share may require that the Company's common stock
equivalents (totaling 19,457,368 shares as of September 30, 2001) be
included in the calculation of the weighted average shares outstanding for
periods in which net income is reported. Following is the reconciliation of
net loss to net loss available to common stockholders:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30,
2001 2000 2001 2000
------- ------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
Net loss $(1,106) $ (461) $(3,424) $(1,100)
Preferred stock dividends:
Series C -- (114) -- (328)
Series D (81) -- (270) --
Accretion of discount on
Series C preferred stock -- -- -- (47)
------- ------- ------- -------
Net loss available to common
stockholders $(1,187) $ (575) $(3,694) $(1,475)
======= ======= ======= =======
</Table>
9
6. SEGMENT INFORMATION
The Company operates in the environmental remediation and hydrocarbon
reclamation/recycling services industry. Substantially all revenue results
from the sale of services using the Company's ITD units. The Company's
reportable segments are based upon geographic area. All intercompany
revenue and expenses have been eliminated.
Following is a summary of segment information:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
2001 2000 2001 2000
------- ------- ------- -------
(IN THOUSANDS) (IN THOUSANDS)
Revenue:
United States $ 140 $ 600 $ 140 $ 1,203
United Kingdom -- -- -- 52
Latin America 697 1,671 2,093 8,028
------- ------- ------- -------
Revenue $ 837 $ 2,271 $ 2,233 $ 9,283
======= ======= ======= =======
Income (loss) from operations:
United States $ (686) $ (47) $(2,037) $ (904)
United Kingdom (132) (137) (418) (376)
Latin America 140 297 151 2,970
Middle East (63) (97) (222) (348)
Corporate (89) (60) (246) (169)
------- ------- ------- -------
Income (loss) from
operations $ (830) $ (44) $(2,772) $ 1,173
======= ======= ======= =======
</Table>
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(IN THOUSANDS)
Assets:
United States $ 5,581 $ 5,891
United Kingdom 916 1,173
Latin America 1,016 4,624
Middle East 3,436 3,440
Corporate 370 25
------- -------
Total assets $11,319 $15,153
======= =======
</Table>
10
7. SUPPLEMENTAL NON-CASH TRANSACTIONS
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
---- ----
(IN THOUSANDS)
Issuance of warrants in connection
with long-term debt agreement $ -- $438
Dividends declared but not yet
Paid $189 $ --
</Table>
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Financial
Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 142 eliminates the amortization of goodwill and requires
that goodwill be reviewed annually for impairment. SFAS No. 142 also
requires that the useful lives of previously recognized intangible assets
be reassessed and the remaining amortization periods be adjusted
accordingly. SFAS No. 142 is effective for fiscal years beginning after
December 15, 2001 and affects all goodwill and other intangible assets
recorded on the Company's balance sheet at that date, regardless of when
the assets were initially recorded. The Company has not yet determined
the effect of SFAS No. 142 on its financial statements.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with our
consolidated condensed financials statements and related notes included
elsewhere in this report, and with our Annual Report on Form 10-K for the year
ended December 31, 2000.
Information Regarding and Factors Affecting Forward-Looking Statements
We are including the following cautionary statement in this Form 10-Q to
make applicable and take advantage of the safe harbor provision of the Private
Securities Litigation Reform Act of 1995 for any forward-looking statements made
by us, or on behalf of us. Forward-looking statements include statements
concerning plans, objectives, goals, strategies, future events or performance
and underlying assumptions and other statements which are other than statements
of historical fact. Certain statements in this Form 10-Q are forward-looking
statements. Words such as "expects", "anticipates", "estimates" and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to risks and uncertainties that could cause actual results to differ
materially from those projected. Such risks and uncertainties are set forth
below. Our expectations, beliefs and projections are expressed in good faith and
are believed to have a reasonable basis, including without limitation, our
examination of historical operating trends, data contained in our records and
other data available from third parties. There can be no assurance, however,
that our expectations, beliefs or projections will result, be achieved, or be
accomplished.
In addition to other facts and matters discussed elsewhere herein, the
following are important factors that, in our view, could cause material adverse
affects on our financial condition and results of operations: our ability to
secure contracts for our ITD units; our ability to attain widespread market
acceptance of our technology; the ability of our existing cash reserves and cash
flows from operations to cover our ongoing cash requirements; our ability to
obtain acceptable forms and amounts of financing to fund planned expansion; the
demand for, and price level of, our services; competitive factors; the actual
useful life of our equipment; our ability to mitigate concentration of business
in a small number of customers; the evolving industry and technology standards;
our ability to protect proprietary technology; our dependence on key personnel;
the effect of business interruption due to political unrest; foreign exchange
fluctuation risk; and our ability to maintain acceptable utilization rates on
our equipment. We are not obligated to update or revise these forward-looking
statements to reflect the occurrence of future events or circumstances.
Overview
We provide environmental reclamation and recycling services to companies
engaged in land-based oil and gas exploration, waste management, and other
industrial applications. Substantially all of our technologies and services are
provided through OnSite Technology ("OnSite"), our wholly-owned operating
subsidiary that forms the cornerstone of our worldwide operations. We continue
to devote substantially all our efforts to the development of markets for
OnSite's services.
Oil and gas exploration, refinery and other types of industrial activities
often produce significant quantities of petroleum-contaminated drill cuttings
and waste, from which our Indirect Thermal Desorption ("ITD") units extract and
recover the hydrocarbons as re-useable or re-saleable liquids, and produce
recycled soil which is compliant with environmental regulations. OnSite's
activities include use of our ITD technology to address hydrocarbon
contamination problems and hydrocarbon recycling and reclamation opportunities
at heavy industrial, refining, petrochemical and waste management sites, as well
as at Superfund, DOD and DOE sites.
12
We operate internationally through our 100%-owned subsidiaries in Mexico
and the United Kingdom, and through our 50%-owned joint company in the Arabian
Gulf region. We are in the process of closing down (liquidating) both our
Colombian and our Venezuelan operations.
Our ITD Units, which are portable equipment, utilize a rotating,
heat-jacketed trundle to vaporize hydrocarbons from contaminated soil or other
contaminated materials. Our ITD Units consist of two principal components: (i)
an indirect thermal desorption unit wherein the hydrocarbon contaminated soil is
indirectly heated, causing the hydrocarbon contamination to vaporize; and (ii) a
condensation process system, which causes the hydrocarbon vapor to condense into
a liquid for recycling.
As of November 9, 2001, our fleet of ten ITD Units is dispersed
geographically as follows: five in Mexico, one in Scotland, two in the Arabian
Gulf region and two in the USA. Two of the units in Mexico are operating with
one customer, and three are with a different client, which operations began at
the end of the third quarter, prior to their contingent sale (see below for
further details). All remaining ITD units are either undergoing routine
maintenance or awaiting contract operations. We fully-own eight of the ten
units, and have a 50% joint-company ownership in the two Arabian Gulf region
units.
On August 23, 2001, we entered into a contract to sell three of our ITD
units to a customer in Mexico. The sale is contingent upon our customer
obtaining financing within one hundred and twenty days from the execution of the
contract. During the interim period before the sale is consummated, our Mexican
subsidiary will operate the ITD units, which operations are to occur mainly
within the fourth quarter of 2001. Upon receipt of the purchase price for the
three ITD units, we will grant to our customer an exclusive license for, and
right to use, ITD technology in Mexico (subject to an existing agreement) and an
option to purchase a fourth ITD unit from us. When the financing is obtained by
the customer, the proceeds from the sale of the three units will be used to pay
on our debt. In the event that our customer is unable to obtain financing within
this time period, we will operate the ITD units in Mexico for our customer under
a standard services contract.
Quarterly Fluctuations
Our revenue may be affected by the timing and deployment of ITD Units to
customer sites under existing contracts, and by the timing of obtaining new
contracts. Accordingly, our quarterly results may fluctuate and the results of
one fiscal quarter should not be deemed to be indicative of the results of any
other quarter, or for the full fiscal year.
Results of Operations
COMPARISON OF OPERATING RESULTS - QUARTERS ENDED SEPTEMBER 30, 2001 AND 2000
Summary. During the third quarter of 2001, we incurred a net loss of
$1,106,000 as compared to a 2000 third quarter net loss of $461,000. Our
$645,000 increase in net loss was primarily due to a substantial reduction in
equipment utilization, most of which resulted from the completion of contract
operations in Colombia at the end of 2000. Gross margin decreased due to
significant reduction in revenue and due to the fixed nature of depreciation
expense which is included in cost of revenue.
Revenue and Gross Margin. Revenue of $837,000 during the third quarter of
2001 generated $96,000 of negative gross margin as compared to revenue of
$2,271,000 and gross margin of $943,000 in the comparable 2000 quarter. The
decrease in revenue and gross margin was due to a substantial drop in ITD
utilization during the third quarter of 2001, where on average we had 2.0 units
in operation in the third quarter of 2001 as compared to 3.7 units in the third
quarter of 2000 (more than 75% of the decreased utilization was due to the
completion of contract operations in Colombia at the end of 2000).
Selling, General and Administrative ("SGA") Expenses. SGA expenses during
the third quarter of 2001 were 30% below the comparable quarter in 2000
primarily due to the winding-down of contract operations in Colombia.
Amortization of Engineering Design and Technology. This represents the
amortization of Acquired Engineering Design and Technology costs, an intangible
asset related to the December 1997 acquisition of the remaining 50% interest in
OnSite from Parker Drilling. The intangible asset is being amortized over an
8-year estimated economic life.
Interest Expense. During the third quarter of 2001, $220,000 of interest
expense was incurred (including amortization of debt issuance costs of
$107,000), compared to interest expense of $267,000 for the third quarter of
2000 (including amortization of debt issuance costs of $66,000). Lower interest
expense for 2001 is primarily due to lower prevailing prime interest rates.
13
Income Taxes. The reported tax provision in the third quarter of 2001
relates to foreign income taxes incurred mainly by our Mexican subsidiary. The
2000 third quarter provision relates mainly to both our Mexican and Colombia
subsidiaries. During both comparative quarters we incurred net operating losses
("NOLs") primarily in the U.S., which may be used to offset taxable income
reported in future periods. The NOLs and certain foreign tax credits associated
with the taxes paid in OnSite's foreign subsidiaries have generated deferred tax
assets, but due to uncertainties regarding the future realization of these
assets, a valuation allowance has been provided for the full amount of the
deferred tax assets.
Minority Interest. Minority interest for the third quarter of 2001 reflects
our 50% minority partner's interest in the net loss of OnSite Arabia. During the
comparable quarter of 2000, the minority interest reflects our 50% minority
partner's interest in the net loss of OnSite Arabia partly offset by our 50%
minority partner's net income of OnSite Colombia.
COMPARISON OF OPERATING RESULTS - NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
Summary. For the nine months ended September 30, 2001, we incurred a net
loss of $3,424,000 as compared to a 2000 nine-month loss of $1,100,000. Our
$2,324,000 increase in net loss for 2001 was due primarily to a substantial
reduction in equipment utilization, most of which resulted from the completion
of contract operations in Colombia at the end of 2000. Gross margin decreased
due to a significant reduction in revenue and due to the fixed nature of
depreciation expense which is included in cost of revenue.
Revenue and Gross Margin. Revenue of $2,233,000 during the first nine
months of 2001 generated $459,000 of negative gross margin as compared to
revenue of $9,283,000 and gross margin of $4,349,000 in the comparable 2000
nine-month period. The decrease in revenue was due to a substantial drop in ITD
utilization during the first nine months of 2001, where on average we had 1.8
ITD units in operation in the first nine months of 2001 as compared to 4.5 units
in the first nine months of 2000 (approximately 85% of the decreased utilization
was due to the completion of contract operations in Colombia at the end of
2000).
Selling, General and Administrative ("SGA") Expenses. SGA expenses during
the first nine months of 2001 were 31% below the comparable six months in 2000
primarily due to the winding-down of contract operations in Colombia.
Amortization of Engineering Design and Technology. This represents the
amortization of Acquired Engineering Design and Technology costs, an intangible
asset related to the December 1997 acquisition of the remaining 50% interest in
OnSite from Parker Drilling. The intangible asset is being amortized over an
8-year estimated economic life.
Interest Expense. During the first nine months of 2001, $700,000 of
interest expense was incurred (including amortization of debt issuance costs of
$262,000), compared to interest expense of $780,000 for the first nine months of
2000 (including amortization of debt issuance costs of $217,000). Lower interest
expense for 2001 is primarily due to lower prevailing prime interest rates.
Income Taxes. The reported tax provision in the first nine months of 2001
relates to foreign income taxes incurred mainly by our Mexican subsidiary. The
first nine-month provision during 2000 relates mainly to our Colombian
subsidiary. During both comparative periods we incurred net operating losses
("NOLs") primarily in the U.S., which may be used to offset taxable income
reported in future periods. The NOLs and certain foreign tax credits associated
with the taxes paid in OnSite's foreign subsidiaries have generated deferred tax
assets, but due to uncertainties regarding the future realization of these
assets, a valuation allowance has been provided for the full amount of the
deferred tax assets.
Minority Interest. Minority interest for the first nine months of 2001
reflects our 50% minority partner's interest in the net loss of OnSite Colombia
and OnSite Arabia. Minority interest for the first half of 2000 reflects our 50%
minority partner's interest in the net income of OnSite Colombia, partially
offset by the net loss of OnSite Arabia.
Liquidity and Capital Resources
We currently have no significant commitments for capital expenditures.
During the past three years, we have expended a significant portion of our
resources to develop markets and industry awareness of our ITD remediation and
recycling/reclamation process technology. Our efforts have been focused
primarily on hydrocarbon soil contamination inherent in oil and gas exploration
activities. Our efforts to develop markets and produce equipment have required
significant amounts of capital, including long-term debt secured by our ITD
units and related ITD technology.
14
We have incurred recurring net losses and have been dependent on revenue
from a limited customer base to provide cash flows. We completed our most
significant service contract in December 2000 and are currently exploring ways
to replace the revenue. During 2000 and throughout 2001, we have experienced a
tightening of cash reserves and took actions to delay payments on our senior
secured debt.
We are currently seeking service contracts in our served markets and are
considering strategic alternatives including the possible sale of all or
substantially all of our assets. As part of our strategic plan, in August 2000,
we reached an agreement with our primary lenders and holders of our outstanding
preferred stock that resulted in a six-month deferment of certain principal,
interest and preferred stock dividends, and in March 2001 and August 2001, we
further reached agreements with the same parties that resulted in our continuing
to remain in compliance with covenants provided in our senior secured debt
agreement and preferred stock agreements. These agreements provide us with
increased financial flexibility to continue our pursuit of new market
opportunities. However, to the extent we do not achieve sustaining profitability
and cash flow, we may be required to seek deferral of all remaining current and
long-term obligations.
Our viability as a going concern is dependent on our ability to generate
backlog, our achievement of a sustaining level of profitability, and the
continued restructuring of our obligations and/or capital infusions. There can
be no assurances, however, that we will remain in compliance with our
obligations, that we will increase ITD utilization or become sufficiently
profitable in a time frame necessary to meet our obligations.
To the extent our cash reserves and cash flows from operations are
insufficient to meet our future cash requirements, we will need to successfully
raise additional capital through the sale of additional equity or the issuance
of debt securities. Such financing may not be available on terms acceptable to
us or at all. Further, the sale of additional equity or convertible debt
securities may result in further dilution to our stockholders.
We have evaluated the carrying value of our long-lived assets, including
associated intangibles. An evaluation of recoverability is performed by
comparing the estimated future undiscounted cash flows associated with the asset
to the asset's carrying amounts to determine if a write-down to market value or
discounted cash flow is required. Given the homogeneous nature and geographic
deployment flexibility of such assets, and based upon our recent evaluation, an
impairment of our long-lived assets was not deemed necessary.
The functional currency of our active foreign operations (Mexico, Scotland
and the Arabian gulf region) is the U.S. dollar because customer invoicing,
customer receivables, imported equipment and many of the operating cost factors
are denominated in U.S. dollars. We plan to continue to implement the same
approach as other foreign operations come on line in order to minimize our risks
associated with foreign exchange fluctuation and its affect on our
profitability.
Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued Financial
Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets."
SFAS No. 142 eliminates the amortization of goodwill, and requires that goodwill
be reviewed annually for impairment. SFAS No. 142 also requires that the useful
lives of previously recognized intangible assets be reassessed and the remaining
amortization periods be adjusted accordingly. SFAS No. 142 is effective for
fiscal years beginning after December 15, 2001 and affects all goodwill and
other intangible assets recorded on our balance sheet at that date, regardless
of when the assets were initially recorded. We have not yet determined the
effect of SFAS No. 142 in our financial statements.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Reports on Form 8-K
On August 31, 2001, we filed a report on Form 8-K, which report included
information under Item 5 "Other Information".
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENVIRONMENTAL SAFEGUARDS, INC.
Date: November 9, 2001 By: /s/ James S. Percell
James S. Percell, President
Date: November 9, 2001 By: /s/ Ronald L. Bianco
Ronald L. Bianco, Chief Financial Officer
16