1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K --------------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended August 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 0-19350 ViroGroup, Inc. Exact name of Registrant as specified in its charter FLORIDA 59-1671036 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 5217 Linbar Drive, Suite 309 Nashville, TN 37211 (Address of principal executive offices) Registrant's telephone number: (615) 832-0081 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock, $.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] 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 registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of November 17, 1997 the aggregate market value of the voting stock of the Registrant held by non-affiliates of the Registrant was $225,060. As of November 17, 1997, the number of outstanding shares of Common Stock, par value $.01 per share, of the Registrant was 795,214. Information required by Part III is incorporated by reference to portions of the Registrant's 1998 Proxy Statement for the Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission within 120 days after the close of the 1997 fiscal year. ================================================================================ 2 PART I ITEM 1. BUSINESS ViroGroup, Inc. (the "Company"), provides a wide range of environmental services to assess and remediate groundwater and soil contamination, to design and monitor solid and hazardous waste landfills, to protect air quality, to assure regulatory compliance and to develop groundwater resources. The Company's strategy is to provide a comprehensive array of services through integrated utilization of a skilled technical staff consisting of hydrogeologists, environ- mental engineers, chemical engineers, chemists, biologists, computer modelers and others to find optimum solutions to a client's environmental challenges. The Company's current market focus is centered on North America with most of its business in the Southeastern United States. BACKGROUND AND ORGANIZATION The Company's client base is diversified. Its clients range in size from large, publicly held corporations to municipalities and local enterprises, including industrial firms, sales and service companies, service stations, and utilities. The majority of the Company's revenues are derived from private-sector clients. The Company's first office was established in Cape Coral, Florida in 1976 and primarily focused on the development, management and protection of groundwater resources such as drinking water. Subsequently, the Company broadened its scope of services to include other environmental services. Primarily in response to anticipated demand for underground petroleum storage tank site assessments and remediations to be paid by the State of Florida through its Inland Protection Trust Fund, the Company in fiscal years 1989 through 1992 opened six additional offices in Florida. In March, 1995, the State suddenly curtailed the program significantly reducing the available work. Primarily as a result of this curtailment, the Company closed three of its offices in 1995 and 1996. The Company also closed two small, nonprofitable offices in Florida and decreased the size of its South Carolina office by one-third in 1997. Present Company locations in Florida are Cape Coral and Pensacola. During fiscal 1992, the Company, in exchange for common stock and cash, acquired a company which mainly provides planning, design and construction Quality Control/Quality Assurance, facility permitting and closure, as well as wastewater services to the solid and hazardous waste management industries. Through this acquisition, the Company acquired locations in California, New York and South Carolina. The New York and California offices were closed in fiscal 1994 and 1996, respectively. During fiscal 1993 the Company acquired an environmental and remediation services company in Nashville, Tennessee, from a Laidlaw Inc. (Laidlaw) affiliate in exchange for 600,000 shares of the Company's Series A Preferred Stock. On the same date the Company sold to 2 3 another Laidlaw affiliate an additional 200,000 shares of Series A Preferred Stock for $2,000,000 in cash. In June 1995 these entities surrendered these holdings in exchange for 397,607 of the Company's $0.01 par value common shares, which represents 50% of the Company's total shares after giving effect to the one-for-eight reverse stock split on January 23, 1997. In addition, the agreement included the following provisions: - - Should Laidlaw sell or transfer the Common Stock received under this agreement at any time between two and six years after issuance, holders of other outstanding Common Shares will be granted the right to participate in any such transaction on the same basis, terms and conditions. - - ViroGroup's Board of Directors was reduced from nine members to seven, three of whom are to be nominated by the holders of the Common Stock issued under the agreement. - - Commencing with the issuance of the Common Stock and for a three-year period thereafter, Laidlaw agreed to extend to ViroGroup a $3.0 million line of credit subordinated to and bearing the same interest rate as the Company's existing bank credit line. Laidlaw, in lieu of its commitment to provide the debt financing to the Company, caused a letter of credit to be issued to collateralize the Company's $3.0 million line of credit to a bank lender. Substantially all of the Company's assets secure this obligation to Laidlaw in the event of a draw upon the line of credit. Furthermore, Laidlaw waived unpaid preferred stock dividends totaling $180,445. As a result of this preferred stock conversion and waiver, the Company is no longer obligated to pay an annual preferred stock dividend of $560,000. In 1996, Laidlaw affiliates were the Company's largest clients, accounting for approximately 20 per cent of the Company's revenues. In 1997, Laidlaw affiliates accounted for only 8 per cent of revenues. The Company is organized into two broad service divisions. These service divisions are Environmental Consulting and Engineering Services, and Hydrogeological and Water Resources Services. Through this organization, each office utilizes the Company's full resources regardless of geographical location, thus contributing to optimizing solutions that address our clients' diverse environmental challenges. This merger of the Company's talent is designed to maximize staff utilization while reducing overhead costs. All Company locations use the name of ViroGroup as their identity. The Company's common stock is listed on the Nasdaq SmallCap System. The Company's principal executive offices are located at 5217 Linbar Drive, Suite 309, Nashville, Tennessee 37211, and its phone number is (615) 832-0081. Unless otherwise 3 4 indicated, references herein to specific years correspond to the Company's fiscal year ending August 31. Environmental Consulting and Engineering Services The Company provides professional services in the following areas: environmental management information services, bio-remediation, remediation design, construction management, contamination assessment, risk assessment, underground storage tank management, transactional environmental audits, operational environmental audits, air quality management, and wastewater management and regulatory assistance, as well as hazardous and solid/liquid waste management consulting services and other services. Environmental, Consulting and Engineering services comprised approximately 89% of the Company's 1997 consolidated gross revenues. Operational Environmental Audits. Operational environmental audits are performed at industrial, commercial and governmental facilities to provide an analysis of a client's environmental compliance status, to suggest ways to minimize hazardous waste and reduce costs and to recommend corrective action, if appropriate. The Company performs these services to help clients comply with environmental and work place laws and regulations, including air emissions, wastewater and groundwater discharges, hazardous and solid wastes, polychlorinated biphenyls, asbestos, pesticides, oil spill control, underground storage tanks, drinking water, contingency planning, OSHA, worker right-to-know, and SARA Title III (community right-to-know). This complex body of environmental laws and regulations has substantially reduced a company's ability to comply without assistance by outside specialists. The Company offers specialized follow-on services to address needs identified during the audit. Chemical and process engineers work with regulatory specialists to develop waste minimization programs. Permit deficiencies are evaluated and corrective action programs including training are implemented. Wastewater and Process Engineering Services. These services include wastewater treatment projects that use physical, chemical and biological processes. Other wastewater management services include, monitoring and inspection of wastewater management systems and compliance with applicable provisions of federal, state and local laws and regulations. NPDES and RCRA (TSD) permit related services are provided as well as wastewater facility, and collection system planning and design. Remediation Design, Construction and Management. ViroGroup provides comprehensive remediation services to correct groundwater and soil contamination. Services provided include remediation plan development, design and installation of treatment and recovery systems, hydrogeological studies, bio-remediation, vapor extraction, RCRA closures, Treatment, Storage and Disposal (TSD) facilities closure, soil/water removal and treatment programs, as well as long-term monitoring and maintenance programs, including monitoring well design and construction, and above-ground tank installation. 4 5 The Company provides complete underground storage tank (UST) assessment and remediation services. Among the services provided are site assessments, hydrogeological studies, remediation plan development, tank removal, replacement tank system design and installation, soil and water removal, treatment system design and installation, as well as systems monitoring and maintenance. Bio-remediation Services. During fiscal 1996 the Company added a new bio-remediation technology to its line of services known as the immobilized microbe bio-reactor system. This technology is a biological treatment process which is a simple, efficient and effective method for treating entrenched organic contamination in both soil and groundwater. It has distinct performance benefits over many traditional bio-remediation technologies and can offer lower cost, efficient remediation for large area contamination. Solid and Hazardous Waste Management Services. These services include planning, design and construction services, facility permitting, permit modifications and construction quality control inspections. Solid waste services are almost exclusively offered to the private sector while wastewater services are mainly offered to county and city governments. Environmental Management Services (EMS). During fiscal 1996 the Company added database design services to help clients efficiently manage their compliance programs. Environmental compliance can be extremely time-consuming and complex. The Company's EMS staff works with clients to evaluate their needs for compliance and designs a database which easily and timely generates automatic tracking, specification calculations and compliance reports. This modular system allows clients to select modules for air permitting, discharge monitoring reporting, permit tracking, and hazardous waste tracking, as well as specific client customized modules. Such flexibility allows the Company to easily tailor these applications to each client's needs and budget. Florida Underground Petroleum Storage Tank (UST) Reimbursement Program. During fiscal 1994, the Company aggressively expanded its participation in the State of Florida financed programs to provide environmental services to evaluate, assess and remediate contaminated underground petroleum storage tank sites. Through its Inland Protection Trust Fund, the State of Florida reimburses certain costs to clean up eligible contaminated sites. Primarily due to an estimated unfunded $450 million backlog and annual tax revenue allocation of only $100 million, in March 1995 new legislation directed the Florida Department of Environmental Protection to cease processing, with certain limited exceptions, applications for reimbursement of costs to clean up UST sites eligible for state funds. In May, 1996 a new law (the "1996 Act") was passed which implemented significant changes to the reimbursement program and addressed the estimated $450 million backlog of unpaid claims. The 1996 Act provided for the elimination of the reimbursement program effective August 1, 1996 and required all reimbursement applications to be submitted by December 31, 1996. Also, the 1996 Act created a non-profit public benefit corporation, which became 5 6 operational in the Fall of 1997, to finance the unpaid backlog. This non-profit corporation is charged with financing the estimated backlog of 9,500 claims totaling over $556 million. Payment of claims will be on a first-come, first-served methodology based on application filing date and an assumed annual allocation rate of $100 million. Claims paid will be subject to a 3.5% annual discount in consideration of the anticipated accelerated payment as compared to the previously expected period of 4 to 5 years. Based upon information received from the State of Florida, it is currently anticipated that payment of the initial portion of the claims (approximately $213 million) should begin in the first quarter of calendar 1998; however, no assurance of that timetable can be given. The Company in prior fiscal years recorded valuation allowances on the amounts due to reflect the State mandated discount and potential denied costs. At August 31, 1996 allowances totaled $931,665 with $889,937 applied as a valuation allowance to the amounts due, resulting in a net amount of $2,812,737 shown as the Amounts Due from State Agency, net, in the accompanying consolidated balance sheet. At August 31, 1997 allowances totaled $913,918 with $166,623 applied as a valuation allowance to the amounts due, resulting in a net of $512,927 shown as the Amounts Due From State Agency, net, in the accompanying consolidated balance sheet. The balance sheet also includes $747,295 which is included in Accrued liabilities to reflect the Company's liability to pay discounts and denied costs on receivables sold to third-parties. All of the approximately $3.1 million in reimbursement applications which were unfiled at August 31, 1996, have been sold to third party financing entities at August 31, 1997. The Company used third-party funding to obtain the cash from the financing entities to avoid the long payout period by the State. In addition to selling the previously mentioned claims, the Company filed approximately $703,000 directly with the State. Specifically, the Company entered into several arrangements to sell substantially all the claims filed with the State for reimbursement. These arrangements required prepayment of a 3 - 4% prepaid fee to cover administrative and other costs for up to the first nine months at the time the financing entity paid the Company. If the State has not paid the funding entities within the first nine months, the Company will pay indemnification costs at the rate of .6875% per month beginning October 1997. In January 1998, the indemnification rate begins to increase each month and could reach 12.375% per month in August 1998. The effect of the rate increase is to generate an overall yield, since inception, of 8.25%. These indemnification costs are being charged against the reserve account at the present time. In the event the State does not meet the projected payment schedule beginning in the first quarter of calendar year 1998, the reserves will not be adequate to absorb all of the indemnification costs. 6 7 Risk Assessment. The Company performs risk assessments for industrial sites to evaluate the potential danger to the health and safety of individuals, as well as the impact on the environment at and near the site. The risk assessment report also predicts the ultimate fate and disposition of any contaminants. The risk assessment provides an assessment of potential harm, predicts who might be affected and proposes and monitors corrective action. At times, the Company performs risk assessments to determine the consequences of deferring remediation while continuing to monitor the problem. Contamination Assessment. The Company provides comprehensive definitions of and solutions for contamination problems. The principal sources of contamination that the Company addresses are: leaking underground storage tanks, spills of hazardous waste and improper disposition of solid and hazardous waste. The Company assigns trained personnel with thorough knowledge of environmental, health and safety regulations to all contamination assessment projects. Transactional Environmental Audits. The Company performs transactional environmental audits in connection with real property transactions, foreclosures and loans secured by real property. Such audits assess environmental risks and estimate remediation needs and costs. In 1980, Congress passed the Comprehensive Environmental Response, Compensation and Liability Act, which generally provides that owners, operators and purchasers of properties contaminated with toxic or hazardous substances may be liable for the cost of clean-up and also may be exposed to third-party liability actions. The demand for environmental audits was increased by the 1986 Superfund Amendment and Reauthorization Act, which created an innocent purchaser defense known as the "due diligence" test. The Company has developed an internal system of classification with scopes of service for various levels of environmental audits ranging from data review and site visits to cases of increased complexity requiring site testing of groundwater, surface water, soils and air for asbestos, radon and other harmful substances. If an audit identifies contamination, an "assessment" of the site follows to determine the extent and significance of the contamination. Air Quality Management. The Company's services include: emissions reduction studies, atmospheric dispersion modeling, air-quality control system design and assistance in obtaining permits. Title V permitting and associated process engineering services are provided to a variety of industrial sectors. The Company's professionals provide enforcement representation, negotiation of financial settlements and consent orders and expert witness services to address air quality issues during administrative and judicial proceedings. Other Services. ViroGroup's professionals provide training services for client management and employees on a variety of environmental issues and regulations and serve as expert witnesses, negotiate financial settlements and consent orders, as well as serve as representation during enforcement administrative and judicial proceedings. The Company does not represent any federal, state or local authorities in enforcement proceedings against private entities. 7 8 HYDROGEOLOGICAL AND WATER RESOURCES SERVICES The Company provides professional services for water supply development, injection well design and water resource planning. These services include computer modeling to assess surface water influences as well as groundwater changes. Computer modeling services result in site-condition analysis ranging from contaminant plume migration to regional well field impacts. Groundwater resource management services are provided primarily in the southeastern United States and the Caribbean. These services comprise approximately 11% of the Company's consolidated gross revenues. Water Supply. The Company assists in the development of groundwater supplies for municipal, agricultural and industrial uses. The Company performs subsurface investigations and upgrades existing systems with cost-effective solutions to water quality or well construction problems. The Company estimates the potential yield of an aquifer and recommends the most efficient well design to maximize yield while minimizing impact, assesses water quantity and quality and supervises the wellfield construction. Identification of an acceptable source of water can be time consuming and expensive in coastal and island hydrogeologic environments. Withdrawals from an aquifer can induce the movement of poorer quality water into the production wells, causing failure of the system. In response to these problems, the Company's professionals conduct research in the hydrodynamics of the fresh/salt water interface and model withdrawal scenarios to maximize both water production and protection of potable water resources. The Company specializes in saltwater intrusion, including identifying, quantifying and controlling the problem. The Company believes that reverse osmosis desalination will become increasingly important in developing water supply systems for municipal and industrial clients. The Company designs and develops wellfields to supply such systems. The Company has special expertise in predicting the long-term effects on water quality of various levels of production from such wellfields through the use of three dimensional computer modeled simulations. The Company originated as a groundwater supply engineering firm and has more than fifteen years' experience with groundwater wellfields. A number of the Company's professionals have degrees in hydrogeology and have published articles on the subject in scientific and technical publications. Water Resource Planning. The Company assists municipalities, water management districts and industrial clients in developing water resource management plans to alleviate water shortages caused by drought conditions, declining water levels, groundwater contamination or saltwater intrusion. The Company's professionals provide specialized regional exploration for new groundwater resources and develop alternative water sources, including reuse of residential and industrial wastewater, storage and recovery of excess freshwater runoff and treatment of salt water by reverse osmosis. 8 9 In connection with its groundwater resource management services, the Company provides both surface and groundwater monitoring, including location and installation of wells, sampling, chain of custody requirements, analytical work and analysis of results. The Company's water monitoring services assist its clients in maintaining regulatory compliance and improving their process flow while recycling water, conserving resources and upgrading treatment plants. Injection Well Technology. Injecting fluids into underground formations containing nonpotable groundwater is called deep-well injection. Treated wastewater or reverse osmosis concentrate water are commonly injected into deeper aquifers containing poorer quality saline water. Also, treated freshwater is injected into aquifers during periods of abundant supply for recovery during peak demand periods. Injection-well technology is used where the receiving aquifer is capable of accepting the injected fluids without endangering any underground source of drinking water. The Company's work includes design of the wells, preparation for construction permits, preparation of technical data, construction, inspection, installation and injection testing. CLIENTS Almost all of the clients that retain the Company to provide environmental services are private-sector clients ranging from large, publicly traded corporations to local enterprises, including industrial, sales and service companies and service stations. Almost all of the clients that retain the Company to provide groundwater resource management services, which principally relate to public water supply development, are public and private utilities and governmental water supply systems. The Company does not provide services to governmental units in connection with regulatory enforcement actions against private companies. During fiscal 1997, the Company's 10 largest clients, in the aggregate, accounted for approximately 50% of gross revenues. The Company's largest client, International Comfort Products, is an international business which has no ownership association with ViroGroup. This client accounts for approximately 14% of total revenues and the loss of this client could have a material adverse effect on the Company. No other client accounted for more than 10% of total revenues. MARKETING The Company's sales and marketing efforts focus on developing new clients including national accounts and generating new business from existing clients. The Company believes its corporate sales and marketing program, which includes three fulltime, professional sales people, teamed with localized marketing by the professional consulting staff is the most effective method of generating revenues. Marketing activities include presentations by senior staff personnel to civic and professional associations, presentations at seminars and publication of articles in professional journals. 9 10 PRICING Approximately 75% of the Company's business consists of charging clients for hours worked on their project plus expenses incurred for their job. The remainder of the revenues are generated by fixed fee contracting and unit price contracts. In all material instances, the fixed fee contracts are for services with which the Company has substantial experience and can reasonably predict costs requirements. The business of the Company is somewhat seasonal. Materials and third-party services used in performing the contracted work are readily available. BACKLOG As of August 31, 1997, the Company's backlog was approximately $4,000,000, compared to approximately $2,000,000 as of August 31, 1996. Management does not believe backlog is a meaningful indication of future revenues. COMPETITION The market for the Company's services is highly competitive. The Company competes with many other firms, ranging from small, local firms to large, national firms having substantially greater financial, and marketing resources than the Company. The Company competes primarily on the basis of quality of service and expertise. Other competitive factors include geographic location, price and availability of personnel. INSURANCE AND LIABILITY It has been both a Company policy, and a requirement of many clients, for the Company to carry insurance for the services it performs. The Company maintains professional liability and contractor's pollution liability insurance in the amount of $5,000,000. The Company's general liability insurance is in the amount of $2,000,000 plus $5,000,000 in excess liability coverage. Aggressive enforcement of RCRA and Superfund Act regulations and legal decisions adverse to insurance carriers involving pollution damage may make it difficult for the Company and others in its industry to obtain adequate liability insurance in the future. In addition, the professional liability insurance policy is available only on a claims made basis, so the insured is only covered if it maintains coverage. While the Company believes it operates safely and prudently, there are various exclusions under its insurance policies and there is no assurance that all possible liabilities that may be incurred by the Company are covered by its insurance or that the dollar amount of such liabilities will not exceed the Company's policy limits. 10 11 EMPLOYEES At August 31, 1997, the Company had 64 fulltime employees of whom 31 hold technical degrees and 12 of whom held advanced degrees. The technical/professional staff includes hydrogeologists, environmental engineers, chemical engineers, civil engineers, geologists and others. The Company's ability to retain and expand its staff of qualified professionals will be an important factor in determining the Company's future success. None of the Company's employees is represented by a union. The Company considers its employee relations to be good. ITEM 2. PROPERTIES The Company leases the following facilities: APPROXIMATE EXPIRATION LOCATION USED FOR SQUARE FOOTAGE DATE -------- -------- -------------- ---- Nashville, Tennessee Corporate 13,000 1998 Headquarters and Operations Office Pensacola, Florida Operations Office 3,200 1999 Lexington, South Operations Office 3,400 1999 Carolina Cape Coral, Florida Operations Office 13,000 2002 The Company believes that its existing facilities are adequate to meet current requirements and that suitable additional or substitute space will be available as needed to accommodate any expansion of operations and for additional offices. ITEM 3. LEGAL PROCEEDINGS In August 1993, a civil action was filed in Hamblen County Chancery Court of the Third District of Tennessee against the Company and Galen of Tennessee, Inc., seeking compensatory and punitive damages of approximately $1,140,000 in regards to an asbestos abatement project. In December 1993, the Court dismissed the lawsuit. The parties are now compelled to submit to arbitration, and Management believes the Company's exposure will be substantially less than $140,000. The plaintiff has not made any demand for arbitration. The Company believes that this action is without merit and intends to vigorously defend itself. 11 12 The Company has been notified by the Environmental Protection Agency, through a General Notice Letter that the Company is a potentially liable party at the Florida Petroleum Reprocessors Site in Davie, Florida. However, at this time, no estimate of the potential liability can be calculated due to the limited amount of information available. This type of liability is an insurable risk and the Company's insurance carrier has been notified; however, no formal claim has been filed at this time. The insurance policy has a deductible of $250,000. Company management is of the opinion that Company liability, if any, will be minimal. The Company is not subject to any other material legal proceedings. From time to time, the Company is involved in other routine litigations, claims and assessments incidental to its business. The Company does not believe that the ultimate resolution of any of the above described matters would have a material adverse impact on the accompanying consolidated financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 12 13 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITIES AND RELATED SHAREHOLDER MATTERS The Company's common stock is listed on the Nasdaq SmallCap System. The number of holders of record of common stock of the Company as of November 18 was 40. The Company believes that there are over 800 beneficial owners of its common stock. The Company has not paid any cash dividends and does not intend to pay any cash dividends in the foreseeable future. The high and low closing prices of the Company's common stock for each quarter of the two most recent fiscal years, 1997 and 1996, respectively, are as follows: FISCAL YEAR FIRST SECOND THIRD FOURTH 1997 - ------------------- ------------ ------------- ----------- -------------- High 4 1/4 4 1/2 2 1 3/4 Low 2 1/4 1 3/4 1 FISCAL YEAR FIRST SECOND THIRD FOURTH 1996 - ------------------- ------------ ------------- ----------- -------------- High 9 1/2 7 8 6 Low 4 4 4 2 1/2 Stock price data reflects inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. The closing price of the Company's common stock, as reported on the Nasdaq SmallCap System, on November 17, 1997, was 5/8. On January 23, 1997, the Company implemented a one-for-eight reverse stock split of the Company's common stock. Prices for prior periods have been adjusted to reflect that reverse split. On August 25, 1997, the Nasdaq announced new requirements for continued listing on the Nasdaq SmallCap Market. As of the date of this annual report, the Company is not in compliance with such requirements which may result in the delisting of the common stock. 13 14 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA For the Years Ended August 31, ---------------------------------------------------------------------------- INCOME STATEMENT DATA: 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- Gross revenues ............................ $ 26,956,682 $ 26,272,211 $ 21,478,007 $ 13,986,538 $ 6,884,742 Cost of gross revenues .................... 18,118,165 17,090,139 15,927,619 9,420,106 5,175,925 ------------ ------------ ------------ ------------ ----------- Gross profit .............................. 8,838,517 9,182,072 5,550,388 4,566,432 1,708,817 Operating expenses (1)(2) ................. 22,013,274 8,732,094 8,287,922 5,764,563 4,488,295 ------------ ------------ ------------ ------------ ----------- Income (loss) from operations before income taxes and cumulative effect of a change in accounting principle ............ (13,174,757) 449,978 (2,737,534) (1,198,131) (2,779,478) Other income (expense), net (3) ........... (94,281) (65,857) 6,888 (177,514) (113,238) ------------ ------------ ------------ ------------ ----------- Income (loss) from operations before income taxes and cumulative effect of a change in accounting principle ............ (13,269,038) 384,121 (2,730,646) (1,375,645) (2,892,716) Income taxes (benefit) .................... (468,000) (176,259) (143,909) -- -- ------------ ------------ ------------ ------------ ----------- Income (loss) before cumulative effect of a change in accounting principle ............ (12,801,038) 560,380 (2,586,737) (1,375,645) (2,892,716) Cumulative effect on prior years of changing the method of accounting for income taxes (4) .......................... -- 52,546 -- -- -- ------------ ------------ ------------ ------------ ----------- Net income (loss) ......................... $(12,801,038) $ 612,926 $ (2,586,737) $ (1,375,645) $(2,892,716) ============ ============ ============ ============ =========== Net income (loss) per common share: Operations ............................... $ (32.20) $ -- $ (3.25) $ (1.73) $ (3.64) Effect of accounting change ............... -- .13 -- -- -- ------------ ------------ ------------ ------------ ----------- Net income (loss) per share (5) ........... $ (32.20) $ .13 $ (3.25) $ (1.73) $ (3.64) ============ ============ ============ ============ =========== Weighted average number of shares outstanding ............................... 397,561 397,607 795,214 795,214 795,214 ============ ============ ============ ============ =========== BALANCE SHEET DATA: Current assets ............................ $ 10,663,724 $ 10,518,359 $ 6,340,770 $ 4,524,526 $ 2,696,042 Total assets .............................. 12,678,319 12,136,255 9,410,953 7,916,270 3,563,969 Short-term debt ........................... 140,869 79,325 37,125 2,500,876 1,160,944 Long-term debt ............................ 118,881 38,234 107,486 0 0 Shareholders' equity ...................... 7,276,966 7,329,892 4,433,659 3,058,014 165,298 - ---------------------- (1) Includes amortization of goodwill in the amount of $11,851,575 for the year ended August 31, 1993. (2) Includes restructuring charges of $470,000 for the year ended August 31, 1993, $47,305 for the year ended August 31, 1994, $326,190 for the year ended August 31, 1995, $326,428 for the year ended August 31, 1996, and $237,755 for the year ended August 31, 1997. (3) Year ended August 31, 1995 includes a $150,168 gain on a favorable contract settlement. (4) The effect of the adoption of SFAS 109, Accounting for Income Taxes as of September 1, 1993. (5) Calculated after the deduction of preferred stock dividends of $272,329 for the year ended August 31, 1993 and $560,000 for the year ended August 31, 1994. For all years presented, primary earnings (loss) per share and fully diluted earnings (loss) per share were the same except for fiscal year 1995. (See Note 1 (h) to Notes to the Consolidated Statements). 14 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table presents, as a percentage of gross revenues, certain selected financial data for the Company for the periods indicated: For the Years Ended August 31, ---------------------------------------- 1995 1996 1997 ---- ---- ---- Gross revenues 100.0% 100.0% 100.0% Cost of gross revenues 74.2 67.3 75.2 ----- ----- ----- Gross profit 25.8 32.7 24.8 Operating expenses 38.6 41.2 65.2 ----- ----- ----- Income (loss) from operations (12.8) (8.5) (40.4) Other income (expense), net (.0) (1.3) (1.6) Income taxes (benefit) (.7) .0 .0 ----- ----- ----- Net income (loss) (12.1) (9.8) (42.0) ===== ===== ===== FISCAL 1997 VS. FISCAL 1996 Gross revenues for 1997 decreased by $7,101,796 from the 1996 level of $13,986,538. The Environmental Consulting and Engineering Services Division decreased by $5,820,295 and the Hydrogeological and Water Resources Services Division decreased by $1,281,501. Division Gross Revenues -------- -------------- % of Increase 1996 1997 (Decrease) ---- ---- ---------- Enviro Florida $ 4,175,484 $1,813,485 (57) Enviro South Carolina/California 4,566,138 1,980,597 (57) Enviro Tennessee/New Orleans 3,185,631 2,312,876 (27) ----------- ---------- TOTAL ENVIRO DIVISION 11,927,253 6,106,958 (49) Hydro Division 2,059,285 777,784 (62) ----------- ---------- TOTAL VIROGROUP, INC. $13,986,538 $6,884,742 (51) =========== ========== 15 16 Each of the Company's offices produces revenue in Enviro and each office showed a decrease in its volume of revenue. The Hydro division operates out of the Cape Coral office only. The majority of the revenue generated by the Enviro operation in Florida has been for the UST program. That program, which was paid for by the State of Florida until May 1996, had a substantial reduction in the amount of work available which was the primary reason for the decrease in Enviro revenues in Florida. South Carolina Enviro had an even greater decrease in revenues primarily due to a major cutback in the work available from Laidlaw affiliates. In 1996, the Laidlaw work amounted to approximately 20% of total Company revenues or $2.8 million. In 1997, Laidlaw affiliate work was just over $500,000 or a decrease of almost $2.3 million. Enviro operations of Tennessee incurred a decrease of approximately $800,000 in 1997. A large portion of that decrease ($300,000) results from the closing of the New Orleans office in late 1996 and which had been included as part of the Tennessee operations. Another significant factor was the decrease in the revenues generated by the Remedial division. That decrease ($500,000) resulted primarily from having a one time, non budgeted job that generated $300,000 in revenue during 1996 and a general lower amount of work available for that division. Hydrogeological and Water Resources Services revenues decreased by $1.3 million in 1997. The primary reason for this decrease was the completion of a large injection well project in 1996. The Company was not able to replace the volume of revenue produced by that job. Gross margin decreased from 32.7% in 1996 to 24.8% in 1997. Competition, a decrease in the amount of work available and lower employee utilization in 1997 all contributed to the decrease. Operating expenses (selling, general and administrative expenses) decreased by $1.2 million in 1997. Office closures, staff downsizing, better personnel utilization, renegotiated contracts and overall improved cost controls all contributed to the decrease in these expenses. The decreases were partially offset by a restructing charge of $238,000 for rent expense and severance pay resulting from closing two small, non-profitable offices and decreasing the size of the South Carolina operation in late 1997. Interest expense decreased by $89,000 in 1997 due to the lower balance of outstanding debt during the year. The interest decrease was offset by a monthly amortization of the prepaid costs ($120,000) incurred in connection with selling the UST receivables in 1997. Other income, net, increased by $73,000. The largest single portion of that increase was the gain on the sale of fixed assets in the amount of $37,000. 16 17 FISCAL 1996 VS. FISCAL 1995 Gross revenues for fiscal 1996 decreased by $7,491,469 to $13,986,538 when compared to fiscal 1995. The Environmental Consulting and Engineering Services Division (Enviro) had a decrease of $8,197,688, while Hydrogeological and Water Resources Services Division (Hydro) increased by $706,219. The Enviro division has personnel located in each of the Company's offices while Hydro division personnel are located in the Cape Coral, Florida office. Division Gross Revenues -------- -------------- % of Increase 1995 1996 (Decrease) ---- ---- -------- Enviro Florida $ 9,118,674 $ 4,175,484 (54) Enviro South Carolina/California 6,142,300 4,566,138 (26) Enviro Tennessee/New Orleans 4,863,967 3,185,631 (35) ----------- ----------- TOTAL ENVIRO DIVISION 20,124,941 11,927,253 (41) Hydro Division 1,353,066 2,059,285 52 ----------- ----------- TOTAL VIROGROUP, INC. $21,478,007 $13,986,538 (35) =========== =========== The Enviro division gross revenues generated from Florida operations, which mainly provides underground petroleum storage tank (UST) site assessments and remediation services, environmental audits and risk assessments had a decrease in gross revenues of $4.9 million or 54%. A majority of this decrease is related to the curtailment and other aspects of the Florida UST cost reimbursement program which began in March, 1995 and was terminated in May, 1996. This program accounted for approximately $2.6 million of 1995 revenues and only $335,000 of 1996 revenues. Because of this gross revenue decrease and other factors, the Company closed its Miami office and reduced personnel in other Florida offices. To expand the Company's revenue potential, the Company began offering two services during 1996. One of these services is bio-remediation and the second is environmental management systems (EMS). Bio-remediation gives the Company a competitive advantage by offering cost efficient, value-added services to remediate large petroleum contaminated sites and EMS is a service needed by all entities that have reporting requirements. The Enviro division revenues generated by the South Carolina/California operations decreased by approximately $1.6 million in 1996. This operation primarily provides waste management, engineering and remediation services and the decrease was mainly caused by a decrease in revenues from Laidlaw facilities located in California and South Carolina. As these Laidlaw projects were completed in California, new projects were not there to replace them. Revenues in 17 18 the California office decreased from $1.4 million in 1995 to $363,000 in 1996. As a result, the California office was closed in late 1996. The work done for Laidlaw in South Carolina, continued to be reduced and 1996 revenues decreased by $600,000 as a result. The South Carolina staff was reduced by 25% because of this revenue drop. The Enviro division gross revenues generated by Tennessee operations decreased by approximately $1.7 million in 1996. This operation primarily provides remediation, engineering, risks assessments and environmental audits. This decrease is partially comprised of a $600,000 decrease in New Orleans office operations which contributed approximately $900,000 and $290,000 in gross revenues for fiscal 1995 and 1996, respectively. Due to this decrease, the New Orleans office was closed in late 1996. The balance of the decrease of $700,000 is mainly due to a decrease in remedial work as well as price competition and general economic conditions. Hydrogeological and Water Resources Services (Hydro) division gross revenues increased by $706,219 when compared to fiscal 1995. This increase is primarily due to a large injection well and well field assessment projects in South Florida which are expected to continue through the second quarter of fiscal year 1997. Overall gross margin increased from 25.8% in fiscal 1995 to 32.7% in fiscal 1996. This increase is a combination of improved margins in fiscal 1996 due to increased utilization of Company personnel and the one-time charges to fiscal 1995 gross revenues to record the discount on the receivables due from the State of Florida relating to the curtailment of the UST program. Operating expenses (selling, general and administrative expenses) decreased in fiscal 1996 by approximately $2.5 million. This decrease is the result of the office closure and personnel downsizing combined with increased staff utilization and improved cost controls. In addition, primarily due to the cessation of the Florida UST program, combined with a decline in landfill related projects and general economic conditions, the Company charged to expense in fiscal 1996 approximately $326,000 in restructuring expenses for employee severance pay, office closing and rent expenses, as well as other related expenses. Interest expense increased by approximately $28,000 to $180,884 in fiscal 1996 due to an increase in average amounts borrowed. Other, net income decreased to $3,370 in fiscal 1996 from $150,168 in fiscal 1995 primarily due to the inclusion in fiscal 1995 of a favorable settlement of claim on a disputed contract. The benefit for income taxes decreased to zero in 1996 because the Company has used all of its tax loss carry-back benefit. Although the Company has substantial tax benefit to carry forward to future years, it cannot presently recognize this benefit in the current year due to the uncertainty of future taxable income. 18 19 LIQUIDITY AND CAPITAL RESOURCES The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities through the ordinary course of business. The Company has incurred losses for the past three years beginning with fiscal year ended August 31, 1995 and has been dependent upon Laidlaw, Inc. to guarantee the Company's bank line of credit. In accordance with the preferred stock conversion agreement, effective June 26, 1998, any amounts borrowed from Laidlaw will convert to a three year term loan payable to Laidlaw with quarterly amortization payments due. If operating losses continue, the Company may not be able to generate sufficient cash flow to service the term debt or to fund operations. See Footnote 2 in Notes to Consolidated Financial Statements for additional details. The Company's operations used cash in the amount of $1,817,103. The decrease in cash results primarily from the net loss of $2,892,716 for the year and the transfer of $596,408 of cash into an escrow account related to the sale of the UST receivables. Investing activities had a net use of cash of $54,956 from equipment purchases. Financing activities generated cash in the amount of $1,681,058 mainly as the result of the sales of UST receivables to a third party ($3,020,989) partially offset by a net decrease in notes payable of $1,330,484. Working capital decreased by approximately $370,000 from 1996 due primarily from the overall decrease in revenues and therefore an overall decrease in receivables. Accounts receivables turnover for 1997 was 3.45 times per year (105 days) compared to 3.4 times per year (107 days) for 1996. During the last half of 1997, more effort was made to collect past due accounts than in prior years. In late 1997, collections became a function of the corporate office instead of relying on each project manager to collect from his/her clients. Net current liabilities decreased mainly due to the payments made to decrease notes payable with cash generated from the sale of the UST receivables. 19 20 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this Item is listed on page F-1 and is incorporated herein by reference. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. 20 21 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS There is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders. EXECUTIVE OFFICERS OF THE REGISTRANT The names, ages and positions of all executive officers of the Company as of November 1, 1997 are listed below, followed by a brief account of their business experience during the past five years. Officers are elected annually by the Board of Directors and serve at the discretion of the Board. There are no family relationships among these officers nor any arrangements or understandings between any officer and any other person pursuant to which an officer was elected. None of these officers has been involved in any court or administrative proceeding within the past five years adversely reflecting on his or her ability or integrity. Name Age Position ---- --- -------- Charles S. Higgins, Jr. 49 President and Chief Executive Officer Lloyd E. Horvath 47 Executive Vice President DeWayne Baskette 57 Chief Financial Officer A. Todd Vehring 38 Vice President Sales and Marketing Charles H. Higgins, Jr., P.E., was appointed Chairman, President and CEO on January 23, 1997. He was Executive Vice President and Chief Operating Officer of the Company from June 1995 until he was appointed to his current position. From March 1993 until June 1995 he was the Vice President in charge of the Environics division. Prior to that, he was President of Environics, Inc., a wholly owned affiliate of Laidlaw, Inc., providing environmental consulting services. Lloyd E. Horvath, P.E., is a water resources engineer and has been employed by the Company since 1977. He has been Vice President of the Company since 1986, Executive Vice President since 1993 and served as a Director from 1977 to February, 1995. 21 22 DeWayne Baskette, CPA, has been Chief Financial Officer of the Company since March 1997. For the two years prior to that date, he was Finance Controller for Thomas Nelson, Inc., a publishing company located in Nashville, Tennessee. During the two years preceding Thomas Nelson, he was a self-employed financial consultant. A. Todd Vehring, P.G., has been Vice President of Sales and Marketing of the company since January 1997. He began with the Company in November of 1995 as the Director of Marketing. Prior to that, February 1994 to September 1995, he served as General Manager and Business Development Manager for Environmental Science and Engineering, Inc., and from March 1993 to February 1994, he was Sales Manager for IT Corp. ITEM 11. EXECUTIVE COMPENSATION There is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT There is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS There is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1998 Annual Meeting of Shareholders. 22 23 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS A PART OF THIS REPORT: (1) Financial Statements The financial statements listed in the accompanying Index to Consolidated Financial Statements and Schedule on page F-1 are filed as part of this Report. (2) Financial Statement Schedules The financial statement schedules listed in the accompanying Index to Consolidated Financial Statements and Schedule on page F-1 are filed as part of this Report. (B) EXHIBITS: Exhibit Number -------------- 10.39 Loan Agreement, Line-of-Credit Note and Irrevocable Letter of Credit dated January 20, 1997 (1) 23.1 Consent of Arthur Andersen LLP (2) 27 Financial Data Schedule (SEC Use Only) (2) (C) REPORTS ON FORM 8-K: None ------------ (1) Filed as an exhibit to the Company's 10-Q for the quarter ended February 28, 1997, as filed with the Securities and Exchange Commission on April 12, 1997, and incorporated herein by reference. (2) Filed herewith. 23 24 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE CONSOLIDATED FINANCIAL STATEMENTS: Page ---- Report of Independent Certified Public Accountants................................................ F-2 Consolidated Balance Sheets....................................................................... F-3 Consolidated Statements of Operations............................................................. F-4 Consolidated Statements of Shareholders' Equity................................................... F-5 Consolidated Statements of Cash Flows............................................................. F-6 Notes to Consolidated Financial Statements........................................................ F-8 Schedule: Report of Independent Certified Public Accountants................................................ F-27 Schedule II - Valuation and Qualifying Accounts................................................... F-28 F-1 25 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of ViroGroup, Inc.: We have audited the accompanying consolidated balance sheets of ViroGroup, Inc. (a Florida corporation) and subsidiaries as of August 31, 1996 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended August 31, 1997. 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ViroGroup, Inc. and subsidiaries as of August 31, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1997, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. ARTHUR ANDERSEN LLP Miami, Florida, October 22, 1997. F-2 26 VIROGROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AUGUST 31, 1996 AND 1997 ASSETS 1996 1997 ------------ ------------- CURRENT ASSETS: Cash and cash equivalents......................................................... $ 191,001 $ -- Restricted cash................................................................... -- 596,408 Accounts receivable, net of allowance for doubtful accounts of $502,551 in 1996 and $310,258 in 1997................................ 3,384,426 1,727,152 Unbilled accounts receivable...................................................... 717,946 254,235 Prepaid income taxes.............................................................. 26,840 4,376 Prepaid expenses and other........................................................ 204,313 113,871 ----------- ----------- Total current assets.......................................................... 4,524,526 2,696,042 AMOUNTS DUE FROM STATE AGENCY, net...................................................... 2,812,737 512,927 PROPERTY AND EQUIPMENT, net............................................................. 543,746 340,869 OTHER ASSETS............................................................................ 35,261 14,131 ----------- ----------- ............................ $ 7,916,270 $ 3,563,969 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable.................................................................. $ 1,160,354 $ 374,703 Accrued liabilities............................................................... 1,197,026 1,863,024 Current maturities of capitalized lease obligations............................... 9,447 -- Notes payable..................................................................... 2,491,429 1,160,944 ----------- ----------- Total current liabilities..................................................... 4,858,256 3,398,671 ----------- ----------- COMMITMENTS AND CONTINGENCIES (Note 10) SHAREHOLDERS' EQUITY: Common stock, $.01 par value, 50,000,000 shares authorized, 795,214 issued and outstanding at August 31, 1996 and 1997, respectively............................ 7,952 7,952 Additional paid-in capital........................................................ 18,333,533 18,333,533 Accumulated deficit............................................................... (15,283,471) (18,176,187) ----------- ----------- Total shareholders' equity.................................................... 3,058,014 165,298 ----------- ----------- $ 7,916,270 $ 3,563,969 =========== =========== The accompanying notes to consolidated financial statements are an integral part of these balance sheets. F-3 27 VIROGROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED AUGUST 31, 1995, 1996 AND 1997 1995 1996 1997 ----------- ----------- ----------- GROSS REVENUES....................................................... $21,478,007 $13,986,538 $ 6,884,742 COST OF GROSS REVENUES............................................... 15,927,619 9,420,106 5,175,925 ---------- ---------- ---------- Gross Profit................................................... 5,550,388 4,566,432 1,708,817 OPERATING EXPENSES Selling, general and administrative expenses, including rentals to related party of $186,000 in 1995, 1996 and 1997, respectively...................................... 7,961,732 5,438,135 4,250,540 Restructuring charge........................................... 326,190 326,428 237,755 ---------- ---------- ---------- (Loss) from operations...................................... (2,737,534) (1,198,131) (2,779,478) OTHER INCOME (EXPENSE): Interest expense............................................... (152,588) (180,884) (92,040) Interest income................................................ 9,308 -- 22,912 Other, net..................................................... 150,168 3,370 (44,110) ---------- -------- ------------ (Loss) before income taxes .................................... (2,730,646) (1,375,645) (2,892,716) BENEFIT FOR INCOME TAXES............................................. 143,909 -- -- ---------- ---------- ----------- Net (loss)..................................................... $(2,586,737) $(1,375,645) $(2,892,716) ========== ========== =========== Net earnings (loss) per common share - Primary..................................................... $ 4.09 $ (1.73) $ (3.64) ========== ========== =========== Net (loss) per common share - Fully diluted............................................... $ (3.25) $ (1.73) $ (3.64) =========== ============ =========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING - Primary.......................................... 470,591 795,214 795,214 ========== ========== ========== Fully diluted ................................... 795,214 795,214 795,214 ========== ========== ========== The accompanying notes to consolidated financial statements are an integral part of these statements. F-4 28 VIROGROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED AUGUST 31, 1995, 1996 AND 1997 Number of Number of Paid-In (Accumulated Shares Amount Shares Amount Capital Deficit) BALANCE, August 31, 1994.......................... 800,000 $ 8,000 397,607 $ 3,976 178,560 $(10,860,644) Conversion of preferred stock into common stock... (800,000) (8,000) 397,607 3,976 154,973 -- Net loss for the year............................. -- -- -- -- -- (2,586,737) Dividends on preferred stock...................... -- -- -- -- -- (460,445) ------- ------- ------- ------- ----------- ------------ BALANCE, August 31, 1995.......................... -- 795,214 7,952 18,333,533 (13,907,826) Net loss for the year............................. -- -- -- -- -- (1,375,645) ------- ------- ------- ----------- ------------ BALANCE, August 31, 1996.......................... -- -- 795,214 7,952 18,333,533 (15,283,471) Net loss for the year............................. -- -- -- -- -- (2,892,716) BALANCE, August 31, 1997.......................... -- 795,214 $ 7,952 $18,333,533 $(18,176,187) ======= ======= ======= ======= =========== ============= The accompanying notes to consolidated financial statements are an integral part of these statements. F-5 29 VIROGROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED AUGUST 31, 1995, 1996 AND 1997 1995 1996 1997 ----------- ----------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) ............................................... $(2,586,737) $(1,375,645) $(2,892,716) Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities- Depreciation and amortization........................... 617,822 387,687 294,717 Provision for bad debts................................. 539,746 48,008 72,526 Restructuring charge.................................... 326,190 326,428 237,755 (Gain) loss on disposition of property and equipment.......................................... 34,950 9,378 (36,884) Discount on long-term receivables....................... 726,308 16,745 -- Changes in assets and liabilities Decrease (increase) in- Restricted cash......................................... -- -- (596,408) Accounts receivable and amounts due from state agency........................................... 793,304 187,561 863,562 Unbilled accounts receivable............................ (228,225) 731,518 463,711 Prepaid expenses and other assets....................... 318,107 192,126 134,036 Increase (decrease) in- Accounts payable........................................ (273,024) (290,631) (785,645) Accrued liabilities..................................... 82,568 (1,421,395) 428,243 Deferred income taxes................................... (17,856) -- -- ---------- ---------- ---------- Total adjustments....................................... 2,919,890 187,425 1,075,613 ---------- ---------- ---------- Net cash provided by (used in) operating activities................................... 333,153 (1,188,220) (1,817,103) ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment........................... (121,433) (41,415) (91,840) Proceeds from sale of property and equipment.................. 22,850 49,283 36,884 ---------- ---------- ---------- Net cash provided by (used in) investing activities................................... (98,583) 7,868 (54,956) ---------- ---------- ---------- F-6 30 CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sell of receivables to third party funders ............................................... -- -- 3,020,989 Proceeds from current notes payable........................... 14,847,778 9,448,098 5,814,599 Repayment of notes payable.................................... (14,821,775) (8,046,374) (7,145,083) Repayment of long-term debt................................... (15,243) (109,228) -- Repayment of capitalized lease obligations.................... (57,142) (25,936) (9,447) Cash paid to issue common stock............................... (29,497) -- -- Proceeds from long-term notes payable......................... 99,437 -- -- Payment of preferred stock dividends.......................... (280,000) -- -- ---------- ---------- ---------- Net cash provided by (used in) financing activities.................................... (256,442) 1,266,560 1,681,058 ---------- ---------- ----------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (21,872) 86,208 191,001 CASH AND CASH EQUIVALENTS, Beginning of year............................................. 126,665 104,793 191,001 --------- ---------- ----------- CASH AND CASH EQUIVALENTS, End of year ............................................... $ 104,793 $ 191,001 $ 0 ========= ========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for- Income taxes................................................ $ 12,586 $ 15,840 $ 8 ========= ========== =========== Interest ............................................... $ 88,667 $ 164,345 $ 92,040 ========= ========== =========== The accompanying notes to consolidated financial statements are an integral part of these statements. F-7 31 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AUGUST 31, 1995, 1996 AND 1997 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (a) Principles of Consolidation- The accompanying consolidated financial statements include the accounts of ViroGroup, Inc. (the Company) and its wholly owned subsidiaries. All intercompany balances and transactions are eliminated in consolidation. (b) Business- Primarily within the southeastern region of the United States, the Company provides a wide range of environmental services to assess and remediate groundwater and soil contamination, to design and monitor solid waste landfills, to protect air quality, to assure regulatory compliance and to develop groundwater resources. (c) Property and Equipment- Property and equipment is stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line basis over the following estimated useful lives: Office furniture and equipment 5 to 7 years Technical equipment 5 years Vehicles 3 to 5 years Leasehold improvements the lessor of 5 years or the remaining life of the lease (d) Income Taxes- The Company and its wholly owned subsidiaries file consolidated federal and state income tax returns. With the beginning of fiscal year 1994, September 1, 1993, the Company adopted the new standard for accounting for income taxes, Statement of Financial Accounting Standards No. 109 (SFAS No. 109). Prior to this date, deferred taxes were computed in F-8 32 accordance with APB Opinion No. 11, "Accounting for Income Taxes," which computed deferred amounts based upon timing differences in recognition of income and expense for financial reporting and for income tax purposes. Effective with the adoption of SFAS No. 109, the Company applies an asset and liability approach to compute deferred tax assets and liabilities with respect to the expected future tax consequence of events recognized in the consolidated financial statements and tax returns. (e) Cash Equivalents- The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. (f) Restricted Cash - Restricted cash represents funds placed in an interest bearing escrow account to provide for potential denied costs and discounts related to long term receivables sold to third parties. (g) Revenues and Expenses- Revenues and expenses are recognized as services are provided and the related costs are incurred. Unbilled revenues are recognized as earned on the percentage of completion method. Extent of progress toward completion is measured based on actual labor and other costs incurred. Billings are made on a periodic basis as arranged. Customers generally arrange with the Company to provide professional services under either fixed fee or "time and materials" contracts. Occasionally, the amount of unbilled revenues, when combined with previously billed revenues, may exceed the original fixed fee or "not to exceed" limit specified in the contract. The Company evaluates such contracts on a case-by-case basis and estimates unbilled revenues to the extent that the Company deems ultimate billing and collection probable. Any differences between these estimates and the amounts ultimately billed and collected are recognized as an adjustment to revenues in the period in which these differences become known. (h) Restructuring Charge- Primarily due to the May 1996 law relating to the Florida UST Program and a continued decline in forecasted landfill design work, as well as general market conditions, the Company in fiscal 1996 implemented the third phase of its restructuring program in fiscal 1996. This action resulted in a one-time restructuring charge to Operating Expenses in fiscal 1996 of $326,428. The restructuring costs remaining to be paid at August 31, 1996 were $174,072 and are included in accrued liabilities in the August 31, 1996 consolidated balance sheet. The Company believes the balance of the accrued restructuring charge of $43,251 which is included in accrued liabilities in F-9 33 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 the accompanying consolidated balance sheet at August 31, 1997 is adequate to absorb these remaining estimated restructuring charges. On February 18, 1997, the Company announced plans to move its Corporate office to Nashville, Tennessee. The relocation was completed in the fourth quarter of fiscal 1997. In addition, the Company closed two non-profitable satellite offices in Tampa, Florida and Jacksonville, Florida and reduced the size of its Lexington, South Carolina office by approximately one-third. A restructuring charge of $237,755 is included in the August 31, 1997 Consolidated Statement of Operations. These restructuring charges consist primarily of employee severance and rent expense and the $237,755 is included in Accrued liabilities on the August 31, 1997 Consolidated Balance Sheet. The charges are estimated to be paid as follows: $230,000 in 1998 and $7,755 in 1999. (I) Earnings (loss) Per Share- Earnings (loss) per share is calculated by dividing net income (loss) attributed to common shareholders (net income less applicable preferred stock dividends) by the weighted average number of common shares and common share equivalents outstanding during the period. Preferred stock dividend requirements were $460,445 for fiscal year 1995 and $0 for fiscal years 1996 and 1997. Common share equivalents are calculated using the "treasury stock method" and include the number of shares issuable on exercise of outstanding options and warrants (only if the exercise prices are below the average quoted market prices of the Company's common stock) less the number of shares that could have been purchased with the proceeds from the exercise of the options and warrants, based on the average quoted market price of the Company's common stock during the periods. Common stock equivalents are not considered for periods in which there is a loss, as their impact would be anti-dilutive. Primary and fully diluted earnings (loss) per share are the same for fiscal years 1996 and 1997, while due to the preferred stock conversion and the resulting issuance of additional shares of common stock, primary earnings and fully diluted loss per share (using the "if converted method") are different in fiscal year 1995 and were calculated as follows: PRIMARY EARNINGS PER SHARE: Net loss for the year ended August 31, 1995 $(2,586,737) Preferred stock dividend F-10 34 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 requirements to June 26, 1995 (460,445) Add gain on conversion of preferred stock 4,970,096 Net income attributable to common shareholders $ 1,922,914 =========== Divided by weighted average shares outstanding 470,591 =========== Primary Earnings Per Share $ 4.09 =========== FULLY DILUTED LOSS PER SHARE: Net loss for the year ended August 31, 1995 $(2,586,737) =========== Divided by weighted average shares outstanding 795,214 =========== Fully Diluted Loss Per Share $ (3.25) =========== (j) Fair Value of Financial Instruments- The carrying amount of accounts receivable, unbilled accounts receivable, amounts due from state agency and notes payable are recorded at cost or adjusted cost which approximates fair value as of August 31, 1997. (k) 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. F-11 35 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 (2) GOING CONCERN The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities through the ordinary course of business. The Company has incurred losses for the past three years beginning with fiscal year ended August 31, 1995 and has been dependent upon Laidlaw, Inc. to guarantee the Company's bank line of credit. In accordance with the preferred stock conversion agreement, effective June 26, 1998, any amounts borrowed from Laidlaw will convert to a three year term loan payable to Laidlaw with quarterly amortization payments due. If operating losses continue, the Company may not be able to generate sufficient cash flow to service the term debt or to fund operations. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amounts and classification of liabilities that might result if the Company is unable to continue as a going concern. Management is aware of the possibility of not being able to continue as a going concern and has implemented the following actions in its fiscal 1998 business plan in an effort to maintain its continuity as a going concern: (a) Implementation of aggressive cost containment procedures. (b) Increase in profitability by placing increased emphasis on products and services which are in high demand and which carry a higher profit margin than traditional services. (c) Closing of small, non-profitable offices and disposing of assets which are not needed. (d) Restructuring all locations to more properly meet the immediate needs of each location. (e) Centralizing controls for operations and for administrative functions, such as accounting, credit management and contract administration. If this business plan is not successful, the Company may not be able to continue as a going concern and the Company's recent history has shown an inability to meet its business plan projections. F-12 36 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 (3) PROPERTY AND EQUIPMENT: Property and equipment consisted of the following at August 31, 1996 and 1997: 1996 1997 ---------- ----------- Office furniture and equipment $ 1,246,158 $ 903,745 Technical equipment 722,452 622,226 Vehicles 395,946 293,489 Leasehold improvements 184,701 184,701 ----------- ----------- 2,549,257 2,004,161 Less Accumulated depreciation and amortization (2,005,511) (1,663,292) ----------- ----------- $ 543,746 $ 340,869 =========== ============ Property and equipment under capitalized lease obligations included in property and equipment consisted of the following at August 31, 1996 and 1997: 1996 1997 ----------- ------------ Capitalized cost $ 51,784 $ 51,784 Less Accumulated depreciation and amortization (39,718) (51,784) ----------- ------------ $ 12,066 $ 0 =========== ============= (4) INCOME TAXES: With the beginning of fiscal year 1994, September 1, 1993, the Company adopted the new standard for accounting for income taxes, SFAS No. 109. F-13 37 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 The components of the net deferred tax asset (liability) as of August 31, 1996 and 1997 are as follows: Deferred Tax Asset (Liability) Current: 1996 1997 - ------- --------- ------- Allowance for bad debts $ 181,252 $ 92,304 Long-term: Excess of tax over book depreciation (121,283) (111,084) Accrued restructuring charge 63,271 113,909 Discount on accounts receivable 246,945 254,080 State net operating loss carry-forwards 268,524 435,896 Federal net operating loss carry-forwards 746,374 1,679,149 Less valuation allowance (1,385,083) (2,464,254) ----------- ----------- $ $ =========== =========== The Company has provided a valuation allowance against 100% of the deferred tax asset that results from federal and state net operating loss carry-forwards due to the lack of availability of federal and state taxable income within the carry-back period, if any, available under the federal and state tax laws and the inability to determine the likelihood that future federal and state taxable income will be sufficient to utilize the deferred tax asset. State net operating loss carry-forwards of approximately $7,662,000 expire between 1998 and 2009. Federal net operating loss carry-forwards of approximately $4,938,000 expire in 2001. A reconciliation of the statutory federal income tax rate and the effective tax rates as a percentage of pre-tax (loss) are as follows for the years ended August 31, 1995, 1996, and 1997: F-14 38 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 1995 1996 1997 ---- ---- ---- Statutory rate (34.0)% (34.0)% (34.0)% Establishment (reversal) of valuation allowance 14.3 30.7 33.1 Limitation on realization of loss carry-forwards 13.5 -- -- Nondeductible expenses .9 3.3 .9 ------ ------ ------ Effective rate (5.3)% 0.0% 0.0% ====== ====== ====== The components of the benefit for income taxes consisted of the following for the years ended August 31, 1995, 1996, and 1997: 1995 1996 1997 ---- ---- ---- Current: Federal $(126,053) $ -- $ -- State -- -- -- --------- ------ ------- (126,053) -- -- Deferred (17,856) -- -- --------- ------ ------- $(143,909) $ -- $ -- ========= ====== ======= (5) NOTES PAYABLE: Notes payable at August 31, 1996 and 1997 consisted of advances against a $3.0 million line of credit. Under this line of credit, the Company may borrow up to $3.0 million at an interest rate of prime (8.5% at August 31, 1997) less .25%. Laidlaw, Inc. (Laidlaw), in lieu of its commitment to provide up to $3.0 million in debt financing to the Company pursuant to the terms of the preferred stock conversion agreement of June 26, 1995, caused a letter of credit to be issued to collateralize the $3.0 million line of credit. Substantially all of the Company's assets secure this obligation to Laidlaw in the event of a draw upon the letter of credit. The line of credit expires January 20, 1998 and the letter of credit expires February 20, 1998. At the letter's expiration, Laidlaw has stated it will comply with the terms of the preferred stock conversion agreement whereby an affiliate will make available to the Company for a three-year period from June 26, 1995 up to $3.0 million in financing with advances thereunder carrying an interest rate F-15 39 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 equal to that available to the Company from alternative sources with the principal and interest to be paid in equal quarterly installments over a three-year period commencing with the line of credit expiration. (6) CAPITALIZED LEASE OBLIGATIONS Capitalized lease obligations at August 31, 1996, consisted of various lease agreements maturing in fiscal 1997, repayable in aggregate monthly lease payments of $1,158, discounted at interest rates ranging between 6% and 11% per annum. As of August 31, 1997, those obligations had been paid off. (7) SHAREHOLDERS' EQUITY: (a) Common and Preferred Stock- In March 1993, the Company amended its Articles of Incorporation to create a Series A Preferred Stock. The Series A Preferred Stock had a stated liquidation value of $10.00 per share and required redemption on March 5, 2003, in either cash or common stock, at the Company's option. The shares bore cumulative per share dividends of $.70 per year, payable quarterly. The owners of the Preferred Stock had the right to elect two directors to the Company's Board of Directors, and the right to elect a majority of the directors in the event that payment of the Preferred Stock dividends was in default for two quarters. In addition, the prior consent of the owners of the Preferred Stock was required, among other things, in order for the Company to repurchase any shares of common stock or to pay any dividends on its common stock in excess of 20% of the Company's net income for the preceding four fiscal year quarters. On March 5, 1993, the Company sold 200,000 shares of Series A Preferred Stock to Bryson Industrial Services, Inc.(Bryson), a wholly owned subsidiary of Laidlaw Environmental Services, Inc., a wholly owned subsidiary of Laidlaw, Inc. for $2,000,000. The Company agreed with Bryson to use the cash proceeds for future acquisitions. On March 5, 1993, the Company acquired Environics, a Tennessee corporation, by merger of Environics into a wholly owned subsidiary of the Company. Upon effectiveness of the merger, OSCO, the sole shareholder of Environics, received 600,000 shares of the Company's Series A Preferred Stock, which were valued by the Company and OSCO at $10.00 per share. OSCO is also a wholly owned subsidiary of Laidlaw Environmental Services, Inc., a wholly owned subsidiary of Laidlaw, Inc. F-16 40 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 On June 26, 1995, all holders of the 800,000 shares of Series A Preferred Stock agreed to amend the conversion rate and surrender their holdings for conversion into 50% of the Company's common equity. This resulted in the issuance to a Laidlaw affiliate of 397,607 shares of the Company's $.01 par value common stock. Also, the agreement, among other things, canceled the previous preferred shareholder rights provisions and provides should Laidlaw sell or transfer the common stock received under the agreement at any time between two and six years after issuance, shareholders of other outstanding common shares will be granted the right to participate in any such transaction on the same basis, terms and conditions. Further, Laidlaw waived accrued but unpaid dividends at June 26, 1995, of $180,445. Due to the amended conversion rate, for earnings per share calculation purposes, the Company realized in fiscal 1995 an equity gain on the conversion totaling $4,970,096. This gain was calculated as the difference between the carrying value of the preferred stock ($8,000,000) plus accrued dividends and the quoted market value of the common stock issued upon conversion, less issuance cost. On January 23, 1997, the Company implemented a one-for-eight reverse stock split of the Company's common stock. The effect of the reverse split upon holders of the Company's common stock is that the total number of shares of the Company's common stock held by each shareholder was automatically converted into that number of whole shares of common stock equal to the number of shares of common stock owned immediately prior to the reverse split divided by eight, adjusted for any fractional shares. The reverse split was effectuated to enable the Company to remain in compliance with the listing criteria of the Nasdaq SmallCap Market. In addition, on August 25, 1997, Nasdaq announced new requirements for continued listing on the Nasdaq Small Cap Market. As of the date of this annual report, the Company is not in compliance with those requirements which may result in the delisting of the common stock. The Company has an authorized capitalization of 50,000,000 shares of common stock, par value $.01 per share. The authorized capital stock of the Company was not reduced or otherwise affected by the reverse split. As of January 23, 1997, the Company had 6,361,708 shares of common stock issued and outstanding. The aggregate number of shares of common stock issued and outstanding following the reverse split is 795,214. All common shares and per share amounts have been adjusted to give retroactive effect of the reverse split. F-17 41 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 (b) Options and Warrants- In May 1991, the Company's Board of Directors adopted the 1991 Long-Term Incentive Plan (the "Incentive Plan") which permits the granting of stock options, stock appreciation rights and other awards. The Board has reserved 37,500 shares of unissued common stock under the Incentive Plan. The Incentive Plan is administered by the Compensation Committee of the Board of Directors which is authorized to determine, from time to time, the term, exercise price, settlement terms, forfeiture provisions and other terms and conditions of each of the types of awards. The following tables set forth the status of the Incentive Plan at August 31, 1997, after giving effect to the one for eight reverse stock split. Number of Number of Number of Shares of Shares of Exercise Shares of Common Common Shares Price Common Stock Stock Out- Per Share Stock Exercised Forfeited standing Date of Grant --------- Granted --------- --------- -------- - ------------- ------- December 1991 $56.00 19,281 (106) (18,350) 825 June 1992 72.00 6,125 (6,125) 0 March 1993 70.00 10,063 (6,000) 4,063 August 1993 32.00 250 250 December 1993 20.00 6,000 (6,000) 0 October 1994 14.00 1,250 (1,250) 0 November 1994 12.00 4,375 (4,375) 0 July 1995 8.00 313 (313) 0 July 1995 7.52 313 (313) 0 January 1996 4.48 6,750 6,750 November 1996 2.56 15,000 (3,125) 11,875 January 1997 1.12 6,250 6,250 March 1997 1.12 3,500 3,500 ------- ------- ------- Balance August 31, 1997 79,470 (106) (45,851) 33,513 ======= ==== ======= ======= F-18 42 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 Except for the options granted in January 1997, March 1997, January, 1996 and November, 1994 the options are exercisable at the rate of 20% per annum, beginning on the first anniversary of the date of grant and expire on the earlier of the employee's termination date or ten years from grant date. Forfeited shares are available for regranting. In January 1997 and March 1997, the Company's Chief Executive Officer and the Chief Financial Officer were granted 6,250 and 2,500 options respectively, at $1.12 per share, the fair market value on the date of grant. The options vest at 25% at six months, 25% at twelve months, 25% at twenty-four months and 25% at thirty-six months. In January 1996, the Company's Chief Executive Officer and Chief Operating Officer were granted options to purchase 3,750 and 3,000 shares of common stock, respectively, at $4.48 per share, the fair market value on the date of grant. These options are exercisable immediately and remain exercisable until the termination date of 5 years from the date of grant. On November 1, 1994, the Company's Chief Executive Officer was granted an option to purchase 4,375 shares of common stock at $12.00 per share, the fair market value on the date of grant. These options become exercisable at the rate of 12 2/3% per annum beginning on the first anniversary of the date of grant. The options expire 10 years from the date of grant. In February, 1995 the Company adopted the Non-Employee Director Stock Option Plan providing for the purchase of up to 7,500 shares of the Company's common stock by non-employee members of the Board of Directors. The plan provides for the grant of an option to purchase of up to 188 common shares annually per director at the fair market price per share on the grant date, and is exercisable six months following the grant date. To the extent not earlier exercised, the option terminates the earlier of three months after the date the optionee ceases to serve as a director, one year after the date the optionee ceases to be a director by reason of death, optionee ceases to be a director by reason of removal for cause or five years from the date of grant. As of August 31, 1997 there are options to purchase 1,500 common shares outstanding and no options had been exercised. The three directors nominated by Laidlaw have waived their participation in this program. In December, 1994, the Company granted to a former Chairman of the Board, an option to purchase 625 common shares at a purchase price per share of $11.84, the fair market value on the grant date. The option was fully exercisable as of the grant date. To the extent not earlier exercised, the option terminates ten years from the grant date. F-19 43 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 In February 1994, the Company entered into a Revolving Reimbursement Facility with a limited liability corporation whereby the corporation agreed to provide up to a maximum of $2,000,000 in financing. Relative to this agreement the Company granted the corporation a warrant to purchase 7,500 shares of voting common stock which can be exercised at any time and in any amount until January 31, 1999 at a price of $28.64 per share, the fair market value on the date of grant. As of August 31, 1997, no purchases relative to this warrant were made. Total shares reserved for issuance under the options and warrants referred to above aggregated 74,268 as of August 31, 1997. All options and warrants outstanding as of August 31, 1997 were 43,138. As permitted under SFAS No. 123 ("SFAS 123), "Accounting for Stock-Based Compensation", the Company accounts for stock-based employee compensation arrangements in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", whereby no compensation cost is deducted in determining net loss. Had the Company recorded stock-based compensation cost for options granted in fiscal 1997 and 1996 pursuant to SFAS 123 (using the Black-Scholes options pricing model) net loss and net loss per share, including the assumptions used in these calculations, would have been as follows for fiscal 1997 and 1996: 1997 1996 ------------- ---------- Pro forma net loss $2,901,174 $1,382,604 Pro forma net loss per share 3.65 1.74 Pro forma weighted average fair value of options granted 1.03 .35 Risk free interest rates 5.37% 5.81%-6.48% Expected lives 5 years 3 years Expected volatility 0% 0% Expected dividends -- -- The following table summarizes information about stock option outstanding at August 31, 1997: F-20 44 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------- -------------------------------- OPTIONS REMAINING OPTIONS OUTSTANDING AT CONTRACTUAL EXERCISABLE AT DATE OF GRANT 8/31/97 LIFE (YEARS) 8/31/97 EXERCISE PRICE - ----------------------- ----------------------------- ------------------ ---------------------- -------------------- December 1991 825 4.3 825 $56.00 March 1993 4,063 5.6 3,250 70.00 August 1993 250 6 200 32.00 December 1994 625 7.3 625 11.84 February 1994 7,500 1.4 7,500 28.64 February 1995 1,500 5 1,500 3.86 January 1996 6,750 8.3 6,750 4.48 November 1996 11,875 9.3 -- 2.58 January 1997 6,250 9.3 1,562 2.00 March 1997 3,500 9.8 -- 1.12 ------ --- ------ ---- TOTAL 43,138 22,212 ====== ====== (8) RELATED-PARTY TRANSACTIONS: ETE (now known as ViroGroup of South Carolina, Inc.), a wholly owned subsidiary of the Company, leases property from an entity controlled by certain of its former shareholders. The lease expires in November 1997 and contains two one-year renewal options. Total rentals earned by this related-party lessor amounted to $186,000 during each of the years ended August 31, 1995, 1996 and 1997. The Company does not plan to exercise its option to renew this lease. F-21 45 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 (9) EMPLOYEE BENEFIT PLANS: The Company has a defined contribution profit sharing plan for the benefit of its eligible employees. Eligibility is determined by specified minimum periods of service and attainment of minimum age requirements. The employer contribution is determined annually by the Board of Directors and involves no unfunded past service costs. No contributions were authorized by the Board of Directors for the years ended August 31, 1995, 1996 and 1997. Employees can also contribute, to the plan on a tax-deferred or non-tax deferred basis, specified percentages of their compensation as defined. The Company will match the employee contributions up to 2% of total compensation. Employee contributions become fully vested immediately. Employer contributions vest at the rate of 20% per annum, beginning after the first year of service (as defined), so that an employee becomes fully vested after six full years of service. Forfeitures of nonvested employer contributions are utilized to reduce required employer contributions and expenses. Contributions to the plan charged to expense amounted to $134,704, $49,925 and $28,782 during the years ended August 31, 1995, 1996 and 1997, respectively. (10) COMMITMENTS AND CONTINGENCIES: (a) Operating leases- The Company leases facilities and equipment from related and unrelated parties under operating leases expiring between 1997 and 2002. Minimum annual lease payments are as follows: F-22 46 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 Minimum Annual Lease Payments Fiscal Year Related Unrelated Ending August 31, Parties Parties ----------------- ------- ------- 1998 $31,000 $ 374,093 1999 -- 272,324 2000 -- 202,744 2001 -- 187,531 2002 -- 76,047 ------- --------- $31,000 $1,112,739 ======= ========== Rent expense under all operating leases amounted to $986,700, $679,036 and $602,551 during the years ended August 31, 1995, 1996 and 1997, respectively. (b) Potential liability for environmental contamination - The Company's environmental services present risks of substantial liability for environmental contamination. Certain of the Company's remediation activities also entail risks of personal injury and property damage. Although the potential liability of the Company is significant, no material legal claim has ever been asserted against the Company. No liability for any such claims is reflected in the accompanying consolidated financial statements. The Company has been notified by the Environmental Protection Agency, through a General Notice Letter that the Company is a potentially liable party at the Florida Petroleum Reprocessors Site in Davie, Florida. However, at this time, no estimate of the potential liability can be calculated due to the limited amount of information available. This type of liability is an insurable risk and the Company's insurance carrier has been notified; however, no formal claim has been filed at this time. The insurance policy has a deductible of $250,000. Company management is of the opinion that Company liability, if any, will be minimal. (c) Insurance- Since July 1993, the Company has maintained certain professional liability insurance policies with an insurance carrier. To the best of the Company's knowledge, there are no outstanding professional liability claims at this time. See Note 10(b) for additional information. F-23 47 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 (d) Litigation, claims and assessments- In May 1996, the Company settled all its remaining claims deriving from Sunshine Jr. Stores, Inc. bankruptcy in 1992. These claims, totaling approximately $270,000, were settled for approximately $237,000 resulting in a charge to the allowance for doubtful accounts in fiscal 1996 of approximately $33,000. In August 1993, a civil action was filed in Hamblen County Chancery Court of the Third District of Tennessee against the Company and Galen of Tennessee, Inc., seeking compensatory and punitive damages of approximately $1,140,000 in regards to an asbestos abatement project. In December 1993, the Court dismissed the lawsuit. The parties are now compelled to submit to arbitration, and the Company's exposure appears to be substantially less than $140,000. The plaintiff has not made any demand for arbitration. The Company believes that this action is without merit and intends to vigorously defend itself. The Company is not subject to any other material legal proceedings. From time to time, the Company is involved in other routine litigation, claims and assessments incidental to its business. The Company does not believe that the ultimate resolution of any of the above described matters would have a material adverse impact on the accompanying consolidated financial statements. (e) Florida Underground Petroleum Storage Tank (UST) Reimbursement Program, Amounts Due from State Agency and the Concentration of Credit Risk. During fiscal 1994, the Company aggressively expanded its participation in the State of Florida financed programs to provide environmental services to evaluate, assess and remediate contaminated underground petroleum storage tank sites. Through its Inland Protection Trust Fund, the State of Florida reimburses certain costs to clean up eligible contaminated sites. Primarily due to an estimated unfunded $450 million backlog and annual tax revenue allocation of only $100 million, in March 1995 new legislation directed the Florida Department of Environmental Protection to cease processing, with certain limited exceptions, applications for reimbursement of costs to clean up UST sites eligible for state funds. In May, 1996 a new law (the "1996 Act") was passed which implemented significant changes to the reimbursement program and addressed the estimated $450 million backlog of unpaid claims. The 1996 Act provided for the elimination of the reimbursement program effective August 1, 1996 and required all reimbursement applications to be submitted by December 31, F-24 48 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 1996. Also, the 1996 Act created a non-profit public benefit corporation, which became operational in the Fall of 1997, to finance the unpaid backlog. This non-profit corporation is charged with financing the estimated backlog of 9,500 claims totaling over $556 million. Payment of claims will be on a first-come, first-served methodology based on application filing date and an assumed annual allocation rate of $100 million. Claims paid will be subject to a 3.5% annual discount in consideration of the anticipated accelerated payment as compared to the previously expected period of 4 to 5 years. Based upon information obtained from the State of Florida, it is currently anticipated that payment of the initial portion of the claims (approximately $213 million) should begin in the first quarter of calendar 1998; however, no assurance of that timetable can be given. The Company in prior fiscal years recorded valuation allowances on the amounts due to reflect the State mandated discount and potential denied costs. At August 31, 1996 these allowances totaled $931,665 with $889,937 applied as a valuation allowance to the amounts due, resulting in a net amount of $2,812,737 shown as the Amounts Due from State Agency, net, in the accompanying consolidated balance sheet. At August 31, 1997 these allowances totaled $913,918 with $166,623 applied as a valuation allowance to the amounts due, resulting in a net of $512,927 shown as the Amounts Due From State Agency, net, in the accompanying consolidated balance sheet. The balance sheet also includes $747,295 which is included as an accrued liability to reflect the Company's liability to pay discounts and denied costs on receivables sold to third-parties. All of the approximately $3.1 million in reimbursement applications at August 31, 1996, have been sold to third party entities at August 31, 1997. The Company used third-party funding to obtain the cash from the buyers to avoid the long payout period by the State. In addition to selling the previously mentioned claims, the Company filed approximately $703,000 directly with the State. Specifically, the Company entered into several arrangements to sell substantially all the claims filed with the State for reimbursement. These arrangements required the Company to pay a 3 - 4% prepaid fee at the time the buyers paid the Company. If the State has not paid the buyers within the first nine months, the Company will pay indemnification costs at the rate of .6875% per month beginning October 1997. In January 1998, the indemnification rate begins to increase each month and could reach 12.375% per month in August 1998. The effect of the rate increase is to generate an overall yield, since inception, of F-25 49 VIROGROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) AUGUST 31, 1995, 1996 AND 1997 8.25%. These indemnification costs are being charged against the reserve account at the present time. In the event the State does not meet the projected payment schedule beginning in the first quarter of calendar year 1998, the reserves will not be adequate to absorb all of the indemnification costs. In addition, the Company has placed 13% of the amounts sold in an interest bearing escrow account to provide for potential state denied costs and state mandated interest discount. The interest earned on the escrowed amounts accrues to the Company's benefit and is recorded as interest income in the period earned. The escrow balance at August 31, 1997, is $596,408 and is included in restricted cash on the accompanying Consolidated Balance Sheet. The Company filed all amounts due from the State prior to the state mandated filing deadline of December 31, 1996. (f) Segment Information The Company operates in one industry segment, as contemplated by Financial Accounting Standards Board Statement No. 14. Laidlaw and its affiliates accounted for approximately 21%, 20% and 8% of consolidated gross revenues for the years ended August 31, 1995, 1996, and 1997, respectively. Included in accounts receivable, net in the accompanying consolidated balance sheets as of August 31, 1996 and 1997 are amounts due from Laidlaw and its affiliates of $432,700 and $128,373, respectively. A Laidlaw affiliate owns 50% of the Company's outstanding common stock and three officers of Laidlaw affiliates are Directors of the Company. F-26 50 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of ViroGroup, Inc.: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of ViroGroup, Inc. and subsidiaries as of August 31, 1996 and 1997, and for each of the three years in the period ended August 31, 1997, included in this Form 10-K, and have issued our report thereon dated October 22, 1997. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the accompanying Index to Consolidated Financial Statements and Schedule on Page F-1 of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Miami, Florida, October 22, 1997 F-27 51 VIROGROUP, INC. AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED AUGUST 31, 1995, 1996, AND 1997 For the Balance at Charged to Balance at Year Ended Beginning of Costs and End of August 31, Description Period Expenses Deductions Other Period - ---------- ----------- ------ -------- ---------- ----- ------ 1995 Allowance for Doubtful Accounts $391,109 $539,746 $295,294(1) $ -- $635,561 ======== ======= ======== ========= ======= Allowance for Discounts and $ -- $726,308(2) $ -- $ -- $726,308 Denied Costs ======== ======== ======== ========= ======= 1996 Allowance for Doubtful Accounts $635,561 $ 48,008 $ 62,721(1) $(118,297)(3) $502,551 ======== ======== ======== ========= ======= Allowance for Discounts and $726,308 $ 16,745(2) $ -- $(146,884)(4) $889,937 Denied Costs ======== ======== ======== ========= ======= 1997 Allowance for Doubtful Accounts $502,551 $ 72,526 $264,819(1) $ -- $310,258 ======== ======== ======== ========= ======= Allowance for Discounts and $889,937 $(17,652) $ 4,370 $(705,662)(5) $166,623 Denied Costs ======== ======== ======== ========= ======= - -------------------------- (1) Represents net accounts written off. (2) Represents a reduction in gross revenues. (3) Represents a transfer to the Allowance for Discounts and Denied Costs. (4) Represents amounts transferred from Allowance for Doubtful Accounts of $118,297 plus allowance transferred from unbilled receivables at August 31, 1997 of $48,665 less amount transferred to accrued liabilities of $20,078 (5) Represents a transfer to accrued liabilities F-28 52 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. VIROGROUP, INC. /s/ CHARLES S. HIGGINS, JR., PRESIDENT ------------------------------------------- Charles S. Higgins, Jr., Chairman, President and Chief Executive Officer Dated: November 25, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. SIGNATURE AND CAPACITY DATE - ---------------------- ---- /s/ DEWAYNE BASKETTE November 25, 1997 - ------------------------------- DeWayne Baskette Chief Financial Officer /s/ A. DENNY ELLERMAN November 25, 1997 - ------------------------------- A. Denny Ellerman, Director /s/JAMES J. HATTLER November 25, 1997 - ------------------------------- James J. Hattler, Director /s/ RICK L. MCEWEN November 25, 1997 - ------------------------------- Rick L. McEwen, Director /s/ SYLVESTER O. OGDEN November 25, 1997 - ------------------------------- Sylvester O. Ogden, Director /s/ KENNETH W. WINGER November 25, 1997 - ------------------------------- Kenneth W. Winger, Director