[LOGO]
To Our Shareholders:
Total Containment completed a difficult 1999 after the record year
experienced in 1998. The mergers of various major oil companies and the
extension of the EPA deadline for conformity with tank deregulation created an
overall slowdown in underground gas station construction which reduced revenues
dramatically and pushed back in time the opportunities which the industry had
hoped to capture. This slowdown, coupled with our aggressive investment program
initiated in late 1997 for both our pipe manufacturing facility and the pipe
replacement program, put a great deal of strain on the financial situation of
the Company during 1999. I would now like to tell you a little more about our
achievements, disappointments, and progress made during 1999.
ACHIEVEMENTS
Product Positioning
We have positioned our products to provide system flexibility to adapt to
the potential change in fuel additives to replace Methyl Tertiary Butyl Ether
("MTBE's"). We have developed, over the last 10 years, an expertise to deal with
very sophisticated materials to provide the hardest and the best anti-permeation
inner layer in the industry. Both of these strengths, as well as superior pipe
construction, allow for the easiest installation worldwide. Depending on the
ultimate choice of fuel additive, our current development program should allow
our retractable piping systems to remain the easiest to install while providing
the flexibility to meet future requirements without breaking concrete.
As regulators push for "dry" underground systems, Total Containment has
developed TotalGard(R) services to eliminate water intrusion into underground
piping systems. Utilizing years of experience and our patented Resump(TM)
technology, Total Containment can solve water intrusion problems, without
digging up a site, requiring minimal downtime and at a fraction of the cost of
new site installation.
Pipe Manufacturing Capabilities
As of November 1999, Total Containment completed the task of bringing in
house the entire pipe manufacturing process by purchasing and installing a
"Corrugator", a plastic extruder that makes the various base pipes for the
Company's piping products. Previously, this base pipe was manufactured by an
outside vendor. The Corrugator is expected to allow the Company to reduce scrap,
product lead times, and overall cost of its products as well as allow the
Company greater possibility regarding research and development.
DISAPPOINTMENTS
Sales
In 1999, the Company experienced a significant decrease in sales, due
primarily to the mergers of several large oil companies and their temporary
reductions in capital spending while awaiting Federal Trade Commission approvals
and due also to the extension of the EPA deadline for conformity with tank
regulations. The Company's net sales decreased to $24.9 million in 1999 from
$53.6 million in 1998. This decrease affected both our product sales as well as
field service operation revenues.
1
<PAGE>
Profits
Net income decreased substantially from net income of $4.6 million in 1998
to a net loss of $6.2 million in 1999. Total Containment was late in reacting to
such a sudden change in industry volume but nevertheless made significant
reductions in personnel levels and activities during the year. However it was
not sufficient to maintain profitable levels.
Pipe Replacement Program
Following a thorough assessment to deal with the deteriorating piping
previously supplied to us by Dayco Products, Inc. prior to 1994; we committed to
a very substantial proactive plan in 1997 and 1998 to replace this product.
Unfortunately, cash flows from operations did not allow us to continue the pipe
replacement program in 1999 at the same levels as 1997 and 1998. Total
Containment expects to continue replacing pipe as results from operations
permit.
We continued pursuing litigation against Dayco Products, Inc. to recover
the damages we sustained as a result of Dayco's deteriorating pipe.
OUTLOOK
During 1997, 1998 and 1999, Total Containment, Inc. laid the foundation for
enhanced profitability with a plan for increased sales, efficiencies and
continued cost reduction. Unfortunately, the significant reduction in industry
volume did not allow the Company to realize these cost reductions and we
incurred substantial one-time expenditures to reduce personnel and cancel
activities. The good news is that the great majority of the stations not in
conformity with current regulations will have to be done eventually; once the
mergers are approved, the oil companies involved will resume their capital
expenditure programs; accomplished retailers not previously involved in the
petroleum industry will build stations this year; our new unique TotalGard
product which is positioned to cater to more regulations for a dry system should
provide ample opportunity to resume with growth and profitability.
Very truly yours,
Pierre Desjardins
Chairman and Chief Executive Officer
John R. Wright, Jr.
President and Chief Operating Officer
2
<PAGE>
SELECTED FINANCIAL DATA
The following table sets forth certain consolidated summary financial data of
the Company for the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- ------- -------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales...................................................... $39,069 $37,730 $45,649 $ 53,582 $24,913
Cost of sales (excluding warranty expense)..................... 23,058 24,288 30,698 30,991 20,618
------- ------- ------- ------- --------
16,011 13,442 14,951 22,591 4,295
Warranty expense............................................... 573 747 1,396 1,636 710
Special pipe warranty charge (reversal)(1)(2).................. 7,500 -- 17,200 (3,347) 800
------- ------- ------- -------- --------
Gross profit (loss)............................................ 7,938 12,695 (3,645) 24,302 2,785
Selling, general and administrative............................ 10,262 10,665 12,307 12,261 11,510
Amortization of patents, licenses and goodwill(3)(4)........... 483 508 521 430 245
Loss on write-off of patent and patent license(4).............. -- -- 565 3,727 --
Other operating expense(5)..................................... -- -- 1,800 -- --
------- ------- ------- -------- -------
Income (loss) from operations.................................. (2,807) 1,522 (18,838) 7,884 (8,970)
Interest expense............................................... 146 362 627 537 725
Other expense(6)............................................... 407 -- -- -- --
------- ------- ------- -------- -------
Income (loss) before income taxes.............................. (3,360) 1,160 (19,465) 7,347 (9,695)
Income tax expense (benefit)................................... (1,112) 762 (7,109) 2,759 (3,525)
------- ------- ------- -------- -------
Net income (loss)(7)........................................... $(2,248) $ 398 $(12,356) $ 4,588 (6,170)
Preferred stock dividend(8).................................... -- -- -- 264 307
------- ------- ------- -------- -------
Net income (loss) applicable to common shareholders............ $(2,248) $ 398 $(12,356) $ 4,324 $(6,477)
======= ======= ======== ======== =======
Earnings (loss) per common share-basic(9)...................... $ (.48) $ .09 $ (2.66) $ .93 $ (1.39)
======= ======= ======== ======== =======
Earnings (loss) per common share - assuming dilution........... $ (.48) $ .08 $ (2.66) $ .89 $ (1.39)
======= ======= ======== ======== =======
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1995 1996 1997 1998 1999
------- ------- ------- ------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital ................................................ $ 8,224 $ 8,261 $ 1,128 $ 4,761 $ 2,721
Goodwill, patents and patent rights and license, net(2)(3)..... 10,317 10,700 9,672 6,102 5,810
Deferred income taxes.......................................... 3,228 1,701 7,420 4,377 8,124
Total assets................................................... 30,702 34,965 40,047 37,155 30,792
Line of credit borrowings(10)(11).............................. 251 3,677 3,197 3,388 3,189
Debt(12)....................................................... 654 2,664 3,049 2,394 4,102
Stockholders' equity(8)........................................ 18,616 19,016 6,440 14,821 12,242
</TABLE>
4
<PAGE>
--------------------
(1) As a result of a review performed during 1998 of the progress regarding the
Company's replacement of deteriorating pipe supplied by Dayco Products,
Inc. ("Dayco") prior to 1994 which the Company sold to end-users, as well
as the costs expected to be incurred to complete this process, the Company
recorded, during the third quarter of 1998, a reduction of the warranty
reserve of approximately $3.3 million.
(2) As a result of a review performed during the fourth quarter of 1999 of the
progress regarding the Company's replacement of deteriorating pipe supplied
by Dayco, and the effects of the Company's decision, during the second
quarter of 1999, to only replace pipe at locations where the pipe is
significantly deteriorated, as well as the costs expected to be incurred to
complete this process, the Company recorded, during the fourth quarter of
1999, a charge to the warranty reserve of $800,000.
(3) In connection with the initial public offering by the Company of 1,346,600
shares of its common stock (the "Offering"), the Company acquired the Tank
Jacket patent from Groupe Treco Ltee ("Treco"), in consideration of the
issuance by the Company to Treco of 45,000 shares of the Company's common
stock. The Tank Jacket patent was valued at $427,500. See Note 12 of Notes
to Consolidated Financial Statements.
(4) Due to a judicial order issued in September 1998 in litigation between the
Company and Environ Products, Inc., which declared invalid a patent
licensed by the Company, the Company wrote off in 1998 approximately $3.7
million of current unamortized cost of the patent license. See Note 12 of
Notes to Consolidated Financial Statements.
(5) The other expense of $1.8 million incurred in 1997 was associated with the
legal settlement regarding licensing of certain patented technology.
(6) In 1995, the Company incurred non-recurring transaction expenses,
consisting primarily of legal fees and special committee and board fees of
approximately $407,000, related to negotiations with a third party and
certain members of management with respect to their proposed acquisition of
the Company. In August 1995, the Company announced that the acquisition
negotiations had been terminated and charged all costs associated therewith
to other expense.
(7) The net loss in 1997, resulting principally from the $20.4 million of
warranty and other expense in 1997, created a deferred tax asset of
approximately $7.4 million. This future tax asset is reflected under
"Deferred Income Taxes" (both current and long-term) on the Company's
balance sheet which will be deductible in future years.
(8) On March 17, 1998, the Company's principal shareholder purchased from the
Company 400 shares of authorized Series A Floating Rate Preferred Stock of
the Company at $10,000 cash per share or $4 million in the aggregate. In
December 1999, the Company's principal shareholder purchased an additional
400 shares of authorized Series B Floating Rate Preferred Stock of the
Company at $10,000 cash per share or $4 million in the aggregate.
(9) Based on approximately 4.6 million weighted average shares outstanding
during 1995, 1996, 1997, 1998 and 1999.
(10) Increases in the line of credit and debt in 1996 were due to increased
working capital requirements for, among other things, warranty charges
related to the Enviroflex(R) pipe, as well as two term loans for expansion
and the acquisition of American Containment, Inc.
5
<PAGE>
(11) In December 1999, the Company entered into a new $5 million line of credit
which expires in June 2001. The line of credit is to be used for working
capital purposes.
(12) In September 1999, the Company refinanced all of its existing long-term
debt with a new $4 million facility with Finloc Inc. Proceeds from the loan
were used to repay $1.9 million of long term debt, $1 million was used to
pay down the existing short term line of credit and approximately $1.1
million was used to pay existing vendors who had supplied various
components in connection with the Company's installation of its corrugator.
6
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for historical information, this report may be deemed to contain
"forward-looking" statements. The Company desires to avail itself of the Safe
Harbor provisions of the Private Securities Litigation Reform Act of 1995 (the
"Act") and is including this cautionary statement for the express purpose of
availing itself of the protection afforded by the Act.
These forward-looking statements include statements with respect to the
Company's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of the Company, including but not
limited to, (i) projections of revenues, costs of raw materials, income or loss,
earnings or loss per share, capital expenditures, growth prospects, dividends,
the effect of currency fluctuations, capital structure and other financial
items, (ii) statements of plans of and objectives of the Company or its
management or board of directors, including the introduction of new products, or
estimates or predictions of actions by customers, suppliers, competitors or
regulating authorities, (iii) statements of future economic performance, (iv)
statements of assumptions, such as the prevailing weather conditions in the
Company's market areas, and other statements about the Company or its business,
and (v) statements preceded by, followed by or that include the words "may,"
"could," "should," "pro forma," "looking forward," "would," "believe," "expect,"
"anticipate," "estimate," "intend," "plan," or similar expressions. These
forward-looking statements involve risks and uncertainties, which are subject to
change based on various important factors (some of which, in whole or in part,
are beyond the Company's control). The following factors, among others, could
cause the Company's financial performance to differ materially from the goals,
plans, objectives, intentions and expectations expressed in such forward-looking
statements: (1) the strength of the United States and global economies in
general and the strength of the regional and local economies in which the
Company conducts operations; (2) the effects of, and changes in, U.S. and
foreign governmental trade, monetary and fiscal policies and laws; (3) the
timely development of competitive new products and services by the Company and
the acceptance of such products and services by the Company and by the
customers; (4) the willingness of customers to substitute competitors' products
and services and vise versa; (5) the impact on operations of changes in U.S. and
foreign governmental laws and public policy, including environmental
regulations; (6) the level of export sales impacted by export controls, changes
in legal and regulatory requirements, policy changes affecting the markets,
changes in tax laws and tariffs, exchange rate fluctuations, political and
economic instability, and accounts receivable collection; (7) changes in capital
expenditures by major oil companies resulting from proposed and completed
mergers and consolidations of the oil companies; (8) technological changes; (9)
regulatory or judicial proceedings; and (10) the success of the Company at
managing the risks involved in the foregoing.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
The following discussion and analysis of financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements of the Company, including the related notes thereto,
appearing elsewhere herein.
7
<PAGE>
RESULTS OF OPERATIONS - 1997-1999
The following table sets forth, for the periods indicated, certain
financial data as a percentage of net sales:
YEAR ENDED DECEMBER 31,
------------------------
1997 1998 1999
----- ----- -----
Net sales......................................... 100.0% 100.0% 100.0%
Cost of sales (excluding warranties).............. 67.2 57.8 82.8
----- ----- -----
32.8 42.2 17.2
Warranty expense.................................. 3.1 3.0 2.8
Special pipe warranty charge (reversal) 37.7 (6.2) 3.2
----- ----- -----
Gross profit...................................... (8.0) 45.4 11.2
Selling, general and administrative............... 27.0 22.9 46.2
Amortization of patents, licenses and goodwill.... 1.1 0.8 1.0
Loss on write-off of patent and patent license.... 1.2 7.0 --
Other operating expense........................... 3.9 -- --
----- ----- -----
Operating income (loss)........................... (41.2) 14.7 (36.0)
Interest expense.................................. 1.4 1.0 2.9
----- ----- -----
Income (loss) before income taxes................. (42.6) 13.7 (38.9)
Income tax expense (benefit)...................... (15.6) 5.1 (14.1)
----- ----- -----
Net income (loss)................................. (27.0)% 8.6% (24.8)%
----- ----- -----
Preferred stock dividend.......................... -- .5 1.2
----- ----- -----
Net income (loss) applicable
to common shareholders......................... (27.0)% 8.1% (26.0)%
......... ===== ===== =====
8
<PAGE>
1999 VERSUS 1998
Net Sales
The Company's net sales for the year ended December 31, 1999 were $24.9
million compared to $53.6 million for the year ended December 31, 1998, a
decrease of 53.5%. The decrease was attributable to a decrease in sales from
both our flexible underground piping system products, and our field operations
at our American Containment, Inc. subsidiary, partly attributable to a general
slowdown in new construction and renovation of petroleum service stations
despite the large number of service stations still not in compliance with the
federally mandated regulations. The decrease was also caused in part by the
Environmental Protection Agency's ("EPA") extention of the deadline for
conformity to new tank regulations. The recently announced merger plans of
several large oil companies has resulted in a decrease in their capital
expenditure plans (with some large oil companies, a temporary suspension) which
has also had a negative impact on the Company's revenues.
Gross Profit (Loss)
The primary component of the Company's cost of sales is the product
manufacturing costs incurred by the Company as well as costs paid to various
third party manufacturers. Other components are the variable and fixed costs of
operating the Company's manufacturing, field service and warehousing operations,
depreciation of molds, tools and equipment, and warranty expense. The Company's
gross profit after the warranty provision for the year ended December 31, 1999
was $2.8 million compared to a $24.3 million profit after the warranty provision
for the year ended December 31, 1998. The decrease is due primarily to the
decrease in product sales volume as well as a decrease in the field service
operation sales volume. Additionally, at the lower revenue levels,
manufacturing, warehousing and field service costs were not fully absorbed. As a
result of a review performed during the fourth quarter of 1999 of the progress
regarding the Company's replacement of deteriorating pipe supplied by Dayco, and
the effects of the Company's decision, during the second quarter of 1999, to
selectively replace pipe as operations permit, as well as the costs expected to
be incurred to complete this process, the Company recorded, during the fourth
quarter of 1999, a charge to the warranty reserve of $800,000. As a result of a
review performed in 1998 of the progress made regarding this replacement pipe
program, including the costs then expected to be incurred to complete this
process, the Company recorded a reduction of the warranty reserve of
approximately $3.3 million in 1998.
Comparing margins before the effect of the warranty provision, the Company
experienced a decrease in gross profit primarily from decreased sales of our
main piping products and field service operations and the resultant unabsorbed
manufacturing, warehousing and field operation costs.
The Company's gross profit percentage after the effect of the warranty
provision decreased to 11.2% for the year ended December 31, 1999, compared to a
gross profit percentage after the effect of the warranty provision of 45.4% for
the year ended December 31, 1998. The gross margin for 1999 was adversely
affected by the decrease in product sales volume as well as a decrease in the
field service operation sales volume and the unabsorbed manufacturing,
warehousing and field services operations costs. The gross profit margin
percentage was also adversely affected by the special warranty charge of
$800,000. The gross margin for 1998 experienced a benefit from the $3.3 million
reduction of the warranty reserve. The Company's gross profit percentage before
effect of the warranty provision for the year ended December 31, 1999 decreased
to 17.2%, compared to a gross profit percentage before the effect of the
warranty provision of 42.2% for the year ended December 31, 1998. The decrease
was primarily attributable to the decrease in product sales volume as well as a
decrease in the field service operation sales volume.
9
<PAGE>
Operating Expense
Selling, general and administrative expenses consist primarily of salaries
and related benefits, payroll taxes, commissions, royalties, legal expenses and
other general, administrative and overhead costs. Selling, general and
administrative expenses for the year ended December 31, 1999 were $11.5 million,
compared to $12.3 million for the year ended December 31, 1998. The decrease
from 1998 to 1999 resulted mainly from a decrease in personnel headcount and
activity levels due to cost reductions initiated by the Company during the
second quarter of 1999. These reductions are partially offset by approximately
$1.5 million in one-time charges for reductions in operations, shutdown of
certain activities, write down of certain asset valuations, severance costs,
truck lease termination expenses, bank line of credit renegotiation costs,
accounts receivable reserves and insurance coverage adjustments.
Amortization of Intangibles
Amortization of intangibles consists of the amortization of goodwill over a
period of 40 years and the amortization of various patents and licenses that are
amortized on a straight-line basis over the estimated lives of the patents
(which range from 13 to 17 years) at the acquisition date or subsequent issuance
date. The decrease in amortization expense to $244,884 in fiscal 1999 from
$430,468 in fiscal 1998 is due to the write off of the patent license in the
third quarter of 1998 (See Note 12 of Notes to Consolidated Financial
Statements).
Other Expense
Other expense of $3.7 million incurred during the year ended December 31,
1998 was associated with the write off of a patent license (originally
capitalized by the Company) in connection with litigation which invalidated the
underlying patent. The Company does not believe that the loss of the patent has
had or will have a material adverse effect on its business. (See Note 12 of
Notes to Consolidated Financial Statements).
Interest Expense
Interest expense for the year ended December 31, 1999 was $725,003,
compared to $536,490 for the year ended December 31, 1998. Interest expense is
incurred on term loans that were used for acquisitions and purchasing equipment
and under the Company's working capital line of credit. The increase is due to a
higher average balance outstanding on the Company's lines of credit during 1999
compared to 1998 that were used to fund the operations of the Company during
1999 (see Note 7 of the Consolidated Financial Statements.) The increase is also
due to a higher variable lending rate experienced in the second half of 1999
compared to 1998.
Income Taxes
The income tax benefit for the year ended December 31, 1999 was $3.5
million compared to an expense of $2.8 million for the year ended December 31,
1998. The Company's effective tax rate was 36.3% during 1999 compared to an
effective tax rate of 37.6% in 1998. In recognizing this benefit in the 1999
period, the Company increased its deferred tax asset on its balance sheet.
Realization of deferred tax assets associated with net operating loss (NOL)
carryforwards is dependent upon generating sufficient taxable income prior to
their expiration. Management believes that the general slowdown that the Company
experienced in its market during 1999 is temporary in nature. Management also
believes that when the mergers of the several large oil companies are approved
by the Federal Trade Commission and when these large oil companies plan and
execute their new capital expenditure plans, the Company will experience an
10
<PAGE>
increase in its revenues and will return to profitable operations. Based on
current projections by management, the expected taxable earnings for the near
future are sufficient to realize the current value of the deferred tax assets.
These projections include results of operations from both product sales as well
as field service operations, and possible outcomes of the Dayco lawsuit.
Although realization is not assured for the remaining deferred tax assets at
December 31, 1999, the Company currently believes that it is more likely than
not that this asset will be realized in future years as a result of taxable
income to be generated by its overall operations, but will continue to monitor
the valuation of this asset on an ongoing basis.
Preferred Stock Dividends
In 1999, the Company accrued a dividend of $306,599 on the Company's
outstanding Series A and B Floating Rate Preferred Stock (the "Preferred
Stock"). (See Note 10 of Notes to Consolidated Financial Statements).
Net Income (Loss) Applicable to Common Shareholders
The Company's net loss applicable to common shareholders for the year ended
December 31, 1999 was $6.5 million, or $1.39 per share, compared to net income
applicable to common shareholders of $4.3 million, or $.93 per share, for the
year ended December 31, 1998. The decrease of $10.8 million was primarily a
result of the decrease in product sales volume as well as a decrease in the
field service operation sales volume, unabsorbed manufacturing, warehousing and
field service costs, charges associated with the shutdown or curtailment of
several activities of the Company and the 1999 special warranty charge of
$800,000. The 1998 results were adversely affected by the $3.7 million write off
of a patent license, which was substantially offset by the reversal of $3.3
million of the warranty reserve.
1998 VERSUS 1997
Net Sales
The Company's net sales for the year ended December 31, 1998 were $53.6
million compared to $45.6 million for the year ended December 31, 1997, an
increase of 17.4%. The increase was primarily attributable to increased sales
from our field operations at our American Containment, Inc. subsidiary, as well
as continued strong sales of our flexible underground piping systems driven by
the buoyancy of the North American market.
Gross Profit (Loss)
The Company's gross profit after the warranty provision for the year ended
December 31, 1998 was $24.3 million compared to a $3.6 million loss after the
warranty provision for the year ended December 31, 1997. During 1997, the
Company recorded warranty expense of $18.6 million primarily to cover the cost
of replacing deteriorating pipe (see Note 2 of Notes to Consolidated Financial
Statements). As a result of a review performed in 1998 of the progress made
regarding this replacement pipe program, including the costs then expected to be
incurred to complete this process, the Company recorded a reduction of the
warranty reserve of approximately $3.3 million in 1998. The Company has been
able to significantly reduce the cost of performing the pipe replacement program
by managing more efficiently the use of outside contractors as well as
controlling the costs incurred by the Company's service crews.
Comparing margins before the effect of the warranty provision, the Company
experienced an increase in gross profit primarily from increased sales and
reduced costs of producing our main piping products. The integration of our pipe
manufacturing plant in October 1997, coupled with lower costs in
11
<PAGE>
certain other products due to our cost reduction program initiated in the second
half of 1997 has reduced the overall cost of the Company's products. The Company
also experienced an increase in gross margin due to a decrease in the costs of
producing certain fiberglass products at its Bakersfield, California operations.
The Company's gross profit percentage after the effect of the warranty
provision increased to 45.4% for the year ended December 31, 1998, compared to a
gross loss after the effect of the warranty provision of 8.0% for the year ended
December 31, 1997. The gross margin for 1997 was adversely affected by the $18.6
million warranty charge. The gross margin for 1998 experienced a benefit from
the $3.3 million reduction of the warranty reserve. The Company's gross profit
percentage before effect of the warranty provision for the year ended December
31, 1998 increased to 42.2%, compared to a gross profit percentage before the
effect of the warranty provision of 32.8% for the year ended December 31, 1997.
The increase was primarily attributable to the reduced costs of our main piping
products as well as lower costs in certain other products.
Operating Expense
Selling, general and administrative expenses for the year ended December
31, 1998 were $12.26 million, compared to $12.31 million for the year ended
December 31, 1997. The Company experienced a decrease in overall legal costs but
it was almost entirely offset by an increase in bad debt expense and training
costs related to the implementation of our new information system.
Amortization of Intangibles
The decrease in amortization expense to $430,468 in fiscal 1998 from
$521,077 in fiscal 1997 is due to the write off of the patent license in the
third quarter of 1998 (See Note 12 of Notes to Consolidated Financial
Statements).
Other Expense
Other expense of $3.7 million incurred during the year ended December 31,
1998 was associated with the write off of a patent license originally
capitalized by the Company in connection with litigation, which invalidated the
underlying patent. The Company does not believe that the loss of the patent has
had or will have a material adverse effect on its business. (See Note 12 of
Notes to Consolidated Financial Statements). The other expense of $1.8 million
incurred in the year ended December 31, 1997 was associated with the legal
settlement regarding licensing of certain patented technology. The Company also
incurred during 1997, $564,684 of other expense related to the write off of a
patent of a product line that has been discontinued.
Interest Expense
Interest expense for the year ended December 31, 1998 was $536,490,
compared to $626,575 for the year ended December 31, 1997. Interest expense is
incurred on term loans that were used for purchasing equipment and under the
Company's working capital line of credit. The decrease is due to a lower average
balance outstanding on the Company's line of credit during 1998 compared to 1997
due to the proceeds from the issuance of the $4 million of Preferred Stock, and
a decrease in the interest rate charged on the line of credit (see Note 7 of the
Consolidated Financial Statements.)
Income Taxes
Income taxes for the year ended December 31, 1998 were $2.8 million
compared to a benefit of $7.1 million for the year ended December 31, 1997. The
Company's effective tax rate was 38% during 1998
12
<PAGE>
compared to an effective tax rate of 37% in 1997. The Company provided a
valuation allowance of $275,465 for state deferred income tax assets in 1997 but
removed the valuation allowance in 1998 due to the expectation that they will be
fully realized.
Preferred Stock Dividends
In 1998, the Company accrued a dividend of $264,301 on the Company's
outstanding Series A Floating Rate Preferred Stock (the "Preferred Stock"). (See
Note 10 of Notes to Consolidated Financial Statements).
Net Income (Loss) Applicable to Common Shareholders
The Company's net income applicable to common shareholders for the year
ended December 31, 1998 was $4.3 million, or $.93 per share, compared to a loss
of $12.4 million, or $2.66 per share, for the year ended December 31, 1997. The
increase of $16.7 million was a result of the prior year results containing a
$20.4 million pre-tax charge to earnings to increase the company's warranty
reserve, to write down certain inventory, as well as to record charges
associated with licensing of certain patented technology and the write off of a
patent. The 1998 results were adversely affected by the $3.7 million write off
of a patent license, which was substantially offset by the reversal of $3.3
million of the warranty reserve. The increase in net income for the year,
excluding the previously mentioned charges, resulted from increased sales and an
increase in gross margin percentage, which was partially offset by the increase
in income tax expense.
SEASONALITY AND ECONOMIC CONDITIONS
The Company's sales are affected by the timing of planned construction of
new service stations and the retrofitting of existing service stations by end
users, both of which are influenced by inclement weather and general economic
conditions. Accordingly, the Company's net sales and operating results for the
quarter ended March 31 are generally adversely affected. The Company's sales
have also been adversely affected, to a slight extent, due to the recent Asian
economic crisis and political changes in certain Latin American countries.
The recently announced merger plans of several large oil companies have
created a short-term uncertainty regarding their retail operation capital
expenditure plans. The Company's 1999 results experienced adverse sales and
operating results due to a reduction in capital expenditures by the large oil
companies related to their retail operations. The decrease was also caused in
part by the EPA's extension of the deadline for conformity to the new tank
regulations. The Company believes that once these mergers receive Federal Trade
Commission approvals, and the major oil companies execute the requirements
mandated by the Federal Trade Commission, the major oil companies will renew
their related capital expenditures.
INFLATION
Management does not believe that inflation has had a material impact upon
results of operations during the years ended December 31, 1997, 1998 or 1999.
13
<PAGE>
RECENT ACCOUNTING PRONOUNCEMENTS
On December 15, 1997, the Company adopted the provisions of Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS No.
128 eliminates the primary and fully diluted earnings per share and requires the
presentation of basic and diluted earnings per share in conjunction with the
disclosure of the methodology used in computing such earnings. Basic earnings
per share excludes the dilution and is computed by dividing income available to
common shareholders by the weighted average number of shares outstanding during
the period. Diluted earnings per share takes into account the potential dilution
that could occur if securities and other contracts to issue common stock were
exercised and converted into common stock.
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards to provide prominent
disclosure of comprehensive income items. Comprehensive income is the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. Prior period amounts have been
restated to conform to the provisions of SFAS No. 130. The adoption of SFAS No.
130 had no impact on the Company's financial position or results of operations.
On January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 requires that
public business enterprises report certain information about the operating
segments in a complete set of financial statements of the enterprise and in
condensed financial statements of interim periods issued to shareholders. It
also requires the reporting of certain information about their products and
services, the geographic area in which they operate, and their major customers.
The adoption of SFAS No. 131 had no impact on the Company's financial position
or results of operations.
On January 1, 1999, the Company, in accordance with the Accounting
Standards Executive Committee of the American Institute of Certified Public
Accountants adopted SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." The SOP segments an internal use
software project into stages and the accounting is based on the stage in which a
cost is incurred. The adoption of SOP 98-1 had no material impact on the
Company's financial position or results of operations.
UPDATE ON YEAR 2000 ISSUES
As of the filing date of this Annual Report on Form 10-K, no significant
problems have been encountered as a result of computer problems related to
operating in calendar year 2000. All known remediation projects and all critical
projects throughout Total Containment have been completed. Contingency plans
were developed for any process determined to be mission critical to the Company.
All manufacturing, shipping and administrative functions have operated normally
since January 1, 2000 and no significant problems have been experienced with
suppliers or customers.
The Company has incurred internal staff costs as well as consulting and
other expenses related to infrastructure and facilities enhancements necessary
to prepare the systems for the year 2000. Testing and conversion of system
applications cost approximately $350,000, of which approximately $300,000 was
incurred as part of the acquisition, during 1998, of the Company's new
information system.
In the opinion of management, the Company believes that all of its
important business resources, either currently or in the near future, are
expected to allow the Company to continue operating through the year 2000 and
that there will be no disruption of any material business operation or
capability.
14
<PAGE>
FINANCIAL CONDITION; LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of approximately $2.7 million at December
31, 1999, compared to working capital of $4.8 million at December 31, 1998. The
decrease is due primarily to the 1999 operating loss of the Company and the use
by the Company of its short-term line of credit to fund such losses partially
offset by the reclass of the line of credit to Long Term Liabilities due to
terms of the new agreement (see Note 7 of Notes to Consolidated Financial
Statements).
In December 1999, the Company entered into a new short term, $5 million
line of credit facility with a new bank. This line of credit, as well as funds
from operations, are used to satisfy the Company's working capital needs. This
line expires on June 30, 2001. Proceeds from this facility were used to repay
the old facility of approximately $3 million. This facility charges interest at
a rate of LIBOR plus 1.50% (7.33% as of December 31, 1999) and is guaranteed by
Canam Steel Corporation, a subsidiary of The Canam Manac Group, Inc. Canam Steel
Corporation charges a fee for this guarantee at the rate of .50% of the
outstanding balance. The line of credit requires the Company to maintain $5.0
million in tangible net worth as defined in the agreement.
In September 1999, the Company refinanced all of its long-term debt of
approximately $1.9 million with a new five-year, $4 million facility with
Finloc, Inc. ("Finloc"), an affiliate of The Canam Manac Group, Inc. Finloc is
currently the holder of approximately 56% of the Company's common stock. The
facility charges interest at the rate of LIBOR plus 4.00% (9.83% at December 31,
1999). The loan is in the form of a six-month promissory note, which requires
payment of the entire principal and accrued interest at its term. Finloc has
provided a written notice of its intent to renew this note every six months for
a period of five years with a reduction of principal of approximately $400,000
from the principal of the previous note. The proceeds of this note were used to
repay the $1.9 million outstanding under the previous long term facilities, $1
million was used to pay down the existing short term line of credit facility and
approximately $1.1 million was used to pay existing vendors who supplied various
components in connection with the Company's installation of its corrugator (see
Note 6 of Notes to Consolidated Financial Statements).
The Company invested $2.2 million, $1.5 million and $2.4 million in capital
equipment and leasehold improvements in 1997, 1998 and 1999, respectively. In
the fourth quarter of 1999, the Company completed the installation of its pipe
manufacturing line at the Oaks, Pennsylvania facility by purchasing, for
approximately $2.1 million, and installing a "corrugator", a plastic extruder
which makes the base pipe for all of its piping products. Previously, between
1997 and 1999, the Company purchased the base pipe from an outside vendor. The
purchase of product molds and tooling constituted $501,000, $197,000 and
$188,000 of these capital expenditures in 1997, 1998, and 1999, respectively.
Because the Company does not discharge a significant amount of material
into the environment, the Company does not anticipate that it will incur any
material costs or expenses in complying with federal, state and local
environmental laws or otherwise relating to the protection of the environment.
The Company does not anticipate that it will incur material costs and expenses
for research and development necessary to modify its existing product lines to
comply with changes in such laws and could, under certain circumstances, become
liable with respect to the discharge of materials into the environment that
results from a defect in a product.
The Company believes that its presently available funds, together with cash
flow expected to be generated from operations and amounts available under its
commitments from its commercial bank, will be adequate to satisfy its
anticipated working capital requirements for the foreseeable future.
15
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and
Shareholders, Total Containment, Inc.
We have audited the consolidated balance sheets of Total Containment, Inc. (a
Pennsylvania Corporation) and Subsidiaries as of December 31, 1998 and 1999, and
the related consolidated statements of operations, changes in shareholders'
equity and cash flows for each of the years in the three year period ended
December 31, 1999. These financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform our audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Total
Containment, Inc. and Subsidiaries at December 31, 1998 and 1999, and the
consolidated results of their operations and their consolidated cash flows for
each of the years in the three year period ended December 31, 1999 in conformity
with generally accepted accounting principles.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
February 18, 2000
16
<PAGE>
TOTAL CONTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------
1998 1999
----------- ----------
ASSETS
Current assets:
Cash................................................ $ 132,164 $ 730,822
Accounts receivable, net of allowance for
doubtful accounts of $420,499 and $359,839
for 1998 and 1999, respectively................... 13,329,081 4,158,027
Inventories......................................... 7,622,796 5,438,388
Deferred income taxes............................... 2,850,602 1,535,137
Other current assets................................ 766,962 624,730
----------- ----------
Total current assets ............................ 24,701,605 12,487,104
Molds and tooling, net.............................. 437,721 329,439
Property and equipment, net......................... 4,386,726 5,576,097
Patents, patent rights and licenses, net............ 309,880 250,551
Goodwill, net....................................... 5,792,391 5,559,608
Deferred income taxes............................... 1,526,823 6,589,243
----------- ----------
$37,155,146 $30,792,042
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit borrowings .......................... $ 3,388,000 $ --
Current portion of long-term debt................... 667,576 875,292
Accounts payable, trade and accrued expenses ....... 6,147,949 3,588,950
Accrued preferred stock dividends................... 264,301 306,599
Other payable....................................... 4,020,481 4,020,481
Warranty reserve - current.......................... 5,451,992 975,170
----------- ----------
Total current liabilities ....................... 19,940,299 9,766,492
Long-term debt........................................ 1,726,798 3,227,097
Line of credit borrowings............................. -- 3,189,391
Non-current warranty.................................. 666,890 2,366,725
----------- ----------
Total liabilities ............................... 22,333,987 18,549,705
----------- ----------
Commitments and contingencies......................... -- --
Shareholders' equity:
Preferred stock - Series A, $10,000 par value;
authorized, issued and outstanding 400 shares..... 4,000,000 4,000,000
Preferred stock - Series B, $10,000 par value;
authorized, issued and outstanding 400 shares..... -- 4,000,000
Common stock - $.01 par value; authorized
20,000,000 shares; 4,652,600 and 4,672,600 shares
issued and outstanding............................ 46,526 46,726
Capital in excess of par value ..................... 13,756,355 13,808,655
Retained earnings................................... (2,815,886) (9,292,432)
Accumulated other comprehensive income................ (165,836) (320,612)
----------- ----------
Total shareholders' equity ....................... 14,821,159 12,242,337
----------- ----------
$37,155,146 $30,792,042
=========== ===========
The accompanying notes are an integral part of these financial statements.
17
<PAGE>
TOTAL CONTAINMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Net sales ............................................ $ 45,648,699 $ 53,581,818 $ 24,913,485
Cost of sales (excluding warranty expense) ........... 30,697,518 30,991,472 20,618,098
------------ ------------ ------------
14,951,181 22,590,346 4,295,387
Warranty expense ..................................... 1,396,329 1,635,660 709,727
Special pipe warranty charge (reversal) .............. 17,200,000 (3,347,567) 800,000
------------ ------------ ------------
Gross profit (loss) .................................. (3,645,148) 24,302,253 2,785,660
Selling, general and administrative .................. 12,307,515 12,261,077 11,510,429
Amortization of patents, licenses and goodwill ....... 521,077 430,468 244,884
Loss on write-off of patent and patent license ....... 564,684 3,727,250 --
Other operating expense .............................. 1,800,000 -- --
------------ ------------ ------------
Income (loss) from operations ........................ (18,838,424) 7,883,458 (8,969,653)
Interest expense ..................................... 626,575 536,490 725,003
------------ ------------ ------------
Income (loss) before income taxes .................... (19,464,999) 7,346,968 (9,694,656)
Income tax expense (benefit) ......................... (7,108,795) 2,759,195 (3,524,709)
------------ ------------ ------------
Net income (loss) .................................... (12,356,204) 4,587,773 (6,169,947)
Preferred stock dividend ............................. -- 264,301 306,599
------------ ------------ ------------
Net income (loss) applicable to common
shareholders ........................................ $(12,356,204) $ 4,323,472 $ (6,476,546)
................................................. =========== =========== ===========
Per share data:
Earnings (loss) per common share - basic ............ $ (2.66) $ .93 $ (1.39)
============ ============ ============
Earnings (loss) per common share assuming dilution .. $ (2.66) $ .89 $ (1.39)
============ ============ ============
Weighted average shares used in computation of
earnings (loss) per common share - basic ........... 4,641,600 4,646,000 4,667,855
============ ============ ============
Weighted average shares used in computation of
earnings (loss) per common share - assuming dilution 4,641,600 4,859,872 4,667,855
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
18
<PAGE>
TOTAL CONTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
CAPITAL COMPREHENSIVE
PREFERRED COMMON IN EXCESS RETAINED INCOME
STOCK STOCK OF PAR VALUE EARNINGS (LOSS) TOTAL
---------- ------- ------------ ------------ ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
January 1, 1997..................... $ -- $46,416 $ 13,728,778 $ 5,216,846 $ 23,539 $19,015,579
Net loss............................ (12,356,204) (12,356,204)
Equity adjustment from foreign
currency translation............... (219,519) (219,519)
---------- ------- ------------ ------------ ------------ ------------
December 31, 1997................... -- 46,416 13,728,778 (7,139,358) (195,980) 6,439,856
Net income.......................... 4,587,773 4,587,773
Equity adjustment from foreign
currency translation............... 30,144 30,144
Issuance of preferred stock......... 4,000,000 4,000,000
Issuance of common stock............ 110 27,577 27,687
Preferred stock dividends........... (264,301) (264,301)
---------- ------- ----------- ------------ --------- ------------
December 31, 1998.................. 4,000,000 46,526 13,756,355 (2,815,886) (165,836) 14,821,159
Net loss .......................... (6,169,947) (6,169,947)
Equity adjustment from foreign
currency translation............... (154,776) (154,776)
Issuance of preferred stock......... 4,000,000 4,000,000
Issuance of common stock............ 200 52,300 52,500
Preferred stock dividends........... (306,599) (306,599)
---------- ------- ----------- ------------ --------- ------------
December 31, 1999.................. $8,000,000 $46,726 $13,808,655 $ (9,292,432) $(320,612) $12,242,337
========== ======= =========== ============ ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
19
<PAGE>
TOTAL CONTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------ -----------
<S> <C> <C> <C>
Cash flows from operation activities:
Net income (loss)......................................... $(12,356,204) $ 4,587,773 $(6,169,947)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization............................ 1,744,418 1,940,778 1,629,614
Loss on write-off of patent.............................. 564,684 3,727,250 --
Change in assets and liabilities:
Accounts receivable..................................... (561,500) (5,424,842) 8,834,718
Inventories............................................. (158,721) (303,804) 2,138,847
Other assets............................................ 1,081,230 1,525,848 78,953
Deferred taxes.......................................... (5,719,438) 3,042,634 (3,746,956)
Accounts payable, trade and accrued expenses............ 987,414 (436,771) (2,275,025)
Other payable........................................... 4,020,481 -- --
Warranty reserve........................................ 12,855,711 (11,205,524) (2,734,445)
----------- ------------ -----------
Net cash provided by (used for) operating activities... 2,458,075 (2,546,658) (2,244,241)
=========== ============ ===========
Cash flows from investing activities:
Purchase of molds and tooling............................. (500,688) (197,066) (187,948)
Purchase of property and equipment........................ (1,699,212) (1,279,361) (2,237,346)
Patent costs and license fees............................. (67,744) -- --
----------- ----------- -----------
Net cash used for investing activities................. (2,267,644) (1,476,427) (2,425,294)
=========== =========== ===========
Cash flows from financing activities:
Proceeds from sale of preferred stock..................... -- 4,000,000 4,000,000
Dividends paid on Preferred Stock......................... -- -- (264,301)
Proceeds from sale of common stock........................ -- 27,687 52,500
Borrowings on long-term debt.............................. 1,154,712 105,000 2,125,392
Payments on long-term debt................................ (770,012) (759,420) (417,377)
Net borrowings (payments) under line of credit............ (480,000) 191,000 (198,609)
----------- ----------- -----------
Net cash provided by (used for) financing activities..... (95,300) 3,564,267 5,297,605
----------- ----------- -----------
Effect of foreign currency exchange rate................... (99,027) (21,137) (29,412)
----------- ----------- -----------
Net increase (decrease).................................... (3,896) (479,955) 598,658
Cash and cash equivalents at beginning of year............. 616,015 612,119 132,164
----------- ----------- -----------
Cash and cash equivalents at end of year................... $ 612,119 $ 132,164 730,822
=========== =========== ===========
Supplemental cash flow information:
Interest paid............................................. $ 626,575 $ 540,469 $ 533,105
Income taxes paid (received) net of refunds............... $(1,024,129) $(1,567,063) $ (369,407)
</TABLE>
The accompanying notes are an integral part of these financial statements.
20
<PAGE>
TOTAL CONTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Total Containment, Inc. (the "Company") is a leading manufacturer and
distributor of underground systems, products and services for the conveyance and
containment of petroleum and alcohol based motor vehicle fuels from underground
storage tanks to aboveground fuel dispensers. The principal end users of the
Company's products are service stations, convenience stores and other retail
sellers of gasoline, gasohol and other motor vehicle fuels, government bodies,
utilities, and other fleet vehicle operators.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation. The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiaries, TCI Environment
NV/SA (TCIE-NV), Rene Morin, Inc., FMW Inc. and American Containment, Inc. All
significant intercompany balances and transactions have been eliminated in
consolidation. The Consolidated Balance Sheets for the 1997 and 1998 periods
were reclassified to conform with current year presentation.
On July 11, 1996, the Company purchased all of the assets and certain
liabilities of American Containment, Inc., a manufacturer and installer of
fiberglass tank and dispenser sumps. This transaction was accounted for under
the purchase method of accounting. Goodwill associated with this purchase is
being amortized over approximately forty years.
Foreign currency translation. TCI Environment NV used the Belgian Franc
through 1998 and has used the Euro since January 1, 1999 as its functional
currency. Changes in the amount of the translation adjustment during each
reporting period are reported as a separate component of Shareholders' Equity
under Accumulated Other Comprehensive Income.
Concentration of credit risks. The Company's trade receivables result
primarily from the sale of product to distributors who sell to automobile
service stations and convenience store markets including several large chains.
The Company traditionally relies on a limited number of suppliers on an
exclusive basis.
Inventories. Inventories are stated at the lower of cost or market, cost
being determined on a first-in, first-out (FIFO) basis.
Property and equipment. Property and equipment are valued at cost.
Depreciation is computed on a straight-line basis over the useful lives of the
assets.
Patents, patent rights and licenses. The Company capitalizes costs of
acquired patents, and other costs related to obtaining and maintaining patents.
Patents, patent rights and licenses are being amortized on a straight-line basis
over the estimated lives of the patents and licenses, which range from 13 to 17
years. Amortization expense aggregated $326,757, $255,500 and $59,329 for 1997,
1998 and 1999, respectively. A patent was written off in the third quarter of
1997 for a product line that was discontinued with a book value of $564,684. Due
to a judicial order issued in September 1998 in the litigation between the
Company and Environ Products, Inc., which declared the underlying patent to the
license invalid, the Company wrote
21
<PAGE>
off in 1998 approximately $3.7 million of current unamortized cost of the patent
license. Accumulated amortization was $346,620 and $405,949 at December 31, 1998
and 1999, respectively.
Goodwill. Goodwill represents the excess of the purchase price over the
fair value of the net tangible and identified intangible assets, and is being
amortized over forty years. Goodwill amortization approximated $166,009,
$174,968 and $185,555 for 1997, 1998 and 1999, respectively. Accumulated
goodwill amortization was $1,443,085 and $1,628,640 at December 31, 1998 and
1999, respectively.
The Company evaluates the carrying value of long-lived assets, including
goodwill, whenever changes in circumstances indicate the carrying amount of such
assets may not be recoverable. In performing such review for recoverability, the
Company compares the expected future cash flows to the carrying value of
long-lived assets and identifiable intangibles. If the anticipated undiscounted
future cash flows are less than the carrying amount of such assets, the Company
recognizes an impairment loss for the difference between the carrying amount of
the assets and their estimated fair value.
Company sponsored retirement plan. Certain employees of the Company
participate in a Company sponsored 401(k) retirement plan. The Company's only
costs during the years ended December 31, 1997, 1998, and 1999 were the
management fees charged for administration of the plan. These costs were
immaterial in each of the three years presented.
Warranty reserve. The Company's Tank Jacket and Pipe Jacket product lines
carry a warranty of one year for workmanship and materials. The Enviroflex
product line carries a ten-year warranty for workmanship and materials. The Tank
Jacket product line also carries a thirty-year warranty for corrosion from
certain specified materials. The Company's warranties are limited to replacement
of defective material; they do not cover by their terms costs associated with
leaks or spillage of tank or pipe contents. Management has accrued a reserve for
anticipated warranty and other product liability claims and associated legal
fees based upon its industry knowledge and actual claims experience.
As the result of a review of piping problems initiated in 1996, the
Company, during the third quarter of 1997, increased its warranty reserve by
approximately $18.6 million primarily to cover the Company's estimate of the
cost, then anticipated to be incurred over a two to three year period, of
inspecting and replacing pipe with deteriorating cover material on the
retractable inner pipe portion of the Company's double-wall underground fuel
dispensing and containment systems installed between 1990 and 1994 at over 4,000
sites. The deterioration results from a microbiological fungus, which, under
certain conditions, affects the outer layers of the system's primary (inner)
retractable pipe. The Company has instituted litigation against the supplier of
the pipe to recover the cost the Company has and will sustain to replace such
pipe, as well as other damages. As a result of a review performed during the
third quarter of 1998 of the progress made regarding this replacement pipe
program, as well as the costs then expected to be incurred to complete this
process, the Company recorded, during the third quarter of 1998, a reduction of
the warranty reserve of approximately $3.3 million. As a result of a review
performed during the fourth quarter of 1999 of the progress regarding the
Company's replacement of deteriorating pipe supplied by Dayco, and the effects
of the Company's decision, during the second quarter of 1999, to only replace
pipe at locations where the pipe is significantly deteriorated, as well as the
costs expected to be incurred to complete this process, the Company recorded,
during the fourth quarter of 1999, a charge to the warranty reserve of
approximately $800,000. (See Note 12 of the Notes to Consolidated Financial
Statements).
Income taxes. The Company uses the liability method (specified by SFAS No.
109) of accounting for income taxes. Under this method, deferred tax liabilities
and assets are recorded for the expected future tax consequences of temporary
differences between the carrying amounts for financial statement purposes and
the tax bases of assets and liabilities. Income tax expense (benefit) for the
years ended December 31, 1997, 1998 and 1999 were a benefit of $7.1 million, a
charge of $2.8 million and a benefit of $3.5 million,
22
<PAGE>
respectively. The variances from 1999 to 1998 and 1998 to 1997 were due to the
change in the Company's income before income taxes. An income tax benefit was
recorded in 1997, which was derived principally from the future deductibility of
warranty expense recognized for financial statement purposes in 1997, had been
established as a deferred tax asset in the amount of $7.4 million as of December
31, 1997 and was segmented into current and long term portions based upon
projections as to the tax period in which the Company expected to receive these
benefits. The Company utilized a portion of the deferred tax asset during 1998,
thereby decreasing its balance to $4.4 million as of December 31, 1998. As a
result of the losses sustained by the Company during 1999, the Company increased
its deferred tax asset by $3.7 million to $8.1 million as of December 31, 1999.
The valuation allowance relating to the state net operating loss carryforward
component of the deferred tax asset was $275,465 at December 31, 1997 but was
eliminated as of December 31, 1998 due to the expectation that the state net
operating loss carryforwards will be utilized. Realization of deferred tax
assets associated with NOL Carryforwards is dependant upon generating sufficient
taxable income prior to their expiration. The Company currently believes that it
is more likely than not that this asset will be realized in future years as a
result of taxable income to be generated but will continue to monitor the
valuation of this asset on an ongoing basis.
The Company's foreign subsidiary has undistributed retained earnings of
$1.4 million and $1.6 million at December 31, 1998 and 1999, respectively.
Because a substantial portion of these earnings has been reinvested in working
capital and the remainder is not expected to be remitted to the Company, U.S.
income and foreign withholding taxes have not been provided on these unremitted
earnings.
Other expenses. The other expense in 1997 of $1.8 million was associated
with the legal settlement regarding licensing of certain patented technology.
The other expense in 1998 of $3.7 million was associated with the write-off of a
patent license (See Note 12 of Notes to Consolidated Financial Statements).
Revenue recognition. Sales are recorded upon shipment. Expenses for
estimated product returns and warranty costs are accrued in the period of sale
recognition.
Earnings (loss) per share. On December 15, 1997, the Company adopted the
provisions of Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share." SFAS No. 128 eliminates the presentation of primary and
fully diluted earnings per share and requires the presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings. Basic earnings per share excludes the dilution
and is computed by dividing income available to common shareholders by the
weighted average number of shares outstanding during the period. Diluted
earnings per share takes into account the potential dilution that could occur if
securities and other contracts to issue common stock were exercised and
converted into common stock.
Advertising Cost. The Company expenses advertising costs as incurred.
Research and Development. Research and Development cost, which are expensed
by the Company as incurred, were $527,000, $375,500 and $270,000 in 1997, 1998,
and 1999, respectively.
New Accounting Pronouncements. On January 1, 1998, the Company adopted SFAS
No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards to
provide prominent disclosure of comprehensive income items. Comprehensive income
is the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. Prior
period presentations have been restated to conform to the provisions of SFAS No.
130. The adoption of SFAS No. 130 had no impact on the Company's financial
position or results of operations. The Company's total
23
<PAGE>
comprehensive income (loss) for the years ended December 31, 1997, 1998 and 1999
was $(12,575,723), $4,617,917 and $(6,324,723) respectively.
On January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 requires that
public business enterprises report certain information about the operating
segments in a complete set of financial statements of the enterprise and in
condensed financial statements of interim periods issued to shareholders. It
also requires the reporting of certain information about their products and
services, the geographic area in which they operate, and their major customers.
The adoption of SFAS No. 131 had no impact on the Company's financial position
or results of operation.
On January 1, 1999, the Company, in accordance with the Accounting
Standards Executive Committee of the American Institute of Certified Public
Accountants adopted SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." The SOP segments an internal use
software project into stages and the accounting is based on the stage in which a
cost is incurred. The adoption of SOP 98-1 had no material impact on the
Company's financial position or results of operations.
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.
Significant estimates made by management that are reasonably subject to change
include the warranty reserve and deferred tax assets.
3. INVENTORIES
Inventories consist of the following:
December 31,
-------------------------
1998 1999
----------- -----------
Raw materials..................................... $ 784,719 $ 525,923
Finished goods.................................... 6,838,077 4,912,465
----------- -----------
$ 7,622,796 $ 5,438,388
=========== ===========
4. MOLDS AND TOOLING
Molds and tooling include the following:
December 31,
Useful -------------------------
Lives 1998 1999
------- ----------- -----------
Molds and tooling ................... 3 years $ 2,386,973 $ 2,566,482
Less - accumulated amortization............... (1,949,252) (2,237,043)
----------- ----------
$ 437,721 $ 329,439
=========== ===========
Amortization expense of molds and tooling costs was $865,106, $698,058 and
$287,791 for the years ended December 31, 1997, 1998 and 1999, respectively.
24
<PAGE>
5. PROPERTY AND EQUIPMENT
December 31,
Useful -------------------------
Lives 1998 1999
---------- ----------- -----------
Furniture, fixtures and
office equipment ................ 3-5 years $ 981,801 $ 1,045,605
Equipment ......................... 5-10 years 4,075,351 6,183,542
Leasehold improvements............. lease term 861,212 963,866
----------- -----------
5,918,364 8,193,013
Less - Accumulated depreciation............... (1,531,638) (2,616,916)
----------- -----------
$ 4,386,726 $ 5,576,097
=========== ===========
Depreciation expense on property and equipment was $322,640, $814,663 and
$1,096,939 for the years ended December 31, 1997, 1998 and 1999, respectively.
Fully depreciated assets of $437,181 and $11,661 were removed from both the
fixed asset and accumulated depreciation account in 1998 and 1999 respectively.
In the fourth quarter of 1999, the Company completed the installation of
its pipe manufacturing line at the Oaks, Pennsylvania facility by purchasing,
for approximately $2.1 million, a "Corrugator", a plastic extruder which makes
the base pipe for all of its piping products. Previously, between 1997 and 1999,
the Company purchased the base pipe from an outside vendor.
6. LONG-TERM DEBT
In September 1999, the Company refinanced all of its long-term debt of
approximately $1.9 million with a new five-year, $4 million facility with
Finloc, Inc. ("Finloc"), an affiliate of The Canam Manac Group, Inc. Finloc is
currently the holder of approximately 56% of the Company's common stock. The
facility charges interest at the rate of LIBOR plus 4.00% (9.83% at December 31,
1999). The loan is in the form of a six-month promissory note, which requires
payment of the entire principal and accrued interest at its term. Finloc has
provided a written notice of its intent to renew this note every six months for
a period of five years with a reduction of principal of approximately $400,000
from the principal of the previous note. The proceeds of this note were used to
repay the $1.9 million outstanding under the previous long term facilities, $1
million was used to pay down the existing short term line of credit facility and
approximately $1.1 million was used to pay existing vendors who supplied various
components in connection with the Company's installation of its corrugator (see
Note 5).
In 1997, the Company borrowed from the bank under a term loan credit
facility to acquire equipment related to a new pipe manufacturing line. The term
loan charged interest at the bank's national commercial rate plus .125% and was
secured by all equipment financed thereunder. At both December 31, 1998 and
25
<PAGE>
August 31, 1999, balances of $807,977 were outstanding under the term loan. This
loan was refinanced in September 1999 as discussed above. In 1996, the Company
executed a term loan with a bank for $1,000,000, which was used for the
acquisition of American Containment, Inc. The term loan charged interest at the
bank's national commercial rate plus .125% and was secured by the assets of
American Containment, Inc. At December 31, 1998 and August 31, 1999, $533,305
and $399,964 was outstanding under the term loan. The loan required the payment
of equal monthly installments of principal in the amount of $16,667 plus
interest on the unpaid principal balance. This loan was refinanced in September
1999 as discussed above.
In 1996, Rene Morin, Inc. borrowed under a term loan for manufacturing
equipment. The term loan bears interest at 9.5%. At December 31, 1998 and 1999,
a balance of $84,000 and $48,000, respectively, was outstanding.
In 1995, the Company executed a term loan agreement with a bank for
$1,600,000, which was used exclusively for the purchase of equipment. The term
loan charged interest at the bank's national commercial rate plus .125% and was
secured by all equipment financed thereunder. At December 31, 1998, and August
31, 1999, $880,000 and $666,667, respectively, was outstanding under the term
loan. The loan required the payment of equal monthly installments of principal
in the amount of $26,667 plus interest on the unpaid principal balance. This
loan was refinanced in September 1999 as discussed above.
Aggregate maturities of the borrowings is as follows:
2000 ........................................ 875,292
2001 ........................................ 827,097
2002 ........................................ 800,000
2003 ........................................ 800,000
2004 ........................................ 800,000
---------
4,102,389
=========
7. LINE OF CREDIT
In December 1999, the Company entered into a new $5 million line of credit
facility with a new bank. The line of credit is to be used for operating working
capital purposes and expires on June 30, 2001. Proceeds from this facility were
used to repay the old facility of approximately $3 million. This facility
charges interest at a rate of LIBOR plus 1.50 % (7.33% as of December 31, 1999)
and is guaranteed by Canam Steel Corporation, a subsidiary of The Canam Manac
Group, Inc. Canam Steel Corporation is currently the holder of all of the
Preferred Stock of the Company. Canam Steel Corporation charges a fee for this
guarantee at the rate of .50% of the outstanding balance. The line of credit
requires the Company to maintain $5.0 million in tangible net worth as defined
in the agreement.
In April 1998, the Company established an overall working capital line of
credit with its then current bank at $10.0 million. Subsequently, the overall
line availability was reduced to $4 million by November 1999. This facility
provided for financing of working capital needs and equipment purchases and was
secured by the Company's receivables, inventory and other assets. The initial
interest rate for this facility was the prime rate plus one-quarter (1/4)
percent and was to expire on December 31, 1999. As of June 30, 1998, the Company
met certain financial covenants contained in the line of credit agreement and
therefore received a reduction in the interest rate effective September 1, 1998,
down to the prime rate (7.75% at December 31, 1998).
26
<PAGE>
Interest expense on borrowings under the lines of credit was $353,796, $307,794
and $499,366 in 1997, 1998 and 1999, respectively.
8. EARNINGS (LOSS) PER SHARE
The following table illustrates the required disclosure of the
reconciliation of the numerators and denominators of the basic and diluted EPS
computations.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1999
----------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ----------
<S> <C> <C> <C>
Loss applicable to common shareholders (6,476,546)
==========
BASIC EPS
Loss applicable to common shareholders (6,476,546) 4,667,855 $(1.39)
EFFECT OF DILUTIVE SECURITIES
Options -- -- --
---------- --------- ------
DILUTED EPS
Loss applicable to common shareholders
plus assumed conversions (6,476,546) 4,667,855 $(1.39)
========== ========= ======
</TABLE>
Options to purchase 715,000 shares of common stock at a range of $2.50 to
$9.50 a share were outstanding during 1999 that were not included in the
computation of diluted EPS because the effect of the options would have been
antidilutive. The options, which expire from December 31, 2000 to December 31,
2009, were still outstanding at December 31, 1999.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
----------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ----------
<S> <C> <C> <C>
Income applicable to common shareholders 4,323,472
==========
BASIC EPS
Income applicable to common shareholders 4,323,472 4,646,000 $.93
EFFECT OF DILUTIVE SECURITIES
Options -- 213,872 --
---------- --------- ----
DILUTED EPS
Income applicable to common shareholders
plus assumed conversions 4,323,472 4,859,872 $.89
========== ========= ====
</TABLE>
Options to purchase 148,000 shares of common stock at a range of $6.63 to
$9.50 a share were outstanding during 1998 that were not included in the
computation of diluted EPS because the options' exercise price was greater than
the average market price of the common shares. 115,000 of the options, which
expire from December 31, 2000 to August 7, 2002, were still outstanding at
December 31, 1999.
27
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1997
-----------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- ----------
<S> <C> <C> <C>
Loss applicable to common shareholders ($12,356,204)
============
BASIC EPS
Loss applicable to common shareholders ($12,356,204) 4,641,600 ($2.66)
EFFECT OF DILUTIVE SECURITIES
Options -- -- --
------------ --------- ------
DILUTED EPS
Loss applicable to common shareholders
plus assumed conversions ($12,356,204) 4,641,600 ($2.66)
============ ========= ======
</TABLE>
Options to purchase 665,000 shares of common stock at a range of $2.50 to
$9.50 a share were outstanding during 1997 that were not included in the
computation of diluted EPS because of the effect of the options would have been
antidilutive. 525,000 of these options, which expire from December 31, 2000 to
August 7, 2002, were still outstanding at December 31, 1999.
9. STOCK OPTION PLAN
At December 31, 1999, the Company had two stock option plans. The Company
applies APB Opinion 25, "Accounting for Stock Issued to Employees" and related
Interpretations in accounting for its plans. Accordingly, no compensation costs
have been recognized for either plan.
On January 16, 1994, the shareholders of the Company approved a Stock
Compensation Plan (the "Plan"). The Plan authorizes the issuance of up to
400,000 shares of the common stock to key employees of the Company and its
subsidiaries. The number of shares authorized for issuance under the Plan, and
the outstanding awards granted under the Plan, are subject to adjustment in the
event of stock dividends, stock splits and similar transactions. Awards may be
granted in the form of nonqualified stock options, incentive stock options,
stock appreciation rights, performance units and restricted stock. The options
granted under the Plan are restricted and unvested at the date of grant. Stock
options are issued at prices equal to the market price at the date of grant. The
stock options have a vesting period of five years from the date of issuance.
On February 27, 1997, the Board of Directors of the Company approved and
adopted the 1997 Stock Compensation Plan, which was approved by shareholders on
April 11, 1997. The 1997 Plan authorizes the issuance of up to an additional
400,000 shares of Common Stock to employees of the Company and its subsidiaries.
The 1997 plan is substantially identical to the 1994 plan. Options to acquire
715,000 shares were outstanding under both plans at December 31, 1999.
On August 28, 1996, the Company granted to its current Chief Executive
Officer, in connection with his employment, incentive stock options of the
Company to purchase 225,000 shares. The options have a term of five years from
the date of grant. The stock options have a vesting period of three years from
the date of issuance, beginning one year from the date of grant. The options
granted to the Chief Executive Officer were not issued under the 1994 Plan. In
August 1997, following the approval of an additional 400,000 option allotment
under the 1997 Plan, the 1996 options granted to the Chief Executive Officer
which were not issued under the Plans were subsequently incorporated into the
1997 Plan without any change in terms.
Had compensation cost for the plan year been determined based on the fair
value of options at the grant dates consistent with the method of SFAS 123,
"Accounting for Stock-Based Compensation," the
28
<PAGE>
Company's net income and diluted earnings per share would have been reduced to
the pro forma amounts indicated below.
1997 1998 1999
------------ ---------- -----------
Net Income (loss) applicable to
Common Shareholders ...
as reported $(12,356,204) $4,323,472 $(6,476,546)
pro forma $(12,554,174) $4,207,743 $(6,608,552)
Basic earnings (loss)
per share ......... as reported $ (2.66) $ .93 $ (1.39)
pro forma $ (2.71) $ .91 $ (1.42)
Diluted earnings (loss)
per share ......... as reported $ (2.66) $ .89 $ (1.39)
pro forma $ (2.71) $ .87 $ (1.42)
These pro forma amounts may not be representative of future disclosure
because they do not take into effect the pro forma compensation expense related
to grants before 1995.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997, 1998 and 1999, respectively; no dividend
yield for all years; expected volatility of 32.00%, 66.63% and 55.20%; risk-free
interest rate of 6.11%, 5.23% and 5.64%; and expected lives of 10 years for all
years for options under the Plan and five years for options granted to the Chief
Executive Officer.
A summary of the status of the Company's option plans as of December 31,
1999, and changes for the three years then ended was as follows:
<TABLE>
<CAPTION>
1997 1998 1999
------------------ ------------------ -------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Price Per of Price Per of Price Per
Shares Share Shares Share Shares Share
------- --------- ------- --------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 595,000 $4.20 665,000 $4.10 683,000 $4.51
Options granted 70,000 2.70 88,000 5.56 128,000 $2.73
Options exercised -- -- (11,000) 2.52 (20,000) $2.63
Options forfeited (59,000) 4.92 (76,000) $4.73
------- ----- ------- ----- -------- -----
Outstanding at end of year 665,00 $4.10 683,000 $4.51 715,000 $3.98
======= ===== ======= ===== ======= =====
Options exercisable at year end 201,000 $5.41 268,600 $5.01 451,000 $4.39
------- ----- ------- ----- ------- -----
Weighted average fair value of
options granted during the year $1.53 $4.33 $2.00
===== ===== =====
</TABLE>
29
<PAGE>
The following information applies to options outstanding at December 31,
1999
Number outstanding.............................. 715,000
Range of exercise prices........................ $2.50 to $9.50
Weighted average exercise price................. $3.98
Weighted average remaining contractual life .... 2 years 2 months
The following table summarizes information about non-qualified stock
options at December 31, 1999
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------- ----------------------------
Number Weighted Number
Outstanding Average Weighted Exercisable Weighted
Range of at Remaining Average at Average
Exercise December 31, Contractual Exercise December 31, Exercise
Prices 1999 Life Price 1999 Price
-------- ------------ ----------- --------- ------------ --------
<S> <C> <C> <C> <C> <C>
$2.50 to $3.50 540,000 2 yr. 4 ms. $2.80 338,000 $2.85
$4.44 to $6.63 75,000 3 yr. 7 ms. $5.08 13,000 $5.18
$9.50 100,000 0 yrs. $9.50 100,000 $9.50
</TABLE>
30
<PAGE>
10. PREFERRED STOCK
In March 1998, the Company's principal shareholder purchased from the
Company 400 shares of authorized Series A Floating Rate Preferred Stock of the
Company at $10,000 cash per share or $4 million in the aggregate. In December
1999, the Company's principal shareholder purchased an additional 400 shares of
Series B Floating Rate Preferred Stock of the Company at $10,000 cash per share,
or $4 million in the aggregate (the Series A and Series B Floating Rate
Preferred Stock are hereafter collectively referred to as the "Preferred
Stock"). The Series A Preferred Stock is entitled to receive, as and if declared
by the Company's Board, dividends at a floating rate equal to the rate payable
by the Company on its line of credit with its commercial bank. Series B
Preferred Stock is entitled to dividends at a floating rate equal to the rate
payable by the Company on its line of credit with its commercial bank plus .8 %.
Dividends are paid quarterly in arrears, and if not declared or paid would
cumulate at the above mentioned rates, plus 50 basis points. As of January 1,
1999, the principal shareholder has waived payment of the dividends for the
foreseeable future, including the nonpayment portion of the interest rate. The
Preferred Stock: (i) does not possess voting rights, (ii) is not convertible
into common stock, and (iii) is not redeemable at the option of the holder. The
Preferred Stock is redeemable at the option of the Company, but only (i) if and
to the extent the Company's net tangible assets at the end of any fiscal quarter
and after such dividend exceeds $4.5 million, or (ii) if at least a majority of
the independent and disinterested members of the audit committee of the
Company's Board of Directors approve such redemption. The preceding provision
relating to redemption constitutes a covenant between the Company, the Company's
principal shareholder and its remaining shareholders and may not be changed
without the approval of at least a majority of the independent and disinterested
members of the audit committee of the Company's Board of Directors.
11. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Year ended December 31,
--------------------------------------
1997 1998 1999
----------- --------- -----------
Currently payable:
Federal................... $(1,390,866) $(354,236) $ (6,399)
State..................... (178,732) 23,018 (35,294)
Foreign................... 180,241 47,779 263,940
Deferred.................... (5,719,438) 3,042,634 (3,746,956)
----------- ---------- -----------
$(7,108,795) $2,759,195 $(3,524,709)
=========== ========== ===========
The Company's income, as reported in the statement of operations, differs
from taxable income as reported in its tax return principally due to the use of
accelerated depreciation for income tax purposes, and the accrual of warranty
expenses and other accruals for financial reporting purposes which are
deductible for income tax purposes when paid.
31
<PAGE>
Deferred income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Depreciation ............................... $ 31,633 $ 51,133 $ 35,100
Allowance for doubtful accounts ............ (58,500) (85,995) 23,658
Warranty reserve ........................... (5,021,502) 4,298,704 $ 1,083,025
Other reserves ............................. (672,011) 549,398 --
Federal and state NOL carryforward ......... -- (1,490,071) $(4,887,470)
Decrease in valuation allowance of state NOL -- (275,465) --
Other ...................................... $ 942) $ (5,070) $ (1,269)
----------- ----------- -----------
$(5,719,438) $ 3,042,634 $(3,746,956)
=========== =========== ===========
</TABLE>
A reconciliation of income taxes with the amounts which would result from
applying the U.S. statutory rate follows:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------
1997 1998 1999
----------- ---------- ----------
<S> <C> <C> <C>
Tax expense (benefit) at U.S. statutory rate.................... $(6,618,099) $2,497,969 $(3,296,183)
State income tax expense (benefit), net of federal benefit...... (910,592) 413,099 (348,359)
Excess foreign tax on foreign subsidiary income................. 35,028 5,029 27,783
Amortization of certain intangible assets and non-deductible
meals and entertainment....................................... 261,794 115,623 93,881
Increase (decrease) in valuation allowance...................... 115,778 (275,465) --
Other........................................................... 7,296 2,940 (1,831)
----------- ---------- -----------
$(7,108,795) $2,759,195 $(3,524,709)
=========== ========== ===========
</TABLE>
32
<PAGE>
Significant components of the deferred tax balances at December 31, 1998
and 1999 are:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1999
------------------------ ------------------------
Current Noncurrent Current Noncurrent
deferred deferred deferred deferred
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Warranty reserve............................ $2,126,277 $ 260,087 $ 380,316 $ 923,023
Other reserves.............................. 165,937 165,937
Allowance for doubtful accounts............. 163,995 140,337 --
Depreciation................................ -- (126,434) -- (161,534)
Net operating loss carry forward............ 372,366 1,393,170 825,252 5,827,754
Other....................................... 22,027 23,295 --
---------- ---------- ---------- ----------
$2,850,602 $1,526,823 $1,535,137 $6,589,243
========== ========== ========== ==========
</TABLE>
33
<PAGE>
The Company's NOL carryforwards begin to expire in 2017. The Company
provided a valuation allowance of $275,465 for state deferred income tax assets
in 1997 but removed the valuation allowance in 1998 due to the expectation that
they will be fully realized. Realization of deferred tax assets associated with
NOL Carryforwards is dependent upon generating sufficient taxable income prior
to their expiration. The Company currently believes that it is more likely than
not that this asset will be realized in future years as a result of taxable
income to be generated but will continue to monitor the valuation of this asset
on an ongoing basis.
12. PATENTS AND TRADEMARKS, LITIGATION AND CONTINGENCIES
In December 1994, the Company acquired a license for all inventions covered
by a third party's patents, patent applications and continuations in exchange
for a payment of $2.0 million in cash and $1.5 million of the Company's Common
Stock. The Company capitalized these costs as well as certain other acquisition
costs. The Company was expensing these costs over a 17-year amortization period.
Two cases were pending in the Eastern District of Pennsylvania, in which
the Company, as exclusive licensee of these certain patents, and the licensor of
those patents sought money damages and an injunction due to patent infringement
by Environ Products, Inc. ("Environ") and Environ sought a declaration of
invalidity of the patents, non-infringement, and unenforceability. These cases
were to be tried in the fall of 1998. The court issued an order on September 29,
1998, which among other things, granted Environ's motions for summary judgment
of invalidity of the patents and non-infringement by Environ. This constituted a
final judgment of all issues which were material to these cases, and the
licensor has filed an appeal to the U.S. Court of Appeals, Federal Circuit. As a
result of this decision, the Company wrote off during 1998 the current
unamortized cost of this license, which was approximately $3.7 million. By a
decision dated September 15, 1999, the U.S. Court of Appeals, Federal Circuit
reversed the decision of the U.S. District Court, and Environ has petitioned the
U.S. Supreme Court for a Writ of Certiorari.
In January 1998, the Company settled and terminated litigation with two
competitors who claimed that they possessed licenses to manufacture and sell
underground systems with retractability and other features covered by patents
licensed to the Company. The purported licensees acknowledged that whatever
license rights they had were terminated and the Company paid approximately $1.64
million to them, excluding various other expenses associated with this
litigation of approximately $160,000.
During 1997, the Company initiated a legal action against Dayco Products,
Inc., a subsidiary of Mark IV Industries, in the United States District Court
for the Eastern District of Pennsylvania seeking, among other things, a judicial
determination that Dayco breached the provisions of two Supply Agreements,
entered into in 1990 and 1993 for the sale of primary pipe. The Complaint
alleges that Dayco supplied pipe that was defective because it was susceptible
to microbial fungus. In its suit, the Company requests that the Court award
damages to cover, among other things, the cost of inspecting and replacing
defective pipe and related costs in an amount to be determined at trial and for
further appropriate relief. The Company, in consultation with its legal counsel,
believes that it is more likely than not that the Company will prevail with
respect to its material claims. (See Note 2 of the Notes to Consolidated
Financial Statements - "Significant Accounting Policies - Warranty Reserve.")
Dayco has filed a counterclaim for approximately $4.0 million for goods,
services, and freight contracted for by the Company, under the Dayco Agreement
(see Note 13 of the Notes to Consolidated Financial Statements - "Commitments")
and damages for alleged breaches of various duties purportedly owed to Dayco. In
addition, Dayco initiated a separate legal action against the Company in
February 1999 in the District Court for the Western District of Missouri,
alleging that the Company is infringing certain patents held by Dayco relating
to hose couplings and is seeking, among other things, a determination of
infringement, damages, and injunctive relief. The Company believes that it has
meritorious defenses to Dayco's claims. As of January 1, 1999 the Company has
entered into a contingency fee
34
<PAGE>
arrangement with its legal counsel whereby the Company will only pay for
out-of-pocket expenses for the remainder of the discovery period and the
trial-related costs. The trial is currently scheduled to commence April 3, 2000
and, although there are outstanding motions that may delay the trial date, the
Company continues to press for the earliest possible trial date.
In additions, Dayco initiated a separate legal action against the Company
in February 1999 in the District Court for the Western District of Missouri,
alleging that the Company is infringing certain patents held by Dayco relating
to hose couplings and is seeking, among other things, a determination of
infringement, damages, and injunctive relief.
A legal action was filed in the Fifth Circuit Court of the State of Hawaii
on September 16, 1997 by JJR Inc., James Jasper Enterprises, Inc., and others
with interests in a retail shopping center on the Island of Kauai, Hawaii,
against the Company, Dayco, and Senter Petroleum, Inc. for damages allegedly
resulting from the failure of the Company's Enviroflex piping system on or about
August 12, 1996 at The Little Gas Shack (the "Shack"), a retail gasoline service
facility supplied by Senter Petroleum, Inc., adjacent to the shopping center.
The Complaint alleges that more than 1,800 gallons of gasoline were released
onto the property occupied by the Shack and the adjacent businesses and into a
nearby stream and the harbor where the shopping center was located. Although the
amount sought by the plaintiffs is not specified in the Complaint, the attorney
retained by the Company's insurance carrier has ascertained that the plaintiffs
are seeking approximately $23 million in damages. The Company has and maintains
insurance with policy limits at the time of this claim of $3 million which may
respond to this claim, however, the amount claimed exceeds the liability limits.
Under the Dayco Supply Agreement, Dayco is required to indemnify and hold the
Company harmless from all claims and suits by third parties based upon the
manufacture of Enviroflex primary pipe or the performance by Dayco of its
obligations under the Agreement (see Note 13). Dayco, has not, as yet, agreed to
honor this obligation. The Company has commenced litigation to enforce its
rights against Dayco. Based upon the Company's investigation to date, the
Company believes that the Enviroflex secondary containment system functioned
properly to contain the overflow and was not responsible for the release, and
that any loss was caused by the failure of equipment manufactured and supplied
by third parties. The Company believes that plaintiff's claims are grossly
excessive and has vigorously defended its position. The Company believes that it
has no material uninsured liability in connection with this matter and that if
it does, it is covered by Dayco's indemnity.
Other Litigation. The Company is also involved in various other legal
actions incidental to the conduct of its business. Management is contesting
these cases vigorously and believes it has meritorious defenses in each matter.
Management does not believe the ultimate outcome of these various legal actions
will have a material effect on the Company's financial condition, results of
operations or working capital requirements.
13. COMMITMENTS
Dayco Agreement. On January 1, 1993, Dayco and the Company entered into a
five year supply agreement (the "Dayco Agreement") pursuant to which Dayco
agreed to sell Enviroflex primary pipe exclusively to the Company for use in
flexible double-wall underground piping systems and the Company agreed to
purchase such pipe exclusively from Dayco. During 1997, the Company terminated
this agreement (see Note 12). Dayco has asserted that it is entitled to payment
of approximately $4.0 million for goods, services, and freight contracted for by
the Company under the Dayco Agreement. The Company has declined to pay this for
the reason, among other things, that management estimates that amounts owed to
the Company by Dayco exceed the amount to which Dayco claims it is entitled.
Employment Agreements. The Company has employment agreements with certain
key executives that provide severance pay benefits if there is a change in
control of the Company. The agreements will continue in effect on a year-to-year
basis until terminated or not renewed by the Company or key executives. Upon a
35
<PAGE>
change in control, the Company shall continue to pay the key executives'
salaries per the agreements and certain benefits for the agreed upon time
periods. The maximum contingent liability under the agreements at December 31,
1999 was $359,000.
Lease Commitments. The Company leases its facilities, certain office
equipment and vehicles under noncancelable operating leases. Total rental
expense under these leases for the years ended December 31, 1997, 1998 and 1999
was approximately $867,000, $943,000 and $1,075,000, respectively.
Future minimum lease payments under noncancelable operating leases at
December 31, 1999 are as follows (rounded to the nearest thousands):
Year ended
December 31,
------------
2000............................................ 912,000
2001............................................ 861,000
2002............................................ 709,000
2003............................................ 672,000
2004............................................ 3,000
---------
3,157,000
=========
14. FOREIGN OPERATIONS AND EXPORT SALES
Summarized financial data with respect to the operations of TCI-Environment
NV at December 31, 1998 and 1999 and for the years then ended follows (rounded
to the nearest thousand):
1998 1999
---------- ----------
Total assets................................... $1,783,000 $2,113,000
Total liabilities.............................. 418,000 537,000
---------- ----------
Net assets..................................... $1,365,000 $1,576,000
========== ==========
Net sales...................................... $3,782,000 $3,248,000
========== ==========
Net income..................................... $ 78,000 $ 384,000
========== ==========
The Company's net sales by geographic region (rounded to the nearest
thousand) are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Net Sales:
United States............................... $33,128,000 $41,950,000 $18,938,000
Canada...................................... 1,463,000 1,646,000 892,000
Mexico, Central and South America........... 6,412,000 5,059,000 1,407,000
Europe and the Middle East.................. 3,536,000 3,781,000 3,248,000
Southeast Asia, Australia and New Zealand... 1,110,000 1,146,000 428,000
----------- ----------- -----------
Total........................................ $45,649,000 $53,582,000 $24,913,000
=========== =========== ===========
</TABLE>
36
<PAGE>
15. RELATED PARTY TRANSACTIONS
Richard DiMaggio, Vice President of the Company, leases space to the
Company and American Containment, Inc. ("ACI"), a wholly owned subsidiary
of the Company, for ACI's office and the Company's fiberglass manufacturing
facility, both of which are located in Bakersfield, California. The
aggregate monthly rental of this space is $7,700, excluding operating
expenses and reimbursement for electricity. The Company believes that the
amount of rent charged by Mr. DiMaggio is not in excess of the amount of
rent charged by unrelated parties for similar premises in the area.
37
