<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-K
                    ANNUAL REPORT PURSUANT TO SECTION 13 OF
                      THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended                Commission File No. 0-20404
December 31, 1996

                                ENVIROGEN, INC.
                                 (Registrant)

           Delaware                                     22-2899415
-----------------------------------           ---------------------------------
   (State of Incorporation)                   (IRS Employer Identification No.)

 4100 Quakerbridge Road
    Lawrenceville, NJ                                          08648
---------------------------                   ---------------------------------
(Address of principal executive                              (Zip code)
  offices)

Registrant's telephone number, including area code:  (609) 936-9300

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share           Common Stock Purchase Warrants
--------------------------------------           ------------------------------
        (Title of Class)                                  (Title of Class)

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes      X        No 
      -------        -------

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. __

     The aggregate market value of the registrant's Common Stock (its only
voting stock) held by non-affiliates of the registrant as of February 28, 1997
was approximately $25,747,700.  (Reference is made to p. 14 herein for a
statement of the assumptions upon which this calculation is based.)

     The number of shares of the registrant's Common Stock outstanding as of
February 28, 1997 was 12,873,340.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the registrant's definitive proxy statement relating to
its scheduled April 9, 1997 Annual Meeting of Stockholders (which proxy
statement is expected to be filed with the Commission not later than 120 days
after the end of the registrant's last fiscal year) are incorporated by
reference in Part III of this report.
<PAGE>
 
                                    PART I

ITEM 1.   BUSINESS

Envirogen, Inc. ("Envirogen" or the "Company") is an environmental biotechnology
company combining unique scientific, engineering and management expertise to
provide innovative solutions for treating hazardous wastes.  Envirogen's
strategic approach includes isolating natural organisms, enhancing their
performance, and then developing engineered systems to optimize their activity
for biodegradation.  Envirogen also employs complementary, non-biological
technologies where the combinations produce synergistic results.  Envirogen
offers solutions for both pollution prevention and remediation problems of
corporations and government agencies.

Envirogen's capabilities mirror the needs of the marketplace, and its
acceleration into commercial activity could not be more timely.  The
Environmental Protection Agency (the "EPA") is currently believed to be more
receptive to innovative approaches than at any time before.  In addition, new
regulations that create more stringent requirements for chemical releases, and
that now require the destruction of specific, difficult compounds, have produced
a need for new biological systems to cost-effectively meet these standards.
Envirogen's capabilities for providing technologies to reduce remediation and
operating costs, and for destroying recalcitrant contaminants, are well suited
to meet these growing market needs.  During 1996, Envirogen spent approximately
$2.4 million on research and development projects.

GROWTH STRATEGY

Envirogen remains confident in its mission to provide innovative, economic
solutions for both the prevention and remediation of hazardous wastes.  Over the
past several years, Envirogen has developed its business systems and
successfully expanded its marketing and sales efforts, resulting in a rapid
acceleration of commercial sales.  In addition to this internal growth strategy,
Envirogen has developed and is implementing an external growth strategy to
accelerate revenue growth and the commercialization of its technologies.  This
external growth strategy includes selectively acquiring companies with
complementary, non-biological technologies aimed at producing synergistic
results, as well as entering into joint ventures and collaborative arrangements
with major firms that are interested in exploring and developing alternative
remediation and pollution prevention technologies.  In connection with this
external growth strategy, Envirogen has accomplished the following in the past
24 months:

     .    Formed a joint venture with nv VAM of the Netherlands to supply
          advanced biofiltration systems and services for the treatment of
          odors, air toxics and volatile organic contaminants to the air
          pollution control market;

     .    Acquired MWR, Inc. of Lansing, Michigan, a leading provider of in situ
          remediation services with particular expertise in soil vapor
          extraction and with 1996 revenues of approximately $4 million;

     .    Entered into a three-year collaborative marketing agreement with Dow
          Environmental Inc., a division of Dow Chemical Company of Midland,
          Michigan, to pursue specific remediation and pollution prevention
          opportunities; and

     .    Entered into a development agreement with Rhone-Poulenc Inc. to
          develop and supply advanced high-performance biological technologies
          and systems for the industrial wastewater treatment market.

                                       2
<PAGE>
 
Consistent with this strategy, Envirogen has entered into a Merger Agreement to
acquire Fluid Management, Inc. ("FMI"), a full-service environmental consulting
and engineering firm with revenues of approximately $21.6 million and pre-tax
net income of approximately $4.3 million during 1996.  See Item 7 of this report
(Management's Discussion and Analysis of Financial Condition and Results of
Operations) and Note 1 of the Company's consolidated financial statements
appearing elsewhere in this report.

THE TECHNOLOGIES

The distinctiveness of Envirogen's technologies is based on two elements: 1)
microorganisms (biocatalysts) with exceptional degradative abilities; and 2)
engineered systems, including proprietary bioreactors and processes, to mix in a
controlled environment its microorganisms with contaminated air, water, or soil
to maximize the degradative properties of the microorganisms.  To achieve this
goal, Envirogen has conducted extensive testing of microorganisms and
bioreactors and has assembled a staff of scientists, engineers and consultants
with expertise in biochemistry, molecular biology, microbiology, chemical and
mechanical engineering and systems design.

Microorganisms
--------------

Envirogen's biodegradation processes are based on naturally occurring
microorganisms that are found in soil, water and sediments at the hazardous
waste site or are transported to the site for controlled usage by Envirogen.
The microorganisms under development primarily are bacteria, which are
microscopic, single-cell organisms that under defined conditions can break down
contaminants into simpler substances to support the organism's growth.  For
example, if the contaminant is benzene, the byproducts from its complete
degradation are carbon dioxide and water.  In other cases, for example
trichloroethylene ("TCE"), microorganisms may break down a contaminant without
supporting the organism's growth in a process called cometabolism, resulting in
carbon dioxide, water and chloride salts.

There are naturally occurring bacteria capable of degrading nearly all natural
organic compounds.  However, highly effective naturally occurring bacteria
capable of degrading many of the synthetic substances (such as polychlorinated
biphenyls ("PCBs") and TCE) are not as common and can be difficult to utilize.
These synthetic compounds were designed to be chemically stable, which means
that it may take years before they are naturally degraded.

Envirogen has isolated natural strains of bacteria that partially or completely
degrade or accelerate the degradation of a number of recalcitrant hazardous
wastes, including PCBs, TCE, chloroform and other chlorinated solvents, methyl
tertiary butyl ether ("MTBE," a gasoline octane enhancer),
hydrochlorofluorocarbons ("HCFCs," ozone-depleting refrigerants) and polycyclic
aromatic hydrocarbons ("PAHs").  These bacteria have been isolated using
specialized enrichment techniques that allow Envirogen to select, isolate and
optimize the superior strains from the general population of bacteria found at
the sites. Envirogen is also designing and testing genetically-modified bacteria
that may have several advantages over naturally occurring bacteria.  These
advantages include the ability to degrade wastes faster and to lower
concentration levels, reducing the overall cost of biodegradation.

Engineered Systems
------------------

Envirogen has designed and constructed several different engineered systems
using bioreactors to enhance the biodegradative capabilities of the
microorganisms when they make contact with the contaminated air, water or soil.
By using a bioreactor, variables such as temperature and pH (acidity or
alkalinity) can be

                                       3
<PAGE>
 
controlled, and measured amounts of oxygen and nutrients can be added to the
mixture of microorganisms and contaminated materials, thereby optimizing the
degradation environment.

Envirogen believes that the engineering and design of a variety of bioreactors
is an important factor in its ability to develop and sell commercially viable
systems for the biodegradation of hazardous wastes.  The design of a bioreactor
to be used at a particular site will depend on the types of wastes to be
degraded, the media (e.g., soil type) in which the wastes are located, the
concentration of the targeted waste and the combination of other chemical wastes
associated with the targeted waste.  Envirogen continues to develop and test
bench-scale and pilot-scale bioreactors utilizing naturally occurring and
genetically-modified bacteria for the degradation of PCE, TCE, MTBE, air toxics,
industrial wastewater effluents, and groundwater contaminants and has conducted
field trials with pilot-scale bioreactors for the degradation of industrial air
toxics, soil and groundwater contaminants, and industrial wastewater streams.
In 1996, Envirogen successfully completed a field demonstration of its MTBE
bioremediation technologies, utilizing a reactor based system for contaminated
groundwater.  The system included a ceramic membrane subsystem supplied by
Rhone-Poulenc.

BUSINESS AREAS

Envirogen is organized along three separate but interrelated product areas
consistent with the three states of matter: soils/sediments (solids), water
(liquids) and air (gases).  Each specific product area is described below:

SOILS

Commercial Programs
-------------------

Hydrocarbons

Many of industry's environmental problems are the result of the release of
simple hydrocarbons.  When pollutants such as gasoline or heating oil are
spilled into the environment, indigenous soil bacteria may quickly adapt to this
new "food source" and begin the biodegradation process to break down the
contaminant into its core components of carbon and hydrogen.  The efforts of
Envirogen's technical team are aimed at optimizing this natural process and
therefore accelerating the cleanup of the site.  This optimization requires the
control of such variables as temperature and pH, and the control and delivery of
nutrients and oxygen.

Substantial cost reductions can be realized by the destruction of these
contaminants in situ (in place).  To realize effective in situ remediation
requires an understanding of efficient microbial activity combined with
engineered control and delivery systems.  Envirogen's acquisition of Vapex
Environmental Technologies, Inc. in 1991 was aimed at developing the capability
to use the underground as a bioreactor for in situ contaminant destruction.  The
results of this unique combination of engineering and scientific capabilities is
apparent with Envirogen receiving awards as prime contractor for the cleanup of
several Superfund sites for groups of prestigious Fortune 100 clients.  The
success of the Vapex acquisition prompted Envirogen to acquire MWR in February
1996.  MWR has very similar engineering capabilities to those offered by
Envirogen but offers different geographical and client coverage.  Envirogen, by
leveraging its engineering and scientific capabilities through its existing
business and the newly-acquired MWR operation, made significant progress in 1996
in expanding both its client base and geographic coverage.

                                       4
<PAGE>
 
Nitroaromatics

Envirogen has continued to develop technologies to biodegrade such nitroaromatic
contaminants as the herbicide dinoseb and the explosive trinitrotoluene (TNT).
Nitroaromatics have become serious environmental problems at many military
installations worldwide where explosives are manufactured and stored, and in
agricultural areas where pesticides have been in widespread use.  Efforts in
this area have included a collaborative marketing agreement with the J.R.
Simplot Company, as well as the ongoing development and marketing of Envirogen's
own technologies.

Developmental Programs
----------------------

PCBs

PCBs are a family of compounds that have been used extensively in many
industrial applications, which included electrical fluids, hydraulic fluids,
paints, cutting oils, antidusting agents and others.  The discovery of
widespread environmental impact and concerns due to their toxicity and hazardous
effects on ecosystems led to a ban on the use and production of PCBs in 1979.

In spite of this ban, PCBs continue to persist in the environment due to their
low water solubility, strong adsorption to soils or sediments, low volatility
and low chemical reactivity.  These qualities, which made PCBs so attractive to
industry, are precisely the qualities that make PCBs so persistent in the
environment.  The United States General Accounting Office has estimated that 150
million pounds of PCB wastes have entered the environment.

Today the accepted means of disposal of PCBs are incineration or landfilling.
Landfilling transfers the problem from one site to another without destroying
the PCBs, and incineration is extremely costly.  Heeding the call for more
economical and effective solutions, Envirogen has been developing alternative
remedial technologies for PCB cleanups.

Microbiology and process engineering have played a key role in Envirogen's goal
of producing a commercial PCB destruction technology.  The scientific challenge
is that PCBs remain persistent in the environment because they are resistant to
microbial degradation.  Expanding on work begun at General Electric and several
university laboratories, Envirogen has isolated superior and novel strains of
PCB-degrading microorganisms, has established conditions for optimal microbial
activity, and has explored the potential barrier-breaking advantages of
genetically-modified bacterial strains.

Systems engineering has played a vital role in developing commercially viable,
cost-effective systems for the biodegradation of PCBs.  Envirogen has developed
soil slurry bioreactors that are designed to use superior strains of
microorganisms for on-site destruction of PCBs.  In addition, Envirogen is
aggressively pursuing in situ applications, which offer the most cost-effective
solution to the destruction of PCBs.  Field testing of both in situ and ex situ
biotreatment techniques have been completed. Finally, Envirogen has engineered
and patented a novel solid phase extraction process, called SoPE(TM), which can
be used as a stand-alone treatment or in conjunction with bioremediation. Field
tests of SoPE(TM) successfully demonstrated the efficacy and cost benefits of
this technology. Envirogen is currently discussing commercial opportunities for
the SoPE(TM) process with several clients.

                                       5
<PAGE>
 
Advanced Technologies

Envirogen's commitment to developing leading edge technologies is nowhere more
evident than in the advanced technology development areas.  The development of
advanced technology not only serves to provide new business opportunities for
Envirogen, but has also helped establish Envirogen as the leader in
environmental biotechnology.  One of the major areas of focus for this program
has been the development and testing of advanced in situ bioremediation
technologies such as bioaugmentation, whereby highly efficient microorganisms
are injected directly into a contaminated aquifer.  In 1996, Envirogen
successfully demonstrated this technology, in combination with complementary
delivery technologies, at two sites, one of which was for a Fortune 100
petroleum company.  This work for the Fortune 100 petroleum company is
significant because it is for the destruction of chlorinated organics at a
geologically-complex site.  Additional field tests are underway for the U.S. Air
Force at the other site.

As mentioned earlier, economic factors have forced pollution generators to seek
lower-cost alternatives to their hazardous waste problems.  In particular,
various agencies of the federal government have been early and strong supporters
of innovative technologies aimed at achieving this goal.  This support is
evident through the government's Small Business Innovation Research (SBIR)
program, which awards grants of various sums to companies for specific areas of
research and development.  Envirogen was awarded three two-year Phase II SBIR
contracts in 1995, one in 1996, one in 1997 and one more is scheduled to start
early in 1997 for the development of advanced technologies.  One SBIR, for the
Department of Defense, is to develop and test specialized microorganisms for
destroying chlorinated solvents, the most significant class of groundwater
contaminants in the United States.  Another SBIR, for the Department of Energy,
is for the development of gene probe technology to improve and document in situ
bioremediation.  The third  SBIR, for the National Science Foundation, is for
the development of a system to degrade the ozone-depleting chemicals, HCFCs.
The fourth SBIR, for the Department of Defense, is for the development and
testing of biofiltration technology for toxic and odorous air-borne chemicals.

These examples, along with many other existing projects still under development,
all lay the scientific groundwork which, when combined with appropriate
engineered systems, lead the way to safer, more responsive commercial
applications.  The result is a cleaner environment achieved with cost-savings
for the end-user.

WATER

Commercial Program
------------------

The enforcement of more rigorous regulations has created a need for specialized
bioreactor systems and biocatalysts to degrade difficult contaminants in
groundwater and industrial effluent streams.  Envirogen is taking advantage of
this favorable market situation to provide high performance aqueous bioreactor
systems, including fluidized bed reactors and membrane bioreactors ("MBRs").  To
increase its momentum in the water treatment program, Envirogen signed an
agreement with Rhone-Poulenc in November 1996 to work collaboratively to
commercialize and market MBRs. Following an 18-month business development
period, the agreement calls for the two parties to form a joint venture.
Envirogen is contributing its expertise in the biological treatment of
wastewater with particular emphasis on its high-performance bioreactors, such as
the membrane and fluidized bed bioreactors.  Rhone-Poulenc is supplying
marketing, project and engineering support as well as membrane systems to the
project.  Envirogen and Rhone-Poulenc have already conducted joint sales
training, design, cost estimating and marketing efforts and are currently
working on projects that integrate their respective technologies.

                                       6
<PAGE>
 
Envirogen, with its advanced knowledge of biocatalysis, is able to determine
which microorganism is appropriate to degrade a specific contaminant and combine
the right microorganism with the right bioreactor design, based on specific
operational guidelines, to optimize the destruction of that contaminant.  The
combination of system improvements and specialized microorganisms is providing
Envirogen's clients with smaller, and therefore less costly, equipment with
lower operating costs than is achievable with conventional systems such as
incineration and carbon adsorption.  These system improvements and specialized
microorganisms allow Envirogen to address difficult contaminant and performance
requirements more effectively than can be done with conventional systems.

Envirogen's development efforts have included the commercialization of the
fluidized bed reactor system ("FBR"), which effectively destroys recalcitrant
compounds in water streams at costs lower than conventional technologies.
Several years of laboratory development and successful field demonstrations of
this process resulted in the sale of Envirogen's first full-scale FBR in 1994.
The design, delivery and installation of this $1.2 million system for aniline
and nitrobenzene destruction from groundwater was completed in 1996 at an
industrial site in New Jersey.  Start-up of this system is expected to be
completed in 1997.  It was estimated by the client that this system will save at
least $1.8 million in capital and operating costs during the life of the project
when compared to conventional technologies.  Envirogen completed installation in
1996 of another FBR at Wright-Patterson Air Force Base for the destruction of
chlorinated solvents and other hydrocarbons in groundwater.  In 1996, Envirogen
also completed the process engineering and design of a large FBR for industrial
wastewater treatment for a Fortune 100 petrochemical company.

The Rhone-Poulenc agreement will also build upon Envirogen's technological
breakthrough of degrading MTBE in an economical membrane bioreactor system,
designed and built in collaboration with Rhone-Poulenc, using their membranes.
Envirogen has successfully demonstrated the system for a Fortune 100 oil company
in Texas and has also completed the design of a full-scale system.  This
breakthrough is significant because no economical removal technology is known to
exist for MTBE.

Developmental Program
---------------------

TCE, a suspected carcinogen, is one of the most prevalent contaminants in
groundwater, yet is often highly resistant to natural biodegradation.  Envirogen
began a program targeting TCE destruction with a technology license from Amgen.
The program progressed through reactor design and scale-up and resulted in a
successful field demonstration at Robins Air Force Base.  This work continued in
1996 with the successful completion of a project at the F.E. Warren Air Force
Base to develop a technology to treat soil vapors contaminated with TCE and
other chlorinated solvents.  This contract was funded by the Air Force Center
for Environmental Excellence.  Envirogen continues to develop technologies
targeting TCE destruction under funding from the U.S. Air Force.

                                       7
<PAGE>
 
AIR

The biological control of airborne toxic compounds is now beginning to be
recognized in the United States as a cost effective alternative to physical and
chemical treatment methods such as incineration, adsorption, and wet chemical
scrubbing.  Biotreatment of easier to degrade compounds, such as odor-causing
hydrogen sulfide, has been commercially successful in Europe for more than ten
years.

Motivated by the 1990 Clean Air Act Amendments ("CAAA"), which increasingly
regulate toxic organic compound releases, Envirogen has embarked upon a program
to commercialize biotechnology to treat both odor-causing chemicals and volatile
organic compounds.  After a series of laboratory and field pilot projects,
Envirogen understands the optimal conditions required by naturally occurring
microorganisms to effectively degrade organic compounds listed under the CAAA.

During the early 1990's, Envirogen targeted specific contaminants such as
hydrogen sulfide, carbon disulfide, styrene, terpenes, alcohol, aldehydes,
isobutane, isopentane, the mixed solvents associated with the printing and
surface coating industries, and hydrocarbons associated with remediation.  These
early projects resulted in two full-scale bioreactor designs: the biofilter and
the biotrickling filter.

In biofiltration systems, microorganisms in the form of a moistened biofilm
layer attached to an organic, porous filter substrate, are used to catalyze
beneficial chemical reactions.  As a contaminated vapor stream passes through
the filter bed, pollutants are transferred from the vapor to the biolayer and
are consumed by the microorganisms.  Biotrickling filters are similar to
biofilters, but contain a synthetic packing material instead of compost or peat,
and operate with a greater liquid flow over the packing to facilitate mass
transfer.  The biotrickling filter expands the benefits and capabilities of
biofiltration systems with certain contaminants.

As a result of Envirogen's experience with the destruction of hydrogen sulfide
and carbon disulfide, Envirogen was awarded a contract from the Nylonge
Corporation, a synthetic sponge manufacturer located in Ohio, to design and
install a biofiltration system to control a 30,000 cfm exhaust air flow.  The
system suffered a shutdown in January 1996 shortly after installation which the
Company believes was primarily caused by a failure of internal grating material
supplied by third parties.  Throughout 1996 Envirogen investigated the cause of
the failure, redesigned the internal grating and rebuilt and restarted the
system at a cost of approximately $650,000.  While the ultimate responsibility
for this cost has not yet been determined, Envirogen is actively pursuing
reimbursement of these expenses from third parties.

Envirogen also received an order from ABTco, a decorative hardwood panel
manufacturer, to design and construct a $1,800,000 biofiltration system at its
Michigan facility.  In 1996, this system was completed and is now fully
operational.  The system processes 50,000 cfm of air and is the first operating
biofilter in the forest products industry in the U.S.  Additionally, Envirogen
has commercialized the biotrickling filter technology for styrene applications,
for isopentane and isobutane used as the blowing agents in foam manufacturing,
and for other selected chemical compounds.  Envirogen is also field testing the
biotrickling filter for a large chemical company for the treatment of a methyl
chloride stream.

In May 1995, Envirogen formed a joint venture with nv VAM of the Netherlands to
expand and enhance Envirogen's portfolio of air treatment products and services.
The venture company, CVT America LLC, is owned 50% by Envirogen and 50% by VAM
and provides patented modular biofiltration systems and other services for the
treatment of odors, air toxics and volatile organic contaminants to specific
segments of the air pollution control market.  Envirogen and VAM, which has a
well-established presence in the European biofiltration market, have combined
their complementary biotreatment capabilities to provide a leadership position
in the air pollution control market.  CVT America realized initial revenues in
1995

                                       8
<PAGE>
 
on sales of its products and services and substantially increased its revenues
in 1996.  CVT America signed an agreement in 1996 with Davis Water, now a
division of U.S. Filter, pursuant to which CVT provides biofilters to Davis
Water to cover specific market segments.  The agreement has already resulted in
several systems sales, and CVT America began recognizing revenue from such sales
in January 1997.

GOVERNMENTAL REGULATION

The federal and state environmental laws regulating Envirogen's current and
proposed biodegradation systems are complex, subject to varying interpretations
and continually evolving.  Compliance with these laws, rules and regulations is
expected to be time consuming and expensive.  Any failure to comply with these
requirements, even if unintentional, could give rise to liabilities, penalties
or fines that could materially adversely affect Envirogen's financial condition
and its reputation.

Under the Toxic Substances Control Act ("TSCA"), the EPA has the authority to
regulate the use of chemicals for commercial purposes.  A premanufacture notice
("PMN") is required to be filed with the EPA 90 days in advance of the
manufacture for commercial purposes of any "new" chemical substance.  To date,
the EPA has not asserted that isolated strains of naturally-occurring
microorganisms are chemical substances under TSCA.  Since 1986, however,
genetically-modified microorganisms, with certain limited exceptions, have been
considered "new" chemical substances by the EPA.  As a result, Envirogen's
manufacture of genetically-modified microorganisms for commercial use or the
release of genetically-modified microorganisms into the environment will require
the filing of a PMN, subject Envirogen to the EPA's premanufacturing review
process and require the development of risk assessment information. Depending on
the nature of the microorganism, this process may be time-consuming and costly.
Envirogen has been advised by the EPA that Envirogen's proposed use of
genetically-modified microorganisms in a bioreactor is a "contained" use for
purposes of research and development. The EPA has proposed new regulations for
its TSCA biotechnology program that if adopted, would define the criteria under
which the use of genetically-modified microorganisms in a bioreactor will be
considered "contained."  If the regulations are adopted, Envirogen believes the
time and cost of obtaining EPA approval for its commercial systems may be
reduced.  Envirogen continues to monitor regulatory approvals required by the
EPA under TSCA and by various state and local authorities related to Envirogen's
intended use of genetically-modified bacteria.

Recombinant DNA research conducted with grants from the National Institute of
Health ("NIH") must comply with NIH's Guidelines for Research Involving
Recombinant DNA Molecules (the "Guidelines").  Although compliance with the
Guidelines is not currently mandated for entities that do not receive any NIH
funding, Envirogen has conducted its research involving genetically-modified
microorganisms in compliance with the Guidelines.  The Guidelines prohibit or
restrict certain recombinant DNA experiments, set forth levels of biological and
physical containment of recombinant DNA molecules for various types of research
and require that institutional biosafety committees, composed of representatives
of Envirogen and the public, approve certain experiments before they are
initiated.

Envirogen's research and development activities on PCBs currently require a
permit under TSCA, and certain of its other research activities on other
hazardous substances require state permits.  These permits have been obtained.
Additionally, other permits may be required from the EPA and various state and
local agencies in connection with the installation, use or operation of
Envirogen's biodegradation systems.

                                       9
<PAGE>
 
Envirogen's biodegradation systems, whether used at a hazardous waste
generator's facility or at a hazardous waste site, also may be subject to
permitting under the Resource Conservation and Recovery Act ("RCRA") as a
Treatment, Storage or Disposal Facility ("TSD facility").  The field
demonstration of a bioreactor system may also require a permit under RCRA.
Obtaining a TSD facility permit can be a time consuming and expensive process,
requiring considerable documentation, including process information, waste
specifications and information regarding compliance assessments, security
procedures, emergency plans and insurance, as well as local public hearings.
Local public opposition may delay the issuance of a TSD facility permit for a
number of years or even cause the EPA to deny the permit.

Envirogen's systems may also be subject to other environmental regulations
including mandatory destruction levels and prohibitions on the release of
significant levels of hazardous wastes into the environment.

Envirogen's vapor extraction technology is subject to strict enforcement of
various EPA and state environmental regulations and various site specific
permitting requirements.  EPA or state regulatory agency review of the remedial
action plan is a prerequisite to installation of a full-scale vapor extraction
system.  In addition, the vapor extraction system must comply with federal and
state air and water pollution control standards and an air emissions permit is
often required.  In some instances, the system will require a permit in order to
discharge the treated waste stream into ground or surface waters.

Federal and state safety and health regulations require Envirogen to train its
employees for work at hazardous waste sites and require the preparation of
health and safety plans for each individual project.

Management believes that Envirogen is in compliance with all material regulatory
requirements.

COMPETITION

The environmental remediation industry is highly fragmented and competitive.
Competitors include engineering and construction firms, environmental management
service firms and specialized technology companies, including companies focusing
on developing advanced biological remediation technologies similar to
Envirogen's technologies.  As technological advances are made and become more
widely known, the larger environmental firms may acquire these companies and
technologies and offer such technologies as part of an overall solution to a
hazardous waste remediation project.  Because these companies have significantly
greater financial resources than Envirogen and can offer a wider range of
services, Envirogen may be at a competitive disadvantage.

In general, competition in the hazardous waste management industry is based
primarily upon the cost of the volume of waste treated, contained or removed.
Where the waste is removed, customers are typically charged on a per ton basis
on contaminated soil excavated and transported to a hazardous waste landfill.
Additional competitive factors include corporate presence in a geographic area,
regulatory support, performance standards and technical reliability and
competence.  Envirogen's competitive position is premised upon the lower-cost
treatment approach traditionally associated with conventional biodegradation
techniques, but focus upon Envirogen's distinctive approach to degrading
recalcitrant hazardous waste.

Certain environmental companies offer full-service, turn-key approaches that are
capable of providing an overall solution to a hazardous waste remediation
project.  Where appropriate, Envirogen teams with larger environmental service
firms to offer consulting, engineering, project management, materials handling
and other complementary techniques that are provided by the larger firm in
conjunction with Envirogen's biodegradation technology.  To date, Envirogen has
been able to establish acceptable levels of such teaming arrangements on
satisfactory terms.

                                       10
<PAGE>
 
In response to the search for alternatives to incineration, deep-well injection
and hazardous waste landfills, various developmental chemical and physical
treatment technologies are being explored by sources within industry, university
research centers and the EPA.  Any of these alternative technologies, if found
to be effective and cost efficient, may directly or indirectly compete with
Envirogen's technologies.  Certain present remediation alternatives are under
regulatory review and, as in the case of incineration, their availability may be
limited or restricted in the future, thereby increasing the need to develop
acceptable alternatives.

Envirogen is aware of a number of potential competitors seeking to develop
commercial systems employing biological degradation technology, many of which
have considerably greater financial resources than Envirogen.  Some of these
companies are focusing directly on the enhancement of the degradative activities
of indigenous microorganisms, and some have isolated strains of microorganisms
that alone or in combination with other isolated strains of bacteria will
degrade certain hazardous wastes.  Envirogen does not expect that other entities
seeking solely to enhance conventional biological treatment systems will be able
to demonstrate these systems' effectiveness in degrading the more recalcitrant
hazardous chemicals targeted by Envirogen.  There are, however, a number of
companies attempting to develop advanced biological treatment techniques similar
to those of Envirogen for treatment of these recalcitrant chemicals.  The less
stable hydrocarbon wastes are not particularly difficult to degrade using
conventional biological methods, and Envirogen expects greater competition in
that market sector.

Envirogen is aware of other companies that have targeted the biodegradation of
TCE and have performed various degrees of testing.  Envirogen is not aware of
any competitor that has had substantial positive results in the biodegradation
of PCB wastes, although Envirogen believes that various companies have targeted
the PCB biodegradation market.  Envirogen is aware of and expects continued
competition in the areas of remediation of industrial air toxics, industrial
wastewaters, groundwater and nitroaromatics.

In addition, there are a significant number of companies that offer soil vapor
extraction and related remediation services.  The EPA has rated soil vapor
extraction as one of the top innovative technologies.  Changes in governmental
regulations, the enforcement of regulations or advances in technology may result
in a decrease in the demand for vapor extraction services or affect the
competitive environment in which Envirogen operates.

EMPLOYEES

As of December 31, 1996, Envirogen had 100 full-time employees, including 40 in
engineering, 24 in research and development, 22 in administration and finance
and 14 in marketing.  Doctoral degrees are held by ten employees and encompass
the disciplines of biochemistry, molecular biology, chemical engineering,
microbiology and microbial physiology.  Each of Envirogen's key employees is
subject to a confidentiality agreement with Envirogen covering Envirogen's
processes and plans relating to its business and activities.  Envirogen is not
subject to any collective bargaining agreements and believes that its
relationship with its employees is excellent.

                                       11
<PAGE>
 
ENVIRONMENTAL LIABILITY AND INSURANCE

Envirogen could be held strictly liable under various laws and regulations if
microorganisms or hazardous wastes cause harm to humans or the environment, even
if Envirogen were not negligent.  Although Envirogen has a $5,000,000 combined
professional liability and contractor's pollution liability insurance program
that also provides limited product liability coverage, there can be no
assurance that environmental liabilities that may be incurred by Envirogen will
be covered by its insurance or that the dollar amount of covered liabilities
will not exceed policy limits.  Accordingly, a partially or completely uninsured
judgment against Envirogen could have a materially adverse effect on Envirogen.
Liability insurance market conditions may make it impossible or uneconomical for
Envirogen to obtain combined professional and contractor's pollution liability
or product liability insurance, which may adversely affect its ability to market
its products and services.  Although Envirogen attempts to mitigate some of the
uninsured risks by typically not taking title to its customers' waste or
transporting such waste, such measures are not sufficient to avoid all potential
liability.

Envirogen may be required to indemnify its customers against losses and fines
associated with work under certain of its contracts in the event that
Envirogen's performance under such contract or contracts is faulty or not
conducted in compliance with deadlines.  Although Envirogen will make every
effort to mitigate losses under indemnification clauses contained in its
contracts, a claim, if successful and of sufficient magnitude, could have a
materially adverse effect on the business or financial condition of Envirogen.

ITEM 2.   PROPERTIES

Envirogen's headquarters and Midatlantic Operations Group are located in
Lawrenceville, New Jersey, where it leases 35,000 square feet of office space
for its administrative, laboratory and pilot facilities.  Envirogen leases
27,000 square feet of office and warehouse space in Lansing, Michigan for its
MWR Operations Group.  Envirogen also leases 10,400 square feet of office space
in Canton, Massachusetts for its Northeast Operations Group.  Another 2,200
square feet of office space is leased in Houston, Texas for its Gulf Coast
Operations Group.  Management believes that Envirogen's facilities are adequate
and suitable for Envirogen's current and proposed operations for the immediately
foreseeable future.

ITEM 3.   LEGAL PROCEEDINGS

Envirogen knows of no material litigation or other legal proceedings pending or
threatened to which it is, or may become, a party.


ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.

                                       12
<PAGE>
 
                            ADDITIONAL INFORMATION

The following information is furnished in this Part I pursuant to Instruction 3
to Item 401(b) of Regulation S-K:

EXECUTIVE OFFICERS OF THE COMPANY

The executive officers of the Company serve at the discretion of the Board of
Directors.  There are no family relationships between any of the executive
officers of the Company.  The following information indicates the position and
age of the Company's executive officers as of the date of this report and their
previous business experience.

<TABLE>
<CAPTION>
     Name                        Age                Position
     ----                        ---                --------   
     <S>                         <C>         <C>
     Harcharan S. Gill, Ph.D.     56         President, Chief Executive Officer and Director
     Ronald Unterman, Ph.D.       51         Vice President and Chief Scientific Officer
     David N. Enegess             50         Vice President-Marketing and Commercial
                                               Development
</TABLE>

Harcharan S. Gill  has been a director, President and Chief Executive Officer of
the Company since August 1994.  Prior to joining the Company, from 1971 to July
1994, Dr. Gill held a number of positions with Dames & Moore, a leading
environmental engineering company.  From  February 1988 to March 1991, he was
General Manager in Toronto, Canada of Trow Dames & Moore, a joint venture of
Trow Consulting Engineers and Dames & Moore.  From April 1991 to March 1992, he
returned to the United States in the capacity as General Manager of the Dames &
Moore Florida and Caribbean Region.  After Dames & Moore became a public company
in 1992, Dr. Gill was Vice President and General Manager of Dames & Moore's
Southern Region, and from April 1994 until July 1994, he served as Vice
President in Dames & Moore's Corporate Development Group.  Dr. Gill received a
Ph.D. in Civil Engineering from Cornell University.

Ronald Unterman is a founder of the Company and was Vice President of Research
and Development from August 1988 until March 1995, at which time he was
appointed Vice President and Chief Scientific Officer. From 1981 until he joined
the Company, Dr. Unterman served as a staff scientist (from November 1981 to
December 1987) and as a manager (from January 1988 to July 1988) of the
Environmental Technology Program at General Electric Company.  His primary area
of research expertise is in the development of methods for biodegrading PCBs.
Dr. Unterman received a B.A. in biology from Haverford College, studied under a
Molecular Biology Fellowship at Rockefeller University and holds a Ph.D. in
biochemistry from Columbia University.

David N. Enegess is a founder of the Company and has been its Vice President of
Marketing and Commercial Development since its incorporation in June 1988.  From
1982 until he joined the Company, he served in various capacities, most recently
as Vice President of Corporate Development, for American NuKEM Corporation
(formerly known as WasteChem Corporation), a company which sells equipment,
systems and services for the treatment of hazardous wastes.  Mr. Enegess
received his undergraduate and masters degrees in chemical engineering from
Tufts University.

                                       13
<PAGE>
 
                                    PART II
                                        

ITEM 5.   MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
          MATTERS

Envirogen's Common Stock and Common Stock Purchase Warrants are traded in the
Nasdaq SmallCap Market under the symbols "ENVG" and "ENVGW," respectively.  Each
Common Stock Purchase Warrant entitles the holder to purchase one-half of one
share of Common Stock at an exercise price of $5.20 per full share, subject to
adjustment, until October 13, 1998.  The Common Stock prices are inter-dealer
prices, without retail markup, markdown or commission, and may not necessarily
represent actual transactions.  The following table sets forth for the periods
indicated the high and low closing prices for Envirogen's Common Stock as
reported by Nasdaq.

<TABLE>
<CAPTION>
               1996                 HIGH          LOW
               ----                 -----         ----
            <S>                     <C>           <C>
            1st Quarter             $4.00         $2.50
            2nd Quarter             $4.63         $2.38
            3rd Quarter             $4.00         $2.13
            4th Quarter             $3.75         $2.38
 
               1995
               ----
            1st Quarter             $1.88         $1.38
            2nd Quarter             $2.25         $1.75
            3rd Quarter             $4.25         $1.50
            4th Quarter             $3.75         $2.50
</TABLE>

The closing price for the Common Stock on February 28, 1997 was $2.63.  For
purposes of calculating the aggregate market value of the shares of Common Stock
of the Company held by nonaffiliates, as shown on the cover page of this report,
it has been assumed that all the outstanding shares were held by nonaffiliates
except for the shares held by directors and executive officers of the Company
and stockholders owning 10% or more of outstanding shares.  However, this should
not be deemed to constitute an admission that all such persons are, in fact,
affiliates of the Company, or that there are not other persons who may be deemed
to be affiliates of the Company.  Further information concerning ownership of
the Company's securities by executive officers, directors and principal
stockholders will be included in the Company's definitive proxy statement to be
filed with the Securities and Exchange Commission.

The number of stockholders of record as of December 31, 1996 was approximately
290, which includes stockholders whose shares were held in nominee name.  The
number of beneficial stockholders at that date was over 1650.

Envirogen has never declared or paid cash or other dividends on its Common
Stock.  The payment of dividends, if any, in the future is within the discretion
of the Board of Directors and will depend upon Envirogen's earnings, capital
requirements, financial condition and other relevant factors.  Envirogen
presently intends to retain all earnings, if any, for future use in its business
and does not anticipate paying dividends in the foreseeable future.

                                       14
<PAGE>
 
ITEM 6.   SELECTED FINANCIAL DATA

The following table contains selected financial data for each of the Company's
last five fiscal years.  This data should be read in conjunction with the
Company's consolidated financial statements and related notes appearing
elsewhere in this report and with Item 7 of this report.

SUMMARY OF OPERATIONS

<TABLE>
<CAPTION>
                                                            Years Ended December 31,
                                      -----------------------------------------------------------------------------

                                            1996            1995            1994            1993            1992
                                            ----            ----            ----            ----            ----
<S>                                   <C>             <C>             <C>             <C>             <C>
 Revenues                             $  12,919,594   $   8,033,698   $   6,134,577   $   4,714,752   $   3,386,459
 Costs and expenses                      15,689,306      10,279,694      10,503,989       9,879,694       7,693,633
 Interest, net                              170,783         169,972         111,659         216,696         235,128
 Equity in loss of
   joint venture                            (52,629)        (93,437)              -               -               -
 Other, net                                   7,601          16,961               -               -               -
                                      -------------   -------------   -------------   -------------   -------------
 Net loss                                (2,643,957)     (2,152,500)     (4,257,753)     (4,948,246)     (4,072,046)
 Preferred stock
   dividends                                (36,458)       (233,333)              -               -               -
                                      -------------   -------------   -------------   -------------   -------------
 Net loss applicable to
   Common Stock                        ($ 2,680,415)   ($ 2,385,833)   ($ 4,257,753)   ($ 4,948,246)   ($ 4,072,046)
                                      =============   =============   =============   =============   =============
 
 Net loss per share
   applicable to
   Common Stock                              ($0.24)         ($0.31)         ($0.57)         ($0.79)         ($0.79)
                                             =======         =======         =======         =======         =======
</TABLE> 
 
 SUMMARY OF FINANCIAL POSITION

<TABLE> 
<CAPTION> 
                                                                      December 31,
                                      -----------------------------------------------------------------------------

                                               1996            1995            1994            1993            1992
                                               ----            ----            ----            ----            ----
  <S>                                 <C>             <C>             <C>             <C>             <C>   
  Total assets                        $  12,716,624   $   8,585,233   $   6,704,806   $  11,945,079   $  10,505,940
  Working capital                         7,094,266       4,934,700       3,628,377       8,204,251       8,145,091
  Long-term obligations                      42,176          60,951         177,704         298,709         175,352
  Redeemable convertible
    Preferred Stock                               -       1,728,621               -               -               -
  Stockholders' equity                   10,047,233       4,863,357       5,400,207       9,694,715       9,523,971
</TABLE>

                                       15
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
          RESULTS OF OPERATIONS

The following information should be read in conjunction with the Company's
consolidated financial statements and notes thereto included in this report.

GENERAL
-------

The source of the Company's revenues to date includes (i) commercial sales of
the Company's biological degradation systems, (ii) remediation services,
including both in situ and ex situ bioremediation, and (iii) funds received from
third parties and government agencies to conduct specific research and
development programs. While the Company has realized significant commercial
revenues for several years from remediation services, it has only recently seen
the first substantial revenues from sales of full-scale biological degradation
systems for the treatment of contaminated air and water streams.  Although great
strides have been made in the commercialization of these systems, significant
expenditures will be required for continued research and development, additional
marketing activities and ultimately the development of manufacturing
capabilities for the further commercialization of the Company's biodegradation
systems.  The amount and timing of such expenditures will vary depending on
several factors, including the progress of development and testing, funding
from third parties, the level of enforcement of environmental regulations by
federal and state agencies, technological advances, changing competitive
conditions and determinations with respect to the commercial potential of the
Company's systems.  The amount and timing of such expenditures cannot be
predicted.

On January 14, 1997, Envirogen entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Fluid Management, Inc., a Wisconsin-based, full service
environmental consulting firm ("FMI"), and the stockholders of FMI, pursuant to
which, among other things, FMI will be merged with and into Envirogen (the
"Merger"), with Envirogen being the surviving corporation.  In the Merger, the
stockholders of FMI will have the right to receive 4,190,477 shares of Common
Stock and $11,000,000 of cash, subject to adjustment pursuant to the Merger
Agreement.  In order to fund the cash portion of the merger consideration and to
provide additional working capital for Envirogen, Envirogen entered into a
Securities Purchase Agreement on January 14, 1997 with Warburg, Pincus Ventures,
L.P., a Delaware limited partnership ("Warburg"), pursuant to which, among other
things, Envirogen will issue and sell to Warburg 6,095,238 shares of Common
Stock for an aggregate cash purchase price of $16,000,000 (the "Warburg
Transaction").  The closing of the Merger and the Warburg Transaction is
expected to occur in April 1997, subject to the approval of the stockholders of
Envirogen and other contingencies customary for a transaction such as the Merger
and the Warburg Transaction.  Accordingly, no assurance can be given that the
Merger and the Warburg Transaction will be consummated.

RESULTS OF OPERATIONS
---------------------

1996 COMPARED TO 1995
---------------------

The Company reported revenues in 1996 of $12,919,594, an increase of 61% from
1995.  The net loss in 1996 increased 12% to $2,680,415, while the net loss per
share was $0.24 compared to $0.31 in 1995.  The decrease in net loss per share
is due to a greater number of shares outstanding resulting from the issuance of
Common Stock in May 1996.

Commercial revenues increased 82% to $10,892,871 from $5,971,278 in 1995 while
revenues from corporate and government research and development contracts
decreased 2% to $2,026,723 from $2,062,420 in 1995.  The increase in commercial
revenues is due primarily to revenues of approximately

                                       16
<PAGE>
 
$3.4 million from the Company's MWR subsidiary that was acquired in February
1996 combined with increased systems sales of approximately $1.6 million by the
Company's Commercial Air Group related to the ABTco biofilter project. Revenues
from remediation activities accounted for 81% of the Company's commercial
revenues during 1996.

Revenues from corporate and government research and development contracts
decreased slightly from last year as revenues from numerous new projects
partially offset the loss of revenues due to the conclusion in December 1995 of
PCB work the Company performed for the Texas Eastern Transmission Corporation.
The Company's Phase II Department of Energy Small Business Innovative Research
Grant (SBIR), Phase II Department of Defense SBIR and Phase II National Science
Foundation SBIR all contributed significantly to 1996 results.  The Company also
recorded initial revenues in 1996 under a new Phase I grant from the Department
of Energy, a new Phase I grant from the National Science Foundation and a new
Phase II grant from the Department of Defense.

Total costs and expenses increased 53% to $15,689,306 in 1996 from $10,279,694
in 1995, due primarily to the increased cost of commercial services and products
associated with the higher revenue levels.  The cost of commercial operations
increased 89% to $9,676,960 due to higher revenue levels, a greater proportion
of which were attributable to lower margin systems sales.  Research and
development expenses decreased 2% to $2,403,566.  General and administrative
expenses increased 24% to $1,965,369 due largely to the increased amortization
of intangible assets associated with the acquisition of MWR in February 1996,
increased legal expenses associated with patent applications and the growth of
the Company.   Marketing expenses decreased 10% to $993,411 due primarily to
reduced personnel related costs combined with other cost reduction efforts.  In
January 1996, a biofiltration system installed by the Company for the Nylonge
Corporation suffered a shutdown, which the Company believes was primarily caused
by a failure of internal grating material supplied by third parties.  Throughout
1996 the Company investigated the cause of the failure, redesigned the internal
grating and rebuilt and restarted the system at a cost of approximately
$650,000. While the ultimate responsibility for these expenses has not yet been
determined, the Company is actively pursuing reimbursement of these expenses
from third parties.  However, there can be no assurance that any such recoveries
will be attained.

Interest income decreased by 4% to $193,776 due to the decreased interest rates
available on the Company's cash balances.  Equity in loss of joint venture,
which resulted from the Company's participation in the CVT America joint
venture, decreased 44% to $52,629.  Prior to the conversion of the Company's
preferred stock in May 1996, the Company paid dividends on the preferred stock
of $36,458 in 1996.

1995 COMPARED TO 1994
---------------------

The Company reported revenues in 1995 of $8,033,698, an increase of 31% from
1994.  The net loss in 1995 decreased by 44% to $2,385,833, while the net loss
per share was $0.31 compared to $0.57 in 1994.  In the third quarter of 1994,
the Company underwent a strategic restructuring of its operations to increase
efficiencies and decrease costs.  The restructuring resulted in cost reductions
that are reflected in the improved 1995 performance.

Commercial revenues increased by 47% to $5,971,278 from $4,061,432  in 1994,
while revenues from corporate and government research and development contracts
decreased slightly to $2,062,420 from $2,073,145 in 1994.  The $1,909,846
increase in commercial revenues was due primarily to approximately $1,000,000 of
increased sales of the Company's commercial air and water systems and an
increase in demand for remediation services in its Midatlantic and Northeastern
Operations Groups.  Commercial revenues were significantly improved versus 1994,
despite the fact that inconclusive test results from a field treatability study
for the treatment of airborne odor-causing effluents at a large industrial
chemical

                                       17
<PAGE>
 
company in New Jersey caused the Company and the client to jointly terminate, in
the second quarter of 1995, a September 1994 contract valued at approximately
$1,000,000.  Revenues from remediation services accounted for 81% of the
Company's 1995 commercial revenues.

Revenues from corporate and government research and development contracts
remained relatively unchanged as the Company was able to replace several
completed large projects, which contributed significant revenues in 1994, with
several new multi-year grants and contracts.  The Company recorded initial
revenues in 1995 under two new Phase I SBIR grants and a multi-year Phase II
SBIR contract from the National Science Foundation, a multi-year Phase II SBIR
grant as well as separate research and consulting contracts from the Department
of Energy, and two Phase I and multi-year Phase II contracts from the Department
of Defense.

Total costs and expenses decreased by 2% to $10,279,694 in 1995 from $10,503,989
in 1994.  The cost of commercial operations increased by 53% to $5,126,901 due
to higher revenue levels and other expenses associated with the continued
commercialization of new technologies, including the design and cost of
production of the Company's biological degradation systems, as well as the
realignment of personnel that resulted in increased headcounts in Commercial
Operations and reduced headcounts in Administration, Marketing and Research and
Development.  Research and development expenses decreased by 26% to $2,459,580,
general and administrative expenses decreased by 31% to $1,583,383 and marketing
expenses decreased by 29% to $1,109,830 due primarily to staff reductions
(realignment of personnel and layoffs) and other cost reduction efforts
resulting from the Company's strategic restructuring of its operations during
the third quarter of 1994.

Interest income increased by 22% to $201,130 due to the increased cash available
for investment as a result of the April 1995 private placement of preferred
stock.  Equity in loss of affiliate of $93,437 is due to the Company's
participation in the CVT America joint venture. Dividends of $233,333 were
recognized on the convertible preferred stock, consisting of $116,666 of regular
dividends and $116,667 for a special dividend paid in connection with the
voluntary conversion of 50% of the preferred stock to common stock in December
1995.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

The Company has funded its operations to date primarily through public offerings
and private placements of equity securities, research and development agreements
with major industrial companies, research grants from government agencies and
revenues from commercial services and sales of biological degradation systems.
At December 31, 1996 the Company had cash and cash equivalents of $4,614,062 and
working capital of $7,094,266.  Additionally, the Company had restricted cash of
$309,300 that was being used to collateralize a bond for a large commercial
project.  Cash and cash equivalents increased by $865,865 from December 31, 1995
to December 31, 1996 due to the net proceeds of $4,607,984 from the May 1996
private placement of Common Stock which offset the cash payment of $1,332,000
for the purchase of MWR, Inc. in February 1996, cash used by operations of
$2,054,402, capital expenditures of $102,744, an advance to affiliate of
$100,000, capital lease principal repayments of $124,020 and cash dividends on
preferred stock of $51,041. The Company expects to incur additional capital
expenditures in connection with the continued development and commercialization
of its technologies. The timing and amount of such expenditures will fluctuate
depending on the timing of field tests, systems development activity, the
rapidity with which the Company's biodegradation systems can be further
commercialized and the availability of capital.  Furthermore, future projects
may require the Company to set aside additional capital to collateralize
performance bonds.

                                       18
<PAGE>
 
Revenue from certain of the Company's contracts is recognized as services are
provided and costs are incurred. For fixed-price contracts, revenue is
recognized on the percentage-of-completion method, measured by the percentage
relationship of costs incurred from contract inception to date to the estimated
total costs for each contract.  The asset "Unbilled revenue" represents revenues
recognized in excess of amounts billed. Correspondingly, the liability "Deferred
revenue" represents billings in excess of costs and estimated earnings. The
balance in these accounts will fluctuate depending on a number of factors,
including the number and size of fixed-price contracts, contract terms and other
timing and cost issues. At December 31, 1996, unbilled revenue was $437,772
greater than at December 31, 1995 due primarily to the acquisition of MWR.

Accounts receivable increased by $1,524,783 from December 31, 1995 to December
31, 1996 primarily due to the acquisition of MWR.  Accounts payable increased by
$563,865 and accrued expenses and other liabilities increased by $342,195 in the
same period due primarily to the acquisition of MWR.

If the Merger and the Warburg Transaction are consummated, of which there can be
no assurance, Envirogen's available capital resources are expected to consist of
the following:  (a) Envirogen's and FMI's cash and cash equivalents on hand
immediately following the Closing, including the net proceeds from the Warburg
Transaction (after the payment of the cash portion of the merger consideration,
the repayment of all outstanding indebtedness of FMI for borrowed money on the
Closing Date and the payment by Envirogen of transaction costs incurred by
Envirogen, FMI (not to exceed $350,000) and Warburg (not to exceed $50,000) in
connection with the Merger and the Warburg Transaction); and (b) the expected
generation of cash from the combined operations of Envirogen and FMI after the
Closing Date.  In addition, Envirogen intends to supplement its working capital
with a credit facility.  There can be no assurance that any such credit facility
will be obtained or, if obtained, will be on terms advantageous to Envirogen.

If the Merger and the Warburg Transaction are not consummated, (a) Envirogen
will continue to incur operating losses during the period of development and
commercialization of its technologies relating to the treatment of hazardous
wastes and industrial pollutants; (b) although it is unable to predict with
certainty, Envirogen believes it will have sufficient capital to meet its
operating requirements at least through 1998; (c) if Envirogen is unable to
obtain continued funding for the development of these technologies through
research and development agreements and increased commercial revenues, it will
be necessary to obtain funding from other sources; and (d) there can be no
assurance that Envirogen will be able to obtain additional funds to meet its
capital requirements or, if successful, the terms of such financing may not be
advantageous to Envirogen.

OTHER MATTERS
-------------

As of December 31, 1996, the Company had a net operating loss carryforward of
approximately $19,300,000 for federal income tax reporting purposes available to
offset future taxable income, if any, through 2011.  The timing and manner in
which these losses may be utilized are limited under Section 382 of the Internal
Revenue Code of 1986 to approximately $1,700,000 per year based on preliminary
calculations of certain ownership changes to date. The Company's net operating
losses may be further limited in the event of additional ownership changes, if
any, as a result of future equity issuances in addition to the shares to be
issued in the Merger and the Warburg Transaction.

                                       19
<PAGE>


ITEM 8.         FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                                ENVIROGEN, INC.
                          CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                              December 31,
                                                             ----------------------------------------
                                                                   1996                     1995
                                                             ----------------        ----------------
<S>                                                          <C>                     <C>
ASSETS
Current assets:
   Cash and cash equivalents                                      $4,614,062             $ 3,748,197
   Accounts receivable, net of allowance for doubtful
     accounts of $245,138 in 1996 and $131,381 in 1995             3,100,447               1,575,664
   Unbilled revenue                                                1,776,004               1,338,232
   Inventory                                                          55,027                  44,430
   Prepaid expenses and other current assets                         175,941                 160,481
                                                                 ------------            ------------ 
       Total current assets                                        9,721,481               6,867,004

Property and equipment, net                                          922,320               1,074,660   
Restricted cash                                                      309,300                 309,300   
Investment in and advances to joint venture                          228,934                 181,563   
Intangible assets, net                                             1,348,677                  26,099   
Other, principally deposits                                          185,912                 126,607   
                                                                 ------------            ------------
       Total assets                                              $12,716,624             $ 8,585,233
                                                                 ============            ============

LIABILITIES
Current liabilities:
   Accounts payable                                               $1,335,954             $   772,089
   Accrued expenses and other liabilities                            955,886                 613,691
   Deferred revenue                                                  312,784                 424,588
   Current portion of note payable                                     4,287                   4,333
   Current portion of capital lease obligations                       18,304                 103,020
   Preferred Stock dividends payable                                                          14,583
                                                                 ------------            ------------ 
       Total current liabilities                                   2,627,215               1,932,304

Deferred rent                                                         12,222                  48,890
Note payable, net of current portion                                                           4,287
Capital lease obligations, net of current portion                     29,954                   7,774
                                                                 ------------            ------------ 
       Total liabilities                                           2,669,391               1,993,255
                                                                 ------------            ------------

Commitments and contingencies (see Note 11)

Redeemable Cumulative Convertible
   Preferred Stock                                                                         1,728,621

STOCKHOLDERS' EQUITY
Common stock                                                         129,319                  90,495
Additional paid-in capital                                        31,925,861              24,100,394
Accumulated deficit                                              (22,001,997)            (19,321,582)
Less:  Treasury stock                                                 (5,950)                 (5,950)
                                                                 ------------            ------------
       Total stockholders' equity                                 10,047,233               4,863,357
                                                                 ------------            ------------
       Total liabilities, redeemable cumulative convertible
        preferred stock and stockholders' equity                 $12,716,624             $ 8,585,233
                                                                 ============            ============
</TABLE> 

The accompanying notes are an integral part of these consolidated financial 
statements.

                                      20
<PAGE>

                                ENVIROGEN, INC.
                    CONSOLIDATED  STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                         Year Ended December 31,
                                          -------------------------------------------------
                                                1996              1995             1994
                                          ---------------   --------------   --------------
<S>                                       <C>               <C>              <C>
Revenues:
  Commercial operations                      $10,892,871       $5,971,278       $4,061,432
  Research and development services            2,026,723        2,062,420        2,073,145
                                          ---------------   --------------   --------------
    Total revenues                            12,919,594        8,033,698        6,134,577
                                          ---------------   --------------   --------------


Cost of commercial operations                  9,676,960        5,126,901        3,358,730
Provision for contract claim                     650,000
Research and development costs                 2,403,566        2,459,580        3,311,301
General and administrative expenses            1,965,369        1,583,383        2,279,502
Marketing expenses                               993,411        1,109,830        1,554,456
                                          ---------------   --------------   --------------
    Total costs and expenses                  15,689,306       10,279,694       10,503,989
                                          ---------------   --------------   --------------


Other income (expense):
  Interest income                                193,776          201,130          164,886
  Interest expense                               (22,993)         (31,158)         (53,227)
  Equity in loss of joint venture                (52,629)         (93,437)
  Other, net                                       7,601           16,961
                                          ---------------   --------------   --------------
      Other income, net                          125,755           93,496          111,659
                                          ---------------   --------------   --------------

Net loss                                      (2,643,957)      (2,152,500)      (4,257,753)

Preferred stock dividends                        (36,458)        (233,333)
                                          ---------------   --------------   --------------

Net loss applicable to Common Stock          ($2,680,415)     ($2,385,833)     ($4,257,753)
                                          ===============   ==============   ==============


Net loss per share applicable to 
    Common Stock                                  ($0.24)          ($0.31)          ($0.57)
                                          ===============   ==============   ==============


Weighted average number of shares of
   Common Stock outstanding                   11,374,922        7,669,639        7,461,821
                                          ===============   ==============   ==============
</TABLE> 


The accompanying notes are an integral part of these consolidated financial 
statements.

                                      21
<PAGE>

                                ENVIROGEN, INC.
          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
             For the years ended December 31, 1996, 1995 and 1994

<TABLE> 
<CAPTION> 
                                                         Additional
                                      Common Stock         Paid-in        Accumulated         Treasury Stock
                                  --------------------                                   -------------------------
                                    Shares     Amount      Capital          Deficit         Shares    Amount
                                  ----------  --------  -------------     -------------  ----------  -------------
<S>                               <C>         <C>       <C>               <C>            <C>          <C> 
BALANCE AT DECEMBER 31, 1993       7,499,250   $74,992   $22,303,219      ($12,677,996)  (55,000)     ($5,500)

Net loss                                                                    (4,257,753)
Expenses from issuance of Common
 Stock and warrants                                          (58,541)
Exercise of stock options/ other      45,500       455        21,781
Treasury stock repurchases                                                                (4,500)        (450)
                                  ----------  --------   -----------      -------------  --------     --------
BALANCE AT DECEMBER 31, 1994       7,544,750   $75,447   $22,266,459      ($16,935,749)  (59,500)     ($5,950)

Net loss                                                                    (2,385,833)
Conversion of Convertible
 Preferred Stock                   1,400,000    14,000     1,697,121
Issuance of Common Stock for
 interest in joint venture            58,140       582       124,418
Exercise of stock options             46,570       466        12,396
                                  ----------  --------   -----------      -------------  --------     --------  
BALANCE AT DECEMBER 31, 1995       9,049,460   $90,495   $24,100,394      ($19,321,582)  (59,500)     ($5,950)

Net loss                                                                    (2,680,415)
Conversion of Convertible
 Preferred Stock                   1,400,000    14,000     1,714,621
Issuance of Common Stock for cash  2,000,000    20,000     4,587,984
Issuance of Common Stock to
 acquire MWR, Inc.                   456,500     4,565     1,506,450
Exercise of stock options             25,980       259        16,412
                                  ----------  --------   -----------      -------------  --------     --------
BALANCE AT DECEMBER 31, 1996      12,931,940  $129,319   $31,925,861      ($22,001,997)  (59,500)     ($5,950)
                                  ==========  ========   ===========      =============  ========     ========
</TABLE> 

Preferred Stock:  Authorized 2,000,000 shares, par value $.01 per share. 140,000
                   shares of Series C Convertible Preferred Stock outstanding
                   at December 31, 1995. No preferred shares issued or
                   outstanding at December 31, 1994 and 1996.
Common Stock:     Authorized 20,000,000 shares, par value $.01 per share.


The accompanying notes are an integral part of these consolidated financial
statements.

                                      22
<PAGE>


                                 ENVIROGEN, INC.
                      CONSOLIDATED  STATEMENTS OF CASH FLOWS


<TABLE>  
<CAPTION> 
                                                                                     Year Ended December 31,
                                                                   --------------------------------------------------------
                                                                        1996                1995                 1994
                                                                   ------------          ------------        -------------- 
<S>                                                                <C>                   <C>                 <C> 
Cash flows from operating activities:                          
  Net loss                                                         ($2,643,957)          ($2,152,500)        ($4,257,753)
  Adjustments to reconcile net loss to cash used by 
  operating activities:
    Depreciation and amortization                                      992,697               574,183             542,984
    Provision for doubtful accounts                                     84,800                60,000              17,700
    Equity in loss of joint venture                                     52,629                93,437
    Other                                                               (8,521)               (1,941)
                                                               
Changes in assets and liabilities:                           
    (Increase) decrease in accounts receivable                        (850,546)              (12,759)             58,881
    (Increase) decrease in unbilled revenue                            107,213              (793,410)           (352,017)
    (Increase) decrease in prepaid expenses and other assets           272,694               (63,031)             (6,044)
    (Increase) decrease in inventory                                    48,606               (44,430)
    (Increase) in restricted cash                                                                               (309,300)
    Increase (decrease) in accounts payable                            182,942               349,877            (643,770)
    Increase (decrease) in accrued expenses and other liabilities     (181,155)               65,380             (71,476)
    Increase (decrease) in deferred revenue                           (111,804)              347,978             (91,297)
                                                                   -----------            ----------          -----------
       Net cash used by operating activities                        (2,054,402)           (1,577,216)         (5,112,092)
                                                                   -----------            ----------          -----------
                                                               
                                                               
Cash flows from investing activities:                          
    Capital expenditures                                              (102,744)              (94,742)           (392,180)
    Investment in and advances to joint venture                       (100,000)             (150,000)
    Purchase of MWR, Inc.                                           (1,332,000)
    Purchase of marketable securities                                                                         (1,958,720)
    Proceeds from maturities of marketable securities                                                          1,958,720
    Proceeds from sale of property and equipment                         9,750                 3,000
                                                                   -----------            ----------          ----------
       Net cash used in investing activities                        (1,524,994)             (241,742)           (392,180)
                                                                   -----------            ----------          ---------- 
                                                               
                                                               
Cash flows from financing activities:                          
  Debt repayment                                                        (4,333)               (4,002)             (3,397)
  Capital lease principal repayments                                  (124,020)             (128,084)           (135,825)
  Net proceeds from issuance of Common Stock                         4,607,984
  Net proceeds from issuance of Redeemable                     
     Cumulative Convertible Preferred Stock                                                3,457,242
  Expenses of converting 50% of Redeemable                     
     Cumulative Convertible Preferred Stock                                                  (17,500)
  Expenses of  issuing Common Stock and warrants                                                                 (58,541)
  Net proceeds from exercise of stock options                           16,671                12,862              21,786
  Cash dividends paid on Redeemable Cumulative                 
     Convertible Preferred Stock                                       (51,041)             (218,750)
                                                                   -----------            ----------          ----------
       Net cash provided by (used in) financing activities           4,445,261             3,101,768            (175,977)
                                                                   -----------            ----------          ---------- 
                                                              
                                                               
Net increase (decrease) in cash and cash equivalents                   865,865             1,282,810          (5,680,249)
                                                               
Cash and cash equivalents at beginning of year                       3,748,197             2,465,387           8,145,636
                                                                   -----------            ----------          -----------  
                                                               
Cash and cash equivalents at end of year                           $ 4,614,062            $3,748,197          $2,465,387
                                                                   ===========            ==========          ===========
                                                               
                                                               
                                                               
Supplemental disclosures of cash flow information:             
-------------------------------------------------
  Cash paid for interest                                               $23,041                $31,061             $43,538
                                                                   ===========             ==========          =========== 
  Cash paid for income taxes                                            $2,110                   $200                  $0
                                                                   ===========             ==========          =========== 

Supplemental disclosures of non-cash investing and financing activities:
------------------------------------------------------------------------   
-The Company entered into capital lease obligations amounting to $48,932 and
 $42,924 for the years ended December 31, 1996 and 1995, respectively.
-In February 1996, the Company acquired MWR, Inc. for $1,332,000 in cash and
 456,500 shares of Common Stock valued at $1,511,015.
-In December 1995, there was a voluntary conversion of 140,000 shares of Series
 C Convertible Preferred Stock into 1,400,000 shares of Common Stock. In May
 1996, there was a voluntary conversion of the remaining 140,000 shares of
 Series C Convertible Preferred Stock into 1,400,000 shares of Common Stock.
-In May 1995, the Company and nv VAM of the Netherlands formed a joint venture,
 CVT America, L.L.C. For its 50% interest, the Company paid $48,250 in cash and
 issued 58,140 shares of Envirogen common stock to VAM valued at $125,000.
</TABLE> 

The accompanying notes are an integral part of these consolidated financial
statements.

                                      23
<PAGE>
 
                                ENVIROGEN, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              __________________


1.   BUSINESS AND ORGANIZATION
     -------------------------

     Envirogen, Inc. ("Envirogen") is an environmental biotechnology company
     engaged in the development  and  design  of  advanced  biological  systems
     to treat and degrade hazardous wastes.  The Company has also been engaged
     in commercial remediation activities through Vapex Environmental
     Technologies, Inc. ("Vapex"), a wholly-owned subsidiary that was merged
     into Envirogen effective December 31, 1994, and through MWR, Inc. ("MWR")
     of Lansing, Michigan, a wholly-owned subsidiary that was acquired on
     February 9, 1996 (see Note 3). The Company also entered into a joint
     venture during 1995 (see Note 18).

     On January 14, 1997, Envirogen entered into an Agreement and Plan of Merger
     (the "Merger Agreement") with Fluid Management, Inc., a Wisconsin-based,
     full service environmental consulting firm ("FMI"), and the stockholders of
     FMI, pursuant to which, among other things, FMI will be merged with and
     into Envirogen (the "Merger"), with Envirogen being the surviving
     corporation.  In the Merger, the stockholders of FMI will have the right to
     receive 4,190,477 shares of Common Stock and $11,000,000 of cash, subject
     to adjustment pursuant to the Merger Agreement.  In order to fund the cash
     portion of the merger consideration and to provide additional working
     capital for Envirogen, Envirogen entered into a Securities Purchase
     Agreement on January 14, 1997 with Warburg, Pincus Ventures, L.P., a
     Delaware limited partnership ("Warburg"), pursuant to which, among other
     things, Envirogen will issue and sell to Warburg 6,095,238 shares of Common
     Stock for an aggregate cash purchase price of $16,000,000 (the "Warburg
     Transaction").  The closing of the Merger and the Warburg Transaction is
     expected to occur in April 1997, subject to the approval of the
     stockholders of Envirogen and other contingencies customary for a
     transaction such as the Merger and the Warburg Transaction.  Accordingly,
     no assurance can be given that the Merger and the Warburg Transaction will
     be consummated.

     While the activities of Vapex and MWR are principally commercial
     remediation, a significant portion of the activities of Envirogen to date
     have been related to research with corporate and governmental sponsors and
     the determination of the feasibility of designed and advanced biological
     systems to treat and degrade hazardous wastes.  Certain of Envirogen's
     bioremediation systems will require substantial additional research,
     development and testing to determine their commercial viability and will
     require significant additional financing.  The Company is subject to a
     number of other risks similar to those of other companies in similar stages
     of development, including but not limited to short operating history
     including losses to date, future capital needs (particularly if the Merger
     and the Warburg Transaction are not consummated), dependence on key
     personnel, competition, risk of technological obsolescence, governmental
     regulations and approvals and limited manufacturing and marketing
     capabilities.

                                       24
<PAGE>
 
                                ENVIROGEN, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              __________________


2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
     ------------------------------------------

     PRINCIPLES OF CONSOLIDATION

     The consolidated financial statements include the accounts of Vapex and
     MWR.  All material intercompany balances and transactions are eliminated in
     consolidation.

     RECLASSIFICATIONS

     Certain reclassifications have been made to conform prior year's
     presentation with the 1996 financial statement presentation.

     USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

     The preparation of financial statements in conformity with generally
     accepted accounting principals 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 dates of the
     financial statements and the reported amounts of revenues and expenses
     during the reporting periods. Actual results could differ from those
     estimates.  Significant estimates in the preparation of these financial
     statements include provisions made for doubtful accounts and contracts and
     amortization periods for intangibles.

     CASH EQUIVALENTS

     The Company considers all highly liquid investments with original
     maturities of three months or less when purchased to be cash equivalents.

     INVENTORY

     Inventories are stated at the lower of cost or market.  Cost is determined
     on a first-in, first-out basis.

     PROPERTY AND EQUIPMENT

     Property and equipment is recorded at cost and consists primarily of office
     and laboratory equipment and leasehold improvements.  Leasehold
     improvements are amortized over the shorter of the terms of the related
     leases or the estimated useful lives of the assets.  Depreciation and
     amortization is calculated on the straight-line method over the estimated
     useful lives of the assets which range from three to five years.  Gains and
     losses on disposals are recognized in the year of disposal.  Repair and
     maintenance expenditures are expensed as incurred; significant renewals and
     betterments are capitalized.  Property and equipment leased under capital
     leases are capitalized at the lower of the present value of minimum lease
     payments or the fair value of the leased property.

     INTANGIBLE ASSETS

     Intangible assets are recorded at cost and are amortized using the
     straight-line method over their estimated useful lives.  The Company
     reviews these items on a regular basis for realization.

                                       25
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


     DEFERRED RENT

     The Company has received rent abatements for limited periods in connection
     with the lease for certain office and laboratory space.  Costs associated
     with this lease recorded on a straight-line basis over the full lease term
     resulted in deferred rent liability of $12,222 and $48,890 at December 31,
     1996 and 1995, respectively.


     REVENUE RECOGNITION
 
     Revenue from certain contracts is recognized as services are provided and
     costs are incurred.  For fixed-price contracts, revenue is recognized on
     the percentage-of-completion method, measured by the percentage of costs
     incurred over the estimated total costs for each contract.  This method is
     used because management considers expended costs to be the best available
     measure of progress on these  contracts.  Contract  costs  include  all
     direct material and labor costs and those indirect costs related to
     contract performance.  Selling, general and administrative costs are
     charged to expense as incurred.  Provisions for estimated losses on
     uncompleted contracts are made in the period in which such losses are
     determined.
 
     The asset "unbilled revenue" represents revenues recognized in excess of
     amounts billed.  Unbilled revenue generally represents work currently
     billable and such work is usually billed through the normal billing
     process.  Correspondingly, the liability "deferred revenue" represents
     billings in excess of revenues recognized.

     Balances billed but not paid by customers pursuant to retainage provisions
     in contracts will be due upon completion of the contracts and acceptance by
     the owner.  The retainage balance at December 31, 1996 of $311,615 is
     expected to be collected within the next 12 months.

     An allowance for doubtful accounts has been established based on
     management's assessment of the collectibility of all amounts billed and
     unbilled (including amounts subject to retainage) as of December 31, 1996.

     RESEARCH AND DEVELOPMENT

     All costs relating to research and development activities are expensed as
     incurred.

     NET LOSS PER COMMON SHARE

     Net loss per common share is computed by dividing the net loss by the
     weighted-average shares of common stock outstanding during the year.
     Preferred Stock, options and warrants have been excluded from the
     calculation of common and common stock equivalent shares because they are
     antidilutive.

                                       26
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


3.   BUSINESS ACQUISITION
     --------------------

     On February 9, 1996, the Company purchased all of the outstanding capital
     stock of MWR, Inc. for approximately $2,843,000.  The purchase price
     included 456,500 shares of Company Common Stock valued at approximately
     $1,511,000.  MWR is a provider of in situ remediation services with
     particular expertise in soil vapor extraction.  The acquisition has been
     accounted for by the purchase method of accounting.  The excess of the
     aggregate purchase price over the fair market value of net assets acquired
     resulted in goodwill of $1,063,615 and a covenant not to compete of
     $232,000.  These intangibles are being amortized over 10 and 5 years,
     respectively.

     The operating results of the acquisition are included in the Company's
     consolidated results of operations from the date of acquisition.  The
     following pro forma financial information assumes the acquisition occurred
     at the beginning of the periods presented and does not purport to be
     indicative of what would have occurred had the acquisition been made as of
     those dates or of results which may occur in the future.

<TABLE>
<CAPTION>
                                                                         Year Ended             Year Ended
                                                                      December 31, 1996     December 31, 1995
                                                                   -----------------------  ------------------
    <S>                                                            <C>                      <C>                
 
     Net revenues                                                            $ 13,198,361       $  12,740,698
     Net loss                                                               ($  2,659,069)     ($   2,745,200)
     Net loss per share applicable to
       Common Stock                                                              ($  0.23)           ($  0.34)
</TABLE> 

4.   PROPERTY AND EQUIPMENT
     ----------------------
 
     Property and equipment, net at December 31, 1996 and 1995
     consisted of the following:

<TABLE> 
<CAPTION>   
                                                                                   1996                1995
                                                                            -------------       -------------
     <S>                                                                    <C>                 <C>   
     Computer equipment                                                     $     283,624       $     238,368
     Acquired computer software                                                   210,000             210,000
     Laboratory and field equipment                                             1,650,326           1,068,665
     Equipment and vehicles under
      capital leases                                                              598,975             565,597
     Furniture and office equipment                                               278,551             278,038
     Leasehold improvements                                                       542,030             537,837
     Construction in progress                                                      12,839              65,232   
                                                                            -------------       -------------
                                                                                3,576,345           2,963,737
     Less:  Accumulated depreciation and
      amortization                                                              2,654,025           1,889,077
                                                                            -------------       -------------
                                                                            $     922,320       $   1,074,660
                                                                            =============       ============= 
</TABLE>

     Accumulated amortization on equipment under capital leases amounted to
     $397,524 and $345,867 at December 31, 1996 and 1995, respectively.
     Depreciation and amortization expense amounted to $797,049, $569,590 and
     $537,808 for the years ended December 31, 1996, 1995 and 1994,
     respectively.  No interest has been capitalized in 1996, 1995 or 1994.

                                       27
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


5.   INTANGIBLE ASSETS
     -----------------

     Intangible assets, net at December 31, 1996 and 1995 consisted of the
     following:

<TABLE>
<CAPTION>
                                            1996             1995   
                                        ----------         -------- 
<S>                                     <C>                <C>      
     Goodwill                           $1,108,361          $44,746 
     Patents                               222,611                  
     Covenant not to compete               232,000                  
     Organizational costs                    5,428            5,428 
     Licensing agreement                     3,500            3,500 
                                        ----------          ------- 
                                         1,571,900           53,674 
     Less:  Accumulated amortization       223,223           27,575 
                                        ----------          ------- 
                                        $1,348,677          $26,099 
                                        ==========          =======  
</TABLE>

     Amortization expense for intangible assets amounted to $195,648, $4,593 and
     $5,176 for the years ended December 31, 1996, 1995 and 1994, respectively.

6.   ACCRUED EXPENSES AND OTHER LIABILITIES
     --------------------------------------

     Accrued expenses and other liabilities at December 31, 1996 and 1995
     consisted of the following:

<TABLE>
<CAPTION>
                                               1996          1995    
                                             ---------    ---------    
<S>                                          <C>          <C>          
     Salaries, benefits and payroll taxes     $279,933     $164,953    
     Taxes                                     417,618      319,641    
     Professional fees                          75,000       69,000    
     Contracts accrual                         178,075       50,000    
     Other                                       5,260       10,097    
                                              --------     --------     
                                              $955,886     $613,691    
                                              ========     ========      
</TABLE>

7.   NOTE PAYABLE
     ------------

     In December 1992, the Company borrowed $20,000 to fund certain leasehold
     improvements to its office and laboratory facilities.  The note payable is
     a five-year term note bearing 8% interest.  The balance at December 31,
     1996 of $4,287 will mature in 1997.

8.   INCOME TAXES
     ------------

     The Company accounts for income taxes under the provisions of Statement of
     Financial Accounting Standards No. 109, "Accounting for Income Taxes"
     ("SFAS 109").  SFAS 109 requires recognition of deferred tax liabilities
     and assets for the expected future tax consequences of events that have
     been included in the financial statements or tax returns.  Under this
     method, deferred  tax  liabilities and  assets  are  determined  based on
     the difference between the financial statement and tax bases of assets and
     liabilities using enacted tax rates in effect for the year in which the
     differences are expected to reverse.  The Company has provided a full
     valuation allowance against the net deferred tax debits due to the
     uncertainty of realization.  The change in the valuation allowance for the
     year ended December 31, 1996 was an increase of $836,264.

                                       28
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


     Temporary differences and carryforwards which give rise to deferred tax
     assets and liabilities at December 31, 1996 and 1995 are as follows:

<TABLE>
<CAPTION>
 
                                              1996                  1995
                                          Deferred Tax          Deferred Tax
                                      Assets (Liabilities)  Assets (Liabilities)
                                      --------------------  --------------------
<S>                                   <C>                   <C>
     Accrued liabilities                $   216,702           $   157,383
     Contract reserve                        60,546                17,000
     Deferred rent                            4,155                16,623
     Depreciation                           266,502               153,496
     Amortization                           (41,769)               11,894
     Bad debts                               69,615                44,670
     Partnership interest                   (18,243)
     Net operating loss - federal         6,613,615             5,984,000
     State taxes                          1,397,461             1,347,254
     Tax credits                            297,187               297,187
                                        -----------           -----------
                Total                     8,865,771             8,029,507
 
     Valuation allowance - federal       (7,468,310)           (6,682,253)
     Valuation allowance - state         (1,397,461)           (1,347,254)
                                        -----------           -----------
          Total deferred taxes          $         0           $         0
                                        ===========           ===========
</TABLE>

     As of December 31, 1996, the Company had a net operating loss carryforward
     of approximately $19,300,000 for Federal income tax purposes which is
     available to offset future taxable income, if any, between the years 1997
     and 2011.  The timing and manner in which these losses may be utilized are
     limited to approximately $1,700,000 per year based on preliminary
     calculations of ownership changes to date by Internal Revenue Code Section
     382.

9.   COMMON STOCK
     ------------

     On May 24, 1996, the Company successfully completed the private placement
     of 2,000,000 shares of Common Stock resulting in net proceeds of
     $4,607,984.  Allen & Company Incorporated ("Allen & Company"), a principal
     stockholder of the Company, acted as the placement agent.  An officer of
     Allen & Company is also a director of the Company.

     SERIES C CONVERTIBLE PREFERRED STOCK
     ------------------------------------

     On April 27, 1995, the Company completed the private placement of 280,000
     shares of Series C Convertible Preferred Stock ("Preferred Stock") for
     $12.50 per share, resulting in net proceeds of $3,457,242.  Allen &
     Company, a principal stockholder of the Company, acted as the placement
     agent and purchased 138,000 shares of Preferred Stock for its own account.
     An officer of Allen & Company is a director of the Company.  The following
     directors of the Company at that time also purchased the indicated number
     of shares of Preferred Stock in the private  placement:  James A. Courter
     (8,000),  Harcharan S. Gill (8,000), Robert F. Hendrickson (8,000), Robert
     F. Johnston (16,000), Seymour L. Meisel (10,000) and Robert C. Miller
     (10,000).  The shares of Preferred Stock were convertible at the option of
     each holder at a conversion rate of ten shares of Common Stock for each
     share of Preferred Stock and were subject to mandatory conversion in April
     1997 upon the fulfillment of certain conditions.  Quarterly dividends on
     the Preferred Stock were payable at a rate of $.625 per share per annum.
     The Preferred Stock was redeemable by the

                                       29
<PAGE>
 
                                ENVIROGEN, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                              __________________


     holders if certain financial covenants were not met.  The Company was in
     compliance with all covenants at December 31, 1995.  On December 28, 1995,
     Preferred Stockholders voluntarily converted 50% of their shares of
     Preferred Stock into 1,400,000 shares of Common Stock, and in consideration
     of such voluntary conversion, a special dividend of $116,667 was paid.  In
     May 1996, the remainder of the Preferred Stock was converted into an
     additional 1,400,000 shares of Common Stock.   Regular Preferred Stock
     dividends of $36,458 and $116,666 were  recognized in 1996 and 1995,
     respectively.  Holders also have certain registration rights with respect
     to the shares of Common Stock issued upon conversion of the Preferred
     Stock.

10.  OPTIONS AND WARRANTS
     --------------------

     In April 1990, the Company adopted the 1990 Incentive Stock Option and Non-
     Qualified Stock Option Plan (the "Plan") which expires in March 2000.
     Under the amended terms of the Plan, the Company's Stock Option Committee
     is authorized to grant incentive stock options ("ISOs") to officers and
     other key employees, as well as non-qualified stock options ("NQSOs") to
     key employees, directors, scientific advisory board members and consultants
     to purchase an aggregate of 2,000,000 shares of Common Stock (3,500,000
     shares, subject to stockholder approval).  Standard provisions of the Plan,
     which may vary with Board and stockholder approval, require that the term
     of each grant not exceed ten years.

     In May 1993, the Company adopted the 1993 Directors' Non-Qualified Stock
     Option Plan (the "1993 Plan") which expires in May 2003.  Under the amended
     terms of the 1993 Plan, an option to purchase 15,000 shares of Common Stock
     shall be automatically granted to each new Non-Employee Director on the day
     the Non-Employee Director is first elected as a member of the Board of
     Directors. Thereafter, an option to purchase 5,000 shares of Common Stock
     shall be granted on June 1 of each year to each Non-Employee Director who
     is elected at subsequent annual meetings of stockholders, except that the
     Chairman of the Board shall be granted an option to purchase 7,500 instead
     of 5,000 shares of Common Stock.  Non-Employee Directors who are not
     initially elected at an Annual Meeting of Stockholders will receive a pro
     rata portion of 5,000 shares (or 7,500 shares with respect to the Chairman
     of the Board) of Common Stock based on the number of full months remaining
     from the date of election until the next Annual Meeting of Stockholders
     divided by twelve.  Any fractional shares resulting from such calculation
     shall be rounded up to the nearest whole number.

     In 1995, the Board of Directors approved a plan allowing employees with
     stock options issued in 1992 and 1993 with exercise prices of $5.00 or more
     per share to exchange such options for new options at the then-current
     market price.  Participating employees received new stock options with an
     exercise price of $3.22 per share for 90% of the options they surrendered.
     Participating employees also agreed to a new five-year vesting schedule
     (20% per year) commencing on September 19, 1995.  As a result, options for
     49,750 shares were forfeited in exchange for new options to purchase 44,775
     shares.

     Generally, options granted become exercisable at a rate of 20% per annum
     from the date of grant, and the option price may not be less than 100% and
     75% of the fair market value on the date of grant for ISOs and NQSOs,
     respectively. The annual Non-Employee Director grants vest at the end of
     the first year of grant.

                                       30
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


Following is a summary of the stock option transactions for 1994, 1995 and 1996:

<TABLE>
<CAPTION>
                                                                   Weighted                                  Weighted
                                                                   Average                                   Average      
                                             Number of             Exercise                                 Fair Value    
                                               Shares              Price Per            Option              per Option        
                                             Outstanding             Share           Price Range             Granted         
                                             -----------          -----------        -----------           ----------     
<S>                                         <C>                   <C>               <C>                    <C>                 
Balance December 31, 1993                     527,500               $ 3.04          $ 0.20 - $ 7.50                       
 Granted                                      238,750               $ 3.11                                                          
 Forfeited                                  ( 150,980)              $ 3.96                                                          
 Exercised                                  (  45,500)              $ 0.49                                                          
                                            ----------                                                                       
Balance December 31, 1994                     569,770               $ 3.04          $ 0.20 - $ 7.50                       
                                            ----------                                                                       
 Granted                                      391,750               $ 2.02                                 $ 1.25     
 Forfeited                                  ( 106,000)              $ 5.04                                                          
 Exercised                                  (  46,570)              $ 0.28                                                          
                                            ----------                                                                       
Balance December 31, 1995                     808,950               $ 2.44          $ 0.20 - $ 7.25                       
                                            ----------                                                                       
 Granted                                      779,665               $ 3.17                                 $ 1.96      
 Forfeited                                  (  31,300)              $ 3.31                                                          
 Exercised                                  (  25,980)              $ 0.64                                                          
                                            ----------                                                                       
Balance December 31, 1996                   1,531,335               $ 2.83          $ 0.20 - $ 7.25      
                                            ==========                      
                                                                            
Exercisable at December 31, 1993              128,800               $ 1.59  
Exercisable at December 31, 1994              180,980               $ 2.37  
Exercisable at December 31, 1995              207,360               $ 2.36  
Exercisable at December 31, 1996              333,770               $ 2.56   
</TABLE>

The weighted average remaining contractual lives of outstanding options at
December 31, 1996 was approximately 6.5 years.

The Company applies the provisions of APB 25 and related interpretations in
accounting for its stock-based compensation plans. Accordingly, no compensation
has been recognized in the financial statements in respect to the above plans.
Had compensation costs for the above plans been determined based on the fair
value at the grant dates for awards under those plans consistent with the method
of Statement of Financial Accounting Standards No. 123 "Accounting for Stock
Based Compensation", the Company's net loss and net loss per share would have
been increased to the pro forma amounts below:

<TABLE>
<CAPTION>
                                                                   1996                   1995       
                                                              --------------         --------------   
<S>                                                           <C>                    <C>            
                                                                                                      
         Pro forma net loss applicable to                      ($3,031,940)            ($2,449,400)   
          Common Stock                                                                                
         Pro forma net loss per share applicable to                 ($0.27)                 ($0.32)    
          Common Stock
</TABLE>

As options vest over a varying number of years, and awards are generally made
each year, the pro forma impacts shown here are likely to increase given the
same level of activity in the future.

                                       31
<PAGE>
 
                                ENVIROGEN, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


     The pro forma compensation expense of $351,525 and $63,567 for 1996 and
     1995, respectively, was calculated based on the fair value of each option
     grant using the Black-Scholes model with the following weighted-average
     assumptions used for grants:

<TABLE>
<CAPTION>
                                            1996             1995   
                                         ----------       ----------
<S>                                      <C>              <C>       
          Dividend yield                     0                0 
          Expected volatility               41.9%            45.3%
          Risk free interest rate            6.53%            6.28%
          Expected option lives              6.5 years        6.5 years  
</TABLE>

     In October 1993, the Company issued 790,148 redeemable Common Stock
     Purchase Warrants. Each warrant entitles the holder to purchase one-half of
     one share of Common Stock for $5.20 per full share subject to adjustment.
     The warrants are exercisable for five years.

     In May 1996, the Company issued warrants to purchase an aggregate of
     200,000 shares of the Company's Common Stock at an exercise price of $2.50
     per share, including warrants to purchase 150,000 shares to a principal
     stockholder.  The warrants expire seven years from date of issuance.  See
     Note 13 for additional information regarding the Company's other warrants.

11.  COMMITMENTS AND CONTINGENCIES
     -----------------------------

     LEASES

     The Company is party to various operating leases relating to office,
     laboratory and pilot plant facilities, as well as automobiles and
     equipment.  All leases expire prior to 2005.  The leases include escalation
     clauses and require that the Company pay for certain operating costs.  It
     is expected that in the normal course of business the majority of the
     leases will be renewed or replaced by other leases.  The Company also has
     capitalized leases consisting principally of leases for computers and field
     equipment.

     Future minimum payments under capital and noncancelable operating leases
     consisted of the following at December 31, 1996:

<TABLE>
<CAPTION>
                                                          Capital                    Operating   
                                                          Leases                      Leases    
                                                       ------------                ------------ 
<S>                                                    <C>                        <C>          
          1997                                         $    23,766                 $    782,401  
          1998                                              19,644                      668,189  
          1999                                               9,048                      539,854  
          2000                                               5,527                      550,534  
          2001                                                   -                      608,757  
          Thereafter                                             -                    1,408,381  
                                                       ------------                ------------  
          Total minimum lease payments                      57,985                   $4,558,116  
                                                                                   ============  
          Less amount representing interest               (  9,727)  
                                                       ------------ 
          Present value of net minimum capital                      
           lease payments                              $    48,258  
                                                       ============  
</TABLE>

     Rent expense for operating leases was $700,985, $557,361 and $577,471 for
     the years ended December 31, 1996, 1995 and 1994, respectively.

                                       32
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


     LICENSES

     Pursuant to a license agreement with Amgen, Inc. ("Amgen") dated February
     27, 1990, the Company was granted an exclusive license to use naturally
     occurring and genetically-modified TCE-degrading bacteria and a non-
     exclusive license to use and sell naturally occurring and genetically-
     modified pesticide-degrading bacteria.  The licenses are royalty-free and
     cover use of the bacteria in the United States and Canada.  The Company
     issued Amgen 35,000 shares of Common Stock valued at $3,500 as
     consideration for the licenses.  The licenses terminate in each country
     upon the later of the expiration of the last remaining licensed patent or
     ten years following the first commercial use of the technology in such
     country.

     The Company has granted a major customer, exclusively for its own
     operations, an irrevocable, non-exclusive, nontransferable license to use
     all presently existing and any future technology that the Company may own
     relating to PCB remediation and that it is not otherwise subject to
     restrictions imposed by third parties.  With certain limited exceptions,
     the Company is required to pay the major customer a royalty based on gross
     revenues received by the Company from the utilization of any jointly-owned
     technology or any PCB-related remediation technology owned, developed or
     obtained by the Company.  The maximum aggregate royalty payable to the
     major customer by the Company under the technology agreement may not exceed
     the development funding received by the Company from the major customer.
     At December 31, 1996, the Company had no obligations under the royalty
     agreement and had received development funding from the inception of the
     development work in 1990 of approximately $3,523,000.

     ENVIRONMENTAL LIABILITY AND INSURANCE

     The Company could be held liable under various laws and regulations if
     microorganisms or hazardous wastes cause harm to humans or the environment,
     even if the Company were not negligent.  Although the Company has a
     $5,000,000 contractor's pollution liability insurance policy, there can be
     no assurance that environmental liabilities that may be incurred by the
     Company will be covered by its insurance or that the dollar amount of
     covered liabilities will not exceed policy limits.

12.  RESEARCH AND DEVELOPMENT CONTRACTS
     ----------------------------------

     The Company contracts with major corporations and government entities to
     conduct feasibility studies, sponsored research and development and to
     remediate contamination problems.  Pursuant to the Company's contracts, the
     work is generally conducted in phases beginning with feasibility studies to
     demonstrate that the Company's bacteria will degrade the targeted waste.
     Each sponsoring corporation or governmental entity may terminate the work
     being conducted by the Company upon the completion of each phase and each
     additional phase generally is separately contracted for by the sponsoring
     corporation or governmental entity.

13.  RELATED PARTY TRANSACTIONS
     --------------------------

     A related party received, among other compensation, warrants to purchase
     123,000 shares of the Company's Common Stock at an exercise price of $8.75
     per share for acting as representative of the underwriters of the Company's
     initial public offering in August 1992. The warrants expire five years from
     date of issuance. 

                                       33
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


     In April 1995, a principal stockholder of the Company acted as the
     placement agent for the Company's private placement of 280,000 shares of
     Series C Convertible Preferred Stock.  An officer of the placement agent is
     also a director of the Company.  The placement agent received warrants to
     purchase 140,000 shares of Common Stock at an exercise price of $1.25 per
     share.  The warrants expire five years from date of issuance.  See Note 9
     for additional information on related parties who purchased Preferred Stock
     in the private placement. In April 1995, the Company entered into a two-
     year financial advisory agreement with the placement agent and agreed to
     pay an annual fee of $100,000.

     In March 1996, the Company issued options for 100,000 shares of  Common
     Stock at $2.82 per share to one of its directors under the 1990 Incentive
     Stock Option and Non-Qualified Stock Option Plan.  The options vest one
     year from date of grant and expire ten years from date of issuance.  The
     director is an officer of a principal stockholder.

     In May 1996, a principal stockholder of the Company acted as the placement
     agent for the Company's private placement of 2,000,000 shares of Common
     Stock.  An officer of the placement agent is also a director of the
     Company.  The placement agent received a placement fee of $300,000, was
     reimbursed for certain legal fees and other expenses and received warrants
     to purchase 150,000 shares of the Company's Common Stock at an exercise
     price of $2.50 per share.  The warrants expire seven years from date of
     issuance.

     In December 1996, the Company engaged a principal stockholder to provide
     financial advisory services, including the preparation and delivery of an
     opinion to the Company's Board of Directors regarding the fairness, from a
     financial point of view, of the terms of the proposed Merger and the
     Warburg Transaction (see Note 1). The Company agreed to pay the stockholder
     $250,000.  An officer of the stockholder is also a director of the Company.

14.  EMPLOYEE BENEFITS
     -----------------

     The Company sponsors a combined 401(k) employee savings and retirement plan
     and profit sharing plan covering all employees who are at least 21 years of
     age and have completed one year of service.  The Company's contribution
     expense related to the 401(k) savings plan was $81,630, $53,992 and $54,516
     for the years ended December 31, 1996, 1995 and 1994, respectively.  There
     was no contribution expense related to the profit sharing plan.  The
     Company does not maintain other pension or postretirement benefit plans.

     In 1995 and 1994 the Company maintained an Executive Bonus Plan.  The plan
     was administered by the compensation committee, which set the performance
     targets for each year and authorized bonuses to the extent to which those
     targets were met.  The Company incurred no expenses relating to the plan
     during those years.

15.  CONCENTRATION OF CREDIT RISK/OTHER
     ----------------------------------

     The Company provides credit to customers on an unsecured basis after
     evaluating customer credit worthiness. The Company also provides a reserve
     for bad debts for accounts receivable where there is a possibility of loss.

                                       34
<PAGE>
 
                                ENVIROGEN, INC.
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED)
                              __________________


     The Company maintains demand deposits with one major bank and money market
     accounts with two financial institutions. At December 31, 1996 and 1995,
     substantially all of the Company's cash and cash equivalents were held in
     these money market accounts.

     The Company performs contracts for various federal government agencies.
     Revenue recognized under these contracts for the years ended December 31,
     1996, 1995 and 1994 was $1,417,059, $834,818 and $869,254, respectively.
     These revenues are primarily from research and development contracts.

16.  RESTRICTED CASH
     ---------------

     At December 31, 1996 and 1995, the Company had $309,300 of restricted cash
     classified as a non-current asset.  These funds serve as collateral on a
     performance bond for a major contract.

17.  INDUSTRY SEGMENT AND MAJOR CUSTOMER DATA
     ----------------------------------------

     The Company's operations are conducted within one business segment.  There
     are minimal revenues attributable to foreign customers.  Customers
     comprising 10% or greater of the Company's revenues are summarized as
     follows:

<TABLE>
<CAPTION>
                              1996         1995       1994  
                              ----         ----       ----  
<S>                           <C>          <C>        <C> 
               Customer A     12%               
               Customer B                  21%        13% 
               Customer C                  10%        19%  
</TABLE>

18.  JOINT VENTURE
     -------------

     On May 5, 1995, the Company and nv VAM of the Netherlands formed a joint
     venture, CVT America, L.L.C. ("CVT America"), to supply advanced
     biofiltration systems and services for the treatment of odors, air toxics
     and volatile organic contaminants to the air pollution control market in
     North and South America. Under the terms of the transaction, VAM
     transferred to CVT America substantially all of the assets, including a
     license agreement for the technology related to the biological treatment of
     chemical contaminants in air streams, of its wholly-owned subsidiary, CVT
     Air Technologies. For its 50% interest in CVT America, the Company paid
     $48,250 in cash and issued 58,140 shares of Envirogen common stock (valued
     at $125,000) to VAM and made an initial capital contribution to CVT America
     of $3,500. Additional capital contributions totaling $98,250 were made in
     the second half of 1995. In April 1996, the Company made an interest
     bearing loan of $100,000 to CVT America. The Company also entered into a
     sublicense agreement with CVT America for the technology licensed from VAM.
     The joint venture has an initial term of three years, subject to renewal.
     The difference between the carrying value and the underlying equity in the
     net assets was $87,687 at the inception of the joint venture. This
     difference is being amortized over the initial three year term of the joint
     venture. The amount amortized through December 31, 1996 amounted to
     $48,715. CVT America's place of business is located at the Company's
     headquarters in Lawrenceville, New Jersey.

                                       35
<PAGE>

                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                             --------------------
 
19.  PROVISION FOR CONTRACT CLAIM
     ----------------------------

     In January 1996, a biofiltration system installed by the Company for the
     Nylonge Corporation suffered a shutdown, which the Company believes was
     primarily caused by a failure of internal grating material supplied by
     third parties.  Throughout 1996, the Company investigated the cause of the
     failure, redesigned the internal grating and rebuilt and restarted the
     system at a cost of approximately $650,000.

20.  SUPPLEMENTARY STATEMENT OF OPERATIONS INFORMATION
     -------------------------------------------------

     Maintenance and repairs expense for the years ended December 31, 1996, 1995
     and 1994 was $79,325, $44,356 and $82,588, respectively.

                                       36
<PAGE>



                                                                     Schedule II
                                Envirogen, Inc.
                       Valuation and Qualifying Accounts
                 Years Ended December 31, 1996, 1995 and 1994

<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------------------------------------------------------------
                                               Balance at        Charged to       Charged to        Balance             Balance
                                               beginning          costs and      other account     booked for           at end of
          Description                           period            expenses        -describe        acquisition           period
------------------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>               <C>             <C>               <C>                 <C> 
Year ended December 31, 1996:
     
     Allowance for doubtful accounts             $131,381           $84,800        $17,043 (a)     $46,000 (b)          $245,138
     Tax valuation allowance                    8,029,507           836,264                                            8,865,771

Year ended December 31, 1995:

     Allowance for doubtful accounts             $107,932           $60,000        $36,551 (a)                          $131,381
     Tax valuation allowance                    7,155,060           874,447                                            8,029,507

Year ended December 31, 1994:

     Allowance for doubtful accounts             $120,366           $17,700        $30,134 (a)                          $107,932
     Tax valuation allowance                    5,199,227         1,955,833                                            7,155,060
------------------------------------------------------------------------------------------------------------------------------------
</TABLE> 

(a)  Uncollectible accounts charged off
(b)  Balance in the financial statements of MWR, Inc. at acquisition

                                      37

<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and Stockholders of Envirogen, Inc.:


We have audited the consolidated financial statements and the financial
statement schedule of Envirogen, Inc. as listed in Item 14(a) of this Form 10-K.
These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and the financial statement schedule based
on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Envirogen, Inc. as
of December 31, 1996 and 1995 and the consolidated results of their operations
and their cash flows for each of the three years in the period ended December
31, 1996 in conformity with generally accepted accounting principles. In
addition, in our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.



                                        Coopers & Lybrand L.L.P.



Princeton, New Jersey
February 20, 1997

                                      38
<PAGE>
 
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

          Not applicable.



                                    PART III

INCORPORATED BY REFERENCE

The information called for by Item 10 "Directors and Executive Officers of the
Registrant" (other than the information concerning executive officers set forth
after Item 4 herein), Item 11 "Executive Compensation", Item 12 "Security
Ownership of Certain Beneficial Owners and Management" and Item 13 "Certain
Relationships and Related Transactions" is incorporated herein by reference to
the Company's definitive proxy statement for its Annual Meeting of Stockholders
scheduled to be held on April 9, 1997 which definitive proxy statement is
expected to be filed with the Commission not later than 120 days after the end
of the fiscal year to which this report relates.

                                      39
<PAGE>
 
                                   SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

                                         Envirogen, Inc.

Dated:  March 11, 1997                   By:      /s/ Harcharan S. Gill
                                               ---------------------------------
                                                    Harcharan S. Gill
                                                      President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on behalf of the registrant, in the capacities indicated,
on the 11th day of March, 1997.

          Signature                                         Title
          ---------                                         -----

      Harcharan S. Gill*                      President, Chief Executive
---------------------------------------
                                                  Officer and Director
       Harcharan S. Gill                       (Principal Executive Office)


      /s/ Patricia A. McQueary                Controller (Principal Financial
----------------------------------------
                                                  and Accounting Officer)
          Patricia A. McQueary


         Robert F. Hendrickson*               Chairman of the Board and Director
-----------------------------------------
       Robert F. Hendrickson


           Robert F. Johnston*                Director
-----------------------------------------
           Robert F. Johnston


           Seymour L. Meisel*                 Director
-----------------------------------------
           Seymour L. Meisel


           Robert C. Miller*                  Director
-----------------------------------------
           Robert C. Miller


           Peter J. Neff*                     Director
-----------------------------------------
           Peter J. Neff

___________
*Harcharan S. Gill, pursuant to a Power of Attorney executed by each of the
directors noted above and filed with the Securities and Exchange Commission as
Exhibit 24 to this Annual Report on Form 10-K, by signing his name hereto, does
hereby sign and execute this Annual Report on Form 10-K on behalf of each of the
persons noted above, in the capacities indicated, and does hereby sign and
execute this Annual Report on Form 10-K on his own behalf, in the capacities
indicated.

                                                 /s/ Harcharan S. Gill
                                             -----------------------------------
                                                  Harcharan S. Gill

                                      40
<PAGE>
 
                                    PART IV
 
ITEM 14.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
            FORM 8-K

(a)  Documents filed as a part of this Report.


1.   Financial Statements:
     ---------------------
 
     Consolidated Balance Sheets as of December 31, 1996 and 1995....... 20

     Consolidated Statements of Operations for the years ended
     December 31, 1996, 1995 and 1994................................... 21

     Consolidated Statements of Changes in Stockholders' Equity
     for the years ended December 31, 1996, 1995 and 1994............... 22

     Consolidated Statements of Cash Flows for the years ended
     December 31, 1996, 1995 and 1994................................... 23

     Notes to Consolidated Financial Statements......................... 24

2.   Financial Statement Schedules:
     ------------------------------

     II.  Valuation and Qualifying Accounts............................. 37

     Report of Independent Accountants.................................. 38

     All other schedules not listed above have been omitted, since they are not
     applicable or are not required, or because the required information is
     included in the consolidated financial statements or notes thereto.

3.   Exhibits:
     ---------

     Exhibit No.                   Description                    Location
     ----------                    -----------                    --------

     2.1    Stock Purchase Agreement dated February 9, 1996
            by and among ETG Environmental, Inc., MWR, Inc.
            and the Registrant................................ (8) (Exh. 2)

     2.2    Agreement and Plan of Merger dated January 14, 1997
            by and among Fluid Management, Inc., William C.
            Smith,Douglas W. Jacobson, Gary W. Hawk, Richard W.
            Schowengerdt and the Registrant (the "Merger
            Agreement")....................................... (11) (Exh.2.1)

     3.1(a) Restated Certificate of Incorporation dated
            September 5, 1991................................. (2) (Exh. 3.1(a))

     3.1(b) Certificate of Amendment to Restated
            Certificate of Incorporation dated August 18, 1992 (2) (Exh. 3.1(c))

     3.2    By-Laws, as amended............................... (2) (Exh. 3.2)

                                      41 
<PAGE>
 
<TABLE> 
<CAPTION> 
Exhibit No.         Description                                    Location
----------          -----------                                    --------
<S>       <C>                                                      <C>      
3.3       Certificate of Designation, Preferences and
          Rights of Series C Convertible Preferred Stock of
          the Company as filed with the Delaware
          Secretary of State on April 26, 1995................... (6) (Exh. 3)

3.4       Form of Certificate of Merger to be filed with the
          Delaware Secretary of State pursuant to the Merger
          Agreement.............................................. (1)

10.1      License Agreement dated February 27, 1990 between the
          Company and Amgen, Inc., as amended March 4, 1992...... (2) (Exh. 10.12)

10.2      Lease dated July 13, 1990 between the Company and
          United States Land Resources, L.P. for office and
          laboratory facilities in Lawrence Township, New
          Jersey, as amended..................................... (2) (Exh. 10.15)

10.3      Lease dated November 15, 1991 between the Company and
          United States Land Resources, L.P. for pilot
          facilities in Lawrence Township, New Jersey............ (2) (Exh. 10.16)

10.4      Envirogen, Inc. 401(k) Plan............................ (2) (Exh. 10.18)

10.5      Registration Rights Agreement dated April 25, 1990
          between the Company and the investors listed thereon... (2) (Exh. 10.19)

10.6      Form of Employee Nondisclosure and Development
          Agreement dated April 25, 1990 between the Company and
          David N. Enegess and Ronald Unterman*.................. (2) (Exh. 10.20)

10.7      Form of Non-Competition Agreement dated April 25, 1990
          between the Company and David N. Enegess and
          Ronald Unterman*....................................... (2) (Exh. 10.21)

10.8      Form of Confidentiality and Non-Compete Agreement dated
          October 31, 1991 between Vapex and Michael C. Marley,
          Bruce L. Cliff and Peter Nangeroni..................... (2) (Exh. 10.26)

10.9      Licensing Agreement between the Company and
          Environmental Research Laboratory-Gulf Breeze
          dated March 10, 1993................................... (3) (Exh. 10.30)

10.10     Collaborative Marketing Agreement between the Company
          and J.R. Simplot Company dated as of June 15, 1993..... (4)

10.11(a)  Employment Agreement dated June 22, 1994 between the
          Company and Harch S. Gill ("Previous Agreement")*...... (5) (Exh. 10.26)

10.11(b)  Employment Agreement dated June 1, 1996 between the
          Company and Harcharan S. Gill (replaces Previous
          Agreement)*............................................ (1)

10.12     Registration Rights Agreement dated as of July 11, 1994 between the
          Company and the investors listed
          thereon................................................ (5) (Exh. 10.27)
</TABLE> 

                                      42
<PAGE>
 
<TABLE> 
<CAPTION> 
Exhibit No.              Description                                       Location
-----------              ------------                                      --------
<S>      <C>                                                               <C> 
10.13    Agreement between Baker Environmental, Inc. and the
         Company dated November 8,  1994.................................  (5) (Exh. 10.29)

10.14    Preferred Stock Purchase Agreement between the Company
         and the several purchasers set forth on Schedule 1.1 thereto,
         dated April 27, 1995............................................  (6) (Exh. 10.1)

10.15    Registration Rights Agreement among the Company and each
         of the shareholders set forth thereon, dated April 27, 1995.....  (6) (Exh. 10.2)

10.16    Financial Advisor Services Agreement between the Company
         and Allen & Company, Incorporated, dated April 27, 1995.........  (6) (Exh. 10.4)

10.17    Operating Agreement of CVT America, L.L.C. dated
         May 5, 1995.....................................................  (6) (Exh. 10.5)

10.18    Sublicense Agreement between CVT America, L.L.C. and
         the Company dated as of May 5, 1995.............................  (6) (Exh. 10.6)

10.19    Agreement between the Department of the Air Force and the
         Company dated September 21, 1995................................  (7) (Exh. 10.1)

10.20    Agreement between the Department of Energy and the Company
         dated September 25, 1995........................................  (7) (Exh. 10.2)

10.21    Registration Rights Agreement dated February 9, 1996 by and
         between ETG Environmental, Inc. and the Company.................  (8) (Exh. 99)

10.22    Envirogen, Inc. 1990 Incentive Stock Option and Non-
         Qualified Stock Option Plan, as amended*........................  (1)

10.23    Envirogen, Inc. 1993 Director's Non-Qualified Stock
         Option Plan, as amended*........................................  (9) (Exh. 10.27)

10.24    1995 Activation Orders between the Company and Texas
         Eastern Transmission Corporation dated February 10, 1995........  (9) (Exh. 10.28)

10.25    Agreement between ABTco and the Company dated
         October 30, 1995................................................  (9) (Exh. 10.29)

10.26    Collaborative Marketing Agreement between the Company
         and Dow Environmental Inc. dated December 28, 1995..............  (9) (Exh. 10.30)

10.27    Development agreement dated November 7, 1996 between
         Envirogen, Inc. and Rhone-Poulenc Inc...........................  (10) (Exh. 10.2)

10.28    Securities Purchase Agreement dated January 14, 1997 by
         and between Warburg, Pincus Ventures, L.P. and the
         Registrant......................................................  (11) (Exh. 2.2)
</TABLE> 

                                      43 
<PAGE>
 
<TABLE> 
<CAPTION> 
Exhibit No.                  Description                          Location
-----------                  -----------                          --------
<S>       <C>                                                  <C>      
21        Subsidiaries of the Company........................  (1)
 
23        Consent of Coopers & Lybrand  L.L.P................  (1)
 
24        Powers of Attorney.................................  (1)
</TABLE> 
_______________________
(1)       Filed herewith.
(2)       Incorporated by reference to the indicated exhibit to the Company's
          Registration Statement on Form S-1 (File No. 33-48576) which became
          effective on August 11, 1992. 
(3)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form  10-K for the year ended December 31, 1992.
(4)       Incorporated by reference to the indicated exhibit to the Company's
          Registration on Form S-1 (File No. 33-65430) which became effective
          on October 13, 1993.
(5)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form  10-K for the year ended December 31, 1994.
(6)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form  10-Q for the quarter ended March 31, 1995.
(7)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form  10-Q for the quarter ended September 30, 1995.
(8)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form  8-K filed January 5, 1996.
(9)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form  10-K for the year ended December 31, 1995.
(10)      Incorporated by reference to the indicated exhibit to the Company's
          Report on  Form 10-Q for the quarter ended September 30, 1996.
(11)      Incorporated by reference to the indicated exhibit to the Company's
          Report on  Form 8-K filed January 14, 1997.

*         Indicates a management contract or compensatory plan or arrangement.

(b)       Reports on Form 8-K

          The Company did not file any reports on Form 8-K during the last
          quarter of the fiscal year covered by this report.

                                      44
<PAGE>
 
                                 EXHIBIT INDEX

Sequential
----------
Exhibit No.              Description
-----------              -----------

2.1       Stock Purchase Agreement dated February 9, 1996
          by and among ETG Environmental, Inc., MWR, Inc.
          and the Registrant, (8)

2.2       Agreement and Plan of Merger dated January 14, 1997 by and
          among Fluid Management, Inc., William C. Smith,
          Douglas W. Jacobson, Gary W. Hawk, Richard W. Schowengerdt
          and the Registrant, (11)

3.1(a)    Restated Certificate of Incorporation dated
          September 5, 1991, (2)

3.1(b)    Certificate of Amendment to Restated
          Certificate of Incorporation dated August 18, 1992, (2)

3.2       By-Laws, as amended, (2)

3.3       Certificate of Designation, Preferences and
          Rights of Series C Convertible Preferred Stock of
          the Company as filed with the Delaware
          Secretary of State on April 26, 1995, (6)

3.4       Form of Certificate of Merger to be filed with the Delaware
          Secretary of State pursuant to the Merger Agreement, (1)

10.1      License Agreement dated February 27, 1990 between the
          Company and Amgen, Inc., as amended March 4, 1992, (2)

10.2      Lease dated July 13, 1990 between the Company and
          United States Land Resources, L.P. for office and
          laboratory facilities in Lawrence Township, New
          Jersey, as amended, (2)

10.3      Lease dated November 15, 1991 between the Company and
          United States Land Resources, L.P. for pilot
          facilities in Lawrence Township, New Jersey, (2)

10.4      Envirogen, Inc. 401(k) Plan, (2)

10.5      Registration Rights Agreement dated April 25, 1990
          between the Company and the investors listed thereon, (2)

                                      45
 
<PAGE>
 
Sequential
----------
Exhibit No.              Description
-----------              -----------

10.6      Form of Employee Nondisclosure and Development
          Agreement dated April 25, 1990 between the Company and
          David N. Enegess and Ronald Unterman*, (2)

10.7      Form of Non-Competition Agreement dated April 25, 1990
          between the Company and David N. Enegess and Ronald
          Unterman*, (2)

10.8      Form of Confidentiality and Non-Compete Agreement dated
          October 31, 1991 between Vapex and Michael C. Marley,
          Bruce L. Cliff and Peter Nangeroni, (2)

10.9      Licensing Agreement between the Company and Environmental
          Research Laboratory-Gulf Breeze dated March 10, 1993, (3)

10.10     Collaborative Marketing Agreement between the Company and
          J.R. Simplot Company dated as of June 15, 1993, (4)

10.11(a)  Employment Agreement dated June 22, 1994 between the Company
          and Harch S. Gill, ("Previous Agreement")*, (5)

10.11(b)  Employment Agreement dated June 1, 1996 between the
          Company and Harcharan S. Gill (replaces Previous Agreement)*, (1)

10.12     Registration Rights Agreement dated as of July 11, 1994 between
          the Company and the investors listed thereon, (5)

10.13     Agreement between Baker Environmental, Inc. and the Company
          dated November 8, 1994, (5)

10.14     Preferred Stock Purchase Agreement between the Company
          and the several purchasers set forth on Schedule 1.1 thereto,
          dated April 27, 1995, (6)

10.15     Registration Rights Agreement among the Company and each
          of the shareholders set forth thereon, dated April 27, 1995, (6)

10.16     Financial Advisor Services Agreement between the Company
          and Allen & Company, Incorporated, dated April 27, 1995, (6)

10.17     Operating Agreement of CVT America, L.L.C. dated
          May 5, 1995, (6)

10.18     Sublicense Agreement between CVT America, L.L.C. and
          the Company dated as of May 5, 1995, (6)

                                      46 
<PAGE>
 
Sequential
--------- 
Exhibit No.         Description
-----------         -----------

10.19     Agreement between the Department of the Air Force and the
          Company dated September 21, 1995, (7)

10.20     Agreement between the Department of Energy and the Company
          dated September 25, 1995, (7)

10.21     Registration Rights Agreement dated February 9, 1996 by and
          between ETG Environmental, Inc. and the Company, (8)

10.22     Envirogen, Inc. 1990 Incentive Stock Option and Non-
          Qualified Stock Option Plan, as amended*, (1)

10.23     Envirogen, Inc. 1993 Director's Non-Qualified Stock
          Option Plan, as amended*, (9)

10.24     1995 Activation Orders between the Company and Texas
          Eastern Transmission Corporation dated February 10, 1995, (9)

10.25     Agreement between ABTco and the Company dated
          October 30, 1995, (9)

10.26     Collaborative Marketing Agreement between the Company
          and Dow Environmental Inc. dated December 28, 1995, (9)

10.27     Development agreement dated November 7, 1996 between
          Envirogen, Inc. and Rhone-Poulenc Inc., (10)

10.28     Securities Purchase Agreement dated January 14, 1997 by
          and between Warburg, Pincus Ventures, L.P. and the
          Registrant, (11)

21        Subsidiaries of the Company, (1)

23        Consent of Coopers & Lybrand L.L.P., (1)

24        Powers of Attorney, (1)

__________________________
(1)       Filed herewith.
(2)       Incorporated by reference to the indicated exhibit to the Company's
          Registration Statement on Form S-1 (File No. 33-48576) which became
          effective on August 11, 1992.
(3)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form 10-K for the year ended December 31, 1992.
(4)       Incorporated by reference to the indicated exhibit to the Company's
          Registration on Form S-1 (File No. 33-65430) which became effective
          on October 13, 1993.
 
                                      47
<PAGE>
 
(5)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form 10-K for the year ended December 31, 1994.
(6)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form 10-Q for the quarter ended March 31, 1995.
(7)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form 10-Q for the quarter ended September 30, 1995.
(8)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form 8-K filed January 5, 1996.
(9)       Incorporated by reference to the indicated exhibit to the Company's
          Report on Form 10-K for the year ended December 31, 1995.
(10)      Incorporated by reference to the indicated exhibit to the Company's
          Report on  Form 10-Q for the quarter ended September 30, 1996.
(11)      Incorporated by reference to the indicated exhibit to the Company's
          Report on  Form 8-K filed January 14, 1997.

*         Indicates a management contract or compensatory plan or arrangement.

                                      48