<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, 1997

                                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 13, 1998
was approximately $21,544,700.  (Reference is made to p. 15 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 13, 1998 was 23,294,835.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the registrant's definitive proxy statement relating to
its scheduled May 21, 1998 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 a technology-based
environmental systems and services company that provides solutions to the
industrial effluent and hazardous waste remediation problems of the private and
public sectors.  The Company also designs and implements effluent treatment
systems, vapor extraction systems and other integrated systems for the on-site
treatment of organic contaminants in soils and groundwater.  The Company's
unique combination of scientific and engineering expertise has allowed it to
develop proprietary biological technologies to complement its non-biological
capabilities.  The developmental efforts at Envirogen focus on the isolation of
naturally occurring organisms and the  creation of genetically modified
organisms, enhancing their performance and then engineering advanced systems to
optimize their activity for the biodegradation of various compounds in soil, air
and water.  Envirogen's strategic approach is to utilize the appropriate
technology to provide its clients with the most efficient, safe and cost-
effective solution to their hazardous waste cleanup and treatment needs.

Envirogen's capabilities mirror the needs of the marketplace, and its
development of innovative, cost-effective technologies should be timely.  The
Environmental Protection Agency (the "EPA") is currently believed to be more
receptive to innovative approaches than at any previous time.  In addition, new
regulations create more stringent requirements for chemical releases, which now
require the destruction of specific, difficult to destroy compounds.  This has
resulted in 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.

Growth Strategy

Envirogen has developed a two-tier growth model that incorporates both an
internal and external growth strategy.  The internal growth strategy centers on
increasing sales of the Company's core businesses through the continued
commercialization of its technologies in concert with focused marketing and
sales efforts.  The Company combines this with an external growth  strategy that
includes the selective acquisitions of companies with complementary capabilities
aimed at producing synergistic results.  The external growth strategy also
includes entering into joint ventures and collaborative marketing agreements
with firms that are interested in exploring and developing alternative
remediation and pollution control technologies.  In connection with this
external growth strategy, Envirogen has completed the following acquisitions in
the past 12 months:

   .  Acquired Fluid Management, Inc. ("FMI") of Pewaukee, Wisconsin, a full-
      service environmental consulting firm with offices in Wisconsin and
      Illinois.  The business and operations of FMI are now fully integrated
      into the Company through the FMI Operations Group, which provides
      specialized services in the area of remedial investigation, design and
      construction, solid waste and landfill management, air sciences,
      engineering and compliance management.

   .  Acquired from nv VAM of the Netherlands the remaining 50% ownership of CVT
      America, LLC (a former joint venture between the Company and VAM).  The
      Company has integrated the operations of CVT America into the Company by
      providing advanced biofiltration systems and services for the treatment of
      odors, air toxics and volatile organic compounds in the air pollution
      control market.

                                       2
<PAGE>
 
Business Areas

Envirogen's core competency is  the application of biotechnology and
biocomplementary technologies combined with expertise in traditional remediation
technology for both the remediation of contaminated waste sites and for the
treatment of contaminated waste streams. The evolution of the Company, catalyzed
by acquisitions that have layered synergistic technologies and capabilities onto
its core base of expertise, is demonstrated by its increased scope of services
and products offered to the marketplace and the broadening of its geographic
presence. Envirogen's primary business areas are described below:

REMEDIATION

The majority of industry's environmental problems are the result of the release
into the environment of contaminants ranging from simple hydrocarbons to complex
chlorinated compounds. Generally, the less complex a contaminant's molecular
make-up, the more easily and quickly it will be degraded by bacteria that use
the contaminant as a "food source." For instance, when hydrocarbon-based
compounds such as gasoline or heating oil are spilled into the environment,
depending on various factors, indigenous soil bacteria are likely to be present
to begin the biodegradation process to break down the contaminant into its core
components of carbon dioxide and water. Contaminants with more complex molecular
structures generally are more difficult to degrade, and as complexity increases,
the likelihood of indigenous bacteria being present that are capable of
degrading the compound decreases, resulting in the need for intervention to
accelerate the natural process. Degrees of intervention range from the
relatively subtle, such as biostimulation (stimulating indigenous bacteria) to
bioaugmentation (injecting bacteria produced in a laboratory into the
subsurface), to the more conspicuous, such as excavation and transport to
another location. With an understanding of the direct relationship between cost
and intervention, whereby costs generally increase with added degrees of
intervention, Envirogen designs solutions that employ the least amount of
intervention necessary in each given case to achieve an environmentally
effective and cost-efficient solution.

Envirogen acquired Pewaukee, Wisconsin-based FMI in April 1997. The acquisition
of this company significantly  enhanced Envirogen's remediation capabilities and
provided Envirogen with greater technical resources, broader geographical
presence and broader client coverage.  As a result of its acquisition of FMI,
Envirogen provides specialized remediation services, including all aspects of
underground and aboveground storage tank management, a broad range of
engineering and construction services, air permitting, compliance management,
storm water management, complete solid waste services, landfill engineering and
waste characterization.

Envirogen's full range of in situ technologies include: traditional approaches,
such as soil vapor extraction and air sparging; innovative biological-based
techniques, such as biostimulation and bioaugmentation; and approaches combining
the two, such as biosparging and bioventing, both of which stimulate degradative
microbial activity through the addition of oxygen to the subsurface. Envirogen
has steadily increased its in situ capabilities both through its internal
developmental efforts as well as through acquisitions of companies with
technologies in this category. Envirogen's acquisition of Vapex Environmental
Technologies, Inc. in 1991 and Lansing-based MWR in 1996 provided it with a
portfolio of  proprietary in situ capabilities.  The scope of economical in situ
capabilities is behind Envirogen's success in receiving several contract awards
from groups of prestigious Fortune 100 clients for the cleanup of Superfund
sites.

                                       3
<PAGE>
 
Depending on the specific circumstances, the remediation of contaminated soils
and groundwater may be undertaken with the contamination remaining in place, or
in situ, or it may require removal of material from the contaminated area(s)
for ex situ destruction. In the latter case, additional costs associated with
the removal process, as well as the costs associated with increased handling,
storage and transport of contaminated matter, are incurred.

Accordingly, Envirogen's process of designing solutions to maximize cost savings
for its clients employs a hierarchical model of increasingly aggressive cleanup
techniques. In situations where the cleanup can be performed in situ, the most
"passive" form of biodegradation, known as intrinsic remediation, is first
considered by Envirogen.  Intrinsic remediation is the approach that allows for
contamination to be biodegraded through microbial degradation processes that
have developed naturally at a contaminated site, and thereby occurs without any
intervention. Based on the increased regulatory acceptance of intrinsic
remediation in recent years, Envirogen has accelerated its efforts with this
approach by developing intrinsic remediation protocols for a wide range of
target contaminants from petroleum hydrocarbons to chlorinated solvents.

Envirogen's ex situ capabilities also include both traditional and innovative
approaches. Envirogen is a provider of reactor-based biosystems for the on-site
destruction of vapor streams as a final remediation step that follows initial
processes such as vapor extraction. Solid Phase Extraction (SoPE/TM/) is a non-
biological patented process developed by Envirogen that uses a foam, typically
polystyrene foam, to desorb contaminants such as pesticides, polyaromatic
hydrocarbons and polychlorinated biphenyls ("PCBs") from soils for disposal or
destruction by other treatment methods. Other ex situ technologies used by
Envirogen include advanced landfarming, which involves the periodic mixing of
contaminated soil with a solid sludge or aqueous slurry surface layer that
contains degradative bacteria, and soil pile treatment, which uses soil mounded
in rows and periodic tilling of the rows to stimulate biological degradation of
contaminants.

POLLUTION CONTROL

The enforcement of more rigorous regulations combined with the high cost of
conventional physical and chemical treatment methods has created the need for
cost-effective specialized bioreactor systems and biocatalysts to degrade
difficult contaminants in industrial air and water effluent streams.
Envirogen's pollution control products to degrade contaminants in air and waste
water streams are described below:

Air
--- 

Motivated by the 1990 Clean Air Act Amendments ("CAAA"), which have increasingly
regulated the release of toxic compounds into the atmosphere, Envirogen embarked
upon a program in the early 1990's to commercialize biotechnology to treat both
odor-causing chemicals and volatile organic compounds.  Referred to as
biofiltration technology, the biological treatment of contaminated air streams
is generally recognized as a cost effective alternative to physical and chemical
treatment methods such as incineration, adsorption and chemical scrubbing.
Envirogen's advancements in biofiltration include the development of systems for
the cost-effective destruction of contaminants such as odors, hydrogen sulfide,
carbon disulfide, styrene, terpenes, alcohol, aldehydes, isobutane, isopentane,
mixed solvents associated with the printing and surface coating industry, and
hydrocarbons associated with remediation.

                                       4
<PAGE>
 
A biofiltration system consists of a large containment vessel ("reactor"),
within which microorganisms, in the form of a moistened layer attached to either
an organic or inorganic filter media, are used to catalyze chemical reactions
that break down airborne contaminants into less harmful compounds. As a
contaminated vapor stream passes through the filter bed, contaminants are
transferred from the vapor to the biofilm layer and are consumed by the
microorganisms.  The initial research of Envirogen, and numerous field trials,
resulted in the following bioreactor technologies:

   .  Biofilter - A Biofilter utilizes an organic filter media as the support
      for the biofilm layer containing the microorganisms.  The system, which is
      optimized for dilute waste streams, provides destruction efficiencies of
      up to 99% and typically provides substantial operating cost savings and
      equivalent or lower initial capital costs than the more traditional
      chemical or physical removal technologies.

   .  Biotrickling Filter - A Biotrickling Filter operates on the same principle
      as a Biofilter but utilizes a synthetic packing material  instead of the
      organic filter media used in the Biofilter.  The Biotrickling Filter
      operates with a recirculating liquid flow over the packing material.  This
      recirculating liquid flow is initially inoculated with microorganisms
      which form a biofilm layer on the packing.  The contaminants are
      transferred to, and degraded by, microorganisms present within both the
      recirculating liquid and the biofilm layer.  The Biotrickling Filter is an
      attractive alternative for the treatment of more difficult to degrade
      compounds and provides the added benefit of reduced system footprint and
      reduced operating costs as compared to more traditional technologies.

To expand on Envirogen's portfolio of air treatment products and services,
Envirogen formed a joint venture in 1995 with nv VAM of the Netherlands.  The
venture was acquired in its entirety by Envirogen in August 1997 and now
provides Envirogen with a line of patented modular biofiltration systems and
other technologies for the treatment of odors, air toxics and volatile organic
contaminants for specific segments of the air pollution control market.  The
acquired technologies, combined with the Biofilter and Biotrickling Filter
designs of Envirogen, underscore Envirogen's leadership position in the
biological air pollution control market.  The Company believes that these
products have applications in a number of industries which include municipal
waste treatment facilities, composting plants and the forest products
industries.

Envirogen is distinguished in this market by having completed work on numerous
full-scale air system installations ranging in contract size from approximately
$35,000 up to $1.8 million.  This includes a Biofilter the Company built for  a
decorative hardwood panel manufacturer and  a Biofilter for  a synthetic sponge
manufacturer.

Envirogen began work in late 1997 on a large flow capacity system, under a
contract with Waste Management of New York ("WMNY").  The contract with WMNY
calls for Envirogen to provide a turn-key biofiltration odor control system to
treat exhaust air from a municipal waste/biosolids composting facility that WMNY
is constructing and will operate for the Municipal Authority of Rockland County
in New York.

                                       5
<PAGE>
 
Water
-----
The enforcement of more rigorous water quality regulations has created a need
for cost-effective systems to degrade contaminants in groundwater and plant
effluent streams.  The biological treatment of contaminated water streams is
generally recognized as a cost effective alternative to more traditional
physical and chemical methods such as thermal, UV-based and adsorption
processes.

Consistent with Envirogen's approach to the treatment of contaminated air
streams, the biological treatment of contaminated water streams relies on the
destruction of chemicals by microorganisms, attached to a filter media or
otherwise contained in a reactor, to catalyze chemical reactions that break down
contaminants into less harmful compounds.  Utilizing its knowledge of
biocatalysis and advanced reactor design, the Company is able to combine
efficient microorganisms with the optimum bioreactor design to achieve the
destruction of a given contaminant.  Envirogen's research and development has
led to full-scale reactor systems for the treatment of contaminants ranging in
complexity from simple hydrocarbons to complex compounds which are difficult to
degrade such as methyl tertiary butyl ether ("MTBE", a gasoline octane
enhancer). The Company has developed the following reactor designs:

   .  Fluidized Bed Reactor - The Fluidized Bed Reactor ("FBR") consists of a
      columnar reactor containing media that serves as an attachment surface for
      microorganisms.  The reactor maintains high concentrations of biomass
      under high flow rate conditions. The contaminated liquid flows through the
      reactor where microorganisms degrade the contaminants.  The optimal use of
      this system is for the treatment of high flow, low concentration waste
      streams containing contaminants such as simple hydrocarbons, aromatics,
      solvents, ammonia or nitrates.

   .  Membrane Bioreactor - The Membrane Bioreactor consists of a liquid-phase
      bioreactor coupled with a membrane clarification unit.  Following the
      biological treatment of the contaminated stream, the contents of the
      bioreactor are pumped to the membrane unit where the solids and liquids
      are separated with clean effluent being discharged and biomass and excess
      effluent being recycled back into the bioreactor.  The optimal use of this
      system is for high concentration, low flow-rate streams with complex
      compounds such as MTBE, 1,4-dioxane, phenols, and pesticides.

In addition, Envirogen has developed other reactor systems for specific
applications.  These systems include Sequencing Batch reactors, Submerged Fixed-
Film reactors and Suspended Growth reactors.  Envirogen's commercialization
efforts in its water program includes installation of a full-scale FBR at an
industrial site  for the removal of aniline and nitrobenzene from groundwater.
As evidence of the cost-effectiveness of the technology, the client estimated
that the FBR system would save at least $1.8 million in capital and operating
costs over the life of the project when compared to conventional technologies.
The Company believes these products have applications in a number of industries
including petrochemicals, pharmaceuticals, pulp and paper, and industries using
paints or solvents.

During 1997, the Company worked with Rhone-Poulenc to develop high-performance
biological technologies and systems for the industrial wastewater treatment
market.  The Company and Rhone-Poulenc are in the process of restructuring their
agreement which will allow each company to move forward on a more independent
basis.

                                       6
<PAGE>
 
Technology

Envirogen  conducts research and development aimed at developing new, more
efficient environmental technologies for the remediation of hazardous waste and
for pollution control.  Envirogen's technology is based on two elements:
microorganisms (biocatalysts) with exceptional degradative abilities; and
engineered systems, including proprietary bioreactors and processes.  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, hydrology, chemical and
mechanical engineering and systems design.  During 1997, Envirogen spent
approximately $2.7 million on research and development projects.

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

Envirogen's biodegradation processes are based on naturally occurring or
genetically modified microorganisms that are either indigenous to a hazardous
waste site or are introduced to the site for controlled usage by Envirogen.  The
microorganisms under development are primarily bacteria, which are microscopic,
single-cell organisms that under defined conditions can break down contaminants
into less complex substances.  For example, if the contaminant is benzene, the
byproducts from its complete degradation are carbon dioxide and water.

There are naturally occurring bacteria capable of degrading nearly all natural
organic compounds under appropriate conditions.  However, highly effective
naturally occurring bacteria capable of degrading many  synthetic compounds
(such as polychlorinated biphenyls ("PCB's") and trichloroethylene ("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, MTBE,
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
contaminated sites. Envirogen is also designing and testing genetically-modified
bacteria that can have several advantages over naturally occurring bacteria.
These advantages include the ability to degrade wastes faster,  reducing the
overall cost of remediation or waste stream treatment.

Envirogen's commitment to developing leading edge technologies not only serves
to provide new business opportunities for Envirogen, but has also helped
establish Envirogen as a leader in environmental biotechnology.  As mentioned
earlier, one of the major areas of focus for Envirogen 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 and 1997, Envirogen successfully
demonstrated this technology, in combination with complementary delivery
technologies, at two sites, one of which was for a Fortune 100 petroleum company
and the second for the U.S. Air Force.  This work  is significant because it
proves the capability for the destruction of chlorinated organics at a
geologically-complex site. Additional field testing is ongoing in the area which
may result in a cost effective solution to in-situ remediation of TCE.

                                       7
<PAGE>
 
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 controlled, and measured amounts of oxygen and nutrients can
be added to the mixture of microorganisms and contaminated materials, thereby
optimizing the degradative 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 chemicals.  The design of a
bioreactor to be used at a particular site or in a particular waste stream
depends on the types of wastes to be degraded, the media (e.g., soil, water or
air) 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 bioreactor
designs utilizing naturally occurring and genetically-modified bacteria for the
degradation of PCE, TCE, MTBE, air toxics, industrial wastewater effluents, and
groundwater contaminants.  Envirogen has successfully completed a field
demonstration of its MTBE bioremediation technology and believes the technology
provides a mechanism to cost-effectively remove MTBE from contaminated
groundwater.

Government Supported Research
-----------------------------

As discussed earlier, strict regulations and the prohibitive cost of traditional
treatment methods have forced business and government 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.  In addition to the numerous Phase I and Phase II SBIRs that
Envirogen has previously received, Envirogen was awarded four two-year Phase II
SBIR contracts in 1997 for the development of advanced technologies.  One SBIR,
for the National Science Foundation ("NSF"), is to engineer biocatalysts to not
only destroy hazardous wastes more efficiently, but also to convert those wastes
into valuable specialty chemicals.  Another SBIR, for the NSF, is to test a
process that utilizes surfactant foams in conjunction with bacteria to enhance
the degradation of chlorinated solvents.  A third SBIR, for the Department of
Defense, is to continue development of a combined anaerobic/aerobic bio-reactor
to treat ground water streams contaminated with chlorinated solvents.  The
fourth SBIR, for the NSF, is to  develop biosensors for detecting and measuring
chlorinated solvents in ground water.

These examples of Envirogen's research and development efforts with
microorganisms and engineered systems, along with many other existing products
and systems still under development, all lay the scientific groundwork which
lead the way to safer, more responsive commercial applications.  The result is a
cleaner environment achieved with cost-savings for industry.

                                       8
<PAGE>
 
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 costly.  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. In April 1997, the EPA adopted new
regulations for its TSCA biotechnology program that define the criteria under
which the use of genetically-modified microorganisms in a bioreactor will be
considered "contained."  Envirogen believes the time and cost of obtaining EPA
approval for its commercial systems may be reduced as a result of the EPA's new
regulations for its TSCA biotechnology program.  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.

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,

                                       9
<PAGE>
 
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 based on tons of
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, with particular focus upon Envirogen's distinctive approach to
degrading recalcitrant hazardous waste.

Envirogen and many other 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 other firms 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 soils.

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, 1997, Envirogen had 231 full-time employees, including 127 in
engineering, 26 in research and development, 54 in administration and finance
and 24 in marketing.  Doctoral degrees are held by nine 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 may not be 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, and under certain circumstances, its subcontractors 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

The Company's headquarters is located in Lawrenceville, New Jersey, where it
leases 40,200 square feet of office space for its administrative, laboratory and
pilot facilities.  The Company also leases an aggregate of approximately 80,300
square feet of office and warehouse space in Illinois, Massachusetts, Michigan,
Texas and Wisconsin.  Management believes that the Company's facilities are
adequate and suitable for its current and proposed operations for the
immediately foreseeable future.

ITEM 3.  LEGAL PROCEEDINGS

The Company is currently involved in litigation relating to services previously
provided at a customer site.  This customer, against whom the Company filed suit
to recover amounts due for work performed, filed a counter-claim against the
Company for breach of contract, declaratory relief and interpleader.  No
specific damages have been claimed by this customer and, at the present time,
management of the Company is unable to predict the outcome of this matter or to
determine whether the outcome of this matter will materially affect the
Company's results of operations, cash flows or financial position.

The Company is also subject to other claims and lawsuits in the ordinary course
of its business.  In the opinion of management, all such pending claims are
either adequately covered by insurance or, if not insured, will not individually
or in the aggregate result in a material adverse effect on the consolidated
financial condition of the Company.

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.

 
     Name                     Age                         Position
     ----                     ---                         --------

William C. Smith               66         Chief Executive Officer and Chairman
                                            of the Board
Ronald Unterman, Ph.D.         52         Senior Vice President and Chief
                                            Scientific Officer
Mark J. Maten                  40         Vice President of Finance and Chief
                                            Financial Officer
Douglas W. Jacobson            52         Senior Vice President of Marketing
David N. Enegess               51         Vice President of Product Development


William C. Smith has been the Chief Executive Officer of the Company since
October 1997. He has been the Company's Chairman of the Board since April 1997
and serves as the President and Chief Executive Officer of the Company's FMI
Operations Group. Mr. Smith joined the Company when Fluid Management, Inc.
("FMI"), a company of which he was a founder, was acquired in April 1997. Mr.
Smith was the President and Chief Executive Officer of FMI. Mr. Smith has over
40 years of technical and financial management experience in the wood chemicals,
plastics and petroleum products industries. Prior to forming FMI, Mr. Smith
served as a consultant to paper mills on environmental matters and to a major
oil company on lignite utilization and recovery and other environmental matters.
Mr. Smith has a degree in Chemical Engineering from the University of Wisconsin
and is a Wisconsin registered Professional Engineer.

Ronald Unterman, Senior Vice President and Chief Scientific Officer, is a
founder of the Company and has been with the Company since August 1988.  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.

Mark J. Maten joined the Company on January 1, 1998 as Vice President of Finance
and Chief Financial Officer.  From February 1997 until December 1997, Mr. Maten
served as a business consultant and financial advisor in a consulting capacity
to a number of companies.  From June 1992 until January 1997, Mr. Maten was
Senior Vice President and Chief Financial Officer of Enviroplan, Inc., a leading
provider of continuous emission monitoring systems to the acid rain market.  Mr.
Maten also served as a member

                                       13
<PAGE>
 
of the Board of Directors for Enviroplan, Inc.  Mr. Maten is a member of the
American Institute of Certified Public Accountants.  Mr. Maten received his
undergraduate degree from the University of Michigan and a Masters in Business
Administration degree from Indiana University.

Douglas W. Jacobson joined the Company as Senior Vice President of Marketing and
Vice President of the Company's FMI Operations Group when FMI, a company of
which he was a founder, was acquired by the Company in April 1997.  Mr. Jacobson
was the Vice President and Secretary of FMI.  Mr. Jacobson has over 25 years of
technical and marketing experience in the petroleum products, oil re-refining
and solvent recovery programs for numerous manufacturing facilities and served
in a sales management capacity for several manufacturing and service companies.
Mr. Jacobson has a degree in Mechanical Engineering from the University of
Wisconsin and is a Wisconsin registered Professional Engineer.

David N. Enegess is a founder of the Company and has been its Vice President of
Marketing and Commercial Development from June 1988 until April 1997, at which
time he was appointed Vice President of Product Development.  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.

                                       14
<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.
 
 
             1997                     HIGH                    LOW
             ----                     -----                  -----
          1st Quarter                 $3.63                  $2.38
          2nd Quarter                 $3.38                  $2.38
          3rd Quarter                 $3.56                  $2.38
          4th Quarter                 $3.50                  $1.31
 
            1996
            ----
          1st Quarter                 $4.00                  $2.50
          2nd Quarter                 $4.63                  $2.38
          3rd Quarter                 $4.00                  $2.13
          4th Quarter                 $3.75                  $2.38


The closing price for the Common Stock on February 13, 1998 was $1.50.  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, 1997 was 284, which
includes stockholders whose shares were held in nominee name.  The number of
beneficial stockholders at that date was over 2,350.

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.

                                       15
<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.
<TABLE>
<CAPTION>
 
 
Summary of Operations
                                                         Years Ended December 31,
                    ----------------------------------------------------------------------------------------
<S>                             <C>            <C>             <C>             <C>             <C>
                                   1997/(1)/       1996/(2)/         1995            1994            1993
                                   ----            ----              ----            ----            ---- 
 Revenues                       $ 25,769,509   $  12,919,594   $   8,033,698   $   6,134,577   $   4,714,752
 Costs and expenses               28,885,818      15,689,306      10,279,694      10,503,989       9,879,694
 Interest, net                       210,573         170,783         169,972         111,659         216,696
 Equity in loss of
   joint venture                    (210,497)        (52,629)        (93,437)              -               -
 Other, net                           26,047           7,601          16,961               -               -
                                ------------   -------------   -------------   -------------   -------------
 Net loss                         (3,090,186)     (2,643,957)     (2,152,500)     (4,257,753)     (4,948,246)
 Preferred stock
   dividends                               -         (36,458)       (233,333)              -               -
                                ------------   -------------   -------------   -------------   -------------
 Net loss applicable to
   Common Stock                  ($3,090,186)   ($ 2,680,415)   ($ 2,385,833)   ($ 4,257,753)   ($ 4,948,246)
                                ============   =============   =============   =============   =============
 
 Basic and diluted net
   loss per share applicable
   to Common Stock                    ($0.15)         ($0.24)         ($0.31)         ($0.57)         ($0.79)
                                      =======         ======          =======         =======         =======
 
</TABLE>

Summary of Financial Position

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

                           1997/(1)/    1996/(2)/      1995         1994        1993
                          -----------  -----------  -----------  ----------  -----------
<S>                       <C>          <C>          <C>          <C>         <C>
Total assets              $42,727,012  $12,716,624   $8,585,233  $6,704,806  $11,945,079
Working capital             8,099,057    7,094,266    4,934,700   3,628,377    8,204,251
Long-term obligations          12,671       42,176       60,951     177,704      298,709
Redeemable convertible
  Preferred Stock                   -            -    1,728,621           -            -
Stockholders' equity       33,992,254   10,047,233    4,863,357   5,400,207    9,694,715
 
</TABLE>
/(1)/   The financial data for 1997 includes the results of operations of FMI
        (acquired April 10, 1997) from the date of acquisition.
/(2)/   The financial data for 1996 includes the results of operations of MWR
        (acquired February 9, 1996) from the date of acquisition.

                                       16
<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.

Certain statements made herein are forward-looking and are made pursuant to the
safe harbor provisions of the Securities Litigation Reform Act of 1995.  Such
statements involve risks and uncertainties which may cause results to differ
materially from those set forth in these statements.  In particular,
unanticipated changes in the economic, competitive, governmental, technological,
marketing and other factors identified herein and in the Company's other filings
with the Securities and Exchange Commission could affect such results.

General
-------

The source of the Company's revenues to date includes (i) remediation services,
including both in situ and ex situ bioremediation, (ii) commercial sales of the
Company's biological degradation systems, 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 April 10, 1997 the Company acquired FMI, a full-service environmental
consulting and engineering firm that is now operated as the Company's FMI
Operations Group.  Remediation services are FMI's core business and generate the
greatest portion of FMI's revenues.  The majority of FMI's work is eligible for
reimbursement to its clients (or their lending banks) under the Wisconsin
Petroleum Environmental Cleanup Fund Act ("PECFA"). Review of the PECFA claims
by the Wisconsin Department of Commerce ("DCOM") and determination of any
ineligible costs typically is not completed until one to three years after the
expense has been incurred and paid by FMI's client (or its bank).  This exposes
the client to the risk that remediation expenses it incurred and paid ultimately
may be disallowed for PECFA reimbursement by DCOM.  While not contractually
obligated to do so, FMI has historically reimbursed its clients (or their
lending banks) for the remediation costs for services provided by FMI which
ultimately were determined by DCOM to be ineligible for reimbursement under
PECFA.

The 1997 Wisconsin state budget bill, which was passed in October 1997, extended
through December 2001 the $1 million maximum per site reimbursement under the
PECFA program (which, under previous legislation, was to be reduced to $190,000
for sites entering the program after June 1, 1998).  However, revised
administrative policies and procedures recently implemented by DCOM in
connection with the legislative process have limited, and are expected to
continue to limit, the types and costs of services  reimbursable by DCOM.  DCOM
has recently limited approval, absent special circumstances, for

                                       17
<PAGE>
 
implementation of remediation activities, instead favoring natural attenuation
as the presumed remedy  and generally allowing reimbursement primarily for site
investigation and monitoring costs.  The implementation of such revised policies
has resulted, and is expected to continue to result, in a decrease in revenues
per site generated by FMI.  A more aggressive marketing strategy has been
implemented with the goal of bringing  a greater number of sites under contract
and increasing overall revenue.

As a result of the acquisition of FMI in April 1997, the Company's results of
operations during 1997 and 1996 are not directly comparable.

Results of Operations
---------------------

1997 Compared to 1996
---------------------

The Company reported revenues in 1997 of $25,769,509, an increase of 99% from
1996.  The net loss applicable to common stock in 1997 increased 15% to
$3,090,186, while the basic and diluted net loss per share was $0.15 compared to
$0.24 in 1996.  The decrease in basic and diluted net loss per share is due to
an increase in the number of shares outstanding primarily from issuance of
common stock in connection with the FMI acquisition and a related private
placement.

Commercial revenues increased 112% to $23,044,622 from $10,892,871 in 1996 while
revenues from corporate and government research and development contracts
increased 34% to $2,724,887 from $2,026,723 in 1996.  The increased commercial
revenues are due primarily to the inclusion of sales of the Company's FMI
Operations Group, acquired on April 10, 1997.  Increased commercial remediation
revenues more than offset decreased revenues from the Company's pollution
control business.  The Company recognized significant revenues from a major
biofilter project during 1996, when the project was  completed.  Revenues from
remediation activities accounted for 98% of the Company's commercial revenues in
1997.

Revenues from corporate and government research and development contracts
increased primarily due to the increased volume of Phase II Small Business
Innovative Research Grants ("SBIR") the Company is actively working on.  In
1997, the Company recorded initial revenues under a Phase I SBIR from the
National Science Foundation, three Phase II SBIRs from the National Science
Foundation, two Phase I and one Phase II SBIRs from the Department of Defense,
as well as two other grants from the Department of Defense and the Department of
Energy.

Total costs and expenses increased 84% to $28,885,818 in 1997 from $15,689,306
in 1996.  The cost of commercial operations increased 74% to $16,799,454 due to
increased revenue levels combined with the establishment of a $500,000 warranty
reserve relating to systems and a $330,000 increase in reserve for bad debts to
cover the write-off of certain uncollectible receivables of the MWR Operations
Group.  Research and development expenses increased 14% to $2,730,211 due to an
increase in work under corporate and government research and development
contracts.  Marketing, general and administrative expenses increased 216% to
$9,356,153 due primarily to expenses of the FMI Operations Group, amortization
of goodwill associated with the FMI acquisition, severance related expenses
associated with the resignation of the Company's former Chief Executive Officer,
and increased marketing expenses associated with the Company's development
programs.  In 1996 the Company provided for a contract claim of $650,000 to
cover the cost of repairing the biofiltration system the Company built for the
Nylonge Corporation.  The repairs to the system were completed and the system
restarted in late 1996.  While the ultimate responsibility for these expenses
has not yet been determined, the Company is actively pursuing

                                       18
<PAGE>
 
reimbursement of these expenses from third parties.  However, there can be no
assurance that any such recoveries will be attained.

Interest income increased 25% to $242,373 due primarily to the increased level
of cash available for investment as a result of the Company's private placement
of common stock in April 1997.  Equity in loss of joint venture amounted to
$210,497 in 1997 compared to $52,629 in 1996 due primarily to the Company's
participation in the losses of the CVT America joint venture.  On August 10,
1997, the Company acquired the remaining 50% of the venture, dissolved the
venture and thereafter continued its operations.

1996 Compared to 1995
---------------------

The Company reported revenues in 1996 of $12,919,594, an increase of 61% from
1995.  The net loss applicable to common stock in 1996 increased 12% to
$2,680,415, while the basic and diluted net loss per share was $0.24 compared to
$0.31 in 1995.  The decrease in basic and diluted net loss per share was 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 was due primarily to revenues of approximately  $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 1995  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 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.  Marketing, general and
administrative expenses increased 10% to $2,958,780 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 offset by a decrease in marketing expenses 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.

                                       19
<PAGE>
 
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.

Liquidity and Capital Resources
-------------------------------

The Company has funded its operations to date primarily through revenues from
commercial services and sales of biological degradation systems, public
offerings and private placements of equity securities, research and development
agreements with major industrial companies and research grants from government
agencies.  At December 31, 1997 the Company had cash and cash equivalents of
$4,863,658 and working capital of $8,099,057.  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 $249,596 from
December 31, 1996 to December 31, 1997 as proceeds from the issuance of common
stock of $15,713,376 more than offset cash utilized in connection with the
acquisition of FMI of $13,574,197, cash used by operations of $1,075,685
(including $610,857 to pay FMI accounts payable that were assumed by the Company
as part of the FMI acquisition), cash invested in and advanced to CVT America of
$304,770 and capital expenditures of $557,635.  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.

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, 1997, unbilled revenue was $2,437,649
higher than at December 31, 1996 due primarily to the increased revenue levels
resulting from the FMI acquisition.

Accounts receivable increased by $3,876,714, prepaid expenses increased by
$342,019 and accounts payable increased by $2,113,558 from December 31, 1996 to
December 31, 1997 primarily due to the acquisition of FMI.  Accrued expenses and
other liabilities increased by $1,170,404 in the same period primarily due to
the acquisition of FMI combined with accrued severance related expenses.   On
December 31, 1997 the Company had $2,577,218 in reserve for claim adjustments
and warranties, $1,919,660 of which is available with respect to potential PECFA
claim adjustments related to approximately $53 million in unsettled PECFA
submittals and $657,558 of which is available with respect to potential systems
warranty claims and other contract issues.

It is anticipated that the Company's currently available cash and cash
equivalents and cash expected to be generated from operations will provide
sufficient operating capital for the foreseeable future.

                                       20
<PAGE>
 
Other Matters
-------------

As of December 31, 1997, the Company had a net operating loss carryforward of
approximately $21,000,000 for federal income tax reporting purposes available to
offset future taxable income, if any, through 2012. 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 and may be further limited in
the event of additional ownership changes.

The Financial Accounting Standards Board issued Financial Accounting Standard
No. 130, "Reporting Comprehensive Income" ("SFAS 130") in June 1997.
Comprehensive income represents the change in net assets of a business
enterprise as a result of nonowner transactions.  Management does not believe
that the future adoption of SFAS 130 will have a material effect on the
Company's financial statements. The Company will adopt SFAS 130 for the year
ending December 31, 1998.

Also in June 1997, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131").  SFAS 131 requires that a business enterprise
report certain information about operating segments, products and services,
geographic areas of operation and major customers in complete sets of financial
statements and in condensed financial statements for interim periods.  The
Company is required to adopt this standard in 1998 and is currently evaluating
the impact of the standard.

In February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits" ("SFAS 132").  SFAS 132 changes current
financial statement disclosure requirements for pension and other postretirement
benefit plans.  SFAS 132 does not, however, change the measurement or
recognition provisions of existing accounting standards.  Management does not
believe that the future adoption of SFAS 132 will have a material effect on the
Company's financial statements.  The Company will adopt SFAS 132 for the year
ending December 31, 1998.

The Company believes that its financial and operational systems, with limited 
modifications, will function properly with respect to dates in the year 2000 and
thereafter. The Company estimates that the costs associated with the Year 2000
issue will be insignificant and as such will not have a material impact on the
Company's financial position or operating results. However, there is no
assurance that our customers or vendors will not have Year 2000 problems which
will affect us.


                                       21
<PAGE>
ITEM 8.         FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


                                ENVIROGEN, INC.
                          CONSOLIDATED BALANCE SHEETS

<TABLE> 
<CAPTION> 
                                                                                                December 31,
                                                                                 ----------------------------------------    
                                                                                      1997                        1996
                                                                                 ------------                ------------
<S>                                                                              <C>                         <C> 
ASSETS                                                             
Current assets:                                                    
  Cash and cash equivalents                                                      $  4,863,658                $  4,614,062
  Accounts receivable, net of allowance for doubtful               
        accounts of $605,963 in 1997 and $245,138 in 1996                           6,977,161                   3,100,447
  Unbilled revenue                                                                  4,213,653                   1,776,004
  Inventory                                                                           248,712                      55,027
  Prepaid expenses and other current assets                                           517,960                     175,941
                                                                                 ------------                ------------
      Total current assets                                                         16,821,144                   9,721,481
                                                                   
Property and equipment, net                                                         1,757,577                     922,320
Restricted cash                                                                       309,300                     309,300
Investment in and advances to joint venture                                            87,648                     228,934
Intangible assets, net                                                             23,488,607                   1,348,677
Other assets                                                                          262,736                     185,912
                                                                                 ------------                ------------
      Total assets                                                               $ 42,727,012                $ 12,716,624
                                                                                 ============                ============
                                                                   
LIABILITIES                                                        
Current liabilities:                                               
  Accounts payable                                                               $  3,449,512                $  1,335,954
  Accrued expenses and other liabilities                                            1,948,215                     777,811
  Reserve for claim adjustments and warranties                                      2,577,218                     178,075
  Deferred revenue                                                                    730,365                     312,784
  Current portion of note payable                                                                                   4,287
  Current portion of capital lease obligations                                         16,777                      18,304
                                                                                 ------------                ------------
      Total current liabilities                                                     8,722,087                   2,627,215
                                                                   
Deferred rent                                                                                                      12,222
Capital lease obligations, net of current portion                                      12,671                      29,954
                                                                                 ------------                ------------
      Total liabilities                                                             8,734,758                   2,669,391
                                                                                 ------------                ------------
                                                                   
Commitments and contingencies (see Note 13)                        
                                                                   
STOCKHOLDERS' EQUITY                                               
Common stock, 23,354,335 and 12,931,940 shares issued              
  at December 31, 1997 and 1996, respectively                                         233,543                     129,319
Additional paid-in capital                                                         58,856,844                  31,925,861
Accumulated deficit                                                               (25,092,183)                (22,001,997)
Less:  Treasury stock, at cost                                                         (5,950)                     (5,950)
                                                                                 ------------                ------------
      Total stockholders' equity                                                   33,992,254                  10,047,233
                                                                                 ------------                ------------
                                                                   
      Total liabilities and stockholders' equity                                 $ 42,727,012                $ 12,716,624
                                                                                 ============                ============

</TABLE> 

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

                                      22
<PAGE>

                                ENVIROGEN, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE> 
<CAPTION> 
                                                                                      Year Ended December 31,
                                                                   -----------------------------------------------------------------
                                                                          1997                 1996                    1995
                                                                   ----------------      ---------------        --------------------
<S>                                                                <C>                   <C>                    <C> 
Revenues:
    Commercial operations                                              $23,044,622          $10,892,871              $5,971,278
    Research and development services                                    2,724,887            2,026,723               2,062,420
                                                                   ----------------      ---------------        ----------------

      Total revenues                                                    25,769,509           12,919,594               8,033,698
                                                                   ----------------      ---------------        ----------------

Cost of commercial operations                                           16,799,454            9,676,960               5,126,901
Provision for contract claim                                                                    650,000
Research and development costs                                           2,730,211            2,403,566               2,459,580
Marketing, general and administrative expenses                           9,356,153            2,958,780               2,693,213
                                                                   ----------------      ---------------        ----------------

      Total costs and expenses                                          28,885,818           15,689,306              10,279,694
                                                                   ----------------      ---------------        ----------------

Other income (expense):
    Interest income                                                        242,373              193,776                 201,130
    Interest expense                                                       (31,800)             (22,993)                (31,158)
    Equity in loss of joint venture                                       (210,497)             (52,629)                (93,437)
    Other, net                                                              26,047                7,601                  16,961
                                                                   ----------------      ---------------        ----------------
        Other income, net                                                   26,123              125,755                  93,496
                                                                   ----------------      ---------------        ----------------

Net loss                                                                (3,090,186)          (2,643,957)             (2,152,500)

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

Net loss applicable to Common Stock                                    ($3,090,186)         ($2,680,415)            ($2,385,833)
                                                                   ================      ===============        ================


Basic and diluted net loss per share applicable
    to Common Stock                                                         ($0.15)              ($0.24)                 ($0.31)
                                                                   ================      ===============        ================

Weighted average number of shares of
    Common Stock used in computing basic
    and diluted net loss per share                                      20,041,958           11,374,922               7,669,639
                                                                   ================      ===============        ================
</TABLE> 

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

                                      23
<PAGE>
                                ENVIROGEN, INC.
          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
             For the years ended December 31, 1997, 1996 and 1995
<TABLE> 
<CAPTION> 

                                                                                       
                                                       Common Stock          Additional                           Treasury Stock
                                                -------------------------     Paid-in         Accumulated     ----------------------
                                                  Shares         Amount       Capital           Deficit         Shares       Amount
                                                ------------  -----------  ---------------  ---------------   ---------  -----------
<S>                                             <C>             <C>          <C>             <C>               <C>          <C> 
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)

Net loss                                                                                       (3,090,186)
Issuance of Common Stock to
  Warburg, Pincus Ventures, L.P. 
  for cash                                       6,095,238        60,952      15,652,424
Issuance of Common Stock to
  acquire Fluid Management, Inc.                 4,190,477        41,905      10,958,097
Issuance of Common Stock to
  acquire remaining interest in
  joint venture                                    100,000         1,000         264,600
Exercise of stock options                           36,680           367          55,862
                                               -----------      --------     -----------     ------------      -------      -------
Balance at December 31, 1997                    23,354,335      $233,543     $58,856,844     ($25,092,183)     (59,500)     ($5,950)
                                               ===========      ========     ===========     ============      =======      =======
</TABLE> 

Preferred Stock:  Authorized 2,000,000 shares, par value $.01 per share.  No 
                  preferred shares issued or outstanding at December 31, 1996 
                  and 1997.
Common Stock:  Authorized 50,000,000 shares, par value $.01 per share.










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

                                      24
<PAGE>

                                 ENVIROGEN, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE> 
<CAPTION> 
                                                                                             Year Ended December 31,
                                                                              ------------------------------------------------------
                                                                                    1997              1996                1995
                                                                              ---------------    --------------    ----------------
<S>                                                                           <C>                <C>               <C>  
Cash flows from operating activities:
  Net loss                                                                       ($3,090,186)      ($2,643,957)        ($2,152,500)
  Adjustments to reconcile net loss to cash used by operating activities:
    Depreciation and amortization                                                  1,826,595           992,697             574,183
    Provision for doubtful accounts                                                  861,223            84,800              60,000
    Equity in loss of joint venture                                                  210,497            52,629              93,437
    Other                                                                              3,707            (8,521)             (1,941)

  Changes in operating assets and liabilities, net of the effect
    of acquisitions:
       Accounts receivable                                                            10,878          (850,546)            (12,759)
       Unbilled revenue                                                             (696,417)          107,213            (793,410)
       Prepaid expenses and other current assets                                    (184,631)          216,271             (42,621)
       Inventory                                                                       7,817            48,606             (44,430)
       Other assets                                                                  (76,824)           56,423             (20,410)
       Accounts payable                                                             (941,189)          182,942             349,877
       Accrued expenses and other liabilities                                        422,812            (7,380)             65,380
       Reserve for claim adjustments and warranties                                  164,573          (173,775)
       Deferred revenue                                                              405,460          (111,804)            347,978
                                                                              ---------------    --------------    ----------------
       Net cash used by operating activities                                      (1,075,685)       (2,054,402)         (1,577,216)
                                                                              ---------------    --------------    ----------------

Cash flows from investing activities:
   Capital expenditures                                                             (557,635)         (102,744)            (94,742)
   Investment in and advances to joint venture                                      (304,770)         (100,000)           (150,000)
   Direct costs relating to purchase of remaining 50% interest
       in joint venture                                                               (6,629)
   Acquisition of Fluid Management, Inc.                                         (13,574,197)
   Acquisition of MWR, Inc.                                                                         (1,332,000)
   Proceeds from sale of property and equipment                                       22,004             9,750               3,000
                                                                              ---------------    --------------    ----------------
       Net cash used in investing activities                                     (14,421,227)       (1,524,994)           (241,742)
                                                                              ---------------    --------------    ----------------

Cash flows from financing activities:
  Debt repayment                                                                      (4,287)           (4,333)             (4,002)
  Capital lease principal repayments                                                 (18,810)         (124,020)           (128,084)
  Net proceeds from exercise of stock options                                         56,229            16,671              12,862
  Net proceeds from issuance of Common Stock                                      15,713,376         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)
  Cash dividends paid on Redeemable Cumulative
       Convertible Preferred Stock                                                                     (51,041)           (218,750)
                                                                              ---------------    --------------    ----------------
       Net cash provided by financing activities                                  15,746,508         4,445,261           3,101,768
                                                                              ---------------    --------------    ----------------

Net increase in cash and cash equivalents                                            249,596           865,865           1,282,810

Cash and cash equivalents at beginning of year                                     4,614,062         3,748,197           2,465,387
                                                                              ---------------    --------------    ----------------

Cash and cash equivalents at end of year                                          $4,863,658        $4,614,062          $3,748,197
                                                                              ===============    ==============    ================
</TABLE> 

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

                                      25
<PAGE>
                                ENVIROGEN, INC.
               CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

<TABLE> 
<CAPTION> 
                                                                                  Year Ended December 31,
                                                                   ---------------------------------------------------
                                                                         1997             1996               1995
                                                                   ---------------   --------------    ---------------
<S>                                                                <C>               <C>               <C> 
Supplemental disclosures of cash flow information:             
-------------------------------------------------
  Cash paid for interest                                                  $21,304          $23,041            $31,061
                                                                   ===============   ==============    ===============
                                                               
  Cash paid for income taxes                                             $112,354           $2,110               $200
                                                                   ===============   ==============    ===============
</TABLE> 

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. No
   capital leases were entered into in 1997.

 - In April 1997, the Company acquired Fluid Management, Inc. for $12,187,531 in
   cash and 4,190,477 shares of Common Stock valued at $11,000,002. In
   connection with the acquisition, the Company also paid $1,386,666 of FMI's
   outstanding debt.

 - 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. In August 1997, the Company purchased the 50% interest held by VAM
   in CVT America for 100,000 shares of Common Stock valued at $265,600 and
   incurred direct costs associated with the acquisition of $6,629.



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

                                      26
<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 internal operations as well as
     through Wisconsin-based Fluid Management, Inc. ("FMI") that was acquired by
     the Company on April 10, 1997 and through MWR, Inc. ("MWR") of Lansing,
     Michigan, a wholly-owned subsidiary that was acquired on February 9, 1996
     (see Note 3).  On August 8, 1997, the Company purchased the 50% interest
     held by nv VAM ("VAM") in CVT America L.L.C., a joint venture between VAM
     and the Company.  CVT America was dissolved upon the closing of the
     transaction and the Company continued its operations thereafter (see Note
     3).

     While the activities of FMI 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,
     losses to date, future capital needs,  dependence on key personnel,
     competition, risk of technological obsolescence, governmental regulations
     and approvals and limited manufacturing and marketing capabilities.

2.   Summary of Significant Accounting Policies
     ------------------------------------------

     Principles of Consolidation

     The consolidated financial statements include the accounts of FMI and MWR.
     Investments in companies in which ownership interests range from 20 to 50
     percent are accounted for using the equity method.  All material
     intercompany balances and transactions are eliminated in consolidation.

     Reclassifications

     Certain reclassifications have been made to conform prior year's
     presentation with the 1997 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, reserve for claim
     adjustments and warranties and amortization periods for intangibles.

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

                             ---------------------

     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, which consist of components used to assemble a variety of
     systems offered for sale by the Company, 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, laboratory and field 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 seven 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.  It is the
     Company's policy to periodically review and evaluate whether there has been
     a permanent impairment in the value of intangibles.  Factors considered in
     the valuation include current operating results, trends, prospects and
     anticipated undiscounted future cash flows.

     Reserve for Claim Adjustments and Warranties

     The Company provides for potential amounts it could repay to customers
     related to remediation performed under the State of Wisconsin Petroleum
     Environmental Cleanup Act ("PECFA").  At December 31, 1997 the Company had
     $1,919,660 in reserve with respect to potential PECFA claim adjustments
     related to approximately $53 million in unsettled submittals.

     The Company also has $657,558 in reserve at December 31, 1997 with respect
     to potential systems warranty claims and other contract issues, the
     majority of which are expected to be settled in 1998.  Estimated warranty
     reserves are related to specific projects and are provided for by charges
     to operations in the period in which the related revenue is recognized or
     at such time as a potential claim arises.

     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.

                                       28
<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 at December 31, 1996.  The
     lease term expired in 1997.

     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, 1997 of $76,525 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, 1997.

     Research and Development

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

     In December 1997, the Company adopted Statement of Financial Accounting
     Standards No. 128 "Earnings Per Share" ("SFAS 128") to calculate net loss
     per share applicable to common stock.  All prior periods presented have
     been retroactively restated to conform to the SFAS 128 requirements.  SFAS
     128 requires the presentation of basic and diluted per share amounts.
     Basic per share amounts are computed by dividing net loss applicable to
     common stock by the weighted average number of common shares outstanding
     during the period.  Diluted per share amounts are computed by dividing net
     loss applicable to common stock by the weighted average number of common
     shares outstanding plus the dilutive effect of common share equivalents.
     Since the Company incurred net losses for all periods presented, both basic
     and diluted per share calculations are the same.  Accordingly, options and
     warrants to purchase 3,790,579,  3,139,409 and 2,428,524 shares of common
     stock that were outstanding at December 31, 1997, 1996 and 1995,
     respectively, and 140,000 shares of Series C Convertible Preferred Stock
     convertible into

                                       29
<PAGE>
 
                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

                             ---------------------

     1,400,000 shares of common stock that were outstanding at December 31, 1995
     were not included in diluted per share calculations, as their effect would
     be antidilutive.

     Impact of the Future Adoptions of Recently Issued Accounting Standards

     The Financial Accounting Standards Board issued Financial Accounting
     Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130") in June
     1997.  Comprehensive income represents the change in net assets of a
     business enterprise as a result of nonowner transactions.  Management does
     not believe that the future adoption of SFAS 130 will have a material
     effect on the Company's financial statements. The Company will adopt SFAS
     130 for the year ending December 31, 1998.

     Also in June 1997, the Financial Accounting Standards Board issued
     Financial Accounting Standard No. 131, "Disclosures about Segments of an
     Enterprise and Related Information" ("SFAS 131").  SFAS 131 requires that a
     business enterprise report certain information about operating segments,
     products and services, geographic areas of operation and major customers in
     complete sets of financial statements and in condensed financial statements
     for interim periods.  The Company is required to adopt this standard in
     1998 and is currently evaluating the impact of the standard.

     In February 1998, the Financial Accounting Standards Board issued Statement
     of Financial Accounting Standards No. 132, "Employers' Disclosures about
     Pensions and Other Postretirement Benefits" ("SFAS 132").  SFAS 132 changes
     current financial statement disclosure requirements for pension and other
     postretirement benefit plans.  SFAS 132 does not, however, change the
     measurement or recognition provisions of existing accounting standards.
     Management does not believe that the future adoption of SFAS 132 will have
     a material effect on the Company's financial statements.  The Company will
     adopt SFAS 132 for the year ending December 31, 1998.

3.   Business Acquisitions
     ---------------------

     On April 10, 1997, the Company acquired Fluid Management, Inc. of Pewaukee,
     Wisconsin for approximately $12.2 million in cash and 4,190,477 shares of
     the Company's common stock valued at $11,000,002.  In connection with the
     acquisition, the Company also paid approximately $1.4 million of FMI's
     outstanding debt.  A portion of the purchase price is being held in escrow
     to satisfy the sellers' indemnification obligations under the Merger
     Agreement.  FMI is a full-service environmental consulting and engineering
     firm with offices in Pewaukee, La Crosse, Ashwaubenon and Mosinee,
     Wisconsin and Geneva, Illinois.  FMI was merged into the Company and the
     acquisition has been accounted for under 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 $22,877,482 and is being
     amortized over 20 years.

     On August 8, 1997, the Company issued 100,000 shares of common stock valued
     at $265,600 to nv VAM in exchange for the transfer by VAM to the Company of
     (i) VAM's 50% ownership interest in CVT America L.L.C. (a joint venture
     between the Company and VAM) and (ii) certain patents and proprietary
     technology related to the biological treatment of chemical contaminants in
     air streams.  The Company also incurred $6,629 in direct costs associated
     with the acquisition.  The acquisition, which has been accounted for under
     the purchase method of accounting, resulted in goodwill of $323,340 which
     is being amortized over ten years.  CVT America was dissolved upon the
     closing of the transaction and the Company continued its operations
     thereafter.

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

                               -----------------

     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 under 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 ten and five years,
     respectively.

     The operating results of the acquisitions are included in the Company's
     consolidated results of operations from the dates of acquisition.  The
     following pro forma financial information assumes the acquisitions occurred
     at the beginning of the periods presented and does not purport to be
     indicative of what would have occurred had the acquisitions been made as of
     those dates or of results which may occur in the future.
 
                                              Year Ended          Year Ended
                                          December 31, 1997   December 31, 1996
                                              (Unaudited)         (Unaudited)
                                          ------------------  ------------------
 
     Net revenues                            $  32,292,697       $34,022,818
     Net loss                                 ($ 1,994,228)        ($ 23,383)
     Basic and diluted net loss per share
      applicable to Common Stock                  ($  0.09)          ($ 0.00)

4.   Significant Fourth Quarter Adjustments
     --------------------------------------

     During the fourth quarter of 1997, the Company recorded approximately $1.2
     million of adjustments which had a negative impact on the Company's
     operations, including warranty reserves associated with systems of $490,000
     and severance-related expenses of $369,000.

5.   Property and Equipment
     ----------------------

     Property and equipment, net at December 31, 1997 and 1996 consisted of the
     following:
 
                                                       1997            1996
                                                    ----------      ----------
     Computer equipment                             $  739,271      $  283,624
     Acquired computer software                        210,000         210,000
     Vehicles                                           42,300     
     Laboratory and field equipment                  2,038,718       1,650,326
     Equipment and vehicles under                           
      capital leases                                   598,975         598,975
     Furniture and office equipment                    564,895         278,551
     Leasehold improvements                            565,822         542,030
     Construction in progress                          359,683          12,839
                                                    ----------      ----------
                                                     5,119,664       3,576,345
     Less: Accumulated depreciation and                    
      amortization                                   3,362,087       2,654,025
                                                    ----------      ----------
                                                    $1,757,577      $  922,320
                                                    ==========      ==========

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

                             --------------------

     Accumulated amortization on equipment under capital leases amounted to
     $497,855 and $397,524 at December 31, 1997 and 1996, respectively.
     Depreciation and amortization expense amounted to $765,703, $797,049 and
     $569,590 for the years ended December 31, 1997, 1996 and 1995,
     respectively. No interest has been capitalized in 1997, 1996 or 1995.

6.   Restricted Cash
     ---------------

     At December 31, 1997 and 1996, 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.

7.   Intangible Assets
     -----------------

     Intangible assets, net at December 31, 1997 and 1996 consisted of the
     following:

                                            1997         1996
                                         -----------   ----------
     Goodwill                            $24,309,182   $1,108,361
     Patents                                 222,611      222,611
     Covenant not to compete                 232,000      232,000
     Other                                                  8,928
                                         -----------   ----------
                                          24,763,793    1,571,900
     Less:  Accumulated amortization       1,275,186      223,223
                                         -----------   ----------
                                         $23,488,607   $1,348,677
                                         ===========   ==========

     Amortization expense for intangible assets amounted to $1,060,891, $195,648
     and $4,593 for the years ended December 31, 1997, 1996 and 1995,
     respectively.

8.   Accrued Expenses and Other Liabilities
     --------------------------------------

     Accrued expenses and other liabilities at December 31, 1997 and 1996
     consisted of the following:
 
                                                     1997           1996
                                                  ----------      --------
     Salaries, benefits and payroll taxes         $  927,804      $279,933
     Taxes                                           429,540       417,618
     Severance                                       322,050    
     Other                                           268,821        80,260
                                                  ----------      --------
                                                  $1,948,215      $777,811
                                                  ==========      ========

9.   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 assets due to the uncertainty of realization.
     The change in the valuation allowance for the year ended December 31, 1997
     was an increase of $3,186,626.

                                       32
<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, 1997 and 1996 are as follows:

 
                                              1997                  1996
                                          Deferred Tax          Deferred Tax
                                      Assets (Liabilities)  Assets (Liabilities)
                                      --------------------  --------------------
     Accrued liabilities                   $ 1,248,537           $   216,702
     Contract reserve                           34,000                60,546
     Deferred rent                                                     4,155
     Depreciation                               30,274               266,502
     Amortization                               67,143               (41,769)
     Bad debts                                 206,027                69,615
     Partnership interest                       29,580               (18,243)
     Net operating loss - federal            7,274,556             6,613,615
     State taxes                             2,865,093             1,397,461
     Tax credits                               297,187               297,187
                                           -----------           -----------
                       Total                12,052,397             8,865,771
     Valuation allowance - federal          (9,187,304)           (7,468,310)
     Valuation allowance - state            (2,865,093)           (1,397,461)
                                           -----------           -----------
     Total deferred taxes                  $         0           $         0
                                           ===========           ===========

     As of December 31, 1997, the Company had a net operating loss carryforward
     of approximately $21,000,000 for Federal income tax purposes which is
     available to offset future taxable income, if any, between the years 1998
     and 2012.  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 under Internal Revenue Code
     Section 382.

10.  Common Stock
     ------------

     On April 10, 1997, the Company issued 6,095,238 shares of common stock to
     Warburg, Pincus Ventures, L.P. ("Warburg Pincus") resulting in net proceeds
     of $15,713,376.  The net proceeds from the financing were used to fund the
     cash portion of the Fluid Management, Inc. acquisition and to supplement
     the working capital of the combined enterprise.  An officer of Warburg
     Pincus was elected to the Company's Board of Directors at its 1997 annual
     meeting.

     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.

     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

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

                              -------------------

     (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 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
     voluntarily 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. In 1997, the shares of Common Stock issued
     upon conversion of the Preferred Stock were registered with the Securities
     and Exchange Commission for resale by the holders thereof.

11.  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 3,500,000 shares of Common Stock.  Standard
     provisions of the Plan, which may vary with Board and stockholder approval,
     require that the term of each grant not exceed ten years.  At December 31,
     1997, there were 1,045,180 additional options available for grant under the
     Plan.

     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.  Standard provisions of
     the Plan, which may vary with Board and stockholder approval, require that
     the term of each grant not exceed ten years.  At December 31, 1997, there
     were 145,335 additional options available for grant under the 1993 Plan.

     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.

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

                              -------------------

     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.

     Following is a summary of the stock option transactions for 1995, 1996 and
     1997:

<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, 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
                                        ---------               
      Granted                           1,375,250       $2.61                        $1.34
      Forfeited                        (  564,400)      $2.99   
      Exercised                        (   36,680)      $1.53   
                                        ---------               
     Balance December 31, 1997          2,305,505       $2.68     $0.20 - $ 7.25
                                        =========               
                                                                
     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   
     Exercisable at December 31, 1997     558,105       $2.79   

</TABLE>

     The weighted average remaining contractual lives of outstanding options at
     December 31, 1997 was approximately 8.12 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:
 
                                           1997          1996          1995
                                       ------------  ------------  ------------
 
     Pro forma net loss applicable 
       to Common Stock                 ($3,561,695)  ($3,031,940)  ($2,449,400)
     Pro forma basic and diluted
       net loss per share applicable 
       to Common Stock                      ($0.18)       ($0.27)       ($0.32)

                                       35
<PAGE>
 
                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

                              -------------------

     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.

     The pro forma compensation expense of $471,509, $351,525 and $63,567 for
     1997, 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:
 
                                          1997          1996          1995
                                       ----------    ----------    ----------
     Dividend yield                          0             0             0
     Expected volatility                  40.6%         41.9%         45.3%
     Risk free interest rate              6.39%         6.53%         6.28%
     Expected option lives                6.5 years     6.5 years     6.5 years

     In October 1993, the Company completed a public offering of 1,500,000
     units, each unit consisted of one share of Common Stock and a warrant 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 October 1993, the Company also 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 14 for additional information regarding the Company's other warrants.

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.  Commitments and Contingencies
     -----------------------------

     Leases

     The Company is party to various operating leases relating to office,
     laboratory and pilot plant facilities, as well as vehicles and office
     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 office and
     laboratory equipment.

                                       36
<PAGE>
 
                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

                              -------------------

 Future minimum payments under capital and noncancelable operating leases
 consisted of the following at December 31, 1997:

                                             Capital           Operating
                                              Leases            Leases
                                            ---------         ----------- 
          1998                               $ 19,146         $1,626,611
          1999                                  9,048          1,401,030
          2000                                  5,527          1,024,017
          2001                                      -            753,033
          2002                                      -            730,515
          Thereafter                                -            804,789
                                             --------         ----------
          Total minimum lease payments         33,721         $6,339,995
          Less amount representing                            ==========
           interest                          (  4,273)
                                             -------- 
          Present value of net minimum               
           capital lease payments            $ 29,448
                                             ======== 

     Rent expense for operating leases was $1,389,345, $700,985 and $557,361 for
     the years ended December 31, 1997, 1996 and 1995, respectively.
 
     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 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 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 customer by the Company under the
     technology agreement may not exceed the development funding received by the
     Company from the customer.  The customer provided no additional funding in
     1997.  At December 31, 1997, 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.

     Litigation

     The Company is currently involved in litigation relating to services
     previously provided at a customer site. This customer, against whom the
     Company filed suit to recover amounts due for work performed, filed a
     counter-claim against the Company for breach of contract, declaratory
     relief and interpleader. No specific damages have been claimed by this
     customer and, at the

                                       37
<PAGE>
 
                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

                           ------------------------



     present time, management of the Company is unable to predict the outcome of
     this matter or to determine whether the outcome of this matter will
     materially affect the Company's results of operations, cash flows or
     financial position.

     The Company is also subject to other claims and lawsuits in the ordinary
     course of its business.  In the opinion of management, all such pending
     claims are either adequately covered by insurance or, if not insured, will
     not individually or in the aggregate result in a material adverse effect on
     the Company's results of operations, cash flows or financial position.

     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.

14.  Related Party Transactions
     --------------------------

     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 10
     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 acquisition of FMI and related
     private placement to Warburg Pincus (see Notes 3 and 10). The Company
     agreed to pay the stockholder $250,000.  An officer of the stockholder is
     also a director of the Company.

                                       38
<PAGE>
 
                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

                           ------------------------



15.  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, with the exception of those employed by the FMI Operations Group.
     The Company's contribution expense related to the 401(k) savings plan was
     $83,488,  $81,630 and $53,992 for the years ended December 31, 1997, 1996
     and 1995, respectively.  There was no contribution expense related to the
     profit sharing plan.

     The FMI Operations Group also has a 401(k) plan which provides for FMI
     employee salary deferral contributions.  Substantially all FMI employees
     are eligible to participate in this Plan.  No Company contributions have
     been made to this plan.  The Company does not maintain other pension or
     postretirement benefit plans.

     Employees of the FMI Operations Group have a bonus plan which provides for
     10% of FMI pre-tax profits to be distributed to FMI employees.  The
     Company's expense related to the FMI bonus plan was $325,125 for the year
     ended December 31, 1997.

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

16.  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.

     The Company maintains demand deposits with two major banks and money market
     accounts with three financial institutions. At December 31, 1997 and 1996,
     substantially all of the Company's cash and cash equivalents were held in
     these money market accounts.

     The Company earns revenues under contracts for various federal government
     agencies. Revenue recognized under these contracts for the years ended
     December 31, 1997, 1996 and 1995 was $2,103,243, $1,417,059 and $834,818,
     respectively.  These revenues are primarily from research and development
     contracts.

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:

                              1997  1996   1995
                              ----  -----  -----
               Customer A       -    12%     -
               Customer B       -     -     21%
               Customer C       -     -     10%
 

                                       39
<PAGE>
 
                                ENVIROGEN, INC.
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

                           ------------------------



18.  Joint Ventures
     --------------

     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 had 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 was to be amortized over the initial three year term of the
     joint venture.  During 1997 the Company advanced an additional $304,770 to
     CVT America.  On August 8, 1997, the Company purchased VAM's 50% interest
     in CVT America for 100,000 shares of common stock valued at $265,600.  CVT
     America was dissolved upon the closing of the transaction and the Company
     continued its operations thereafter (see Note 3).

     The Company obtained a 50% interest in Miller Environmental Technologies
     L.L.C. ("MET") when it acquired FMI on April 10, 1997.  MET is jointly-
     owned by the Company and a subsidiary of a Milwaukee, Wisconsin based scrap
     metal recycler, which is one of the largest scrap metal recyclers in the
     United States.  MET provides comprehensive environmental services to the
     scrap metal recycling industry throughout the United States.  The service
     areas addressed by MET include soil and groundwater remediation, compliance
     management, air sciences and engineering, storage tank services and
     wastewater and storm water management.  All of the consulting and
     engineering services delivered by MET are conducted by the Company through
     subcontracting arrangements. The Company also receives a monthly fee in the
     amount of $1,000 from MET for the provision of certain office and record
     keeping services. From April 10, 1997 through December 31, 1997, fees
     earned for providing services to MET amounted to $116,690 (including the
     monthly office and record keeping services fee).

19.  Supplementary Statement of Operations Information
     -------------------------------------------------

     Maintenance and repairs expense for the years ended December 31, 1997, 1996
     and 1995 was $225,248, $79,325 and $44,356, respectively.

                                       40
<PAGE>
                                                                    Schedule II

                                 Envirogen, Inc.
                        Valuation and Qualifying Accounts
                  Years Ended December 31, 1997, 1996 and 1995

<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------------------------------------------------------------
                                            Balance at        Charged to          Charged to                              Balance
                                            beginning          costs and       other accounts       Deductions           at end of
                   Description              of period          expenses           -describe        -describe (a)           period
------------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>              <C>               <C>                 <C>                <C> 
Year ended December 31, 1997:

     Allowance for doubtful accounts          $245,138        $512,225            $120,000 (b)      $271,400              $605,963
     Tax valuation allowance                 8,865,771       3,186,626                                                  12,052,397
     Reserve for claim adjustments
       and warranties                          178,075         930,783           1,802,743 (b)       334,383             2,577,218
                                                                                            
Year ended December 31, 1996:                                                               
                                                                                            
     Allowance for doubtful accounts          $131,381         $84,800             $46,000 (c)       $17,043 (c)          $245,138
     Tax valuation allowance                 8,029,507         836,264                                                   8,865,771
     Reserve for claim adjustments
       and warranties                           50,000         650,000             344,760 (c)       866,685               178,075
                                                                                            
Year ended December 31, 1995:                                                               
                                                                                            
     Allowance for doubtful accounts          $107,932         $60,000                               $36,551              $131,381
     Tax valuation allowance                 7,155,060         874,447                                                   8,029,507
     Reserve for claim adjustments
       and warranties                           50,000                                                                      50,000
------------------------------------------------------------------------------------------------------------------------------------
</TABLE> 

(a)  Actual write-offs
(b)  Balance in the financial statements of FMI, Inc. at acquisition 
(c)  Balance in the financial statements of MWR, Inc. at acquisition

                                      41
<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, 1997 and 1996 and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1997 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 19, 1998

                                       42
<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 May 21, 1998 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.

                                       43
<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, 1997 and 1996........  22
 
     Consolidated Statements of Operations for the years ended 
     December 31, 1997, 1996 and 1995....................................  23
 
     Consolidated Statements of Changes in Stockholders' Equity for the 
     years ended December 31, 1997, 1996 and 1995........................  24
 
     Consolidated Statements of Cash Flows for the years ended
     December 31, 1997, 1996 and 1995....................................  25
 
     Notes to Consolidated Financial Statements..........................  27
 
2.   Financial Statement Schedules:
     ------------------------------

     II.  Valuation and Qualifying Accounts..............................  41
 
     Report of Independent Accountants...................................  42

     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:
     ---------
<TABLE> 
<CAPTION> 

     Exhibit No.         Description                                           Location
     ----------          -----------                                           --------
     <S>     <C>                                                               <C>      
     2.1     Stock Purchase Agreement dated February 9, 1996 by and among 
             ETG Environmental, Inc., MWR, Inc. and the Registrant...........  (6) (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").....................  (8) (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)
</TABLE> 

                                       44
<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...................  (4) (Exh. 3)

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

     10.3    Agreement between Baker Environmental, Inc. and the Company 
             dated November 8, 1994..........................................  (3) (Exh. 10.29)

     10.4    Agreement between the Department of the Air Force and the
             Company dated September 21, 1995................................  (5) (Exh. 10.1)

     10.5    Agreement between the Department of Energy and the Company dated 
             September 25, 1995..............................................  (5) (Exh. 10.2)

     10.6    Envirogen, Inc. 1990 Incentive Stock Option and Non-Qualified 
             Stock Option Plan, as amended*..................................  (9) (Exh. 10.22)

     10.7    Envirogen, Inc. 1993 Director's Non-Qualified Stock Option Plan, 
             as amended*.....................................................  (7) (Exh. 10.27)

     10.8    Agreement between ABTco and the Company dated October 30, 1995..  (7) (Exh. 10.29)

     10.9    Securities Purchase Agreement dated January 14, 1997 by and 
             between Warburg, Pincus Ventures, L.P. and the Company..........  (8) (Exh. 2.2)

     10.10   Employment Agreement dated April 10, 1997 between the Company 
             and William C. Smith*...........................................  (10) (Exh. 10.1)

     10.11   Employment Agreement dated April 10, 1997 between the Company 
             and Douglas W. Jacobson*........................................  (10) (Exh. 10.2)

     10.12   Letter Agreement dated October 20, 1997 between 
             Harcharan S. Gill and the Company...............................  (11) (Exh. 10)

     21      Subsidiaries of the Company.....................................  (1)
 
     23      Consent of Coopers & Lybrand  L.L.P.............................  (1)
 
     24      Powers of Attorney..............................................  (1)
 
     27      Financial Data Schedule.........................................  (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.            
            
 

                                       45
<PAGE>
 
     (3)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form  10-K for the year ended December 31, 1994.
     (4)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form  10-Q for the quarter ended March 31, 1995.
     (5)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form  10-Q for the quarter ended September 30, 1995.
     (6)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 8-K filed January 5, 1996. 
     (7)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-K for the year ended December 31, 1995.
     (8)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form  8-K filed January 14, 1997.
     (9)   Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-K for the year ended December 31, 1996.
     (10)  Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-Q for the quarter ended June 30, 1997.
     (11)  Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 8-K filed October 20, 1997.

     *     Indicates a management contract or compensatory plan or arrangement.

     (b)   Reports on Form 8-K

           On October 20, 1997, the Company filed a Report on Form 8-K reporting
           the resignation of Harcharan S. Gill, the Company's President and
           Chief Executive Officer.

                                       46
<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 26, 1998                   By:     /s/ William C. Smith
                                             --------------------------------
                                                     William C. Smith
                                                  Chief Executive Officer

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 26th day of March, 1998.

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

     William C. Smith*            Chief Executive Officer and Chairman of the
-------------------------------   Board (Principal Executive Officer)
     William C. Smith

     /s/ Mark J. Maten            Vice President of Finance and Chief
-------------------------------   Financial Officer (Principal Financial
       Mark J. Maten              and Accounting Officer)

  Robert F. Hendrickson*          Director
-------------------------------
   Robert F. Hendrickson

     Robert S. Hillas*            Director
-------------------------------
     Robert S.  Hillas

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

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

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

------------------
*William C. Smith, 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/ William C. Smith
                                             ----------------------------------
                                                       William C. Smith

                                       47
<PAGE>
 
                                 EXHIBIT INDEX

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

2.1        Stock Purchase Agreement dated February 9, 1996
           by and among ETG Environmental, Inc., MWR, Inc.
           and the Registrant, (6) (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, (8) (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)

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, (4) (Exh. 3)

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

10.3       Agreement between Baker Environmental, Inc. and the Company
           dated November 8, 1994, (3) (Exh. 10.29)

10.4       Agreement between the Department of the Air Force and the
           Company dated September 21, 1995, (5) (Exh. 10.1)

10.5       Agreement between the Department of Energy and the Company
           dated September 25, 1995, (5) (Exh. 10.2)

10.6       Envirogen, Inc. 1990 Incentive Stock Option and Non-
           Qualified Stock Option Plan, as amended*, (9) (Exh. 10.22)

10.7       Envirogen, Inc. 1993 Director's Non-Qualified Stock
           Option Plan, as amended*, (7) (Exh. 10.27)

10.8       Agreement between ABTco and the Company dated
           October 30, 1995, (7) (Exh. 10.29)


                                      48
<PAGE>
 
Exhibit No.            Description
-----------            -----------
 
10.9       Securities Purchase Agreement dated January 14, 1997 by
           and between Warburg, Pincus Ventures, L.P. and the
           Registrant, (8) (Exh. 2.2)

10.10      Employment Agreement dated April 10, 1997 between
           the Company and William C. Smith*, (10) (Exh. 10.1)

10.11      Employment Agreement dated April 10, 1997 between
           the Company and Douglas W. Jacobson*, (10) (Exh. 10.2)

10.12      Letter Agreement dated October 20, 1997 between
           Harcharan S. Gill and the Company, (11) (Exh. 10)

21         Subsidiaries of the Company, (1)

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

24         Powers of Attorney, (1)

27         Financial Data Schedule (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, 1994.
(4)        Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-Q for the quarter ended March 31, 1995.
(5)        Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-Q for the quarter ended September 30, 1995.
(6)        Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 8-K filed January 5, 1996.
(7)        Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-K for the year ended December 31, 1995.
(8)        Incorporated by reference to the indicated exhibit to the Company's
           Report on  Form 8-K filed January 14, 1997.
(9)        Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 10-K for the year ended December 31, 1996.
(10)       Incorporated by reference to the indicated exhibit to the Company's
           Report on form 10-Q for the quarter ended June 30, 1997.
(11)       Incorporated by reference to the indicated exhibit to the Company's
           Report on Form 8-K filed October 20, 1997.

*          Indicates a management contract or compensatory plan or arrangement.

                                      49