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U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-KSB [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 Commission file no. 000-21325 SYSTEMONE TECHNOLOGIES INC.  Florida
    
    65-0226813(State of Incorporation)
8305 N.W. 27th Street
    
    (I.R.S. Employer Identification No.)Suite 107
Miami, Florida
    
    33122(Address of Issuers Principal Executive Offices)
    
    (Zip Code)
 (305) 593-8015   Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.001 par value, and the Common Stock Purchase Rights attached thereto Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes x No o Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained herein, and no disclosure will be contained, to the
best of Issuers knowledge, in definitive proxy or information statements
incorporated by reference in PART III of this Form 10-KSB or any amendment to
this Form 10-KSB. x State the issuers revenues for its most recent fiscal year: $16,847,498 The aggregate market value of the Issuers Common Stock held by non-affiliates
as of March 19, 2004 was $595,210, computed by reference to the closing bid
price of the Common Stock as reported on the OTC Electronic Bulletin Board on
such date. As of March 19, 2004, there were 4,960,087 shares of the Issuers Common Stock
issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE The information required by Part III, Items 9-12 and 14, is incorporated
by reference from the Issuers definitive proxy statement (to be filed within
120 days after the end of the Issuers fiscal year ended December 31, 2003).




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TABLE OF CONTENTS  ITEM 1. DESCRIPTION OF BUSINESSITEM 2. DESCRIPTION OF PROPERTYITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERSITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONITEM 7. FINANCIAL STATEMENTSITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREITEM 8A. CONTROLS AND PROCEDURESPART IIIITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACTITEM 10. EXECUTIVE COMPENSATIONITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSITEM 13. EXHIBITS AND REPORTS ON FORM 8-KITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESSIGNATURESCONSENT OF BDO SEIDMAN LLPCERTIFICATION OF CEO PURSUANT RULE 13a-14(a)CERTIFICATION OF DIRECTOR OF FINANCECERTIFICATION OF CEO & DIRECTOR OF FINANCE    Table of Contents  Preliminary Note Regarding Forward-Looking Statements The following items contain certain forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the
Exchange Act), which represent the expectations or beliefs of SystemOne
Technologies Inc. (the Company), including, but not limited to, statements
regarding the development of a new distribution system for the Companys
products in light of the termination of the Exclusive Marketing Agreement (as
defined herein) and the sufficiency of the Companys cash and financial
resources to support the cost of developing such new distribution system as
well as for its other ongoing liquidity and capital resource needs. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
generality of the foregoing, words such as may, will, expect, believe,
anticipate, intend, could, should, estimate, continue, project,
target, or the negative or other variations thereof or comparable terminology
are intended to identify forward-looking statements. These statements by their
nature involve substantial risks and uncertainties, certain of which are beyond
the Companys control. Readers are cautioned that any such forward-looking
statements are not guarantees of future performance and that actual results may
differ materially from those projected in the forward-looking statements as a
result of various factors. The accompanying information contained herein,
including, without limitation, the information set forth under the headings
Managements Discussion and Analysis or Plan of Operation, and Business,
identifies important factors that could cause such differences. These
forward-looking statements are further qualified by important factors that
could cause actual events to differ materially from those in such
forward-looking statements. These factors include, without limitation, (i)
increased competition, (ii) the sufficiency of the Companys patents, (iii) the
ability of the Company to manufacture its products on a cost effective basis,
(iv) market acceptance of the Companys products, (v) the effects of
governmental regulation and (vi) the ability of the Company to obtain adequate
financing to support its operational and marketing plans, (vii) the expansion
of its sales support and (viii) future product development. Results actually
achieved may differ materially from the expected results included in
forward-looking statements as a result of these or other factors. In
particular, the Companys performance for the foreseeable future will be
dependent on, among other things, (i) the ability to enter into satisfactory
arrangements with distributors and other resellers of the Companys parts
washers, (ii) the ability of the Company and any such distributors and
resellers to penetrate the market for parts washers and to offer the SystemOne®
Washers on commercial terms and prices that will be attractive to customers,
(iii) the sufficiency of the Companys current financial resources to sustain
the Companys operations pending the development of a new distribution system
and continued sales revenue, (iv) the ability of the Company to successfully
market and sell its products in international markets and (v) the ability of
the Company to commercialize new products under development. 2




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ITEM 1. DESCRIPTION OF BUSINESS GENERAL AND RECENT DEVELOPMENTS The Company designs, manufactures and sells a full line of patented,
self-contained, recycling industrial parts washers (the SystemOne® Washers),
for use in the automotive, aviation, marine and general industrial repair
markets. The Company has been awarded eleven patents for its products, which
incorporate innovative, proprietary resource recovery and waste minimization
technologies to distill contaminated solvents and yield pure solvent allowing
cleaning solvents to be used, recycled and re-used perpetually, eliminating the need for costly and dangerous storage, transportation,
and off-site processing of hazardous waste. The Company was incorporated as Mansur Industries Inc. in November 1990 and, as
a development stage company, devoted substantially all of its resources to
research and development programs related to its full line of self-contained,
recycling industrial parts washers until June 1996. The Company commenced its
planned principal operations in July 1996 and began to generate significant
revenue from product sales commencing in 1997. Between 1997 and 2000, the
Company developed a national direct marketing and distribution organization,
including the establishment of regional distribution centers and a service
fleet, to market its products directly to customers. Shifting its strategy in late 2000, the Company appointed Safety-Kleen Systems,
Inc. a wholly owned subsidiary of Safety-Kleen Corp. (collectively
Safety-Kleen) the exclusive distributor for SystemOne® parts washers in the
United States, Puerto Rico, Canada and Mexico (the Territory) under the
Marketing and Distribution Agreement dated November 14, 2000, as amended and
restated as of March 8, 2001 (the Exclusive Marketing Agreement). This
strategic shift allowed the Company to eliminate its entire national direct
sales and service infrastructure permitting a significant reduction in the
Companys operating expenses. The Company retained five regional service
managers strategically located throughout the country to provide technical
expertise as needed. Also, during 2000 the Companys operating subsidiary was
merged with and into the Company and the Company changed its name to SystemOne
Technologies Inc. The Company began shipping SystemOne® parts washers to Safety-Kleen in January
2001 and immediately began to benefit from lower manufacturing costs per unit
due to higher production volume as well as lower selling, general and
administrative costs resulting from the elimination of its national direct
sales and service infrastructure. During the period January 2001 through
September 2003, the Company shipped approximately 30,000 parts washers to
Safety-Kleen. On September 30, 2003, the Company entered into a Comprehensive Settlement
Agreement (the Settlement Agreement) with Safety-Kleen to terminate the
Exclusive Marketing Agreement. The Settlement Agreement provides for a total
payment of $14 million to the Company, consisting of a termination fee and a
lump sum payment of the accumulated deferred price on the approximately 30,000
parts washer units shipped to Safety-Kleen under the Exclusive Marketing
Agreement prior to its termination. Of this amount, the Company received $10
million during the fourth quarter of 2003, $2.5 million during January and
February 2004 and anticipates 3




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receiving the balance of $1.5 million on or before March 31, 2004. The balance
is currently secured by a letter of credit posted by Safety-Kleen. In addition,
the Settlement Agreement (i) canceled all remaining purchase commitments under
the Exclusive Marketing Agreement, effective as of October 1, 2003, (ii)
settled all disputes regarding the Exclusive Marketing Agreement, and (iii)
released the parties from all claims that each may have against the other.
Safety-Kleen was also given the right (but not the obligation) in 2005 to
purchase the lesser of up to 3,000 parts washer units or one-sixth of the
Companys then annual production capacity. Because Safety-Kleen was the Companys only customer, the Company must
establish new distribution channels for its products and is currently
undertaking that effort. To date the Company has communicated with more than 90
potential distributors nationwide and estimates that approximately 40 to 50
distributors in this group may be qualified distributors for the Companys
products. Approximately eight distributors have been appointed to date and the
Company began shipping initial orders to its new distributors in the first
quarter of 2004 and expects to ship approximately 150 units during the first
quarter of 2004 with increases throughout the year, although there can be no
assurances of such increases. This projection compares to 3,750 units that
would have been shipped in the first quarter of 2004 under the Exclusive
Marketing Agreement. The distribution agreements with newly appointed distributors are non-exclusive
and require minimum initial orders of 10 units. Distributors take title to the
inventory upon shipment (FOB plant) and the Company does not accept returned
goods. Pricing is based on the Companys standard national price list for both
its SystemOne branded products and private label. The Company provides a
one-year parts only warranty and distributors are responsible for all warranty
labor on the equipment. See Marketing and Distribution for further
discussion. Based on current plans and estimates and taking into account the expected
investment necessary to rebuild the Companys distribution system, management
has allocated approximately $5 million of available cash to reduce and retire
certain indebtedness of the Company, which as of December 31, 2003, included
$23,155,512 principal amount of the Companys 8.25% Subordinated Convertible
Notes due December 31, 2005 (the Notes) and $4,893,348 of 10% secured
Promissory Notes (the Secured Notes), due December 31, 2005 including accrued
interest. Although the Notes are subordinated to the Companys outstanding
Secured Notes, the holders of the Secured Notes have consented to the Companys
purchase of the Notes before repaying the Secured Notes. During March 2004, the Company repurchased and retired $13.5 million principal
amount of the Notes for an aggregate purchase price of $2.9 million. The
Company expects to recognize a pre-tax gain of approximately $10.4 million in
the first quarter of 2004 on the repurchase and retirement of these Notes. EXCLUSIVE MARKETING AGREEMENT WITH SAFETY-KLEEN Prior to the execution of the Settlement Agreement in September 2003, the
Company operated under the Exclusive Marketing Agreement which (a) made
Safety-Kleen the exclusive marketer, distributor and service provider for the
Companys Series 100, Series 300 and Series 500 4




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SystemOne® parts washers
in the Territory, and (b) obligated Safety-Kleen to
purchase minimum quantities of the Companys parts washing equipment for each
contract year through December 26, 2005, the initial term of the Exclusive
Marketing Agreement. The Company retained the rights to sell, lease, rent and
service all of the Companys parts washing equipment outside the Territory and,
subject to Safety-Kleens right of first refusal, other product lines within
the Territory. The minimum annual sales under the Exclusive Marketing Agreement escalated from
10,000 equivalent units during each of the first two contract years to 12,500
equivalent units in year three (which began December 26, 2002) and were
scheduled to escalate to 15,000 equivalent units in year four (beginning
December 26, 2003) and 18,000 equivalent units in year five (beginning December
26, 2004), all at specified prices. Under the Exclusive Marketing Agreement, the price for each unit purchased by
Safety-Kleen consisted of two components: a standard price payable on net
30-day terms from the date of shipment and a deferred price (approximately 12%
of the total price) payable in equal installments over a 12-quarter period
which was accounted for as set forth in Note 1(f) to the financial statements. Pursuant to the Exclusive Marketing Agreement, Safety-Kleen assumed all
service, maintenance and repair responsibilities for the Companys installed
base of SystemOne® parts washers including units sold prior to the Exclusive
Marketing Agreement and units sold pursuant to the Exclusive Marketing
Agreement. The Company is responsible solely for the cost of parts required for
warranty repairs during the warranty period for all units sold. For units sold
prior to the Exclusive Marketing Agreement, the Company agreed to pay
Safety-Kleen a total one-time fee of $500,000 for all warranty service to be
performed by Safety-Kleen on these units, which amount was fully paid as of
December 31, 2003. For units sold pursuant to the Exclusive Marketing
Agreement, Safety-Kleen is responsible for the labor cost of all service,
maintenance and repair during the warranty period. On July 30, 2003, the Company entered into the SystemOne Equipment Inspection
and Repair Agreement (the Repair Agreement) with Safety-Kleen following
Safety-Kleens assertions that the molded tanks in parts washers manufactured
by the Company may develop leaks and were, therefore, defectively designed or
manufactured, constituting a purported material breach of the Exclusive
Marketing Agreement by the Company. The Company informed Safety-Kleen that it
believed that it was not in material breach of the Exclusive Marketing
Agreement and that the molded tanks were not defectively designed or
manufactured. Although the Company complied with the material requirements of the Repair
Agreement, a number of controversies remained between the Company and
Safety-Kleen, including claims by Safety-Kleen of material breaches of the
Exclusive Marketing Agreement by the Company. All such alleged claims were
resolved under the Settlement Agreement. In addition, under the Settlement
Agreement, the Company is required to continue to supply any parts at its sole
expense in accordance with, and for the balance of, the three-year warranty
applicable to units sold to Safety-Kleen. The Company will also continue to
provide repair and replacement parts for the items not covered by warranty at
Safety-Kleens expense. 5




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INDUSTRY AND COMPETITION Based upon industry research, the Company estimates that domestic expenditures
in connection with industrial parts cleaning equipment and services exceed $1.0
billion annually. Industrial parts cleaning equipment are used by automotive,
aviation and marine service, repair and rebuilding facilities, gas stations,
transmission shops, parts remanufacturers, machine shops, and general
manufacturing operations of every size and category employing service,
maintenance and repair operations. Conventional industrial parts cleaning
equipment typically remove lubrication oils from tools and parts through the
use of mineral spirit solvents that become progressively more contaminated and
less effective in the cleaning process. Eventually, the solvent becomes
saturated with oil, sludge and other contaminants and is typically classified
as a hazardous waste under federal and state regulations. Under the most common
current practice, the contaminated solvent must be stored until pick-up, when
pure solvent is delivered and the contaminated solvent is transported to
regional refining facilities. This delivery and off-site recycling program is
typically scheduled on 4 to 16 week cycles. In contrast, the distillation
process used in the Companys SystemOne® Washers removes all the contaminants
from the solvent within the cleaning unit itself, minimizing the volume of
waste by-product and providing pure solvent to the customer on demand,
eliminating the need for costly and potentially dangerous storage and
transportation of hazardous waste. Moreover, the small amount of waste
by-product yielded in the distillation process used in the SystemOne® General
Parts Washers can typically be recycled or disposed of together with the
customers used motor oil, which is generally not classified as hazardous
waste. Accordingly, the Company believes that its product line presents an
attractive and economical alternative to users of other technologically
outdated, non-recycling parts cleaning equipment because the Companys
SystemOne® product line facilitates efficient and economical compliance with
environmental regulations, minimizes waste disposal requirements, reduces
insurance costs and increases worker productivity as a result of enhanced
cleaning solution utilization. The industrial parts cleaning industry is highly competitive and dominated by
Safety-Kleen. The Company believes that Safety-Kleen services a dominant
portion of the parts washing machines currently in use and that no other
competitor accounts for more than 10% of the parts washer market in the United
States. The Company believes that Safety-Kleen will be the Companys primary
competitor. Other than SystemOne part washers still in Safety-Kleens inventory, the
Company is not aware of any competitor that is currently marketing a self
contained recycling parts washer competitive with the Companys SystemOne®
products and at comparable pricing to the Companys SystemOne® products.
Certain of the Companys target customers have attempted to enhance the
capabilities of their existing industrial parts washers by acquiring stand
alone equipment capable of distilling solvent. In addition to the non-recycling
products discussed above, there are competitors which use ultrasonic, aqueous,
or other chemical free parts cleaning technologies. Although there is a wide
variety of such machinery currently available to the public, the Company
believes that the SystemOne® Washers compare favorably on the basis of, among
other things: (i) delivery of pure solvent on demand; (ii) lower overall
cost; (iii) reduced time and cost associated with documenting compliance with
applicable environmental and other laws; 6




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(iv) reduced safety and environmental risks associated with competitive
machines and services; (v) customer service; and (vi) difficulty in handling
the regulated substances used and/or generated by competitive machines. The Company is broadening its product line with the launch of its new Paint Gun
Cleaner in early 2004. The Company estimates there are approximately 42,000
paint and body shops in the United States currently holding painting permits.
Approximately 79% of these paint and body shops are highly accessible,
individually owned small businesses and are single location operations. Market
research indicates that purchase decisions for such equipment is based on
recommendations from manufacturers agents, as well as three criteria; quality,
price and ease of use. The Companys new Spray Gun Washer has been designed to
meet all three criteria as well as incorporating the Companys proprietary
resource recovery and waste minimization technologies to distill contaminated
paint thinners for perpetual use and re-use, eliminating the need for costly
and potentially dangerous storage and transportation of hazardous thinner
waste. Although the Company has conducted extensive research regarding the potential
market for its new Spray Gun Washer, there can be no assurance that this new
product will gain customer acceptance or that the Companys marketing plans
will prove to be successful. Furthermore, the market for spray gun cleaning
equipment is competitive and other manufacturers of such equipment may have
greater financial resources and brand recognition than the Company. STRATEGY The Companys strategy is to continue its focus on the research, design,
development, manufacture and sale of its SystemOne® Washers. To date, the
Company has shipped over 50,000 SystemOne Washers and believes that its
products have achieved significant market penetration because of the
technological, economic and environmental advantages of the Companys products
over competitive equipment. The Company plans to place strong emphasis in 2004 on the following
initiatives: LAUNCH ITS NEW PAINT GUN WASHER PRODUCT LINE. The Company expects to broaden
its industrial parts cleaning product line with the commercial launch of its
new paint and coatings Spray Gun Washer during early 2004. As with any new
product, unanticipated design or production problems could delay such
introduction. See Products. The Company has one patent issued and one patent
pending for its Paint Gun Washer. DEVELOP A THIRD PARTY DOMESTIC DISTRIBUTION NETWORK. In light of the
termination of the Exclusive Marketing Agreement, the Company is in the process
of establishing a new distribution network for its products and is currently
undertaking the appointment of new distributors throughout the United States.
See Marketing & Distribution. EXPAND INTO INTERNATIONAL MARKETS. The Company estimates that the combined
worldwide international market for parts washer equipment is approximately
equal in size to the U.S. market. The European market, a potential new market
for the Companys product lines, is a highly fragmented market with only one
significant operator, Safety-Kleen Europe Limited (not affiliated with
Safety-Kleen Corp.), with approximately 125,000 installed parts washer units 7




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throughout Europe. The Company determined that it would have the best access to
the international markets through a third party distributor and in October 2003
entered into a distribution agreement with Hockman-Lewis Limited appointing
them as the Companys exclusive international sales distributor in all export
markets worldwide. See Marketing & Distribution. As of the date hereof, the
Company has not completed any international sales. PRODUCTS The Companys entire product line incorporates resource recovery and waste
minimization technologies for which the Company has obtained patent protection.
All of the Companys products (i) provide continuously recycled cleaning
solution during the cleaning process, (ii) eliminate the necessity for
continual replacement and disposal of contaminated cleaning solution and (iii)
facilitate practical and cost effective compliance with demanding environmental
laws and regulations. All of the Companys products described below are
available for commercial sale. SYSTEMONE® GENERAL PARTS WASHER was the first of the Companys products to be
commercially available. The SystemOne® General Parts Washer provides users with
pure mineral spirit solvent on demand for parts and tools cleaning purposes,
utilizing a low-temperature vacuum distillation process to recycle contaminated
solvents within the unit. This process allows the solvent to be perpetually
used and reused without the need for off-site processing, minimizes the volume
of waste by-product and eliminates the need for storage and disposal of the
hazardous waste solvent. The markets for SystemOne® General Parts Washers are
automotive, aviation and marine service, repair and rebuilding facilities, gas
stations, transmission shops, parts remanufacturers, machine shops, and general
manufacturing operations of every size and category employing service,
maintenance and repair operations. The SystemOne® General Parts Washer was
enhanced during fiscal 2003 for improved performance, reduced size and greater
mobility. SYSTEMONE® MOBILE WASHER is a mobile telescoping mini-parts washer designed
specifically as a satellite unit to the SystemOne® General Parts Washer. The
SystemOne® Mobile Washer may be placed directly under the automobile being
serviced and accesses clean solvent from the SystemOne® General Parts Washer
that also serves to recycle the contaminated solvents. SYSTEMONE® SPRAY GUN WASHER incorporates the Companys recycling/reclamation
capabilities for paint thinner recovery. The target markets for paint and
coatings spray gun washers consist of automotive, aviation and marine paint
shops and all general manufacturing operations that maintain spray painting and
spray on coatings operations. MANUFACTURING AND SUPPLY OF RAW MATERIALS The Company currently leases a 62,000 square foot facility located in Miami,
Florida which serves as the Companys executive office, manufacturing and
research facility. On November 17, 2003, the Company entered into an agreement
to sublease approximately 25,000 square feet of unneeded space in this facility
to a third party. All of the Companys manufacturing operations, including
design, fabrication, painting and assembly are performed at this facility.
Annual 8




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manufacturing capacity of SystemOne® Washers at this facility is approximately
5,000 units and can be expanded up to 25,000 on two full shifts. The Company
currently manufactures its other products in amounts required for testing, test
marketing and/or commercial production in these manufacturing facilities. The
facility is leased through October 2005 and the lease provides two renewal
terms of three years each, exercisable at the Companys option upon six months
prior written notice. In the second quarter of 2002, the Company reduced its
leased space from 75,000 square feet to 62,000 square feet and negotiated a
lower rental rate. The SystemOne® Washers are assembled from raw materials and components all of
which the Company believes are readily obtainable in the United States. The
Company believes that it is not dependent upon any of its current suppliers to
obtain the raw materials and components necessary to assemble and manufacture
SystemOne® Washers. The Company currently procures raw materials and components
for its SystemOne® Washers from approximately 50 sources. MARKETING AND DISTRIBUTION In light of the previously disclosed Settlement Agreement with Safety-Kleen,
the Companys strategy is to establish new distribution channels for its
products. The Company has determined that its best potential channels of
distribution are in the following three industry segments: ENVIRONMENTAL SERVICES/USED OIL COLLECTION: The environmental services industry
consists of parts washer services, used oil collection and other waste removal
services. Although Safety-Kleen holds a dominant market share in the parts
washer segment (about 50%  60%), its used oil collection segment represents
about 10%  15% of total used oil collection in the United States. This highly
fragmented industry is composed of numerous regional operators whose customer
base generally overlaps Safety-Kleens parts washer market share. Used oil
recovery operators generally do not provide parts washer services to their oil
customers because they often lack the infrastructure to deliver, collect,
refine and redeliver cleaning solvents, and the cost of establishing such an
infrastructure is significant. The Companys SystemOne recycling parts washers
do not require such an infrastructure as they recycle the cleaning solvents
automatically on-site eliminating the need to deliver, collect, refine and
redeliver such solvents typically required of traditional non-recycling parts
washers. The Companys SystemOne recycling washers provide the oil collection
operators with an opportunity to expand their service offerings to their
customer base with a new parts washer offering that they can bundle with
their other environmental services. AUTOMOTIVE LUBRICATION DISTRIBUTORS: Automotive lubrication distributors for
major lubrication products represent potential distribution partners for the
Companys products because they provide an array of products and services to
the same customer base that utilizes parts washers. They typically have
expansive sales and service infrastructures and customer bases. The SystemOne
parts washer line represents a product offering that is complementary to
lubrication distributors typical product and service offerings. AUTOMOTIVE SERVICES EQUIPMENT DISTRIBUTORS: Automotive equipment distributors
with adequate sales and services infrastructure also represent a potential
distribution channel for the Companys products because they provide an array
of products and services to 9




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the same customer base that utilizes parts washers. Equipment distributors
provide an additional advantage in that they are generally highly experienced
in equipment leasing and may provide a greater variety of leasing and financing
options with attractive terms. In order to have access to as many potential distributors in the industry
segments described above, the Company (i) has joined or is developing
relationships with several key industry associations including, among others,
the Association of Independent Oil Distributors (AIOD); the National Oil
Recyclers Association (NORA); and the National Independent Parts Cleaner
Association (NIPCA); (ii) participates or intends to participate in all
relevant trade shows including the Automotive Aftermarket Products Expo
(AAPEX), the NORA show, the National Autobody Congress and Exposition (NACE),
and the Auto Mechanika Show (in Frankfurt, Germany), and (iii) has initially
appointed five regional sales support managers to assist in locating, training
and supporting the Companys network of distributors nationwide. To date the Company has communicated with more than 90 potential distributors
nationwide and estimates that approximately 40 to 50 distributors in this group
represent potentially qualified distributors for the Companys products.
Approximately eight distributors have been appointed to date and the Company
anticipates the shipment of initial orders in the first quarter of 2004 to
total approximately 150 units with increases throughout the year, although
there can be no assurances of such increases. This projection compares to 3,750
units that would have been shipped in the first quarter of 2004 under the
Exclusive Marketing Agreement. The Company has entered into a distribution agreement, dated October 23, 2003,
with Hockman-Lewis Limited appointing them as the Companys international sales
distributor in all export markets worldwide (the International Distribution
Agreement). Hockman-Lewis has over 70 years of experience in managing export
sales and marketing on behalf of many prominent American manufacturers of
automotive service equipment. The International Distribution Agreement has a
five-year term subject to extension for up to two additional five-year terms
unless either party provides not less than 180 days notice of non-renewal. To
maintain its exclusive status, Hockman-Lewis is required to make annual minimum
purchases commencing in year two of the term in the amount of $800,000 and
escalating to $5 million in year five. With sales offices in the United States,
Singapore, and the United Kingdom, Hockman-Lewis personnel travel extensively
throughout the world utilizing its international sales force to locate, appoint
and support leading equipment distributors in international territories
worldwide. Hockman-Lewis multilingual personnel provide marketing and
technical support to their distribution partners as well as managing all
aspects of handling, financing, invoicing, shipping and documentation on behalf
of its clients. To date, there have not been any sales under the International
Distribution Agreement. PATENTS, TRADEMARKS AND PROPRIETARY TECHNOLOGY The Company has been awarded 11 United States patents for its product line
including its SystemOne® General Parts Washer (four patents), Power Spray
Washer, Spray Gun Washer, Immersion Washer, Floor Washer, MiniDisposer (thermal
oxidizer) and Vapor Recovery System (two patents). The Company applies for
patents as appropriate and currently has a second patent pending relating to
the Paint Gun Washer. The Companys patents on its principal product, the 10




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SystemOne® General Parts Washer, have terms that commenced September 1994 and
continue through September 2015. The Company holds 12 foreign patents in
Europe, Canada, Mexico and Japan relating to its SystemOne® technologies and
has three additional foreign patents pending in Europe and Canada. The Company believes that patent protection is important to its business. There
can be no assurance as to the breadth or degree of protection which existing or
future patents, if any, may afford the Company, that any patent applications
will result in issued patents, that patents will not be circumvented or
invalidated or that the Companys competitors will not commence marketing
self-contained washers with similar technology. In addition, it is costly to
enforce patent and other intellectual property rights against infringing
parties. In the event the Companys products or processes infringe patents or
proprietary rights of others, the Company may be required to incur costs to
defend such claims, modify the design of its products or obtain a license, any
of which could harm the Companys results of operations. The Company has received federal trademark registrations with respect to the
SystemOne® mark and design and Qsol® mark and design for the Companys
proprietary solvent formulas. The Company also relies on trade secrets and proprietary know-how and employs
various methods to protect the concepts, ideas and documentation of its
proprietary information. However, such methods may not afford complete
protection and there can be no assurance that others will not independently
develop such know-how or obtain access to the Companys know-how, concepts,
ideas and documentation. Although the Company has and expects to continue to
have confidentiality agreements with certain employees and vendors, there can
be no assurance that such arrangements will adequately protect the Companys
trade secrets. Because the Company believes that its proprietary information is
important to its business, failure to protect such information could have a
material adverse effect on the Company. RESEARCH AND DEVELOPMENT The Company recognizes that the industrial parts cleaning industry may be
entering a phase of rapid technological change and the Company will seek to
retain what it perceives as its technological superiority over competitors
products. In this regard, the Company intends to continue to seek means of
enhancing and improving its SystemOne® Washers. In order to keep pace with the
rate of technological change, the Company also intends to devote considerable
resources in time, personnel and funds on research and development for future
products as well as improvements to existing products. The Company recognizes
that many of its competitors have far greater financial resources than the
Company which may be devoted to research and development and there can be no
assurance that the Company will maintain a technological advantage over its
competitors or that the Company will develop new products capable of
commercialization. Research and development expenses increased by $26,471 or 8.3% from $320,083
for the year ended December 31, 2002 to $346,554 for the year ended December
31, 2003. The increase is primarily due to an increase in wages for the
Companys engineering staff. For 2004, the Company expects to expend
approximately the same amount as in 2003. 11




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The Companys engineering team is currently working on four projects: enhancing
its Spray Gun Washer; developing a new industrial washer for the printing
industry (the Printing Washer); developing an automated version of its
General Parts Washer (the Agitation Washer); and implementing the ISO 9001:2000 quality process. The Companys new Printing Washer under development utilizes the same core
resource recovery technology as the General Parts Washer to clean components of
printing presses and printing rollers. The Company plans to finish the design,
development and field testing of its Printing Washer by late 2004, although
unanticipated development and engineering problems could cause delays. Assuming
timely completion of development and testing, the Company anticipates
commencing marketing of the Printing Washer in early 2005, provided acceptable
distribution agreements can be finalized. The Company believes that currently
there are no existing parts washers marketed specifically for this industry.
The Company did not incur any costs in 2003 relating to the Printing Washer and
estimates that it will incur approximately $87,000 in 2004 to design, develop,
test and tool the Printing Washer. The Company does not anticipate any
significant technological issues will result in adapting its core resource
recovery technologies for the printing industry, although there can be no
assurance that field-testing will not reveal unanticipated problems. The Companys automated
Agitation Washer utilizes its core resource recovery technology with an
automated agitation washing system versus the manual system employed
in the General Parts Washer. The new version will improve productivity with certain cleaning applications as there will be
no need for the user to manually operate the cleaning device of the unit. The
Company did not incur any costs in 2003 relating to the Agitation Washer and estimates that it will incur approximately
$87,000 in 2004 to design, develop, test and tool this new product. The Company began implementation of ISO 9001:2000 during 2002 toward attaining
certification. ISO 9001:2000 is part of a family of international quality
standards which requires the Company to establish and maintain a quality
system. The Companys quality system will include internal quality audits,
corrective and preventive action systems, management review and ongoing third
party assessments. Although the Company expected to be certified in 2003 by
Perry Johnson, Inc., a training, consulting and implementation firm, the
Companys engineering department had to focus on issues related to the Repair
Agreement and the implementation was postponed until mid 2004. Costs incurred
relating to the certification were approximately $87,000 in 2003 and the
Company estimates that it will spend the same amount to complete this project
in 2004. This quality system is being implemented to maximize customer
satisfaction although it is not currently required for either domestic or
international sales. GOVERNMENT REGULATION The Company believes that federal and state laws and regulations have been
instrumental in shaping the industrial parts washing industry. Federal and
state regulations dictate and restrict to varying degrees what types of
cleaning solvents may be utilized, how a solvent may be stored, and the manner
in which contaminated solvents may be generated, handled, transported, recycled
and disposed. 12




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##### Table of Contents



The Company believes that customer demand for its SystemOne® Washers is
partially a function of the legal environment in which customers for the
Companys products conduct business; accordingly, the federal and state laws
and regulations discussed below regulate the behavior of the Companys
customers. The Companys SystemOne® Washers were designed to help minimize the
cost of complying with existing federal and state environmental laws and
regulations. Any changes, relaxation or repeal of the federal or state laws and
regulations which have shaped the parts washing industry may significantly
affect demand for the Companys products and the Companys competitive
position. REGULATION OF HANDLING AND USE OF SOLVENTS. Federal and state regulations have
restricted the types of solvents that may be utilized in industrial parts
cleaning machines. Stoddard solvents, more commonly known as mineral spirits
and solvent naphtha, are the cleaning solvents typically used in industrial
parts washers. The Company uses mineral spirits with a minimum of 140 degrees
Fahrenheit ignitable limits in its SystemOne® Washers. Such mineral spirits do
not exhibit the ignitability characteristic for liquid hazardous wastes as
defined in the Resource Conservation and Recovery Act of 1976, as amended (the
RCRA), and the regulations under that statute adopted by the United States
Environmental Protection Agency (the EPA). Certain machines sold by the
Companys competitors use mineral spirits with lower ignitable limits, which
may, after use, render such mineral spirits subject to regulation as a
hazardous waste. The Company believes that the ability to recycle the mineral
spirits used in its SystemOne® Washers provides a significant economic benefit
to the Companys customers by allowing them to avoid the expenses and potential
liability associated with the disposal of such solvent as a hazardous waste. Federal, state and many local governments have adopted regulations governing
the handling, transportation and disposal of mineral spirit solvents. On the
federal level, under the Hazardous Materials Transportation Act (HMTA), the
United States Department of Transportation has promulgated requirements for the
packaging, labeling and transportation of mineral spirits in excess of
specified quantities. Relative to the handling and disposal of mineral spirits,
many states and local governments have established programs requiring the
assessment and remediation of improper discharges of hazardous materials into
the environment. Liability under such programs is possible for improper release
of mineral spirits in violation of applicable standards. Civil penalties and
administrative costs may also be imposed for such violations. The Companys
products do not require the transportation of mineral spirits that necessitate
compliance with HMTA requirements providing significant economic benefits. REGULATION OF GENERATION, TRANSPORTATION, TREATMENT, STORAGE AND DISPOSAL OF
CONTAMINATED SOLVENTS. The generation, transportation, treatment, storage and
disposal of contaminated solvents is regulated by the federal and state
governments. At the federal level, the RCRA authorized the EPA to develop
specific rules and regulations governing the generation, transportation,
treatment, storage and disposal of hazardous solvent wastes as defined by the
EPA. The Company believes that none of the solvent recycled in SystemOne®
Washers when used in accordance with its intended purpose and instructions is
subject to regulation as a hazardous waste. In contrast, the Company believes
that the mixture of solvent and contaminants which is periodically recovered
from the machines of many of its competitors is subject to regulation as
hazardous waste. 13




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##### Table of Contents



The Company believes that the ability to manage its residue by-product as used
non-hazardous oil rather than as a hazardous waste is economically attractive
to the Companys customers for a number of reasons. The Company believes that
substantially all of its target equipment users currently have established
systems for the handling, transportation, recycling and/or disposal of
non-hazardous used oil. Accordingly, the classification of the residue as
non-hazardous used oil enables the Companys customers to dispose of or recycle
the residue at no significant additional cost and avoid certain costs
associated with establishing and disposing of wastes in compliance with a
hazardous waste disposal system. Even if the residue by-product were required
to be handled, transported, recycled and/or disposed of as a hazardous waste,
the fact that the SystemOne® Washers effect a substantial reduction in the
volume of waste product requiring disposal would still serve to significantly
reduce disposal costs. PRODUCT LIABILITY AND INSURANCE The Company is subject to potential product liability risks through the use of
its industrial parts cleaning equipment. The Company has implemented
appropriate quality control measures and currently maintains product liability
insurance with respect to such potential liabilities. There can be no
assurance, however that such insurance would be adequate to cover any
particular claim or that insurance will continue to be available on acceptable
terms. EMPLOYEES As of February 10, 2004, the Company had 48 full time employees. At February 7,
2003, the Company had 76 full time employees. The reduction is due to the
cutback in Company manufacturing personnel and non-essential administrative
personnel during the third quarter of 2003 as a result of termination of the
Exclusive Marketing Agreement. 
 ITEM 2. DESCRIPTION OF PROPERTY The Company maintains its executive offices and its manufacturing and research
and development facilities in a 62,000 square foot building located in Miami,
Florida. The initial term of the lease for this facility expires October 3,
2005. This lease provides for two renewal terms of three years each and is
exercisable at the Companys option upon six months prior written notice. The
Companys annual lease payments are approximately $441,000, subject to an
annual 3.0% increase, plus the Companys proportionate share of the facilities
maintenance and operating expenses. The Company has the right to cancel this
lease upon three months prior written notice, subject to certain conditions.
The Company has also been granted a right of first refusal with respect to
vacant space adjoining these facilities. Subsequent to the termination of the Exclusive Marketing Agreement and as a
result of the reduction in production, the Company subleased 25,000 square feet
of unneeded space to a non-related third party. The initial term of the
sublease started on December 15, 2003 and expires October 3, 2005. The annual
sublease payments are approximately $120,000 inclusive of electricity and sales
tax. All of the Companys manufacturing operations, including design, fabrication,
painting and assembly are performed at this facility. Annual manufacturing
capacity of SystemOne® Washers at this facility is approximately 5,000 units
and can be expanded up to 25,000 units on two full 14




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##### Table of Contents



shifts. The Company currently manufactures its other products in amounts
required for testing, test marketing and/or commercial production in these
manufacturing facilities. 
 ITEM 3. LEGAL PROCEEDINGS On or about October 17, 2003, the Company, along with Safety-Kleen, was sued in
the Court of Common Pleas for Beaver County, Pennsylvania, by plaintiff
Sirotas Machine Company, Inc. The plaintiff seeks damages in the amount of
approximately $335,000 resulting from a fire that the plaintiff claims was
caused by a SystemOne parts washer. Based upon an initial investigation by the
Companys insurance carrier, the Company believes that the claim is without
merit and anticipates that its insurance carrier will aggressively defend the
claim. Accordingly, the Company currently anticipates that this case will not
have a material adverse effect on the Companys financial position or its
results of operations. The Company is subject to various claims and lawsuits that are routine
litigation incidental to its business. On the basis of advice from legal
counsel, management does not expect that the ultimate resolution of these
matters will have a materially adverse effect on the Companys financial
position or results of operations. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Companys security holders during
the fourth quarter of 2003. 
 PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Companys securities are quoted on the OTC Electronic Bulletin Board under
its symbol STEK.OB. The following table sets forth, for the periods indicated, the high and low bid
quotations for the Common Stock as reported on the OTC Electronic Bulletin
Board for the periods indicated. The OTC Electronic Bulletin Board quotations
represent quotations between dealers without adjustment for retail markups,
markdowns or commissions and may not necessarily represent actual transactions. HIGH BID PRICE
    
    LOW BID PRICE2003Fourth Quarter
    
    $
    0.50
    
    
    $
    0.10Third Quarter
    
    $
    0.73
    
    
    $
    0.45Second Quarter
    
    $
    0.70
    
    
    $
    0.50First Quarter
    
    $
    0.70
    
    
    $
    0.402002Fourth Quarter
    
    $
    0.90
    
    
    $
    0.60Third Quarter
    
    $
    1.50
    
    
    $
    0.85Second Quarter
    
    $
    2.08
    
    
    $
    1.50First Quarter
    
    $
    2.30
    
    
    $
    2.04
 15




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##### Table of Contents



As of December 31, 2003, there were 43 holders of record of the Companys
Common Stock. The Company believes that there are in excess of 500 beneficial
owners of the Common Stock. On March 19, 2004, the closing bid price of the
Common Stock was $.12 per share. To date, the Company has not declared or paid any dividends on its Common
Stock. Pursuant to the terms of the Companys outstanding Convertible
Subordinated Notes, its Senior Revolver (as defined below), the Subordinated
Loan Agreement (as defined below) and outstanding series of preferred stock,
the Company may not declare or pay any dividends or make any other
distributions, except dividends or distributions payable in equity securities.
The payment of dividends, if any, is within the discretion of the Board of
Directors and will depend upon the Companys earnings, its capital requirements
and financial condition, contractual restrictions and other relevant factors.
The Board does not intend to declare any dividends on the Companys common
stock in the foreseeable future, but instead intends to retain future earnings,
if any, for use in the Companys business operations and to make principal and
interest payments on the Companys outstanding indebtedness. The following table includes the following information as of December 31, 2003
for the Companys Executive Incentive Plan, which is its only equity incentive
compensation plan.  
    
    The number of securities to be issued upon exercise of
outstanding options, warrants and rights (column (a));  
    
    The weighted-average exercise price of the outstanding
options, warrants and rights disclosed (column (b)); and  
    
    Other than securities to be issued upon exercise of the
outstanding options, warrants and rights disclosed in column (a),
the number of securities remaining available for future issuance
under the plan. Equity Compensation Plan Information Number of Securities
    
    Weighted-average
    
    Number of Securities remainingto be issued upon
    
    exercise price of
    
    available for future issuanceexercise of
    
    outstanding
    
    under equity compensationoutstanding options,
    
    options, warrants
    
    plans (excluding securitieswarrants and rights
    
    and rights
    
    reflected in column (a))Column (a)
    
    Column (b)
    
    Column (c)Executive Incentive
Plan
    
    
    421,328
    
    
    $
    3.45
    
    
    
    328,672
 Pursuant to an amendment approved by the Companys shareholders during 2000,
stock options to purchase up to 750,000 shares of common stock may be granted
under the Plan. 16




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##### Table of Contents



ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following discussion and analysis should be read in conjunction with the
Companys audited financial statements, including the notes thereto, contained
elsewhere in this report. GENERAL AND RECENT DEVELOPMENTS The Company designs, manufactures and sells the SystemOne Washers, a full line
of patented, self-contained, recycling industrial parts washers for use in the
automotive, aviation, marine and general industrial repair markets. The Company
has been awarded eleven patents for its products, which incorporate innovative,
proprietary resource recovery and waste minimization technologies to distill
contaminated solvents and yield pure solvent allowing cleaning solvents to be
used, recycled and re-used perpetually, eliminating the need
for costly and dangerous storage, transportation and offsite processing of
hazardous waste. The Company commenced its planned principal operations in July 1996 and began
to generate significant revenue from product sales commencing in 1997. Between
1997 and 2000, the Company developed a national direct marketing and
distribution organization, including the establishment of regional distribution
centers and a service fleet, so as to market its products directly to
customers. Shifting its strategy in late 2000, the Company appointed Safety-Kleen Systems
the exclusive distributor for SystemOne® parts washers in the United States,
Puerto Rico, Canada and Mexico under the Exclusive Marketing Agreement. This
strategic shift allowed the Company to eliminate its entire national direct
sales and service infrastructure permitting a significant reduction in the
Companys operating expenses. The Company retained five regional service
managers strategically located throughout the country to provide technical
expertise as needed. The Company began shipping SystemOne® parts washers to Safety-Kleen in January
2001 and immediately began to benefit from lower manufacturing costs per unit
due to higher production volume as well as lower selling, general and
administrative costs resulting from the elimination of its national direct
sales and service infrastructure. During the period January 2001 through
September 2003, the Company shipped approximately 30,000 parts washers to
Safety-Kleen. On September 30, 2003, the Company entered into the Settlement Agreement with
Safety-Kleen to terminate the Exclusive Marketing Agreement. The Settlement
Agreement provides for a total payment of $14 million to the Company,
consisting of a termination fee and a lump sum payment of the accumulated
deferred price on the approximately 30,000 parts washer units shipped to
Safety-Kleen under the Exclusive Marketing Agreement prior to its termination.
Of this amount, the Company received $10 million during the fourth quarter of
2003, $2.5 million during January and February 2004 and anticipates receiving
the balance of $1.5 million on or before March 31, 2004. The balance is
currently secured by a letter of credit posted by Safety-Kleen. In addition,
the Settlement Agreement (i) canceled all remaining purchase commitments under
the Exclusive Marketing Agreement, effective as of October 1, 2003, (ii)
settled all disputes regarding the Exclusive Marketing Agreement, and (iii)
released the parties from all claims that each may have against the other.
Safety-Kleen was also given the right (but not the obligation) in 2005 to
purchase the lesser of up to 3,000 parts washer units or one-sixth of the
Companys then annual production capacity. 17




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##### Table of Contents



Because Safety-Kleen was the Companys only customer, the Company must
establish new distribution channels for its products and is currently
undertaking that effort. To date the Company has communicated with more than 90
potential distributors nationwide and estimates that approximately 40 to 50
distributors in this group may be qualified distributors for the Companys
products. Approximately eight distributors have been appointed to date and the
Company began shipping initial orders to its new distributors in the first
quarter of 2004 and expects to ship approximately 150 units during the first
quarter of 2004 with increases throughout the year, although there can be no
assurances of such increases. This projection compares to 3,750 units that
would have been shipped in the first quarter of 2004 under the Exclusive
Marketing Agreement. The U.S. distribution agreements with newly appointed distributors are
non-exclusive and require minimum initial orders of 10 units. Distributors take
title to the inventory upon shipment (FOB plant) and the Company does not
accept returned goods. Pricing is based on the Companys standard national
price list for both its SystemOne branded products and private label. The
Company provides a one-year parts only warranty and distributors are
responsible for all warranty labor on the equipment. See Description of
Business  Marketing and Distribution for further discussion. The Company has entered into a distribution agreement, dated October 23, 2003,
with Hockman-Lewis Limited appointing them as the Companys international sales
distributor in all export markets worldwide. The International Distribution
Agreement has a five-year term subject to extension for up to two additional
five-year terms unless either party provides not less than 180 days notice of
non-renewal. To maintain its exclusive status, Hockman-Lewis is required to
make annual minimum purchases commencing in year two of the term in the amount
of $800,000 and escalating to $5 million in year five. See Description of
Business  Marketing and Distribution for further discussion. During March 2004, the Company repurchased and retired $13.5 million principal
amount of the Notes for an aggregate purchase price of $2.9 million. The
Company expects to recognize a pre-tax gain of approximately $10.4 million in
the first quarter of 2004 on the repurchase and retirement of these Notes. CRITICAL ACCOUNTING POLICIES Note 1 to the financial statements set forth herein includes a summary of the
significant accounting policies and methods used in the preparation of the
Companys financial statements. Management believes the following policies are
critical to an understanding of the Companys financial statements. These
policies have been discussed with the audit committee. REVENUE RECOGNITION Pursuant to the Exclusive Marketing Agreement, the price charged to
Safety-Kleen was determined annually based on the actual manufacturing costs
incurred during a specified three month period of the previous year. Under the
Exclusive Marketing Agreement, the price for each unit purchased by
Safety-Kleen consisted of two components: a standard price payable on net 18




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30-day terms from the date of shipment and a deferred price (approximately 12%
of the total price) payable in equal installments over a 12-quarter period
which was accounted for as set forth in Note 1(f) to the financial statements.
The Company recognized revenue at the time of shipment (F.O.B. shipping dock)
for the total sales price, but applied a discount to reflect the present value
of the 12 quarterly deferred price payments utilizing a discount rate of 14%
which was the interest rate then paid on the Companys Senior Revolver. In
addition, the Company recognized imputed interest income over the discount
period as the deferred portion of the purchase price was amortized over the
scheduled payment period. The receivable related to the deferred portion of the
purchase price and interest income recognized through September 30, 2003 was
paid pursuant to the Settlement Agreement. The collectability of receivables is evaluated routinely and, if deemed
necessary, the Company records an allowance for doubtful accounts. The
allowance for doubtful accounts was $0 and $123,287 at December 31, 2003 and
2002, respectively. The Company wrote off all uncollectible receivables against
the reserve in fiscal year 2003. The Company recognized other income of $5,778,701 in the fourth quarter of 2003
relating to the termination of the Exclusive Marketing Agreement with
Safety-Kleen and expects to recognize the remainder of the termination fee,
approximately $4 million, as other income in the first quarter of 2004. Because
the termination fee is considered a gain contingency, only the portion of the
gain that had been received in cash as of December 31, 2003 in excess of the
receivable due from Safety-Kleen for the deferred price can be recognized as a
gain. Deferred revenue on the balance sheet relates to extended two-year warranty
contracts purchased by customers and is recognized in income on the
straight-line basis over the term of each contract. PRODUCT WARRANTY The Company generally warrants that its products will be free of material
defects during the three-year warranty period. Pursuant to the Exclusive
Marketing Agreement, Safety-Kleen assumed all service, maintenance and repair
responsibilities for the Companys installed base of SystemOne® parts washers
including units sold prior to the Exclusive Marketing Agreement and units sold
pursuant to the Exclusive Marketing Agreement. The Company is responsible
solely for the cost of parts required for warranty repairs during the warranty
period for all units sold. For units sold prior to the Exclusive Marketing
Agreement, the Company agreed to pay Safety-Kleen a total one-time fee of
$500,000 for all warranty service to be performed by Safety-Kleen on these
units, which amount was fully paid as of December 31, 2003. For units sold
pursuant to the Exclusive Marketing Agreement, Safety-Kleen is responsible for
the labor cost of all service, maintenance and repair during the warranty
period. The Company accrues estimated warranty costs as the parts washers are
sold to customers. Such accrued warranty costs consist of the estimated cost of
parts projected to be consumed during the remaining warranty period based on
actual parts used during the previous 19 month period. Under the Settlement
Agreement, the Company is required to continue to supply any warranty related
parts free of charge in accordance with, and for the balance of, the three-year
warranty period applicable to units sold to Safety-Kleen. The Company will
also continue to provide repair and replacement parts for the 19




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items not covered by warranty at Safety-Kleens expense. Effective January 1,
2004, all of the Companys products will be offered with a one year limited
warranty. Warranty accrual activity during the years ended December 31, is as follows: 2003
    
    2002Beginning balance
    
    $
    674,490
    
    
    $
    1,071,607Warranty provision
    
    
    528,067
    
    
    
    346,406Warranty payments
    
    
    (785,297
    )
    
    
    (743,523
    )Ending balance
    
    $
    417,260
    
    
    $
    674,490
 USE OF ESTIMATES Management of the Company uses estimates and assumptions relating to the
reporting of assets and liabilities and the disclosure of contingent assets and
liabilities to prepare these financial statements in conformity with accounting
principles generally accepted in United States of America. Actual results could
differ from those estimates. YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 RESULTS OF OPERATIONS The Company sold 9,401 SystemOne® General Parts Washers during 2003 compared to
10,218 units in 2002. Revenue decreased by $872,228, or 4.9%, to $16,847,498
for the year ended December 31, 2003 from $17,719,726 for the year ended
December 31, 2002. The revenue decrease resulted from the decrease in
equivalent units sold as a result of the termination of the Exclusive Marketing
Agreement effective October 1, 2003. As detailed in the table below, the
Company did not sell any parts washers during the fourth quarter of 2003.
Revenue during the fourth quarter resulted from the sale of parts only. The
decrease in volume was partially offset by a price increase of $35 per parts
washer or approximately 2.3% pursuant to the terms of the Exclusive Marketing
Agreement and an increase of $200,000 or 54.6% in parts sold to Safety-Kleen
compared to the same period in the prior year. Sales during 2003 and 2002 were
entirely to Safety-Kleen. Management expects revenue in fiscal 2004 to be
significantly less than 2003 as a result of the termination of the Exclusive
Marketing Agreement and the need for the Company to transition from single
customer distribution under the Exclusive Marketing Agreement to new multiple
distribution channels. 1st  3rd Qtr
    
    4th Qtr
    
    12/31/03Quantity sold
    
    
    9,401
    
    
    
    
    
    
    
    9,401Revenue
    
    $
    16,829,019
    
    
    $
    18,479
    
    
    $
    16,847,498Cost of goods sold
    
    
    (10,346,651
    )
    
    
    (807,787
    )
    
    
    (11,154,438
    )Gross profit (loss)
    
    
    6,482,368
    
    
    
    (789,308
    )
    
    
    5,693,060Operating expenses
    
    
    2,581,196
    
    
    
    769,609
    
    
    
    3,350,805Safety-Kleen termination fee
income
    
    
    
    
    
    
    5,778,701
    
    
    
    5,778,701Interest expense, net
    
    
    (1,934,500
    )
    
    
    (727,876
    )
    
    
    (2,662,376
    )Income before tax provision
    
    
    1,966,672
    
    
    
    3,491,908
    
    
    
    5,458,580
 20




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Gross profit as a percentage of sales was 33.8% and 38.4% for the years ended
December 31, 2003 and 2002, respectively. The decrease in gross margin is
primarily due to additional warranty costs of approximately $448,000 related to
the Repair Agreement and the significant decrease in production volume in the
fourth quarter of 2003. The reduction in volume resulted in excess capacity for
labor and overhead of approximately $450,000 that increased unit cost of sales.
Additionally, the Company recognized a loss on the trade and writedown of
production equipment of approximately $234,000. The Company traded certain used
production assets for new production assets to be used in the manufacturing
plant and wrote off the impaired value of certain production equipment that
were held for sale at the end of fiscal 2003. The Company incurred other
write-offs relating to the downsizing of the manufacturing plant. Selling, general and administrative expenses increased $223,677 or 8.0% to
$3,004,251 for the year ended December 31, 2003 from $2,780,574 for the
comparable period of 2002. The increase is attributable primarily to increased
legal fees related to executing the Repair Agreement and the termination of the
Exclusive Marketing Agreement which totaled approximately $297,000. Such
increased expenses were partially offset by a reduction in annual rent of
$129,000 under the Companys real property lease beginning in the second
quarter of 2002. The reduction in rent was the result of the decrease in leased
space from 75,000 square feet to 62,000 square feet and lower lease rates
negotiated in September 2003. Management expects general and administrative
expenses to decrease in 2004 and selling expenses, including advertising,
printing, promotional and travel expenses, to increase as a result of building
its new distribution system. Research and development expenses increased by $26,471 or 8.3% from $320,083
for the year ended December 31, 2002 to $346,554 for the year ended December
31, 2003. The increase is primarily due to an increase in wages for the
Companys engineering staff. For 2004, the Company expects to expend
approximately the same amount as 2003. The Company recognized operating profit of $2,342,255 and $3,777,878 for the
years ended December 31, 2003 and 2002, respectively. The decrease in operating
profit is primarily attributable to the impact from the Repair Agreement and
terminating the Exclusive Marketing Agreement resulting in zero sales of parts
washers in the fourth quarter of 2003 and an increase in selling, general and
administrative expenses as explained above partially offset by higher unit
prices and parts sales. The Company recognized other income of $5,778,701 in the fourth quarter of 2003
relating to the termination of the Exclusive Marketing Agreement with
Safety-Kleen and expects to recognize the remainder of the termination fee of
approximately $4 million as other income in the first quarter of 2004. Because
the termination fee is considered a gain contingency, only the portion of the
gain that had been received in cash as of December 31, 2003 in excess of the
receivable due from Safety-Kleen for the deferred portion of the sales price,
can be recognized as a gain. 21




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Interest expense decreased $121,993 or 3.8% to $3,051,845 for the year ended
December 31, 2003 from $3,173,838 for the comparable period in 2002. The
decrease in interest expense is due to (i) fully amortizing in January 2002 the
debt discount associated with common stock warrants previously issued, (ii) a
reduction in the outstanding principal of the Senior Revolver, (iii) a
reduction in the interest rate on the Subordinated Promissory Notes from 16% in
2002 to 10% in 2003 and (iv) lower amortization of debt issue costs in 2003.
The decrease is partially offset by increased debt balances attributable to
capitalization of accrued interest in connection with the December 9, 2002 debt
restructuring. Interest expense is expected to continue to decrease in 2004 as
a result of paying off the Senior Revolver in January 2004, repurchasing and
retiring $13.5 million principal amount of the Subordinated Convertible Notes
in March of 2004 and lower interest rates. Interest income increased $21,848 or 5.9% to $389,469 for the year ended
December 31, 2003 from $367,621 for the comparable period of 2002. The increase
is mainly due to the increase in the deferred portion of the sales price
resulting from the cumulative increase in units sold under the Exclusive
Marketing Agreement. As a result of the termination of the Exclusive Marketing
Agreement no interest income was recognized on the deferred portion of the
sales price in the fourth quarter of 2003, however, nominal interest income was
recognized from invested cash on hand. Income tax provision increased from zero in the year ended December 31, 2002 to
$186,705 in the comparable period of 2003. The increase is due to the
alternative minimum tax payable as a result of the Company recognizing pre-tax
income during the year ended December 31, 2003. The Company expects to utilize
available net operating losses to reduce its taxable income, if any, in 2004. Despite the current years net income, the Company has utilized net operating
loss carryforwards to reduce its federal and state tax burden. Based on an
evaluation of available evidence, in view of the Companys significant
historical losses, management believes that it is not likely that the deferred
tax assets will be realized; therefore a full valuation reserve is provided for
the deferred tax asset. During the year ended December 31, 2003, the Company
utilized net operating loss carry-forwards of approximately $9,100,000 to
reduce its federal and state taxes. As a result of the foregoing, the Company recognized net income of $5,271,875
for the year ended December 31, 2003 compared to net income of $971,661 for the
year ended December 31, 2002. Dividends on preferred stock are paid-in-kind by issuing additional shares of
preferred stock. For the year ended December 31, 2003 paid-in-kind dividends
totaled $2,236,058, a decrease of $58,308 or 2.5% compared to paid-in-kind
dividends of $2,294,366 for the year ended December 31, 2002. The decrease is
primarily attributable to $173,038 recognized as dividends in the prior year
for the fair market value of the warrants issued in December 2002 to the
holders of the Series D Preferred Stock. The decrease is offset by the
compounding effect of paying dividends on additional shares of preferred stock
that were previously issued as paid-in-kind dividends. The dividends also
include the amortization of preferred stock discounts associated with common
stock warrants issued to investors in the amount of $725,459 and $725,527 for
the years ended December 31, 2003 and 2002, respectively. 22




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The Companys net income attributable to common shares increased $4,358,522 or
329.5% to $3,035,817 for 2003 from a net loss of $1,322,705 for 2002, or basic
and diluted net income per common share of $.61 and $.45, respectively for 2003
as compared to a basic and diluted loss per common share of $.28 for 2002. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities for the year ended December 31, 2003
increased by $10,098,420 to $11,281,976 compared to net cash provided by
operating activities of $1,183,556 for the prior year. The increase is
primarily attributable to an increase in net income of $4,300,214 from $971,661
for the year ended December 31, 2002 to $5,271,875 for the year ended December
31, 2003. This source of cash includes a decrease in receivables of $4,587,341
attributable to Safety-Kleen paying substantially all of its outstanding
receivables subsequent to the termination of the Exclusive Marketing Agreement.
The increase is partially offset by: (i) an increase in inventories of
$493,880, (ii) a decrease in accounts payable and accrued expenses of $87,390
and (iii) a decrease in warranty accrual of $257,230. The increase in
inventories is largely due to accepting inventory previously ordered which was
not consumed because production decreased significantly in the fourth quarter
of 2003 due to termination of the Exclusive Marketing Agreement. The decrease
in accounts payable and accrued expenses is primarily attributable to a
reduction of purchasing inventory and plant supplies in November and December
of 2003 due to the significant reduction in manufacturing activity due to
termination of the Exclusive Marketing Agreement. The decrease in warranty
accrual is due to (i) the warranty period ending on all units sold prior to the
Exclusive Marketing Agreement becoming effective, (ii) the absence of any
additional warranty accrual since there were no units sold in the fourth
quarter of 2003 and (iii) final payment of the warranty reserve established at
the end of 2000 related to transitioning to Safety-Kleen service, maintenance
and repair responsibilities for previously sold SystemOne parts washers through
the remaining warranty periods. The Company paid approximately $75,000 and
$300,000 related to this reserve in 2003 and 2002, respectively. Net cash used in investing activities for the year ended December 31, 2003 was
$42,153, a decrease of $19,195, compared to $61,348 during the prior year. This
decrease is due to purchasing more manufacturing equipment with cash in 2002
than in 2003. The Company acquired manufacturing equipment totaling
approximately $23,000 through a capital lease during the first quarter of 2003.
The Company expects to spend approximately $20,000 in capital purchases during
2004. Net cash used in financing activities for the year ended December 31, 2003 was
$3,385,721, an increase of $2,709,827 compared to $675,894 during the prior
year. The increase in cash used in financing activities is primarily
attributable to the Company paying down the Senior Revolver (as defined below)
by $3,234,632 during 2003 compared to $80,000 during 2002. At December 31, 2003,
the Company had working capital of $9,034,603 and cash
and cash equivalents totaling $8,359,168, compared to working capital of
$2,788,463 and cash and cash equivalents of $505,066 at December 31, 2002. The
significant increase in net working capital is
due to payments from Safety-Kleen pursuant to the termination of the Exclusive
Marketing Agreement of $10,000,000 received in the fourth quarter of 2003. 23




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The Company is party to a Revolving Credit Loan Agreement (the Senior
Revolver) with Hansa Finance Limited Liability Company (Hansa), which
provides the Company with a revolving line of credit that matures on May 30,
2005 and, under which, interest is due monthly. On November 24, 2003, the
Company and Hansa amended the Senior Revolver to change the calculation of the
Advance Limit and reduce the interest rate to 13%. Effective November 24, 2003,
pursuant to the second amendment, the Advance Limit is the lesser of $3,000,000
or an amount based on the Companys receivables and inventory and the
$2,500,000 Advanced Supplement was eliminated. The President of Hansa Finance Limited Liability Company, Mr. Paul A.
Biddelman, is a director of the Company. At December 31, 2003, the Company exceeded its lending limits and, as a result thereof, the Company has repaid the outstanding
balance of the Senior Revolver of approximately $1.4 million in January 2004 from cash provided by the Settlement Agreement. In 2002, the Companys primary source of cash was its operations. In 2003, the
Companys primary sources of cash were operations and the $10,000,000 received
from Safety-Kleen pursuant to the termination of the Exclusive Marketing
Agreement. Going forward, any failure to obtain new distributors and customers
in a timely manner could have a material adverse effect on the Companys
results of operations, cash flows and financial condition. If the payments
under the Settlement Agreement, together with any future sales revenue and
other available capital resources are insufficient to fund the Companys
transition to a new distribution system, the Company could be required to seek
additional debt or equity capital. There can be no assurance that any such
additional capital would be available on acceptable terms or at all. In its
opinion on the Companys financial statements, included herein, the Companys
independent accountants, BDO Seidman, LLP, stated that the Companys financial
condition described above raises substantial doubt about the Companys ability
to continue as a going concern. The financial statements have been prepared
assuming that the Company will continue as a going concern and management
believes that the $14 million to be received from Safety-Kleen should be
sufficient to sustain the Company until it finalizes its transition from single
customer distribution under the Exclusive Marketing Agreement to new multiple
distribution channels. The Companys material short-term financial commitments are obligations to make
(i) lease payments on the Companys principal executive and manufacturing
facility in Miami, Florida and equipment leases (approximately $40,000 per
month), (ii) installment payments for financed manufacturing equipment
(approximately $1,000 per month), and (iii) interest payments on the Companys
8.25% Partial Cash Pay Notes (defined below, approximately $32,000 per month)
Dividends on the Companys Series B, Series C, and Series D Convertible
Preferred Stock can be paid by issuance of additional shares of such series. On December 9, 2002, the Company exchanged (i) all of its then outstanding
8.25% Subordinated Convertible Notes due February 23, 2003 for $22,108,568
aggregate principal amount of the Notes (half of which provided for
all interest to be paid by accretion to the principal amount and
half of which provided for substantially all interest to be paid in cash) and Warrants (the New
Warrants) for the purchase of an aggregate of 750,000 shares of Common Stock
at an 24




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##### Table of Contents



exercise price of $.01 per share expiring on December 31, 2005; and (ii) all of
its then outstanding 16% Promissory Notes due November 30, 2002 for the Secured
Notes bearing interest due of maturity at 10% and maturing on December 31, 2005
in an aggregate principal amount of $4,418,373. The estimated fair market
value of the New Warrants at December 9, 2002 was $519,114 and was charged to
unamortized note discount and credited to additional paid-in capital. The
discount will be amortized to interest expense over the term of the Notes. The issuance of the 750,000 warrants to the holders of the Subordinated
Convertible Notes, described above, would have triggered certain anti-dilution
rights pursuant to the Companys outstanding (i) shares of Series D Preferred
Stock, $1.00 per share, (ii) warrants issued May 2, 2000 exercisable for an
aggregate of 571,428 shares of Common Stock, and (iii) warrants issued August
7, 2000 exercisable for an aggregate of 942,858 shares of Common Stock
(collectively, the Outstanding Warrants). The holders of the Series D
Preferred Stock and Outstanding Warrants waived their anti-dilution rights in
exchange for warrants for the purchase of an aggregate of 250,000 shares of
Common Stock at an exercise price of $.01 per share expiring on December 31,
2005. The estimated fair market value of these warrants at December 9, 2002 was
$173,038 and was recorded as a dividend and credited to additional paid-in
capital. In connection with the Exchange, the holders of the Companys outstanding
shares of Preferred Stock agreed to extend the date upon which the Company must
redeem such shares from May 17, 2004 to the earlier of the 90th day after all
of the Notes are paid in full or March 31, 2006. The Company is required to issue an additional 942,858 warrants to the holders
of its Secured Notes if the Company (i) sells debt or equity securities, or
debt securities convertible into equity securities, or incurs debt with a final
scheduled maturity date more than twelve months after issuance providing gross
cash proceeds to the Company in an amount equal to or greater than the
outstanding principal amount of the Secured Notes or (ii) enters into a merger,
consolidation, sale of all or substantially all of its assets or other business
combination transaction with a party that prior to such transaction owns less
than 25 percent of the voting power of the Companys outstanding equity
securities. The fair market value of the warrants would be charged to
operations should the warrants become issuable. In September 2002, the Company entered into agreements with its Chief Executive
Officer and President which extended their employment agreements for twenty-four
months expiring on December 31, 2004. Based on current plans and estimates and taking into account the expected
investment necessary to rebuild the Companys distribution system, management
has allocated approximately $5 million of available cash to reduce and retire
certain indebtedness of the Company, which as of December 31, 2003, included
$23,155,512 principal amount of the Notes due December 31, 2005
and $4,893,348 of Secured Notes, due December 31, 2005 including accrued
interest. Although the Notes are subordinated to the Companys outstanding
Secured Notes, the holders of the Secured Notes have consented to the Companys
purchase of the Notes before repaying the Secured Notes. 25




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##### Table of Contents



During March 2004, the Company repurchased and retired $13.5 million principal
amount of the Notes for an aggregate purchase price of $2.9 million. The
Company expects to recognize a pre-tax gain of approximately $10.4 million in
the first quarter of 2004 on the repurchase and retirement of these Notes. Although the Company believes that it will continue to be able to meet its
operating cash requirements from (i) the $8,359,168 cash balance as of December
31, 2003, (ii) the $4 million balance of payments collected or expected to be
collected under the Settlement Agreement prior to March 31, 2004 and (iii) the
Senior Revolver, if none of the outstanding convertible debt and convertible
preferred stock is converted to common stock or purchased at a discount other than
discussed above, significant amounts of cash would be required, commencing in
2004, to repay long term debt, accrued interest and redeemable preferred stock
as follows: DEBT PLUS INTEREST**
    
    PREFERRED STOCK
    
    TOTAL2004
    
    
    416,995
    
    
    
    
    
    
    
    416,9952005
    
    
    18,147,685
    
    
    
    
    
    
    
    18,147,6852006
    
    
    
    
    
    
    23,618,000
    *
    
    
    23,618,000Total
    
    $
    18,564,680
    
    
    $
    23,618,000
    
    
    $
    42,182,680
   *
    
    Assuming no pre-payment in full of Notes.**
    
    Assuming repurchase and retirement of
Subordinated Convertible Notes discussed above. The Company entered into an agreement on February 15, 2003 to extend the
maturity from May 30, 2003 to May 30, 2005 of the Senior Revolver. Prior to 2001, the Company suffered recurring losses from operations, primarily
resulting from the significant expenses incurred in the establishment of its
former direct national marketing and distribution organization, and has a net
capital deficiency. Beginning in the first quarter of 2001, the Company
recognized income from operations in each quarter until the last quarter of
2003. As of December 31, 2003, the Companys accumulated deficit totaled
$59,737,494. The following table discloses the Companys contractual obligations as of
December 31, 2003: 2004
    
    2005
    
    2006
    
    TotalCapital leases
    
    $
    14,236
    
    
    $
    2,235
    
    
    
    
    
    
    $
    16,471Operating leases
    
    
    484,147
    
    
    
    364,384
    
    
    
    
    
    
    
    848,531Long term debt
    
    
    402,759
    **
    
    
    18,145,450
    **
    
    
    
    
    
    
    18,548,209Preferred Stock
    
    
    
    
    
    
    
    
    
    
    23,618,000
    *
    
    
    23,618,000Warranty Obligations
    
    
    240,742
    
    
    
    88,259
    
    
    
    88,259
    
    
    
    417,260Employment agreements
    
    
    400,000
    
    
    
    
    
    
    
    
    
    
    
    400,000Purchase orders
    
    
    425,000
    
    
    
    
    
    
    
    
    
    
    
    425,000Total
    
    $
    1,966,884
    
    
    $
    18,600,328
    
    
    $
    23,706,259
    
    
    $
    44,273,471
   *
    
    Assuming no pre-payment in full of Notes.**
    
    Assuming repurchase and retirement of
Subordinated Convertible Notes discussed above. 26




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##### Table of Contents



OFF-BALANCE SHEET ARRANGEMENTS The Company did not have any off-balance sheet financing transactions in 2002
and 2003. As of December 31, 2003, the Companys contractual obligations are as
shown in the above table. RELATED PARTY TRANSACTIONS All of the outstanding Preferred Stock and Secured Promissory Notes of the
Company are held by Hanseatic Americas LDC and Environmental Opportunities
Funds. The Senior Revolver is held by Hansa Finance LLC. Mr. Kenneth Leung,
Chief Investment Officer of the Environmental Opportunities Fund, the
Environmental Opportunities Fund II, L.P. and the Environmental Opportunities
Fund II (Institutional) L.P., and Mr. Paul A. Biddelman, the President of
Hanseatic Americas LDC and Hansa Finance LLC, are directors of the Company. NEW ACCOUNTING STANDARDS See Note 1 of the Consolidated Financial Statements for a full description of
recent accounting pronouncements including the respective expected dates of
adoption and effects on results of operations and financial condition. 
 ITEM 7. FINANCIAL STATEMENTS The financial statements of the Company required by Form 10-KSB are attached
hereto following Part III of this report commencing on page 37. 
 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 
 ITEM 8A. CONTROLS AND PROCEDURES Evaluation of the
Companys Disclosure Controls and Procedures. As of the end
of the period covered by this Annual Report on Form 10-KSB, the Company has
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (Disclosure Controls). This evaluation (the Controls
Evaluation) was done under the supervision and with the participation of the
Companys management, including its Chief Executive Officer (CEO) and
Director of Finance and Administration / Principal Financial Officer (PFO).
Rules adopted by the SEC require that in this section of the Annual Report the
Company present the conclusions of its CEO and the PFO about the effectiveness
of the Companys Disclosure Controls based on and as of the date of the
Controls Evaluation. CEO and PFO
Certifications. Appearing as Exhibits 31.1 and 31.2 to this Annual
Report are Certifications of the CEO and the PFO. The Certifications are
required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the
Section 302 Certifications). This section of this 27




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##### Table of Contents



Annual Report is the information concerning the Controls Evaluation referred to
in the Section 302 Certifications and this information should be read in
conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented. Disclosure Controls. Disclosure Controls are procedures that are designed with
the objective of ensuring that information required to be disclosed in the
Companys reports filed under the Exchange Act, such as this Annual Report, is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms. Disclosure
Controls are also designed with the objective of ensuring that such information
is accumulated and communicated to the Companys management, including, without
limitation, the CEO and PFO, as appropriate to allow timely decisions regarding
required disclosure. Limitations on the Effectiveness of Controls. The Companys management,
including, without limitation, the CEO and PFO, does not expect that the
Companys Disclosure Controls will prevent all error and fraud. A control
system no matter how well conceived and operated can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making
can be faulty and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by (i) the individual acts of
certain persons, (ii) the collusion of two or more people, or (iii) management
override of the controls and procedures. The design of any system of controls
also is based in part upon certain assumptions about the likelihood of future
events and there can be no assurance that any design will succeed in achieving
its stated goals under all potential future conditions. As such, over time
controls may become inadequate because of changes in conditions or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and may not be detected. Scope of the Controls Evaluation. The CEO/PFO evaluation of the Companys
Disclosure Controls included a review of the controls objectives and design,
the controls implementation by the Company and the effect of the controls on
the information generated for use in this Annual Report. In the course of the
Controls Evaluation, management sought to identify data errors, controls
problems or acts of fraud and to confirm that appropriate corrective action,
including process improvements, were being undertaken. This type of evaluation
will be done on a quarterly basis so that the conclusions concerning controls
effectiveness can be reported in the Companys Quarterly Reports on Form 10-QSB
and Annual Reports on Form 10-KSB. The overall goals of these various review
and evaluation activities are to monitor the Companys Disclosure Controls and
to make modifications, as necessary. In this regard, the Companys intent is
that the Disclosure Controls will be maintained as dynamic controls systems
that change (including with improvements and corrections) as conditions
warrant. Conclusions. Based upon the Controls Evaluation, the Companys CEO and PFO
have concluded, subject to the limitations noted above, that as of the end of
the period covered by this Annual Report, our Disclosure Controls are effective
to provide reasonable assurance that 28




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##### Table of Contents



information required to be disclosed in the Companys reports filed under the
Exchange Act, such as this Annual Report, is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms. There have been no changes in the Companys internal controls over financial
reporting during the fiscal quarter ended December 31, 2003 that have
materially affected, or are reasonably likely to materially affect, the
Companys internal controls over financial reporting. 
 PART III 
 ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Incorporated by reference from the Companys definitive proxy statement to be
filed within 120 days after the end of the Companys fiscal year. 
 ITEM 10. EXECUTIVE COMPENSATION Incorporated by reference from the Companys definitive proxy statement to be
filed within 120 days after the end of the Companys fiscal year. 
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Incorporated by reference from the Companys definitive proxy statement to be
filed within 120 days after the end of the Companys fiscal year. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference from the Companys definitive proxy statement to be
filed within 120 days after the end of the Companys fiscal year. 
 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits EXHIBIT
    
    DESCRIPTION3.1
    
    Amended and Restated Articles of Incorporation of the
Company, as amended to date (incorporated by reference to
Exhibit 3.1 of the Companys Quarterly Report on Form 10-QSB
for the quarter ended June 30, 2000 (Commission File Number:000-21325)).3.2
    
    Bylaws of the Company (incorporated by reference to
Exhibit 3.2 of the Companys Registration Statement on Form
S-1, as amended (No. 333-08657)).4.1
    
    The rights of holders of shares of the Companys Common
Stock, par value $.001, Series B Preferred Stock, $1.00 par
value per share, Series C Preferred Stock, $1.00 par value
per share and Series D Preferred Stock, $1.00 par value per
share are set forth in the Companys Amended and Restated
Articles of Incorporation as referenced in Exhibit 3.1 hereto.
 29




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##### Table of Contents



4.2
    
    Certificate for Shares of Common Stock, $.001 par value per
share (incorporated by reference to Exhibit 4.1 of the
Companys Registration Statement on Form S-1, as amended
(No. 333-08657)).4.3
    
    Certificate for Shares of Series B Preferred Stock, $1.00
par value per share (incorporated by reference to Exhibit
4.2 of the Companys Current Report on Form 8-K filed with
the Commission on May 27, 1999 (Commission File Number:000-21325)).4.4
    
    Certificate for Shares of Series C Preferred Stock, $1.00
par value per share (incorporated by reference to Exhibit
4.2 of the Companys Current Report on Form 8-K filed with
the Commission on August 31, 1999 (Commission File Number:000-21325)).4.5
    
    Certificate for Shares of Series D Preferred Stock, $1.00
par value per share (incorporated by reference to Exhibit
4.2 of the Companys Current Report on Form 8-K filed with
the Commission on May 15, 2000 (Commission File Number:000-21325)).4.6
    
    Form of Warrant dated August 7, 2000 (incorporated by reference
to Exhibit 4.7 of the Companys Annual Report on Form
10-KSB for the year ended December 31, 2000 (Commission File
Number 000-21325)).4.7
    
    Form of Warrant dated May 2, 2000 (incorporated by reference
to Exhibit 4.1 of the Companys Quarterly Report on Form
10-QSB for the quarter ended June 30, 2000 (Commission File
Number 000-21325)).4.8
    
    1998 Common Stock Purchase Rights Agreement, dated as of
October 1, 1998, between the Company and Continental Stock
Transfer & Trust Company (incorporated by reference to
Exhibit 4.1 of the Companys Form 8-A12G filed with the
Commission on October 6, 1998 (Commission File Number:000-21325)), as amended by (i) First Amendment to Rights
Agreement, dated as of May 2, 2000, by and between the
Company and Continental Stock Transfer and Trust Company.
(incorporated by reference to Exhibit 4.2 of the Companys
Quarterly Report on Form 10-QSB for the quarter ended June
30, 2000 (Commission File Number: 000-21325)), (ii) Second
Amendment to Rights Agreement, dated as of August 7, 2000,
by and between the Company and Continental Stock Transfer
and Trust Company. (incorporated by reference to Exhibit 4.3
of the Companys Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2000 (Commission File Number:000-21325)), and (iii) Third Amendment to Rights Agreement,
dated as of November 7, 2000, by and between the Company and
Continental Stock Transfer and Trust Company. (incorporated
by reference to Exhibit 4.1 of the Companys Form 8-A12G/A
filed with the Commission on December 28, 2000 (Commission
File Number: 000-21325)).4.9
    
    Exchange Agreement dated as of December 9, 2002 between the Company
and the Holders party thereto (incorporated by reference to Exhibit
4.1 of the Companys Current Report on Form 8-K filed with the
Commission on December 13, 2002 (Commission File Number:000-21325)).4.10
    
    Form of 8.25% Subordinated Convertible Note due December 31, 2005
dated as of December 9, 2002 (partial cash pay) (incorporated by
reference to Exhibit 4.2 of the Companys Current Report on Form
8-K filed with the Commission on December 13, 2002 (Commission File
Number: 000-21325)).
 30




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##### Table of Contents



4.11
    
    Form of 8.25% Subordinated Convertible Note due December 31, 2005
dated as of December 9, 2002 (PIK pay) (incorporated by reference
to Exhibit 4.3 of the Companys Current Report on Form 8-K filed
with the Commission on December 13, 2002 (Commission File Number:000-21325)).4.12
    
    Form of Warrant for the Purchase of Shares of Common Stock at an
exercise price of $.01 per share dated as of December 9, 2002
(incorporated by reference to Exhibit 4.4 of the Companys Current
Report on Form 8-K filed with the Commission on December 13, 2002
(Commission File Number: 000-21325)).4.13
    
    Form of Promissory Note dated as of December 9, 2002 (incorporated
by reference to Exhibit 4.5 of the Companys Current Report on Form
8-K filed with the Commission on December 13, 2002 (Commission File
Number: 000-21325)).4.14
    
    Waiver Agreement dated as of December 9, 2002, by and among the
Company, Hanseatic Americas LDC, Environmental Opportunities Fund
II, L.P. and Environmental Opportunities Fund II (Institutional),
L.P. (incorporated by reference to Exhibit 4.6 of the Companys
Current Report on Form 8-K filed with the Commission on December
13, 2002 (Commission File Number: 000-21325)).4.15
    
    Letter Agreement dated December 9, 2002, by and among the Company,
Hanseatic Americas LDC, Environmental Opportunities Fund, L.P.,
Environmental Opportunities Fund II, L.P. and Environmental
Opportunities Fund II (Institutional), L.P. (Institutional), L.P.
(incorporated by reference to Exhibit 4.7 of the Companys Current
Report on Form 8-K filed with the Commission on December 13, 2002
(Commission File Number: 000-21325)).10.1
    
    Shareholders Agreement, dated May 2, 2000 by and among the
Company and the other parties thereto (incorporated by
reference to Exhibit 10.1 of the Companys Current Report on
Form 8-K filed with the Commission on May 15, 2000
(Commission File Number: 000-21325)).10.2
    
    The Companys Executive Incentive Plan, as amended to date
(incorporated by reference to Annex A of the Companys
Definitive Schedule 14A, filed with the Commission on June
14, 2000 (Commission File Number: 000-21325)).10.3
    
    Form of Indemnification Agreement between the Company and
each of its directors and executive officers (incorporated
by reference to Exhibit 10.3 of the Companys Registration
Statement on Form S-1, as amended (No. 333-08657)).10.4
    
    Intertek Testing Services Listing, Labeling, and Follow-up
Service Agreement (incorporated by reference to Exhibit
10.32 of the Companys Quarterly Report on Form 10-QSB for
the quarter ended June 30, 1997 (Commission File Number
000-21325)).10.5
    
    Loan Agreement, dated August 7, 2000, by and among the
Company, Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II (Institutional), L.P.
and Hanseatic Americas LDC (incorporated by reference to
Exhibit 10.1 of the Companys Quarterly Report on Form
10-QSB for the quarter ended June 30, 2000 (Commission File
Number: 000-21325)).10.6
    
    First Amendment to Loan Agreement, dated November 10, 2000,
by and among the Company, Environmental Opportunities Fund
II, L.P., Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC (Incorporated by .
reference to exhibit 10.6 of the Companys Annual Report on Form
10-KSB for the year ended December 31, 2000 (Commission File
Number: 000-21325)).
 31




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10.7
    
    Second Amendment to Loan Agreement, dated November 30, 2000,
by and among the Company, Environmental Opportunities Fund
II, L.P., Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC (incorporated by
reference to Exhibit 10.7 of the Companys Annual Report on Form
10-KSB for the year ended December 31, 2000 (Commission File
Number 000-21325)).10.8
    
    Letter Agreement regarding the Loan Agreement, dated August
7, 2000, by and among the Company, Environmental
Opportunities Fund II, L.P., Environmental Opportunities
Fund II (Institutional), L.P., Environmental Opportunities
Fund (Cayman), L.P., Hanseatic Americas LDC, Paul Mansur and
Pierre Mansur (incorporated by reference to Exhibit 10.3 of
the Companys Quarterly Report on Form 10-QSB for the
quarter ended June 30, 2000 (Commission File Number:000-21325)).10.9
    
    Security Agreement, dated August 7, 2000, by and among the
Company, Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II (Institutional), L.P.
and Hanseatic Americas LDC (incorporated by reference to
Exhibit 10.4 of the Companys Quarterly Report on Form
10-QSB for the quarter ended June 30, 2000 (Commission File
Number: 000-21325)).10.10
    
    First Amendment to Security Agreement, dated November 10,
2000, by and among the Company, Environmental Opportunities
Fund II, L.P., Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC (incorporated by
reference to Exhibit 10.12 of the Companys Annual Report on Form
10-KSB for the year ended December 31, 2000 (Commission File
Number 000-21325)).10.11
    
    Second Amendment to Security Agreement, dated November 30,
2000, by and among the Company, Environmental Opportunities
Fund II, L.P., Environmental Opportunities Fund II
(Institutional), L.P. and Hanseatic Americas LDC (incorporated by
reference to Exhibit 10.13 of the Companys Annual Report on Form
10-KSB for the year ended December 31, 2000 (Commission File
Number 000-21325)).10.12
    
    Second Amended and Restated Marketing and Distribution
Agreement, dated as of March 8, 2001 by and between the
Company and Safety-Kleen Systems, Inc. (incorporated by reference
to Exhibit 10.16 of the Companys Annual Report on Form
10-KSB for the year ended December 31, 2000 (Commission File
Number 000-21325)).10.13
    
    Revolving Credit Loan Agreement by and between the Company
and Hansa Finance Limited Liability Company, dated as of
November 30, 2000 (incorporated by reference to Exhibit 10.17 of
the Companys Annual Report on Form 10-KSB for the year ended
December 31, 2000 (Commission File Number 000-21325)).10.14
    
    Security Agreement by and between the Company and Hansa
Finance Limited Liability Company, dated as of November 30,
2000 (incorporated by reference to Exhibit 10.19 of the Companys
Annual Report on Form 10-KSB for the year ended December 31, 2000
(Commission File Number 000-21325)).10.15
    
    Third Amendment to Loan Agreement, dated February 27, 2002, by and
among the Company, Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P. and Environmental Opportunities Fund II
(Institutional), L.P. (incorporated by reference to Exhibit
10.1 of the Companys Current Report on Form 8-K filed with
the Commission on March 1, 2002 (Commission File Number:000-21325)).
 32




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10.16
    
    Letter Agreement dated February 27, 2002, by and among the Company,
Hanseatic Americas LDC, Environmental Opportunities Fund II, L.P.,
Environmental Opportunities Fund II (Institutional), L.P.,
Environmental Opportunities Fund, L.P. and Environmental
Opportunities Fund (Cayman), L.P. (incorporated by reference to
Exhibit 10.2 of the Companys Current Report on Form 8-K filed with
the Commission on March 1, 2002 (Commission File Number:000-21325)).10.17
    
    Letter Agreement dated February 27, 2002, by and among the Company,
Paul I. Mansur, Pierre G. Mansur, Hanseatic Americas LDC,
Environmental Opportunities Fund II, L.P., Environmental
Opportunities Fund II (Institutional), L.P., Environmental
Opportunities Fund, L.P. and Environmental Opportunities Fund
(Cayman), L.P. (incorporated by reference to Exhibit 10.3 of the
Companys Current Report on Form 8-K filed with the Commission on
March 1, 2002 (Commission File Number: 000-21325)).10.18
    
    Fourth Amendment to Loan Agreement, dated September 30, 2002, by
and among the Company, Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P. and Environmental Opportunities Fund II
(Institutional), L.P. (incorporated by reference to Exhibit
10.1 of the Companys Current Report on Form 8-K filed with
the Commission on September 30, 2002 (Commission File Number:000-21325)).10.19
    
    Employment Agreement between Paul I. Mansur and the Company dated
as of January 1, 2003 (incorporated by reference to Exhibit
10.1 of the Companys Quarterly Report on Form 10-QSB for the
quarter ended September 30, 2002 filed with the Commission on
November 14, 2002 (Commission File Number: 000-21325)).10.20
    
    Employment Agreement between Pierre G. Mansur and the Company
dated as of January 1, 2003 (incorporated by reference to Exhibit
10.2 of the Companys Quarterly Report on Form 10-QSB for the
quarter ended filed with the Commission on November 14, 2002
(Commission File Number: 000-21325)).10.21
    
    Fifth Amendment to Loan Agreement, dated as of December 9, 2002, by
and among the Company, Hanseatic Americas LDC, Environmental
Opportunities Fund II, L.P. and Environmental Opportunities Fund II
(Institutional), L.P. (incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed with the Commission
on December 13, 2002 (Commission File Number: 000-21325)).10.22
    
    Third Amendment to Security Agreement, dated as of December 9,
2002, by and among the Company, Hanseatic Americas LDC,
Environmental Opportunities Fund II, L.P. and Environmental
Opportunities Fund II (Institutional), L.P. (incorporated by
reference to Exhibit 10.2 of the Companys Current Report on Form
8-K filed with the Commission on December 13, 2002 (Commission File
Number: 000-21325)).10.23
    
    Letter Agreement dated December 9, 2002, by and among the Company,
Hanseatic Americas LDC, Environmental Opportunities Fund II, L.P.
and Environmental Opportunities Fund II (Institutional), L.P.
(incorporated by reference to Exhibit 10.2 of the Companys Current
Report on Form 8-K filed with the Commission on December 13, 2002
(Commission File Number: 000-21325)).10.24
    
    First Amendment to Revolving Credit Loan Agreement by and between
the Company and Hansa Finance Limited Liability Company, dated as
of February 15, 2003 (incorporated by reference to Exhibit 10.1 of
the Companys Current Report on Form 8-K filed with the Commission
on March 18, 2003 (Commission File Number: 000-21325)).10.25
    
    Revolving Credit Note, dated as of February 15, 2003 (incorporated
by reference to Exhibit 10.2 of the Companys Current Report on
Form 8-K filed with the Commission on March 18, 2003 (Commission
File Number: 000-21325)).
 33




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10.26
    
    SystemOne Equipment Inspection and Repair Agreement, effective as
of July 30, 2003, by and between Safety-Kleen Systems, Inc. and the
Company (incorporated by reference to Exhibit 10.1 of the Companys
Current Report on Form 8-K filed with the Commission on October 1,
2003 (Commission File Number: 000-21325)).10.27
    
    Comprehensive Settlement Agreement dated as of September 30, 2003,
by and between Safety-Kleen Systems, Inc. and the Company
(incorporated by reference to Exhibit 10.1 of the Companys Current
Report on Form 8-K filed with the Commission on July 31, 2003
(Commission File Number: 000-21325)).10.28
    
    Marketing and Distribution Agreement dated as of October 23, 2003,
by and between Hockman-Lewis Limited and the Company (incorporated
by reference to Exhibit 10.1 of the Companys Quarterly Report on
Form 10-QSB filed with the Commission on November 14, 2003
(Commission File Number: 000-21325)).23.1
    
    Consent of BDO Seidman, LLP31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Exchange Act.31.2
    
    Certification of Director of Finance and Administration (Principal
Financial Accounting Officer) pursuant to Rule 13a-14(a) under the
Exchange Act.32.1
    
    Certification of Chief Executive Officer and Director of Finance
and Administration (Principal Financial Accounting Officer)
pursuant to Rule 13a-14(b) under the Exchange Act and 18 U.S.C.
Section 1350.
 (B) Reports on Form 8-K Form 8-K filed with the Securities and Exchange Commission on
October 1, 2003. Form 8-K filed with the Securities and Exchange Commission on
November 18, 2003. Form 8-K filed with the Securities and Exchange Commission on
December 2, 2003. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Incorporated by reference from the Companys definitive proxy statement to be
filed within 120 days after the end of the Companys fiscal year. 34




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SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
as amended (the Exchange Act), the Company has caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized. SYSTEMONE TECHNOLOGIES INC.Dated: March 25, 2004
    
    By: /s/ Paul I. Mansur
Paul I. Mansur
Chief Executive Officer
(Principal Executive Officer)
 In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Company and in the capacities and on the
dates indicated. SIGNATURES
    
    
    
    TITLE
    
    
    
    DATE/s/ Pierre G. Mansur

Pierre G. Mansur
    
    
    
    Chairman of the Board and President;
Director
    
    
    
    March 25, 2004/s/ Paul I. Mansur

Paul I. Mansur
    
    
    
    Chief Executive Officer; Principal
Executive Officer; Director
    
    
    
    March 25, 2004/s/ Steven M. Healy

Steven M. Healy
    
    
    
    Director of Finance and
Administration; Principal Financial
Accounting Officer
    
    
    
    March 25, 2004/s/ Kenneth C. Leung

Kenneth C. Leung
    
    
    
    Director
    
    
    
    March 25, 2004/s/ Paul A. Biddelman

Paul A. Biddelman
    
    
    
    Director
    
    
    
    March 25, 2004/s/ John W. Poling

John W. Poling
    
    
    
    Director
    
    
    
    March 25, 2004
 35




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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of SystemOne Technologies Inc.
Miami, Florida We have audited the accompanying balance sheets of SystemOne Technologies Inc.
as of December 31, 2003 and 2002 and the related statements of operations,
stockholders deficit, and cash flows for the years then ended. These financial
statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SystemOne Technologies Inc. at
December 31, 2003 and 2002, and the results of its operations and its cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has terminated its relationship with its only
customer, has significant indebtedness, and has a stockholders deficiency that
raise substantial doubt about its ability to continue as a going concern.
Managements plans in regard to these matters are also described in Note 2. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty. BDO Seidman, LLP
March 6, 2004, except as to Notes 2 and 13, which are as of March 15, 2004 36




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SYSTEMONE TECHNOLOGIES INC.
BALANCE SHEETS DECEMBER 312003
    
    2002ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,359,168
    
    
    $
    505,066Receivables (Note 3)
    
    
    7,126
    
    
    
    2,585,536Inventories (Note 4)
    
    
    1,744,682
    
    
    
    1,250,802Prepaid and other assets
    
    
    385,961
    
    
    
    384,351Assets held for sale (Note 5)
    
    
    38,688
    
    
    
    Total current assets
    
    
    10,535,625
    
    
    
    4,725,755Property and equipment, net (Note 5)
    
    
    539,525
    
    
    
    1,133,005Non-current portion of receivables, net of discount (Note 3)
    
    
    
    
    
    
    2,008,818Debt issue costs (Note 1(h))
    
    
    197,138
    
    
    
    316,531Total assets
    
    $
    11,272,288
    
    
    $
    8,184,109LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS DEFICITCurrent liabilities:Accounts payable and accrued expenses
    
    $
    1,165,584
    
    
    $
    1,252,974Warranty accrual (Note 1(i))
    
    
    240,742
    
    
    
    435,392Deferred revenue (Note 1(f))
    
    
    63,890
    
    
    
    106,814Current installments of long-term debt (Note 7)
    
    
    30,806
    
    
    
    142,112Total current liabilities
    
    
    1,501,022
    
    
    
    1,937,292Long-term debt (Note 7)
    
    
    29,149,699
    
    
    
    30,834,546Warranty accrual, non-current (Note 1(i))
    
    
    176,518
    
    
    
    239,098Total liabilities
    
    
    30,827,239
    
    
    
    33,010,936Commitments and contingenciesRedeemable convertible preferred stock, voting, $1.00 par value
per share. Authorized 1,500,000 shares, 197,376 issued and
outstanding (182,270 in 2002) at liquidation value (Note 8)
    
    
    19,737,600
    
    
    
    18,227,000Less unamortized discount
    
    
    (282,885
    )
    
    
    (1,008,344
    )Net redeemable convertible preferred stock (Note 8)
    
    
    19,454,715
    
    
    
    17,218,656Stockholders deficit:Common stock, $0.001 par value per share, authorized
25,000,000 shares, issued and outstanding 4,960,087 in
2003 and 4,742,923 in 2002
    
    
    4,960
    
    
    
    4,743Additional paid-in capital
    
    
    20,722,868
    
    
    
    20,723,085Deficit
    
    
    (59,737,494
    )
    
    
    (62,773,311
    )Total stockholders deficit
    
    
    (39,009,666
    )
    
    
    (42,045,483
    )Total liabilities, redeemable convertible
preferred stock and stockholders deficit
    
    $
    11,272,288
    
    
    $
    8,184,109
 See accompanying notes to financial statements. 37




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SYSTEMONE TECHNOLOGIES INC.
STATEMENTS OF OPERATIONS FOR THE YEARS ENDEDDECEMBER 312003
    
    2002Revenue
    
    $
    16,847,498
    
    
    $
    17,719,726Cost of goods sold (Note 5)
    
    
    (11,154,438
    )
    
    
    (10,916,191
    )Gross profit
    
    
    5,693,060
    
    
    
    6,803,535Operating expenses:Selling, general and administrative
    
    
    3,004,251
    
    
    
    2,780,574Research and development
    
    
    346,554
    
    
    
    320,083Restructuring and other charges
    
    
    
    
    
    
    (75,000
    )Total operating expenses
    
    
    3,350,805
    
    
    
    3,025,657Operating income
    
    
    2,342,255
    
    
    
    3,777,878Other income (expense):Safety-Kleen termination fee income (Note 2)
    
    
    5,778,701
    
    
    
    Interest expense
    
    
    (3,051,845
    )
    
    
    (3,173,838
    )Interest income
    
    
    389,469
    
    
    
    367,621Other income (expense), net
    
    
    3,116,325
    
    
    
    (2,806,217
    )Income before income tax provision
    
    
    5,458,580
    
    
    
    971,661Income tax provision (Note 11)
    
    
    (186,705
    )
    
    
    Net income
    
    
    5,271,875
    
    
    
    971,661Dividends and accretion of discount on redeemable
convertible preferred stock
    
    
    (2,236,058
    )
    
    
    (2,294,366
    )Net income (loss) attributable to common shares
    
    $
    3,035,817
    
    
    $
    (1,322,705
    )Basic net income (loss) per common share
    
    $
    0.61
    
    
    $
    (0.28
    )Diluted net income (loss) per common share
    
    $
    0.45
    
    
    $
    (0.28
    )Weighted average shares outstanding  basic
    
    
    4,936,763
    
    
    
    4,742,923Weighted average shares outstanding  diluted
    
    
    10,066,255
    
    
    
    4,742,923
 See accompanying notes to financial statements. 38




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SYSTEMONE TECHNOLOGIES INC.
STATEMENTS OF STOCKHOLDERS DEFICIT COMMON STOCK
    
    ADDITIONALPAID-IN
    
    
    
    
    
    TOTALSTOCKHOLDERS'SHARES
    
    PAR
    
    CAPITAL
    
    DEFICIT
    
    DEFICITBalance, January 1, 2002
    
    
    4,742,923
    
    
    $
    4,743
    
    
    $
    20,030,933
    
    
    $
    (61,450,606
    )
    
    $
    (41,414,930
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    971,661
    
    
    
    971,661Declaration of in-kind
preferred dividends and
accretion of discount on
preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,294,366
    )
    
    
    (2,294,366
    )Warrants issued
    
    
    
    
    
    
    
    
    
    
    692,152
    
    
    
    
    
    
    
    692,152Balance, December 31, 2002
    
    
    4,742,923
    
    
    
    4,743
    
    
    
    20,723,085
    
    
    
    (62,773,311
    )
    
    
    (42,045,483
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,271,875
    
    
    
    5,271,875Declaration of in-kind
preferred dividends and
accretion of discount on
preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,236,058
    )
    
    
    (2,236,058
    )Warrants exercised
    
    
    217,164
    
    
    
    217
    
    
    
    (217
    )
    
    
    
    
    
    
    Balance, December 31, 2003
    
    
    4,960,087
    
    
    $
    4,960
    
    
    $
    20,722,868
    
    
    $
    (59,737,494
    )
    
    $
    (39,009,666
    )
 See accompanying notes to financial statements. 39




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SYSTEMONE TECHNOLOGIES INC.
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDEDDECEMBER 312003
    
    2002Cash flows from operating activities:Net income
    
    $
    5,271,875
    
    
    $
    971,661Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    385,817
    
    
    
    509,834Amortization of debt issue costs
    
    
    119,393
    
    
    
    354,816Loss on disposal, trade and writedown of fixed assets
    
    
    234,075
    
    
    
    889Interest accrued on convertible debt and amortization of note discounts
    
    
    1,566,622
    
    
    
    2,114,654Recoveries of doubtful accounts
    
    
    (113
    )
    
    
    (30,379
    )Changes in operating assets and liabilities:Receivables
    
    
    4,587,341
    
    
    
    (1,109,755
    )Inventories
    
    
    (493,880
    )
    
    
    (202,239
    )Prepaid and other assets
    
    
    (1,610
    )
    
    
    (75,339
    )Accounts payable and accrued expenses
    
    
    (87,390
    )
    
    
    (943,919
    )Warranty accrual
    
    
    (257,230
    )
    
    
    (397,117
    )Deferred revenue
    
    
    (42,924
    )
    
    
    (9,550
    )Net cash provided by operating activities
    
    
    11,281,976
    
    
    
    1,183,556Cash flows used in investing activities:Purchase of equipment
    
    
    (42,153
    )
    
    
    (61,348
    )Net cash used in investing activities
    
    
    (42,153
    )
    
    
    (61,348
    )Cash flows used in financing activities:Payments made for financing costs
    
    
    
    
    
    
    (303,919
    )Repayments of long-term debt
    
    
    (3,234,632
    )
    
    
    (80,000
    )Repayments of capital lease obligations
    
    
    (151,089
    )
    
    
    (291,975
    )Net cash used in financing activities
    
    
    (3,385,721
    )
    
    
    (675,894
    )Net increase in cash and equivalents
    
    
    7,854,102
    
    
    
    446,314Cash and equivalents at beginning of year
    
    
    505,066
    
    
    
    58,752Cash and equivalents at end of year
    
    $
    8,359,168
    
    
    $
    505,066Supplemental disclosures:Cash paid for:Interest
    
    $
    1,409,509
    
    
    $
    690,837Taxes
    
    $
    40,402
    
    
    $
    Non-cash financing and investing activities:Acquisition of leased equipment through a capital lease
    
    $
    22,946
    
    
    $
    5,858Value of common stock purchase warrants issued in connection with the
debt restructuring
    
    
    
    
    
    $
    692,152In-kind dividends and accretion on redeemable preferred stock
    
    $
    2,236,058
    
    
    $
    2,294,366
 See accompanying notes to financial statements. 40




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SYSTEMONE TECHNOLOGIES INC.
NOTES TO FINANCIAL STATEMENTS (1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) BUSINESS SystemOne Technologies Inc. (the Company) designs, manufactures and sells a
full line of patented, self-contained, recycling industrial parts washers,
(the SystemOne® Washers), for use in the automotive, aviation, marine and
general industrial repair markets. The Company has been awarded eleven patents
for its products, which incorporate innovative, proprietary resource recovery
and waste minimization technologies to distill contaminated solvents and yield
pure solvent allowing cleaning solvents to be used, recycled and re-used
perpetually, eliminating the need for costly and dangerous storage and
transportation of hazardous waste and without requiring off-site processing.
The Company, which was incorporated as Mansur Industries Inc. in November 1990,
commenced the sale of SystemOne® Washers in July 1996 and has sold
approximately 50,000 total SystemOne units through December 31, 2003. On November 14, 2000, the Company entered into an exclusive Marketing and
Distribution Agreement, as amended (the Exclusive Marketing Agreement) with
Safety-Kleen Systems, Inc., a wholly-owned subsidiary of Safety-Kleen Corp.
(collectively, Safety-Kleen) representing a major strategic shift in
direction and focus for the Company. Under the Exclusive Marketing Agreement, Safety-Kleen was appointed the
exclusive distributor of certain SystemOne® parts washer equipment in the
United States, Canada, Mexico and Puerto Rico (the Territory). Safety-Kleen
commenced marketing the Companys products throughout Safety-Kleens 173
branches across North America in January 2001. The Company retained the right
to distribute its equipment outside of the Territory as well as the right,
subject to a right of first offer for Safety-Kleen in certain circumstances, to
market newly developed industrial and commercial parts washers through its
distribution channels. The Exclusive Marketing Agreement was terminated by the Company and
Safety-Kleen effective October 1st, 2003, and the Company plans to transition
from a single customer distribution to multiple distribution channels. The
Company did not sell any parts washers during the fourth quarter of 2003.
Revenue during the fourth quarter was from the sale of parts only. For more
information regarding the termination of the Exclusive Marketing Agreement and
its potential effect on the Companys financial position and results, see note
2 below. The Company currently operates under one business segment. (b) CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, demand deposits, and short-term
investments with original maturities of three months or less. 41




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(c) ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS Accounts receivable are customer obligations due under normal trade terms. The
Company performs continuing evaluations of its customers financial condition
and ability to pay. The Company reserves amounts deemed to be uncollectible in
its allowance for doubtful accounts. The collectability of receivables is evaluated routinely and, if deemed
necessary, the Company records an allowance for doubtful accounts. The
allowance for doubtful accounts was $0 and $123,287 at December 31, 2003 and
2002, respectively. The Company writes off all uncollectible receivables
against the reserve. (d) INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using
the first-in, first-out method. (e) PROPERTY, EQUIPMENT AND DEPRECIATION Property and equipment are stated at cost. Equipment under capital leases are
stated at the present value of minimum lease payments at inception. Depreciation is calculated using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized using the
straight-line method over the shorter of the estimated useful life of the asset
or the term of the lease. (f) REVENUE RECOGNITION Pursuant to the Exclusive Marketing Agreement, the price charged to
Safety-Kleen was determined annually based on the actual manufacturing costs
incurred during a specified three month period of the previous year. Under the
Exclusive Marketing Agreement, the price for each unit purchased by
Safety-Kleen consisted of two components: a standard price payable on net
30-day terms from the date of shipment and a deferred price (approximately 12%
of the total price) payable in equal installments over a 12-quarter period. The
Company recognized revenue at the time of shipment (F.O.B. shipping dock) for
the total sales price, but applied a discount to reflect the present value of
the 12 quarterly deferred price payments utilizing a discount rate of 14% which
was the interest rate then paid on the Companys Senior Revolver. In addition,
the Company recognized imputed interest income over the discount period as the
deferred portion of the purchase price was amortized over the scheduled payment
period. The receivable related to the deferred portion of the purchase price
and interest income recognized through September 30, 2003 was paid pursuant to
the Comprehensive Settlement Agreement. (See Note 2) The Company recognized other income of $5,778,701 in the fourth quarter of 2003
relating to the termination of the Exclusive Marketing Agreement with
Safety-Kleen and expects to recognize the remainder of the termination fee,
approximately $4 million, as other income in the first quarter of 2004. Because
the termination fee is considered a gain contingency, only the 42




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portion of the gain that had been received in cash as of December 31, 2003 in
excess of the receivable due from Safety-Kleen for the deferred price can be
recognized as a gain. Deferred revenue on the balance sheet relates to extended two-year warranty
contracts purchased by customers and is recognized in income on the
straight-line basis over the term of each contract. (g) CONCENTRATION OF CREDIT RISK The Company primarily maintains cash balances at one financial institution.
Accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up
to $100,000. From time to time, the Company had cash in financial institutions
in excess of FDIC limits. As of December 31, 2003, the Company
had cash in excess of FDIC limits of approximately $8,259,168. (h) DEBT ISSUE COSTS Debt issue costs associated with the Companys 8.25% Subordinated Convertible
Notes due 2005, 10% Promissory Notes due 2005, and Revolving Credit Loan are
being amortized using the effective interest method over the term of the debt.
The balance of unamortized debt issue costs at December 31, 2003 and 2002 was,
$197,138 (net of accumulated amortization of $106,783) and $316,531 (net of
accumulated amortization of $112,389), respectively. Amortization expense is
expected to be approximately $98,600 in 2004 and 2005. (i) PRODUCT WARRANTY The Company generally warrants that its products will be free of material
defects during the three-year warranty period. Pursuant to the Exclusive
Marketing Agreement, Safety-Kleen assumed all service, maintenance and repair
responsibilities for the Companys installed base of SystemOne® parts washers
including units sold prior to the Exclusive Marketing Agreement and units sold
pursuant to the Exclusive Marketing Agreement. The Company is responsible
solely for the cost of parts required for warranty repairs during the warranty
period for all units sold. For units sold prior to the Exclusive Marketing
Agreement, the Company agreed to pay Safety-Kleen a total one-time fee of
$500,000 for all warranty service to be performed by Safety-Kleen on these
units, which amount was fully paid as of December 31, 2003. For units sold
pursuant to the Exclusive Marketing Agreement, Safety-Kleen is responsible for
the labor cost of all service, maintenance and repair during the warranty
period. The Company accrues estimated warranty costs as the parts washers are
sold to customers. Such accrued warranty costs consist of the estimated cost of
parts projected to be consumed during the remaining warranty period based on
actual parts used during the previous 19 month period. Under the Settlement
Agreement, the Company is required to continue to supply any warranty related
parts free of charge in accordance with, and for the balance of, the three-year
warranty period applicable to units sold to Safety-Kleen. The Company will
also continue to provide repair and replacement parts for the items not covered
by warranty at Safety-Kleens expense. Effective January 1, 2004, all of the
Companys products will be offered with a one year limited warranty. 43




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Warranty accrual activity during the years ended December 31, is as follows: 2003
    
    2002Beginning balance
    
    $
    674,490
    
    
    $
    1,071,607Warranty provision
    
    
    528,067
    
    
    
    346,406Warranty payments
    
    
    (785,297
    )
    
    
    (743,523
    )Ending balance
    
    $
    417,260
    
    
    $
    674,490
 (j) FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of the Companys long-term debt and redeemable convertible
preferred stock has been estimated by discounting the future cash flows at
rates currently offered to the Company for similar securities of comparable
maturities. The fair values of all other financial instruments are believed to
approximate their carrying amounts. (k) REDEEMABLE CONVERTIBLE PREFERRED STOCK The shares of each series of redeemable convertible preferred stock were issued
at discounts from their mandatory redemption values. The carrying amounts of
the preferred stocks are accreted to their redemption values using the
straight-line method, from the date of issuance of each series to the date of
mandatory redemption. (l) RESEARCH AND DEVELOPMENT Research and development expenses are expensed as incurred. (m) INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry-forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Realization of deferred tax assets associated with federal and state net
operating loss carry-forwards (NOLs) is dependent upon generating sufficient
taxable income prior to their expiration. The Company believes that there is a
risk that these NOLs may expire unused and accordingly, has established a
valuation reserve against them in full. (n) STOCK BASED COMPENSATION In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No.
123. This Statement amends methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In
addition, this Statement amends the 44




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disclosure requirements of Statement No. 123 to require prominent disclosures
in both annual and interim financial statements. Certain of the disclosure
modifications are required for fiscal years ending after December 15, 2002 and
are included in the Notes to Financial Statements. The Company accounts for stock options issued using the intrinsic value method
and, accordingly, no compensation cost has been recognized for stock options
granted as such options granted had an exercise price greater than or equal to
the market value of the underlying common stock on the date of the grant. For
options granted under variable accounting, compensation cost is recognized for
the difference between the exercise price and the market price of the common
shares until such options are exercised, expired or forfeited. No compensation
cost has been recognized for options under variable accounting provision as the
performance criteria have not yet been met. Compensation cost will be
recognized if and when the performance criteria are met, based on the excess of
market price over exercise price at that date. Per share weighted-average fair value on the date of grant of stock options
granted during 2003 ranged from $.28 to $.47 and was $1.17 in 2002; using the
Black-Scholes option-pricing model with the following assumptions:
2003-expected dividend yield of zero percent, risk-free interest rate of 5.07
percent, expected life of seven years and a volatility ranging from 58.6 to
166.1 percent; 2002-expected dividend yield of zero percent, risk-free interest
of 4.78 percent, expected life of seven years and a volatility rate of 86.6
percent. If the Company determined compensation cost based on the fair value of the
options at the grant date, the Companys net income (loss) to common shares and
basic and diluted net loss per common share would have reflected the pro forma
amounts shown below: 2003
    
    2002Net income (loss) attributable to common
shares, as reported
    
    $
    3,035,817
    
    
    $
    (1,322,705
    )Add: Stock-based employee compensation
expense included in reported net income
(loss), net of related tax effects
    
    
    
    
    
    
    Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    (41,748
    )
    
    
    (242,775
    )Pro forma net income (loss)
    
    $
    2,994,069
    
    
    $
    (1,565,480
    )Basic income (loss) per common share  as
reported
    
    $
    .61
    
    
    $
    (.28
    )Basic income (loss) per common share  pro
forma
    
    $
    .61
    
    
    $
    (.33
    )Diluted income (loss) per common share  as
reported
    
    $
    .45
    
    
    $
    (.28
    )Diluted income (loss) per common share  pro
forma
    
    $
    .45
    
    
    $
    (.33
    )
 45




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(o) BASIC AND DILUTED INCOME (NET LOSS) PER SHARE In accordance with the requirements of SFAS No. 128, Earnings Per Share(SFAS
No. 128), basic earnings per share is computed by dividing net income or loss
by the weighted average number of shares outstanding. Diluted income per share
is calculated using the weighted average number of shares outstanding during
the period plus the additional dilutive effect of common share equivalents.
Options and warrants are accounted for under the treasury stock method while
convertible securities are accounted for under the if-converted method. Under
the if-converted method, securities are assumed to be converted at the
beginning of the period if the conversion of those shares would be dilutive. The following reconciles the components of the earnings (loss) per share (EPS)
computation (in thousands): FOR THE YEARS ENDED DECEMBER 31, 2003
    
    2002(In thousands, except per share
    
    Income
    
    Shares
    
    Per-Share
    
    Income (Loss)
    
    Shares
    
    Per-Sharedata)
    
    (Numerator)
    
    (Denominator)
    
    Amount
    
    (Numerator)
    
    (Denominator)
    
    AmountEarnings per common
share:Net income
    
    $
    5,271,875
    
    
    
    4,936,763
    
    
    
    
    
    
    $
    971,661
    
    
    
    4,742,923Dividends on
Redeemable
Convertible
Preferred stock
    
    
    (2,236,058
    )
    
    
    
    
    
    
    
    
    
    
    (2,294,366
    )Net income (loss)
applicable to
common shareholders
    
    $
    3,035,817
    
    
    
    4,936,763
    
    
    $
    .61
    
    
    
    ($1,322,705
    )
    
    
    4,742,923
    
    
    
    ($.28
    )Effect of dilutive
securities:Warrants
    
    
    
    
    
    
    787,200
    
    
    
    
    
    
    
    Preferred Stock C
    
    
    845,970
    
    
    
    2,774,343
    
    
    
    
    
    
    
    Preferred Stock B
    
    
    651,172
    
    
    
    1,567,949
    
    
    
    
    
    
    
    Net income (loss)
applicable to
common shareholders
plus assumed
conversions
    
    $
    4,532,959
    
    
    
    10,066,255
    
    
    $
    .45
    
    
    
    ($1,322,705
    )
    
    
    4,742,923
    
    
    
    ($.28
    )
 As of December 31, 2003, the following were outstanding, but were not included
in the computation of diluted EPS because the exercise prices were greater than
the average market price of the common shares: (i) warrants to purchase 29,750
shares, 1,250 shares, 942,858 shares and 571,428 shares at $19.50, $11.50,
$3.50, and $3.50, per share respectively, and (ii) 421,328 stock options with
exercise prices ranging from $19.50 to $1.00. Convertible Preferred Stock 46




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Series D and Subordinated Convertible Notes (including accrued payment-in-kind
interest) convertible to 768,400 and 1,362,089 shares at $3.50 and $17.00,
respectively were anti-dilutive and, therefore, were not included in the number
of weighted average shares used in computing diluted income per share. As of December 31, 2002, the following were outstanding, but were not included
in the computation of diluted loss per share because they are antidilutive due
to the Companys loss: (i) warrants to purchase 29,750 shares, 1,250 shares,
942,858 shares, 571,428 shares, 1,134,615 shares, 250,000 shares and 750,000
shares at $19.50, $11.50, $3.50, $3.50, $3.50, $0.01 and $0.01 per share,
respectively, (ii) Convertible Preferred Stock Series B, C and D and
Subordinated Convertible Notes (including accrued payment-in-kind interest)
convertible to 1,446,517, 2,564,857, 708,657 and 1,306,971 shares at $4.68,
$3.50, $3.50 and $17.00, respectively, and (iii) 533,716 stock options with
exercise prices ranging from $19.50 to $2.50. (p) COMPREHENSIVE INCOME (LOSS) Pursuant to SFAS No. 130, Reporting Comprehensive Income, the Company is
required to report comprehensive income (loss) and its components in its
financial statements. The Company does not have any significant components of
other comprehensive income (loss) to be reported under SFAS No. 130. Total
comprehensive income (loss) is equal to net income (loss) reported in the
financial statements. (q) USE OF ESTIMATES Management of the Company uses estimates and assumptions relating to the
reporting of assets and liabilities and the disclosure of contingent assets and
liabilities to prepare these financial statements in conformity with generally
accepted accounting principles. Actual results could differ from those
estimates. (r) RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application
of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 applies immediately to variable interest
entities (VIEs) created after January 31, 2003, and to VIEs in which an
enterprise obtains an interest after that date. On October 9, 2003 the FASB
issued FASB Staff Position No. FIN 46-6 Effective Date of FASB Interpretation
No.46 Consolidation of Variable Interest Entities, which defers the
implementation date for public entities that hold an interest in a variable
interest entity or potential variable interest entity from the first fiscal
year or interim period beginning after June 15, 2003 to the end of the first
interim or annual period ending after December 15, 2003. This deferral applies
only if 1) the variable interest entity was created before February 1, 2003 and
2) the public entity has not issued financial statements reporting that
variable interest entity in accordance with FIN 46, other than disclosures
required by paragraph 26 of FIN 46. The 47




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adoption of FIN 46 did not have a material impact on the Companys financial
position, liquidity or results of operations. In May 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under FASB
Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The adoption of SFAS No. 149 did not materially impact the Companys
financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. The statement
requires that an issuer classify financial instruments that are within its
scope as a liability. Many of those instruments were classified as equity under
previous guidance. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003. Otherwise, it is effective on July
1, 2003 except for mandatorily redeemable non controlling (minority) interest
which, on October 29, 2003, the FASB decided to defer indefinitely. The
adoption of SFAS No. 150 did not materially impact the Companys financial
position or results of operations. (2) LIQUIDITY AND OUTLOOK On July 30, 2003, the Company entered into the SystemOne Equipment Inspection
and Repair Agreement (the Repair Agreement) with Safety-Kleen. The Repair
Agreement was entered into following Safety-Kleens assertions that the molded
tanks in parts washers manufactured by the Company may develop leaks and were,
therefore, defectively designed or manufactured, constituting a purported
material breach of the Exclusive Marketing Agreement by the Company. The
Company informed Safety-Kleen that it believed that it was not in material
breach of the Exclusive Marketing Agreement. Although the Company complied with the material requirements of the Repair
Agreement, a number of controversies remained between the Company and
Safety-Kleen, including claims by Safety-Kleen of material breaches of the
Exclusive Marketing Agreement by the Company. In order to settle these claims,
on September 30, 2003, the Company entered into a Comprehensive Settlement
Agreement (the Settlement Agreement) with Safety-Kleen to terminate the
Exclusive Marketing Agreement. The Settlement Agreement provides for a total
payment of $14 million to the Company, consisting of a termination fee and a
lump sum payment of the accumulated deferred price on the approximately 30,000
parts washer units shipped to Safety-Kleen under the Exclusive Marketing
Agreement prior to its termination. Of this amount, the Company received $10
million during the fourth quarter of 2003, $2.5 million during January and
February 2004 and anticipates receiving the balance of $1.5 million on or
before March 31, 2004. The balance is currently secured by a letter of credit
posted by Safety-Kleen. In addition, the Settlement Agreement (i) canceled all
remaining purchase commitments under the Exclusive Marketing Agreement,
effective as of October 1, 2003, (ii) settled all disputes regarding the
Exclusive Marketing Agreement, and (iii) released the parties from all claims
that each may have 48




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against the other. Safety-Kleen was also given the right (but not the
obligation) in 2005 to purchase the lesser of up to 3,000 parts washer units or
one-sixth of the Companys then annual production capacity. Because Safety-Kleen was the Companys only customer, the Company must
establish new distribution channels for its products and is currently
undertaking that effort. To date the Company has communicated with more than 90
potential distributors nationwide and estimates that approximately 40 to 50
distributors in this group may be qualified distributors for the Companys
products. Approximately eight distributors have been appointed to date and the
Company began shipping initial orders to its new distributors in the first
quarter of 2004 and expects to ship approximately 150 units during the first
quarter of 2004 with increases throughout the year, although there can be no
assurances of such increases. This projection compares to 3,750 units that
would have been shipped in the first quarter of 2004 under the Exclusive
Marketing Agreement. Prior to the execution of the Settlement Agreement on September 30, 2003, the
Company operated under the Exclusive Marketing Agreement which (a) made
Safety-Kleen the exclusive marketer, distributor and service provider for the
Companys Series 100, Series 300 and Series 500 SystemOne® parts washers in the
United States, Puerto Rico, Canada and Mexico (the Territory), and (b)
obligated Safety-Kleen to purchase minimum quantities of the Companys parts
washing equipment for each contract year through December 26, 2005, the initial
term of the Exclusive Marketing Agreement. The Company retained the rights to
sell, lease, rent and service all of the Companys parts washing equipment
outside the Territory and, subject to Safety-Kleens right of first refusal,
other product lines within the Territory. In December 2002, the Company completed an exchange of its then outstanding
8.25% Subordinated Convertible Notes due February 23, 2003, and 16% Promissory
Notes due November 30, 2002 for the now outstanding 8.25% Subordinated
Convertible Notes due December 31, 2005, 10% Promissory Notes due December 31,
2005, and warrants to purchase shares of the Companys common stock, $.001 par
value per share at an exercise price of $.01 per share. In connection with the Exchange, the holders of the Companys outstanding
shares of Preferred Stock agreed to extend the date upon which the Company must
redeem such shares from May 17, 2004 to the earlier of the 90th day after all
of the Subordinated Convertible Notes are paid in full or March 31, 2006 (but
not earlier than May 17, 2004). Although the Company believes that it will continue to be able to meet its
operating cash requirements from (i) the $8,359,168 cash balance as of December
31, 2003, (ii) the $4 million balance of payments expected to be collected
under the Settlement Agreement prior to March 31, 2004 and (iii) the Senior
Revolver, if none of the outstanding convertible debt and convertible preferred
stock is converted to common stock, significant amounts of cash would be
required, commencing in 2004, to repay long term debt, accrued interest and
redeemable preferred stock as follows: 49




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DEBT PLUS INTEREST**
    
    PREFERRED STOCK
    
    TOTAL2004
    
    
    416,995
    
    
    
    
    
    
    
    416,9952005
    
    
    18,147,685
    
    
    
    
    
    
    
    18,147,6852006
    
    
    
    
    
    
    23,618,000
    *
    
    
    23,618,000Total
    
    $
    18,564,680
    
    
    $
    23,618,000
    
    
    $
    42,182,680
   *
    
    Assuming no pre-payment in full of Subordinated Convertible Notes.**
    
    Assuming repurchase and retirement of
Subordinated Convertible Notes discussed in Note 13. The Company entered into an agreement on February 15, 2003 to extend the
maturity date of the Companys Senior Revolver from May 30, 2003 to May 30,
2005. (3) TRADE RECEIVABLES Trade receivables consisted of the following at December 31: 2003
    
    2002Receivables
    
    $
    7,126
    
    
    $
    4,717,641Less non-current portion of receivables,
net of discount
    
    
    
    
    
    
    (2,008,818
    )7,126
    
    
    
    2,708,823Less allowance for doubtful accounts
    
    
    
    
    
    
    (123,287
    )$
    7,126
    
    
    $
    2,585,536
 Non-current portion of receivables at December 31, 2002 was to mature as
follows: 20022003
    
    $
    2,585,5362004
    
    
    1,533,0102005
    
    
    700,5822006
    
    
    36,2294,855,357Less discount for imputed interest
    
    
    (261,003
    )Less current portion
    
    
    (2,585,536
    )Non-current portion of receivable, net
    
    $
    2,008,818
 At December 31, 2002, substantially all receivables were with one customer,
Safety-Kleen. 50




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(4) INVENTORIES Inventories consisted of the following at December 31: 2003
    
    2002Raw materials
    
    $
    1,681,310
    
    
    $
    1,048,004Work in process and finished goods
    
    
    246,605
    
    
    
    359,0571,927,915
    
    
    
    1,407,061Less allowance for obsolete inventories
    
    
    (183,233
    )
    
    
    (156,259
    )$
    1,744,682
    
    
    $
    1,250,802
 (5) PROPERTY AND EQUIPMENT, NET Property and equipment, net consisted of the following at December 31: ESTIMATEDUSEFUL2003
    
    2002
    
    LIVESFurniture and equipment
    
    $
    453,821
    
    
    $
    472,276
    
    
    5 yearsMachinery and equipment
    
    
    1,809,780
    
    
    
    2,728,848
    
    
    5-10 yearsLeasehold improvements
    
    
    300,966
    
    
    
    296,921
    
    
    3-5 years2,564,567
    
    
    
    3,498,045Less accumulated depreciation
and amortization
    
    
    (2,025,042
    )
    
    
    (2,365,040
    )$
    539,525
    
    
    $
    1,133,005
 Property and equipment under capital leases consisted of the following at
December 31: 2003
    
    2002Machinery and equipment
    
    $
    31,304
    
    
    $
    794,083Less accumulated amortization
    
    
    (8,878
    )
    
    
    (364,034
    )$
    22,426
    
    
    $
    430,049
 Depreciation expense for the years ended December 31, 2003 and 2002 was
$385,817 and $509,834, respectively. In November 2003 the Company traded several production assets for new assets to
be used in the manufacturing plant in a nonmonetary transaction. Assets with
carrying value of $303,000 were traded for assets valued at $142,000. The
resulting loss on the trade of fixed assets of $161,000 has been recorded as
part of cost of goods sold in the fiscal 2003 statement of operations. During the fourth quarter of fiscal year 2003, management committed to sell
certain production equipment with a carrying amount of $109,000 as a result of
the reduction in production due to the termination of the Safety-Kleen
Agreement. The Company believes the production equipment will be sold no later
than the end of the fourth quarter of fiscal 2004. On December 29, 2003, the
Company determined that the plan of sale criteria in FASB Statement No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, had been met.
Accordingly, the carrying value of the production equipment was adjusted to its
fair value less costs to sell, amounting to approximately $39,000, which was
determined based on current market prices of the assets. The resulting $70,000
impairment loss has been recorded as part of cost of goods sold in the fiscal
2003 statement of operations. The carrying value of the production equipment
that is held for sale is included in the Assets held for sale caption in the
2003 balance sheet. 51




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(6) LEASE AGREEMENTS The Company has a lease obligation for its corporate headquarters that expires
on October 3, 2005. This lease provides two renewal terms of three years each
exercisable at the Companys option upon six months prior written notice. The
Companys annual lease payments under the lease are approximately $441,000
subject to an annual increase of 3 percent, which does not include utilities
and the Companys proportionate share of the facilities maintenance and
operating expenses. Rent expense is being straight lined over the entire lease
term. Total rent expense was $440,419 and $497,439 for the years ended December 31,
2003 and 2002, respectively. The Company is obligated under capital leases for certain machinery and
equipment that expire at various dates during the next two years. Future minimum lease payments under non-cancelable operating leases and future
minimum capital lease payments as of December 31, 2003 are as follows: CAPITAL
    
    OPERATINGLEASES
    
    LEASESYear ended December 31:2004
    
    $
    14,236
    
    
    $
    484,1472005
    
    
    2,235
    
    
    
    364,384Total minimum lease payments
    
    
    16,471
    
    
    $
    848,531Less amount representing interest (at rates
ranging from 11.86% to 15.45%)
    
    
    (1,428
    )Present value of net minimum capital lease payments
    
    $
    15,043
 On November 17, 2003, the Company entered into an agreement to sublease
approximately 25,000 square feet of its facility to a third party. Future
minimum lease payments to be received under this sublease as of December 31,
2003 are as follows: SUBLEASEYear ended December 31:2004
    
    $
    120,0002005
    
    
    90,000Total minimum lease payments
    
    $
    210,000
 52




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(7) LONG TERM DEBT Long-term debt and obligations under capital leases consists of the following
at December 31: 2003
    
    2002Subordinated Convertible Notes due December 31,
2005 (Subordinated Convertible Notes), with
interest at 8.25%, including payment in-kind interest
    
    $
    23,155,512
    
    
    $
    22,218,505Revolving credit loan, with interest at 13% (14%
until November 23, 2003), due May 30, 2005,
including accrued interest
    
    
    1,453,324
    
    
    
    4,670,000Subordinated Promissory Notes (Secured Notes), with
interest at 10% due December 31, 2005, including
accrued interest
    
    
    4,893,348
    
    
    
    4,445,374Capital leases (note 6)
    
    
    15,043
    
    
    
    143,18629,517,227
    
    
    
    31,477,065Less: unamortized discount
    
    
    (336,722
    )
    
    
    (500,407
    )29,180,505
    
    
    
    30,976,658Less: current portion
    
    
    (30,806
    )
    
    
    (142,112
    )Long-term portion
    
    $
    29,149,699
    
    
    $
    30,834,546
 On December 9, 2002, the Company exchanged (i) all of its then outstanding
8.25% Subordinated Convertible Notes due February 23, 2003 (the Old Junior
Notes) for (a) 8.25% Subordinated Convertible Notes due December 31, 2005 in
an aggregate principal amount equal to 50% of the sum of the aggregate
principal amount of the Old Junior Notes plus all interest accrued thereon,
bearing interest which when due may be added at the Companys option to the
principal amount of such notes through December 31, 2002 and thereafter shall
be paid in cash (Partial Cash Pay Notes), (b) 8.25% Subordinated Convertible
Notes due December 31, 2005 in an aggregate principal amount equal to 50% of
the sum of the aggregate principal amount of the Old Junior Notes plus all
interest accrued thereon, bearing interest which when due may be added to the
principal amount for the life of such notes (PIK Pay Notes and together with
the Partial Cash Pay Notes, the Subordinated Convertible Notes), and (c)
Warrants (the New Warrants) for the purchase of an aggregate of 750,000
shares of Common Stock at an exercise price of $.01 per share expiring on
December 31, 2005; (ii) all of its then outstanding 16% Promissory Notes due
November 30, 2002 (the Old Secured Notes) for 10% Promissory Notes (the
Secured Notes and collectively with the Subordinated Convertible Notes and
the New Warrants, the Current Securities) due December 31, 2005 in an
aggregate principal amount equal to the sum of the aggregate principal amount
of all Old Secured Notes plus all interest accrued thereon, with interest which
when due will be added to the principal amount for the life of such notes. The
estimated fair market value of the New Warrants at December 9, 2002 was
$519,114 and was charged to unamortized note discount and credited to
additional paid-in capital. The discount will be amortized to interest expense
over the term of the Subordinated Convertible Notes. 53




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The issuance of the 750,000 warrants to the holders of the Subordinated
Convertible Notes, described above, would have triggered certain anti-dilution
rights pursuant to the Companys outstanding (i) shares of Series D Preferred
Stock, $1.00 per share, (ii) warrants issued May 2, 2000 exercisable for an
aggregate of 571,428 shares of Common Stock, and (iii) warrants issued August
7, 2000 exercisable for an aggregate of 942,858 shares of Common Stock
(collectively, the Outstanding Warrants). The holders of the Series D
Preferred Stock and Outstanding Warrants waived their anti-dilution rights in
exchange for warrants for the purchase of an aggregate of 250,000 shares of
Common Stock at an exercise price of $.01 per share expiring on December 31,
2005. The estimated fair market value of these warrants at December 9, 2002 was
$173,038 and was recorded as a dividend and credited to additional paid-in
capital. The Subordinated Convertible Notes are unsecured and are subordinate and junior
to all indebtedness of the Company. Pursuant to these notes, the Company is not
permitted to incur, create, assume or guarantee, or otherwise become liable in
any manner with respect to any indebtedness (the Incurrence) unless, after
giving pro forma effect to the Incurrence, the ratio of total debt, as defined,
to income before (i) interest, (ii) income taxes, and (iii) depreciation and
amortization, is less than 6.0:1.0; provided, however, the Company may incur up
to $10 million of total debt, excluding the Subordinated Convertible Notes, at
any time. The Subordinated Convertible Notes are convertible by the holders thereof into
shares of the Companys common stock at a conversion price of $17.00 per share.
The Subordinated Convertible Notes may be redeemed by the Company at a
redemption price of 102% of the principal amount plus any accrued but unpaid
interest. As of December 31, 2003, none of the Companys Subordinated
Convertible Notes has been redeemed. The Company is party to a Revolving Credit Loan Agreement (the Senior
Revolver) with Hansa Finance Limited Liability Company (Hansa), which
provides the Company with a revolving line of credit. In connection with the
Senior Revolver, the Company granted the lender a security interest in
substantially all of the Companys assets, including its intellectual property.
Pursuant to the Senior Revolver the Company may borrow twice a month up to the
Advance Limit. Effective prior to November 24, 2003, the Advance Limit was the
lesser of $5,000,000 or the sum of the Advance Supplement (as defined) plus an
amount based on the Companys receivables and inventory. The Advance Supplement
was $2,500,000 for the period from April 1, 2001 until maturity. Effective
November 24, 2003, the Advance Limit is the lesser of $3,000,000 or an amount
based on the Companys receivables and inventory and there is no longer an
Advance Supplement. In addition, Hansa agreed to reduce the annual interest
rate under the Senior Revolver to 13 percent. The
President of Hansa Finance Limited Liability Company, Mr. Paul A. Biddelman, is
a director of the Company. Interest is due and payable monthly. At
December 31, 2003, the Company exceeded its lending limits
and, as a result thereof, the Company has repaid the outstanding balance of the Senior Revolver of
approximately $1.4 million in January 2004 from cash provided by
the Settlement Agreement. The Company and Hansa entered
into an agreement on February 15, 2003 to extend the maturity of the Senior
Revolver from May 30, 2003 to May 30, 2005. 54




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Interest is due and payable on maturity of the Secured Notes. In connection
with the Secured Notes, the Company granted the lenders a security interest in
substantially all of the Companys assets other than its intellectual property.
The security interest is subordinated to the Senior Revolver. Mr. Kenneth
Chuan-Kai Leung, Chief Investment Officer of the Environmental Opportunities
Fund II, L.P. and the Environmental Opportunities Fund II (Institutional),
L.P., and Mr. Paul A. Biddelman, the President of Hanseatic Americas LDC, which
entities are the holders of 100% of the Secured Notes, are directors of the
Company. The Company is required to issue an additional 942,858 warrants to the holders
of its Secured Notes if the Company (i) sells debt or equity securities, or
debt securities convertible into equity securities, or incurs debt with a final
scheduled maturity date more than twelve months after issuance providing gross
cash proceeds to the Company in an amount equal to or greater than the
outstanding principal amount of the Secured Notes or (ii) enters into a merger,
consolidation, sale of all or substantially all of its assets or other business
combination transaction with a party that prior to such transaction owns less
than 25 percent of the voting power of the Companys outstanding equity
securities. The fair market value of the warrants would be charged to
operations should the warrants become issuable. The Senior Revolver and the Secured Notes may be prepaid without penalty. Any
cash proceeds from any new financing or the issuance of stock must be used for
the payment of interest and principal on the Senior Revolver and the Secured
Notes. Long-term debt matures as follows: Year ended
December 31,2004
    
    $
    30,8062005
    
    
    29,486,421$
    29,517,227
 The carrying amount of debt,
excluding capital leases, was approximately $29.5
million and $30.8 million at December 31, 2003 and 2002, respectively.
Management estimates the fair value of the debt to be
$11.1 million and $27.4
million at December 31, 2003 and 2002, respectively. 55




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(8) REDEEMABLE CONVERTIBLE PREFERRED STOCK Shares of redeemable convertible preferred stock (the Preferred Stock),
stated at redemption values of $100 per share at December 31 are as follows: 2003
    
    20028.25% Series B. Authorized 150,000 shares,
issued and outstanding 73,380 shares
(67,697 in 2002)
    
    $
    7,338,000
    
    
    $
    6,769,7008.00% Series C. Authorized 150,000 shares,
issued and outstanding 97,102 shares
(89,770 in 2002)
    
    
    9,710,200
    
    
    
    8,977,0008.25% Series D. Authorized 150,000 shares,
issued and outstanding 26,894 shares
(24,803 in 2002)
    
    
    2,689,400
    
    
    
    2,480,30019,737,600
    
    
    
    18,227,000Less unamortized discounts
    
    
    (282,885
    )
    
    
    (1,008,344
    )$
    19,454,715
    
    
    $
    17,218,656
 Each series of the Preferred Stock has a Liquidation Value of $100 per share.
The dividend rate payable on all outstanding shares is applied to the
Liquidation Value of each share per annum. Through the second anniversary, as
defined, of the issuance of each series of the Preferred Stock, all dividends
were payable by the issuance of additional shares of the applicable Preferred
Stock valued at the Liquidation Value. Currently dividends may, at the option
of the Company, be paid either through the issuance of additional shares of the
applicable Preferred Stock, cash or any combination of the Preferred Stock or
cash. At any time prior to redemption, each holder of Preferred Stock may convert all
or part of such Holders shares of Preferred Stock into shares of the Companys
common stock at the following conversion prices (in each case subject to
adjustment in certain circumstances): $4.68 per share for the
Series B Preferred Stock
$3.50 per share for the Series C Preferred Stock
$3.50 per share for the Series D Preferred Stock Until the Mandatory Redemption Date (as defined below), the Company has the
right to redeem any outstanding shares of each series of Preferred Stock at a
redemption price of 102% of the Liquidation Value of the redeemed shares. The holders of the Preferred Stock are entitled to vote together with the
holders of the Companys Common Stock as a single class on all matters to come
before a vote of the shareholders of the Company. Each share of Preferred Stock
is entitled to the number of votes equal to the number of shares of Common
Stock into which it is then convertible. As amended, the holders have demand
registration rights in certain circumstances. The Company is required to redeem the Preferred Stock at the earlier of (i) the
ninetieth day after the date that all of the Subordinated Convertible Notes
shall have been repaid in full, and (ii) March 31, 2006 (such earlier date, the
Mandatory Redemption Date), but in no event shall the 56




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Mandatory Redemption Date be deemed to occur prior to May 17, 2004. On the
Mandatory Redemption Date, the Company is required to redeem each series of
Preferred Stock outstanding at a redemption price per share equal to the
Liquidation Value plus accrued and unpaid dividends. Assuming the Company
continues to issue dividends on each series of Preferred Stock by issuing
additional shares of Preferred Stock, the aggregate amount redeemable on March
31, 2006 would be $23,618,000. If on the Mandatory Redemption Date, the Company
does not have sufficient funds to redeem all shares, any available funds will
be used to redeem shares of Preferred Stock on a proportionate basis. If all
outstanding shares of Preferred Stock are not redeemed, the then current
conversion price with respect to any shares not redeemed will be reduced (but
not increased) to the greater of (a) 50% of the then current conversion price,
and (b) the closing price of the Companys common stock as reported by Nasdaq
(or such other principal national exchange on which the common stock is then
listed) on the Mandatory Redemption Date. The purchasers of the Series D Preferred Stock received warrants on May 2, 2000
which expire in April 2005, to acquire an aggregate of 571,428 shares of the
Companys common stock at an exercise price of $3.50 per share. The fair value
of the warrants, based on the Black-Scholes option-pricing model, of $1,185,644
was charged to unamortized discount and credited to additional paid-in capital.
The discount is being accreted to dividends on the Preferred Stock over the
period to May 2004 which was the original Mandatory Redemption Date prior to
the extension. In addition, the Series D Preferred Stock warrants created a beneficial
conversion feature in the Series D Preferred Stock which has a value of
$814,356. The value assigned to the beneficial conversion feature is the
product of the value of the common stock at the commitment date and the
additional shares into which the security is convertible and was charged to
unamortized discount and credited to additional paid-in capital. The discount
is being accreted to dividends on the Preferred Stock over the period to May
2004 which was the original Mandatory Redemption Date prior to the extension. The issuance of the 750,000 warrants to the holders of Subordinated Convertible
Notes, described in footnote 7, would have triggered certain anti-dilution
rights pursuant to the Companys outstanding (i) shares of Series D Preferred
Stock, $1.00 per share, (ii) warrants issued May 2, 2000 exercisable for an
aggregate of 571,428 shares of Common Stock, and (iii) warrants issued August
7, 2000 exercisable for an aggregate of 942,858 shares of Common Stock
(collectively, the Outstanding Warrants). The holders of the Series D
Preferred Stock and Outstanding Warrants waived their anti-dilution rights in
exchange for warrants for the purchase of 250,000 shares of Common Stock at an
exercise price of $.01 per share expiring on December 31, 2005. The fair market
value of these warrants at December 9, 2002 was $173,038 and was recorded as a
dividend and credited to additional paid-in capital. The carrying amount of the
Preferred Stock was approximately $19.7 million and
$17.2 million at December 31, 2003 and 2002, respectively. Management estimates
the fair value of the Companys Preferred Stock to be $8.9 million and $15.9
million at December 31, 2003 and 2002, respectively. 57




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The shares of Common Stock issuable upon conversion of the Series B, C and D
Preferred Stock include registration rights whereby the Company must register
the underlying shares upon notice from holders thereof that they have a bona
fide intent to sell the related shares with a market value of at least
$1,000,000. (9) STOCKHOLDERS DEFICIT In connection with the Exclusive Marketing Agreement with Safety-Kleen, the
Company issued to Safety-Kleen a five-year warrant to purchase up to 1,134,615
shares of the Companys common stock at $3.50 per share. This warrant was
cancelled in the fourth quarter of 2003 as required by the Settlement
Agreement. During the fiscal year ended December 31, 2003, an aggregate of 220,313
warrants with an exercise price of $.01 per share previously issued to the
holders of Subordinated Convertible Notes were converted by cashless exercises
into an aggregate of 217,164 shares of the Companys common stock. At December 31, 2003 the Company had 4,960,087 Common Stock purchase rights
(the Rights) outstanding which expire on September 30, 2008. The Rights
contain provisions to protect shareholders in the event of an unsolicited
attempt to acquire the Company that is not believed by the board of directors
to be in the best interest of shareholders. The Rights are evidenced by the
certificates for common stock, are subject to anti-dilution provisions and are
not exercisable, transferable or exchangeable apart from the Common Stock until
10 days after an Acquiring Person, as defined, acquires beneficial ownership of
15% or more, or, in the case of an Adverse Person, as defined, 10% or more of
the Companys Common Stock. The Rights entitle the holder, except such an
Acquiring Person or Adverse Person to buy that number of shares of Common Stock
of the Company which at the time of such acquisition would have a market value
of two times the exercise price of the Right. The Rights have no voting rights
and are redeemable, at the option of the Company, at a price of $0.001 per
Right prior to the acquisition by an Acquiring Person of 15% or more of the
Companys Common Stock. (10) STOCK-BASED COMPENSATION The Company has an executive incentive compensation plan (the Plan) pursuant
to which the Companys board of directors may grant stock options to officers
and key employees. Pursuant to an amendment approved by the Companys
shareholders during 2000, stock options to purchase up to 750,000 shares of
common stock may be granted under the Plan. Stock options are granted with an
exercise price equal to the stocks fair market value at the date of grant
subject to a minimum exercise price of $1.00 per share. All stock options have
a seven-year term and vest and become exercisable over a three-year period from
the date of grant. At December 31, 2003, there were 328,672 additional shares available for grant
under the Plan. 58




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Stock-option activity during the periods indicated was as follows: WEIGHTEDAVERAGENUMBER OF
    
    EXERCISESHARES
    
    PRICEBalance at December 31, 2001
    
    
    503,966
    
    
    $
    8.22Granted
    
    
    108,500
    
    
    
    2.50Exercised
    
    
    
    
    
    
    Forfeited
    
    
    (11,000
    )
    
    
    2.77Expired
    
    
    (67,750
    )
    
    
    3.50Balance at December 31, 2002
    
    
    533,716
    
    
    
    7.77Granted
    
    
    352,828
    
    
    
    1.00Exercised
    
    
    
    
    
    
    Forfeited
    
    
    (5,500
    )
    
    
    2.50Cancelled
    
    
    (424,716
    )
    
    
    6.85Expired
    
    
    (35,000
    )
    
    
    3.50Balance at December 31, 2003
    
    
    421,328
    
    
    
    3.45
 Stock options consisted of the following at December 31, 2003: Options Outstanding
    
    Options ExercisableWeightedWeighted
    
    Average
    
    
    
    
    
    WeightedAverage
    
    Remaining
    
    
    
    
    
    AverageRange of
    
    
    
    
    
    Exercise
    
    Estimated
    
    
    
    
    
    ExerciseExercise Price
    
    Number
    
    Price
    
    Life
    
    Number
    
    Price$1.00 to $8.8125
    
    
    366,828
    
    
    $
    1.26
    
    
    
    6.6
    
    
    
    14,000
    
    
    
    7.78$13.125 to $19.50
    
    
    54,500
    
    
    $
    18.18
    
    
    
    1.0
    
    
    
    54,500
    
    
    
    18.18421,328
    
    
    
    
    
    
    
    
    
    
    
    68,500
    
    
    
    16.05
 At December 31, 2003 and 2002, the number of options exercisable was 68,500 and
315,257, respectively, and the weighted-average exercise prices of those
options were $16.05 and $10.81, respectively. On June 28, 2003, the Company canceled 424,716 options issued prior to March
31, 2003, at various exercise prices ranging from $2.50 to $19.50 per share
(the Canceled Options). On December 30, 2003 the Canceled Options were
replaced with 235,828 options with an exercise price of $1.00 per share. In
addition, the Company issued 107,000 options in March 2003 at an exercise price
of $1.00 per share. These March 2003 options are subject to variable accounting
provisions as they were issued within six months of the Canceled Options. The
March 2003 options did not affect the fiscal year 2003 statement of operations
as the market value of the Companys stock did not reach $1.00 during 2003. The
Company plans to recognize compensation expense in the subsequent years if and when the stock price
increases above $1.00 per share. 59




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(11) INCOME TAXES The components of the income tax provision are as follows: Year ended December 31,
    
    2003
    
    2002CurrentFederal
    
    $
    186,705
    
    
    $
    State
    
    
    
    
    
    
    186,705
    
    
    
    Deferred
    
    
    
    
    
    
    Total
    
    $
    186,705
    
    
    $
    
 The actual income tax expense differs from the expected income tax effect
(computed by applying the U.S. federal corporate tax rate of 34 percent to
income before income tax provision) for the years ended December 31, 2003 and
2002 as follows: 2003
    
    2002Computed expected income tax expense
(benefit)
    
    $
    1,855,917
    
    
    $
    330,366State income tax expense, net of U.S.
federal income tax expense
    
    
    199,773
    
    
    
    35,448Change in valuation allowance
    
    
    (1,497,932
    )
    
    
    211,236Previously unrecorded benefit
    
    
    (269,393
    )
    
    
    Other
    
    
    (101,660
    )
    
    
    (577,050
    )Income tax expense
    
    $
    186,705
    
    
    $
    
 During the year ended December 31, 2003, the Company utilized net operating
loss carry forwards of approximately $9,100,000 to reduce its federal and state
taxes. Temporary differences between financial statement carrying amounts and tax
basis of assets and liabilities that give rise to significant portions of the
deferred tax assets and liabilities as of December 31, 2003 and 2002 are as
follows: 2003
    
    2002Deferred tax assets:Net operating loss carryforward
    
    $
    18,266,710
    
    
    $
    21,681,222Deferred revenue
    
    
    24,042
    
    
    
    40,194Warranty accrual
    
    
    141,132
    
    
    
    234,996Research and development
    
    
    311,998
    
    
    
    204,166Inventory
    
    
    79,986
    
    
    
    62,107Debt issue costs
    
    
    6,032
    
    
    
    14,898Bad debt reserve
    
    
    
    
    
    
    46,393Accrued expenses
    
    
    26,341
    
    
    
    238,294Patents
    
    
    259,472
    
    
    
    43,955Original Issue Discount  Debt
    
    
    168,945
    
    
    
    
 60




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2003
    
    2002Termination fee settlement
    
    
    1,505,200
    
    
    
    Alternative Minimum Tax Credit
    
    
    180,831
    
    
    
    Total gross deferred tax assets
    
    
    20,970,689
    
    
    
    22,566,225Less valuation allowance
    
    
    (20,966,124
    )
    
    
    (22,464,056
    )Net deferred tax assets
    
    
    4,565
    
    
    
    102,169Deferred tax liabilities:Fixed assets
    
    
    4,565
    
    
    
    102,169Total gross deferred tax liabilities
    
    
    4,565
    
    
    
    102,169Deferred tax assets, net
    
    $
    
    
    
    $
    
 At December 31, 2003, the Company had federal and state net operating loss
carry-forwards of $48,542,944 which expire in the years 2012 through 2021. Realization of the benefits related to the net operating loss carryforwards may
be limited in any one year due to IRS Code Section 382, relating to change of
ownership. (12) CONTINGENCY On or about October 17, 2003, the Company, along with Safety-Kleen, was sued in
the Court of Common Pleas for Beaver County, Pennsylvania, by plaintiff
Sirotas Machine Company, Inc. The plaintiff seeks damages in the amount of
approximately $335,000 resulting from a fire that the plaintiff claims was
caused by a SystemOne parts washer. Based upon an initial investigation by the
Companys insurance carrier, the Company believes that the claim is without
merit and anticipates that its insurance carrier will aggressively defend the
claim. Accordingly, the Company currently anticipates that this case will not
have a material adverse effect on the Companys financial position or its
results of operations. (13) SUBSEQUENT EVENTS Based on current plans and estimates and taking into account the expected
investment necessary to rebuild the Companys distribution system, management
has allocated approximately $5 million of available cash to reduce and retire
certain indebtedness of the Company, which as of December 31, 2003, included
$23,155,512 principal amount of the Subordinated Convertible Notes and
$4,893,348 of the Secured Notes, including accrued interest. Although the
Notes are subordinated to the Companys outstanding Secured Notes, the holders
of the Secured Notes have consented to the Companys purchase of the
Subordinated Convertible Notes before repaying the Secured Notes. On March 15 2004, the Company repurchased and retired $13.5 million
principal amount of the Subordinated Convertible Notes for an aggregate
purchase price of $2.9 million. The Company expects to recognize a pre-tax
gain of approximately $10.4 million in the first quarter of 2004 on the
repurchase and retirement of these Notes. 61




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Exhibit Index EXHIBIT
    
    DESCRIPTION23
    
    Consent of BDO Seidman, LLP31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under
the Exchange Act.31.2
    
    Certification of Director of Finance and Administration (Principal Financial
Accounting Officer) pursuant to Rule 13a-14(a) under the Exchange Act.32.1
    
    Certification of Chief Executive Officer and Director of Finance and
Administration (Principal Financial Accounting Officer) pursuant to
Rule 13a-14(b) under the Exchange Act and 18 U.S.C. Section 1350.
 62