UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

         (Mark One)
            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                     For the fiscal year ended June 30, 1998

            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                         Commission File Number 0-19343

                              Valley Systems, Inc.
             (Exact name of registrant as specified in its charter)

                                    Delaware
         (State or other jurisdiction of incorporation or organization)

                                   34-1493345
                      (IRS Employer Identification Number)

               11580 Lafayette Drive NW, Canal Fulton, Ohio 44614
                 (Address of principal executive offices)(zip code)

       Registrant's telephone number, including area code: (330) 854-4526

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

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.01 par value
                                (Title of Class)

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

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

         As of August 31, 1998: (a) 7,906,617  shares of Common Stock,  $.01 par
value, of the registrant were outstanding;  (b) 2,072,872 shares of Common Stock
were held by  non-affiliates;  and (c) the aggregate  market value of the Common
Stock held by non-affiliates  was $2,202427,  based on the closing sale price of
$1.0625 per share on August 31, 1998.



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                       DOCUMENTS INCORPORATED BY REFERENCE


Part I:           None

Part II:          None

Part III:         All items - see  registrant's  definitive proxy statement
                  which  involves the  election of  directors  and which will be
                  filed with the  commission  within 120 days after the close of
                  the fiscal year.

            Item 10:       Directors and Executive Officers of the Registrant

            Item 11:       Executive Compensation

            Item 12:       Security  Ownership  of Certain Beneficial Owners and
                           Management

            Item 13:       Certain Relationships and Related Transactions




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                                     Part I
ITEM 1.  BUSINESS

General

         The  Company  is  engaged  in the  business  of  providing  specialized
industrial  cleaning and other  services to divisions and  facilities of Fortune
500 companies and other substantial  businesses engaged in heavy industry.  Such
services  generally involve the removal of industrial grime,  deposits,  wastes,
encrustations or coatings from equipment and facilities. The Company's principal
customers are in the chemical,  plastics,  power generation,  petroleum refining
and  primary  metals  businesses.  The  Company's  industrial  cleaning  methods
include,  in addition  to the use of  waterblasting,  vacuuming,  and other more
conventional   procedures,   the  application  of  ultra-high  pressure  ("UHP")
waterjetting and cutting methods.

Industrial Cleaning Services

         Until  1984 the only  technologies  used by the  Company  in  providing
commercial  and  industrial  cleaning  services  were  vacuum  (wet and dry) and
conventional  water blast cleaning  techniques.  These  conventional  methods of
service  are still  provided by the  Company.  The market  applications  for the
Company's  conventional  method  services in  industrial  cleaning  are many and
varied,  and include  removing  materials  and deposits  from items such as heat
exchangers,  boilers, condensers,  building surfaces, vats, slabs and molds. The
Company also provides sewer cleaning, pipe inspection and other services for its
customers. See "Item 1 - Business-Company  Operations".  Such other services are
essentially  incidental to the Company's business and are not deemed material to
its future operations.
See "Item 1-Business-Company Operations-Revenue by Service Line".

         Industrial vacuuming removes industrial waste and debris, and retrieves
salvageable materials, using truck mounted equipment to vacuum up the designated
waste. Most of the Company's vacuum equipment can be used in either a wet or dry
medium, but the Company also uses equipment that only has a wet application. The
Company uses both commercially  available  equipment and internally designed and
fabricated   equipment  in  the   performance  of  industrial   vacuum  cleaning
activities.  The Company's  vacuum  equipment  can be used to clean  underground
lines,  pipes,  storm drains and sewers, as well as to meet the demands of other
cleaning applications.  In performing its conventional vacuum cleaning services,
the vacuumed material is either  transported by the Company for disposal on-site
at the  customer's  location,  or is  transferred  by the Company  on-site  into
barrels, bins or other storage vessels supplied by the customer, for disposal by
the customer.

         In 1984, to overcome the limitations of conventional technologies,  the
Company began providing UHP waterjetting  services.  Although  pressurized water
cleaning  equipment for use in  industrial  cleaning,  construction,  mining and
other  applications  is  commercially  available,  the UHP equipment used by the
Company is designed and fabricated by the Company.  The Company has been able to
enhance and modify its UHP equipment since its first introduction.  In 1991, the
Company purchased certain patents and know-how related to equipment designs, UHP
waterjet  guns  and  other   technologies.   See  "Item   1-Business-Proprietary
Technology, Patents Trademarks and Equipment".

         Benefits from the application of UHP technology  include (1) the use of
a very low  volume of water,  (2) the  uniform  cleaning  of a  material  from a
surface, (3) the minimization of surface damage or degradation, (4) the decrease
of environmental and  health/safety  impacts through the reduction or absence of
dust,  fumes,  sand,  solvents  or  chemicals  and other  by-products  requiring



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disposal,  (5) the reduced volume of residue or waste product  (including water)
clean-up,   (6)  the   elimination  of  many  safety  hazards   associated  with
conventional methods and the need for "hot work" permits (i.e., UHP waterjetting
is a  non-spark  generating  activity),  and (7)  the  elimination  of  airborne
contaminants,  reducing preparatory  activities (covering surrounding areas) and
clean-up times, which yields increased productivity.

         With the addition of an abrasive  material into the water  stream,  the
Company's UHP equipment can also cut virtually any material.  This  technique is
used where heat or open flames would  damage the material  being cut or create a
safety hazard.  Most of the UHP cutting services involve gas pipelines,  storage
tanks and regenerator heads in the refining industry.

         Advantages of UHP technology could become more pronounced in the future
as the result of certain  actions  taken by  environmental  regulatory  agencies
which are  expected to restrict the use of  conventional  cleaning  methods.  In
1989, the Occupational  Safety and Health  Administration  ("OSHA")  promulgated
regulations which significantly  reduce allowable exposure levels to crystalline
silica for  employees  of United  States  companies,  which  inhibits the use of
sandblasting  in industrial  cleaning and facilities  maintenance  applications.
Sandblasting  is not favored by many of the Company's  customers  because of the
dispersion of particulates  into the air, its effect on machinery and equipment,
and the necessity of  transporting  and disposing of the sand waste  thereafter.
Additionally,   the   institution  of   increasingly   stringent   environmental
regulations  governing  the  generation  and disposal of all forms of industrial
waste,  both hazardous and  non-hazardous,  will impose  significant  additional
costs on most  conventional  industrial  cleaning  services.  The inherent  cost
advantages  afforded by the absence of particulate and other residue by-products
should  enhance the future market demand for UHP services such as those provided
by the Company.  See "Item  1-Business-Environmental  Standards  and  Government
Regulations".

Service Procedures

         Generally,  the Company  performs its  services at customer  facilities
using  truck-mounted  equipment.  Teams  of  two or  more  persons  operate  the
Company's equipment. The Company's employees extend pipe and/or hose, as well as
additional equipment, from the truck into the customer's tank, container,  paint
stack, boiler or other area to be cleaned.

         The Company has also installed stationary, electrically powered UHP and
conventional  waterblast  units at some  customer  facilities.  These  permanent
installations,  utilized where repetitive day-to-day cleaning is required,  have
enhanced the Company's  service  capabilities  while reducing customer down time
and overall cleaning costs.

         In  connection  with  the  use  of  vacuuming  and  other  conventional
technologies,  the waste material is conveyed into the  equipment's  own holding
tank, or a Company or  customer-owned  and controlled  roll-off  container,  for
transportation  by  the  customer  to  a  proper  customer-designated   disposal
location, generally on-site at the customer's facility.

         In providing UHP waterjetting  services,  the Company's cleaning system
either (1)  captures  all  water,  waste and  residue  produced,  which  permits
pre-treating  of such materials in accordance with local  requirements  prior to
discharge into the available sewer system,  or (2) allows direct untreated sewer
discharge of such resultant waste  material.  Whether or not such waste material



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is  pre-treated  depends  upon the nature of the  materials to be removed in the
cleaning  process (as disclosed to the Company by the  customer),  the nature of
any cleaning additives and other materials used by the Company itself, and local
regulations.

Company Operations

         The Company's  sales from its primary  service lines in dollar  amounts
and by percentage were as follows:
                                             Year ended June 30
                                          1998       1997       1996        
                                        --------   --------   --------        
          Dollars (in thousands):          
               UHP                      $ 11,402   $ 11,629   $  9,882 
               Vacuum                      6,859      5,947      6,788 
               Waterblasting               4,755      4,135      3,958 
               Other                       1,415      1,377      1,247 
                                        --------   --------   -------- 
                    Total               $ 24,431   $ 23,088   $ 21,875 
                                        ========   ========   ======== 
          Percentage:                                                 
               UHP                         46.7%      50.4%      45.2% 
               Vacuum                      28.1%      25.8%      31.0% 
               Waterblasting               19.4%      17.9%      18.1% 
               Other                        5.8%       5.9%       5.7% 
                                        --------   --------   -------- 
                    Total                 100.0%     100.0%     100.0% 
                                        ========   ========   ======== 
                                                              

         The  Company  does not depend  upon any one  customer  for sales of its
services.  During the fiscal year ended June 30, 1998,  the Company had sales to
approximately  400 different  customers.  One customer  accounted for 9% and two
other  customers  were each 7% of Fiscal 1998 net sales.  Various plants of E.I.
DuPont (which make independent  purchasing decisions) made up 13% of Fiscal 1997
net sales. Four other customers each accounted for 6% of Fiscal 1997 net sales.

         The Company does not depend upon a limited  number of suppliers for the
conduct of its business.  The loss of any one of its suppliers  would not have a
material adverse effect on the Company's business.

         The  Company  currently  services  clients  through  a number of branch
offices and customer site  facilities  located  throughout the United States and
Puerto Rico.  The branch office  locations  are  facilities at which the Company
houses  equipment  and  maintains  an  administrative  staff.  Each  location is
equipped to perform  minor  equipment  maintenance.  The Company has  mechanics,
machinists  and  facilities  to  perform  major  equipment  maintenance  at  its
headquarters facility.  The customer-site  facilities are trailers and equipment
at customer  locations  used by the  Company to service  that  customer  and the
surrounding area.

         While the Company has some long-term commitments from customers for the
provision of  services,  most  frequently  orders for services are received on a
job-by-job basis. In certain  instances the Company  maintains  equipment at the
locations of customers which have issued "blanket orders" to the Company for the
provision  of  services  over an extended  period.  Such  blanket  orders do not
obligate the customer to purchase a specified dollar amount of services. Blanket
orders permit the Company to be contacted to perform services when needed.  Such
blanket  orders,  in combination  with the location of the Company's  equipment,
allow the Company to expedite its response to a particular  customer's needs and
to obtain a potential competitive  advantage.  The Company provides its services

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<PAGE>

primarily  at  prescribed  rates or based upon  competitive  bidding and in some
cases through  direct  negotiation  with the customer.  Due to the nature of its
business,  there are relatively few  pre-scheduled or contracted  service calls.
Most  services are  performed on an emergency  basis or upon less than two weeks
advance notice.  Accordingly,  the Company does not have any significant backlog
of service orders.  Management of the Company does not consider  backlog size to
be an important indicator of future performance.

         The Company's  management knows of no significant  seasonal  influences
related to the provision of its services.

         The  Company  does not  provide a  separate  guaranty  or  warranty  to
customers  for the services it  provides.  Due to the size and type of customers
serviced,  the Company does not generally experience significant delays or other
problems in collecting its accounts  receivable.  Standard payment terms average
60 days.

Insurance

         Much of the work performed by the Company is pursuant to contracts that
require the Company to indemnify the customer for injury or damage  occurring on
the work site. The terms of such indemnity  agreements  vary, but generally they
provide  that the Company is  required  to  indemnify  the  customer  for losses
resulting from or incurred in connection with  performance by the Company of its
services  whether or not the  Company  has been  negligent.  Liability  for such
indemnification claims is generally covered by the Company's insurance policies.

         Although the Company believes that its insurance  coverage is generally
consistent  with  industry  practice,  there are  exclusions  from the Company's
insurance  coverage for matters of  environmental  pollution  and other types of
environmental  damage  claims.  An  uninsured  or partially  insured  claim,  if
successful and of sufficient magnitude,  could have a material adverse effect on
the Company or its financial condition.

Competition

         The market for industrial  cleaning  services is fragmented.  There are
many  competitors,  no one of which is  believed  to hold a  substantial  market
share. The Company  competes with a number of companies in substantially  all of
the regions in which it operates. Many of these competitors are local operations
servicing a limited  geographic area. There are,  however,  a few large national
and regional  competitors  that have  significantly  greater  resources than the
Company.  In recent  years there has been a trend  toward  consolidation  in the
industrial  cleaning industry.  In 1997 Phillip Services Corp. acquired Allwaste
Inc., one of the Company's national competitors.  Other significant regional and
national  competitors include C.H. Heist Corp.,  HydroChem  Industrial Services,
Inc.,  MPW  Industrial   Services  Group,  Inc.  and  Rust   International,   an
engineering,  construction  and  environmental  cleanup firm controlled by Waste
Management, Inc.

         The Company's principal  competitive  advantages are the quality of the
equipment  that it uses, its ability to provide quick response times to customer
needs,  its  safety  record,  its  reputation  for  competent  and  professional
performance,  and the  training  and  mobility  of its  service  force.  Another
important competitive advantage is the Company's UHP proprietary  technology and
equipment. See "Item 1 - Business - Proprietary Technology,  Patents, Trademarks
and Equipment".

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<PAGE>

         The  Company  relies  heavily  on repeat  customers,  and uses both the
written and verbal  referrals of its  satisfied  customers to help  generate new
customers.  Many of the  Company's  customers or  prospective  customers  have a
qualification procedure for becoming an approved bidder or vendor based upon the
satisfaction of particular performance and safety standards set by the customer.
Such customers often maintain a list of vendors meeting such standards and award
contracts for  individual  jobs only to such vendors.  The Company  continuously
monitors and  attempts to improve the quality of service it  provides,  and this
process is intended to help the Company maintain  standards of performance which
are acceptable to its customers. The headquarters and Canton, Ohio facilities of
the Company received  certification to the International Standard of ISO 9002 in
July  1997.  The  Company  is among the first  within  its  industry  to receive
registration to ISO 9002. The Company believes that its  relationships  with its
customers have been good.

Proprietary Technology, Patents, Trademarks and Equipment

         The Company holds three patents  expiring in 2004,  2005, and 2013 with
respect to tooling and equipment used in connection with its  pressurized  water
technology.  The Company also is the licensee under an exclusive patent license,
granted by the  University of Missouri,  involving a certain  waterjet  cleaning
tool and  deposit  removal  process.  The patent  being  licensed to the Company
terminates in 2000. In June 1991,  the Company  purchased two of these  patents,
the patent license,  certain UHP tools, equipment,  know-how, and technology and
documentation  related to those tools and  equipment,  a trademark  for the term
"Water  Laser",  and all new related  inventions  hereinafter  developed  by the
sellers of the  technology.  The patents,  license,  and know-how  relate to UHP
technology  applicable  to industrial  cleaning.  The  acquisition  provides the
Company with the potential power to foreclose third parties from the use of such
patent technology. In connection with the purchase of the above technologies and
patents,  the Company also  received from the sellers an agreement not to engage
in any business involving the development,  testing, manufacturing or use of any
technology, tools, equipment, designs or patents which use water or UHP water as
any part of its operation.

         The Company has developed a great deal of  proprietary  technology  and
know-how which it uses in connection  with its provision of industrial  cleaning
services to  customers.  The Company  continues  to develop new and  proprietary
technology related to its UHP technology and other services,  and has additional
patents pending.

         Most of the technology and the equipment used in providing conventional
vacuum and waterblasting services are readily available in the industry. The UHP
waterjetting  services  provided  by  the  Company  result  from  the  Company's
proprietary   technologies,   as  well  as  its  self-designed  and  constructed
equipment,  tools  and  accessories.  These  technologies  include  not only the
techniques used by its service personnel in physically  providing services,  but
also the design of the component  parts of the equipment  used by the Company in
providing the services.  Although  certain basic pieces of equipment are readily
available (e.g.,  diesel and electrical motors,  vehicular  chassis,  etc.), the
design  of other  components  assembled  into  the  Company's  UHP  waterjetting
equipment is proprietary to the Company.  Such  components are fabricated in the
Company's  machine shops and assembled into finished  pieces of equipment at the
Company's headquarters facility.

         All of the Company's  employees sign  confidentiality  agreements which
obligate them to protect the Company's proprietary  technology and know-how from
unauthorized  use and  disclosure,  and otherwise to treat such  information  as
confidential. Management of the Company believes that with respect to certain of

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its know-how and design  improvements,  even if such  processes or products were
patentable,  any  patent  protection  which  could be  obtained  would not be as
beneficial  to the  Company as the  continued  maintenance  of such  proprietary
information as confidential material whenever possible.

         The Company's name and logos have been registered as service marks with
the United States Patent and Trademark Office.

         The Company does not operate under any licenses or  franchises  granted
by third parties, other than the University of Missouri patent license.

Environmental Standards and Government Regulations

         The Company's operations are subject to numerous rules and  regulations
at the federal, state and  local  levels.  The  Company  believes  that it is in
substantial  compliance with the various rules and regulations.  The Company has
not experienced any significant regulatory problems.

         All of the Company's  operations are subject to  regulations  issued by
the United States  Department of Labor under the Occupational  Safety and Health
Act ("OSHA").  Additionally, some of the Company's operations are subject to the
provisions of the Federal Mine Safety and Health Act of 1977. These  regulations
have strict  requirements for protecting  employees  involved with any materials
that are classified as hazardous. Violations of these rules can result in fines.

         The Company does not believe that its current activities are subject to
the  duties  pertaining  to  hazardous  waste  treatment,  storage  or  disposal
facilities,  nor those  duties  pertaining  to  hazardous  waste  generators  or
transporters.

         In the event the Company  performs a cleaning  operation  involving the
disposal of a waste that would be defined as hazardous  under RCRA,  the Company
could also be  classified  as a "generator"  of hazardous  waste,  and therefore
responsible  for  manifesting  and  transporting  all such  waste  to  permitted
treatment,  storage  or  disposal  facilities  in  accordance  with  RCRA.  As a
generator,  the Company  could be  potentially  liable  under the  Comprehensive
Environmental Response,  Compensation and Liability Act of 1980 ("CERCLA"), also
known as the  Superfund  Act. To the Company's  knowledge,  none of the sites at
which the Company  performs  services have been  designated as Superfund  sites.
Moreover,  to the Company's knowledge,  it has not sent any hazardous substances
or wastes to any site that has been  designated as a Superfund site. Many states
have implemented environmental guidelines similar in nature to RCRA and CERCLA.

         On  the  local  level,  rules  and  regulations  exist  and  are  being
promulgated  to govern the discharge of  wastewater  into sewer  systems.  These
rules can vary widely by locale.  The Company has developed  systems that permit
it to comply with these  regulations,  when  applicable.  Future changes in such
rules and  regulations  could have a  significant  impact on the Company in that
additional capital expenditures might be required. However, the more intensified
regulation  also serves to foreclose  potential  new entrants  with little or no
experience in industrial  cleaning  services,  as well as those lacking adequate
capital.

         The Company  believes  that it has  obtained  the permits and  licenses
required  to  perform  its  business  and  believes  that  it is in  substantial
compliance with all federal,  state and local laws and regulations governing its
business.  To date, the Company has not been subject to any  significant  fines,
penalties or other  liabilities  under such laws and  regulations.  However,  no

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<PAGE>

assurance  can be given that future  changes in such law,  and  regulations,  or
interpretations  thereof,  will  not have an  adverse  impact  on the  Company's
operations.

         The  Company's  general  liability  insurance is subject to a pollution
exclusion  endorsement.  Such  exclusion is  generally  found in the majority of
general  liability  policies.   The  Company  does  not  maintain  environmental
impairment  liability  insurance.  Thus a claim for damages  against the Company
that  involves  pollution  or  environmental  impairment  will not be covered by
insurance,  and, depending on the size of the claim, may have a material adverse
effect  upon  the  business  and  operations  of  the  Company.  See  "Item  1 -
Business-Insurance".

Employees

         As of August 31, 1998,  the Company  employed 375 full time  employees.
Due to the nature of the  services  provided  (i.e.,  primarily  on a job-by-job
basis), the number of Company employees is subject to fluctuation.  No employees
are currently covered by collective bargaining agreements.  The Company believes
that its relations with its employees are good.

ITEM 2.  PROPERTIES

         The Company's  headquarters facility in Canal Fulton, Ohio is comprised
of two buildings:  a 16,000 square foot office,  equipment warehouse and machine
shop  facility  and an 9,000  square  foot  office,  machine  shop,  and service
dispatch  facility.  The  Company  owns both  buildings,  as well as a  regional
training and repair facility in Texas.

         The Company  leases the other  facilities  used in its  business  under
short-term leases,  generally one to three years. Management does not anticipate
any material problems in negotiating  extensions of these existing arrangements.
If  necessary,  management  believes  that it would be able to  obtain  adequate
alternate facilities on terms acceptable to the Company.

ITEM 3.  LEGAL PROCEEDINGS

         As  previously  reported,  the  Company  initiated  litigation  in 1993
against  certain  former  officers and directors in the United  States  District
Court for the Northern District of Ohio,  Eastern Division.  This litigation was
resolved on terms favorable to the Company in December 1996, after the trial had
commenced.  All claims between the Company and the former officers and directors
have now been resolved.

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

         No matters  were  submitted  to a vote of security  holders  during the
fourth quarter of the year ended June 30, 1998.





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

         The Company's  Common Stock trades on the Nasdaq SmallCap Market of the
Nasdaq Stock Market under the symbol:  VALE. The following  table sets forth the
high and low sale prices for the periods indicated.
                                                          High            Low
             Fiscal 1997:
             July 1, 1996 - September 30, 1996          $ 1.188        $  .688
             October 1, 1996 - December 31, 1996          1.438           .938
             January 1, 1997 - March 31, 1997             1.563           .938
             April 1, 1997 - June 30, 1997                1.688           .875
             Fiscal 1998:
             July 1, 1997 - September 30, 1997            1.750          1.250
             October 1, 1997 - December 31, 1997          1.750           .750
             January 1, 1998 - March 31, 1998             1.188           .875
             April 1, 1998 - June 30, 1998                1.500           .938

         No dividends have been declared on the Common Stock since the inception
of the Company,  and the Company does not anticipate paying any cash dividend in
the  foreseeable  future.  In addition,  the Company is  restricted  from paying
dividends  on its Common  Stock  under its credit  agreement  with its  majority
stockholder.

         Based on  information  furnished  by certain  brokerage  firms that are
record holders of the Company's  Common Stock,  the Company has in excess of 800
beneficial owners of its Common Stock.

ITEM 6.   SELECTED FINANCIAL DATA

                                  1998      1997      1996      1995      1994
                                --------  --------  --------  --------  --------
Sales                           $24,431   $23,088   $21,875   $24,231   $27,494 
Gross profit                      9,040     8,559     6,853     8,562     6,291 
Selling, general and                                                            
 administrative expenses          7,145     7,268     7,254     7,155     8,830 
Litigation settlements and                                                      
 related fees                                (752)                        1,351 
Restructuring charges                                                     3,548 
Interest expense                    593       592       572       895     1,506 
Net income (loss)                 1,302     1,451      (973)      512    (8,539)
Income (loss) per common                                                        
 share - basic and diluted          .12       .13      (.16)      .02     (1.31)
Total assets                     15,934    14,568    15,123    15,704    19,740 
Total long-term debt              7,585     7,235     7,021     5,858    10,194 
Total stockholders' equity        5,354     4,437     4,031     5,412      (251)
                                          



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<PAGE>




ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                   CONDITION AND RESULTS OF OPERATIONS

         The  following  discussion  should  be read  in  conjunction  with  the
Consolidated  Financial Statements and Notes thereto appearing elsewhere in this
Report.

FORWARD LOOKING STATEMENTS:

         Forward-looking  statements  in this Form 10-K are made pursuant to the
safe harbor provisions of the Private Securities  Litigation Reform Act of 1995.
Such  forward-looking  statements are subject to certain risks and uncertainties
that could  cause  actual  results to differ  materially  from those  projected.
Readers  are  cautioned  not to place undue  reliance  on these  forward-looking
statements,  which  speak  only  as of the  date  hereof.  Potential  risks  and
uncertainties  include,  but are not limited to,  general  business and economic
conditions; the financial strength of the various industries the Company serves,
the competitive pricing environment of the industrial cleaning service industry,
the cost and  effectiveness of planned marketing  campaigns,  the success of the
Company to continue to develop new  applications and markets for its technology,
and the  accuracy of the  estimates  used to evaluate  the likely  effect of the
Asset Purchase Agreement discussed later in this section.

Results of Operations - 1998 compared to 1997

         Sales  increased  5.8% in the fiscal  year ended June 30, 1998 from the
prior year. Sales of UHP waterjetting  services decreased by 2.0% from the prior
year,  and amounted to 47% of total sales in 1998,  compared to 50% in 1997. The
decrease in UHP sales was due to one large emergency  project in 1997 (hurricane
damage to a customer's facility) that was not repeated.  Excluding this project,
UHP sales  increased  by 4%.  UHP  sales to the  hazardous  materials  abatement
industry  grew from $1.2  million in 1997 to $2.2  million in 1998.  The Company
expects UHP sales to this industry to continue  increasing in Fiscal 1999. Sales
of  the  Company's   other  major  service   lines,   vacuum  and   conventional
waterblasting,  each  increased  by 15% in 1998  over  the  prior  year.  Vacuum
services  totaled 28% of sales in 1998,  compared to 26% in 1997.  Waterblasting
services were 19% of total sales this year, compared to 18% in 1997. The revenue
gains in  vacuum  and  waterblasting  came  from  increased  sales  to  existing
accounts, as well as new customers.

         As there was no significant  shift in sales between the various service
lines in 1998,  gross  margin as a  percentage  of sales was 37%, the same as in
1997. As announced in May 1998,  the Company has been selected to be the primary
supplier  of  vacuum  and  waterblasting  services  to  FirstEnergy  Corp.  This
three-year  contract is expected to add  approximately  $3 million of additional
revenues  annually to these service lines. This may cause these service lines to
be a higher  percentage of total sales in future years. The Company expects that
greater  efficiencies  due to larger  volumes  should allow  maintenance  of its
existing gross margin percentages.

         Selling,  general and  administrative  expenses decreased by 2% in 1998
from 1997, and  represented  29% of sales this year compared to 31% in the prior
year. Lower insurance  expenses due to better loss experience  helped cause this
decrease,  as well as lower  occupancy  costs resulting from the purchase of the
Company's  headquarters facility. The Company intends to continue its efforts to
control  costs in this area.  Interest  expense  remained  constant from 1997 to
1998, and amounted to 2% of sales in 1998 and 3% in the prior year.

         All of the above factors resulted in net income of $1.3 million in 1998
(5.3% of  sales),  or $.12 per  common  share,  basic  and  diluted.  This is an
increase of 86% from the  comparable  1997 income  from  operations  of $700,000
(3.0%  of  sales),  or $.04 per  common  share,  before  gain on  settlement  of

                                       11
<PAGE>

litigation.  Net income in 1997 was improved by a one-time gain on settlement of
litigation of $752,000, or $.09 per share.

Results of Operations - 1997 compared to 1996

         Sales  increased 5.5% in the fiscal year ended June 30, 1997 from 1996.
A shift in sales from vacuum  services to UHP  waterjetting  services  continued
from the prior year. UHP sales  increased 18% in 1997 from 1996, and represented
50% of total sales. In 1996, UHP services  represented 45% of total sales. Sales
of vacuum services  decreased by 12% and went from 31% of total sales in 1996 to
26% in 1997. Sales of waterblasting  services, the Company's other major service
line,  increased 5% in 1997 from 1996 and represented 18% of total sales in both
years.

         The shift in sales from vacuum  services to UHP  waterjetting  services
was expected.  Competition in the vacuum services area has increased steadily in
recent years. There has been consolidation in the industry and some competitors,
including some larger than the Company, have lowered rates to gain market share.
The Company has generally  chosen not to compete on price and has emphasized its
UHP  waterjetting  service  line,  where  management  believes  it  has a  clear
technological advantage.

         Sales  of UHP  waterjetting  services  were  also  aided in 1997 by new
applications for the Company's  technology in the hazardous  materials abatement
industry.  The Company had sales of $1.2 million in this area in 1997,  compared
to less than $400,000 in 1996.

         The Company's gross margin in 1997 increased to 37% of sales,  from 31%
in the prior year.  Increased sales of the UHP waterjetting  service line caused
part of this improvement.  Lower equipment repair costs resulting from increased
emphasis  on  preventive   maintenance   also   contributed.   Lower   equipment
depreciation costs spread over higher revenues also helped to increase the gross
margin percentage.

         Selling,  general and administrative  expenses increased by .2% in 1997
over  the  prior  year,  and  represented  31% of sales in 1997 and 33% in 1996.
Interest expense  increased 4% in 1997 from 1996, and represented 3% of sales in
both years.

         Net income in 1997 was increased by a  one-time  gain on settlement  of
litigation of $752,000, or $.09 per common share.

Quarterly Operating Results (unaudited)

         The following table presents certain unaudited  consolidated  quarterly
operating  information for the Company and includes all  adjustments  considered
necessary for a fair presentation of such information for the interim periods.
 
                                      Three Months Ended
                            (In thousands, except per share data)
               9/30/96 12/31/96 3/31/97 6/30/97 9/30/97 12/31/97 3/31/98 6/30/98
               ------- -------- ------- ------- ------- -------- ------- -------
Sales           $6,275   $5,133  $5,321  $6,359 $ 5,856  $ 6,058 $ 5,865 $ 6,652
Gross profit     2,367    1,727   2,138   2,327   2,200    2,117   2,210   2,513
Net income         250      437     305     459     304      131     344     523
Earnings per
 common share:
 basic and
 diluted        $  .02   $  .04  $  .03  $  .04 $   .03  $   .00 $   .03 $   .06

          Net income in the quarter ended  December  31,  1996 was increased  by
$752,000,  or $.09  per  common  share,  by a  one-time  gain on  settlement  of
litigation.


                                       12
<PAGE>

Liquidity and Capital Resources

         Working  capital  totaled $3.6 million at June 30, 1998 and 1997.  Cash
generated from operations totaled $3.8 million in 1998, compared to $2.6 million
in 1997. The  improvement  is primarily due to better  management of the various
components of working capital.

         Additions to property and  equipment  were $4.1 million in 1998,  which
includes $1.8 million acquired with capital leases,  compared to $1.7 million in
1997. Additions to property and equipment in 1996 were $2.5 million. $650,000 of
1998 additions were to purchase the Company's  headquarters facility in Ohio and
a regional  facility in Texas.  $400,000 of these funds were  obtained from a 10
year  mortgage on the  headquarters  facility,  and the  remainder  from working
capital.  The remaining $3.5 million of additions was for  equipment.  More than
half of equipment  additions were purchased or constructed in the fourth quarter
of 1998, and were necessary to service the FirstEnergy  Corp.  contract referred
to above.  Five-year capital leases financed $1.8 million of the $3.5 million of
equipment purchases.  The remainder was purchased from working capital. All 1997
and 1996  additions  were financed  through  operations  or borrowings  from the
Company's  revolving  line of credit,  which  expires in July 2000.  The Company
anticipates  spending less on additions to property and equipment in Fiscal 1999
than in 1998, but more than in 1997.  Total  additions to property and equipment
in 1999 are not expected to significantly  exceed  depreciation  expense in that
year.

         Financing  activities  provided $100,000 of cash in 1998, compared with
using $1.0 million in 1997. The Company  purchased  500,000 shares of its common
stock in 1997 in accordance  with a share purchase  program  announced in August
1996,  for a total cost of  $564,000.  This  expenditure,  along with payment of
preferred  stock  dividends of $385,000,  accounted  for most of the 1997 use of
cash. The Company does not expect to purchase additional common shares in Fiscal
1999.

         During 1997 the Company negotiated an extension of its credit agreement
with  its  majority  stockholder  and its bank  line of  revolving  credit.  The
existing  arrangements  were extended two years,  to July 2000.  The Company had
$1.5 million of credit  available  under these  agreements on June 30, 1998. The
Company  expects  to have  adequate  cash  flows  from  operations  to meet  all
obligations in Fiscal 1999.  Capital  expenditures will be partially funded from
cash flow,  and partially  financed  under terms  similar to those in 1998.  The
Company does not anticipate  difficulty in obtaining any necessary financing for
these expenditures.

Asset Purchase Agreement

         On  September  8, 1998,  the  Company  entered  into an Asset  Purchase
Agreement  (the   "Agreement")   with  HydroChem   Industrial   Services,   Inc.
("HydroChem") pursuant to which HydroChem plans to purchase substantially all of
the Company's assets and assume  substantially all of the Company's  outstanding
liabilities.  The stated  purchase price is  approximately  $29.8 million,  with
$25.8 million  payable in cash at the closing and the remaining $4 million to be
deposited  into escrow and held  pursuant to an Escrow  Agreement  (the  "Escrow
Agreement");  provided, however, that in the event that the net assets reflected
on the Company's  balance  sheet at closing are greater or less than  $5,353,593
(which was the total at June 30, 1998),  any excess or deficiency  shall be paid
to the  Company  (in the  case of an  excess)  or  HydroChem  (in the  case of a
deficiency) as an adjustment to the purchase price. The escrow funds will secure
HydroChem's rights to indemnification, including indemnification with respect to
certain   potential   environmental   expenses  and  remediation  cost  and  the
collectibility of certain accounts  receivable which are to be guaranteed by the
Company.  At such time as the Company delivers to HydroChem a certificate to the

                                       13
<PAGE>

effect that the Company has completed  environmental  remediation as required by
the Agreement  (if any), an amount equal to $1 million,  less the sum of (i) the
aggregate cost of such  environmental  remediation and (ii) the aggregate amount
of other claims of HydroChem subject to  indemnification  under the Agreement in
excess of $3 million, shall be released to the Company from escrow. In addition,
provided   that  any  disputes   existing  on  each  of  the  first  and  second
anniversaries of the Agreement,  respectively,  do not exceed specified amounts,
then $1  million  of the  escrow  funds  will be  released  following  each such
anniversary,   reduced  in  each  instance  by  payments   previously   made  in
satisfaction of the Company's indemnification and guaranty obligations. If there
are no claims by  HydroChem  against all or a portion of the escrow funds on the
third  anniversary  of the  Agreement,  then the remaining  escrow funds will be
released to the Company. To the extent disputed claims do exist, an amount equal
to the disputed  amount will continue to be held in escrow until fully resolved.
The escrowed funds will be HydroChem's  sole recourse in connection  with claims
under the Agreement.

         The  Company  currently   estimates  that  expenses  of  effecting  the
transaction and  liquidating the Company over the next several years,  including
legal  and   accounting   fees,   income  taxes  (net  of  net  operating   loss
carryforwards),  and liabilities not assumed by HydroChem, will be approximately
$3.8 million.  As a result, the Company  anticipates there will be approximately
$22.0 million (exclusive of escrowed funds) available  following payment of such
expenses  and  liabilities.  Of  this  amount,  approximately  $600,000  will be
utilized to redeem  outstanding  employee stock  options.  Stock options will be
redeemed at a price of $3.00 per option share less the exercise  price  thereof.
Currently,  options to purchase  387,280  shares are  outstanding  at a weighted
average exercise price of $1.50 per share. All options, vested and unvested, are
expected  to be  redeemed.  In  addition,  approximately  $5.6  million  will be
utilized to redeem the Company's  outstanding  preferred  stock, all of which is
held by Rollins Holding  Company,  Inc.,  which is an affiliate of the Company's
largest  common  stockholder,  Rollins  Investment  Fund,  and of Joe  Young,  a
director of the Company.  The remaining amount,  anticipated to be approximately
$15.9 million,  will be distributed to the Company's common stockholders as soon
after the  closing of the  transaction  as is  practicable.  Based on  7,906,617
shares of common  stock  outstanding  on August 31,  1998,  the  initial  amount
expected to be distributed to shareholders is expected to be approximately $2.01
per share. Because of the duration of the Escrow Agreement, the Company does not
plan to formally  dissolve  until all escrow funds have either been  released to
the Company or paid to HydroChem.  As a result,  the Company expects to maintain
its corporate  existence  for at least three years  following the closing of the
transaction.  As escrow funds, if any, are released to the Company, they will be
distributed to the common stockholders.

         The  transaction is subject to approval of the Company's  stockholders;
however,  the Company  has been  informed  by its  largest  common  stockholder,
Rollins Investment Fund, and by its sole preferred stockholder,  Rollins Holding
Company,   Inc,  which  together  represent  sufficient  votes  to  approve  the
transaction,  that they intend to take action by written  consent to approve the
transaction. Upon receipt of such written consents, the Company will prepare and
forward to each of its  stockholders  an  information  statement  describing the
transaction.

         HydroChem has agreed,  effective as of the closing of the  transaction,
to offer  employment to all employees of the Company (subject to satisfaction of
HydroChem's  standard  conditions to  employment)  unless  otherwise  reasonably
determined by HydroChem.  The closing of the  transaction  is subject to several
terms and  conditions,  including  the  receipt of third  party or  governmental
consents,  the material accuracy of all representations and warranties contained
in the Agreement,  and no material adverse changes in the financial condition of
the Company.

                                       14
<PAGE>

         In  addition  to  standard  termination  provisions  such as those with
respect to material breaches of the Agreement or conflicting laws, the Agreement
may be terminated  by HydroChem  (i) at any time after  December 31, 1998, if by
that date, the conditions to  HydroChem's  performance  under the Agreement have
not been  fulfilled  or  waived,  (ii) at any time prior to the later of (A) the
fifteenth  business day after the delivery of exhibits and  schedules or (B) the
fifteenth  business day after such date as HydroChem  actually  receives certain
preliminary schedules, if HydroChem's general due diligence investigation of the
Company or any subsidiary thereof discloses facts or circumstances which reflect
in a material  adverse way on the Company or any  subsidiary  thereof,  (iii) if
there has been a  material  adverse  change  in the  Company  or any  subsidiary
following  the date of the  Agreement.  The Company may  terminate the Agreement
after  December  31,  1998 if, by that date,  the  conditions  to the  Company's
performance  under the Agreement shall not have been fulfilled or waived. In the
event of any termination of the Agreement as set forth above,  there shall by no
liability on the part of either  HydroChem  or the Company to the other,  except
for the material breach of any representation, warranty or covenant contained in
the Agreement which is in the reasonable control of the party in breach.

         Following the closing of the transaction,  the Company anticipates that
it will be delisted from the Nasdaq Small-Cap Market.  Following such delisting,
there will be no trading  market for the Company's  common  stock.  As a result,
stockholders  may be unable to buy or sell shares of the Company's  common stock
and may be required to maintain  their  investment  in the company  until it has
been dissolved.

         A copy of the Agreement,  without  exhibits,  has been filed as Exhibit
"2.1"to this Form 10-K, and is incorporated by reference herein.

Year 2000 Issue

         The Year 2000 issue is the result of computer  programs  being  written
using two digits  rather than four digits to define the  applicable  year.  This
could  result in a system  failure  or  miscalculations  if a  computer  program
recognizes  a date of "00" as the year 1900  instead of 2000.  The  Company  has
assessed  the  Year  2000  issue  with  regard  to its  internal  financial  and
operational systems as well as third parties with which the Company has material
relationships.

         The Company has  completed  all  significant  remediation  of Year 2000
issues for its  internal  financial  and  operational  systems,  including  both
information  technology  ("IT") systems and non-IT systems that include embedded
technology such as microcontrollers.  The total cost for this remediation effort
was less than $100,000, and was expensed as incurred.

         The Company has  identified  third  parties  with which it has material
relationships  with respect to the Year 2000 issue.  These parties are primarily
large financial, telecommunication and information processing entities. All such
third  parties have reported to the Company that they are on schedule with their
projects to remediate Year 2000 issues, and that they anticipate being Year 2000
compliant  timely.  The Company  intends to continue to monitor the  progress of
these third parties and will develop contingency plans during Fiscal 1999 in the
event one or more of these  third  parties  fail to  remediate  their  Year 2000
issues in such a way as to materially  effect the operations of the Company.  At
this time the Company  believes the risk of such third party  failures  having a
material impact on the Company's operations is remote.

Accounting Standards

          During 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No.130, "Reporting Comprehensive Income"("SFAS

                                       15
<PAGE>

No.  130").  SFAS No. 130  established  standards  for  reporting and display of
comprehensive  income and its  components.  SFAS No. 130 is effective for fiscal
years  beginning  after  December  15,  1997  and  is  not  expected  to  have a
significant impact on the consolidated financial statements of the Company.

         During 1997, the Financial  Accounting Standards Board issued Statement
of Financial Accounting Standards  No. 131,  "Disclosures  about  Segments of an
Enterprise  and  Related  Information"  ("SFAS No.  131").  SFAS No. 131 will be
effective  for the fiscal year ending June 30, 1999. As the adoption of SFAS No.
131  requires  only  additional  disclosures,  there  will be no  effect  on the
Company's  consolidated  financial  position  or results of  operations  or cash
flows.

         In March 1998 the American  Institute of Certified  Public  Accountants
("AICPA") issued  Statement of Position ("SOP") 98-1,  "Accounting for the Costs
of Computer Software  Developed or Obtained for Internal Use," which establishes
new  accounting  and  reporting  standards  for the costs of  computer  software
developed  or  obtained  for  internal  use.  This  statement  will  be  applied
prospectively  and is  effective  for  financial  statements  for  fiscal  years
beginning  after  December  15,  1998.  The impact of this new  standard  is not
expected to have a  significant  effect on the Company's  financial  position or
results of operations.

         In April 1998 the AICPA  issued SOP 98-05,  "Reporting  on the Costs of
Start-Up Activities," which requires costs of start-up activities be expensed as
incurred.  This statement is effective for financial statements for fiscal years
beginning  after December 15, 1998.  The statement  requires  capitalized  costs
related to start-up activities to be expenses as a cumulative effect of a change
in accounting  principle  when the statement is adopted.  The impact of this new
standard is not expected to have a significant effect on the Company's financial
position or results of operations.

         In June 1998 the Financial  Accounting Standards Board issued Statement
of  Financial   Accounting   Standards  No.  133,   "Accounting  for  Derivative
Instruments and Hedging Activities." The statement is effective for fiscal years
beginning  after June 15, 1999. The Company plans to adopt this statement at the
beginning  of fiscal  2000.  This  statement  is not expected to have a material
impact on the Company's financial position or results of operations.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The  required  financial  statements  of the  Registrant  are set forth
immediately  following the signature page to this  registration  statement.  See
"Item 14 - Exhibits,  Financial Statements,  Schedules and Reports on Form 8-K",
for index to the financial statements.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                  ACCOUNTING AND FINANCIAL DISCLOSURE

         None.



                                       16
<PAGE>


                                    PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The  information  required by this item is set forth under the captions
"Election  of  Directors"  and  "Executive  Compensation"  of  the  registrant's
definitive proxy statement, and incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

         The  information  required  by this item is set forth under the caption
"Executive  Compensation"  of the registrant's  definitive proxy statement,  and
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT

         The  information  required  by this item is set forth under the caption
"Beneficial Ownership of Voting Securities" of the registrant's definitive proxy
statement, and incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The  information  required  by this item is set forth under the caption
"Executive  Compensation"  of the registrant's  definitive proxy statement,  and
incorporated herein by reference.

                                     PART IV
ITEM 14. EXHIBITS,  FINANCIAL  STATEMENTS,  FINANCIAL  STATEMENT  SCHEDULES  AND
         REPORTS ON FORM 8-K

A.   (1)          Financial Statements Filed

                  Valley Systems, Inc. and Subsidiaries:
                      Report of Independent Accountants.
                      Consolidated Balance Sheets at June 30, 1998 and 1997.
                      Consolidated Statements of Income for the years ended June
                      30,  1998,  1997  and  1996.  Consolidated  Statements  of
                      Stockholders'  Equity for the years  ended June 30,  1998,
                      1997 and 1996.
                      Consolidated Statements of Cash Flows for the years  ended
                      June 30, 1998, 1997 and 1996.
                      Notes to Consolidated Financial Statements.

     (2)          Exhibits

No.        Description of Exhibit
---        ----------------------
2.1    Asset  Purchase  Agreement  between  Registrant  and HydroChem Industrial
       Services,  Inc. dated September 9, 1998 (19)
3.1    Restated Certificate of Incorporation of Registrant. (1)
3.2    Certificate of Amendment of Certificate of  Incorporation  of Registrant.
       (16)
3.3    By-laws of Registrant (as amended). (16)
4.1    Form of Designation of Rights and  Preferences  of the Series A Preferred
       Stock. (1)
4.2    Form of Designation of Rights and  Preferences  of the Series B Preferred
       Stock. (1)

                                       17
<PAGE>

No.        Description of Exhibit
---        ----------------------
4.3    Certificate  of  Designation  of  Rights  and  Preferences  of  Series  C
       Preferred Stock. (15)
4.4    Specimen Certificate of Common Stock. (1)
4.5    Form of Underwriter's Warrant Agreement. (1)
4.6    1991 Stock Option Plan, and Form of Agreement. (1)(13)
4.7    Warrant Grant Agreement  dated June 2, 1994  between the  Registrant  and
       Rollins Investment Fund. (14)
10.1   Employment  Agreement, dated as of March 13, 1991, between the Registrant
       and Eugene R. Valentine. (1)
10.2   Business  Development  Contract  between  the  Registrant and the Aberlyn
       Group, Inc. dated as of October 1, 1990. (1)
10.3   Agreement  and  Undertaking  dated  April  29,  1991  by  and  among  the
       Registrant,  Eugene  R. Valentine,  Aberlyn Group, Inc., Lawrence Hoffman
       and Robert M. Rubin. (1) 
10.4   Form of  Voting  Trust  Agreement  between  Eugene R. Valentine  and  the
       Aberlyn Group, Inc. (1)
10.5   Letter dated March 15, 1991, to Aberlyn  Group, Inc., respecting  sale of
       Common Stock to Consultant in certain events. (1)
10.6   Lease  between the Registrant  and  Eugene R.  Valentine  and  Cynthia J.
       Valentine dated as of November 1, 1988 as amended in March 1991. (1)
10.7   Securities Purchase  Agreement  dated  December 16, 1991  between Rollins
       Investment Fund ("RIF") and the Registrant. (2)
10.8   Stock Purchase Agreement, dated June 12, 1992, among Eugene R. Valentine,
       Nicholas J. Pace and Rollins Investment Fund. (3)
10.9   Reorganization  Agreement dated July 31, 1992 between  Registrant and the
       stockholders of BMW Industrial Services, Inc., and exhibits thereto. (4)
10.10  Agreement  dated  July  31,  1992  between  Registrant  and   Power  City
       Industrial Services, Inc. (4)
10.11  Loan  Agreement from Rollins  Investment  Fund to Eugene R. Valentine and
       Cynthia J. Valentine, dated October 14, 1992. (5)
10.12  Loan Agreement from Eugene R. Valentine to Registrant,  dated October 16,
       1992. (5)
10.13  Standby and Subordination Agreement  from Eugene R. Valentine and Cynthia
       J. Valentine to Fifth Third Bank. (5)
10.14  Credit and Security  Agreement  dated  December 30, 1991 by and among the
       Fifth  Third  Bank,  the  Registrant,  Valley  Systems  of Ohio, Inc. and
       Diversified Specialty Enterprises, Inc. (6)
10.15  Lease  agreements  between  Munco  Development Company and the Registrant
       with  respect to  leases of office space  at  Crescent  Pointe  Building,
       Canton, Ohio. (6)
10.16  Amendment No.1, dated as of November 16, 1992, to the Credit and Security
       Agreement,  dated as of December 31, 1991,  by and between Registrant and
       the Fifth Third Bank. (7)
10.17  Amendment  No. 2, dated  as of July 20, 1993, to the Credit and  Security
       Agreement, dated as of  December 30, 1991, by and betwee  the  Registrant
       and the Fifth Third Bank. (8)
10.18  Equipment Lease Agreement and  Riders  No. 1 & No. 2 by and  between  the
       Registrant and Ally Capital Corporation dated December 18, 1992. (9)
10.19  Letter   Agreement   dated   September  9,  1993  between   Ally  Capital
       Corporation   and   the   Registrant   and  Subordination   and  Security
       Agreement made as of September 9,  1993 between Ally  Capital Corporation
       and Rollins Investment Fund. (9)

                                       18
<PAGE>
No.        Description of Exhibit
---        ----------------------
10.20  Loan  and  Security  Agreement,  dated as of June 29, 1994 by and between
       Registrant and Rollins Investment Fund. (15)
10.21  Term Note dated June 29, 1994 from Registrant to Rollins Investment Fund.
       (15)
10.22  First  Amendment  to  Term  Note dated September 2, 1994  by  and between
       Registrant and Rollins Investment Fund. (15)
10.23  First  Amendment to Loan and Security  Agreement  dated March 28, 1995 by
       and between Registrant and Rollins Investment Fund. (16)
10.24  Second  Amendment  to Loan and Security  Agreement dated November 5, 1996
       by and between Registrant and Rollins Investment Fund. (18)
16.1   Letter dated July 8, 1993 from Valley Systems,  Inc. to Feldman,  Radin &
       Co., P.C. terminating the auditor's services. (10)

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

(1)  Hereby  incorporated  by  reference  to  the  filing  of  the  Registrant's
     Registration  Statement on Form S-1  declared  effective by the SEC on June
     11, 1991.
(2)  Hereby  incorporated  by  reference  to the filing of the  Schedule  13D of
     Rollins Investment Fund, dated December 20, 1991.
(3)  Hereby  incorporated  by  reference  to the filing of the  Schedule  13D of
     Rollins Investment Fund, dated June 18, 1992.
(4)  Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated August 10, 1992.
(5)  Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated October 30, 1992.
(6)  Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-K dated November 6, 1992.
(7)  Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated December 21, 1992.
(8)  Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated July 30, 1993.
(9)  Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-K dated September 24, 1993.
(10) Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated July 9, 1993.
(11) Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-Q dated February 11, 1994.
(12) Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated June 29, 1994.
(13) This is a compensatory plan or arrangement.
(14) Hereby incorporated by reference to the filing of the Registrant's Form 8-K
     dated September 2, 1994.
(15) Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-K dated September 26, 1994.
(16) Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-K dated September 25, 1995.
(17) Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-K dated September 24, 1996.
(18) Hereby  incorporated  by reference to the filing of the  Registrant's  Form
     10-K dated September 22, 1997.
(18) Included as an exhibit in this Form 10-K.


Reports on Form 8-K filed during the three months ended June 30, 1998

         None.




                                       19
<PAGE>

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant had duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                   VALLEY SYSTEMS, INC.


                                   By: \s\ Ed Strickland
                                           President and
                                           Chief Executive Officer


         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.



     Signature                         Title                        Date
     ---------                         -----                        ----
\s\  Ed Strickland          President and Chief
                            Executive Officer                 September 25, 1998

\s\  Dennis D. Sheets       Vice President, Chief Financial
                            Officer, Treasurer and Secretary  September 25, 1998
                      
\s\  Allen O. Kinzer        Director                          September 25, 1998

\s\  Joe M. Young           Director                          September 25, 1998





                                       20
<PAGE>



                      VALLEY SYSTEMS, INC. AND SUBSIDIARIES
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


                                                                         Page
                                                                        Number

REPORT OF INDEPENDENT ACCOUNTANTS                                         22

CONSOLIDATED BALANCE SHEETS - June 30, 1997 and 1996                      23

CONSOLIDATED STATEMENTS OF INCOME - Years ended June
    30, 1997, 1996 and 1995                                               24

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - Years
    ended June 30, 1997, 1996 and 1995                                    25

CONSOLIDATED STATEMENTS OF CASH FLOWS - Years ended
    June 30, 1997, 1996 and 1995                                          26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                             27-34

     All  schedules  are  omitted  because  they  are  not  required  under  the
instructions,  are inapplicable, or the information is included elsewhere in the
financial statements.
 


                                       21
<PAGE>



Report of Independent Accountants



To the Stockholders of
 Valley Systems, Inc.:


In our opinion,  the  accompanying  consolidated  balance sheets and the related
consolidated  statements  of  income,  stockholders'  equity  and of cash  flows
present  fairly,  in all material  respects,  the  financial  position of Valley
Systems,  Inc. and  Subsidiaries  (the "Company") at June 30, 1998 and 1997, and
the results of their operations and their cash flows for each of the three years
in the  period  ended June 30,  1998,  in  conformity  with  generally  accepted
accounting principles.  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 of these
statements  in accordance  with  generally  accepted  auditing  standards  which
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,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.



PricewaterhouseCoopers LLP



Cleveland, Ohio
August 27, 1998, except for Note 13, as to which the date is September 9, 1998








                                       22
<PAGE>



                     VALLEY SYSTEMS, INC. AND SUBSIDIARIES
                          Consolidated Balance Sheets
                             June 30, 1998 and 1997

                                                         1998           1997
                                                    ------------   ------------ 
                        ASSETS
Current assets:
     Cash                                            $   207,492    $   200,093
     Accounts receivable                               5,740,394      5,638,350
     Prepaid supplies                                    522,992        469,839
     Prepaid expenses                                    155,439        160,772
                                                    ------------   ------------
        Total current assets                           6,626,317      6,469,054

Property and equipment, net                            8,896,650      7,551,004
Intangible assets                                        411,000        548,000
                                                    ------------   ------------
             Total assets                            $15,933,967    $14,568,058
                                                    ============   ============
       LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Accounts payable                                $   726,054    $   971,611
     Accrued expenses                                  1,610,470      1,428,834
     Current portion of long-term debt                   659,257        495,929
                                                    ------------   ------------
        Total current liabilities                      2,995,781      2,896,374
Long-term debt                                         7,584,593      7,235,120
Commitments and contingencies
Stockholders' Equity:
     Preferred stock, $.10 par value; authorized
        2,000,000 shares, issued and outstanding
        55,000 shares                                      5,500          5,500
     Common stock, $.01 par value; authorized
        12,000,000 shares, issued and outstanding
        8,512,073 shares                                  85,121         85,121
     Paid-in capital                                  26,786,040     26,786,040
     Accumulated deficit                             (20,840,060)   (21,757,089)
     Treasury stock, at cost, 605,456 shares            (683,008)      (683,008)
                                                    ------------   ------------ 
                                                       5,353,593      4,436,564
                                                    ------------   ------------
                                                                
    Total liabilities and stockholders' equity       $15,933,967    $14,568,058
                                                    ============   ============


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




                                       23
<PAGE>



                     VALLEY SYSTEMS, INC. AND SUBSIDIARIES
                       Consolidated Statements of Income
                for the years ended June 30, 1998, 1997 and 1996

                                            1998        1997           1996
                                     ------------   ------------   ------------
Sales                                 $24,431,385    $23,088,298    $21,874,776
Cost of sales                          15,391,490     14,529,554     15,021,953
                                     ------------   ------------   ------------
     Gross profit                       9,039,895      8,558,744      6,852,823
Selling, general and
  administrative expenses               7,144,739      7,267,973      7,254,467
Interest expense                          593,127        592,024        571,700
                                     ------------   ------------   ------------
Income (loss) from operations
  before gain on settlement of
  litigation and income taxes           1,302,029        698,747       (973,344)

Gain on settlement of litigation                -        752,236              -
                                     ------------   ------------   ------------
Income (loss) from operations
  before income taxes                   1,302,029      1,450,983       (973,344)

Income taxes                                    -              -              -
                                     ------------   ------------   ------------
     Net income (loss)                $ 1,302,029    $ 1,450,983    $  (973,344)
                                     ============   ============   ============
Net earnings per common share:
   Basic                              $       .12    $       .13    $      (.16)
                                     ============   ============   ============
   Assuming dilution                  $       .12    $       .13    $      (.16)
                                     ============   ============   ============
Weighted average shares used in
  computation - basic and diluted       7,906,617      8,203,069      8,490,111
                                     ============   ============   ============


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




                                       24
<PAGE>




                     VALLEY SYSTEMS, INC. AND SUBSIDIARIES
                Consolidated Statements of Stockholders' Equity
                for the years ended June 30, 1998, 1997 and 1996


              Preferred  Common   Paid-In    Accumulated   Treasury
               Stock(1) Stock(2)  Capital      Deficit       Stock      Total
               -------- ------- ----------- ------------- ---------- ---------- 
Balance, June
 30, 1995        $7,500 $85,121 $26,784,040 $(21,464,729) $       -  $5,411,932
Purchase of 
 treasury stock                                            (118,638)   (118,638)
Retirement of
 Series B
 preferred stock (2,000)              2,000                                   -
Net loss                                        (973,344)              (973,344)
Series C
 preferred
 dividends                                      (288,749)              (288,749)
                 ------ ------- ----------- ------------- ---------- ----------
Balance, June
 30, 1996         5,500  85,121  26,786,040  (22,726,822)  (118,638)  4,031,201
Purchase of
 treasury
 stock                                                     (564,370)   (564,370)
Net income                                     1,450,983              1,450,983
Series C
 preferred
 dividends                                      (481,250)              (481,250)
                 ------ ------- ----------- ------------- ---------- ----------
Balance, June
 30, 1997         5,500  85,121  26,786,040  (21,757,089)  (683,008)  4,436,564

Net income                                     1,302,029              1,302,029
Series C
 preferred
 dividends                                      (385,000)              (385,000)
                 ------ ------- ----------- ------------- ---------- ----------
Balance, June
 30, 1998        $5,500 $85,121 $26,786,040 $(20,840,060) $(683,008) $5,353,593
                 ====== ======= =========== ============= ========== ==========

    (1)  Share amounts are equivalent to ten times dollar amounts.
    (2)  Share amounts are equivalent to one hundred times dollar amounts.

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





                                       25
<PAGE>




                     Valley Systems, Inc. and Subsidiaries
                     Consolidated Statements of Cash Flows
                for the years ended June 30, 1998, 1997 and 1996

                                                1998        1997        1996
                                             ----------  ----------  ----------
Cash flows from operating activities:
 Net income (loss)                           $1,302,029  $1,450,983  $ (973,344)
 Adjustments to reconcile net income
  (loss) to cash provided by operating
  activities:
    Depreciation and amortization             2,758,868   3,138,326   3,516,986
    Gain on disposition of property
      and equipment                             (66,083)     (5,784)     (6,865)
    (Increase) decrease in assets:
       Accounts receivable                     (102,044)   (953,631)   (658,313)
       Prepaid supplies                         (53,153)    (26,393)     16,143
       Prepaid expenses                           5,333      32,815      18,922
    Increase (decrease) in liabilities:
       Accounts payable                        (245,557)    214,939     218,840
       Accrued expenses                         181,636  (1,251,382) (1,531,797)
                                             ----------  ----------  ----------
    Cash provided by operating activities     3,781,029   2,599,873     600,572
                                             ----------  ----------  ----------
Cash flows from investing activities:
 Additions to property and equipment         (2,295,049) (1,665,092) (2,547,375)
 Proceeds from dispositions of property
  and equipment                                 240,092     148,240      99,541
                                             ----------  ----------  ----------
    Cash used by investing activities        (2,054,957) (1,516,852) (2,447,834)
                                             ----------  ----------  ----------
Cash flows from financing activities:
 Net (payments) borrowings from
  revolving line of credit                   (1,467,355)    583,403   2,911,279
 Payments of other long-term debt              (252,394)   (603,060)   (702,810)
 Additional borrowings of long-term debt        386,076           -           -
 Payments of preferred stock dividends         (385,000)   (385,000)   (385,000)
 Purchase of treasury stock                           -    (564,370)   (118,638)
                                             ----------  ----------  ----------
    Cash (used in) provided by
      financing activities                   (1,718,673)   (969,027)  1,704,831
                                             ----------  ----------  ----------
Increase (decrease) in cash                       7,399     113,994    (142,431)
Cash at beginning of year                       200,093      86,099     228,530
                                             ----------  ----------  ----------
                                                             
Cash at end of year                          $  207,492  $  200,093  $   86,099
                                             ==========  ==========  ==========
Cash paid for:
 Interest                                     $ 589,340   $ 592,024   $ 571,700
Non-cash investing activities:
 Property and equipment acquired with
  capital leases                             $1,846,474
Non-cash financing activities:
 Reclassification of payments from
  former directors and officers                                      $1,017,000
 Preferred stock dividends accrued                         $ 96,250


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



                                       26
<PAGE>




                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 1.    Description of Business:

       The  Company  is  engaged  in  the  business  of  providing   specialized
       industrial  cleaning and other  services to divisions  and  facilities of
       Fortune 500 companies and other substantial  businesses  engaged in heavy
       industry.  Such  services  generally  involve the  removal of  industrial
       grime,  deposits,  wastes,  encrustations and coatings from equipment and
       facilities.  The  Company's  principal  customers  are in  the  chemical,
       plastics,  power  generation,   petroleum  refining  and  primary  metals
       businesses.   The  Company's  industrial  cleaning  methods  include,  in
       addition  to  the  use  of   waterblasting,   vacuuming  and  other  more
       conventional  procedures,  the application of ultra-high pressure ("UHP")
       waterjetting methods.

 2.    Summary of Significant Accounting Policies:

       Principles  of  Consolidation:   The  consolidated  financial  statements
       include the  accounts of the Company and its  wholly-owned  subsidiaries.
       All  material  intercompany  transactions  have  been  eliminated  in the
       accompanying consolidated financial statements.

       Revenue  Recognition:  Sales and the related  cost of sales for  services
       provided are recorded as the services are performed.

       Accounts  Receivable:  The  Company's  customers  are  located  primarily
       throughout  the United  States.  The Company  monitors  potential  credit
       losses  and such  losses  have  been  within  management's  expectations.
       Accounts  receivable which become  uncollectible  are written off against
       operations  at the time  they  are  deemed  to be  worthless.  The  total
       uncollectible accounts charged to operations for the years ended June 30,
       1998, 1997 and 1996 were $14,000, $51,000, and $6,000, respectively.  The
       allowance for doubtful accounts was $125,000 at June 30, 1998 and 1997.

       Prepaid  Supplies:  Prepaid  supplies  consist  of  item  to  be  used in
       operations,  and are stated at the lower of cost (first in, first out) or
       market.

       Property and  Equipment:  Property and equipment are stated at cost.  The
       Company  uses the  straight-line  method of  depreciation  for  financial
       reporting purposes. For income tax purposes,  depreciation is computed by
       either the accelerated or modified cost recovery  methods.  The estimated
       useful lives for financial reporting purposes are as follows:

                   Building and leasehold improvements       7 to 20 years
                   Automobiles and trucks                    3 to 7 years
                   Equipment                                 3 to 7 years
       The cost and related accumulated  depreciation of assets retired, sold or
       otherwise  disposed of are removed from the accounts and any gain or loss
       is reflected in the current years' results of operations.

       Income  Taxes:  Deferred  income  taxes are  provided  to reflect the tax
       effects of  temporary  differences  between financial and  tax reporting,
       principally related to depreciation.



                                       27
<PAGE>


 2.    Summary of Significant Accounting Policies, Continued:

       Intangible Assets: Intangible assets include the cost of certain patents,
       technology,  trademarks,  and a  non-compete  agreement.  These items are
       being amortized to operations on a straight-line basis over 10 years, the
       period in which the  economic  benefits  are  estimated  to be  realized.
       Accumulated amortization amounted to $959,000 and $822,000 as of June 30,
       1998 and 1997, respectively.

       Income  (Loss)  Per  Common  Share:  In  February  1997 the  FASB  issued
       Statement  No. 128,  "Earnings  Per Share" ("FAS No.  128").  FAS No. 128
       specifies the computation,  presentation, and disclosure requirements for
       earnings per share  ("EPS") for entities  with publicly held common stock
       or potential  common stock. It replaces the  presentations of primary EPS
       with the  presentation  of basic EPS, and replaces fully diluted EPS with
       diluted EPS. It also requires dual  presentation of basic and diluted EPS
       on the face of the income statement for all entities with complex capital
       structures, and requires a reconciliation of the basic EPS computation to
       the diluted  EPS  calculation.  FAS No. 128 is  effective  for  financial
       statements for periods ending after December 15, 1997.

       Earnings  per share of common  stock for the periods  ended June 30, 1998
       have been calculated according to the guidelines of FAS No. 128. Earnings
       per share of common  stock for the  periods  ended June 30, 1997 and 1996
       have been restated to conform to FAS No. 128.

       Basic  earnings per common share are computed by dividing net income less
       preferred stock dividend requirements  ($385,000 per year for all periods
       presented)  for the period by the  weighted  average  number of shares of
       common  stock  outstanding  for the period.  Diluted  earnings per common
       share do not vary from basic  earnings  per share for any of the  periods
       presented because there were no dilutive potential shares of common stock
       outstanding.  The  dilutive  effect of  outstanding  potential  shares of
       common stock is computed using the treasury stock method.

       Use of Estimates:  The preparation of financial  statements in conformity
       with generally accepted accounting principles requires management to make
       estimates  and  assumptions   that  affect  the  amounts  of  assets  and
       liabilities  and disclosure of contingent  assets and  liabilities at the
       dates of the financial  statements  and the reported  amounts of revenues
       and expenses during the reporting periods. Actual results may differ from
       those estimates.

       Fair Value of  Financial  Instruments:  The  carrying  values of accounts
       receivable and short-term  borrowings  represent  reasonable estimates of
       the fair values of these instruments due to their short  maturities.  The
       fair value of long-term debt is estimated by discounting  the future cash
       flows  using  rates  currently  available  to the  Company  for debt with
       similar terms and remaining maturities.  The estimated fair values of the
       long-term debt at June 30, 1998 approximated its carrying values.

       New Accounting  Pronouncements:   During  1997, the  Financial Accounting
       Standards Board issued Statement of Financial  Accounting  Standards  No.
       130, "Reporting  Comprehensive  Income" ("SFAS No.  130").  SFAS No.  130
       established standards for reporting and display of  comprehensive  income
       and its components.  SFAS No. 130 is effective for fiscal years beginning
       after December 15, 1997 and is not expected to have a significant  impact
       on the consolidated financial statements of the Company.


                                       28
<PAGE>


 2.    Summary of Significant Accounting Policies, Continued:

       During 1997, the Financial Accounting Standards Board issued Statement of
       Financial Accounting Standards No. 131, "Disclosures about Segments of an
       Enterprise and Related Information" ("SFAS No.131"). SFAS No. 131 will be
       effective for the fiscal year ending June 30,  1999.  As the  adoption of
       SFAS  No. 131  requires  only  additional disclosures,  there  will be no
       effect  on  the Company's  consolidated  financial position or results of
       operations or cash flows.

       In March 1998 the  American  Institute of  Certified  Public  Accountants
       ("AICPA") issued Statement of Position ("SOP") 98-1,  "Accounting for the
       Costs of Computer Software Developed or Obtained for Internal Use," which
       establishes  new  accounting  and  reporting  standards  for the costs of
       computer software  developed or obtained for internal use. This statement
       will be applied  prospectively and is effective for financial  statements
       for fiscal years  beginning  after  December 15, 1998. The impact of this
       new  standard  is not  expected  to  have  a  significant  effect  on the
       Company's financial position or results of operations.

       In April  1998 the AICPA  issued SOP  98-05,  "Reporting  on the Costs of
       Start-Up  Activities,"  which  requires  costs of start-up  activities be
       expensed  as  incurred.   This   statement  is  effective  for  financial
       statements  for fiscal years  beginning  after  December  15,  1998.  The
       statement requires capitalized costs related to start-up activities to be
       expenses as a cumulative effect of a change in accounting  principle when
       the statement is adopted. The impact of this new standard is not expected
       to have a  significant  effect on the  Company's  financial  position  or
       results of operations.

       In June 1998 the Financial Accounting Standards Board issued Statement of
       Financial  Accounting  Standards  No.  133,  "Accounting  for  Derivative
       Instruments  and Hedging  Activities."  The  statement is  effective  for
       fiscal years  beginning  after June 15, 1999.  The Company plans to adopt
       this  statement at the  beginning of fiscal 2000.  This  statement is not
       expected to have a material impact on the Company's financial position or
       results of operations.

       Reclassifications:  Certain  amounts  in the 1997 consolidated  financial
       statements have been reclassified to conform to the 1998 presentation.

 3.    Property and Equipment:

       Property and equipment consist of the following:

                                                         1998           1997 
                                                     -----------    -----------
          Land                                       $   420,683    $   184,759 
          Building and leasehold improvements          1,032,752        580,000 
          Automobiles and trucks                       8,600,072      9,753,233 
          Equipment                                    8,637,151      7,470,264 
          Equipment in progress and parts                199,538        339,293 
                                                     -----------    ----------- 
                                                      18,890,196     18,327,549 
          Less accumulated depreciation                                         
            and amortization                           9,993,546     10,776,545 
                                                     -----------    ----------- 
                                                     $ 8,896,650    $ 7,551,004 
                                                     ===========    ===========
                                                                    
       Included in property and  equipment  are assets under  capital  leases of
       $3,618,000  and  $2,151,000  with  related  accumulated  depreciation  of
       $1,230,000 and $1,481,000 as of June 30, 1998 and 1997, respectively.


                                       29
<PAGE>


 3.    Property and Equipment, Continued:

       The Company  incurred  repairs  and  maintenance  costs on  property  and
       equipment of approximately $1,350,000,  $1,450,000 and $1,850,000 for the
       years ended June 30, 1998, 1997 and 1996, respectively.

 4.    Accrued Expenses:

       Accrued expenses consist of the following:
                                                          1998           1997  
                                                     -----------    -----------
          Accrued payroll and compensation           $   927,000    $   819,000
          Accrued payroll taxes, workers                                       
           compensation insurance and other                                    
           employee benefits                             373,000        184,000
          Accrued preferred stock dividends               96,250         96,250
          Other accrued liabilities                      214,220        329,584
                                                     -----------    -----------
                                                     $ 1,610,470    $ 1,428,834
                                                     ===========    ===========
                                                                    

 5.    Long-Term Debt:

       Long-term debt is comprised of the following:
                                                          1998           1997  
                                                     -----------    -----------
          Capitalized leases (A)                     $ 2,114,640    $   521,151
          Revolving loan - bank (C)                    5,742,543      7,209,898
          Mortgage loan - bank (D)                       386,667              -
                                                     -----------    -----------
                                                       8,243,850      7,731,049
          Less: current portion of long-term debt        659,257        495,929
                                                     -----------    -----------
                                                     $ 7,584,593    $ 7,235,120
                                                     ===========    ===========
                                                                    
       A.     Capitalized leases are  due  in  monthly installments ranging from
              $4,000 to $15,000 and bear interest of 8.5%.

       B.     The Company has  a  loan  agreement with its majority stockholder,
              which expires in 2000 and provides a total credit facility  to the
              Company as follows:

                      Through July 1999:                        $9,000,000
                      August 1999 through July 2000:            $8,000,000

              This  facility may be utilized by borrowings at .5% over the prime
              rate (payable  quarterly) or, at the Company's  option,  by having
              the  stockholder  provide bank letters of credit which the Company
              can  utilize as  collateral  for other  obligations.  The  Company
              reimburses the  stockholder  for the actual cost of the letters of
              credit.  This loan agreement is  collateralized by essentially all
              assets of the  Company,  and  prohibits  payments of common  stock
              dividends.  At June 30, 1998, there are no loans outstanding under
              this facility,  and the stockholder has issued  $8,280,000 in bank
              letters of credit,  leaving $720,000 of the facility  available to
              the Company.

       C.     This obligation represents borrowings under a $7,500,000 revolving
              loan  agreement with a bank. The loan bears interest at 1.7% below
              the prime rate (6.80% at June 30, 1998),  payable monthly,  and is
              collateralized  by  a  bank  letter  of  credit  provided  by  the
              Company's majority  shareholder under the loan agreement described
              in B. above. This revolving loan agreement decreases to $6,500,000
              in July 1999 and expires July 2000.

                                       30
<PAGE>

 5.    Long-Term Debt, Continued:

       D.     Mortgage  loan  payable in  monthly  installments  of $2,778  plus
              interest  on the  outstanding  balance  at the prime rate (8.5% at
              June 30, 1998),  due September  2007.  The Company's  headquarters
              facility is pledged as security for this loan.

              The  aggregate  maturities  on  the  aforementioned  debt  are  as
              follows:
                                 Year Ended June 30
                                        1999              $   659,000
                                        2000                  369,000
                                        2001                6,143,000
                                        2002                  434,000
                                        2003                  428,000
                                        Thereafter            210,850
                                                         ------------
                                                          $ 8,243,850
                                                         ============
 6.    Income Taxes:

       The income  tax  provision  for the three  years  ended June 30,  1998 is
       comprised of the following amounts:

                                                             1998   1997   1996 
                                                            -----  -----  -----
          Current:
            Federal                                         $  -   $  -   $  -
                                                            =====  =====  =====

          Statutory rate                                     34 %   34 %   (34)%
          Operating loss utilized                           (34)   (34)
          Operating loss not utilizable                                     34
                                                            -----  -----  -----
          Effective rate                                      - %    - %    - %
                                                            =====  =====  =====
          
       Deferred federal income taxes reflect the impact for financial  statement
       reporting  purposes  of  temporary   differences  between  the  financial
       statement and tax basis of assets and  liabilities.  At June 30, 1998 and
       1997, the components of the net deferred tax assets and liabilities  were
       as follows:



<PAGE>


                                                          1998           1997  
                                                     -----------    -----------
          Deferred tax assets:
           Allowance for doubtful accounts           $    50,000    $    50,000 
           Vacation accrual                              144,000        140,000 
           Net operating loss carryforwards            7,654,878      8,026,232 
           Other                                         164,912        123,253 
                                                     -----------    ----------- 
                                                       8,013,790      8,339,485 
          Deferred tax liabilities:                                             
           Basis difference in fixed assets             (596,930)      (549,523)
                                                     -----------    -----------
          Net deferred tax assets                      7,416,860      7,789,962 
          Valuation allowance                         (7,416,860)    (7,789,962)
                                                     -----------    -----------
               Net deferred taxes recognized         $         -    $         - 
                                                     ===========    ===========
                                                                    

       The  Company  has   approximately   $19,100,000  of  net  operating  loss
       carryforwards  for future  years,  which cannot be utilized to create tax
       refunds. Such amounts begin to expire in the year 2005.

                                       31
<PAGE>

 7.    Commitments:

       The  Company  has  various  capital  and  operating  leases in effect for
       equipment,  vehicles and  facilities  with initial terms ranging from one
       month to five years  with  renewal  options  generally  being  available.
       Minimum  commitments  under all capital and operating  leases at June 30,
       1998 are as follows:

                                                        Capital      Operating
                                                     -----------    -----------
         1999                                        $   755,504     $  170,000
         2000                                            454,699        142,000
         2001                                            454,699         47,000
         2002                                            454,699         24,000
         2003                                            412,202          2,000
                                                     -----------    -----------
         Total minimum lease payments                  2,531,803     $  385,000
                                                                    ===========
         Less amount representing interest               417,163
                                                     -----------
         Total present value of capital
           obligation                                  2,114,640
         Less current portion                            617,035
                                                     -----------
             Long-term obligation under 
              capital leases                         $ 1,497,605
                                                     ===========
                
       Operating lease expense amounted to $379,000,  $441,000 and  $364,000 for
       the years ended June 30, 1998, 1997 and 1996, respectively.


 8.    Litigation:

       In addition to the matters  discussed  below,  the Company is involved in
       various litigation arising in the ordinary course of business. Management
       believes that the ultimate  resolution of such litigation will not have a
       material effect on the Company's operations or financial position.

       A.    The Company  filed a lawsuit in September  1993 against  certain of
             its former directors and officers,  as well as other parties.  This
             lawsuit was settled in December 1996.

       B.    During the fiscal year ended June 30, 1996, the Company  determined
             that amounts contributed to it by two former officers and directors
             that were  previously  classified  as loans to the Company were not
             loans. Instead, such contributions were determined to be repayments
             by the former  officers  and  directors  of  amounts  owed by those
             officers and directors to the Company at the time the contributions
             were made. Because the former officers and directors in the lawsuit
             described above contested this  determination,  an equal amount was
             reserved.  As a  result  of the  settlement  of this  lawsuit,  the
             reserve was  eliminated  in the quarter  ended  December  31, 1996,
             resulting  in a gain of  $752,000  after  related  expenses  of the
             litigation.

 9.    Major Customers:

       The  following  table shows the  percentage  of total sales made to major
       customers for each fiscal year:
                                              1998          1997          1996
                                              ----          ----          ----
                  Customer A                    9%            6%           10%
                  Customer B                    7%           13%           14%
                  Customer C                    7%            6%            5%

                                       32
<PAGE>


10.    Stockholders' Equity:

       A.    At June 30,  1995,  there were 20,000  shares of Series B Preferred
             Stock outstanding.  These shares were transferred to the Company in
             1996 as part of a settlement of litigation, and were then retired.

       B.    In September  1994,  the Company  issued  55,000 shares of Series C
             Preferred Stock to its majority stockholder, which then transferred
             them to an affiliate. Each share of the Series C Preferred Stock is
             entitled  to  a  cumulative  annual  dividend  of  $7.00,   payable
             quarterly.  The  proceeds  from  the sale of the  preferred  shares
             totaled $5.5  million;  $3.0 million in the  conversion of debt for
             equity and $2.5 million of cash. In the event the Company is merged
             or consolidated such that the majority  shareholder no longer holds
             a controlling  interest in the surviving or resulting  entity,  the
             preferred  stock must be redeemed and retired for $5.5 million plus
             any accrued and unpaid cumulative dividends.

11.    Stock Options and Warrants:

       A.    In 1991,  the Company  adopted a stock option  plan.  Up to 400,000
             shares of common  stock may be issued  under the plan.  Outstanding
             options on June 30, 1998 were as follows:

                                     Shares
                             -----------------------
               Option Price    Total     Exercisable   Expiration Date
               ------------  --------    -----------   ---------------
                 $3.00         10,000       10,000           2001
                 $1.50         22,080       22,080           2001
                 $1.50         40,500       40,500           2002
                 $1.50        217,000      130,200           2004
                 $1.50         37,700        7,540           2006
                 $1.50         20,000        4,000           2007
                             --------     --------                     
                              347,280      214,320
                             ========     ========

       B.    In October 1994,  the Company issued stock options to its directors
             to purchase a total of 50,000  shares of its common  stock at $1.50
             per share. These options can be exercised up to 10,000 shares on or
             after  each of the first  five  anniversary  dates,  and  expire in
             October  2004.  These options are not part of the stock option plan
             above.  The Company also issued  options  under the plan to certain
             employees to purchase a total of 246,200  shares of common stock at
             $1.50 per share.  These  options can be  exercised up to 20% of the
             shares on or after  each of the first  five  anniversary  dates and
             expire in 2004.


       C.    On July 5, 1996, the Company modified options issued under the plan
             to purchase  34,780 shares of common stock at an original  exercise
             price of $3.00  per share by  repricing  the  options  to $1.50 per
             share. There was no compensation expense recognized related to this
             modification.  The Company  also issued  options  under the plan to
             certain  employees  to purchase a total of 64,700  shares of common
             stock at $1.50 per share.  These options can be exercised up to 20%
             of the shares on or after each of the first five anniversary  dates
             and expire in 2006.



                                       33
<PAGE>


11.    Stock Options and Warrants, continued:


       D.    In 1997 the  Company  issued  options  under  the  plan to  certain
             employees  to purchase a total of 35,000  shares of common stock at
             $1.50 per share.  These  options can be  exercised up to 20% of the
             shares on or after  each of the first  five  anniversary  dates and
             expire in 2007.


       E.     In 1998, 1997 and 1996,  respectively, options to purchase 46,700,
              24,000 and 18,300 shares of common stock were forfeited.


       F.    The Company has elected to adopt the  "disclosure-only"  provisions
             of Statement of Financial Accounting Standards No. 123, "Accounting
             for  Stock  Based   Compensation"   ("SFAS  No.   123"),   with  no
             compensation cost recognized for options granted at or above market
             value.  For SFAS No. 123, the fair value of each option granted was
             estimated  on the  date of grant  using  the  Black-Scholes  option
             pricing model with the following assumptions for 1998 and 1997: (a)
             risk-free  interest rates of 6.40% to 7.04%;  (b) no dividend yield
             in either year; (c) expected  terms of 8 years;  and (d) volatility
             of 95%.


             If the Company had elected to recognize  the  compensation  cost of
             its stock  option plan based on the fair value of the awards  under
             that plan in  accordance  with SFAS No. 123,  net income would have
             increased to $1,383,952 ($.13 per common share,  assuming dilution)
             for the year ended June 30,  1998 and reduced to  $1,306,346  ($.11
             per common  share,  assuming  dilution) for the year ended June 30,
             1997.


       G.    At  June  30, 1998,  warrants  to  purchase shares of the Company's
             common stock were outstanding as follows:

             Warrant
             Price          Shares     Expiration Date
             $  3.09     2,314,000     May 2000
             $ 15.00       100,000     September 2001

12.    Employee Benefit Plan:

       In 1991, the Company adopted a 401(k) plan that covers  substantially all
       employees.  The plan is a  discretionary  plan in that the Company may or
       may not make contributions to the plan. The Company did not contribute to
       the plan during the three years ended June 30, 1998.

13.    Subsequent Event:

       On September 9, 1998 the Company entered into an Asset Purchase Agreement
       whereby  essentially  all  assets  of the  Company  will be sold to,  and
       substantially  all  liabilities  of  the  Company  will  be  assumed  by,
       HydroChem Industrial  Services,  Inc. The purchase price for these assets
       and liabilities is $29.8 million,  adjusted for increases or decreases in
       net assets after June 30, 1998. This  transaction is expected to close in
       the second quarter of the fiscal year ended June 30, 1999.


                                       34
<PAGE>