<PAGE>
 
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C. 20549

                                  FORM 10-KSB
(Mark One)

(   X   )        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
          FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 (FEE REQUIRED)

(       )     TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
               SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
    FOR THE TRANSITION PERIOD___________________ TO _____________________. 
                         COMMISSION FILE NO. 000-24470

                      NATIONAL ENVIRONMENTAL SERVICE CO.
                (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)

                 OKLAHOMA                             73-1296420
     (STATE OR OTHER JURISDICTION OF               (I.R.S. EMPLOYER
     INCORPORATION OR ORGANIZATION)                IDENTIFICATION NO.)

     12331 EAST 60TH STREET, TULSA, OK                    74146
 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)               (ZIP CODE)

                   ISSUER'S TELEPHONE NUMBER: (918)250-2227

   SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                 Title of class: Common Stock, $.01 Par value

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

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB __________________.

     State issuer's revenues for its most recent fiscal year $14,746,000.
                                                             ------------
 
     The aggregate market value of the voting stock held by non-affiliates of
the registrant computed using the average of the high and low sales prices at
which the stock sold on February 27, 1998  was $11,489,812.


The number of shares outstanding of each of the issuer's classes of common stock
as of February 27, 1998 is shown below:
                                                              NUMBER OF SHARES
          TITLE OF CLASS                                         OUTSTANDING
          --------------                                         -----------
     Common Stock, $.01 Par Value                                 7,876,143
 
          DOCUMENTS INCORPORATED BY REFERENCE
          -----------------------------------
          Portions of the Proxy Statement for the Annual Meeting of Stockholders
of National Environmental Service Co. to be held May 21, 1998, are incorporated
by reference in Part III of this Form 10-KSB.

TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): YES   ; NO X .
                                                              ---    ---
<PAGE>
 
                                    PART I

ITEM 1. DESCRIPTION OF BUSINESS
                                   BUSINESS

THE COMPANY

     The business of National Environmental Service Company commenced in 1986
and consisted of providing testing and service on underground storage tanks and
piping systems.  With adoption of the U.S. Environmental Protection Agency
("EPA") regulations in 1988, implementing the Resource Conservation and Recovery
Act ("RCRA"), as amended by the Solid Waste Disposal Act ("SWDA"), the Company's
focus shifted toward environmental services, assessment and remediation.  It
currently is engaged in the businesses of installation of fueling systems and
related facilities, providing cathodic protection for underground metal tanks,
installation of spill and overfill protection, environmental site assessments,
contaminated soil and water remediation, and the installation and removal of
storage tanks.

     All of the common stock of the Company was purchased from the original
owners in May 1989, by two employees of the Company, Eddy L. Patterson and
Albert A. McCutchan.  Messrs. Patterson and McCutchan have served as President
and Executive Vice President, respectively, of the Company since that time.  In
1988 (the year prior to purchase by current management), the Company had
revenues of $340,000 and pre-tax income of $41,000 (unaudited).  In 1997, the
Company had revenues of $14,746,000 and pre-tax income of $1,204,000.   At the
time of purchase by Messrs. Patterson and McCutchan, the Company had eight
full-time employees and one office. At the end of 1997, the Company had 97
full-time employees. In addition to the corporate office in Tulsa, Oklahoma, the
Company had regional offices in Dallas (as of December 29, 1995), Houston
(closed effective January 31, 1998) and San Antonio, Texas.

     The Company operated under an S Corporation election for federal income tax
purposes effective January 1, 1990.  This election was revoked effective April
30, 1994.  In April 1994, in preparation for the initial public offering of the
Company's common stock which commenced in September 1994 and terminated in
January 1995 (the "Offering"), the Company amended its Certificate of
Incorporation to increase its authorized capital to 20,000,000 shares of Common
Stock and 1,000,000 shares of Preferred Stock and effected a stock split whereby
the shares owned by each of the Company's two equal shareholders increased from
225 shares of Common Stock, $1.00 par value, to 2,295,257 shares of newly
authorized Common Stock, $.01 par value.

     The Company's headquarters are located at 12331 East 60th Street, Tulsa,
Oklahoma 74146 and its telephone number is (918) 250-2227.  It also has regional
offices in Dallas and San Antonio, Texas.  The Company has regional managers in
each of its offices who are responsible for the operations conducted in their
respective regions.

GENERAL

     The Company provides "turn-key" installation of fueling systems and related
facilities, testing, cathodic protection, remediation, consulting services, and
fueling equipment sales, installation, and service to individuals and businesses
who are owners or operators of underground fuel storage tanks and fueling
systems.  Environmental laws and regulations adopted or implemented within the
last ten years have

                                       1
<PAGE>
 
generated increasing demand for the types of services provided by the Company
and its competitors. The principal activities of the Company have focused on
underground storage tanks and fueling systems, primarily because to date they
have been the subject of substantially greater regulation by both federal and
state authorities than above-ground tanks. Primary customers of the Company are
owners of fueling systems, underground storage tanks, above-ground storage tanks
and pipelines. These include motor fuel service stations and convenience stores,
commercial trucking companies, railroads, airports, oil producers, refiners,
pipeline operators and federal, state and local governments.

SERVICES

     A recent phenomenon at supermarkets and grocery stores is the installation
of gasoline fueling facilities at the perimeters of the stores' parking lots.
This move into retail gasoline sales has provided an opportunity for the Company
to use its experience in the fuel services industry to also become a "turn-key"
builder of fuel facilities for multinational oil companies and supermarket
chains.

     A significant portion of the Company's work involves clean-up of sites
contaminated by leaking underground storage tanks for which the site owners or
operators are entitled to funding from state indemnity funds.  Generally, in
order to be eligible for reimbursement of clean-up costs from state indemnity
funds, owners of underground storage tanks must have registered their
underground storage tanks with the fund manager and complied with all applicable
regulations.  Although the Company generally contracts with the owners to
perform this work, payment is frequently received directly from the state agency
responsible for administering leaking underground storage tank programs
(commonly known as "LUST" programs).

     These state LUST programs are generally funded by motor fuel taxes, permit
and installation fees for storage tanks and penalties and reimbursements
collected from tank owners and operators.  Thus, most LUST funds are not
dependent upon appropriations or a state's financial condition for funding.
Nevertheless, almost all provisions establishing LUST funds provide that, if
sufficient funding is unavailable, claims are to be paid in the order they were
filed.  Most LUST funds also contain a cap on the amount paid for a single spill
or release occurrence.  If funds were to become unavailable under any state LUST
programs, the entity with whom the Company has contracted to perform the work
would be contractually obligated to pay the Company for its work.  Because of
the shortage of LUST funds in Nebraska, the Company's Nebraska operations
declined, and as result, the Company closed its Omaha office as of March 31,
1996.

     Under its cathodic protection distributorship program (described below),
the Company sells cathodic protection systems designed and manufactured by the
Company to other environmental and pump and tank service companies.  The Company
believes this program will allow the Company greater participation in the huge
market for these services prior to the December 1998 deadline of the regulatory
requirement that such systems be installed for older underground tanks in
existing fueling systems.

New Installations:      The Company provides "turn-key" installation of new
                        fueling facilities including the underground storage
                        tanks, piping, dispensing equipment, and other site
                        improvements including the building, canopy, and related
                        equipment.


Cathodic Production:    The Company employs a method of method of protecting
                        metal underground storage tanks and pipelines from the
                        natural processes of corrosion which involves

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<PAGE>
 
                        placing metal rods (anodes) in holes drilled around a
                        tank. The rods are connected to a low-voltage electrical
                        power supply such as a rectifier. The introduction of
                        the electrical current into the ground concentrates
                        corrosion away from the tank to the anodes. Corrosion
                        protection of metal underground storage tanks and piping
                        is required by EPA regulations. In 1995, the Company
                        began offering a cathodic protection dealership program
                        to qualified individuals and companies. Under this
                        program, distributors are established and trained to
                        install cathodic protection systems manufactured by the
                        Company. The Company provides technical support and
                        certification of systems installed.

Spill and
 Overfill Protection:   Spill and overfill protection is attained by placing
                        spill containment basins around the fill pipe of an
                        underground storage tank and installing an overfill
                        prevention valve in the fill pipe.

Environmental Site
 Assessments:           Whenever an underground storage tank leak is suspected,
                        an investigation to confirm the presence of a leak must
                        be conducted within seven days. The Company's personnel
                        possess the experience to conduct such investigations.
                        In addition, when title to commercial real estate is
                        being transferred, an investigation for contamination
                        may be requested. The Company's staff of hydrologists,
                        environmental engineers and technicians review any
                        documents regarding historical uses of the site, analyze
                        soil and water samples and study the sub-surface geology
                        to determine if there is contamination or potential
                        contamination of soil and water on the site. Possible
                        contaminants include hydrocarbons, PCB's, radon,
                        asbestos and other hazardous materials. These services
                        include Phase I visual assessments and Phase II drilling
                        and sampling.

Soil and Water
 Remediation:           Often through the Company's performance of other
                        services, opportunities arise for the Company to provide
                        Phase III soil and water remediation services which
                        primarily involve treatment of ground or surface water
                        and the use of air sparging and vapor extraction units
                        (manufactured by Fuel Recovery Systems, Inc. ("FRS"), a
                        wholly-owned subsidiary) which utilize perforated pipes
                        to inject air into the soil in order to promote the
                        degradation of contaminants by endemic microbes and to
                        extract vapors produced by such degradation from the
                        soil. In some cases, contaminated soil must be removed
                        and transported to hazardous waste disposal sites.

Tank Removals:          Because of stringent environmental regulations, many
                        companies are choosing to exit the fuel storage
                        business. In addition, many tanks too corroded to
                        upgrade are being removed and replaced. The Company is
                        engaged in the removal and disposal of old tanks,
                        cleaning-up any contaminated soil, and the replacement
                        of any concrete or asphalt.

                                       3
<PAGE>
 
Equipment Sales and
 Service                The Company has become a distributor for Wayne Fueling
                        Equipment sales and service in Houston and for eastern
                        Oklahoma, western Arkansas, and southwestern Missouri.
                        The Company has developed a significant fueling
                        equipment service facility in Dallas to serve the
                        Dallas-Fort Worth Metroplex.


MATERIAL CONTRACTS

     The Whiteman A.F.B. contract began April 1995 and was completed in 1997.
At Whiteman, the Company  demolished an old  fuel storage facility and replaced
it with a new system.  In addition, other above and underground fuel storage
tanks were to have been removed and replaced.  Revenues to be earned under the
Whiteman contract total approximately $1.8 million, of which $1 million was
reported as revenue in 1995 and  $502 thousand in 1996.  The contract was
completed in early 1997.
 
     The Warren A.F.B. contract began November 1995 and was completed in
September 1997. Revenues to be earned by the Company under the Warren contract
total approximately $1,100,000 of which $33,000 was recorded in 1995, $705,000
was recorded in 1996, and the remaining $338,000 was recorded in 1997. At
Warren, the Company upgraded fuel tanks for 50 missile launch facilities by
adding piping, spill and overfill equipment, leak detection and automatic tank
gauging.

     The Company is performing cathodic protection and other fuel system upgrade
work for two convenience store chains and fuel system installations for two
grocery store chains.   Revenues earned in 1996 were $1,400,000 and $1,065,000
for the two convenience store chains.  The total of revenues for both chains
combined in 1997 was $1,315,000.  Revenues earned in 1996 for fuel system
installations for one grocery store chain was $1,324,000.   Revenues for 1997
for fuel system installations at two grocery chains were $1,323,000 and
$2,071,000.  Revenues for work on these chains will continue in 1998 as
additional stores are scheduled for upgrades and installations.

     The Company is performing site upgrades on eleven hospitals owned by a
national hospital corporation.  The upgrades include removal and replacement of
emergency generator fuel storage tanks, piping, and related equipment.  The
total revenues expected from these contracts should exceed $900,000.

COMPETITION

     The Company competes with numerous other companies and individuals
(consultants, etc.) in providing the various types of services described above,
but very few companies offer the complete range of services which the Company
provides.  There are even fewer competitors for the installation of "turn-key"
fueling facilities for gasoline service stations and convenience store chains.
The main factors on which the Company competes for business are personal
contacts, experience, reputation, price, availability and location.  Many of the
Company's potential customers seek competitive bids in awarding contracts for
the work to be performed.

     For certain competitive bid projects, particularly those involving large
expenditures for labor or materials, the financial strength of the bidder may be
an important factor.  The Company often competes against companies with
substantially greater financial and/or human resources.

                                       4
<PAGE>
 
MARKETING

     A large percentage of the Company's business is from previous customers and
their referrals.  The Company also obtains referrals from petroleum equipment
manufacturers and environmental consultants with whom the Company has worked.
The Company maintains a full-time marketing staff of two and has four other
executive and administrative personnel who spend a significant amount of time
calling on prospective customers.  The marketing staff also responds to
inquiries obtained through advertising in state and national trade publications,
direct mail and trade show participation.  Approximately 20% of the services
performed by the Company have been pursuant to projects awarded by competitive
bidding.

FUTURE GROWTH

     Acquisition of Other Businesses.  The Company plans to increase the types
of services it is able to provide within the environmental protection and
remediation industry, to diversify its product and service offering and to
expand the geographic regions in which it performs these services.  In pursuit
of these expansion goals, the Company intends to consider acquiring companies
that perform other types of environmental and other services compatible with the
Company's expertise and marketing philosophy.

EFFECT OF GOVERNMENTAL REGULATIONS

     The RCRA, as amended by SWDA, and as implemented by EPA regulations, is
intended to protect human health and the environment from hazardous material,
including leaks or spills from underground storage tanks.  The term "hazardous
materials" includes motor fuels (gasoline and diesel) and chemicals used in
manufacturing processes.  The goals of the underground storage tank regulations
include preventing leaks and spills, detecting leaks and spills, correcting
problems caused by leaks and spills and requiring each state to undertake a
regulatory program equal to or more stringent than required by the EPA.

     The regulations require the underground storage tank owner or operator to
take action to correct problem underground storage tanks, to upgrade them to
meet prescribed standards and to maintain them in proper condition.  All
underground storage tanks had to be tested not later than December 1993, and
must be tested annually until upgraded to meet leak detection, spill and
overfill prevention, interior lining, piping and cathodic protection standards
established by the EPA.  Required upgrading must be completed by December 22,
1998.  Owners of underground storage tanks also must demonstrate their financial
ability to pay for damages caused by spills or leaks.

     States' regulations may differ from federal regulations. While Iowa
required spill and overfill protection and cathodic protection to be installed
by 1995, the state has not made significant progress in the clean-up of
contaminated sites as have other states.  The Company's operations in Iowa
declined due to completion of upgrade work to meet  the 1995 deadline and the
lack of significant clean-up opportunities. The Iowa office was closed in March
1996.  The Nebraska office was also closed in March 1996 due to a shortage of
state LUST funds for clean-up of contaminated sites.

     For the most part, the applicable federal and state environmental
regulations do not provide for liability for a contractor with respect to the
removal of tanks or conducting remedial services.  If a release occurs or if
applicable standards are not met, such regulations hold the owner or operator of
the tank responsible.  Consequently, the only exposure of the Company would be
based on general negligence principles and the contractual arrangement with the
owner or operator of the tank.  The Company maintains

                                       5
<PAGE>
 
insurance coverage to protect itself against any such liabilities which may
arise from the installation, removal or replacement of underground storage
tanks. It believes that the amount and coverage of its insurance are standard in
the industry and are consistent with prudent practices. However, there can be no
assurance that any such insurance will be sufficient to avoid any substantial
loss or liability of the Company by virtue of any negligent performance of or
breach of its contractual obligations by the Company.

     Certain licensing requirements pertaining to entities which inspect,
install, protect, repair and remove storage tanks and which investigate and
clean up releases are in place in states in which the Company operates.  The
Company and/or its employees maintain licenses in 18 states on an on-going basis
and obtain licenses in other states as needed.  Generally, state licenses are
issued after review of applications which include descriptions of the Company's
experience, the backgrounds of its personnel and payment of the applicable
license fees.  In addition, some states require certain employees, such as tank
testers and installers, to be separately licensed.  Usually passing a written
examination is required to obtain these licenses.  The Company has not
encountered any material difficulties in obtaining required licenses, but the
Company cannot predict when licensing requirements may change.

     As part of the remediation services offered to its customers, the Company
often disposes of, or arranges for the disposal of, contaminated soil or water.
Prior to any disposal, the Company must obtain approval from the appropriate
state agency to dispose of the contaminated soil in an approved landfill. Under
the Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), any person who disposes of statutorily defined hazardous substances
at a disposal site is potentially liable for clean up costs if there is a
release from such disposal site.  However, petroleum products are excluded for
the most part from the scope of these provisions.  Since virtually all of the
material which the Company disposes or arranges the disposal of consists of
petroleum products and material contaminated by petroleum products, the Company
is largely exempt from these provisions of CERCLA.  The only exposure the
Company would likely face in this area would be for failure to obtain necessary
state agency approvals for disposal of waste materials or the failure to dispose
of such materials in approved landfills.

DEPENDENCE ON MAJOR CUSTOMERS

      In 1997, the Company received 14 percent of its revenue from one grocery
store chain.  The Company believes that it has a broad overall customer base and
the loss of any single customer would not have a material adverse affect on its
business, although the loss of several of those customers could have such an
effect.

TRADEMARKS, LICENSES

     On November 1, 1992, the Company entered into a license agreement to use
patented technology for testing above-ground storage tanks.  The term of the
license is for the remaining life of the patent (12 years) and requires the
Company to pay the licensor 2% of its annual revenues from use of the
technology.  The Company has not yet realized significant revenues from the use
of such technology, but anticipates that utilization of the technology may
produce significant new revenue if more states and the Federal government enact
above-ground storage tank testing and upgrading legislation.

FORWARD LOOKING STATEMENTS

     Certain statements included in this report which are not historical facts
are forward looking

                                       6
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statements, including the information provided with respect to the projected or
future business opportunities, expansions and diversification; contract
completions, expected financing sources and related matters. These forward
looking statements are based on current expectations, estimates, assumptions and
beliefs of management; and words such as "expects," "anticipates," "intends,"
"believes," "estimates" and similar expressions are intended to identify such
forward looking statements. These forward looking statements involve risks and
uncertainties, including, but not limited to, changes in governmental
regulations, the Company's ability to effectively and efficiently absorb its
newly acquired businesses and assets and any additional businesses and/or assets
it may acquire in the near future, general economic conditions and conditions
affecting the industries which utilize the Company's services and products, the
availability of experienced personnel, raw materials and equipment and the
Company's ability to comply with its obligations under its existing contracts
and to obtain new contracts. Accordingly, actual results may differ materially
from those expressed in the forward looking statements.

EMPLOYEES

     The Company has 97 full-time employees and no part-time employees. This
number includes 7 senior managers, 6 division managers, 10 field supervisors, 2
marketing employees, 4 full-time professionals, 18 accounting/clerical/drafting
personnel, and 50 technical and field personnel. The areas of expertise of the
professionals include hydrogeology, environmental engineering, biology and
chemistry. The Company has no collective bargaining agreements and management
considers employee relations to be excellent.

ITEM 2.  DESCRIPTION OF PROPERTY.

                                   PROPERTIES

     The Company maintains its corporate headquarters, an equipment storage yard
and a warehouse in a business park in Tulsa, Oklahoma, each with 9,000, 10,000
and 4,500 square feet, respectively.  The facility was leased from McCutchan and
Patterson Partnership, a partnership owned by the President and Executive Vice
President of the Company.  The  lease was in effect through 1997 with annual
lease payments totaling $66,000.

     On February 27, 1998, the Company acquired the office building, warehouse
and lot on which the Company's corporate offices are located.  The purchase
price was $600,000, and the Company secured a loan from Citizen's Bank of Tulsa
for $480,000 secured by a mortgage on the acquired real estate.  The loan has a
term of 7 years.  The interest rate floats at one-half percent above Low New
York Prime rate, and the current rate is 9.0% per annum.  The Company paid a
one-half percent origination fee.

     The Company acquired Lab One Analytical, Inc. on  January 30, 1998, for
$75,000 cash and 225,000 shares of the Company's common stock.

     Both Lab One Analytical, Inc. and the real estate were purchased from Eddy
Patterson and Albert McCutchan, the President and Executive Vice President of
the Company following the completion of independent appraisals of the entities
and the review and unanimous consent of the outside directors of the Company to
the transactions and terms and conditions thereof.

     The Company constructed a new building in San Antonio, Texas, which was
completed during the

                                       7
<PAGE>
 
first quarter of 1995 at a cost of $259,000. At December 31, 1997, a balance of
$466,000 remained to be paid which includes liens on real estate and other
equipment.

     The Company leased space for its Dallas office on October 1, 1995.  Annual
lease payments are $34,000.  The lease expires on September 30, 1998.

     The Company leased space for its Houston office on November 1, 1996.  The
annual lease payments are $23,000, and the lease expires on October 31, 1999.
This office was closed on January 31, 1998, and the Company is in the process of
subleasing the office for the remainder of the lease term.

     The Company owns various vehicles and equipment which were purchased at a
total cost of approximately $2,178,000. At December 31, 1997, the Company had
outstanding loans of approximately $808,000 principal amount collateralized by
the vehicles, equipment, and real estat e.

ITEM 3.  LEGAL PROCEEDINGS.

     The Company has various legal proceedings for the collection of accounts
receivable.  The amounts sought in the legal proceedings are relatively
insignificant with regard to the Company's total accounts receivable balances.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     None.

                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

     The Company's common stock began trading on March 7, 1995, and was quoted
on the OTC Bulletin Board.  Prior to that time, there was no public trading
market for the stock.

     On January 24, 1996, the Company's stock began trading on The Nasdaq Stock
Market under the symbol: NESC.

     The following table sets forth, for the periods indicated, the high and low
bid prices of the Company's common stock on the OTC Bulletin Board through
January 23, 1996 and on the Nasdaq Small Cap Market thereafter.  These
quotations reflect interdealer prices, without retail markup, markdown or
commissions, and may not represent actual transactions.

<TABLE>
<CAPTION>
 
Quarter
 ended                        High    Low
 -----                       ------  ------
<S>                          <C>     <C>
 
          3/31/96             $3.50   $2.00
          6/30/96              2.00    0.875
          9/30/96              3.375   1.00
          12/31/96             2.00    0.75
 
</TABLE> 

                                       8
<PAGE>
 
<TABLE> 
<CAPTION> 

          Quarter
          ended              High    Low
          ------             ------  ------
<S>                          <C>     <C> 
          3/31/97            $1.875  $0.875
          6/30/97             2.00     .625
          9/30/97             2.875   1.625
          12/31/97            4.375   2.375
</TABLE>

     At December 31, 1997, there were 257 holders of record of the Company's
outstanding shares of common stock and an estimated 300 additional shareholders
whose shares were registered in street name. No shares of preferred stock are
currently outstanding.
 
     The Board of Directors paid no dividends to shareholders in 1997.   The
Board of Directors declared a dividend of three cents per share to shareholders
of record on February 15, 1996.  The dividend was paid on March 1, 1996.  The
Company paid no dividends in 1995.

     Payment of dividends in the future, if any, will depend on the applicable
legal and contractual restrictions, as well as the Company's earnings, financial
position, expansion plans and objectives and cash requirements, among other
factors.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

COMPARISON OF RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997, TO THE
YEAR ENDED DECEMBER 31, 1996.

     The Company had revenues of $14,746,000 in 1997 compared to $10,261,000 in
1996, a 44% increase.   Fueling systems installation and repair accounted for
the largest source of revenues in 1997 as compared to 1996, a 81% increase.
Fueling systems installation and repair revenues in 1997 were $9,569,000
compared to $5,300,000 for 1996.  The fueling systems installation and repair
revenues increased due to significantly greater activity in the installation of
fueling systems for petroleum companies, convenience stores and grocery store
chains.   Cathodic Protection revenues increased 49% in 1997 as compared to
1996.  Cathodic Protection revenues were $3,564,000 in 1997 compared to
$2,398,000 in 1996. The increase resulted from increased purchases of cathodic
protection kits from the Company's distributor network and increases in the
installation of cathodic protection systems by the Company.  The increased sales
result from the approaching deadline for regulatory compliance by owners and
operators of underground storage tanks.  Site assessment revenues were $573,000
in 1997 compared to $1,549,000 in 1996.   Site assessment revenues exhibited the
largest decrease in 1997 compared to 1996.  The decrease of 63% resulted from
the significantly increased activity in Texas in 1996 following that state's
revision of its LUST cleanup program.  The Company performed an unusually large
amount of assessments in late 1996 which boosted that year's revenue
considerably in relation to 1997.  Remediation revenues increased 8% in 1997
compared to 1996, $776,000 compared to $720,000.   Sales of Parts and Pumps
increased to $674,000 in 1997 compared to $114,000 in 1996.  The increase
resulted from the considerable expansion of the Company's service division
activities in 1997 following the division's establishment in late 1996 and the
increase in sales of pumps and parts due to the Company's increased activity in
installing fueling systems for petroleum companies, convenience stores, and
grocery chains.

     Costs and expenses in 1997 were $10,129,000 compared to $7,833,000 in 1996,
an increase of 29%.  Costs and expenses for 1997 represented 69% of total
revenue for the year compared with 76% for

                                       9
<PAGE>
 
1996. The decrease in percentage of costs and expenses in 1997 resulted from
problems encountered on one government contract in 1996. Additionally, 1996
costs and expenses included the initial loss of operational efficiencies
following the acquisition of two small companies which became the Dallas
division office. The percentage of increase in labor costs was 8%, relatively
minor in comparison to the increase in revenue. Labor costs for 1997 were
$1,922,000 compared to $1,774,000 for 1996. Payments to subcontractors increased
10% to $1,463,000 in 1997 compared to $1,332,000 in 1996. Supplies and materials
cost increased 73% in 1997 to $4,740,000 compared to $2,744,000 for 1996. The
increase in both subcontractor expense and supplies and materials was due to
increased volume of business in the fueling systems installation and repair area
which include the type of projects requiring more equipment and supplies and use
of subcontractors. Lab service costs decreased from $536,000 in 1996 to $304,000
in 1997, primarily due to the significant decrease in site assessments in Texas
as explained in the revenues paragraph above.

     Selling, general and administrative expenses were $3,215,000 in 1997
compared to $2,775,000 in 1996, a 16% increase.  The $440,000 increase was due
to salary increases and the employment of more highly qualified and skilled
employees in 1997.  Salaries accounted for $288,000 of the $440,000 increase.
Salaries increased 21% to $1,645,000 in 1997 compared to $1,357,000 in 1996.
Part of the increase in salaries for 1997 over 1996 was the result of a one time
temporary reduction of $103,000 of certain executive officer salaries during
1996.  Office supplies and postage was $112,000 in 1997 compared to $82,000 in
1996.  Telephone expenses were $108,000 in 1997 compared to $74,000 in 1996.
Both telephone expense and office supplies and postage increases were related to
the increased volume of sales. Professional fees increased to $116,000 in 1997
compared to $75,000 in 1996.  The Company's efforts in capital acquisition and
investor relations accounted for most of the increase in professional fees.
Advertising expense declined to $43,000 in 1997 compared to $79,000 in 1996 due
to less advertising in trade publications.

     Interest expense is higher due to the larger debt balance in 1997 resulting
from funding for long-term contracts, additional working capital, and purchases
of machinery and equipment.   Interest expense for 1997 was $308,000 compared to
$238,000 in 1996.

CAPITAL RESOURCES AND LIQUIDITY

     Cash on hand at the end of 1997 was $90,000 compared to $119,000 at the end
of 1996.  Net cash used by operating activities was $1,496,000 in 1997 compared
to $563,000 in 1996.  The increase in the net cash used was due to an increase
in accounts receivable of $1,696,000 and an increase in costs and estimated
earnings in excess of billings of $1,437,000.   The increase in accounts
receivable and costs and estimated earnings in excess of billings is due to the
44% increase in revenues.

     The Company continued to make periodic debt repayments during the year. The
Company continued to make investments in property, plant and equipment as well
as materials and supplies as needed. The Company secured $1,000,000 from a
private placement of one million shares of common stock during the second
quarter of 1997. As part of the private placement, the company granted options
to purchase 530,000 shares of common stock at $1.50 per share exercisable at any
time prior to April 30, 1999. The Company secured $540,000 when options for
450,000 shares were exercised at $1.20 per share (adjusted from $1.50) on
December 8, 1998. Accounts receivable at the end of 1997 totaled $5,015,000
compared to $3,198,000 at the end of 1996. Costs and estimated earnings in
excess of billings on uncompleted contracts were $2,066,000 at the end of 1997
compared to $629,000 at the end of 1996. Accounts payable increased to
$1,827,000 at the end of 1997 compared to $1,362,000 at the end of 1996.

                                       10
<PAGE>
 
     During 1997, the Company obtained  installment loans which totaled $312,000
and were secured by 13 trucks and attached equipment.
 
     The Company extended its revolving line of credit in April 1997, and the
extended loan maturity was May 31, 1997.  The amount of the line was decreased
from $2.1 million to $2.0 million pending the transfer of the Company's banking
relationships from Boatmen's National Bank of Oklahoma ("Boatmen's") to Bank of
Oklahoma.  The interest rate on the loan during the extension was national prime
plus 3 percenage points.  On July 15, 1997, the Company executed loan documents
and transferred its line of credit loan and various equipment loans to the Bank
of Oklahoma. The line of credit was increased to $2.5 million with an interest
rate of national prime plus 1.5 percentage points.  The Company used $2.028
million of the new line to payoff the line of credit at Boatmen's.  The line of
credit was increased to $3.0 million on December 2, 1997.  All other terms and
conditions of the line of credit remained unchanged.  Various equipment loans at
Boatmen's totaling $391,000 were consolidated into a Bank of Oklahoma $500,000
loan on equipment with an interest rate of Wall Street Journal prime plus 1.5%.
                                           -------------------                  
The monthly payment of $10,624 is based on a five year amortization.  A balloon
payment at maturity is required on July 31, 2000.
 
CAPITAL EXPENDITURES

     The Company has no commitments for material capital expenditures.  The
Company acquired Lab One Analytical, Inc. on  January 30, 1998 for $75,000 cash
and 225,000 shares of the Company's common stock.  On February 27, 1998, the
Company acquired the office building, warehouse and lot on which the Company's
corporate offices are located.  The purchase price was $600,000. The Company may
make capital expenditures in connection with acquisition of other companies or
businesses.

YEAR 2000 ISSUE

     The Company is making an assessment of its Year 2000 date issues as it
relates to computer operations of the Company, the computer hardware and
software owned by the Company, the accounting software provided by its vendor,
the software of other suppliers and vendors, and the software of customers. The
most critical aspect for the Company regarding the Year 2000 problem involves
the Company's accounting software.  The Company's vendor of the software is
addressing this issue and assures its users that all software will be revised to
permit the usage of the year 2000 date without adverse consequences to the
software users' systems.  The Company has made arrangements with its local
computer systems consultant to survey all of the Company's computers and non-
accounting software acquired and used in Company operations.  This survey will
include alarm systems, office equipment, computers, "off-the-shelf" software,
and software designed by the Company or its subsidiaries.  It has been
determined that Year 2000 problems encountered by the Company's customers would
not be material.  However, the Company does supply equipment which will be
affected by the Year 2000 problem.  The Company will contact vendors of such
equipment supplied by the Company and determine if the equipment requires
modifications to address its customers' Year 2000 problems. The Company has
determined that the Year 2000 problem is not a material event or uncertainty
that would cause reported financial information not to be necessarily indicative
of future operating results or financial condition.  Additionally, the Company
has determined that the costs or consequences of incomplete or untimely
resolution of the Year 2000 issue is not a material event.  These determinations
are based on three factors:  the availability of accounting software which has
dealt with the Year 2000 problem, the relatively small amount of reliance by the
Company on specialized software or computer equipment, and the inconsequential
impact on the Company of any of the Company's customers' Year 2000 problems.

                                       11
<PAGE>
 
ITEM 7.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         The Company's Consolidated Financial Statements required by this item
         begin at page F-1 hereof.
         
ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE.
 
         None.
 
                                   PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

     Information required by this item is incorporated by reference to the
sections entitled "Election of Directors,"  " Executive Officers"and "Section
16(a) Beneficial Ownership Compliance" of the Company's Proxy Statement to be
filed with the Securities and Exchange Commission in connection with the
Company's 1998 annual meeting.

ITEM 10. EXECUTIVE COMPENSATION

     Information required by this item is incorporated by reference to the
sections entitled "Board Compensation and Committees" and "Executive Officers-
Executive Compensation" of the Company's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the Company's 1998 annual
meeting.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Information required by this item is incorporated by reference to the
Section entitled "Principal Shareholders " of the Company's Proxy Statement to
be filed with the Securities and Exchange Commission in connection with the
Company's 1998 annual meeting.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information required by this item is incorporated by reference to the
Section entitled "Certain Relationships and Related Transactions" of the
Company's Proxy Statement to be filed with the Securities and Exchange
Commission in connection with the Company's 1998 annual meeting.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
 
    (A)  EXHIBITS

         3.1   Amended and Restated Certificate of Incorporation of National
               Environmental Service Co. and amendments thereto (incorporated by
               reference to Exhibit 3.1 to the Registrant's Registration
               Statement on Form SB-2, No. 33-78612-D, (the "Registration
               Statement")).
         3.1a  Amendment to Amended and Restated Certificate of Incorporation of
               National Environmental Service Co., dated June 17, 1994
               (incorporated by reference to
     

                                       12
<PAGE>
 
               Exhibit 3.1a to the Registration Statement).
         3.2   Amended and Restated Bylaws of National Environmental Service
               Co., as amended on June 16, 1994 (incorporated by reference to
               Exhibit 3.2 to the Registration Statement).
         4.1   Form of Stock Certificate (incorporated by reference to Exhibit
               4.1 to the Registrant's Form 10-KSB for the year ended December
               31, 1994 (the "1994 10-KSB").
         10.1  Contract with U.S. Corps of Engineers regarding project for
               Tinker Air Force Base, Oklahoma (incorporated by reference
               Exhibit 10.1a to the Registration Statement).
         10.2  Office Warehouse lease between Registrant McCutchan and Patterson
               Partnership (incorporated by reference as filed as Exhibit 10.2
               on Form 10-KSB for the fiscal year ended December 31, 1994).
         10.5  National Environmental Service Co. 1994 Employee Stock Plan dated
               April 22, 1994. (incorporated by reference to Exhibit 10.7 to the
               1994 10-KSB).
         10.6  National Environmental Service Co. 1994 Director Stock Option
               Plan dated April 22, 1994 (incorporated by reference to Exhibit
               10.8 to the 1994 10-KSB).
         10.7  Contract with the U.S. Corps of Engineers regarding project for
               Fort Hood, TX (incorporated by reference to Exhibit 10.9 to the
               1994 10-KSB).
         10.8  Contract with U.S. Corps of Engineers regarding project for
               Whiteman Air Force Base, Missouri (incorporated by reference as
               filed as Exhibit 10.1 to Form 10-QSB for the quarter ended March
               31, 1995).
         10.9  Bank IV Oklahoma, N.A. Credit Agreement dated January 9, 1995
               (incorporated by reference as filed as Exhibit 10.2 on Form 
               10-QSB for the quarter ended March 31, 1995) and amendments to
               the Credit Agreement.
         10.11 Private Placement Agency Agreement between National Environmental
               Service Co. Peacock, Hislop, Staley & Given, Inc. dated January
               15, 1998; Amendment to the Placement Agency Agreement dated
               January 15, 1998; and First Supplement to the Private Placement
               Memorandum dated January 12, 1998.
         10.12 National Environmental Service Co. Common Stock Purchase Warrant
               to Peacock, Hislop, Staley & Given, Inc. dated January 21, 1998
         10.13 Purchase and Sale Agreement for sale of real estate dated January
               30, 1998, between National Environmental Service Co. and
               McCutchan and Patterson, an Oklahoma general partnership.
         10.14 Citizens' Bank of Tulsa Credit Agreement dated February 27, 1998.
         10.15 Agreement and Plan of Merger with respect to Lab One Analytical,
               Inc. dated January 30, 1998.
         21.1  Subsidiaries of National Environmental Service Co.
         27.1  Financial Data Schedule

    (B)  REPORTS ON FORM 8-K
         None.

 

                                       13
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS
 
 
                                                             Page
                                                             ----
 
Report of Independent Auditors                               F-2
 
Consolidated Balance Sheet as of December 31, 1997           F-3
 
Consolidated Statements of Income for the Years Ended
   December 31, 1997 and 1996                                F-4
 
Consolidated Statement of Changes in Shareholders' Equity
   for the Years Ended December 31, 1997 and 1996            F-5
 
Consolidated Statements of Cash Flows for the Years Ended
   December 31, 1997 and 1996                                F-6
 
Notes to Consolidated Financial Statements                   F-7

                                      F-1

<PAGE>
 
                        REPORT OF INDEPENDENT AUDITORS



To the Board of Directors
National Environmental Service Co.



We have audited the accompanying consolidated balance sheet of National
Environmental Service Co. (the "Company") as of December 31, 1997 and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for the two years in the period then ended.  These financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of National Environmental Service
Co. as of December 31, 1997 and the results of its operations and its cash flows
for the two years in the period then ended in conformity with generally accepted
accounting principles.


TULLIUS TAYLOR SARTAIN & SARTAIN LLP

Tulsa, Oklahoma
March 13, 1998

                                      F-2

<PAGE>
 
                       NATIONAL ENVIRONMENTAL SERVICE CO.
                           CONSOLIDATED BALANCE SHEET
                               December 31, 1997
                           (In Thousands of Dollars)

                                     ASSETS
                                     ------
<TABLE>
<CAPTION>
<S>                                                                   <C> 
Current assets:
        Cash                                                         $    90   
        Accounts receivable:                        
          Trade, net of allowance for doubtful accounts of $52         5,015 
          Refundable income tax                                           46
        Costs and estimated earnings in excess of billings on
          uncompleted contracts                                        2,066
        Materials and supplies                                           946
        Prepaid expenses                                                  82
                                                                     -------
        Total current assets                                           8,245
                                                                     -------
Property and equipment, at cost:
        Land                                                              50
        Buildings and improvements                                       344
        Vehicles                                                       1,916
        Testing, drilling and other equipment                            262
        Furniture, fixtures and other                                    710
                                                                     -------
                                                                       3,282
        Less accumulated depreciation                                  1,438
                                                                     -------
        Property and equipment, net                                    1,844
                                                                     -------
Other                                                                     22
                                                                     -------
Total assets                                                         $10,111
                                                                     =======
</TABLE>
                     LIABILITIES AND SHAREHOLDERS' EQUITY
                     ------------------------------------
<TABLE>
<CAPTION>
<S>                                                                  <C>
Current liabilities:
        Current maturities of long-term obligations                  $ 2,870
        Notes payable to related parties                                  31
        Accounts payable                                               1,827
        Accrued liabilities                                              583
                                                                     -------
        Total current liabilities                                      5,311
                                                                     -------
Long-term notes payable                                                  588
                                                                     -------
Deferred income taxes                                                    113
                                                                     -------
Commitments and contingencies
Shareholders' equity:
        Preferred Stock; 1,000,000 shares authorized; none issued
        Common Stock; par value $.01; authorized 20,000,000 shares;
          issued 7,251,143 shares                                         73 
        Additional paid-in capital                                     3,234
        Retained earnings                                                840
        Common stock in Treasury, at cost, 12,376 shares                 (48)
                                                                     -------
        Total shareholders' equity                                     4,099
                                                                     -------
Total liabilities and shareholders' equity                           $10,111
                                                                     =======
</TABLE>

              The accompanying notes are an integral part of the
                             financial statements.

                                      F-3

<PAGE>
 
                      NATIONAL ENVIRONMENTAL SERVICE CO.
                       CONSOLIDATED STATEMENTS OF INCOME
                For the Years Ended December 31, 1997 and 1996
              (In Thousands of Dollars except per share amounts)

<TABLE>
<CAPTION>
 
                                               1997      1996
                                             --------  --------
<S>                                          <C>       <C>
Revenue:
   Site assessments                          $   576   $ 1,549
   Cathodic protection                         3,564     2,398
   Fueling Systems                             9,569     5,300
   Remediation                                   776       720
   Other                                         261       294
                                             -------   -------
Total revenue                                 14,746    10,261
 
Costs and expenses                            10,129     7,833
Selling, general and
     administrative expenses                   3,215     2,775
                                             -------   -------
Income (loss) from operations                  1,402      (347)
 
Other income (expense):
     Interest                                   (308)     (238)
     Other income                                110        54
                                             -------   -------
Income (loss) before income taxes              1,204      (531)
                                             -------   -------
Provision  (benefit) for taxes on income
     Current                                     361      (196)
     Deferred                                     97        36
                                             -------   -------
                                                 458      (160)
                                             -------   -------
Net income (loss)                            $   746   $  (371)
                                             =======   =======
Basic net income (loss) per share            $  0.12   $ (0.06)
                                             =======   =======
Diluted net income (loss) per share          $  0.11   $ (0.06)
                                             =======   =======
 
</TABLE>

   The accompanying notes are an integral part of the financial statements.

                                      F-4


<PAGE>
 
                      NATIONAL ENVIRONMENTAL SERVICE CO.
           CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
                For the years ended December 31, 1997 and 1996
                           (In Thousands of Dollars)

 
                                                   
<TABLE>
<CAPTION>                                                                      Additional
                                         Common                   Common        paid-in    Retained   Treasury
                                      stock shares             stock issued     capital    earnings    shares    Total
                               --------------------------      ------------    ----------  --------   --------  --------
                                  Issued      In Treasury
                               -------------  -----------
<S>                            <C>            <C>              <C>             <C>         <C>        <C>       <C>
Balance at Dec.31, 1995           5,786,143        9,580            $   58        $1,701    $  638      $ (27)   $2,370
 
Shares issued to
acquire business                     15,000                                           45                             45
 
Purchases of Treasury stock                        1,000                                                   (3)       (3)
 
Adjusted shares issued to
acquire business                                  18,636                                                  (46)      (46)
 
Dividends paid                                                                                (173)                (173)
 
Net income (loss)                                                                             (371)                (371)
                                  ---------       ------            ------        ------    ------      -----    ------  
Balance at Dec.31, 1996           5,801,143       29,216                53         1,746        94        (76)    1,822  
 
Shares sold                       1,450,000                             15         1,488                          1,503  
 
Shares issued
employee awards                                  (16,840)                                                  28        28  
 
Net income (loss)                                                                              746                  746   
                                  ---------       ------            ------        ------    ------      -----    ------

Balance at Dec 31, 1997           7,251,143       12,376            $   73        $3,234     $ 849      $ (48)   $4,099  
                                  =========       ======            ======        ======     =====      =====    ======  
</TABLE>

         The accompanying notes are an integral part of the financial
                                  statements.

                                      F-5

                                  
<PAGE>
 
                      NATIONAL ENVIRONMENTAL SERVICE CO.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                For the Years Ended December 31, 1997 and 1996
                           (In Thousands of Dollars)
<TABLE>
<CAPTION>
 
                                                                     1997           1996
                                                                  -----------     --------
<S>                                                               <C>             <C>
Operating activities:
   Net income (loss)                                                 $   746      $  (371)
   Adjustments to reconcile net income (loss) to
     net cash used in operating activities:
         Depreciation and amortization                                   317          318
         Deferred taxes                                                   97          (36)
         Stock issued as employee compensation                            28            -
         Change in:
           Accounts receivable                                        (1,696)        (458)
           Costs and estimated earnings in excess
             of billings on uncompleted contracts                     (1,437)         (90)
           Materials and supplies                                       (321)        (181)
           Prepaid expenses                                              (49)          71
           Accounts payable                                              465          162
           Billings in excess of costs and estimated
             earnings on uncompleted contracts                          ( 68)          68
           Accrued liabilities                                           422          (23)
           Other                                                           -          (23)
                                                                     -------      -------
Net cash used in operating activities                                 (1,496)        (563)
                                                                     -------      -------
Investing activities:
   Acquisition of  business, net of cash acquired                          -         (240)
   Purchases of property and equipment                                  (556)        (190)
   Proceeds from sales of property and equipment                           5           41
                                                                     -------      -------
   Net cash used in investing activities                                (551)        (389)
                                                                     -------      -------
Financing activities:
   Proceeds from issuance of common stock                              1,502            -
   Proceeds from notes payable and long-term
     obligations                                                       4,560        3,161
   Increase (decrease) in notes payable to related parties              (257)         289
   Principal payments on notes payable and
     long-term obligations                                            (3,787)      (2,166)
   Dividends paid                                                          -         (173)
       Purchase of common shares                                           -          (49)
                                                                     -------      -------
   Net cash provided by financing
     activities                                                        2,018        1,062
                                                                     -------      -------
Increase (decrease) in cash                                              (29)         110
Cash, beginning of year                                                  119            9
                                                                     -------      -------
Cash, end of year                                                    $    90      $   119
                                                                     =======      =======
Cash paid during the year for interest                               $   304      $   238
                                                                     =======      =======
Supplemental disclosure of non-cash investing activities:
   Acquisition of business for common stock                          $     0      $    45
                                                                     =======      =======
 
</TABLE>

   The accompanying notes are an integral part of the financial statements.

                                      F-6

<PAGE>
 
                      NATIONAL ENVIRONMENTAL SERVICE CO.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                        
1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     DESCRIPTION OF BUSINESS - National Environmental Service Co. (the
     "Company") is engaged in the businesses of providing cathodic protection
     for underground metal tanks, installation of spill and overfill protection,
     environmental site assessments, contaminated soil and water remediation and
     the installation and removal of storage tanks, and the construction of
     fueling systems and related facilities. The Company is headquartered in
     Tulsa, Oklahoma, and has three division facilities in Texas.

     CONSOLIDATION - The Company owns 100% of Fuel Recovery systems, Inc. The
     financial statements of Fuel Recovery Systems, Inc. are consolidated and
     all material intercompany accounts and transactions are eliminated.

     MATERIALS AND SUPPLIES - Materials and supplies consist of purchased
     materials and are valued at cost (first-in, first-out).

     PROPERTY AND EQUIPMENT - Property and equipment are carried at cost.
     Depreciation is provided using the straight-line method over the estimated
     useful lives of the related assets. Gains and losses on retirement of
     property and equipment are recognized in the period of retirement.

     NET INCOME PER SHARE - In the fourth quarter of 1997, the Company adopted
     Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
     Share" (see Note 10). SFAS 128 replaced primary earnings per share ("EPS")
     with basic EPS and fully diluted EPS with diluted EPS. Basic EPS is
     calculated by dividing net earnings available to common shares by the
     weighted average common shares outstanding. Diluted EPS is calculated
     similarly, except that it includes the dilutive effect of the assumed
     exercise of all dilutive potential common shares outstanding. SFAS 128 also
     requires previously reported EPS to be restated. The adoption of SFAS 128
     did not have a material effect on the calculation of EPS.

     INCOME TAXES - Deferred taxes are determined under the liability method,
     whereby deferred tax assets and liabilities are recognized based on
     differences between financial statement and tax bases of assets and
     liabilities using presently enacted rates. At December 31, 1997 and 1996,
     deferred taxes were recorded primarily for temporary differences related to
     depreciation of fixed assets.

     FINANCIAL INSTRUMENTS - The Company's financial instruments consist of
     trade accounts receivable, trade accounts payable, short-term and long-term
     debt. The carrying amounts of these financial instruments approximate fair
     value at December 31, 1997. The fair value of debt is estimated based on
     current rates offered for similar debt.

     CONCENTRATION OF CREDIT RISK - Financial instruments which potentially
     subject the Company to concentrations of credit risk consist primarily of
     trade receivables from customers and cost and estimated earnings in excess
     of billings on uncompleted contracts which will be due from customers when
     billable under the contracts. The Company does not require collateral from
     its customers although it may have the ability to place liens. Such credit
     risk is considered by management to be limited due to the Company's broad
     customer base. Sales to the U.S. Corp of Engineers amounted to 2% and 14%
     of sales during fiscal 1997 and 1996, respectively. One commercial customer
     accounted for 14% of sales in 1997.


                                        F-7

                                      
<PAGE>
 
     REVENUE RECOGNITION - The Company enters into both fixed fee and cost-plus-
     fee contracts. For long-term contracts, revenue is recognized on the
     percentage of completion method measured by the percentage of direct costs
     to date to estimated total direct cost for each long-term contract. For
     short-term and multiple unit contracts, revenue is recognized as services
     are rendered, based on physical completion of the project. Related costs
     are expensed as incurred. Provisions for estimated losses on uncompleted
     fixed fee contracts are made in the period in which such losses are
     determined.

     MANAGEMENT ESTIMATES - The preparation of financial statements in
     conformity with generally accepted accounting principles requires
     management to make estimates and assumptions that affect the reported
     amounts of assets and liabilities and disclosure of contingent assets and
     liabilities at the date of the financial statements and reported amounts of
     revenue and expense during the reporting period. Actual results could
     differ from those estimates.

     NEW ACCOUNTING STANDARDS - The Company will adopt SFAS No. 130, "Reporting
     Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an
     Enterprise and Related Information" during 1998. The Company is evaluating
     the impact of these statements on its consolidated financial statements.

     ACQUISITIONS - On February 29, 1996, the Company acquired an environmental
     company in Dallas, Texas, for 15,000 shares of common stock and $239,000
     cash. The Company acquired assets of $541,000 and assumed liabilities of
     $257,000. Additionally, operating lease obligations totaling $112,000 were
     assumed. The revenue and expenses of the acquired business have been
     included in the financial statements since the acquisition date. Revenues
     and expenses for the two month period prior to the acquisition were not
     material.

     EMPLOYEE STOCK OPTIONS - When the exercise price of employee stock options
     equals or exceeds the market value of the stock at the date of grant, the
     company recognizes no compensation expense.

2.   ACCOUNTS RECEIVABLE
 
          Accounts receivable consist of unpaid billings for long-term
     percentage of completion type contracts, billings for short-term multiple
     unit contracts (completed contracts), and completed contract projects not
     yet billed. Accounts receivable not billed at December 31, 1997, total
     $521,000, for which all of the related contracts were completed. Retainage
     receivable at December 31, 1997, totaled $250,000.

          Accounts receivable at December 31, 1997, include amounts subject to
     claims of $461,000 arising from disputes. In the opinion of the Company's
     legal counsels, the Company has valid claims against the counterparties.

3.   UNCOMPLETED CONTRACTS

          Costs, estimated earnings and billings on uncompleted contracts are
     summarized as follows (in thousands):

                                      F-8

<PAGE>
 
<TABLE>
<CAPTION>
 
                                                              1997
                                                             ------
<S>                                                          <C>
     Costs incurred on uncompleted contracts                 $2,841
     Estimated earnings recognized                            1,086
                                                             ------
                                                              3,927
     Billings to date                                         1,861
                                                             ------
                                                             $2,066
                                                             ======
     Included in the accompanying balance sheet under the following caption:
     Costs and estimated earnings in excess of
     billings on uncompleted contracts                       $2,066 
                                                             ======
</TABLE> 
 
4.   NOTES PAYABLE
 
          Notes payable at December 31, 1997, consist of the following (in
     thousands):
<TABLE> 
<CAPTION> 
<S>                                                                                  <C> 
     Revolving line of credit of $3,000,000 bearing interest at the prime rate
          published in The Wall Street Journal plus 1.5% floating ( 10.0% at
                           -------------------
          December 31, 1997), payable on July 31, 1998, with interest payable
          monthly. The line is collateralized by accounts receivable,
          inventory, and equipment.                                                   $2,650
 
     Note payable to a bank bearing interest at the prime rate published in
          The Wall Street Journal plus 1.5% floating (10.0% at December 31,
              -------------------
          1997), payable in monthly installments of $10,624
          including interest with the final installment due July 2000. The note
          is collateralized by real estate, receivables,
          inventory, and equipment.                                                      466

     Notes payable bearing interest at rates from 5.9% to 10%, payable in
          monthly installments aggregating $13,313 including interest with
          various maturity dates through January 2001.  The notes are
          collateralized by vehicles.                                                    342
                                                                                     -------
                                                                                     $ 3,458 
 
     Less current portion                                                             (2,870)
                                                                                     -------
     Total long-term notes payable                                                   $   588            
                                                                                     =======
</TABLE>
          Maturities of long-term debt over the next five years are as follows:
     1998 - $2,870,000, 1999 - $224,000, 2000 - $358,000, 2001 - $6,000.

          The Company extended its Revolving line of credit in April 1997, and
     the extended loan maturity was May 31, 1997. The amount of the line was
     decreased from $2.1 million to $2.0 million pending the transfer of the
     Company's banking relationships from Boatmen's National Bank of Oklahoma to
     Bank of Oklahoma. The interest rate on the loan during the Boatmen's
     extension was national prime plus 3 percentage points. On July 15, 1997,
     the Company executed loan documents and transferred its line of credit loan
     and various equipment loans to the Bank of Oklahoma. The line of credit was
     increased to $2.5 million with an interest rate of Wall Street Journal
                                                        -------------------
     prime plus 1.5 percentage points. The Company used $2.028 million of the
     new line to payoff the line of credit at Boatmen's. The line of credit was
     increased to $3.0 million on December 2, 1997. All other terms and
     conditions remained unchanged. Various equipment loans at Boatmen's
     totaling $391,000 were consolidated into a Bank of Oklahoma $500,000 loan
     on equipment with an interest rate of Wall Street
                                           -----------

                                      F-9

<PAGE>
 
     Journal prime plus 1.5%. The loan is amortized on a five year term with
     -------
     monthly payments. A balloon payment at maturity is required on July 31,
     2000. The monthly payment is $10,624.

          The Revolving line of credit and note payable to a bank contain
     certain restrictive covenants. The Company is restricted from paying
     dividends and is limited as to the incurrence of additional debt and as to
     capital expenditures and other acquisitions. In addition, the Company must
     maintain minimum leverage and current ratios. The Company's president and
     executive vice president have guaranteed the repayment of the Revolving
     line of credit and note payable to a bank.

5.   COMMITMENTS AND CONTINGENCIES

          Total rent expense for the years ended December 31, 1997 and 1996, was
     $165,000 and $125,000, respectively. Rental commitments under noncancelable
     leases are $48,000 in 1998 and $21,000 in 1999.

6.   STOCK OPTION PLANS
 
          Effective April 22, 1994, the Company established The National
     Environmental Service Co. 1994 Employee Stock Plan (the "Plan"), the
     purpose of which is to help the Company retain key employees and to reward
     them for contributing to the Company's success. On the same date, the
     Company also established The National Environmental Service Co. Director
     Stock Option Plan (the "Director Plan"), the purpose of which is to provide
     an incentive to non-employee Directors of the Company so they may increase
     their interest in the success of the Company and to encourage them to
     remain as Directors by providing them an opportunity to obtain or increase
     their equity interest in the Company. The total amount of common stock
     authorized and reserved for issuance under the Employee Plan is 573,876
     shares. At December 31, 1997, options to purchase 238,000 common shares at
     $3.00 per share are outstanding. A total of 75,200 options were
     exercisable. Under the Director Plan, 150,000 shares of common stock have
     been reserved for issuance and no options are outstanding as of December
     31, 1997.

          SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
     provides an alternative method of determining compensation cost for stock
     options, which alternative method may be adopted at the option of the
     Company. Had compensation cost for these plans been determined consistent
     with SFAS 123, the Company's net income and EPS would have been reduced to
     the following pro forma amounts:
<TABLE> 
<CAPTION>
 
                                                       1997             1996 
<S>                                                 <C>               <C> 
     Net income (loss):
        As reported                                 $ 746,000        $(371,000)
        Pro Forma                                     625,000         (451,000)
     Basic EPS:
        As reported                                 $    0.12        $   (0.06)
        Pro Forma                                        0.10            (0.08) 
     Diluted EPS:
        As reported                                 $    0.11        $   (0.06)
        Pro Forma                                   $    0.09        $   (0.08)
</TABLE> 
 
                                     F-10

<PAGE>
 
     A summary of the status of the Company's stock options at December 31, 1997
     and 1996, and changes during the years then ended is presented below:
<TABLE> 
<CAPTION> 
                                                                          1997                          1996
                                                                   -------------------------------------------------------
                                                                              Wtd. Avg.                         Wtd. Avg.
                                                                   Shares    Exer. Price          Shares       Exer. Price
                                                                   -------------------------------------------------------
    <S>                                                            <C>        <C>                <C>            <C> 
     Outstanding at beginning of year                               238,000      $3.00           318,000          $3.00
     Granted                                                         40,000      $3.00            20,000          $3.00
     Forfeited                                                      (40,000)     $3.00          (100,000)         $3.00 
                                                                    -------------------------------------------------------
     Outstanding at end of year                                     238,000      $3.00           238,000          $3.00
     Exercisable at end of year                                      75,200      $3.00            43,600          $3.00
                                                                    =======================================================
     Weighted average fair value of options granted                              $2.34                            $1.38
                                                                                 =====                            =====
</TABLE>

     Weighted average remaining contractual life        7.5 years
 
          The fair value of each option grant is estimated on the date of grant
     using the Black-Scholes option pricing model with the following weighted-
     average assumptions used for grants in 1997 and 1996, respectively: risk
     free interests rates of 6.37% and 6.89%; expected dividend yields of 0%;
     expected lives of 10 years in 1997 and 1996; and expected volatility of
     107% and 110%.

          At December 31, 1997 and 1996, 723,876 and 577,192 shares of common
     stock were reserved for the exercise of stock awards of which 485,876 and
     339,192 shares were available for future grants.

7.   SHAREHOLDERS' EQUITY
 
          The Company secured $1,000,000 from a private placement of one million
     shares of common stock during the second quarter of 1997. As part of the
     private placement, the Company granted options to purchase 530,000 shares
     of common stock at $1.50 per share exercisable at any time prior to April
     30, 1999. The Company secured $540,000 when options for 450,000 shares were
     exercised at $1.20 per share (adjusted from $1.50) on December 8, 1998.

          The Board of Directors declared a dividend of three cents per share to
     shareholders of record on February 15, 1996. The dividend was paid March 1,
     1996.

8.   INCOME TAXES
 
          The tax effects of temporary differences that give rise to the
     deferred tax assets and liabilities at December 31, 1997, are as follows:

     Deferred tax assets:
          Allowance for doubtful accounts                            $19
          Other                                                       17
                                                                  ------
          Total deferred tax assets                                   36

     Deferred tax liability:
          Financial basis in excess of tax basis of fixed assets    (149)
                                                                  ------
     Net deferred tax liability                                    $(113)
                                                                  ======

                                     F-11

<PAGE>
 
          The following table summarizes the significant differences between the
     U.S. Federal statutory tax rate and the Company's effective tax rate for
     financial statement purposes.

<TABLE>
<CAPTION>
 
                                        1997                  1996   
                                        ----                  ----
<S>                                     <C>                    <C>  
     Statutory tax rate                 34.0%                 34.0%
     State income taxes, net             2.4%                  -
     Other                               1.6%                 (3.9)
                                        38.0%                 30.1%
                                        ====                  ====
</TABLE> 
 
9.   RELATED PARTIES
 
          The Company purchases laboratory analysis services from Lab One
     Analytical, Inc. ("Lab One"), a company affiliated through common
     ownership. For the years ended December 31, 1997 and 1996, purchases of
     these services amounted to $217,000 and $431,000, respectively included in
     costs and expenses. The Company acquired Lab One subsequent to December 31,
     1997. See Note 11.

          The Company leases office space from a partnership owned by the
     Company's two principal shareholders. Payments under this lease amounted to
     $88,000 in 1997 and $77,000 in 1996 included in selling, general, and
     administrative expenses. The Coompany acquired the office space subsequent
     to December 31, 1997. See Note 11.


          In 1996, the Company borrowed $400,000 from its two principal
     shareholders and repaid $111,000. In 1997, the Company repaid notes payable
     of $257,000 to the two principal shareholders.

          During 1997 and 1996, the Company's revenues included sales of $86,000
     and $234,000 respectively to entities with which two Directors of the
     Company are affiliated.

10.  NET INCOME PER SHARE

          Basic and diluted EPS for the years ended December 31, 1997 and 1996,
     were computed as follows:

<TABLE>
<CAPTION>
 
                                                                        1997                     1996
                                                                      --------                 --------
        <S>                                                           <C>                      <C> 
        Basic EPS Computation:
           Net income (loss) available to common
            stockholders                                               $   746                  $ (371)
        Weighted average number of common
            shares outstanding                                           6,486                   5,775
                                                                        ------                  ------
         Basic EPS                                                       $0.12                  $(0.06)
                                                                        ======                  ======
 
         Diluted EPS Computation:
         Net income (loss) available to common
            stockholders                                                $  746                   $(371)
         Average number of common shares
            outstanding                                                  6,486                   5,775
         Incremental number of shares for
            assumed exercise of options                                    124                      -
                                                                        ------                  ------
         Total shares                                                    6,610                   5,775 
                                                                        ------                  ------
         Diluted EPS                                                    $ 0.11                  $(0.06)
                                                                        ======                  ======
</TABLE>
 
                                     F-12

<PAGE>
 
          Outstanding stock options to purchase common stock with an exercise
     price greater than the average market price of common stock were not
     included in the computation of diluted EPS for 1996. The balance of such
     options was 238,000 with an exercise price of $3.00 per share.

11.  SUBSEQUENT EVENTS
 
          The Company acquired Lab One on January 30, 1998, for $75,000 cash and
     225,000 shares of the Company's common stock, a total purchase price of
     $750,000.

          On February 27, 1998, the Company acquired the office building,
     warehouse and lot on which the Company's corporate offices are located. The
     purchase price was $600,000, and the Company secured a loan from Citizens'
     Bank of Tulsa for $480,000 secured by a mortgage on the acquired real
     estate. The loan has a term of 7 years. The interest rate floats at 0.5%
     above Low New York Prime rate, and the current rate is 9.0% per annum. The
     Company paid 0.5% origination fee.

          Both Lab One and the real estate were purchased from Eddy Patterson
     and Albert McCutchan, the President and Executive Vice President of the
     Company following the completion of independent appraisals of the entities
     and the review and unanimous consent of the outside directors of the
     Company to the transactions and terms and conditions thereof.

          Due to common ownership, these transactions will be accounted for in a
     manner similar to the pooling of interests method in 1998. The combined
     unaudited revenues and expenses of the Company and the acquired entities
     during 1997 were $14,746,000 and $13,220,000, respectively. All
     transactions were with the Company. 

          In January 1998, the Company sold 400,000 shares of common stock at
     $2.00 per share and warrants to purchase 50,000 shares of common stock at
     $2.00 per share under a private placement arrangement with Peacock, Hislop,
     Staley & Given, Inc. Gross proceeds totaled $800,000. Net proceeds totaled
     $744,000.
                   
12.  QUARTERLY FINANCIAL DATA (UNAUDITED)
 
     Selected comparative fourth quarter data is as follows:
<TABLE> 
<CAPTION> 

                                                      1997                    1996  
                                                     -----                   ------      
<S>                                                  <C>                     <C> 
       Revenues                                      $4,552                   $2,774
       Costs and expenses                             4,247                    2,938
                                                     ------                   ------
       Operating income (loss)                          305                     (164)
       Interest expense                                  98                       79
                                                     ------                   ------
       Income (loss) before income taxes                207                     (243)
       Provision for income taxes (benefit)             113                      (57)
                                                     ------                   ------
       Net income (loss)                             $   94                    $(186)
                                                     ------                   ------
       Basic net income (loss) per common share      $ 0.01                   $(0.03)
                                                     ------                   ------
       Diluted net income (loss) per common share    $ 0.01                   $(0.03)                         
                                                     ======                   ======
</TABLE>

       In the fourth quarter of 1996, the Company substantially reduced its
       estimate of profit that will be realized on one of its long-term
       contracts, resulting in lower revenue recognition and an operating loss
       for the quarter.

                                     F-13

<PAGE>
 
                                  SIGNATURES

     In accordance with Section 13 or 15(d) of the Exchange Act, Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized,  March 20, 1998.

                                      NATIONAL ENVIRONMENTAL SERVICE CO.
 

                                      By: /s/ Eddy L. Patterson
                                         ---------------------------------------
                                              Eddy L. Patterson, President

     In accordance with the requirements of Section 13 or 15(d) of the Exchange
Act, this report has been signed below by the following persons, on behalf of
the Registrant and in the capacities and on the dates indicated.
<TABLE> 
<CAPTION> 
     Signatures                                   Title                        Date
     ----------                                   -----                        ---- 
<S>                                   <C>                                   <C>       
/s/ Eddy L. Patterson                   President, Chief Executive Officer    March 20, 1998
-------------------------------         and Director                                                                 
Eddy L. Patterson                                        
                               
/s/ Albert A. McCutchan                 Executive Vice President and          March 20, 1998
-------------------------------         Director                                         
Albert A. McCutchan                                      
                               
/s/Larry G. Johnson                     Secretary, Treasurer and Chief        March 20, 1998
-------------------------------         Financial Officer                                          
Larry G. Johnson                  
                               
/s/ Robert Watson                       Controller (Principal Accounting      March 20, 1998
-------------------------------         Officer)                                       
Robert Watson                                              
                               
/s/ E. R. Foraker                       Director                              March 20, 1998
-------------------------------
E.R. Foraker                   
                               
/s/ Jerry Danielson                     Director                              March 20, 1998
-------------------------------                               
Jerry Danielson                
                               
/s/ W. F. Simpson                       Director                              March 20, 1998
-------------------------------                               
W. F. Simpson
</TABLE> 

                                     F-14

                              
<PAGE>
 
                                   EXHIBITS

      10.11     Private Placement Agency Agreement between National
                Environmental Service Co. and Peacock, Hislop, Staley & Given,
                Inc. dated January 15, 1998; Amendment to the Placement Agency
                Agreement dated January 15, 1998; and First Supplement to the
                Private Placement Memorandum dated Janaury 12, 1998.

 
      10.12     National Environmental Service Co. Common Stock Purchase Warrant
                to Peacock, Hislop, Staley & Given, Inc. dated January 21, 1998.

      10.13     Purchase and Sale Agreement for sale of real estate dated
                January 30, 1998 between National Environmental Service Co. and
                McCutchan and Patterson, an Oklahoma general partnership.
 
      10.14     Citizens' Bank of Tulsa Credit Agreement dated February 27,
                1998.

      10.15     Agreement and Plan of Merger with respect to Lab One Analytical,
                Inc. dated January 30, 1998.

      21.1      Subsidiaries of National Environmental Service Co.

      27.1      Financial Data Schedule