<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, 1998

(  _  )       TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
              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 $18,304,000.
                                                             ------------
 
     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 26, 1999 was $6,882,208

The number of shares outstanding of each of the issuer's classes of common stock
as of February 26, 1999 is shown below:                 
                                                          NUMBER OF SHARES
          TITLE OF CLASS                                    OUTSTANDING
          --------------                                    -----------
     Common Stock, $.01 Par Value                           7,888,643
 
          DOCUMENTS INCORPORATED BY REFERENCE
          -----------------------------------
          Portions of the Proxy Statement for the Annual Meeting of Stockholders
of National
     Environmental Service Co. to be held May 20, 1999, 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 Hazardous and Solid Waste Amendment of 1984
("HASWA"), 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 Chairman 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 1998, the Company had
revenues of $18,304,000 and pre-tax income of $2,365,000. At the time of
purchase by Messrs. Patterson and McCutchan, the Company had eight full-time
employees and one office. At the end of 1998, the Company had 131 full-time
employees. In addition to the corporate office in Tulsa, Oklahoma, the Company
had regional offices in Oklahoma City, Oklahoma; Dallas, Texas; San Antonio,
Texas; Columbia, South Carolina; Largo, Florida; Greenville, North Carolina;
Pittsburgh, Pennsylvania; and South Charleston, West Virginia.

        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.

        The Company acquired the assets of a division of a company on July 1,
1998. This office is located in Columbia, South Carolina. The Company assumed
the remainder of the lease which has an expiration date of September 30, 2001.
Annual lease payments are $27,000 through September 30, 1999. Thereafter until
expiration of the lease the annual lease payments are $29,000.

        The Company established an office in Largo, Florida, on August 1, 1998.
Effective January 1, 1999, the Company acquired a company occupying the same
building and assumed the monthly rent payment of $1,328. The building is rented
on a month to month basis. The Largo company had a satellite office in South
Charleston, West Virginia, where the Company assumed the lease on a warehouse
building. The lease expires on May 31, 1999. Annual lease payments are $4,500.

        The Company established an office in Pittsburgh, Pennsylvania, on
October 1, 1998. The Company entered into a lease agreement that has an
expiration date of September 30, 1999. Annual lease payments are $10,200.

                                       1
<PAGE>
 
        The Company acquired the assets of a company located in Greenville,
North Carolina, as of January 11, 1999. The Company assumed the lease that has
an expiration date of June 1, 2001. Annual lease payments are $21,000.

        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. The Company has
division 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, fuel management and maintenance 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
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, grocery stores and
convenience stores with fueling facilities, 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 "turnkey" 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).

                                       2
<PAGE>
 
        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.

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 such as the building, canopy, and related
                         equipment.

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

Fueling Systems -
  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.

Fueling Systems -
  Equipment Sales        The Company has become a distributor for Wayne Fueling 
  and Service:           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.

Fueling Systems -
  Fuel Management        The Company has entered into agreements to provide 
  and Maintenance:       fuel management and maintenance for new entrants into
                         the automobile fueling business. The significant move
                         of the grocery store chains into provision of fueling
                         has given the Company an opportunity to provide a much
                         needed service to those companies that do not have the
                         experience, staff, or desire to manage their fuel
                         acquisitions, regulatory reporting, environmental
                         compliance, and maintenance. The Company believes this
                         to be a source of revenues that will continue beyond
                         the initial installation of equipment and related
                         facilities.

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

                                       3
<PAGE>
 
                         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.

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.

Environmental -
  Soil and Water         Often through the Company's performance of other 
  Remediation:           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.

MATERIAL CONTRACTS

        The Company has several contracts for the installation of turn-key
fueling systems installations for various owners: three sites for a grocery
store chain totaling $970,000, one site for a municipality totaling $495,000,
one site for a school district in the amount of $189,000, and one site for a
county government for $235,000. The Company has installed fueling systems for a
large Texas grocery chain for the last three years. Individual contracts are
issued for each of these sites as they are released for construction. The
Company expects to complete a number of these locations in 1999; however,
contracts will not be signed until the work is released. There are numerous
other contracts for the installation of cathodic protection, system upgrades,
and environmental remediation. Individually, these contracts are not significant
but represent a series of projects which have been verbally committed by various
companies.

                                       4
<PAGE>
 
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.

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 six and has several other
executives and division managers 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 10% 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 HASWA, and as implemented by EPA regulations, is
intended to protect human health and the environment from regulated substances,
including leaks or spills from underground storage tanks. The term "regulated
substances" 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

                                       5
<PAGE>
 
lining, piping and cathodic protection standards established by the EPA.
Required upgrading was to be completed by December 22, 1998. Some states have
extended the enforcement deadline until the first or second quarter of 1999.
However, a significant percentage of the sites did not meet the deadline and
will either be permanently closed and dismantled or closed pending completion of
work to meet current requirements. Owners of underground storage tanks also must
demonstrate their financial ability to pay for damages caused by spills or
leaks.

        States' regulations may be more stringent than 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 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

                                       6
<PAGE>
 
landfills.

DEPENDENCE ON MAJOR CUSTOMERS

         In 1998, the Company received 16 percent of its revenues from a major
oil company marketer and 14 percent of its revenue from one grocery store chain
in 1997. 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 (9 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 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

        As of February 26, 1999, the Company has 157 full-time employees and no
part-time employees. This number includes 6 senior managers, 10 division
managers, 12 field supervisors, 6 marketing employees, 16 full-time
professionals, 28 accounting/clerical/drafting personnel, and 79 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

                                       7
<PAGE>
 
        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 Chief Executive
Officer 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 obtained 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 8.25% per annum. The Company
paid a one-half percent origination fee.

        The real estate was purchased from Eddy Patterson and Albert McCutchan,
the Chief Executive Officer and Executive Vice President of the Company
following the completion of an independent appraisal of the real estate 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 4000 square feet building in San Antonio,
Texas, and was completed during the first quarter of 1995. At December 31, 1998,
a balance of $374,000 remained to be paid on the related bank note payable 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 $36,000. The lease expires on September 30, 2001.

        The Company established an office and leased space in Oklahoma City on
April 1, 1998. The annual lease payment is $13,000, and the lease expires on
March 31, 1999.

        The Company owns various vehicles, equipment, and real estate which were
purchased at a total cost of approximately $4,382,000. At December 31, 1998, the
Company had outstanding loans of approximately $4,548,000 principal amount
collateralized by the vehicles, equipment, real estate, and other assets. This
amount includes the balance owed under the line of credit agreement which was
$3,150,000 at December 31, 1998.

ITEM 3. LEGAL PROCEEDINGS.

        The Company is not a party to any litigation which, in the judgment of
the Company, would have a material adverse effect on its operations or financial
condition if adversely determined. However, due to the nature of its business,
it is, from time to time, and is currently, a party to certain legal proceedings
arising in the ordinary course of its business.

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

        None.

                                       8
<PAGE>
 
                                    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 Nasdaq SmallCap Market.
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> 
                  3/31/97                   $1.875            $0.875
                  6/30/97                    2.00               .625
                  9/30/97                    2.875             1.625
                  12/31/97                   4.375             2.375
          
                  Quarter
                  ended                     High              Low
                  -----                     ----              ---
                  3/31/98                   $3.375            $2.25
                  6/30/98                    2.75              1.50
                  9/30/98                    2.00              1.125
                  12/31/98                   2.00              1.375
</TABLE> 

        At December 31, 1998, there were 253 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 or
1998.

        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, 1998, TO THE
YEAR ENDED DECEMBER 31, 1997.

        The Company had revenues of $18,304,000 in 1998 compared to $14,746,000
in 1997, a 24% increase. Fueling systems installation and repair revenue
declined 8% in 1998 as compared to 1997. Fueling systems installation and repair
revenues in 1998 were $8,830,000 compared to $9,569,000 for

                                       9
<PAGE>
 
1997. The fueling systems installation and repair revenues decreased due to the
delay into 1999 of some planned installations and store owners' concentration of
resources on the upgrading of existing sites to meet December 1998 regulatory
deadlines. Cathodic Protection revenues increased 78% in 1998 as compared to
1997, or $6,355,000 in 1998 compared to $3,564,000 in 1997. The increase
resulted from increased purchases of cathodic protection kits by the Company's
distributor network and increases in the installation of cathodic protection
systems by the Company. The increased sales were caused by the December 1998
deadline for regulatory compliance by owners and operators of underground
storage tanks. Site assessment revenues were $1,553,000 in 1998 compared to
$576,000 in 1997, a 171% increase. The increase in site assessments and reports
resulted from the new offices established in Florida and South Carolina and the
additional site assessments being performed in Texas. Owners and operators of
underground storage tanks in Texas must have had corrective action plans in
place prior to the December 1998 Environmental Protection Agency deadlines in
order to avoid significant increases in their deductibles for clean-up of
contaminated sites. Remediation revenues increased 53% in 1998 compared to 1997,
or $1,186,000 compared to $776,000. The increase in remediation revenues
resulted from more field work in Texas and the addition of work produced by the
new offices in Oklahoma City, South Carolina and Florida. Sales of fueling
equipment and service increased to $878,000 in 1998 compared to $261,000 in
1997. The increase resulted from the continued growth of the Company's pump
service operation in Dallas, Texas. The operation was established in the second
quarter of 1997 and has grown steadily as new customers have been added.

        Costs and expenses in 1998 were $11,859,000 compared to $10,028,000 in
1997, an increase of 18%. Costs and expenses for 1998 represented 65% of total
revenue for the year compared with 68% for 1997. The decrease in percentage of
costs and expenses in 1998 resulted from increased sales of cathodic protection
goods and services, a revenue category with a relatively high gross margin. The
percentage of increase in labor costs was 26%, only slightly higher than the 24%
growth in revenues during the same period. Labor costs for 1998 were $2,465,000
compared to $1,952,000 for 1997. Payments to subcontractors increased 161% to
$3,826,000 in 1998 compared to $1,463,000 in 1997. Supplies and materials cost
decreased 23% in 1998 to $3,778,000 compared to $4,922,000 for 1997. The
increase was due to the significantly greater use of subcontractors on the
greater volume of turn-key fueling systems installations performed in 1998
compared to 1997. Additionally, the subcontracts required the subcontractors to
provide supplies and materials. This requirement caused the subcontractor
expense category to increase while at the same time it caused a decrease in
supplies and materials expense. Depreciation expense increased 16% due to the
significant increase in vehicles and equipment added to the company during 1998.
Depreciation expense was $333,000 in 1998 compared to $287,000 in 1997.
Equipment rental expense declined $52,000 from $261,000 in 1997 to $209,000 in
1998. This reduction was due to the greater provision of equipment by the
subcontractors in 1998 compared to 1997.

        Selling, general and administrative expenses were $3,715,000 in 1998
compared to $3,198,000 in 1997, an increase of 16%. The $517,000 increase was
due to the addition of offices in Oklahoma City, Florida, South Carolina, and
Pennsylvania during the last half of 1998. Salaries accounted for $221,000 of
the $517,000 increase. Salaries increased 13% to $1,899,000 in 1998 compared to
$1,678,000 in 1997. Office supplies and postage was $186,000 in 1998 compared to
$114,000 in 1997. Telephone expenses were $184,000 in 1998 compared to $112,000
in 1997. Both telephone expense and office supplies and postage increases were
related to the increased volume of sales as well as the addition of four offices
in the last half of 1998. Bad debt expense declined to $21,000 in 1998 compared
to $79,000 in 1997. The reserve for bad debt level for 1998 was maintained
without the need for the level of bad debt expense required in 1997. General
insurance increased $66,000 in 1998 compared to 1997 due to

                                      10
<PAGE>
 
increased workers compensation insurance premiums resulting from increased
employee levels and volume of work performed. General insurance expense was
$260,000 in 1998 compared to $194,000 in 1997.

        Interest expense is higher due to the larger debt balance in 1998
resulting from funding for long-term contracts, additional working capital, and
purchases of machinery and equipment. Interest expense for 1998 was $407,000
compared to $370,000 in 1997.

CAPITAL RESOURCES AND LIQUIDITY

        Cash on hand at the end of 1998 was $152,000 compared to $93,000 at the
end of 1997. Net cash provided by operating activities was $28,000 in 1998
compared to net cash used by operating activities of $1,254,000 in 1997. The
increase in the net cash provided was due to an increase in net income of
$688,000 ($1,470,000 in 1998 compared to $782,000 in 1997) and a decrease in
costs and estimated earnings in excess of billings of $587,000 ($1,479,000 at
the end of 1998 compared to $2,066,000 at the end of 1997). These increases in
net cash provided were partially offset by increases in accounts receivable of
$2,743,000. The increase in accounts receivable is due to the 24% increase in
revenues and the reduction in costs and estimated earnings in excess of
billings.

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 8.25% per annum. The Company paid a 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 were accounted for in a
manner similar to the pooling of interests method in 1998. The combined revenues
and expenses of the Company and the acquired entities during 1997 was
$14,746,000. 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 $712,000.

        On July 2, 1998, Bank of Oklahoma renewed the Line of Credit Loan which
was to mature on July 31, 1998. The amount of the line was increased from $3
million to $4.5 million at a rate based on Chase Manhattan Prime plus 3/4th of 1
percent. The maturity is July 31, 1999. Additionally, Bank of Oklahoma has
committed to advancing 80% of the purchase price (up to $700,000 on individual
notes) for the purchase of equipment, machinery, and vehicles.

                                      11
<PAGE>
 
        On July 15, 1998, the Company purchased certain assets, assumed certain
leases, and hired the employees of Steffen, Robertson and Kirsten (U.S.), Inc.'s
Columbia, South Carolina, office. The purchase price was $472,686 plus 12,500
shares of the Company's common stock. The assets purchased included fixed
assets, accounts receivable, and accrued revenues for work performed but not
invoiced. The effective date of the acquisition was June 26, 1998.

        The Company continued to make periodic debt repayments during this
period. The Company has no commitments for material capital expenditures.

YEAR 2000

        The Year 2000 issue represents a potentially serious information systems
problem because many software applications and operation systems written in the
past may not properly recognize calendar dates beginning in the Year 2000. This
problem could force computers to either shut down or provide incorrect data or
information. In consultation with its software and hardware providers, the
Company began the process of identifying the changes required to its major
financial/administrative systems and hardware in October of 1998. The Company is
in the process of testing its computer hardware and software for Year 2000
compliance and expects to complete this testing by the end of the first quarter
of 1999. The Company is also in the process of surveying its vendors and service
suppliers.

        The Company believes that the costs to address its Year 2000 compliance
issues will not be significant. Substantially all of the Company's computer
hardware and software are "off-the-shelf" versions which the Company believes
can be upgraded or replaced as required. The cost for such replacements is
currently estimated to be approximately $15,000.

        The Company's principal exposure will be (1) in its inability to process
accounting transactions and invoice customers and (2) the ability of its vendors
and service suppliers to provide critical components or services to the Company.
While the Company believes it will not encounter material problems in either
respect, it is in the process of developing contingency plans to implement a
manual system for accounting and invoicing functions and identifying alternative
sources for the goods and services that are critical to the Company. The Company
believes that its customer base is sufficiently broad and varied and that it
will not encounter material difficulties if the ability of some of them to do
business were substantially curtailed due to Year 2000 problems. Additionally,
the fueling systems industry tends to utilize electronics and systems which are
not particularly date sensitive.

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.

                                      12
<PAGE>
 
                                   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 1999 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 1999 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 1999 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 1999 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
                       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
                4.2    National Environmental Service Co. Common Stock Purchase
                       Warrant to Peacock, Hislop, Staley & Given, Inc. dated
                       January 21, 1998 (incorporated by 

                                      13
<PAGE>
 
                       reference to Exhibit 4.2 to the 1997 10-KSB).
               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).
               10.9    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, (incorporated by reference to
                       Exhibit 10.11 to the Registrant's Form 10-KSB for the
                       year ended December 31, 1997, the "1997 10-KSB").
               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 (incorporated by reference to Exhibit 10.13
                       to the 1997 10-KSB).
               10.14   Citizens' Bank of Tulsa Credit Agreement dated February
                       27, 1998 (incorporated by reference to Exhibit 10.14 to
                       the 1997 10-KSB).
               10.15   Agreement and Plan of Merger with respect to Lab One
                       Analytical, Inc. dated January 30, 1998 (incorporated by
                       reference to Exhibit 10.15 to the 1997 10-KSB).
               10.16   Copy of Amendment Two to Revolving Credit and Term Loan
                       Agreement dated as of July 2, 1998 and Promissory Note
                       between the Company and Bank of Oklahoma, N.A.
                       (incorporated by reference to Exhibit 10.16 on Form 10-
                       QSB for the quarter ended June 30, 1998).
               10.17   Copy of Purchase Agreement dated July 15, 1998 to be
                       effective as of June 26, 1998 between National
                       Environmental Service Company and Steffen, Robertson &
                       Kirsten (U.S.), Inc. (incorporated by reference to
                       Exhibit 10.17 on Form 10-QSB for the quarter ended June
                       30, 1998).
               10.18   Definitive Agreement dated December 16, 1998, containing
                       the terms of the acquisition of certain assets and the
                       assumption of certain liabilities of THH Alpha, Inc., THH
                       Services, LTD., UTTS Services, LTD., UTTS, Inc., and
                       Carolina Drilling Services, Inc.
               10.19   Agreement for Acquisition of certain assets and the
                       assumption of certain liabilities of National
                       Environmental Corporation, dated December 18, 1998.
               21.1    Subsidiaries of National Environmental Service Co.
               27.1    Financial Data Schedule

        (B)    REPORTS ON FORM 8-K

               None.

                                      14
<PAGE>
 
                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                      Page
                                                                      ----
<S>                                                                   <C> 
                                                                          
Report of Independent Auditors                                        F-2 
                                                                          
Consolidated Balance Sheet as of December 31, 1998                    F-3 
                                                                          
Consolidated Statements of Income for the Years Ended                     
   December 31, 1998 and 1997                                         F-4 
                                                                          
Consolidated Statement of Changes in Shareholders' Equity                 
   for the Years Ended December 31, 1998 and 1997                     F-5 
                                                                          
Consolidated Statements of Cash Flows for the Years Ended                 
   December 31, 1998 and 1997                                         F-6 
                                                                          
Notes to Consolidated Financial Statements                            F-7  
</TABLE>

                                      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, 1998; 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, 1998; 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 12, 1999

                                      F-2
<PAGE>
 
                      NATIONAL ENVIRONMENTAL SERVICE CO.
                          CONSOLIDATED BALANCE SHEET
                               December 31, 1998
                           (In Thousands of Dollars)

                                    ASSETS
                                    ------

<TABLE>
<CAPTION>
<S>                                                                         <C>                           
Current assets:
     Cash                                                                   $   152
     Accounts receivable:   
      Trade, net of allowance for doubtful accounts of $73                    7,915  
     Costs and estimated earnings in excess of billings on
      uncompleted contracts                                                   1,479  
     Materials and supplies                                                   1,061  
     Prepaid expenses                                                            32
                                                                            -------
     Total current assets                                                    10,639
                                                                            -------
Property and equipment, at cost:
     Land                                                                        50
     Buildings and improvements                                                 608
     Vehicles                                                                 2,143
     Testing, drilling and other equipment                                      618
     Furniture, fixtures and other                                              963
                                                                            -------
                                                                              4,382
     Less accumulated depreciation                                            1,956
                                                                            -------
     Property and equipment, net                                              2,426
                                                                            -------
Other                                                                           107
                                                                            ------- 
Total assets                                                                $13,172
                                                                            =======
</TABLE>

                     LIABILITIES AND SHAREHOLDERS' EQUITY
                     ------------------------------------

<TABLE>
<CAPTION>
<S>                                                                         <C>
Current liabilities:
     Current maturities of long-term obligations                            $ 3,541
     Accounts payable                                                         1,554
     Accrued income taxes                                                       911 
     Other accrued liabilities                                                  209 
                                                                            ------- 
     Total current liabilities                                                6,215 
                                                                            -------  
Long-term notes payable                                                       1,007 
                                                                            -------   
Deferred income taxes                                                           197 
                                                                            -------    
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 7,888,643 shares                                                    79   
     Additional paid-in capital                                               3,948
     Retained earnings                                                        1,966
     Common stock in Treasury, at cost, 122,991 shares                         (240)
                                                                            -------    
     Total shareholders' equity                                               5,753
                                                                            -------    
Total liabilities and shareholders' equity                                  $13,172
                                                                            =======
</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, 1998 and 1997
              (In Thousands of Dollars except per share amounts)

<TABLE>
<CAPTION>
                                          1998           1997  
                                        -------        ------- 
<S>                                     <C>            <C>     
Revenue:                                                       
  Fueling Systems                       $ 8,330        $ 9,569 
  Cathodic protection                     6,355          3,564 
  Site assessments                        1,553            576 
  Remediation                             1,186            776 
  Other                                     880            261 
                                        -------        ------- 
Total revenue                            18,304         14,746 
                                                               
Costs and expenses                       11,859         10,028 
Selling, general and                                           
      administrative expenses             3,715          3,198 
                                        -------        ------- 
Income from operations                    2,730          1,520 
                                                               
Other income (expense):                                        
      Interest                             (407)          (370)
      Other, net                             42            111 
                                        -------        ------- 
Income before income taxes                2,365          1,261 
                                        -------        ------- 
 Provision for taxes on income                                 
      Current                               817            382 
      Deferred                               78             97 
                                        -------        ------- 
                                            895            479 
                                        -------        ------- 
Net income                              $ 1,470        $   782 
                                        =======        ======= 
Basic net income per share              $  0.19        $  0.12 
                                        =======        ======= 
Diluted net income per share            $  0.19        $  0.11 
                                        =======        =======  
</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, 1998 and 1997
                           (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, 1996        5,801,143       29,216    $   58     $ 1,746     $   94   $  (76)   $ 1,822  
                                                                                                                                    

Shares sold                    1,450,000                     15       1,488                          1,503                          

                                                                                                                                    

Shares issued to acquire                                                                                                            

related party business                                                                                                              

and building                     225,000                      2                   (344)               (342)
                                                                                                                                    

Shares issued                                                                                                                       

employee awards                               (16,840)                                       28         28 
                                                                                                                                    

Net income                                                                         746                 746 
                               ---------      -------    ------     -------     ------   -------   ------- 
                                                                                                                                    

Balance at Dec 31, 1997        7,476,143       12,376        75       3,234        496      (48)    3 ,757                          

                                                                                                                                    

Shares sold                      400,000                      4         695                            699                
                                                                                                                                    

Shares issued to                                                                                                                    

acquire business                  12,500                      -          19                             19                          

                                                                                                                                    

Purchase of                                                                                                                         

Treasury Stock                                110,615                                      (192)      (192)                         

                                                                                                                                    

Net income                                                                       1,470               1,470                          

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

Balance at Dec 31, 1998        7,888,643      122,991    $   79     $ 3,948     $1,966   $ (240)   $ 5,753  
                               =========      =======    ======     =======     ======   =======   =======     
</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, 1998 and 1997
                           (In Thousands of Dollars)

<TABLE>
<CAPTION>
 
                                                                 1998                       1997    
                                                              -----------                 --------  
<S>                                                           <C>                         <C>       
Operating activities:                                                                               
   Net income                                                   $ 1,470                   $   782   
   Adjustments to reconcile net income to net                                                       
    cash provided by (used in) operating activities:                                                
      Depreciation and amortization                                 388                       317   
      Deferred taxes                                                 78                        97   
      Stock issued as employee compensation                           -                        28   
      Change in:                                                                                    
        Accounts receivable                                      (2,743)                   (1,696)  
         Costs and estimated earnings in excess                                                     
          of billings on uncompleted contracts                      860                    (1,437)  
        Materials and supplies                                      (67)                     (321)  
        Prepaid expenses                                             50                       (49)  
        Accounts payable                                           (524)                      671   
        Billings in excess of costs and estimated                                                   
          earnings on uncompleted contracts                           -                       (68)  
        Accrued liabilities                                         531                       422   
        Other                                                       (15)                        -   
                                                                -------                   -------   
Net cash provided by (used in) operating activities                  28                    (1,254)  
                                                                -------                   -------   
Investing activities:                                                                               
   Acquisition of  business, net of cash acquired                  (473)                     (721)  
   Purchases of property and equipment                             (590)                     (556)  
   Proceeds from sales of property and equipment                     11                         5   
                                                                -------                   -------   
   Net cash used in investing activities                         (1,052)                   (1,272)  
                                                                -------                   -------   
Financing activities:                                                                               
   Proceeds from issuance of common stock                           699                     1,504   
   Proceeds from notes payable and long-term                                                        
      obligations                                                 4,336                     5,040   
   Decrease in notes payable to related parties                     (31)                     (257)  
   Principal payments on notes payable and                                                          
      long-term obligations                                      (3,729)                   (3,787)  
   Purchase of common shares                                       (192)                        -   
                                                                -------                   -------   
   Net cash provided by financing                                                                   
      activities                                                  1,083                     2,500   
                                                                -------                   -------   
Increase (decrease) in cash                                          59                       (26)  
Cash, beginning of year                                              93                       119   
                                                                -------                   -------   
Cash, end of year                                               $   152                   $    93   
                                                                =======                   =======    
</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,
     installation and removal of storage tanks, and the installation of fueling
     systems and related facilities. The Company is headquartered in Tulsa,
     Oklahoma, and has division facilities in Oklahoma City, Oklahoma; Dallas
     and San Antonio, Texas; Largo, Florida; Columbia, South Carolina;
     Greenville, North Carolina; South Charleston, West Virginia; and
     Pittsburgh, Pennsylvania.

     CONSOLIDATION - The Company owns 100% of Fuel Recovery Systems, Inc. and
     Lab One Analytical, Inc. ("Lab One"). The financial statements of Fuel
     Recovery Systems, Inc. and Lab One 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, 1998 and 1997,
     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, 1998. 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

                                      F-7
<PAGE>
 
     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. One commercial customer accounted for 16% of sales in 1998
     and a different customer for 14% of sales in 1997.
 
     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 adopted SFAS No. 130, "Reporting
     Comprehensive Income," in 1998. The Company has no comprehensive income
     items for the two years in the period ended December 31, 1998. Therefore,
     net income equals comprehensive income. The Company will adopt SFAS No.
     133, "Accounting for Derivative Investments and Hedging Activities" during
     1999. Currently, the company does not engage in hedging activities or
     transactions involving derivatives.

     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.   SUPPLEMENTAL CASH FLOW INFORMATION

<TABLE>
<CAPTION>
                                                     1998   1997
                                                     ----   ----
     <S>                                             <C>    <C>    
     Cash paid for interest                          $ 405  $ 304  
                                                     =====  =====  
     Cash paid for income taxes                      $ 319      0
                                                     =====  =====
     Non-cash investing and financing activities:
          Issuance of common stock in connection
              with business acquisitions             $  19  $ 605
          Issuance of stock option and warrants          
          for services                               $ 175  $  51
                                                     =====  =====
</TABLE>

3.   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.
Retainage receivable at December 31, 1998, totaled $343,000.

          Accounts receivable at December 31, 1998, include amounts subject to
claims of $660,000 arising from disputes. The Company is suing to collect
various collection matters. In the opinion of the Company's legal counsel, the
Company has valid claims against the defendants.

                                      F-8
<PAGE>
 
4.   UNCOMPLETED CONTRACTS

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

<TABLE>
<CAPTION>
                                                                            1998
                                                                           ------
     <S>                                                                   <C>
     Costs incurred on uncompleted contracts                               $  580                                            
     Estimated earnings recognized                                          1,254
                                                                           ------
                                                                            1,834
     Billings to date                                                         355
                                                                           ------
                                                                           $1,479
                                                                           ======

     Included in the accompanying balance sheet under the following caption:
     Costs and estimated earnings in excess of
        billings on uncompleted contracts                                  $1,479 
                                                                           ======
 
</TABLE> 

5.   NOTES PAYABLE

<TABLE> 
     <S>                                                                                                 <C> 
          Notes payable at December 31, 1998, consist of the following (in thousands):
 
     Revolving line of credit of $4,500,000 bearing interest at the prime rate published
          in The Wall Street Journal plus .75% floating ( 8.5% at December 31, 1998),
             -----------------------
          payable on July 31, 1999, with interest payable monthly.  The line is
          collateralized by accounts receivable, inventory, and equipment.                               $ 3,150
 
     Note payable to a bank bearing interest at the prime rate published in The Wall
                                                                            --------
          Street Journal plus .75% floating (8.5% at December 31, 1998), payable in
          --------------
          monthly installments of $10,257 including interest with the final
          installment due July 2000.  The note is collateralized by real estate,
          receivables, inventory, and equipment.                                                             374
 
     Note payable to bank bearing interest at Low New York Prime rate plus .5% floating
          (8.25% at December 31, 1998), payable in monthly installments of $7,774
          including interest with the final installment due March 2005. The loan is
          collateralized by real estate and equipment.                                                       443
 
     Notes payable bearing interest at rates from 5.9% to 10%, payable in monthly
          installments aggregating $25,493 including interest with various maturity dates
          through December 2001.  The notes are collateralized by vehicles.                                  581
                                                                                                         -------
                                                                                                           4,548
 
     Less current portion                                                                                 (3,541)
                                                                                                         -------
     Total long-term notes payable                                                                       $ 1,007    
                                                                                                         =======
</TABLE>

          Maturities of long-term debt over the next five years are as follows:
1999- $3,541,000, 2000 - $542,000, 2001 - $207,000, 2002 - $72,000, 2003 -
$78,000.

     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

                                      F-9
<PAGE>
 
     and as to capital expenditures and other acquisitions. In addition, the
     Company must maintain minimum leverage and current ratios.

6.   COMMITMENTS AND CONTINGENCIES

          Total rent expense for the years ended December 31, 1998 and 1997, was
     $66,000 and $67,000, respectively. Rental commitments under noncancelable
     leases are $94,000 in 1999, $82,000 in 2000, and $56,000 in 2001.

          The Company is not a party to any litigation which, in the judgment of
     the Company, would have a material adverse effect on its operations or
     financial condition if adversely determined. However, due to the nature of
     its business, it is, from time to time, and is currently, a party to
     certain legal proceedings arising in the ordinary course of its business.

7.   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 638,864
     shares. At December 31, 1998, options to purchase 190,000 common shares at
     $3.00 per share and 65,000 shares at $2.00 per share are outstanding. A
     total of 131,000 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, 1998.

          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> 
                                           1998           1997      
                                        --------------------------
     <S>                                <C>             <C> 
     Net income (loss):
        As reported                      $1,470,000     $782,000
        Pro Forma                         1,405,000      703,000
     Basic EPS:                          
        As reported                      $0.19          $0.12
        Pro Forma                        $0.18          $0.10
     Diluted EPS:                        
        As reported                      $0.19          $0.11
        Pro Forma                        $0.18          $0.10
</TABLE> 

                                      F-10
<PAGE>
 
     A summary of the status of the Company's stock options at December 31, 1998
     and 1997, and changes during the years then ended is presented below:

<TABLE> 
<CAPTION> 
                                                                       1998                         1997               
                                                             ---------------------------------------------------
                                                                          Wtd. Avg.                  Wtd. Avg.
                                                              Shares      Exer. Price    Shares      Exer. Price
                                                             --------------------------------------------------- 
     <S>                                                     <C>         <C>             <C>        <C> 
     Outstanding at beginning of year                         238,000    $3.00           238,000    $3.00
     Granted                                                   75,000    $2.00            40,000    $3.00
     Forfeited                                               ( 58,000)   $2.83           (40,000)   $3.00    
                                                             ----------------------------------------------- 
     Outstanding at end of year                               255,000    $2.75           238,000    $3.00
     Exercisable at end of year                               131,000    $2.73            75,200    $3.00     
                                                              ==============================================
     Weighted average fair value of options granted                      $1.03                      $2.34
                                                                         =====                      =====

     Weighted average remaining contractual life              6.1 years
</TABLE> 

     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 1998 and 1997, respectively: risk free
     interests rates of 5.51% and 6.37%; expected dividend yields of 0%;
     expected lives of 10 years in 1998 and 1997; and expected volatility of 77%
     and 107%.

     At December 31, 1998 and 1997, 788,864 and 723,876 shares of common stock
     were reserved for the exercise of stock awards of which 638,864 and 485,876
     shares were available for future grants.

8.   SHAREHOLDERS' EQUITY

          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
     $712,000.

          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, 1997.

9.   INCOME TAXES

          The tax effects of temporary differences that give rise to the
     deferred tax assets and liabilities at December 31, 1998, are as follows:

<TABLE> 
     <S>                                                              <C> 
     Deferred tax liability:
             Financial basis in excess of tax basis of fixed assets   $(209)
             Other                                                       12
                                                                      ------
             Net deferred tax liability                               $(197)
                                                                      ======
</TABLE> 

                                     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> 
                                             1998           1997 
                                             -----          ----- 
     <S>                                     <C>            <C>  
     Statutory tax rate                      34.0%          34.0%
     State income taxes, net                  2.5%           2.4%
     Other                                    1.3%           1.6%
                                             -----          -----
                                             37.8%          38.0%
                                             =====          ===== 
</TABLE> 

10.  RELATED PARTIES

          The Company purchases laboratory analysis services from Lab One. On
     January 30, 1998, the Company acquired Lab One 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 land on which the Company's corporate offices are located.
     The purchase price was $600,000.

          Lab One and the real estate were purchased from the Company's
     principal shareholders (the Chairman and CEO and Executive Vice President)
     following completion of independent appraisals and the unanimous consent of
     the Company's outside directors.

          Due to common ownership interests in the Company and acquired
     businesses, the business combinations have been accounted for in a manner
     similar to the pooling of interest method. The 1997 financial statements
     have been restated by decreasing costs and expenses $101,000, decreasing
     selling, general and administrative expenses $17,000, increasing interest
     expense by $62,000 and income taxes by $21,000, and increasing net income
     by $36,000. The assets were recorded by the Company at the cost basis of
     the principal shareholders. The excess of the purchase price over the
     recorded cost of the assets acquired of $344,000 is reported as a reduction
     in shareholders' equity.

11.  NET INCOME PER SHARE

          Basic and diluted EPS for the years ended December 31, 1998 and 1997,
     were computed as follows:

<TABLE> 
<CAPTION> 
                                                             1998         1997
                                                            -------     -------
     <S>                                                    <C>         <C> 
     Basic EPS Computation:                                             
            Net income available to common                              
                   shareholders                             $ 1,470     $   782
            Weighted average number of common                           
                   shares outstanding                         7,793       6,711
                                                            -------     -------
     Basic EPS                                              $  0.19     $  0.12 
                                                            =======     =======
</TABLE> 

                                     F-12
<PAGE>
 
<TABLE> 
     <S>                                                    <C>            <C>          
     Diluted EPS Computation:                                                           
            Net income available to common                                              
                   shareholders                             $ 1,470        $    782     
            Average number of common shares                                             
                   outstanding                                7,793           6,711     
            Incremental number of shares for                                            
                   assumed exercise of options                   12             124     
                                                            -------        --------     
     Total shares                                             7,805           6,835     
                                                            -------        --------     
     Diluted EPS                                            $  0.19        $   0.11     
                                                            =======        ========      
</TABLE> 

            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 1998. The balance of such
     options was 230,703 with an exercise price of $3.00 per share and 115,000
     with a price of $2.00 per share.

12.  SEGMENT INFORMATION

     The Company adopted SFAS No. 131, "Disclosures About Segments of an
     Enterprise and Related Information", in 1998 which changes the way the
     Company reports information about its operating segments. The information
     for 1997 has been restated from the prior year's presentation in order to
     conform to the 1998 presentation.

     The Company's business segments have been grouped as follows:

<TABLE> 
<CAPTION> 
     1998                                            Thousands of Dollars                       
                                   ------------------------------------------------------------ 
                                                     Inter-
                                                     Segment           Pre-tax
     Segment                       Sales             Sales             Income            Assets
     -------                       ------------------------------------------------------------
     <S>                           <C>              <C>                <C>              <C>    
     Fueling Installations         $14,872                             $  964           $ 7,480
     Environmental                   2,617                                487             2,661
     FRS                                             1,874                598               251
     Other                             815             819                316             2,780
                                   ------------------------------------------------------------
                                   $18,304          $2,693             $2,365           $13,172
                                   ============================================================
</TABLE> 
     
<TABLE> 
<CAPTION> 
     1997                                            Thousands of Dollars                      
                                   ------------------------------------------------------------ 
                                                     Inter-            Pre-tax
                                                     Segment           Income
     Segment                       Sales             Sales             (Loss)            Assets
     -------                       ------------------------------------------------------------
     <S>                           <C>              <C>                <C>              <C>    
     Fueling Installations         $12,132                             $ 825            $ 6,129
     Environmental                   1,347                               283              1,212
     FRS                                             1,074               329                353
     Other                           1,267             347              (176)             2,808 
                                   ------------------------------------------------------------
                                   $14,746          $1,421            $1,261            $10,502
                                   ============================================================
</TABLE> 

13.  SUBSEQUENT EVENTS -

          On January 1, 1999, the Company acquired the assets of a company in
     Largo, Florida, for $50,000 and the assumption of certain liabilities
     totaling $95,590. The acquired business is a provider

                                     F-13
<PAGE>
 
     of environmental, drilling, and related services to the owners and
     operators of fueling systems as well as other businesses.

          On January 11, 1999, the Company acquired the assets, subject to
     certain liabilities assumed, of a group of companies based in Greenville,
     North Carolina, which provides services to the owners and operators of
     fueling systems. The purchase price of the assets acquired was $791,000
     consisting of $250,000 cash, notes payable, and the award of 40,000 shares
     of Company stock, and options to purchase 45,000 shares of Company stock.

                                     F-14
<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 19, 1999.

                                        NATIONAL ENVIRONMENTAL SERVICE CO.


                                        By:/s/ Eddy L. Patterson   
                                           -------------------------------------
                                              Eddy L. Patterson, Chairman &
                                              Chief Executive Officer

     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.

     Signatures                              Title                     Date
     ----------                              -----                     ----

/s/ Eddy L. Patterson          Chairman, Chief Executive Officer  March 19, 1999
---------------------------- 
Eddy L. Patterson              and Director
                            
                            
/s/ James Howell               President                          March 19, 1999
---------------------------- 
James Howell                
                            
                            
/s/ Albert A. McCutchan        Executive Vice President and       March 19, 1999
----------------------------
Albert A. McCutchan            Director
                            
                            
/s/Larry G. Johnson            Secretary, Treasurer and Chief     March 19, 1999
-----------------------------
Larry G. Johnson               Financial Officer
                            
                            
/s/ Robert Watson              Controller (Principal Accounting   March 19, 1999
-----------------------------
Robert Watson                  Officer)
                            
                            
/s/ E. R. Foraker              Director                           March 19, 1999
-------------------------------
E.R. Foraker                
                            
                            
/s/ W. F. Simpson              Director                           March 19, 1999
---------------------------- 
W. F. Simpson               
                            
                            
/s/ Dallin Bagley              Director                           March 19, 1999
---------------------------- 
Dallin Bagley

                                     F-15
<PAGE>
 
                                   EXHIBITS


          10.18    Definitive Agreement dated December 16, 1998, containing the
                   terms of the acquisition of certain assets and the assumption
                   of certain liabilities of THH Alpha, Inc., THH Services,
                   LTD., UTTS Services, LTD., UTTS, Inc., and Carolina Drilling
                   Services, Inc.
          
          10.19    Agreement for Acquisition of certain assets and the
                   assumption of certain liabilities of National Environmental
                   Corporation, dated December 18, 1998.
                   
          21.1     Subsidiaries of National Environmental Service Co.
          
          27.1     Financial Data Schedule

                                     F-16