SYNAGRO TECHNOLOGIES INC - 10-K Annual Report

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

FORM 10-K

|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

|| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO .

COMMISSION FILE NUMBER 0-21054

SYNAGRO TECHNOLOGIES, INC.
(Exact name of Registrant as Specified in its Charter)

DELAWARE 76-0511324
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)

1800 BERING DRIVE, SUITE 1000 77057
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)

Internet Website -- www.synagro.com

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(713) 369-1700

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

Common Stock, $.002 par value
Preferred Stock Purchase Rights
(Title of each class)

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

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

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Securities Exchange Act of 1934 Rule 12b-2).Yes || No |X|.

The aggregate market value of the 18,440,140 shares of the Registrant's
common stock held by nonaffiliates of the Registrant was $46,653,554 on June 30,
2003, based on the $2.53 last sale price of the Registrant's common stock on the
Nasdaq Small Cap Market on that date.

As of March 29, 2004, 19,775,821 shares of the Registrant's common stock
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Proxy Statement for the 2004 Annual Meeting of Stockholders of the
Registrant (Sections entitled "Election of Directors," "Management
Stockholdings," "Principal Stockholders," "Executive Compensation," "Option
Exercises and Year End Values," "Employment Agreements," "Equity Compensation
Plans," "Compensation Committee Report," "Common Stock Performance Graph" and
"Certain Transactions") is incorporated by reference in Part III of this Report.

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PART I

ITEM 1. BUSINESS

FORWARD-LOOKING STATEMENTS

We are including the following cautionary statements to secure the
protection of the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 for all forward-looking statements made by us in this Annual
Report on Form 10-K. Forward-looking statements include, without limitation, any
statement that may predict, forecast, indicate, or imply future results,
performance, or trends, and may contain the words "believe," "anticipate,"
"expect," "estimate," "project," "will be," "will continue," "will likely
result," or words or phrases of similar meaning. In addition, from time to time,
we (or our representatives) may make forward-looking statements of this nature
in our annual report to shareholders, proxy statement, quarterly reports on Form
10-Q, current reports on Form 8-K, press releases or in oral or written
presentations to shareholders, securities analysts, members of the financial
press or others. All such forward-looking statements, whether written or oral,
and whether made by or on our behalf, are expressly qualified by these
cautionary statements and any other cautionary statements which may accompany
the forward-looking statements. In addition, the forward-looking statements
speak only of the Company's views as of the date the statement was made, and we
disclaim any obligation to update any forward-looking statements to reflect
events or circumstances after the date thereof. Forward-looking statements
involve risks and uncertainties which could cause actual results, performance or
trends to differ materially from those expressed in the forward-looking
statements. We believe that all forward-looking statements made by us have a
reasonable basis, but there can be no assurance that management's expectations,
beliefs or projections as expressed in the forward-looking statements will
actually occur or prove to be correct. Factors that could cause actual results
to differ materially are discussed under "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Risk Factors Which May Affect
Future Results."

RESTATEMENT OF 2002 AND 2001 FINANCIAL STATEMENTS

In our financial statements for the years ended December 31, 2002 and
2001, we deducted our preferred stock dividends related to our redeemable
preferred stock from our accumulated deficit in our consolidated balance sheets
and our consolidated statements of stockholders' equity. We recently became
aware that Securities and Exchange Commission ("SEC") rules require that when a
company has an accumulated deficit, preferred stock dividends should be deducted
from additional paid in capital. Therefore, we have revised our financial
statements to deduct preferred stock dividends previously charged to accumulated
deficit from additional paid in capital. This revision has no impact on our
total consolidated stockholders' equity. The revision also had no effect on our
consolidated statements of operations or statements of cash flows for 2002 or
2001.

This table recaps the adjustments related to the revision of our preferred
stock dividends for the periods presented (in thousands):

Our financial statements for the year ended December 31, 2001, were
audited by Arthur Andersen LLP, who issued an unqualified opinion on our 2001
financial statements. Since Arthur Andersen has ceased operations, they are no
longer available to audit the revised reporting of the preferred stock dividends
and re-issue their audit report. As we were unable to have the adjustments
pertaining to our 2001 financial statements audited by our filing deadline, the
Arthur Andersen unqualified opinion has been removed and our 2001 financial
statements and related note disclosures contained herein are unaudited and are
labeled as such. As a result, this Annual Report on Form 10-K does not
completely satisfy the financial statement requirements of Regulation S-X.

Since we are unable to file three years of audited financial information
in this Annual Report on Form 10-K as required under Rules 3-01 and 3-02 of
Regulation S-X, our reports filed under the Securities Exchange Act of 1934 (the
"Exchange Act") will not be in full compliance with the requirements of the
Exchange Act. As a result, the effectiveness of our Registration Statement on
Form S-8 (No. 333-64999) will be suspended, and we will be unable to issue
shares under our stock option plans and agreements. In addition, we will not be
in compliance with Item 13(a) (1) of Schedule 14A under the Exchange Act in
connection with our solicitation of proxies for our 2004 annual meeting of
shareholders. During any period when we are not current with our SEC reports,
neither our affiliates nor any person that purchased shares from us in a private
offering during the preceding two years will be able to sell their shares in
public markets pursuant to Rule 144 under the Securities Act of 1933.

Because of the recent identification of this issue, it was impracticable
to complete a re-audit of our 2001 financial statements by our filing deadline.
While the consolidated financial statements for 2001 are unaudited, they include
all adjustments (consisting of a normal and recurring nature) that are, in the
opinion of management, necessary for a fair presentation of the financial
condition, results of operations, and cash flows for that year. The consolidated
financial statements for the fiscal years ended 2003 and 2002 have been audited
by PricewaterhouseCoopers LLP.

BUSINESS OVERVIEW

We are a national water and wastewater residuals management company
serving more than 1,000 municipal and industrial wastewater treatment accounts
and have operations in 37 states and the District of Columbia. We offer many
services that focus on the beneficial reuse of organic nonhazardous residuals
resulting from the wastewater treatment process. We believe that the services we
offer are compelling to our customers because they allow our customers to avoid
the significant capital and operating costs that they would have to incur if
they internally managed their wastewater residuals.

We provide a broad range of services, including facility operations,
facility cleanout services, regulatory compliance, dewatering, collection and
transportation, composting, drying and pelletization, product marketing,
incineration, alkaline stabilization, and land application. We currently operate
five heat-drying facilities, five composting facilities, three incineration
facilities, 26 permanent and 44 mobile dewatering units, and service over 200
small wastewater treatment plants (ranging from 500 gallons per day to 500,000
gallons per day).

Approximately 83 percent of our 2003 revenue was generated through more
than 630 contracts that range from one to twenty-five years in length. These
contracts have an estimated remaining contract value, which we call backlog, of
approximately $1.9 billion, which represents more than six times our 2003
revenue (see "Backlog" for a more detailed discussion). Our backlog assumes the
renewal of contracts in accordance with their renewal provisions. In general,
our contracts contain provisions for inflation-related annual price increases,
renewal provisions, and broad force majeure clauses. Our top ten customers and
facilities have an average of ten years remaining on their current contracts,
including renewal options. In 2003, we experienced a contract retention rate
(both renewals and rebids) of approximately 86 percent.

We benefit from significant customer diversification, with our single
largest customer accounting for 17 percent of our 2003 annual revenues, and our
top ten customers accounting for approximately 37 percent of our 2003 revenues.
For the year ended December 31, 2003, our municipal and industrial customers
accounted for approximately 86 percent and 7 percent, respectively, of our
revenues.

INDUSTRY OVERVIEW

HISTORY

Most residential, commercial, and industrial wastewater is collected
through an extensive network of sewers and transported to

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wastewater treatment plants, which are known as publicly owned treatment works
("POTWs"). When wastewater is treated at POTWs or at industrial wastewater
pre-treatment facilities, the process separates the liquid portion of the
wastewater from the solids (or wastewater residuals) portion. The water is
treated for ultimate discharge, typically into a river or other surface water.
Prior to the promulgation of the 40 CFR Part 503 Regulations by the
Environmental Protection Agency ("EPA") pursuant to the Clean Water Act ("Part
503 Regulations") in 1993, most POTWs simply disposed of untreated wastewater
residuals through surface water dumping, incineration, and landfilling. The Part
503 Regulations began a phase out of surface water dumping of wastewater
residuals and, after one of the EPA's most thorough risk assessments, encouraged
their beneficial reuse. This created significant growth for the wastewater
residuals management industry. To establish beneficial reuse as an option for
wastewater generators, the EPA established a classification methodology for the
wastewater residuals that is based on how the wastewater residuals are
processed. Now, in most cases, the POTW further processes the wastewater
residuals and produces a semisolid, nutrient-rich by-product known as biosolids.
We use the term "wastewater residuals" to include both solids that have been
treated pursuant to the Part 503 Regulations and those that have not. Biosolids,
as a subset of wastewater residuals, is intended to refer to wastewater solids
that meet either the Class A or Class B standard as defined in the Part 503
Regulations.

CLASSES OF BIOSOLIDS

When treated and processed according to the Part 503 Regulations,
biosolids can be beneficially reused and applied to crop land to improve soil
quality and productivity due to the nutrients and organic matter that they
contain. Biosolids applied to agricultural land, forest, public contact sites,
or reclamation sites must meet either Class A or Class B bacteria, or pathogen
and insect and rodent attraction, or vector attraction reduction requirements
contained in the Part 503 Regulations. This classification is determined by the
level of processing the biosolids have undergone. Pursuant to the Part 503
Regulations, there are specific methods available to achieve Class A standards
and other specific methods available to achieve Class B standards, otherwise the
biosolids are considered Sub-Class B. Each alternative for Class A requires that
the resulting biosolids be essentially pathogen free. In general, Class A
biosolids are generated by more capital intensive processes, such as composting,
heat drying, heat treatment, high temperature digestion and alkaline
stabilization. Class A biosolids have the highest market value, are sold as
fertilizer, and can be applied to any type of land or crop.

Class B biosolids are treated to a lesser degree by processes such as
digestion or alkaline stabilization. These biosolids are typically land applied
on farmland by professional farmers or agronomists and are monitored to comply
with associated federal and state reporting requirements. The Part 503
Regulations, however, regulate the type of agricultural crops for which Class B
biosolids may be used.

Finally, in some cases, the POTW does not treat its wastewater residuals
to either Class A or Class B standards and such residuals are considered
Sub-Class B. These residuals can either be processed to Class A standards or
Class B standards by an outside service provider or disposed of through
incineration or landfilling.

MARKET SIZE/FRAGMENTATION

According to the EPA's 1999 study entitled Biosolids Generation, Use, and
Disposal in the United States, the quantity of municipal biosolids produced in
the United States was projected to be approximately 7.1 million dry tons in
2000, processed through approximately 16,000 POTWs. It is estimated that 8.2
million dry tons of biosolids will be generated in 2010, and that an additional
3,000 POTWs will be built by 2012. It is also estimated that 63 percent of these
biosolids volumes are currently beneficially reused, growing to 70 percent by
2010. An independent 2000 study by the Water Infrastructure Network, entitled
Clean & Safe Water for the 21st Century, estimates that municipalities spend
more than $22 billion per year on the operations and maintenance of wastewater
treatment plants. We estimate that, based on conversations with consulting
engineers, up to 40 percent of those annual costs, or $8.8 billion, are
associated with the management of municipal wastewater residuals.

Industry sources estimate that industrial generators of wastewater (such
as food and beverage processors and pulp and paper manufacturers) spend
approximately $7 billion per year on operations and maintenance. Assuming that,
as is the case with POTWs, 40 percent of these expenditures are associated with
the management of residuals, related annual costs represent approximately $2.8
billion. Therefore, we estimate the total size of the combined municipal and
industrial wastewater residuals market to be $11.6 billion.

We believe that the management of wastewater residuals is a highly
fragmented industry and that we are the only dedicated provider of a full range
of services on a national scale. Historically, POTWs performed the necessary
wastewater residuals management services, but this function is increasingly
being performed by private contractors in an effort to lower cost, increase

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efficiency and comply with stricter regulations.

MARKET GROWTH

We believe the estimated $11.6 billion wastewater residuals industry will
continue to grow at four to five percent annually over the next decade. The
growth in the underlying volumes of wastewater residuals generated by the
municipal and industrial markets is driven by a number of factors. These factors
include:

Population Growth and Population Served. As the population grows,
the amount of biosolids produced by municipal POTWs is expected to
increase proportionately. In addition to population growth, the amount of
residuals available for reuse should also grow as more of the population
is served by municipal sewer networks. As urban sprawl continues and the
desire of cities to annex surrounding areas increases, POTWs will treat
more wastewater. It is expected that the amount of wastewater managed on a
daily basis by municipal wastewater treatment plants will increase more
than 40 percent by 2012, which should significantly increase the amount of
municipal residuals generated.

Pressures To Better Manage Wastewater. There is tremendous pressure
from many stakeholders, including environmentalists, land owners, and
politicians, being applied to municipal and industrial wastewater
generators to better manage the wastewater treatment process. The costs
(such as regulatory penalties and litigation exposure) of not applying the
best available technology to properly manage waste streams have now grown
to material levels. This trend should continue to drive the growth of more
wastewater treatment facilities with better separation technologies, which
increase the amount of residuals ultimately produced.

Stricter Regulations. If the trend continues and laws and
regulations that govern the quality of the effluent from wastewater
treatment plants become stricter, POTWs and industrial wastewater
treatment facilities will be forced to remove more and more residuals from
the wastewater, thereby increasing the amount of residuals needing to be
properly managed.

Advances in Technology. The total amount of residuals produced
annually continues to increase due to advancements in municipal and
industrial wastewater treatment technology. In addition to improvements in
secondary and tertiary treatment methods, which can increase the quantity
of residuals produced at a wastewater treatment plant, segregation
technologies, such as microfiltration, also result in more residuals being
separated from the wastewater.

MARKET TRENDS

In addition to the growth of the underlying volumes of wastewater
residuals, there is a trend of municipalities converting from Sub-Class B and
Class B processes to Class A processes. There are numerous reasons for this
trend, including:

Decaying Infrastructure. Many municipal POTWs operate aging and
decaying wastewater infrastructure. According to the Water Infrastructure
Network's 2000 study, municipalities will need to spend more than $900
billion over the next 20 years to upgrade these systems. As this effort is
rolled out and POTWs undergo design changes and new construction,
opportunities will exist to also upgrade wastewater residuals treatment
processes. We expect that the trend toward more facility-based approaches,
such as drying and pelletization, will increase with this infrastructure
spending. In addition, the need to provide capital for these expenditures
should create pressures for more outsourcing opportunities.

Shrinking Agricultural Base and Urbanization. As population density
increases, the availability of nearby farmland for land application of
Class B biosolids becomes diminished. Under these circumstances, the
transportation costs associated with a Class B program may increase to
such an extent that the higher upfront processing costs of Class A
programs may become attractive to generators. Production of Class A
pellets offers significant volume reduction, greatly reduced
transportation costs, and the enhanced value of pellets allows, in many
cases, revenue realization from product sales.

Public Sentiment. While the Part 503 Regulations provide equal
levels of public safety in the distribution of Class A and Class B
biosolids, the public sometimes perceives a greater risk from the
application of Class B biosolids. This is particularly true in heavily
populated areas. Municipalities are responding to these public and
political pressures by upgrading their programs to the Class A level.
Certain municipalities and wastewater agencies have industry leadership
mindsets where they endeavor to provide their constituents with the
highest level, most advanced treatment technologies available. These
municipalities and agencies will typically fulfill at least a portion of
their residuals management needs with Class A technologies.

Regulatory Stringency. With the promulgation of the Part 503
Regulations, the EPA and, subsequently, state regulatory

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agencies have made the distribution of Class A biosolids products largely
unrestricted. Utilization requirements for Class B biosolids are
significantly more onerous. Based on this, municipalities are moving to
Class A programs to avoid the governmental permitting, public hearings,
compliance and enforcement bureaucracy associated with Class B programs.
This regulatory support to reduce and recycle residuals, and to increase
the quality of the biosolids, works in our favor.

COMPETITIVE STRENGTHS

We believe that we benefit from the following competitive strengths:

BROAD SERVICE OFFERING

We provide our customers with complete, vertically integrated services and
capabilities, including facility operations, facility cleanout services,
regulatory compliance, dewatering, collection and transportation, composting,
drying and pelletization, product marketing, incineration, alkaline
stabilization, and land application. Advantages to our customers include:

Significant Land Base. We have a large land base available for the
land application of wastewater residuals. We currently maintain permits
and registration or licensing agreements on more than 950,000 acres of
land in 27 states. We feel that this land base provides us with an
important advantage when bidding new work and retaining existing business.

Large Range of Processing Capabilities and Product Marketing
Experience. We are one of the most experienced firms in treating
wastewater residuals to meet the EPA's Class A standards. We have numerous
capabilities to achieve Class A standards, and we currently operate five
heat-drying facilities and five composting facilities. In addition, we are
the leader in marketing Class A biosolids either generated by us or by
others. In 2003, we marketed over one-half of the heat-dried pellets
produced in the United States, produced either by us or by municipally
owned facilities.

Regulatory Compliance and Reporting. An important element for the
long-term success of a wastewater residuals management program is the
certainty of compliance with local, state and federal regulations.
Accurate and timely documentation of regulatory compliance is mandatory.
We provide this service, as part of our turn-key operations, through a
proprietary integrated data management system (the Residuals Management
System) that has been designed to store, manage and report information
about our clients' wastewater residuals programs. We believe that our
regulatory compliance and reporting capabilities provide us with an
important competitive advantage when presented to the municipal and
industrial wastewater generators.

LARGEST IN SCALE

We are the only national company focused exclusively on wastewater
residuals management services. We believe that our leading market position
provides us with more operating leverage and a unique competitive advantage in
attracting and retaining customers and employees as compared to our regional and
local competitors. We believe the advantages of scale include:

Knowledgeable Sales Force. We have a sales force dedicated to the
wastewater residuals market. We market our services via a multi-tiered
sales force, utilizing a combination of business developers, engineering
support staff, and seasoned operations directors. This group of
individuals is responsible for maintaining our existing business and
identifying new wastewater residuals management opportunities. On average,
these individuals have in excess of ten years of industry experience. We
believe that their unique knowledge and longstanding customer
relationships gives us a competitive advantage in identifying and
successfully securing new business.

Bonding Capacity. Commercial, federal, state and municipal projects
often require operators to post performance and, in some cases, payment
bonds at the execution of a contract. The amount of bonding capacity
offered by sureties is a function of financial health of the company
requesting the bonding. Operators without adequate bonding may be
ineligible to bid or negotiate on many projects. We have strong bonding
relationships with large national sureties. As of March 26, 2004, we had a
bonding capacity of approximately $172 million with approximately $117
million utilized as of that date. We believe the existing capacity is
sufficient to meet bonding needs for the foreseeable future. To date, no
payments have been made by any bonding company for bonds issued on our
behalf.

Financial Stability. With assets of $492 million and total
capitalization of $427 million as of December 31, 2003, we believe we have
a degree of financial stability greater than our local and regional
competitors, which makes us an attractive, long-term partner for municipal
and industrial customers.

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BUSINESS STRATEGY

Our goals are to strengthen our position as the only national company
exclusively focused on wastewater residuals management and to continuously
improve our margins. Components of our strategy to achieve these goals include:

INTERNAL GROWTH BASED ON OUTSOURCING

We believe that we have the opportunity to expand our business by
providing services for new customers who currently perform their own wastewater
residuals management and by increasing the range of services that our existing
customers outsource to us.

Developing New Customers. We estimate that a majority of the
wastewater treatment facilities located in the United States perform their
own wastewater residuals management services. In many cases, we believe
that we can provide the customer with better service at a cost that is
lower than what it costs to provide the service internally. We take a
collaborative approach with potential customers where our sales force
consults with potential customers and positions us as a solution provider.

Expanding Services to Existing Customers. We have the opportunity to
provide many of our existing customers with additional services as part of
a complete residuals management program. We endeavor to educate these
existing customers about the benefits of a complete residuals management
solution and offer other services where the value is compelling. These
opportunities may provide us with long-term contracts, increased barriers
to entry, and better relationships with our customers. For example, we
have made a concerted effort to provide in-plant dewatering services to
our customers because we believe we can typically provide this necessary
service below the customer's internal operating costs. As a result, we now
operate more than 44 mobile and 26 permanent dewatering facilities
throughout the United States.

IMPROVE MARGINS

We actively work to improve our margins by increasing revenues while
leveraging our operating infrastructure in the field and our corporate overhead.
This strategy encompasses increasing revenues by providing additional services
to our existing customer base, targeting new work in specific market segments
that have historically generated the highest returns for us and prospective
marketing initiatives with both industrial and municipal clients to
strategically position us for success in securing new business. Additionally, we
will increase our efforts in contract administration and renegotiation to pass
costs to the customer that were not anticipated in our arrangement with the
customer.

SELECTIVELY SEEK COMPLEMENTARY ACQUISITIONS

We selectively seek strategic opportunities to acquire businesses
that profitably expand our service offerings, increase our geographic
coverage, or increase our customer base. We believe our strategic
acquisitions enable us to gain new industry residuals expertise and
efficiencies in our existing operations.

SERVICES AND OPERATIONS

Today, generators of municipal and industrial residuals must provide
sound environmental management practices with limited economic resources.
For help with these challenges, municipal and industrial generators
throughout the United States have turned to us for solutions.

We partner with our clients to develop cost-effective,
environmentally sound solutions to their residuals processing and
beneficial use requirements. We provide the flexibility and comprehensive
services that generators need, with negotiated pricing, regulatory
compliance, and operational performance. We work with our clients to find
innovative and cost effective solutions to their wastewater residuals
management challenges. In addition, because we do not manufacture
equipment, we are able to provide unbiased solutions to our customers'
needs. We provide our customers with complete, vertically integrated
services and capabilities, including design/build services, facility
operations, facility cleanout services, regulatory compliance, dewatering,
collection and transportation, composting, drying and pelletization,
product marketing, incineration, alkaline stabilization, and land
application.

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[WASTEWATER RESIDUALS SERVICES ORGANIZATIONAL CHART]

1. Design and Build Services. We designed, built, and operate five
heat-drying and pelletization facilities and five composting facilities. We
currently have two new drying facilities under permit and construction that we
will operate when they are completed. We operate three incineration facilities,
two of which we significantly upgraded and one that we built. Lastly, we have
designed, built, and operate over 20 biosolids dewatering facilities. All of our
facility design, construction and operating experience is with biosolids
projects.

2. Facility Operations. Our facility operations and maintenance group
provides contract operations to customers that desire to outsource the overall
management of their wastewater treatment facilities. Our operations and
maintenance personnel are experienced in many different types of treatment
processes. Our staff members have operated wastewater treatment plants ranging
in size from 127 million gallons per day down to facilities that serve
individual homes. They have managed processes including activated sludge,
rotating biological contactors, membrane separation, biological nutrient removal
and chemical precipitation. Our maintenance staff provides maintenance and
repair services to municipal and industrial wastewater treatment systems,
including automated instrumentation and controls. Our certified laboratories
provide analytical data that our customers need for regulatory compliance
monitoring. We currently service over 200 small wastewater treatment plants
(ranging from 500 gallons per day to over 500,000 gallons per day).

3. Facility Cleanout Services. Our facility cleanout services focus on the
cleaning and maintenance of the digesters at municipal and industrial wastewater
facilities. Digester cleaning involves complex operational and safety
considerations. Our self-contained pumping systems and agitation equipment
remove a high percentage of biosolids without the addition of large quantities
of dilution water. This method provides our customers a low bottom-line cost per
dry ton of solids removed. Solids removed from the digesters can either be
recycled through our ongoing agricultural land application programs or
landfilled.

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4. Regulatory Compliance. An important element for the long-term success
of a wastewater residuals management program is the certainty of compliance with
local, state and federal regulations. Accurate and timely documentation of
regulatory compliance is mandatory. We provide this service through our
proprietary Residuals Management System ("RMS").

RMS is an integrated data management system that has been designed to
store, manage and report information about our clients' wastewater residuals
programs. Every time our professional operations or technical staff performs
activities relating to a particular project, RMS is updated to record the
characteristics of the material, how much material was moved, when it was moved,
who moved it and where it went. In addition to basic operational information,
laboratory analyses are input in order to monitor both annual and cumulative
loading rates for metals and nutrients. This loading information is coupled with
field identification to provide current information for agronomic application
rate computations.

This information is used in two ways. First and foremost, it provides a
database for regulatory reporting and provides the information required for
monthly and annual technical reports that are sent to the EPA and state
regulatory agencies. Second, information entered into RMS is used as an
important part of the invoicing process. This check and balance system provides
a link between our operational, technical and billing departments to ensure
correct invoicing and regulatory compliance.

RMS is a tool that gives our clients timely access to information
regarding their wastewater residuals management program. We continue to dedicate
resources to the continuous improvement of RMS. We believe that our regulatory
compliance and reporting capabilities provide us with a competitive advantage
when presented to the municipal and industrial wastewater generators.

5. Dewatering. We provide residuals dewatering services for wastewater
treatment facilities on either a permanent, temporary or emergency basis. These
services include design, procurement, and operations. We provide the staffing to
operate and maintain these facilities to ensure satisfactory operation and
regulatory compliance of the residuals management program. We currently operate
26 permanent facilities and 44 mobile dewatering units.

6. Collection and Transportation. For our liquid residuals operations, a
combination of mixers, dredges and/or pumps are used to load our tanker
trailers. These tankers transport the residuals to either a land application
site or one of our residuals processing facilities. For our dewatered residuals
operations, the dewatered residuals are loaded into trailers by either front end
loaders or conveyors. These trailers are then transported to either land
application sites or to one of our residuals processing facilities.

7. Composting. For composting projects, we provide a comprehensive range
of technologies, operations services and end product marketing through our
various divisions and regional offices. All of our composting alternatives
provide high-quality Class A products that we market to landscapers, nurseries,
farms and fertilizer companies through our Organic Product Marketing Group
("OPMG") described below. In some cases, fertilizer companies package the
product and resell it for home consumer use. We utilize three different types of
composting methodologies: aerated static pile, in-vessel, and open windrow. When
a totally enclosed facility is not required, aerated static pile composting
offers economic advantages. In-vessel composting uses an automated, enclosed
system that mechanically agitates and aerates blended organic materials in
concrete bays. We also offer the windrow method of composting to clients with
favorable climatic conditions. In areas with a hot and dry climate, the windrow
method lends itself to the efficient evaporation of excess water from dewatered
residuals. This makes it possible to minimize or eliminate any need for bulking
agents other than recycled compost. We currently operate five composting
facilities.

8. Drying and Pelletizing. The heat drying process utilizes a
recirculating system to evaporate water from wastewater residuals and create
pea-sized pellets. A critical aspect of any drying technology is its ability to
produce a consistent and high quality Class A end product that is marketable to
identified end-users. This requires the system to manufacture pellets that meet
certain criteria with respect to size, dryness, dust elimination,
microbiological cleanliness, and durability. We market heat-dried biosolids
products to the agricultural and fertilizer industries through our Organic
Product Marketing Group described below.

We built and currently operate five drying and pelletization facilities
with municipalities, including one in Pinellas County, Florida, two in
Baltimore, Maryland, one in New York, New York, and one in Hagerstown, Maryland.
We are currently in the permitting and construction phases of two drying and
pelletization facilities for Honolulu, Hawaii, and Sacramento, California, which
we will operate when the facilities are completed.

9. Product Marketing. In 1992, we formed the OPMG to market composted and
pelletized biosolids from our own facilities as well as municipally owned
facilities. OPMG currently markets in excess of 880,000 cubic yards of compost
and 169,000 tons of pelletized biosolids annually. OPMG markets a majority of
its biosolids products under the trade names Granulite(TM) and AllGro(TM). Based
on our experience, OPMG is capable of marketing biosolids products to the
highest paying markets. We are the leader in marketing end-use

9

wastewater residuals products, such as compost and heat-dried pellets used for
fertilizers, and, in 2003, we marketed approximately 56 percent of the
heat-dried pellets produced in the United States.

10. Incineration. In the Northeast, we economically and effectively
process wastewater residuals through the utilization of the proven thermal
processing technologies of multiple-hearth and fluid bed incineration. In
multiple-hearth processing, residuals are fed into the top of the incinerator
and then mechanically passed down to the hearths below. The heat from the
burning residuals in the middle of the incinerator dries the residuals coming
down from the top until they begin to burn. Since residuals have approximately
the same British thermal unit value as wood chips, very little additional fuel
is needed to make the residuals start to burn. The resulting ash by-product is
nontoxic and inert, and can be beneficially used as alternative daily cover for
landfills. In fluid bed processing, residuals are pumped directly into a boiling
mass of super heated sand and air (the fluid bed) that vaporizes the residuals
on contact. The top of the fluid bed burns off any remaining compounds resulting
in very low air emissions and very little ash by-product. Computerized control
of the entire process makes this modern technology fuel efficient, easy to
operate, and an environmentally friendly disposal method. We currently operate
three incineration facilities.

11. Alkaline Stabilization. We provide alkaline stabilization services by
using lime to treat Sub-Class B biosolids to Class-B standards. Lime chemically
reacts with the residuals and creates a Class B product. We offer this treatment
process through our BIO*FIX process. Due to its very low capital cost, BIO*FIX
is used in interim and emergency applications as well as long-term programs. The
BIO*FIX process is designed to effectively inactivate pathogenic microorganisms
and to prevent vector attraction and odor. The BIO*FIX process combines specific
high-alkalinity materials with residuals at minimal cost. During the past
several years, our engineers have developed and improved the BIO*FIX chemical
formulations, and the material handling and instrumentation and control systems
in concert with clients, federal and state regulators, consulting engineers and
academic researchers.

12. Land Application. The beneficial reuse of municipal and industrial
biosolids through land application has been successfully performed in the United
States for more than 100 years. Direct agricultural land application has the
proven benefits of fertilization and organic matter addition to the soil.
Agricultural communities throughout the country are well acquainted with the
practice of land application of biosolids and have first hand experience with
the associated agricultural and environmental benefits. Currently, we recycle
Class B biosolids through agricultural land application programs in 27 states.
Our revenues from land application services are the highest among our service
offerings.

CONTRACTS

Approximately 83 percent of our 2003 revenue was generated through more
than 630 contracts with original terms that range from one to twenty-five years
in length. These contracts have a backlog of approximately $1.9 billion, of
which we estimate approximately $203 million will be realized in 2004. Our
December 31, 2003, backlog represents more than six times our 2003 revenue. In
general, our contracts contain provisions for inflation-related annual price
increases, renewal provisions, and broad force majeure clauses. Our top ten
customers have an average of ten years remaining on their current contracts,
including renewal options. In addition, we experienced a contract retention rate
of approximately 86 percent in 2003 (see "Backlog" for a more detailed
discussion).

Although we have a standard form of agreement, terms may vary depending
upon the customer's service requirements and the volume of residuals generated
and, in some situations, requirements imposed by statute or regulation.
Contracts associated with our land application business are typically two- to
four-year exclusive arrangements excluding renewal options. Contracts associated
with drying and pelletizing, incineration or composting are typically longer
term contracts, from five to twenty years, excluding renewal options, and
typically include provisions such as put-or-pay arrangements and estimated
adjustments for changes in the consumer price index for contracts that contain
price indexing. Other services such as cleanout and dewatering typically may or
may not be under long-term contract depending on the circumstances.

The majority of our contracts are with municipal entities. Typically, a
municipality will advertise a request for proposal and numerous entities will
bid to perform the services requested. Often the municipality will choose the
best qualified bid by weighing multiple factors, including range of services
provided, experience, financial capability and lowest cost. The successful
bidder then enters into contract negotiations with the municipality.

Contracts typically include provisions relating to the allocation of risk,
insurance, certification of the material, force majeure conditions, change of
law situations, frequency of collection, pricing, form and extent of treatment,
and documentation for tracking

10

purposes. Many of our agreements with municipalities and water districts provide
options for extension without the necessity of going to bid. In addition, many
contracts have termination provisions that the customer can exercise; however,
in most cases, such terminations create obligations to our customers to
compensate us for lost profits.

Our largest contract is with the New York Department of Environmental
Protection. The contract relates to the New York Organic Fertilizer Company
dryer and pelletizer facility and was assumed in connection with the Bio Gro
acquisition in 2000. The contract provides for the removal, transport and
processing of wastewater residuals into Class A product that is transported,
marketed and sold to the fertilizer industry for beneficial reuse. The contract
has a term of 15 years and expires in June 2013. The contract includes
provisions relating to the allocation of risk, insurance, certification of the
material, force majeure conditions, change of law situations, frequency of
collection, pricing, form and extent treatment, and documentation for tracking
purposes. In addition, the contract includes a provision that allows for the New
York Department of Environmental Protection to terminate the contract.

BACKLOG

At December 31, 2003, our estimated remaining contract value, which we
call backlog, was approximately $1.9 billion. In determining backlog, we
calculate the expected payments remaining under the current terms of our
contracts, assuming the renewal of contracts in accordance with their renewal
provisions, no increase in the level of services during the remaining term, and
estimated adjustments for changes in the consumer price index for contracts that
contain price indexing. However, on the same basis, except assuming the renewal
provisions are not exercised, we estimate our backlog at December 31, 2003,
would have been approximately $1.3 billion. These estimates are based on our
operating experience, and we believe them to be reasonable. However, there can
be no assurance that our backlog will be realized as contract revenue or
earnings.

SALES AND MARKETING

We have a sales and marketing group that has developed and implemented a
comprehensive internal growth strategy to expand our business by providing
services for new customers who currently perform their own wastewater residuals
management and by increasing the range of services that our existing customers
outsource to us.

In addition, to maintain our existing market base, we endeavor to achieve
a 100 percent renewal rate on expiring service contracts. For 2003, we achieved
a renewal rate of approximately 86 percent. We believe that the ability to renew
existing contracts is a direct indication of the level of customer satisfaction
with our operations. Although we value our current customer base, our focus is
to increase revenues that generate long-term, stable income at acceptable
margins rather than simply increasing market share.

Our sales and marketing group also works with our operations staff, which
typically responds to requests to proposals for routine work that is awarded to
the lowest cost bidder. This allows our sales and marketing group to focus on
prospective, rather than reactive, marketing activities. Our sales and marketing
group is focused on developing new business from specific market segments that
have historically netted the highest returns. These are segments where we
believe we should have an enhanced competitive advantage due to the complexity
of the job, the proximity of the work to our existing business, or a unique
technology or facility that we are able to offer. We seek to maximize profit
potential by focusing on negotiated versus low-bid procurements, long-term
versus short-term contracts and projects with multiple services. In addition, we
are focusing on the rapidly growing Class A market. Our sales incentive program
is designed to reward the sales force for success in these target markets.

We proactively approach municipal market segments, as well as new
industrial segments, through professional services contracts. We are in a unique
industry position to successfully market through professional services contracts
because we are an operations company that is solution and technology neutral as
we offer virtually every type of proven service category marketed in the
industry today. This means we can customize a wastewater residuals management
program for a client with no technology or service category bias.

ACQUISITIONS HISTORY

In May 2003, we purchased Aspen Resources, Inc. ("Aspen"). The purchase of
Aspen provides us with added expertise in the management of pulp and paper
organic residuals. Historically, acquisitions have been an important part of our
growth strategy. We completed 19 acquisitions from 1998 through 2003,
highlighted by our acquisition in August 2000 of Waste Management's Bio Gro
Division. Bio Gro had been the one of the largest providers of wastewater
residuals management services in the United States, with 1999 annual revenues of
$118 million. Bio Gro provided wastewater residuals management services in 24
states and was the market leader in thermal drying and pelletization. Other
acquisitions from 1998 to the present include the following:

11

COMPANY DATE ACQUIRED U.S. MARKET SERVED CAPABILITIES ACQUIRED
------- ------------- ------------------ ---------------------

A&J Cartage, Inc. ............................... June 1998 Midwest Land Application
Recyc, Inc. ..................................... July 1998 West Composting
Environmental Waste Recycling, Inc. ............. November 1998 Southeast Land Application
National Resource Recovery, Inc. ................ March 1999 Midwest Land Application
Anti-Pollution Associates ....................... April 1999 Florida Keys Facility Operations
D&D Pumping, Inc. ............................... April 1999 Florida Keys Land Application
Vital Cycle, Inc. ............................... April 1999 Southwest Product Marketing
AMSCO, Inc. ..................................... May 1999 Southeast Land Application
Residual Technologies, LP ....................... January 2000 Northeast Incineration
Davis Water Analysis, Inc. ...................... February 2000 Florida Keys Facility Operations
AKH Water Management, Inc. ...................... February 2000 Florida Keys Facility Operations
Ecosystematics, Inc. ............................ February 2000 Florida Keys Facility Operations
Rehbein, Inc. ................................... March 2000 Midwest Land Application
Whiteford Construction Company .................. March 2000 Mid-Atlantic Cleanouts
Environmental Protection & Improvement Co. ...... March 2000 Mid-Atlantic Rail Transportation
Earthwise Organics, Inc. ........................ August 2002 West Composting
Earthwise Trucking .............................. August 2002 West Transportation

With the Bio Gro acquisition in August 2000, we substantially grew our
service offerings and geographic coverage. As a result, we have shifted our
focus to internal growth. We will continue to selectively seek acquisitions,
such as Aspen, if strategically and economically attractive.

COMPETITION

We provide a variety of services relating to the transportation and
treatment of wastewater residuals. We are not aware of another company focused
exclusively on the management of wastewater residuals from a national
perspective. We have several types of direct competitors. These include small
local companies, regional residuals management companies, and national and
international water and wastewater operations privatization companies.

We compete with these competitors in several ways, including providing
quality services at competitive prices, partnering with technology providers to
offer proprietary processing systems, and utilizing strategic land application
sites. Municipalities often structure bids for large projects based on the best
qualified bid, weighing multiple factors, including experience, financial
capability and cost. We also believe that the full range of wastewater residuals
management services we offer provide a competitive advantage over other entities
offering a lesser complement of services.

In many cases, municipalities and industries choose not to outsource their
residuals management needs. In the municipal market, we estimate that up to 60
percent of the POTW plants are not privatized. We are actively reaching out to
this segment to persuade them to explore the benefits of outsourcing these
services to us. For these generators, we can offer increased value through
numerous areas, including lower cost, ease of management, technical expertise,
liability assumption/risk management, access to capital or technology and
performance guarantees.

FEDERAL, STATE AND LOCAL GOVERNMENT REGULATION

Federal and state environmental authorities regulate the activities of the
municipal and industrial wastewater generators and enforce standards for the
discharge from wastewater treatment plants (effluent wastewater) with permits
issued under the authority of the Clean Water Act, as amended, and state water
quality control acts. The treatment of wastewater produces an effluent and
wastewater solids. The treatment of these solids produces biosolids. To the
extent demand for our residuals treatment methods is created by the need to
comply with the environmental laws and regulations, any modification of the
standards created by such laws and regulations may reduce the demand for our
residuals treatment methods. Changes in these laws or regulations, or in their
enforcement, may also adversely affect our operations by imposing additional
regulatory compliance costs on us, requiring the modification of and/or
adversely affecting the market for our wastewater residuals management services.

12

The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA") generally imposes strict joint and several liability for cleanup
costs upon: (1) present owners and operators of facilities at which hazardous
substances were disposed; (2) past owners and operators at the time of disposal;
(3) generators of hazardous substances that were disposed at such facilities;
and (4) parties who arranged for the disposal of hazardous substances at such
facilities. CERCLA Section 107 liability extends to cleanup costs necessitated
by a release or threat of release of a hazardous substance. However, the
definition of "release" under CERCLA excludes the "normal application of
fertilizer." The EPA regulations regard biosolids applied to land as a
fertilizer substitute or soil conditioner. The EPA has indicated in a published
document that it considers biosolids applied to land in compliance with the
applicable regulations not to constitute a "release." However, the land
application of biosolids that do not comply with Part 503 Regulations could be
considered a release and lead to CERCLA liability. Monitoring as required under
Part 503 Regulations is thus very important. Although the biosolids and alkaline
waste products may contain limited quantities or concentrations of hazardous
substances (as defined under CERCLA), we have developed plans to manage the risk
of CERCLA liability, including training of operators, regular testing of the
biosolids and the alkaline admixtures to be used in treatment methods and
reviewing incineration and other permits held by the entities from which
alkaline admixtures are obtained.

PERMITTING PROCESS

We operate in a highly regulated environment and the wastewater treatment
plants and other plants at which our biosolids management services may be
provided are usually required to have permits, registrations and/or approvals
from federal, state and/or local governments for the operation of such
facilities.

Many states, municipalities and counties have regulations, guidelines or
ordinances covering the land application of Class B biosolids, many of which set
either a maximum allowable concentration or maximum pollutant-loading rate for
at least one pollutant. The Part 503 Regulations also require monitoring Class B
biosolids to ensure that certain pollutants or pathogens are below thresholds.
The EPA has considered increasing these thresholds or adding new thresholds for
different substances, which could increase our compliance costs. In addition,
some states have established management practices for land application of Class
B biosolids. In some jurisdictions, state and/or local authorities have imposed
permit requirements for, or have prohibited, the land application or
agricultural use of Class B biosolids. There can be no assurance that any such
permits will be issued or that any further attempts to require permits for, or
to prohibit, the land application or agricultural use of Class B biosolids
products will not be successful.

Any of the permits, registrations or approvals noted above, or
applications therefore may be subject to denial, revocation or modification
under various circumstances. In addition, if new environmental legislation or
regulations are enacted or existing legislation or regulations are amended or
are enforced differently, we may be required to obtain additional, or modify
existing, operating permits, registrations or approvals. The process of
obtaining or renewing a required permit, registration or approval can be lengthy
and expensive and the issuance of such permit or the obtaining of such approval
may be subject to public opposition or challenge. Much of this public opposition
or challenge, as well as related complaints, relates to odor issues, even when
we are in compliance with odor requirements and even though we have worked hard
to minimize odor from our operations. There can be no assurances that we will be
able to meet applicable regulatory requirements or that further attempts by
state or local authorities to prohibit, or public opposition or challenge to,
the land application, agricultural use of biosolids, thermal processing or
biosolids composting will not be successful.

PATENTS AND PROPRIETARY RIGHTS

We have several patents and licenses relating to the treatment and
processing of biosolids. Our patents have durations from 2008 to 2020. While
there is no single patent that is material to our business, we believe that our
aggregate patents are important to our prospects for future success. However, we
cannot be certain that future patent applications will be issued as patents or
that any issued patents will give us a competitive advantage. It is also
possible that our patents could be successfully challenged or circumvented by
competition or other parties. In addition, we cannot assure that our treatment
processes do not infringe patents or other proprietary rights of other parties.

In addition, we make use of our trade secrets or "know-how" developed in
the course of our experience in the marketing of our services. To the extent
that we rely upon trade secrets, unpatented know-how and the development of
improvements in establishing and maintaining a competitive advantage in the
market for our services, we can provide no assurances that such proprietary
technology will remain a trade secret or that others will not develop
substantially equivalent or superior technologies to compete with our services.

13

EMPLOYEES

As of March 26, 2004, we had approximately 973 full-time employees. These
employees include approximately 4 executive officers, 11 nonexecutive officers,
115 operations managers, 58 environmental specialists, 45 maintenance personnel,
181 drivers and transportation personnel, 101 land application specialists, 291
general operation specialists, 45 sales employees and 122 technical support,
administrative, financial and other employees. Additionally, we use contract
labor for various operating functions, including hauling and spreading services,
when it is economically advantageous.

Although we have 37 union employees, our employees are generally not
represented by a labor union or covered by a collective bargaining agreement. We
believe we have good relations with our employees. We provide our employees with
certain benefits, including health, life, dental, and accidental death and
disability insurance and 401(k) benefits.

POTENTIAL LIABILITY AND INSURANCE

The wastewater residuals management industry involves potential liability
risks of statutory, contractual, tort, environmental and common law liability
claims. Potential liability claims could involve, for example:

- personal injury;

- damage to the environment;

- violations of environmental permits;

- transportation matters;

- employee matters;

- contractual matters;

- property damage; and

- alleged negligence or professional errors or omissions in the
planning or performance of work.

We could also be subject to fines or penalties in connection with
violations of regulatory requirements.

We carry $51 million of liability insurance (including umbrella coverage),
and under a separate policy, $10 million of aggregate pollution legal liability
insurance ($10 million each loss) subject to retroactive dates, which we
consider sufficient to meet regulatory and customer requirements and to protect
our employees, assets and operations. There can be no assurance that we will not
face claims under CERCLA or similar state laws resulting in substantial
liability for which we are uninsured and which could have a material adverse
effect on our business.

Our insurance programs utilize large deductible/self-insured retention
plans offered by a commercial insurance company. Large deductible/self-insured
retention plans allow us the benefits of cost-effective risk financing while
protecting us from catastrophic risk with specific stop-loss insurance limiting
the amount of self-funded exposure for any one loss and aggregate stop-loss
insurance limiting the self-funded exposure for health insurance for any one
year.

ITEM 2. PROPERTIES

We currently lease approximately 18,414 square feet of office space at our
principal place of business located in Houston, Texas. We also lease regional
operational facilities in: Houston, Texas; Sacramento, California; Denville, New
Jersey; Baltimore, Maryland; and have 17 district offices throughout the United
States.

14

We own and operate three drying and pelletization facilities; one located
in New York, New York, and two in Baltimore, Maryland. We also operate two
drying and pelletizing facilities in Hagerstown, Maryland, and Pinellas County,
Florida, and three incineration facilities located in Woonsocket, Rhode Island;
Waterbury, Connecticut; and New Haven, Connecticut. Additionally, we own
property in Salome, Arizona; Maysville, Arkansas; Lancaster, California; King
George, Virginia; and Wicomico County, Maryland. These properties are utilized
for composting, storage or land application.

We maintain permits, registrations or licensing agreements on more than
950,000 acres of land in 27 states for applications of biosolids.

ITEM 3. LEGAL PROCEEDINGS

Our business activities are subject to environmental regulation under
federal, state and local laws and regulations. In the ordinary course of
conducting our business activities, we become involved in judicial and
administrative proceedings involving governmental authorities at the federal,
state and local levels. We believe that these matters will not have a material
adverse effect on our business, financial condition and results of operations.
However, the outcome of any particular proceeding cannot be predicted with
certainty. We are required under various regulations to procure licenses and
permits to conduct our operations. These licenses and permits are subject to
periodic renewal without which our operations could be adversely affected. There
can be no assurance that regulatory requirements will not change to the extent
that it would materially affect our consolidated financial statements.

RIVERSIDE COUNTY

The parties have settled all pending litigation between us and Riverside
County. We agreed to pay host fees for biosolids received at the facility and
that the conditional use permit ("CUP") will expire December 31, 2008, which is
nine months earlier than when it was originally set to expire.

We lease land and operate a composting facility in Riverside County,
California, under a conditional use permit ("CUP"). The CUP allows for a
reduction in material intake and CUP term in the event of noncompliance with the
CUP's terms and conditions. In response to alleged noncompliance due to
excessive odor, on or about June 22, 1999, the Riverside County Board of
Supervisors attempted to reduce our intake of biosolids from 500 tons per day to
250 tons per day. We believe that this was not an authorized action by the Board
of Supervisors. On September 15, 1999, we were granted a preliminary injunction
restraining and enjoining the County of Riverside ("County") from restricting
the intake of biosolids at our Riverside composting facility.

In the lawsuit that we filed in the Superior Court of California, County
of Riverside, we also complained that the County's treatment of us is in
violation of our civil rights under U.S.C. Section 1983 and that our due process
rights were being affected because the County was improperly administering the
odor protocol, as well as other terms in the CUP. The County alleged that the
odor "violations," as well as our actions in not reducing intake, could reduce
the term of the CUP. We disagreed and challenged the County's position in the
lawsuit.

We incurred approximately $667,000 of project costs in connection with our
efforts to relocate the facility prior to the current settlement. Since we will
now remain at the existing Riverside County site, these costs were written off
through depreciation expense in cost of services in the fourth quarter of 2003.

RELIANCE INSURANCE

For the 24 months ended October 31, 2000 (the "Reliance Coverage Period"),
we insured certain risks, including automobile, general liability, and worker's
compensation, with Reliance National Indemnity Company ("Reliance") through
policies totaling $26 million in annual coverage. On May 29, 2001, the
Commonwealth Court of Pennsylvania entered an order appointing the Pennsylvania
Insurance Commissioner as Rehabilitator and directing the Rehabilitator to take
immediate possession of Reliance's assets and business. On June 11, 2001,
Reliance's ultimate parent, Reliance Group Holdings, Inc., filed for bankruptcy
under Chapter 11 of the United States Bankruptcy Code of 1978, as amended. On
October 3, 2001, the Pennsylvania Insurance Commissioner removed Reliance from
rehabilitation and placed it into liquidation.

Claims have been asserted and/or brought against us and our affiliates
related to alleged acts or omissions occurring during the Reliance Coverage
period. It is possible, depending on the outcome of possible claims made with
various state insurance guaranty

15

funds, that we will have no, or insufficient, insurance funds available to pay
any potential losses. There are uncertainties relating to our ultimate
liability, if any, for damages arising during the Reliance Coverage Period, the
availability of the insurance coverage, and possible recovery for state
insurance guaranty funds.

In June 2002, we settled one such claim that was pending in Jackson
County, Texas. The full amount of the settlement was paid by insurance proceeds;
however, as part of the settlement, we agreed to reimburse the Texas Property
and Casualty Insurance Guaranty Association an amount ranging from $0.6 to $2.5
million depending on future circumstances. We estimated our exposure at
approximately $1.0 million for the potential reimbursement to the Texas Property
and Casualty Insurance Guaranty Association for costs associated with the
settlement of this case and for unpaid insurance claims and other costs
(including defense costs) for which coverage may not be available due to the
pending liquidation of Reliance. We believe accruals of approximately $1.0
million as of December 31, 2003, are adequate to provide for our exposures. The
final resolution of these exposures could be substantially different from the
amount recorded.

DESIGN AND BUILD CONTRACT RISK

We participate in design and build construction operations, usually as a
general contractor. Virtually all design and construction work is performed by
unaffiliated subcontractors. As a consequence, we are dependent upon the
continued availability of and satisfactory performance by these subcontractors
for the design and construction of our facilities. There is no assurance that
there will be sufficient availability of and satisfactory performance by these
unaffiliated subcontractors. In addition, inadequate subcontractor resources and
unsatisfactory performance by these subcontractors could have a material adverse
effect on our business, financial condition and results of operation. Further,
as the general contractor, we are legally responsible for the performance of our
contracts and, if such contracts are under-performed or nonperformed by our
subcontractors, we could be financially responsible. Although our contracts with
our subcontractors provide for indemnification if our subcontractors do not
satisfactorily perform their contract, there can be no assurance that such
indemnification would cover our financial losses in attempting to fulfill the
contractual obligations.

OTHER

During 2003, we entered into a settlement agreement with one of our
customers related to certain outstanding issues, including, among other things,
equipment and building acceptance and warranty obligations. These obligations
were assumed by us in connection with the Bio Gro acquisition that closed in
August 2000. These obligations were included as a liability in the opening
balance sheet for the Bio Gro acquisition. Under the agreement, the customer
agreed to pay approximately $0.7 million for amounts due to us, while we agreed
to pay the customer approximately $1.4 million in exchange for the settlement of
the outstanding issues, including termination of future warranty obligations. In
connection with the agreement, we reduced our liabilities for these obligations
by approximately $2.0 million. This amount was recorded as a reduction of cost
of services in the accompanying consolidated statement of operations for 2003.

There are various other lawsuits and claims pending against us that have
arisen in the normal course of business and relate mainly to matters of
environmental, personal injury and property damage. The outcome of these matters
is not presently determinable but, in the opinion of management, the ultimate
resolution of these matters will not have a material adverse effect on our
consolidated financial condition, results of operations or cash flows.

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

None.

PART II

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

COMMON STOCK PRICE RANGE

Our Common Stock is listed on the Nasdaq Small Cap Market ("Nasdaq"), and
trades under the symbol "SYGR." The following table presents the high and low
closing prices for our Common Stock for each fiscal quarter of the fiscal years
ended 2003 and 2002, as reported by the Nasdaq.

16

HIGH LOW
-------- --------

FISCAL YEAR 2003
First Quarter .............. $ 2.68 $ 2.12
Second Quarter ............. 2.90 2.22
Third Quarter .............. 2.88 2.15
Fourth Quarter ............. 2.48 2.02

FISCAL YEAR 2002
First Quarter .............. $ 2.54 $ 2.00
Second Quarter ............. 3.50 2.31
Third Quarter .............. 3.35 2.07
Fourth Quarter ............. 2.73 1.95

As of March 26, 2004, we had 19,775,821 shares of Common Stock issued and
outstanding. On that date, there were 267 holders of record of our Common Stock.

DIVIDEND POLICY

Historically, we have reinvested earnings available for distribution to
holders of Common Stock, and accordingly, we have not paid any cash dividends on
our Common Stock. Although we intend to continue to invest future earnings in
our business, we may determine at some future date that payment of cash
dividends on Common Stock would be desirable. The payment of any such dividends
would depend, among other things, upon our earnings and financial condition.
Further, we have bank and preferred stock covenants restricting dividend
payments.

EQUITY COMPENSATION PLAN INFORMATION

The following table summarizes as of December 31, 2003, certain
information regarding equity compensation to our employees, officers, directors
and other persons under our equity compensation plans:

Number of Securities
Number of Remaining Available for
Securities to be Future Issuance Under
Issued upon Weighted Average Equity Compensation
Exercise of Exercise Price of Plans
Outstanding Stock Outstanding Stock (Excluding Securities
Options Options Reflected in column (a))
Plan Category (a) (b) (c)
-------------- --- --- ---

Equity compensation plans approved by
security holders (1) ....................... 5,584,765 $ 2.84 3,795,000
Equity compensation not approved by
security holders (2) ....................... 3,126,954 $ 3.07 --
--------- ---------
Total ......................................... 8,711,719 3,795,000
========= =========

(1) We have outstanding stock options granted under the 2000 Stock Option
Plan ("the 2000 Plan") and the Amended and Restated 1993 Stock Option Plan ("the
Plan") for officers, directors and key employees. There were 3,795,000 options
for shares of common stock reserved under the 2000 Plan for future grants.
Effective with the approval of the 2000 Plan, no further grants will be made
under the 1993 Plan.

(2) Represents options granted pursuant to individual stock option
agreements. An aggregate of 1,181,954 options were granted to executive officers
in 1998 and prior. These options had an exercise price equal to the market
price, vested over three years, and expire ten years from the date of grant. An
aggregate of 850,000 options were granted to executive officers as an inducement
essential to the individuals entering into an employment contract with the
Company. These options have an exercise price equal to market value on the date
of grant, vest over three years, and expire ten years from the date of grant.

17

ITEM 6. SELECTED FINANCIAL DATA

The following table summarizes selected consolidated financial data of the
Company for each fiscal year of the five-year period ended December 31, 2003.
The following selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements, including the notes
thereto, included elsewhere herein.

YEAR ENDED DECEMBER 31,
---------------------------------------------------------
2003 2002 2001 2000 1999
--------- -------- --------- --------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

Revenue .................................................... $ 298,552 $272,628 $ 260,196 $ 163,098 $56,463
Gross profit ............................................... 64,101 70,748 68,275 43,198 13,992
Selling, general and administrative
expenses ................................................. 26,070 22,935 21,784 14,337 6,876
Reorganization costs ....................................... 1,169 905 -- -- --
Special charges (credit), net .............................. -- -- (4,982) -- 1,500
Amortization of intangibles ................................ 450 108 4,489 3,516 1,527
Interest expense, net ...................................... 23,356 23,498 26,968 18,908 3,236
Net income before cumulative effect of
change in accounting for derivatives and
asset retirement obligations, preferred
stock dividends and noncash beneficial .................. 7,754 11,064 19,664 6,551 1,148
conversion charge
Cumulative effect of change in accounting
for derivatives .......................................... -- -- 1,861 -- --
Cumulative effect of change in accounting
for asset retirement obligations ......................... 476 -- -- -- --
Preferred stock dividends .................................. 8,209 7,659 7,248 3,939 --
Noncash beneficial conversion charge ....................... -- -- -- 37,045 --
Net income (loss) applicable to common
stock .................................................... $ (931) $ 3,405 $ 10,555 $ (34,433) $ 1,148

Basic -
Earnings (loss) per share before cumulative
effect of change in accounting for derivatives
and asset retirement obligations, and noncash
beneficial conversion charge .......................... $ (0.03) $ 0.17 $ 0.64 $ 0.14 $ 0.07
Cumulative effect of change in accounting
for derivatives ....................................... -- -- (0.10) -- --
Cumulative effect of change in accounting
for asset retirement obligations ...................... (0.02) -- -- -- --
Noncash beneficial conversion charge ..................... $ -- $ -- $ -- $ (1.92) $ --
--------- -------- --------- --------- -------
Net income (loss) per share - basic ...................... $ (0.05) $ 0.17 $ 0.54 $ (1.78) $ 0.07
========= ======== ========= ========= =======

Diluted -
Earnings (loss) per share before preferred stock
dividends (when dilutive), cumulative effect
of change in accounting for derivatives and
asset retirement obligations and noncash
beneficial conversion charge .......................... $ (0.03) $ 0.17 $ 0.40 $ 0.14 $ 0.07
Cumulative effect of change in accounting
for derivatives ....................................... -- -- (0.04) -- --
Cumulative effect of change in accounting
for asset retirement obligations ...................... (0.02) -- -- -- --
Noncash beneficial conversion charge ..................... $ -- $ -- $ -- $ (1.92) $ --
--------- -------- --------- --------- -------
Net income (loss) per common share -
diluted ............................................... $ (0.05) $ 0.17 $ 0.36 $ (1.78) $ 0.07
========= ======== ========= ========= =======

Working capital ............................................ $ 18,697 $ 19,069 $ 7,315 $ 17,734 $ 3,982
Total assets ............................................... 492,024 493,467 451,948 449,362 99,172
Total long-term debt, net of current
maturities ............................................... 269,133 283,530 249,016 279,098 42,182
Redeemable Preferred Stock ................................. 86,299 78,090 70,431 63,367 --
Stockholders' equity ....................................... 65,374 65,801 61,891 53,564 45,314

18

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

OVERVIEW

The following is a discussion of our results of operations and financial
position for the periods described below. This discussion should be read in
conjunction with the consolidated financial statements included herein. Our
discussion of our results of operations and financial condition includes various
forward-looking statements about our markets, the demand for our products and
services and our future results. These statements are based on certain
assumptions that we consider reasonable. Our actual results may differ
materially from these indicated forward-looking statements. For information
about these assumptions and other risks and exposures relating to our business
and our company, you should refer to the section entitled "Forward-Looking
Statements" and "Risk Factors Which May Affect Future Results."

RESTATEMENT OF 2002 AND 2001 FINANCIAL STATEMENTS

In our financial statements for the years ended December 31, 2002 and
2001, we deducted our preferred stock dividends related to our redeemable
preferred stock from our accumulated deficit in our consolidated balance sheets
and our consolidated statements of stockholders' equity. We recently became
aware that SEC rules require that when a company has an accumulated deficit,
preferred stock dividends should be deducted from additional paid in capital.
Therefore, we have revised our financial statements to deduct preferred stock
dividends previously charged to accumulated deficit from additional paid in
capital. This revision has no impact on our total consolidated stockholders'
equity. The revision also had no effect on our consolidated statements of
operations or statements of cash flows for 2002 or 2001.

This table recaps the adjustments related to the revision of our preferred
stock dividends for the periods presented (in thousands):