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, 2004

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 88-0219860
(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 18,442,140 shares of the Registrant's
common stock held by nonaffiliates of the Registrant was $52,375,678 on June 30,
2004, based on the $2.84 last sale price of the Registrant's common stock on the
Nasdaq Small Cap Market on that date.

As of March 17, 2005, 20,149,292 shares of the Registrant's common stock
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Proxy Statement for the 2005 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."

BUSINESS OVERVIEW

GENERAL

We are the largest recycler of biosolids and other organic residuals in the
United States and the only national company focused exclusively on the $8
billion organic residuals industry, which includes water and wastewater
residuals. We serve more than 600 municipal and industrial water and wastewater
treatment accounts with operations in 37 states and the District of Columbia.

Biosolids and other organic residuals are solid or liquid material
generated by municipal wastewater treatment facilities or residual management
facilities. We provide our customers with services and capabilities that focus
on the beneficial reuse of organic nonhazardous residuals, including biosolids,
resulting primarily 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 water and wastewater residuals.

We partner with our clients to develop cost-effective and environmentally
sound solutions for their residuals processing and beneficial use requirements.
Our broad range of services include drying and pelletization, composting,
product marketing, incineration, alkaline stabilization, land application,
collection and transportation, regulatory compliance, dewatering, and facility
cleanout services. We currently operate six heat-drying facilities, five
composting facilities, three incineration facilities and 31 permanent and 35
mobile dewatering units.

Our existing customer base is comprised primarily of municipal customers,
which accounted for approximately 88 percent of our revenues for the year ended
December 31, 2004, as well as industrial and commercial waste generators. We
also cater to buyers who purchase our fertilizers and other marketed products,
which total approximately 3 percent of our total revenues. Our size and scale
offer significant advantages over our competitors in terms of operating
efficiencies and the breadth of services we provide our

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customers. Approximately 89 percent of our revenue for the year ended December
31, 2004 was derived from sources that we believe are recurring in nature,
including contracts, purchase orders and product sales.

Contract revenues accounted for approximately 83 percent of our revenue for
the year ended December 31, 2004. These revenues were generated through more
than 560 contracts that range from one to twenty-five years in length. Contract
revenues are generated primarily from land application, collection and
transportation services, dewatering, incineration, composting, drying and
pelletization services and facility operations and maintenance services. These
contracts have an estimated remaining contract value including renewal options,
which we call backlog, of approximately $2.2 billion as of December 31, 2004.
This backlog represents more than six times our revenue for the year ended
December 31, 2004. Our estimated backlog, excluding renewal options, was
approximately $1.5 billion as of December 31, 2004. See -- "Backlog." Our top
ten customers, which represent approximately $1.2 billion, or 55%, of our
backlog as of December 31, 2004, have an average of eight years remaining on
their current contracts, including renewal options. We have historically enjoyed
high contract retention rates (both renewals and rebids) of approximately 85
percent to 90 percent of contract revenue value. As of December 31, 2004, our
contract retention rate was approximately 88 percent.

DESCRIPTION OF BUSINESS BY SEGMENT

The Company evaluates operating results, assesses performance and allocates
resources on a geographic basis, with the exception of its rail operations and
its engineering, facilities, and development ("EFD") group which are separately
monitored. Accordingly, the Company reports the results of its activities in
three operating segments, which include: Residuals Management Operations, Rail
Transportation, and EFD. The Company has determined that its segment disclosures
for 2003 and 2002 should be restated to expand its segment disclosure from one
reporting segment as was originally reported to three reporting segments.
Accordingly, the segment information presented for 2003 and 2002 herein has been
restated.

The table below shows the total revenues (in thousands) contributed
annually by each of our reportable segments in the three-year period ended
December 31, 2004. More information about our results of operations by
reportable segment is included in Note 20 to the consolidated financial
statements included in this report.

Revenues generated from the services that the Company provides are
summarized below:

Facilities operations include revenues generated from providing drying and
pelletization, composting, and incineration operations services. Land
application and disposal includes revenues generated from providing

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land application, dewatering, and disposal services. Product marketing includes
revenues generated from selling pellets and compost as organic fertilizers.
Cleanout services include revenues generated from lagoon and digester cleanout
projects.

Residuals Management Operations derives its revenues from facilities
operations, product marketing, land application and disposal, and cleanout
services. Rail Transportation derives its revenues from land application and
disposal services. EFD derives its revenues from product marketing, and design
and build services.

INDUSTRY OVERVIEW

HISTORY

We believe that the organic residuals industry, which includes water and
wastewater residuals, is approximately $8 billion in size and 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, including:

- Population growth and population served;

- Pressures to better manage wastewater;

- More restrictive laws and regulations; and

- Advances in technology.

Most residential, commercial, and industrial wastewater is collected
through an extensive network of sewers (laterals, interceptors and force mains),
and transported to wastewater treatment plants, which are primarily publicly
owned treatment works ("POTWs"). When wastewater is treated at POTWs or at
industrial wastewater pre-treatment facilities, the treatment process normally
consists of biological and/or chemical treatment (secondary treatment) followed
by some type of clarification (separates the liquid portion of the wastewater
from the solids/wastewater residuals). The clarified water may be further
treated (disinfection and filtration -- tertiary treatment) depending upon
effluent limitation requirements contained in the POTW's National Pollutant
Discharge Elimination System permit and discharged -- typically into a river or
other surface water. Prior to the promulgation of the 40 CFR Part 503
Regulations by the Environmental Protection Agency, or EPA, pursuant to Section
405 of the Clean Water Act ("Part 503 Regulations") on February 19, 1993, many
POTWs were beneficially recycling their wastewater residuals under 40 CFR Part
257. Some POTWs were landfilling, incinerating, or surface disposing of their
residuals. Ocean dumping was banned in 1989 and completely phased out by 1991.
The Part 503 Regulations were much more comprehensive than Part 257, especially
in the level of risk assessment that was done by the EPA to develop the
pollutant concentration requirements. The Part 503 Regulations supported the
EPA's beneficial use policy that was published in 1984 and provided some closure
to regulatory process that had been on going since the Clean Water Act
amendments of 1977. Once the Part 503 regulations were final, they 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
requirements of Class A or B standards as defined in the Part 503 Regulation.

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
or vector attraction reduction requirements contained in

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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, including EPA studies and manuals and research and
analysis reports from Informa Economics, Inc., and internal information have led
us to estimate that a total volume of 135 million dry tons of organic residuals
are processed each year. Therefore, we estimate the total size of the combined
municipal and industrial wastewater residuals market to be $8 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
efficiency and comply with stricter regulations.

We believe we compete in a stable, recession resistant industry. We provide
a necessary service to our municipal and industrial customers. We derive
substantially all of our revenues from municipal water and wastewater utilities.
Demand for our industry's services are promulgated by government regulations
defining the use and disposal of wastewater residuals. We believe that
population growth, better wastewater management treatment processes and stricter
regulations are factors driving growth in the industry.

MARKET GROWTH

We believe the estimated $8 billion organic residuals industry, which
includes water and wastewater residuals, 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

5

more wastewater. It is expected that the amount of wastewater residuals managed
on a daily basis by municipal wastewater treatment plants will increase to more
than 8.2 million dry tons by 2010.

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 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.

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COMPETITIVE STRENGTHS

We believe that the following strengths differentiate us in the
marketplace:

National, Full-Service Industry Leader. We are the largest recycler of
biosolids and other organic residuals in the United States and the only national
company focused exclusively on water and wastewater residuals management. We
provide our customers with services and capabilities, including drying and
pelletization, composting, product marketing, incineration, alkaline
stabilization, land application, collection and transportation, regulatory
compliance, dewatering, and facility cleanout services. We believe our broad
range of services exceeds those offered by our competitors in the water and
wastewater residuals management industry and provides us with a unique and
differentiated service offering platform. 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.

Recurring Revenues and Stable Operating Cash Flows. Approximately 89
percent of our revenue for the year ended December 31, 2004 was derived from
sources that we believe are recurring in nature, including long-term contracts
primarily with municipal customers. These contracts accounted for approximately
83 percent of our revenue for the year ended December 31, 2004. Our contract
expirations are staggered, mitigating the impact of any individual contract
loss. Our contract revenue backlog, including renewal options, was approximately
$2.2 billion as of December 31, 2004. This backlog represents more than six
times our revenue for the year ended December 31, 2004. Our estimated backlog,
excluding renewal options, was approximately $1.5 billion as of December 31,
2004. We believe our recurring revenue base, stable capital expenditures
requirements and minimal working capital requirements will allow us to maintain
predictable and consistent cash flows. See "Business -- Backlog."

Significant Land Base. We have a large land base available for the land
application of wastewater residuals. As of December 31, 2004, we maintained
permits and registration or licensing agreements on more than 913,000 acres of
land in 25 states. We feel that this land base provides us with an important
advantage when bidding for 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 currently operate 11 Class A processing
facilities and believe that our next two largest Class A competitors operate
five and three Class A facilities, respectively. Class A residuals undergo more
processing than Class B residuals, and may be distributed and marketed as
commercial fertilizer. We have numerous capabilities to achieve Class A
standards, and we currently operate six heat-drying facilities and five
composting facilities. In addition, we are a leader in marketing Class A
biosolids either generated by us or by others. For the year ended December 31,
2004, we marketed 165,000 tons or approximately 52 percent of the heat-dried
pellets produced in the United States. We also marketed 401,000 tons of compost,
which we believe is significantly more than any other producer of municipal
based compost materials.

Experienced 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.

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.

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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 the financial health of the company requesting the bonding.
Operators without adequate bonding may be ineligible to bid or negotiate on many
projects. Our national presence and tenure in the market have helped us develop
strong bonding relationships with large national sureties that smaller industry
participants do not possess. 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.

Strong, Experienced Management Team. We have a strong and experienced
management team at the corporate and operating levels. Our senior management on
average has been involved in the environmental services industry for over 20
years. We believe the skill and experience of our management team continue to
provide significant benefits to us as we evaluate opportunities to expand our
business.

BUSINESS STRATEGY

Our goals are to maintain and strengthen our position as the only national
company exclusively focused on water and wastewater residuals management. Our
business strategy is to increase cash flow from operations and profitability
through a combination of organic growth, growth through complementary
acquisitions and a disciplined approach to capital expenditures.

Organic Growth. 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. The principal factors contributing to our
organic growth include:

- Developing New Customers. Our sales and marketing efforts focus on
adding new customers by marketing our products and services. In many
cases, we believe that we can provide the customer with better service at
a cost to them that is lower than what it costs them to provide the
service internally or with their current service provider. 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.

- Capitalize on Increased Demand for Facilities Operations Services. In
order to take advantage of operating efficiencies, technology and our
comprehensive capabilities, we will endeavor to capitalize on the
increased demand for facilities operations services, including drying and
pelletizing, dewatering, composting and incineration. We believe this
focus will result in more long-term contracts and recurring revenue. In
addition, we are building several new facilities, which we expect will
also result in longer-term contracts, steady revenue streams, higher
barriers to entry for competitors, higher switching costs for the
customer and lower seasonality. We opened one of these facilities in
Sacramento in 2004.

Growth through Complementary Acquisitions. We plan to continue to pursue
strategic acquisitions in a disciplined manner in order to achieve further
growth. 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. Determination of attractive acquisition targets is based on many
factors, including the size and location of the business and customers served,
existing contract terms, potential operating efficiencies and cost savings.

Disciplined Approach to Capital Expenditures. Whether a new contract or an
acquisition, we are focused on the ability to generate the revenues and
operating cash flow to validate the capital investment

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decision. As such, new contracts, renewals and/or acquisitions undergo a
comprehensive financial analysis to ensure that our return criteria are being
met. In addition, capital expenditures relating to maintenance activities are
also subject to rigorous internal review and a formal approval process.

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.

[Wastewater Residuals Services FLOWCHART]

1. Design and Build Services. We designed, built, and operate six
heat-drying and pelletization facilities and five composting facilities. We
currently have one new drying facility under permit and construction that we
will operate when it is 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.

9

2. 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.

3. 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.

4. 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
31 permanent and 35 mobile dewatering units.

5. 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.

6. 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.

10

7. Drying and Pelletization. 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 six drying and pelletization facilities with
municipalities, including one in Pinellas County, Florida, two in Baltimore,
Maryland, one in New York, New York, one in Hagerstown, Maryland and one in
Sacramento, California. We are currently in the construction phase of one drying
and pelletization facility for Honolulu, Hawaii, which we will operate when the
facility is completed.

8. 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 891,000 cubic yards of compost
and 165,000 tons of pelletized biosolids annually. OPMG markets a majority of
its biosolids products under the trade names GranuliteCompany and AllGroCompany.
Based on our experience, OPMG is capable of marketing biosolids products to the
highest paying markets. We are the leader in marketing end-use wastewater
residuals products, such as compost and heat-dried pellets used for fertilizers.
In 2004, we marketed 165,000 tons or approximately 52 percent of the heat-dried
pellets produced in the United States. We also marketed 401,000 tons of compost,
which we believe is significantly more than any other producer of municipal
based compost materials.

9. 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.

10. 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.

11. 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 25 states.
Our revenues from land application services are the highest among our service
offerings.

11

CONTRACTS

Contract revenues accounted for approximately 83 percent of our revenue for
the year ended December 31, 2004. These revenues were generated through more
than 560 contracts that range from one to twenty-five years in length. Contract
revenues are generated primarily from land application, collection and
transportation services, dewatering, incineration, composting, drying and
pelletization services and facility operations and maintenance services. These
contracts have an estimated backlog, including renewal options, of approximately
$2.2 billion as of December 31, 2004. This backlog represents more than six
times our revenue for the year ended December 31, 2004. 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 eight years remaining on their current contracts, including
renewal options. We have historically enjoyed high contract retention rates
(both renewals and rebids) of approximately 85 percent to 90 percent of contract
revenue value. During 2004, our contract retention rate was approximately 88
percent. See "-- Backlog" for a more detailed discussion.

Our contract with the New York City Department of Environmental Protection
accounted for 16% of our revenues in 2004. No other customer accounted for more
than 10% of our revenues in 2004.

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 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 City 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 City Department of Environmental Protection to terminate the contract. See
"Risk Factors -- Risks Relating to our Business and the Industry -- A
significant amount of our business comes from a limited number of customers and
our revenue and profits could decrease significantly if we lost one or more of
them as customers."

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BACKLOG

At December 31, 2004, our estimated remaining contract value including
renewal options, which we call backlog, was approximately $2.2 billion, of which
we estimate approximately $191.0 million will be realized in 2005. 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. Assuming the renewal provisions
are not exercised, we estimate our backlog at December 31, 2004 would have been
approximately $1.5 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. See
"Risk Factors -- Risks Relating to our Business and Industry -- We are not able
to guarantee that our estimated remaining contract value, which we call backlog,
will result in actual revenues in any particular fiscal period."

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 retain
our existing service contracts. For 2004, we achieved a retention rate (renewals
and rebids) of approximately 88 percent. We believe that the ability to retain
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 facilities operations 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 offers 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 Resources"). The
purchase of Aspen Resources 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 18 acquisitions from 1998
through 2004, highlighted by our acquisition in August 2000 of Waste
Management's Bio Gro Division. Bio Gro had been 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

13

services in 24 states and was the market leader in thermal drying and
pelletization. Other acquisitions from 1998 to the present include the
following:

COMPETITION

We provide a variety of services relating to the transportation and
treatment of wastewater residuals. Although water, land application, fertilizer,
farming, consulting and composting companies provide some of the same services
we offer, we believe that we are the only national company to provide a
comprehensive suite of services. 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. Our direct competitors
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, state and local environmental authorities regulate the activities
of the municipal and industrial wastewater generators and enforce standards for
the discharge from wastewater treatment plants (effluent

14

wastewater) with permits issued under the authority of the Clean Water Act, as
amended, state water quality control acts and local regulations. 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.

The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA") generally imposes strict, joint and several liability for cleanup
costs upon various parties, including: (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 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 generally 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

15

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 current patents expire between 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.

EMPLOYEES

As of March 16, 2005, we had approximately 964 full-time employees. These
employees include approximately 4 executive officers, 11 nonexecutive officers,
119 operations managers, 64 environmental specialists, 46 maintenance personnel,
168 drivers and transportation personnel, 91 land application specialists, 286
general operation specialists, 42 sales employees and 133 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 approximately 36 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

16

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; El Dorado Hills, California; Mount
Arlington, New Jersey; Baltimore, Maryland and Waterbury, Connecticut; and we
have 18 district offices throughout the United States.

We own and operate four drying and pelletization facilities; one located in
New York, New York, two in Baltimore, Maryland, and one in Sacramento,
California. 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.
We also operate five composting facilities located in Corona, California;
Burlington, New Jersey; Rockland, New Jersey; Salome, Arizona; and Chino,
California. 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
approximately 913,000 acres of land in 25 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, results of operations and
cash flows.

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 any changes in regulatory requirements will not have a
materially adverse effect on our financial condition, results of operations or
cash flows.

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 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
17

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, 2004, 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

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.

SELF-INSURANCE

The Company is substantially self-insured for worker's compensation,
employer's liability, auto liability, general liability and employee group
health claims in view of the relatively high per-incident deductibles the
Company absorbs under its insurance arrangements for these risks. Losses are
estimated and accrued based upon known facts, historical trends, industry
averages, and actuarial assumptions regarding future claims development and
claims incurred but not reported.

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

None.

18

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 2004 and 2003, as reported by the Nasdaq.

As of March 9, 2005, we had 19,809,621 shares of Common Stock issued and
outstanding and 262 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. Currently, covenants relating to our outstanding preferred
stock and bank debt restrict our ability to pay dividends. We expect that our
board of directors will adopt a dividend policy in the second quarter of 2005
that reflects an intention to distribute a substantial portion of the cash
generated by our business in excess of operating needs, interest and principal
payments on our indebtedness and capital expenditures as regular quarterly
dividends to our stockholders. In connection with the adoption of such a policy,
we would enter into a new credit facility allowing for the payment of dividends
and all of our outstanding preferred stock would be converted into shares of
Common Stock.

EQUITY COMPENSATION PLAN INFORMATION

The following table summarizes as of December 31, 2004, certain information
regarding equity compensation to our employees, officers, directors and other
persons under our equity compensation plans:

19

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

(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
"1993 Plan") for officers, directors and key employees. There are 3,614,000
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 have
been 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 us. 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.

ITEM 6. SELECTED FINANCIAL DATA

The following table summarizes our selected consolidated financial data for
each fiscal year of the five-year period ended December 31, 2004. 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.

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

Pursuant to SFAS 131, "Disclosure about Segments of an Enterprise and
Related Information", the Company has restated its segment disclosure from one
reporting segment as was originally reported to three reporting segments (see
Note 20).

21

BACKGROUND

We generate substantially all of our revenue by providing water and
wastewater residuals management services to municipal and industrial customers.
We provide our customers with services and capabilities, including, drying and
pelletization, composting, product marketing, incineration, alkaline
stabilization, land application, collection and transportation, regulatory
compliance, dewatering, and facility cleanout services. We currently serve more
than 600 customers in 37 states and the District of Columbia. Our contracts
typically have inflation price adjustments, renewal clauses and broad force
majeure provisions. For the year ended December 31, 2004, we experienced a
contract retention rate (both renewals and rebids) of approximately 88 percent.

We categorize our revenues into five types -- contract, purchase order
(PO), product sales, design\build construction and event work.

Contract revenues are generated primarily from land application, collection
and transportation services, dewatering, incineration, composting, drying and
pelletization services and facility operations and maintenance, and are
typically performed under a contract with terms ranging from 1 to 25 years.
Contract revenues accounted for approximately 83 percent, 84 percent and 81
percent of total revenues in 2004, 2003 and 2002, respectively.

Purchase order revenues are primarily from facility operations, maintenance
services, and collection and transportation services where services are
performed on a recurring basis, but not under a long-term contract. Purchase
order revenues accounted for approximately three percent, four percent and five
percent of total revenues in 2004, 2003 and 2002, respectively.

Product sales revenues are primarily generated from sales of composted and
pelletized biosolids from internal and external facilities. Revenues from
product sales accounted for approximately three percent of total revenues in
2004 and four percent of total revenues in 2003 and 2002, respectively.

Design\build construction revenues are derived from construction projects
where we agree to design and build a biosolids processing facility such as a
drying and pelletization facility, composting facility, incineration facility or
a dewatering facility that we will subsequently operate once the facility
commences commercial operations. Revenues from design/build construction
projects accounted for approximately three percent, two percent and four percent
of total revenues in 2004, 2003 and 2002 respectively.

Event project revenues are typically generated from digester or lagoon
cleanout projects and temporary dewatering projects. Revenue from event projects
accounted for approximately eight percent, six percent and six percent of total
revenues in 2004, 2003 and 2002.

Revenues under our facilities operations and maintenance contracts are
recognized either when wastewater residuals enter the facility or when the
residuals have been processed, depending on the contract terms. All other
revenues under service contracts are recognized when the service is performed.
Revenues from design/build construction projects are accounted for under the
percentage-of-completion method of accounting. We provide for losses in
connection with long-term contracts where an obligation exists to perform
services and it becomes evident that the projected contract costs will exceed
the related revenue.

Our costs relating to service contracts include processing, transportation,
spreading and disposal costs, and depreciation of operating assets. Our
spreading, transportation and disposal costs can be adversely affected by
unusual weather conditions and unseasonably heavy rainfall, which can
temporarily reduce the availability of land application. Material must be
transported to either a permitted storage facility (if available) or to a local
landfill for disposal. In either case, this results in additional costs for
transporting, storage and disposal of the biosolid materials versus land
application in a period of normal weather conditions. Processing and
transportation costs can also be adversely impacted by higher fuel costs. In
order to manage this risk at processing facilities, we generally enter into
contracts that pass-thru fuel cost increases to the customer, or we lock in our
fuel costs with our fuel suppliers for terms ranging from twelve to twenty four
months. We subcontract a significant portion of our transportation requirements
to numerous contractors which enables us to minimize the impact of changes in
fuel costs for over the road equipment. We have also periodically

22

implemented temporary fuel surcharges with selected customers. Our costs
relating to construction contracts primarily include subcontractor costs related
to design, permit and general construction. Our selling, general and
administrative expenses are comprised of accounting, information systems,
marketing, legal, human resources, regulatory compliance, and regional and
executive management costs. Historically, we have included amortization of
goodwill resulting from acquisitions as a separate line item in our income
statement. Effective January 1, 2002, goodwill is no longer amortized in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," and the
line item will contain only amortization of intangibles and acquisition-related
costs for the years ended December 31, 2004, 2003 and 2002.

Our management reviews and analyzes several trends and key performance
indicators in order to manage our business. Since approximately 90% of our
revenues are generated from municipal water and wastewater plants, we monitor
trends involving municipal generators, including, among other things, aging
infrastructure, technology advances, and regulatory activity in the water and
wastewater residuals management industry. We use this information to anticipate
upcoming growth opportunities, including new facility growth opportunities
similar to the Sacramento, California and Pinellas County, Florida dryer
projects that we started over the past two years. We also use this information
to manage potential business risks such as increased regulatory pressure or
local public opposition to residuals management programs. On an ongoing basis,
our management also considers several variables associated with the ongoing
operations of the business, including, among other things:

- new sales (including the mix of contract and event sales) and existing
business retention objectives necessary to maintain the company's high
percentage of contract and other recurring revenues;

- storage and permitted landbase available to efficiently manage land
application of biosolids, especially during inclement weather patterns;

- monitoring regulatory and permit compliance requirements and safety
programs and initiatives specific to our business; and

- reviewing and monitoring utility costs, fuel costs, subcontractor
transportation costs, equipment utilization and availability, equipment
purchasing activity, headcount, field operating overhead and selling,
general and administrative expenses.

23

RESULTS OF OPERATIONS

The following table sets forth certain items included in the consolidated
financial statements as a percentage of revenue for the periods indicated (in
thousands):

24

Revenue and income from operation are summarized by reporting segment, as
follows (in thousands):

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2003

For the year ended December 31, 2004, revenue was approximately $325.9
million compared to approximately $298.6 million for 2003, an increase of
approximately $27.3 million, or 9.1 percent. Approximately $20.0 million of the
increase related to an 8 percent increase in contract service revenues,
approximately $5.9 million of the increase related to design build work and
approximately $4.9 million of the increase was associated with event revenues.
Contract revenues include $6.7 million of revenue in 2004 on a contract that was
originally expected to be completed over a multi-year period. Excluding this
work, contract revenues increased 5 percent in 2004 compared to 2003. These
revenue increases were partially offset by declines in product sales and
purchase order revenues. Our Residuals Management Operations revenues for the
year ended December 31, 2004, increased approximately $21.2 million or 8.4
percent to $274.8 million compared to $253.6 million for 2003 due primarily to
the approximately $20.0 million increase in contract revenue described above.
Our Rail Transportation revenues for the year ended December 31, 2004, decreased
approximately $2.0 million or 5.0 percent to $38.0 million compared to $40.0
million for 2003 due primarily to a decrease in event revenues from cleanout
services. Our Engineering, Facilities, and Development revenues for the year
ended December 31, 2004, increased approximately $8.5 million to $17.3 million
compared to $8.7 million for 2003 due primarily to an increase in construction
revenues on a new facility in Honolulu, Hawaii, and the startup of a new dryer
facility in Pinellas County, Florida.

Gross profit for the year ended December 31, 2004, was approximately $67.8
million compared to approximately $64.1 million for 2003, an increase of
approximately $3.7 million, or 5.8 percent. Gross profit increased due to an
increase in margins from increased revenue growth, an improvement in land
application margins (which benefited from more normal weather patterns in 2004
compared to 2003) and a significant improvement on cleanout and other event
margins, partially offset by higher repairs and maintenance expenses at the
Company's drying and incineration facilities, a $1.3 million increase in
depreciation and amortization expense, and a $2.1 million decrease related to a
one-time non-cash gain associated with a positive settlement of a warranty
obligation recorded as a reduction of cost of operations in 2003. In 2003, land
application margins were negatively impacted by unusually inclement weather
primarily on the east coast, which significantly increased our storage,
landfill, and transportation costs as we were not able to efficiently access our
landbase. Fiscal 2003 was one of the wettest years on record in the mid-Atlantic
and southeast states. Land application margins returned to expected levels in
2004 as we experienced more normal weather patterns. Cleanout margins were in
line with our internal expectations in 2004, and significantly improved over
2003 margins which were negatively impacted by certain large cleanout jobs that
experienced cost overruns.

25

Selling, general and administrative expenses were approximately $24.3
million for the year ended December 31, 2004 compared to approximately $26.1
million for the year ended December 31, 2003, a decrease of $1.7 million or 6.6
percent. Selling, general and administrative expenses as a percentage of
revenues decreased to 7.5 percent in 2004 from 8.7 percent in 2003. The decrease
in general and administrative expenses primarily relates to a $1.0 million
provision for bad debts recognized in 2003 versus a $0.3 million provision
recognized in 2004, a reduction in overhead and certain administrative functions
implemented in the fourth quarter of 2003, which were partially offset by
increased incentive compensation and commissions related to improved operating
results in 2004. The reduction in certain administrative functions resulted from
a management review of our overhead structure in response to the lower than
expected operating results for 2003.

(Gain) loss on sale of assets increased by $0.9 million primarily as a
result of a gain on the sale of land in June 2004.

As a result of the reduction of overhead and certain administrative
functions in the fourth quarter of 2003, we recorded $1.2 million in
reorganization costs in 2003 related to severance and termination costs. No such
costs were recorded in 2004.

We incurred a special charge of $0.3 million for costs associated with the
re-audit of our 2001 financial statements during the third quarter of 2004.
There was no such special charge during 2003.

Amortization of intangibles decreased to approximately $0.1 million in 2004
from approximately $0.5 million in 2003. The amortization in 2003 resulted from
the write off of $0.4 million of due diligence costs on potential acquisitions
that were not consummated. There were no such write offs in 2004.

As a result of the foregoing, income from operations for the year ended
December 31, 2004, was approximately $43.9 million compared to approximately
$36.4 million in 2003, an increase of approximately $7.5 million, or 20.5
percent. Our Residuals Management Operations income from operations increased
from $46.7 million in 2003 to $55.9 million in 2004 due primarily to the
increase in contract and event revenues described above and the improvement in
land application and event gross profit margins described above. Our Rail
Transportation income from operations decreased from $6.2 million in 2003 to
$5.1 million in 2004 due primarily to the decrease in revenues described above
and an increase in rail and overhead costs. Our Engineering, Facilities, and
Development loss from operations decreased from a loss of $3.8 million in 2003
to a loss of $1.6 million in 2004 due primarily to the increase in construction
revenues and the startup of a new dryer facility described above.

Other expense, net for the year ended December 31, 2004, was approximately
$22.3 million compared to approximately $23.4 million in 2003, a decrease of
approximately $1.1 million. The decrease relates primarily to a reduction of
$1.1 million in interest expense related to reductions in debt and savings
associated with interest rate swaps.

For the year ended December 31, 2004, we recorded a provision for income
taxes of approximately $8.6 million compared to $5.2 million in the prior year.
Our effective tax rate was 40.0 percent in 2004 compared to 40.4 percent in
2003. The decrease in the effective tax rate is primarily related to the
decrease in other non-deductible expenses including meals and entertainment
expenses. Our provision for income taxes differs from the federal statutory rate
primarily due to state income taxes. Our 2004 tax provision is principally a
deferred tax provision that will not significantly impact cash flow since we
have significant tax deductions in excess of book deductions and net operating
loss carryforwards available to offset taxable income.

As a result of the foregoing, net income before cumulative effect of change
in accounting for asset retirement obligations and preferred stock dividends
increased to approximately $13.0 million for 2004 compared to approximately $7.8
million in 2003.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003 AND 2002

For the year ended December 31, 2003, revenue was approximately $298.6
million compared to approximately $272.6 million for 2002, an increase of
approximately $26.0 million, or 9.5 percent. Approxi-

26

mately $25.0 million of the increase in revenues relates to increased volume
from service and maintenance contracts and approximately $6.2 million of the
increase in revenue relates to acquisitions. The $6.2 million increase in
revenues from acquisitions relates to the net increase in year over year
contract revenues realized from the Aspen Resource acquisition which was
completed in May 2003, and the acquisition of Earthwise Organics, Inc. and
Earthwise Trucking (collectively "Earthwise"), which was completed in September
2004. The increase in revenues from contracts and acquisitions was partially
offset by a decrease of approximately $6.3 million related to design/build
contract revenues as projects were completed in the first half of 2003 and were
expected to be replaced by the Honolulu project, which was delayed beyond 2003.
Our Residuals Management Operations revenues for the year ended December 31,
2003, increased approximately $26.9 million or 11.9 percent to $253.6 million
compared to $226.7 million for 2002 due primarily to the approximately $25.0
million increase in contract revenue described above. Our Rail Transportation
revenues for the year ended December 31, 2003, increased approximately $7.8
million or 24.4 percent to $40.0 million compared to $32.2 million for 2002 due
primarily to an increase in event revenues from cleanout services and an
increase in contracted land application revenues. Our Engineering, Facilities,
and Development revenues for the year ended December 31, 2003, decreased
approximately $8.3 million to $8.7 million compared to $17.0 million for 2002
due primarily to a decrease in construction revenues on a new dryer facility in
Pinellas County, Florida which was completed in 2002.

Gross profit for the year ended December 31, 2003, was approximately $64.1
million compared to approximately $70.7 million for 2002, a decrease of
approximately $6.6 million, or 9.3 percent. Gross profit as a percentage of
revenue decreased to 21.5 percent in 2003 from 26.0 percent in 2002. The
decrease in gross profit from 2003 to 2002 is primarily due to
higher-than-expected handling, storage and disposal costs due to unusually
inclement weather incurred primarily in the first half of the year that could
not be passed to the customer and cost overruns on certain one-time event
projects. Additionally, gross profit in 2003 was negatively impacted by higher
repairs and utilities costs of $2.3 million. The settlement of the litigation
between the Company and Riverside County, California resulted in an increase of
$0.7 million in depreciation expense, which impacted 2003, as well as increased
insurance costs from unfavorable development of prior year claims on our
self-insured risk management program totaling $0.6 million, and approximately
$1.0 million of facility startup costs. These decreases in gross profit were
partially offset by margin from the overall increase in revenue and
approximately $2.1 million of income from a positive settlement of a warranty
obligation.

Selling, general and administrative expenses were approximately $26.1
million, or 8.7 percent of revenues, for the year ended December 31, 2003,
compared to approximately $22.9 million, or 8.4 percent of revenues, for 2002,
an increase of approximately $3.2 million. Selling, general and administrative
expenses increased as a percent of revenues primarily due to recording bad debt
expense of $1.0 million in the fourth quarter of 2003.

In response to lower-than-expected operating results, management performed
a review of our overhead structure and reorganized certain administrative
functions in the fourth quarter of 2003. As a result of these decisions, we
recorded $1.2 million in reorganization costs in 2003 related to severance and
termination costs.

Amortization of intangibles increased from approximately $0.1 million in
2002 to approximately $0.4 million in 2003 resulting from the write off of $0.4
million of due diligence costs on potential acquisitions that were not
consummated.

As a result of the foregoing, income from operations for the year ended
December 31, 2003, decreased to approximately $36.4 million from approximately
$47.0 million in 2002, a decrease of approximately $10.6 million, or 22.6
percent. Our Residuals Management Operations income from operations decreased
from $52.9 million in 2002 to $46.7 million in 2003 due primarily to a decrease
in land application and event gross profit margins described above, partially
offset by incremental contract revenues described above. Our Rail Transportation
income from operations increased from $5.5 million in 2002 to $6.2 million in
2003 due primarily to the increase in revenues described above. Our Engineering,
Facilities, and Development loss from operations increased from a loss of $1.7
million in 2002 to a loss of $3.8 million in 2003 due primarily to the decrease
in construction revenues related to a new dryer facility described above.

27

Other expense for the year ended December 31, 2003, was approximately $0.1
million compared to approximately $5.7 million in 2002, a decrease of
approximately $5.6 million. The decrease relates primarily to the write off of
deferred debt costs of $7.2 million related to the refinancing of debt in 2002,
offset by a gain associated with an offset swap arrangement entered into in 2002
of approximately $1.7 million. There was no such swap activity in 2003.

Interest expense for the year ended December 31, 2003, remained flat at
approximately $23.4 million compared to approximately $23.5 million in 2002.

For the year ended December 31, 2003, we recorded a provision for income
taxes of approximately $5.2 million compared to $6.8 million in the prior year.
Our effective tax rate was 40.4 percent in 2003 compared to 38 percent in 2002.
The increase in the effective tax rate is primarily related to the increase in
income taxes at the state level. Our provision for income taxes differs from the
federal statutory rate primarily due to state income taxes. Our 2003 tax
provision is principally a deferred tax provision that will not significantly
impact cash flow since we have significant tax deductions in excess of book
deductions and net operating loss carryforwards available to offset taxable
income.

As a result of the foregoing, net income before cumulative effect of change
in accounting for derivatives and asset retirement obligations and preferred
stock dividends decreased to approximately $7.8 million for 2003 compared to
approximately $11.1 million in 2002.

LIQUIDITY AND CAPITAL RESOURCES

OVERVIEW

During the past three years, our principal sources of funds were cash
generated from our operating activities. We use cash mainly for capital
expenditures, working capital and debt service. In the future, we expect that we
will use cash principally to fund working capital, our debt service and
repayment obligations, and capital expenditures. In addition, we may use cash to
pay dividends on our preferred stock and potential earn out payments resulting
from prior acquisitions. We have historically financed our acquisitions
principally through the issuance of equity and debt securities, our credit
facility, and funds provided by operating activities.

HISTORICAL CASH FLOWS

Cash Flows from Operating Activities. For the year ended December 31,
2004, cash flows from operating activities increased to approximately $35.1
million from approximately $24.1 million for the same period in 2003, an
increase of approximately $10.9 million, or 45.2 percent. The increase primarily
relates to a $5.1 million increase in net income applicable to common stock, a
$4.3 million increase in noncash charges related to depreciation and
amortization expense and deferred income taxes, and a reduction of cash required
for working capital of $4.1 million. Accounts receivable and current costs and
estimated earnings in excess of billings as a percentage of total annual revenue
increased from 20.2 percent at December 31, 2003 to 22.1 percent at December 31,
2004. This increase is primarily related to an increase in costs and estimated
earnings in excess of billings of approximately $12.0 million on contracts
accounted for under the percentage of completion method of accounting. This
increase in cost in excess of billings was offset by an increase in accounts
payable (including payments to subcontractors which are not made until payments
on construction billings have been received from the customer), accrued expenses
for incentive compensation, insurance premiums and reserves, and other reserves.
The increase in accounts receivable and costs in excess of billings is believed
to be fully collectible and thus no additional increase to allowance for
doubtful accounts has been deemed necessary.

For the year ended December 31, 2003, cash flows from operating activities
decreased to approximately $24.1 million from approximately $29.7 million for
the same period in 2002, a decrease of approximately $5.6 million, or 18.9
percent. The decrease primarily relates to the decrease in income from
operations of $10.4 million partially offset by cash flow generated from the
decrease in prepaid expenses as a result of the change in renewal dates for
insurance.