10-Q 1 d10q.txt QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______ 0-21946 ---------------------------- (Commission File No.) HI-RISE RECYCLING SYSTEMS, INC. ---------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) FLORIDA 65-0222933 ---------------------------------- --------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 8505 N.W. 74/TH/ STREET, MIAMI, FLORIDA 33166 ------------------------------------------ ------------------------------------ (Address of principal executive offices) (Zip Code) (305) 597-0243 ------------------------------------------------------------- Registrant's Telephone Number, including area code 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[_] As of September 17, 2001, there were 16,947,355 shares of the registrant's Common Stock, par value $.01 per share, issued and outstanding. INDEX

Pages PART I FINANCIAL INFORMATION Item 1 Consolidated Financial Statements: Consolidated Balance Sheets as of ~~March~~June 3130, 2001 and December 31, 2000............................. 3 Consolidated Statements of Operations for the Three and Six Months Ended ~~March~~June 3130, 2001 and 2000................................................................................... 4 Consolidated Statements of Cash Flows for the ~~Three~~Six Months Ended ~~March~~June 3130, 2001 and 2000............................................................................................ 5 Notes to Consolidated Financial Statements........................................................ 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations............. 1210 Item 3 Quantitative and Qualitative Disclosures About Market Risk........................................ 16 PART II OTHER INFORMATION Item 1 Legal Proceedings................................................................................. 16 Item 2 Changes in Securities............................................................................. 17 Item 3 Defaults Upon Senior Securities................................................................... 17 Item 4 Submission of Matters to a Vote of Security Holders............................................... 17 Item 5 Other Information................................................................................. 17 Item 6 Exhibits and Reports on Form 8-K.................................................................. 1817 SIGNATURES........................................................................................ 1918

2 HI-RISE RECYCLING SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS JUNE 30, 2001 AND DECEMBER 31, 2000 (UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)

~~MARCH~~June 3130, ~~2001~~December ~~DECEMBER~~ 31, 2001 2000 -------------- ----------------- ASSETS Current assets: Cash and cash equivalents...................................................... $ ~~448~~169 $ 375 Accounts receivable, net of allowance for doubtful ~~9,447 12,125~~ accounts of $1,~~078~~039 and $1,376 in 2001 and 2000, respectively..................................... 11,453 12,125 Inventories......... ~~Inventories~~........................................................... 6,~~488~~019 8,109 Other assets................................................................... 1,~~562~~680 1,175 --------- --------- Total current assets......................................................... 1719,~~945~~321 21,784 Property and equipment, net..................................................... 54,~~201~~965 5,316 Net investment in sales type leases............................................. 76,~~937~~527 7,047 Prepaid financing costs......................................................... 1,~~917~~743 2,619 Other assets.................................................................... ~~454~~439 451 Goodwill........................................................................ 47,~~624~~225 47,841 --------- --------- Total assets................................................................. $ 8180,~~078~~220 $ 85,058 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable............................................................... $ 45,~~010~~006 $ 5,132 Accrued liabilities............................................................ 46,~~687~~347 3,837 Cash overdrafts................................................................ ~~787~~1,203 1,096 Income taxes payable........................................................... 57375 ---- Current portion of long-term debt.............................................. 5860,~~713~~549 56,894 --------- --------- Total current liabilities.................................................... 6873,~~254~~480 66,959 Long-term debt.................................................................. 1,~~285~~259 1,194 --------- --------- Total liabilities............................................................ 6974,~~539~~739 68,153 Commitments and contingencies Mandatorily redeemable preferred stock, $.01 par value per share; 50 shares authorized, 37.5 shares and 50 shares issued and outstanding at ~~March~~June 3130, 2001 and December 31, 2000, respectively, liquidation preferences of $~~548~~436 and $532 at ~~March~~June 3130, 2001 and December 31, 2000, respectively................................................................... ~~548~~436 532 Shareholders' equity: Preferred stock, $.01 par value per share; 1,000,000 shares authorized; 100 shares issued and outstanding at ~~March~~June 3130, 2001 and December 31, 2000, liquidation preference of $1,000 at ~~March~~June 3130, 2001 and December 31, 2000...................................................................... ---- ---- Common stock, $.01 par value per share; 50,000,000 shares authorized; 16,947,355 and 16,403,926 shares issued and outstanding at ~~March~~June 3130, 2001 and December 31, 2000, respectively......................................~~........~~ 169 164 Additional paid-in capital..................................................... 40,~~328~~438 40,348 Accumulated deficit............................................................ (2935,~~506~~562) (24,139) --------- --------- Total shareholders' equity................................................... 105,~~991~~045 16,373 --------- --------- Total liabilities and shareholders' equity................................... $ 8180,~~078~~220 $ 85,058 ========= =========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS 3 HI-RISE RECYCLING SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

Three Months Three Months Six Months Six Months Ended Ended Ended Ended June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 --------------- --------------- --------------- --------------- Revenues: Equipment sales.........................~~.......................~~ $ 1013,~~789~~285 $ 1517,~~221~~254 $ 24,074 $ 32,475 Service and parts revenue...............~~.......................~~ ~~848~~873 ~~624~~1,088 1,721 1,712 ---------- ----------- ---------- ---------- Total revenues......................~~.......................~~ 1114,~~637~~158 1518,~~845~~342 25,795 34,187 ---------- ----------- ---------- ---------- Costs and expenses: Cost of equipment and parts sold........~~.......................~~ 1012,~~565~~700 1112,~~454~~907 23,265 24,361 Selling and marketing...................~~.......................~~ ~~919~~1,043 ~~914~~1,131 1,962 2,045 General and administrative..............~~.......................~~ 34,~~212~~948 32,~~222~~864 8,160 6,086 ---------- ----------- ---------- ---------- Total costs and expenses............~~.......................~~ 1418,~~696~~691 1516,~~590~~902 33,387 32,492 ---------- ----------- ---------- ---------- Operating income (loss).............~~.......................~~ (34,~~059~~533) ~~255~~1,440 (7,592) 1,695 ---------- ----------- ---------- ---------- Other income (expense): Interest income.........................~~.......................~~ 6497 ~~205~~139 161 344 Interest expense........................~~.......................~~ (21,~~214~~619) (1,~~447~~543) (3,833) (2,990) ---------- ----------- ---------- ---------- Income (loss) before income taxes.......~~.......................~~ (56,~~209~~055) 36 (~~987~~11,264) (951) Benefit (provision) for income taxes....~~.......................~~ --- (15) (157) ~~375~~360 ---------- ----------- ---------- ---------- Net income (loss).......................~~.......................~~ $ (56,~~366~~055) $ 21 $ (~~612~~11,421) $ (591) ========== =========== ========== ========== Net income (loss) per common share: Basic................................... $ (0.36) $ 0.~~.....................~~00 $ (0.3268) $ (0.0504) ========== =========== ========== ========== Diluted................................. $ (0.36) $ 0.~~.....................~~00 $ (0.3268) $ (0.0504) ========== =========== ========== ========== Weighted average common shares outstanding: Basic...................................~~.......................~~ 16,~~811~~947 15,280 16,879 14,~~439~~860 ========== =========== ========== ========== Diluted.................................~~.......................~~ 16,~~811~~947 16,467 16,879 14,~~439~~860 ========== =========== ========== ==========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS 4 HI-RISE RECYCLING SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (AMOUNTS IN THOUSANDS)

2001 2000 ------------ ------------ Cash flows used in operating activities $ (13,~~262~~680) $ (43,~~268~~681) Cash flows from investing activities: ~~Increase~~Sales inand ~~deferred~~redemptions ~~acquisition~~of ~~costs~~investments........................... -- ~~(76)~~170 Purchase of property and equipment............................. (~~266~~353) (~~345~~720) --------- --------- Net cash used in investing activities........................ (~~266~~353) (~~421~~550) Cash flows from financing activities: Payments on long-term debt..................................... --(81) (~~696~~3,023) Proceeds from long-term debt................................... 13,~~910~~801 56,~~094~~663 Cash overdrafts................................................ ~~(309)~~107 ~~476~~973 --------- --------- Net cash provided by financing activities.................... 13,~~601~~827 4,~~874~~613 Net (decrease) increase in cash and cash equivalents............~~...........~~ 73(206) ~~185~~382 Cash and cash equivalents, beginning of period.................. 375 194 --------- --------- Cash and cash equivalents, end of period........................ $ ~~448~~169 $ ~~379~~576 ========= =========

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS 5 HI-RISE RECYCLING SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements, which are for interim periods, do not include all disclosures provided in the annual consolidated financial statements. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the footnotes thereto contained in the Annual Report on Form 10-K of Hi-Rise Recycling Systems, Inc. (the "Company") for the year ended December 31, 2000 as filed with the Securities and Exchange Commission. The December 31, 2000 consolidated balance sheet was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, the accompanying unaudited consolidated financial statements contain all normal and recurring adjustments necessary for a fair presentation of the Company's financial position, results of operations and cash flows as of the dates and for the periods presented. The consolidated results of operations for the six months ended June 30, 2001 are not necessarily indicative of the results to be expected for the full year. The Company's business has continued to suffer from softened demand for its products due in large part to competition and to decreased equipment expenditures from its largest customers. The Company has also experienced aggressive competitive pricing introduced in certain of its key Solid Waste Division markets. These factors have all contributed to a significant deterioration in operating margins. This resulted in substantial losses, the continued use of cash in operations and defaults under its credit facility (the "Credit Facility") with General Electric Capital Corporation ("GECC") and certain other lenders (the "Other Lenders") under both its borrowing base eligibility and other financial covenants as of June 30, 2001 and December 31, 2000. The Board of Directors engaged Grisanti, Galef and Goldress, Inc. ("GGG") on October 16, 2000. GGG is a corporate performance consulting firm with experience in providing interim leadership to under-performing companies. The initial engagement involved an assessment of the Company's operations and of operating and manufacturing initiatives in order to make preliminary recommendations for future operating strategies. Based upon these recommendations, the Board of Directors determined to further retain GGG in November 2000. The GGG management team worked throughout the fourth quarter of 2000 to obtain short term financing in order to stabilize the Company's operations while a financial and operating plan was being developed. During December 2000, the Company was able to reach an agreement with GECC and the Other Lenders whereby amounts available under its existing credit facilities were increased by an aggregate of $5.5 million by obtaining an additional term loan ("Term Loan C") from GECC which matured on February 15, 2001. During June 2001, GECC acquired all of the interests, rights and obligations of the Other Lenders under the Credit Facility. As such, GECC is the sole remaining lender. Also, during July 2001, the Company was able to reach an agreement with GECC whereby amounts available under its existing credit facilities were increased by an aggregate of $2.5 million by increasing the Term Loan C from $5.5 million to $8.0 million. In addition, the maturity date of the term loan was extended to August 31, 2001. The Company is currently in discussions with GECC to restructure its existing Credit Facility. The Company is evaluating the strategic alternatives available to it taking into consideration the best interests of its creditors, employees, shareholders, customers and vendors. The alternatives under consideration in addition to the restructuring of its existing credit facilities include alternative sources of capital and the sale of the Company or some or all of its assets, including pursuant to a voluntary bankruptcy proceeding. The GGG management team also instituted significant restructuring initiatives, which have included the reorganization of the Company's Architectural Division and Solid Waste Division into two completely separate operating units. Major changes within the business units have been implemented, including changes in operating and reporting responsibilities, manufacturing and distribution process, inventory production strategies and credit and collection policies. These initiatives have also included personnel reduction, responsibility changes, the closure of manufacturing locations and the discontinuance of certain products and service offerings. 6 The recently introduced changes have reduced inventory levels, production and overall manufacturing costs. However, continued softness in product demand and aggressive competitive pricing continue to negatively impact the Company's operations. The Company incurred a net loss of $11.4 million for the six months ended June 30, 2001 and is currently in default under its Credit Facility under both its borrowing base eligibility and other financial covenants. Because the Company is in default, all amounts due under the Credit Facility are presented as current liabilities, which has created a substantial working capital deficiency in the accompanying balance sheets as of June 30, 2001 and December 31, 2000. GECC has declared all amounts outstanding, together with accrued interest, to be immediately due and payable. As the Company does not currently have existing liquidity to repay these amounts, GECC could proceed against the collateral, which would have a material adverse effect on the Company's business and financial condition. If the Company is unable to renew, replace or modify the existing Credit Facility with facilities of like amount, or if the Company is unable to implement other alternative strategies, then the Company will have insufficient cash to continue to operate the business as it is now conducted, and may be unable, in whole or in part, to fund the purchase of equipment, fund other working capital requirements or continue to operate as a going concern. The accompanying consolidated financial statements have been prepared on a basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Accordingly, the consolidated financial statements do not include any adjustments that might be required if the Company would have to liquidate its assets or satisfy its liabilities other than through its normal business operations. If the Company is not able to continue in business as a going concern substantial impairment losses would probably be required if assets were to be liquidated in other than the normal course of business. 2. INVENTORIES Inventories as of June 30, 2001 consisted of the following (amounts in thousands): Raw materials................................................... $ 3,746 Work in progress................................................ 442 Finished goods.................................................. 1,831 ------- $ 6,019 ======= 3. SEGMENTS OF THE BUSINESS The Company operates in the United States and Canada in two primary industry segments: (1) Architectural Specified Services which involves complete handling of hi-rise systems, compactors and chutes primarily in high-rise buildings and (2) Solid Waste Division which involves the construction, repair and maintenance of waste handling equipment, trucks and transfer stations. The following is a summary of selected financial data for these business segments (amounts in thousands):

Architectural Specified Solid Waste Consolidated Services Division Total ------------- ------------- -------------- ASAs OFof ~~AND~~and ~~FOR~~for ~~THE~~the ~~THREE~~six ~~MONTHS~~months ~~ENDED~~ended ~~MARCH~~June 3130, 2001 Revenues..................................................... $ 36,~~380~~839 $ 818,~~257~~956 $ 1125,~~637~~795 Income (loss) before income taxes............................ (12,~~138~~801) (48,~~071~~463) (511,~~209~~264) Total assets................................................. 2419,~~947~~851 5660,~~131~~369 8180,~~078~~220 ASAs OFof ~~AND~~and ~~FOR~~for ~~THE~~the ~~THREE~~six ~~MONTHS~~months ~~ENDED~~ended ~~MARCH~~June 3130, 2000 Revenues..................................................... $ 37,~~505~~581 $ 1226,~~340~~606 $ 1534,~~845~~187 Income (loss) before income taxes............................ (~~147~~202) (~~840~~749) (~~987~~951) Total assets................................................. 6625,~~590~~032 3276,~~489~~803 99101,~~079~~835

7 4. INCOME TAXES Because of the losses incurred, the Company has recorded a valuation allowance against substantially all deferred tax assets representing primarily the tax benefit of net operating loss carryforwards. 5. PER SHARE DATA Basic net income (loss) per common share is calculated by dividing net income (loss) available to common shareholders by the weighted average common shares outstanding during the periods presented. Diluted net income (loss) per share is calculated by dividing net income (loss) per share available to common shareholders by the weighted average common shares outstanding, increased by the assumed conversion of other potentially dilutive securities during the period. Shares used in the diluted calculation would include the weighted average effect of shares assumed to be issued under options and warrants under the treasury stock method. In addition, the calculation would include the dilutive effect of the assumed conversion into common shares of the Company's Series B Preferred Stock and the resulting elimination of the stated dividend requirements, which are payable in common stock upon conversion of the Series B Preferred Stock. Potentially dilutive shares were excluded from the diluted loss per share calculation for the three and six months ended June 30, 2001 because their effects would have been anti-dilutive to the loss incurred by the Company, therefore, the amounts reported for basic and diluted net loss per share were the same. As of June 30, 2001, stock options and warrants totaling 20,450,890 shares as well as 604,738 common shares issuable upon conversion of the Series B Preferred Stock were excluded from the diluted loss per share calculation because their effect was anti-dilutive. 6. PREFERRED SHARES In 1997, the Company sold 200 shares of newly created Series B non-voting convertible preferred stock, par value of $.01 per share (the "Series B Preferred Stock"), and warrants to purchase an aggregate of 888,887 shares of common stock at $2.25 per share, in a private placement for an aggregate purchase price of $2,000,000. During June 2000, 100 shares of the Series B Preferred Stock were converted, pursuant to its original terms, into 549,650 shares of common stock at a per share conversion price of $2.25. Common shares issued upon conversion included 105,206 shares issued as dividends. In July 2000, the Company sold 50 shares of newly created 13% Series C Preferred Stock, $0.01 par value per share (the "Series C Preferred Stock"), to Donald Engel, the Company's former Chief Executive Officer, for an aggregate purchase price of $500,000. The Series C Preferred Stock ranks: (i) prior to all of the Company's common stock; (ii) prior to any class or series of capital stock of the Company hereafter created specifically ranking by its terms junior to any Series C Preferred Stock of whatever subdivision, and (iii) junior to the Company's Series B Preferred Stock, in each case as to distributions of assets upon liquidation, dissolution or winding up of the Company, whether voluntary or involuntary. The holders of the Series C Preferred Stock are entitled to receive cumulative cash dividends, payable quarterly in arrears, at the rate per share of 13% per annum. Dividends on the Series C Preferred Stock accrue from the date of issuance or thereafter, from the most recent date on which dividends were payable, and are payable quarterly each year. The Series C Preferred Stock may be redeemed, in whole or in part, at the option of the Company at any time prior to October 31, 2001 at $10,000 per share, plus accrued and unpaid dividends, if any, to the date of redemption. Any and all outstanding shares of Series C Preferred Stock shall be redeemed by the Company no later than October 31, 2001. In connection with the resignation of Mr. Engel from all positions held by him with the Company and its subsidiaries, in May 2001 Mr. Engel surrendered to the Company for cancellation 12.5 shares of the 50 shares of the Series C Preferred Stock held by him, such shares having a liquidation value of $125,000, in satisfaction of certain amounts owed by Mr. Engel to the Company. 7. CREDIT FACILITY The Company's operations and acquisitions have been financed through both equity and debt arrangements. The primary source of financing has been through the Credit Facility. On October 28, 1998, the Company entered into the Credit Facility. On June 30, 2000, the Company and all of the Company's subsidiaries entered into a second amendment to the Credit Facility with GECC as administrative agent, and the Other Lenders 8 from time to time as they become party thereto, to increase the Credit Facility to $63 million. The Company is currently in default under both its borrowing eligibility and other financial covenants. On October 19, 2000, the Company entered into a third amendment to the Credit Facility to allow for overline advances in the aggregate amount of $500,000. On December 4, 2000, the Company entered into a fourth amendment to the Credit Facility with GECC to increase amounts available under the Credit Facility by an aggregate of $5.5 million by obtaining the additional subordinated Term Loan C from GECC which matured on February 15, 2001. During June 2001, GECC acquired all of the interests, rights and obligations of the Other Lenders under the Credit Facility. As such, GECC is the sole remaining lender. Also, in July 2001, the Company was able to reach an agreement with GECC whereby amounts available under its existing credit facilities were increased by an aggregate of $2.5 million by increasing the Term Loan C from $5.5 million to $8.0 million. In addition, the maturity date of the term loan was extended to August 31, 2001. The overline advances and the increases in the Credit Facility in December 2000 and July 2001 were made notwithstanding the existence of the pending defaults. The increases in the available lines of credit under the Credit Facility have been used for working capital requirements. The Company's Credit Facility with GECC requires the maintenance of certain financial covenants, borrowing base eligibility and other restrictions. The Company is currently in default under its Credit Facility under both its borrowing base eligibility and other financial covenants. Specifically, among other defaults, the Company has overdrawn approximately $15,500,000 more funds than it was permitted based upon its eligible collateral levels. GECC has declared all amounts outstanding, together with accrued interest, to be immediately due and payable. As the Company does not currently have existing liquidity to repay these amounts, GECC could proceed against the collateral, which would have a material adverse effect on the Company's business and financial condition. So long as an Event of Default (as defined in the Credit Facility) shall have occurred and be continuing and at the election of GECC as Administrative Agent , the interest rates applicable to all outstanding obligations under the Credit Facility shall be increased by two percent (2%) per annum above the rates of interest or the rate of fees otherwise applicable (the "Default Rate"). Interest and letter of credit fees shall accrue at the Default Rate from the initial date of such Event of Default until that Event of Default is cured or waived and shall be payable upon demand. The lenders under the Credit Facility have not elected to have the Company accrue interest and fees at the Default Rate. The Company has not made interest payments nor reduced the aggregate principal amount since November 2000. Since the Company is in default, all amounts due under the Credit Facility are presented as current liabilities in the accompanying consolidated balance sheet as of June 30, 2001. 8. LEGAL MATTERS As a result of operations conducted in the ordinary course of business, from time to time the Company may be, and currently is, subject to product liability and/or warranty claims and litigation. The Company believes, though no absolute assurance can be given to that effect, that the current levels of coverage provided by the Company's product liability insurance policy are adequate and that any such claims will not have a material adverse effect on the Company's financial condition or results of operations. On March 28, 2001, Acosta Family Limited Partnership, lessor of Hesco's office and manufacturing facilities and the Company's principal executive office, filed a lawsuit in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida against the Company's subsidiary, Hesco Sales, Inc. ("Hesco"). The complaint filed in this action sought undisclosed damages alleging breach of a lease expiring February 26, 2005 (the "Acosta Lease") through the alleged failure on the part of Hesco to maintain the property, alleged noncompliance with environmental laws and alleged failure of Hesco to provide insurance to lessor insuring against loss of rent. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation. On March 30, 2001, Edelsy Marcano ("Marcano"), a former employee of Hesco, filed a lawsuit in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida against Hesco. The complaint filed in this action sought undisclosed damages alleging breach of the Employment Agreement, dated February 20, 1998, between Marcano and Hesco, resulting from Hesco's decision to terminate Marcano's employment for cause. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation. On or about July 31, 2000, the Commissioner of Environmental Protection for the State of Connecticut (the "Plaintiff") brought an action in Superior Court, Judicial District of Hartford, State of Connecticut, against DeVivo Industries, Inc. ("DeVivo"), a wholly-owned subsidiary of the Company, alleging that DeVivo violated several 9 provisions of Connecticut law by its failure to obtain permits relating to its construction, installation and operation in 1986 and 1994 of paint spray booths used in its manufacturing processes. DeVivo has entered into a Stipulation for Judgment, dated May 16, 2001, with the Plaintiff pursuant to the terms of which DeVivo paid a civil penalty in the amount of $200,000 in exchange for the settlement of all allegations contained in the complaint. DeVivo has been indemnified for the entire $200,000 amount by the former shareholders of DeVivo pursuant to the terms and conditions of the Stock Purchase Agreement dated as of February 23, 1999, by and among Hi-Rise Recycling Systems, Inc., DII Acquisition Corp., DeVivo, Ecological Technologies and the shareholders of DeVivo. DeVivo has submitted applications for the necessary permits. On May 3, 2001, the Equal Employment Opportunity Commission ("EEOC") notified Hesco that a charge of employment discrimination had been filed against Hesco under Title VII of the Civil Rights Act of 1964 for charges of age and national origin discrimination alleged by Jose A. Martinez, a former employee of Hesco, whose employment had been terminated by Hesco. Hesco has replied to the EEOC notice and intends to vigorously defend against all allegations made in the complaint. Hesco believes the suit is without merit; however, Hesco is unable to predict the outcome of the litigation. On May 8, 2001, Jeffrey Annunziata ("Annunziata"), a former employee of Hi- Rise, filed a lawsuit in the Superior Court, Judicial District of Litchfield, Connecticut against the Company. The complaint filed in this action seeks unspecified damages alleging breach of the Employment Agreement, dated February 23, 1999, between Annunziata and the Company, and violation of the Connecticut Unfair Trade Practices Act resulting from the Company's decision to terminate Annunziata's employment for cause. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation. The Company believes that these actions will not have a material adverse effect on its financial condition or results of operations; however, the Company cannot currently predict the outcome of these matters. 9. RECLASSIFICATIONS Certain prior period amounts in the consolidated financial statements have been reclassified to conform with the current period presentation. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General Hi-Rise Recycling Systems, Inc. (the "Company") was incorporated in May 1990 and was engaged principally in product development until January 1991, when it installed the first Hi-Rise System on a shared savings basis. The Company only began to generate significant revenues in 1998. The Company is primarily engaged in manufacturing, distributing, marketing and selling solid waste handling equipment. Until February 1997, the Company was primarily engaged in distributing, marketing and selling the Hi-Rise System(TM), a proprietary automated system designed to collect source-separated recyclables and other solid waste in multi-story residential and commercial buildings. In 1998 and 1999, the Company made a number of acquisitions of businesses in its solid waste and architectural specified service divisions. As a result of these acquisitions, the solid waste division has become the Company's single largest source of revenue. In addition, the Company's other principal sources of revenue consist of sales of rubbish and linen chutes, trash compaction systems and the Hi-Rise System and sales-type leases of the Hi-Rise System. Business Segments The Company operates in two business segments comprised of the Architectural Specified Services Division, which manufactures the Hi-Rise System and rubbish, linen and laundry chutes designed primarily for multi-story residential and commercial buildings, and the Solid Waste Division, which, through its four operations and seven manufacturing facilities, manufactures a wide line of solid waste handling equipment. For the six months ended June 30, 2001, approximately 73% of the Company's revenues were derived from its Solid Waste Division and the other 27% of its revenues were derived from its Architectural Specified Services Division. 10 Current Business Environment The Company's business has continued to suffer from softened demand for its products due in large part to competition and to decreased equipment expenditures from its largest customers. The Company has also experienced aggressive competitive pricing introduced in certain of its key Solid Waste Division markets. These factors have all contributed to a significant deterioration in operating margins. This has resulted in substantial losses, the continued use of cash in operations and defaults under the Company's Credit Facility with GECC under both its borrowings base eligibility and other financial covenants. This situation, coupled with the task of integrating all of the Company's acquisitions, has led to a number of management initiatives. These initiatives included the review of the manufacturing process and staffing levels at all locations and changes in production management in certain of its Solid Waste Division operations. Management also examined the products being manufactured by its various facilities and reviewed its products to determine if standardization and/or products rationalization was warranted in light of the current business environment described above. The initiatives also included an extensive review of the Company's balance sheet. This included a review of the allowance for doubtful accounts, exposures related to slow paying or non-paying sales type lease customers, the carrying value of its inventories in view of the manufacturing conditions discussed above and the exposure to loss related to certain distributor accounts. The Board of Directors engaged Grisanti, Galef, and Goldress, Inc. ("GGG") on October 16, 2000. GGG is a corporate performance consulting firm with experience in providing interim leadership to under-performing companies. The initial engagement involved an assessment of the Company's operations and to assess the operating and manufacturing initiatives in order to make preliminary recommendations for future operating strategies. Based upon these recommendations, the Board of Directors determined to further retain GGG in November 2000. Dr. James Ashton, a GGG partner, assumed responsibility for the operational management of the Company. Donald Engel, former Chairman of the Board and Chief Executive Officer ("CEO"), requested that the Board of Directors delegate his CEO responsibilities to Dr. Ashton. Dr. Ashton appointed Mel Johnson as Acting Chief Operating Officer of the Solid Waste Division, Michael Bracken, an employee of the Company, as Acting Chief Operating Officer of the Architectural Specified Services Division and Ronald Miller as Acting Chief Financial Officer. In order to address the near term liquidity needs of the Company, the GGG management team worked throughout the fourth quarter of 2000 to obtain short term financing in order to stabilize the Company's operations while a financial and operating plan was developed. During December 2000, the Company was able to reach agreement with GECC and the other lenders whereby amounts available under its existing credit facilities were increased by an aggregate of $5.5 million by obtaining an additional subordinated term loan from GECC which matured on February 15, 2001. The Company is currently in default under both its borrowing base eligibility and other financial covenants. For more information regarding the Credit Facility, see "Recent Developments" and see "Liquidity and Capital Resources". The GGG team has instituted significant restructuring initiatives, including the reorganization of the Company's Architectural Specified Services Division and Solid Waste Division into two completely separate operating units. Major changes within the business units have been implemented, including changes in operating and reporting responsibilities, manufacturing and distribution processes, inventory production strategies and credit and collection policies. In addition, these initiatives have included personnel terminations, responsibility changes, the closure of manufacturing locations, and the discontinuance of certain products and service offerings. Management believes that they have stabilized the Company's business units and restructured lender relationships. However due to the size of the debt, management will consider all alternatives going forward. There can be no assurance that the Company will be able to continue in its present form and no assurance as to any value that might remain for the shareholders. The Company is evaluating the strategic alternatives available to it taking into consideration the best interests of its creditors, employees, shareholders, customers and vendors. The alternatives under consideration in addition to the restructuring of its existing credit facilities include alternative sources of capital and the sale of the Company or some or all of its assets, including pursuant to a voluntary bankruptcy proceeding. 11 Recent Developments On April 17, 2001, Gary McAlpin, the Company's former President and Chief Operating Officer, resigned from all offices and positions he held with the Company and each of its subsidiaries, and on April 30, 2001, Kevin Bartczak, the Company's former Chief Financial Officer resigned from all offices and positions he held with the Company and each of its subsidiaries. The Company has appointed Ronald Miller as its Chief Financial Officer. In addition, on May 2, 2001, Donald Engel, the Company's former Chairman of the Board and Chief Executive Officer, resigned from all offices and positions he held with the Company and each of its subsidiaries and surrendered 12.5 shares of 13% Series C Preferred Stock, par value $0.01 per share, having a liquidation value of $125,000, in satisfaction of certain amounts owed by Mr. Engel to the Company. In June 2001, GECC acquired all of the interests, rights and obligations of the other lenders under the Credit Facility. As such, GECC is the sole remaining lender. Also, in July 2001, the Company was able to reach an agreement with GECC whereby amounts available under its existing credit facilities were increased by an aggregate of $2.5 million by increasing the Term Loan C under its Credit Facility from $5.5 million to $8.0 million. In addition, the maturity date of Term Loan C was extended to August 31, 2001. The Company is currently in discussions with GECC to restructure its existing Credit Facility, is exploring alternative sources of capital and is considering other alternatives, including the selling of some or all of the Company's assets. In July 2001, Joel M. Pashcow, a member of the Board of Directors resigned as a director of the Company. Results Of Operations Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000 Total revenue during the three months ended June 30, 2001 was $14,158,000, a decrease of $4,184,000, or approximately 23%, compared to total revenue of $18,342,000 during the comparable three-month period of 2000. The primary reason for the decrease is the decline in revenue throughout the Solid Waste Division of $4,051,000. The Company's Solid Waste Division business has suffered from softened demand for its products due in large part to competition and to decreased equipment expenditures from its largest customers. In addition, the Architectural Specified Services Division revenue decreased by $133,000. This decrease was also due to softened demand for its products due to decreased expenditures from its largest customers and distributors. During the three months ended June 30, 2001, the Company recognized interest income of approximately $97,000, a decrease of $42,000, or approximately 30%, compared to $139,000 during 2000. The decrease is primarily attributable to the substantial reduction in the Company's investment in sales type leases of Hi-Rise Systems and waste equipment. Cost of equipment and parts sold decreased by $207,000, or approximately 2%, from $12,907,000 during the three months ended June 30, 2000 to $12,700,000 during the three months ended June 30, 2001. This decrease is primarily attributable to the decrease in sales of Solid Waste Division products. As a percentage of revenue, cost of equipment sold increased to 90% during the three months ended June 30, 2001 from 70% during the prior comparable three month period. Generally, individual subsidiaries have not performed at projected or prior year levels due to the continued economic slow-down. In addition, pricing competition, freight costs, product mix and general plant inefficiencies in the Architectural Specified Services Division have negatively impacted gross margins. Due to the aggressive competitive pricing in certain of the key Solid Waste Division markets noted earlier, the Company reduced its selling prices in certain markets, which management estimates has increased the cost of equipment sold as a percentage of revenues by approximately 13%. In addition, Management estimates that higher freight costs have increased the cost of equipment and parts sold by approximately $100,000, or 1% as a percentage of revenues. Also, the Company recorded inventory related charges of approximately $300,000, or 2% as a percentage of revenues. General plant inefficiencies have increased the cost of equipment sold as a percentage of revenue by approximately 2%. Selling and marketing expenses during the three months ended June 30, 2001 were $1,043,000, a decrease of $88,000, or approximately 8%, compared to selling and marketing expenses of $1,131,000 during the comparable three month period of 2000. This decrease is primarily a result of the decreased sales for the same period. 12 General and administrative expenses during the three months ended June 30, 2001 were $4,948,000, an increase of $2,084,000, or approximately 73%, compared to general and administrative expenses of $2,864,000 during the comparable three month period of 2000. General and administrative expenses for the three months ended June 30, 2001 include additional costs of $480,000 paid to management consultants, increased legal and professional fees of $250,000, losses on transferred leases, residual adjustments and the re-negotiation of certain lease receivable accounts of $1,750,000. These increases were partially offset by a decrease in salary costs of $325,000. Interest expense increased $76,000, or approximately 5%, to $1,619,000, for the three months ended June 30, 2001 from $1,543,000 for the comparable three month period of 2000. This increase is a result of increased borrowings under the Company's credit facilities. These credit facilities have financed substantially all of the Company's acquisitions and are used to finance its working capital needs. As a result of the foregoing, the Company realized a net loss of $6,055,000 for the quarter ended June 30, 2001, compared to net income of $21,000 for the quarter ended June 30, 2000. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Total revenue during the six months ended June 30, 2001 was $25,795,000, a decrease of $8,392,000, or approximately 25%, compared to total revenue of $34,187,000 during the comparable six-month period of 2000. The primary reason for the decrease is the decline in revenue throughout the Solid Waste Division of $7,650,000. The Company's Solid Waste Division business has suffered from softened demand for its products due in large part to competition and to decreased equipment expenditures from its largest customers. In addition, the Architectural Specified Services Division revenue also decreased by $742,000. This decrease was also due to softened demand for its products due to decreased expenditures from its largest customers and distributors. During the six months ended June 30, 2001, the Company recognized interest income of approximately $161,000, a decrease of $183,000, or approximately 53%, compared to $344,000 during 2000. The decrease is primarily attributable to the substantial reduction in the Company's investment in sales type leases of Hi- Rise Systems and waste equipment. Cost of equipment and parts sold decreased by $1,096,000, or approximately 4%, from $24,361,000 during the six months ended June 30, 2000 to $23,265,000 during the six months ended June 30, 2001. This decrease is primarily attributable to the decrease in sales of Solid Waste Division products. As a percentage of revenue, cost of equipment sold increased to 90% during the six months ended June 30, 2001 from 71% during the prior comparable six month period. Generally, individual subsidiaries have not performed at projected or prior year levels due to the continued economic slow-down. In addition, pricing competition, increased steel prices, freight costs, product mix and general plant inefficiencies in the Architectural Specified Services Division have negatively impacted gross margins. Due to the aggressive competitive pricing in certain of the key Solid Waste Division markets noted earlier, the Company reduced its selling prices in certain markets, which management estimates has increased the cost of equipment sold as a percentage of revenues by approximately 14%. Steel prices increased from an average of 16 cents per pound in the first six months of 2000 to approximately 17 cents per pound in the first six months of 2001, which price increases management estimates have increased the cost of equipment sold by approximately $250,000, or 1% as a percentage of revenues. Management estimates that higher freight costs have increased the cost of equipment and parts sold by approximately $200,000, or 1% as a percentage of revenues. Also, the Company recorded inventory related charges of approximately $525,000, or 2% as a percentage of revenues. General plant inefficiencies have increased the cost of equipment sold as a percentage of revenue by approximately 1%. Selling and marketing expenses during the six months ended June 30, 2001 were $1,962,000, a decrease of $83,000, or approximately 4%, compared to selling and marketing expenses of $2,045,000 during the comparable six month period of 2000. This decrease is primarily a result of the decreased sales for the same period. General and administrative expenses during the six months ended June 30, 2001 were $8,160,000, an increase of $2,074,000, or approximately 34%, compared to general and administrative expenses of $6,086,000 during the comparable six month period of 2000. General and administrative expenses decreased by approximately $617,000 due to expenses incurred in the six months ended June 30, 2000 for unsuccessful acquisitions and a financing which were not consummated and by reduced salary costs of $225,000. This decrease in expenses was offset by increases in the six months ended June 30, 2001 for $880,000 paid to management consultants, increased 13 legal and professional fees of $350,000, losses on transferred leases, residual adjustments and the re-negotiation of certain lease receivable accounts of $1,750,000. Interest expense increased $843,000, or approximately 28%, to $3,833,000, for the six months ended June 30, 2001 from $2,990,000 for the comparable six month period of 2000. This increase is a result of increased borrowings under the Company's credit facilities and amortization of prepaid costs associated with the warrants issued to GECC during December 2000. These credit facilities have financed substantially all of the Company's acquisitions and are used to finance its working capital needs. As a result of the foregoing, the Company realized a net loss of $11,421,000 for the six months ended June 30, 2001, compared to a net loss of $591,000 for the six months ended June 30, 2000. Liquidity and Capital Resources Until February 1997, the Company was primarily engaged in distributing, marketing and selling the Hi-Rise System, a proprietary automated system designed to collect source-separated recyclables and other solid waste in multi- story residential and commercial buildings. In 1998, the Company acquired Hesco, Acme Chute Company, Inc. and Bes-Pac Inc. and, in 1999 the Company acquired DeVivo Industries, KE Corporation and American Gooseneck Inc. These acquisitions were financed through borrowings made under the Credit Facility and through private placements of the Company's securities. The Company's operations and acquisitions have been financed through both equity and debt arrangements. The primary source of financing has been the Credit Facility. On October 28, 1998, the Company entered into the Credit Facility. On June 30, 2000, the Company and all of the Company's subsidiaries entered into a second amendment to the Credit Facility with GECC as administrative agent, and the Other Lenders from time to time as they become party thereto, to increase the Credit Facility to $63 million. The Company is currently in default under both its borrowing eligibility and other financial covenants. On October 19, 2000, the Company entered into a third amendment to the Credit Facility to allow for overline advances in the aggregate amount of $500,000. On December 4, 2000, the Company entered into a fourth amendment to the Credit Facility with GECC and the Other Lenders to increase amounts available under the Credit Facility by an aggregate of $5.5 million by obtaining an additional subordinated term loan from GECC which matured on February 15, 2001 (the "Term Loan C"). In July 2001, the Company was able to reach an agreement with GECC whereby amounts available under its existing credit facilities were increased by an aggregate of $2.5 million by increasing the Term Loan C from $5.5 million to $8.0 million. In addition, the maturity date of the Term Loan C was extended to August 31, 2001. The overline advances and the increase in the Credit Facility in December 2000 and July 2001 were made notwithstanding the existence of the pending defaults. The increases in the available lines of credit under the Credit Facility have been used for working capital requirements. On July 5, 2000, the Company sold 50 shares of its Series C Preferred Stock, to Donald Engel, the Company's former Chairman of the Board and Chief Executive Officer, for an aggregate purchase price of $500,000. The holders of the Series C Preferred Stock are entitled to receive cumulative cash dividends, payable quarterly in arrears, at the rate of 13% per annum. Dividends on the Series C Preferred Stock accrue from the date of issuance or thereafter, from the most recent date on which dividends were payable, and are payable quarterly each year. Any and all outstanding shares of Series C Preferred Stock are required to be redeemed by the Company on October 31, 2001. Also, pursuant to the terms of the Credit Facility, the Company is permitted to return or repay amounts invested by Mr. Engel only to the extent that (i) no Default or Event of Default (as defined in the Credit Facility) shall have occurred, and (ii) after giving effect to the return or repayment of the amounts invested by Mr. Engel, the Company and its subsidiaries shall have Borrowing Availability (as defined in the Credit Facility) of at least $2,500,000. Also, payment of the dividends is subject to the same conditions set forth with respect to the return or repayment of the amounts invested by Mr. Engel. In connection with the resignation of Mr. Engel from all positions held by him with the Company and its subsidiaries, Mr. Engel surrendered to the Company for cancellation 12.5 shares of the 50 shares of the Series C Preferred Stock held by him, such shares having a liquidation value of $125,000, in satisfaction of certain amounts owed by Mr. Engel to the Company. The Company's Credit Facility with GECC requires the maintenance of certain financial covenants, borrowing base eligibility and other restrictions. The Company is currently in default under its Credit Facility under both its borrowing base eligibility and other financial covenants. Specifically, among other defaults, the Company has overdrawn approximately $1,800,000 more funds than it was permitted based upon its eligible collateral levels. GECC has declared all amounts outstanding, together with accrued interest, to be immediately due and payable. As 14 the Company does not currently have existing liquidity to repay these amounts, GECC could proceed against the collateral, which would have a material adverse effect on the Company's business and financial condition. So long as an Event of Default (as defined in the Credit Facility) shall have occurred and be continuing and at the election of GECC as Administrative Agent, the interest rates applicable to all outstanding obligations under the Credit Facility shall be increased by two percent (2%) per annum above the rates of interest or the rate of fees otherwise applicable (the "Default Rate"). Interest and letter of credit fees shall accrue at the Default Rate from the initial date of such Event of Default until that Event of Default is cured or waived and shall be payable upon demand. The lenders under the Credit Facility have not elected to have the Company accrue interest and fees at the Default Rate. The Company has not made interest payments nor reduced the aggregate principal amount since November 2000. Because the Company is in default, all amounts due under the Credit Facility are presented as current liabilities in the accompanying consolidated balance sheet as of June 30, 2001. As of June 30, 2001, the Company had a working capital deficit of $54,159,000 due to amounts borrowed from its primary lenders being presented as current obligations, and had cash and cash equivalents aggregating $169,000, compared to a working capital deficit of $45,175,000 and cash and cash equivalents of $375,000 at December 31, 2000. The Company's existing financial condition will limit its ability to obtain additional sources of financing. If the Company is unable to obtain additional sources of financing, or to renew, replace or modify the existing Credit Facility with facilities of like amount, or if the Company is unable to implement other alternative strategies, then the Company will have insufficient cash to continue to operate the business as it is now conducted, and may be unable, in whole or in part, to fund the purchase of equipment or fund other working capital requirements, or continue to operate as a going concern. As part of the $5,500,000 term loan provided by GECC on December 4, 2000, the Company canceled warrants to purchase an aggregate of 1,476,259 shares of Common Stock previously issued to GECC and issued warrants to GECC to purchase an aggregate of 17,382,053 shares of the Company's Common Stock at an exercise price of $.01 per share. During the six months ended June 30, 2001, net cash used in operating activities was $3,680,000, compared to net cash used in operating activities of $3,681,000 during the six months ended June 30, 2000. The net cash used in operating activities was primarily the result of the net loss of $11,421,000 for the six months ended June 30, 2001. Accounts receivable decreased by $672,000 as a result of decreased sales in the first and second quarter coupled with increased collection efforts. In addition, inventory decreased by $2,090,000 primarily as a result of "just-in-time" management initiatives. Accounts payable and accrued expenses increased by $2,384,000 primarily as a result of unpaid accrued interest on the Credit Facility. Net cash used in investing activities was $353,000 during the six months ended June 30, 2001. This was the result of cash used for the purchase of capital equipment. Net cash provided by financing activities was $3,827,000 during the six months ended June 30, 2001, primarily as a result of borrowings under the Company's Credit Facility. The Company currently has no outstanding material commitments for capital expenditures. Cautionary Statement Relating to Forward-Looking Statements The foregoing Management's Discussion and Analysis of Financial Condition and Results of Operations contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations and beliefs concerning future events and involve known and unknown risks and uncertainties. When used herein the terms, "anticipate," "believe," "estimate," "expect" and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements. Such statements reflect the current risks, uncertainties and assumptions related to certain factors including, without limitation, decline in demand for the Company's products, increases in costs of sales, inability to amend, restructure or replace the Credit Facility under which the Company is currently in default, failure to successfully implement certain restructuring initiatives, customer relations, relationships with vendors, steel costs, the interest rate environment, the inability to integrate successfully acquired operations, one- time events, the effect of general economic conditions and factors affecting the waste hauling and construction industries, and other factors described herein and in other filings made by the Company with the Securities and Exchange Commission. These statements by their nature involve substantial risks and uncertainties and actual events or results may vary materially 15 from those described herein as anticipated, believed, estimated or intended. The Company undertakes no obligation to update, and the Company does not have a policy of updating or revising, these forward-looking statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rates: The Company's interest rate risk results from holding variable rate debt obligations, as an increase in interest rates results in lower earnings and increased cash outflows. The interest rate on the Company's Credit Facility is payable primarily at variable rates. The effect of a 1% increase in interest on the Company's borrowings would result in an increase in interest expense of $224,000 for the six months ended June 30, 2001. Steel Prices: The Company is exposed to fluctuations in steel costs, which comprise the largest material component in all of its products. Accordingly, an increase in steel costs would result in lower earnings and increased cash outflows. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS As a result of operations conducted in the ordinary course of business, from time to time the Company may be, and currently is, subject to product liability and/or warranty claims and litigation. The Company believes, though no absolute assurance can be given to that effect, that the current levels of coverage provided by the Company's product liability insurance policy are adequate and that any such claims will not have a material adverse effect on the Company's financial condition or results of operations. On March 28, 2001, Acosta Family Limited Partnership, lessor of the office and manufacturing facilities of Hesco Sales, Inc. ("Hesco"), a subsidiary of the Company, and the Company's principal executive office, filed a lawsuit in the Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida against Hesco. The complaint filed in this action sought undisclosed damages alleging breach of a lease expiring February 26, 2005 through the alleged failure on the part of Hesco to maintain the property, alleged noncompliance with environmental laws and alleged failure of Hesco to provide insurance to lessor insuring against loss of rent. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation. On March 30, 2001, Edelsy Marcano, a former employee of Hesco, filed a lawsuit in the Circuit Court of the Eleventh Judicial Circuit in and for Miami- Dade County, Florida against Hesco. The complaint filed in this action sought undisclosed damages alleging breach of the Employment Agreement, dated February 20, 1998, between Marcano and Hesco, resulting from Hesco's decision to terminate Marcano's employment for cause. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation. On or about July 31, 2000, the Commissioner of Environmental Protection for the State of Connecticut (the "Plaintiff") brought an action in Superior Court, Judicial District of Hartford, State of Connecticut, against DeVivo, a wholly- owned subsidiary of the Company, alleging that DeVivo violated several provisions of Connecticut law by its failure to obtain permits relating to its construction, installation and operation in 1986 and 1994 of paint spray booths used in its manufacturing processes. DeVivo has entered into a Stipulation for Judgment, dated May 16, 2001, with the Plaintiff pursuant to the terms of which DeVivo has paid a civil penalty in the amount of $200,000 in exchange for the settlement of all allegations contained in the complaint. DeVivo has been indemnified for the entire $200,000 amount by the former shareholders of DeVivo pursuant to the terms and conditions of the Stock Purchase Agreement dated as of February 23, 1999, by and among Hi-Rise Recycling Systems, Inc., DII Acquisition Corp., DeVivo, Ecological Technologies and the shareholders of DeVivo. DeVivo has submitted applications for the necessary permits. On May 3, 2001, the Equal Employment Opportunity Commission ("EEOC") notified Hesco that a charge of employment discrimination had been filed against Hesco under Title VII of the Civil Rights Act of 1964 for charges of age and national origin discrimination alleged by Jose A. Martinez, a former employee of Hesco, whose employment had been terminated by Hesco. Hesco has replied to the EEOC notice and intends to vigorously defend against all allegations made in the complaint. Hesco believes the suit is without merit; however, Hesco is unable to predict the outcome of the litigation. 16 On May 8, 2001, Jeffrey Annunziata ("Annunziata"), a former employee of Hi- Rise, filed a lawsuit in the Superior Court, Judicial District of Litchfield, Connecticut against the Company. The complaint filed in this action seeks unspecified damages alleging breach of the Employment Agreement, dated February 23, 1999, between Annunziata and the Company, and violation of the Connecticut Unfair Trade Practices Act resulting from the Company's decision to terminate Annunziata's employment for cause. The Company has filed a response and intends to vigorously defend against all allegations made in the complaint. The Company believes the suit is without merit; however, the Company is unable to predict the outcome of the litigation. The Company believes that these actions will not have a material adverse effect on its financial condition or results of operations, however, the Company cannot currently predict the outcome of these matters. ITEM 2. CHANGES IN SECURITIES No changes in securities have occurred during the first six months of 2001. ITEM 3. DEFAULTS UPON SENIOR SECURITIES The Credit Facility requires the Company to maintain certain covenants and borrowing base eligibility requirements. The Company is currently in default under its Credit Facility under both its borrowing base and eligibility and other financial covenants. Accordingly, all amounts aggregating $60,428,132 due under the Credit Facility are presented as current liabilities as of June 30, 2001. (See also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources".) ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the second quarter of 2001. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS Exhibits Description -------- ----------- 10.65 Sixth Amendment to Credit Agreement and Composite Amendment Agreement, dated as of July 11, 2001. (B) REPORTS ON FORM 8-K: None 17 SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: September 19, 2001 HI-RISE RECYCLING SYSTEMS, INC. By: /s/ JAMES ASHTON ------------------------------- James Ashton, Chief Executive Officer By: /s/ RONALD MILLER ------------------------------- Ronald Miller, Chief Financial Officer 18 Exhibits Description -------- ----------- 10.65 Sixth Amendment to credit agreement and composite Amendment Agreement, dated as of July 11, 2001.

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