10-K 1 a71027e10-k.txt FORM 10-K FISCAL YEAR ENDED DECEMBER 31, 2000 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 0-21975 ECO SOIL SYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEBRASKA 47-0709577 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 10740 THORNMINT ROAD SAN DIEGO, CA 92127 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (858) 675-1660 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.005 PAR VALUE 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 filer, 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. [] As of April 16, 2001, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $9,075,262. As of April 16, 2001, the number of shares outstanding of the Registrant's Common Stock, $.005 par value, was: 19,645,144. DOCUMENTS INCORPORATED BY REFERENCE The information called for by Part III is incorporated by reference to the definitive Proxy Statement for the 2001 Annual Meeting of Shareholders of the Registrant, which will be filed on or prior to April 30, 2001. ================================================================================ 2 FORWARD-LOOKING STATEMENTS CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. Statements contained in this document that are not based on historical fact are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. To the extent statements in this report involve, without limitation, product development and introduction plans, the Company's expectations for growth, estimates of future revenue, expenses, profit, cash flow, balance sheet items, sell-through or backlog, forecasts of demand or market trends for the Company's various product categories and for the industries in which the Company operates or any other guidance on future periods, these statement are forward-looking statements. Forward-looking statements also may be identified by use of forward-looking terminology such as "may," "will," "expect," "estimate," "anticipate," "believe," "continue" or similar terms, variations of those terms or the negative of those terms. These risks and uncertainties include those identified by the Company under the caption "Factors That Could Affect Future Performance" in Item 1, and other risks identified from time to time in the Company's filings with the Securities and Exchange Commission, press releases and other communications. The Company assumes no obligation to update forward-looking statements. PART I ITEM 1. BUSINESS GENERAL Eco Soil Systems, Inc. (the "Company") develops, markets and sells proprietary biological and traditional chemical products that provide solutions for a wide variety of turf and crop problems in the golf and agricultural industries. The Company has developed a portfolio of microbial programs to be applied via standard spray procedures in the case of the FreshPack(TM) product line, or through the Company's patented BioJect(R) system. These naturally occurring microbes complement or reduce the need for many chemical products currently used in golf and agricultural markets. The Environmental Protection Agency (EPA) has approved the BioJect as a means of application for biopesticides and the BioJect is described as the application method under the directions for use on the Company's EPA registered exclusive microbial products. By fermenting microbes at or near the customer's site and delivering them for distribution through the customer's existing irrigation system via the BioJect, or through standard application practices, customers can cost-effectively reap the benefits associated with quality microbial products while mitigating the adverse environmental effects associated with chemical products. The Company initially focused its sales and marketing efforts on the golf market and in 1998 entered the agricultural crop and horticultural markets. By utilizing microbes that occur naturally in the environment, Eco Soil's microbial solutions overcome many of the problems associated with traditional chemical products. Traditional chemical products require repeated applications, which can lead to pest resistance and/or adverse environmental effects. The Company's microbial programs reduce the frequency rate of chemical product application, resulting in lower overall product and labor cost and increasing the effectiveness of traditional chemical products. In addition, the Company believes that the use of microbes, either FreshPack or distributed through the BioJect system, provide environmental benefits as compared to chemical product applications by limiting the exposure of humans to chemical products, reducing residual pesticide contaminants in plants and soil, and minimizing groundwater pollution. Eco Soil's FreshPack and BioJect programs overcome many of the obstacles that historically have hindered widespread use of microbes in the golf and agricultural industries. Biological products generally have been perceived as economically infeasible because of their short shelf life, rapid deterioration upon exposure to light or heat, specialized transportation requirements and need for daily, manual treatments. For large-scale applications, the BioJect system preserves and protects the potency of microbes, significantly reduces shipping costs, controls the concentration of product and allows for automated daily application by fermenting microbes at the customer's site and distributing them through the customer's existing irrigation system. The Company's FreshPack products are packaged and designed to deliver a microbial-based program to the customer. The FreshPack products, which contain certain microbes together with other soil amendments, are intended to address several problems encountered by the Company's golf course customers by enhancing the development of the root systems, reducing the level of soil alkalinity, increasing the level of oxygen in the soil and increasing the porosity of the soil. The FreshPack products are fermented centrally and then shipped via overnight or second day delivery to the customer to be immediately 2 3 applied to the problem area of the course. The Company views its FreshPack product line as an additional method of delivering microbial solutions to the customer. Moreover, if the economics are such that the BioJect System is of greater value, the FreshPack products serve as an introduction to the efficacy of the microbial products prior to the customer's making the financial commitment to a BioJect System. The Company intends to expand the usage of the FreshPack products into the agricultural markets in the near future. The Company generates recurring revenues both from the sale of its FreshPack programs and by delivering programs through BioJect systems to customers. The Company has entered into technology transfer agreements pursuant to which it has obtained rights to certain microbes from leading biotechnology companies and organizations such as Mycogen Corporation, Encore Technologies, Inc. and the USDA and major universities such as Michigan State University, Rutgers University and the University of California, Riverside. The Company currently offers BioJect customers a menu of three microbial-based programs and will continue to develop the library of approximately 2,500 microbes from the Agrium acquisition. Through the Agricultural Supply subsidiary, the Company offers a complete program to the agriculture market consisting of various soil analyses to establish a customized program regimen delivered through the Company's proprietary equipment, the BioJect and CalJect. The programs' goals are to utilize soil remediation and microbial activity to move soil pH towards neutral, improve soil structure and infiltrate and release nutrients through increased mineralization and organic matter degradation. The Company performs the soil analysis at the beginning of the season, develops a treatment regimen, installs and services the equipment at the customer's site and provides the microbials and other soil additive products for the customer to use throughout the crop's growing season. While the Company is redirecting its agricultural efforts to focus primarily in the United States, approximately 47% of its agriculture business in 1999 was derived from sales outside the United States, primarily in Mexico. In 2000 the agricultural business in Mexico was reduced due to store closings and tighter credit policies, but this was partly offset by the addition of sales to Cargill in Canada. In total, approximately 40% of the agricultural business in 2000 was outside the United States. On July 28, 2000, the Company completed the sale of substantially all of the assets of its Turf Partners subsidiary (the "Asset Sale") to the Simplot Company ("Simplot"). At the closing of the Asset Sale, Simplot made a cash payment of $23 million and assumed Turf Partners' existing long-term debt and vendor payables totaling $37.3 million. Simplot also assumed Turf Partners' outstanding contracts and leases. The Asset Sale was consummated pursuant to an Amended and Restated Asset Purchase Agreement dated April 5, 2000, as amended by a First Amendment to Amended and Restated Asset Purchase Agreement dated June 9, 2000. In connection with the Asset Sale, the Company entered into two distribution agreements with Simplot. In the first agreement, a Distribution and License Agreement, Simplot agreed to purchase and distribute a minimum of $5 million of the Company's proprietary FreshPack(TM) products during the first two years of the five-year agreement. In the second agreement, Simplot agreed to distribute the Company's proprietary products in Simplot's Soilbuilders stores. The Company and Simplot also entered into a field trials agreement pursuant to which Simplot will pay the Company to perform Field Trials of the Company's BioJect(R) system and microbials on selected Simplot crops in 2001. HISTORY Eco Soil was incorporated under Nebraska law in November 1987. The Company initially marketed a program that developed blended fertilizers and soil amendments to golf courses and to other residential and commercial customers in the Lincoln, Nebraska area. In 1991, the Company decided that it needed a broader strategic vision and, consequently, concentrated on the development of biological inoculation service and nutrient programs. In the next several years, the Company developed its BioJect, CleanRack(TM), CalJect(TM) and SoluJect(TM) systems for distribution to the turf maintenance industry. More recently, the Company has added its FreshPack products to its line of microbial-based programs. STRATEGY The Company's strategy is to expand its leadership position in the distribution and sale of microbial products in the golf industry and to continue to leverage its experience in this industry to further expand into the agricultural crop market. 3 4 Increase Penetration of Golf Markets. The Company currently has an installed base of BioJect systems dispersed among 16 states and 5 countries. The Company intends to continue to focus its sales and marketing efforts on increasing FreshPack program sales, the number of installations of its BioJect system and expanding the number of menu items sold to each customer. The Company has initiated a new strategy to sell or lease the Bioject to the end user. This program was test marketed in the fourth quarter 2000 and rolled out nationally in February 2001. The idea of reducing the operating budget of the Golf Course customer by "unbundling" the program cost into a one time capital or "lease to own" cost and reduced annual microbial and service costs drives this new strategy. As a stand alone proprietary product strategy and in order to increase awareness of the effectiveness of biological products and to generate new Bioject customers, the Company will continue to actively market its FreshPack products to golf industry customers. The Company believes that as it demonstrates the advantages of its proprietary products, the use of biological products in the golf industry will become more widespread and the Company will be well positioned to exploit new market opportunities. The Simplot distribution agreement that resulted from the sale of the Turf Partners business on July 28, 2000, covers about 7,000 golf courses in the United States. The Company is in the process of locating other distributors, particularly in the Southern United States, to try to reach the other 9,000 golf courses that are not presently able to purchase the proprietary products. In the fourth quarter 2000 the Company continued the development of its e-commerce platform that would allow distributors and other customers to order proprietary products directly from the Company via the Internet. Expand into Agricultural Markets. Although the Company initially set its attention on golf applications for the BioJect system and FreshPack products, the Company has added focus on the agricultural crop and horticulture markets and expects the these markets to be an important area of growth over the long term both for its BioJect System, and FreshPack products. By combining its proprietary BioJect and CalJect products in a single program, the Company has been successful in reducing the alkalinity of its customers' soil, increasing the crops' nutrient uptake and reducing the number of pathogens in the soil. When combined with micro-irrigation systems, the Company's proprietary products have allowed customers to increase both the quantity and quality of their fruit production. For growers that do not utilize micro-irrigation, the Company is adapting its FreshPack product line for specific application practices on a focus number of crops. Furthermore, the Company intends to leverage its fermentation capabilities on a regional basis by offering growers access to fresh microbial products fermented at central locations, offering a low-cost hybrid of the BioJect and FreshPack products. The Company intends to market its products into the agricultural markets principally through its independent dealers, strategic partnership with Simplot and other potential partnerships with established agricultural companies such as the Joint Development Agreement announced on February 12, 2001 with the Cargill Corporation. In April 1998, the Company acquired Agricultural Supply, Inc. ("Agricultural Supply"), a distributor of micro-irrigation products in Southern California and Mexico. The acquisition of Agricultural Supply included a 50% interest in Agricultural Supply de Mexico ("ASM"), Agricultural Supply's Mexican affiliate. In June 1998, the Company acquired Controlled Irrigation International, Inc. (d.b.a. Yuma Sprinkler and Pipe Supply) ("Yuma Sprinkler"), a distributor of micro-irrigation products in Arizona and Mexico. Also in June 1998, the Company acquired Riegomex S.A. de C.V. ("Riegomex") and the remaining 50% interest in ASM. By working with distributors of micro-irrigation products and hiring selected personnel, the Company believes that it can develop an integrated sales force and penetrate the agricultural markets with its proprietary products. In the 2nd Quarter 2000 the Company did a restructuring of the agricultural business that included closing the AG Supply corporate office and two unprofitable store locations in the U.S. in addition, three unprofitable store locations were closed in Mexico and the Mexican organization reduced from three regions to one in order to reduce administrative costs. Offsetting the loss of revenues from the store closings was the addition of the Cargill business and strategic development effort in Canada. Increase Number of Microbial Menu Items. In order to maximize the revenues it generates from each BioJect system and from FreshPack sales, the Company intends to expand the selection of microbes it offers to its customers. To this end, the Company has entered into discussions with various leading biotechnology companies and major universities to obtain rights to additional microbes. In September 1999, Eco Soil acquired the Agricultural Biological Division (AgBio) of Canadian-based Agrium, Inc. This acquisition gave Eco Soil immediate access to a variety of products, including four EPA-registered biochemical insecticidal products for use in agriculture, one pending EPA-registered biofungicide (AtEze(TM)) and several Rhizobium soil inoculants (RhizUp(TM)). In addition, the acquisition included a microbiological collection in excess of 2,500 unique biocontrol and growth-promoting microorganisms. The Company also has increased its research and development efforts to determine which microbes will be suitable for distribution through the BioJect system or as a new FreshPack 4 5 product. In 2000 the Company has expanded the products offered for sale to include applications in the Sod Farm and Municipal / Governmental markets with some encouraging early successes. PRODUCTS PROPRIETARY PRODUCTS The Company's proprietary products consist of (i) the BioJect system, which automatically ferments and distributes microbes through irrigation systems, (ii) the FreshPack line of products, which are packaged biological and soil amendments, (iii) the CalJect and SoluJect systems, which permit the injection of soil and water amendments into irrigation systems, and (iv) other proprietary products, including the BioRack system , Specialty Chemical products and drip irrigation design services. BIOJECT SYSTEM The BioJect system permits the introduction of microbes into the soil with the required frequency and in a cost-effective and environmentally safe manner. Because biological products are subject to degradation upon exposure to high temperatures, light or long storage periods, the introduction of these microbes into the soil on a regular basis had not been economically feasible prior to the development of the BioJect system. The BioJect system overcomes the traditional problems associated with the introduction of microbes into the soil by fermenting them at the customer's site during the day and then dispensing the microbes into the customer's irrigation system automatically at night. The BioJect system includes fermentation chambers, pumps, injectors and computer controls that coordinate the scale-up of microbial products and their injection into the customer's irrigation system. The BioJect system is equipped with hardware and proprietary software that allow the user to select or pre-program the microbe application rate and time of delivery through its user-friendly control panel. The system also automatically controls the amount of nutrients, dissolved oxygen, temperature and pH of the fermentation chamber to optimize the scale-up of microbial populations from a starter culture. The Company believes that its BioJect system will become the preferred distribution vehicle for many microbial products because it is able to overcome the poor shelf life characteristics that have previously prevented biological products from being practical alternatives or complements to chemical products. The BioJect system has been designed to apply up to three microbial products at a time. The Company is the sole supplier of all of the consumables (biologicals and media) that are required in its BioJect system, as well as hardware maintenance services. The BioJect system is one of the Company's primary products, and the Company intends to continue enhancing the capabilities of and promoting the BioJect system to the golf industry and the expansion of its BioJect system into the agricultural ornamental and crop industries. The Company's installed base of BioJect systems is shown in the following table:

The Company's installed base of BioJect systems experienced rapid growth through 1998. Installed systems declined in 1999 and 2000 due to an increased marketing focus by the Company on its proprietary FreshPack products and the poor state of the Mexican agricultural market. 5 6 The Company has installed its BioJect systems for some of the most famous and notable golf courses in the country, including the following: - Westchester Country Club (NY) - Lancaster Country Club(PA) - Chevy Chase Country Club (MD) - Medinah Country Club(IL) - Winged Foot Golf Club (NY) - Rancho Bernardo Inn(CA) - Del Mar Country Club (CA) - Siwanoy Country Club(NY) - Four Seasons Resort Aviara (CA) - Club at Pelican Bay(FL) The Company offers a menu of six microbial products that can be delivered through its BioJect system. The BioJect system has evolved from delivering only bacteria of the Bacillus family to delivering a variety of microbial products. The Company licenses and/or acquires such microbes from universities and corporations. These products appear on the Company's BioJect menu and complement or reduce the need for many chemical fungicides, herbicides, insecticides and fertilizers. The consumable product in each menu item is a microbe, and each microbe is cultured in the BioJect system under a proprietary formula. Different microbes are used for different applications due to their mode of action or performance characteristics. Set forth below is a table showing the name of each of the Company's microbial products, the Company's rights to themicrobe, the source of the microbe and the application for each microbe.

The Company has obtained rights to several microbes pursuant to a license and supply agreement with Encore and certain assignments of intellectual property made by Encore to the Company. The license and supply agreement provides for worldwide, royalty-free license to use, sell and distribute Azospirillum brasilense Cd for application through the BioJect system. In addition, Encore has assigned to the Company all of Encore's rights to media (proprietary material formulations used to promote fermentation and multiplication of microbial products in the BioJect system) and rights to Pseudomonas aureofaciens TX-1 (Spot-less) that Encore obtained under a license agreement with Michigan State University. 6 7 In September of 1999, Eco Soil acquired the Agricultural Biological Division (AgBio) of Canadian-based Agrium, Inc. This acquisition included both RhizUp and AtEze products. RhizUp(TM) is a commercial product introduced to the Canadian market four years ago that forms a symbiotic relationship with legumes such as soybeans and peanuts. RhizUp(TM) allows for decreased nitrogen fertilizer while supporting the growth of the plant. AtEze(TM) is a bacteria known as Pseudomonas chlororaphis, which has been used as a biopesticide to prevent fungal disease of vegetables and ornamental plants, including the Rhizoctonia, Fusarium and Pythium species. The AtEze(TM) biofungicide has shown efficacious field results against the primary fungal pathogens of these plants and should enhance Eco Soil's position within the worldwide greenhouse market. The purchase of the AgBio division provides Eco Soil with a microbiological collection in excess of 2,500 unique biocontrol and growth-promoting microorganisms. In addition to new products, Eco Soil was also able to retain two of Agrium's key employees, including one senior scientist and one marketing manager. To further increase the menu of items for use in its BioJect system, the Company intends to enter into additional licensing agreements with leading biotechnology companies and major universities once new microbial products have been proven effective. To meet the technical challenges associated with the task of optimizing the scale-up of these distinct microbes within the BioJect system and distributing them within the irrigation cycle, the Company has entered into research and development agreements with companies specializing in the fermentation of microbes. To date, the Company has completed 34 field trials for its proprietary products in turf through university collaborations for both the BioJect System and FreshPack products. The following is a list of Universities through which the Company has conducted these trials: - Clemson University - University of California, Riverside - Cornell University - University of Connecticut - Michigan State University - University of Illinois - North Carolina State University - University of Maryland - Ohio State University - University of Massachusetts - Purdue University - University of Missouri - Rutgers University - University of Rhode Island - University of Arizona FRESHPACK PRODUCTS The Company's FreshPack products are packaged and designed to deliver a microbial-based program to the customer. The FreshPack products, which contain certain microbes together with other soil amendments, are intended to address several problems encountered by the Company's golf course customers by helping them to develop stronger root systems, reduce the level of soil alkalinity, increase the level of oxygen in the soil and increase the porosity of the soil. The FreshPack products are fermented centrally and then shipped via overnight or second day delivery to the customer to be immediately applied to the problem area of the course. 7 8 Set forth below is a table showing the name of each of the Company's FreshPack products, the individual products that make up each FreshPack program, and the application for each program.

The Company views its FreshPack product line as an additional method of delivering microbial solutions to the customer. Moreover, if the economics are such that the BioJect System is of greater value, the FreshPack products serve as an introduction to the addition of a BioJect machine and the sale of associated microbial products. The Company intends to expand the usage of these products into the agricultural markets in the near future. The Company has sold its FreshPack products to some of the most famous and notable golf courses and turf customers in the world, including the following: - Chicago Bears - Newport Country Club (RI) - Chicago White Sox - Raven Golf Club (AZ) - Atlantic Golf Club (NY) - San Diego Country Club (CA) - Brae Burn Country Club (MA) - Sleepy Hollow Country Club (NY) - Fairview Golf Club (PA) - Titlest Practice Facility (CA) - Four Seasons Golf Club (PA) - The Phoenician (AZ) - La Costa Country Club (CA) CALJECT AND SOLUJECT SYSTEMS The Company's CalJect system permits the injection of soluble soil and water amendments into irrigation systems. The Company's SoluJect system performs the same function as the CalJect System and is installed principally at golf courses because of the SoluJect system's smaller tank size. The Company has developed ESSI Soluble Gypsum, a soil amendment, specifically for distribution through the CalJect and SoluJect systems. ESSI Soluble Gypsum combats water salinity, soil alkalinity and bicarbonate problems most often encountered by golf courses and growers in the western United States and Mexico. The Company believes that use of the CalJect and SoluJect systems and ESSI Soluble Gypsum can reduce golf courses' and growers' water consumption and improve turf quality and crop yields. As golf courses and growers irrigate with poor quality water, salts accumulate in their soils. These salts damage soil and roots, reducing turf quality and crop yields. The Company believes that approximately 20% of water used on golf courses in the western United States is used to leach the excess salt that accumulates in the soil. Eliminating the need for such extra water could mean significant savings for golf courses. In addition, alkaline soils typically found in the western United States and Mexico harm turf and crops by poisoning roots, blocking nutrient uptake and impeding water infiltration. The CalJect and SoluJect systems provide for automatic application of water and soil amendments through irrigation systems to address these problems. 8 9 The CalJect and SoluJect systems convert the Company's water and soil amendment products, including ESSI Soluble Gypsum, into solution form and inject them into an irrigation system. The Company designs and implements a customized CalJect or SoluJect program for each of its customers based on soil and water test results. The Company monitors the success of each program and prepares a soil and water analysis for each customer. Independent consultants make on-going recommendations based on the results of such analyses. OTHER PROPRIETARY PRODUCTS The Company also offers the BioRack system, an equipment wash rack and water treatment system that recycles contaminated equipment wash water, making it suitable for recycling or discharge. The BioRack system is designed to decontaminate wash water so that it complies with applicable state and federal environmental and safety regulations and is suitable for discharge or can be safely recycled. DISTRIBUTED PRODUCTS In addition to the proprietary products described above, the Company also sells a complete line of traditional chemical fertilizers and pesticides and other maintenance products through Company-owned dealers and distributors. In order to meet all of its customers maintenance needs, the Company's distributors keep in stock an inventory of branded pesticides, fertilizers, seed, and other necessary products from many agricultural manufacturers. In the agriculture industry, the Company sells a number of micro-irrigation products as well as pumps and piping. These products are manufactured by T-Systems, Inc., Spears Manufacturing, Hydro Agri, and United Agriculture Products, Inc. SALES AND DISTRIBUTION The Company has focused on establishing sales and distribution capabilities by acquiring independent product dealers and distributors and integrating them into a single, nationwide sales organization to promote sales of the Company's BioJect systems, FreshPack products and CalJect/SoluJect systems to golf courses and agriculture. The Company has hired sales and other key personnel to establish a presence in the areas not served by Simplot. The Company has also acquired four distributors of micro-irrigation products, which are located in Southern California and Arizona and have substantial operations in Mexico. The Company currently has 11 sales people in the United States and 16 in Mexico in agriculture. DISTRIBUTION TO GOLF MARKETS In general, major golf course markets are represented by a single sales organization that controls a significant portion of new product introductions and subsequent penetrations into golf courses in their regions. Prior to the Company's initial dealer acquisitions in May 1996, the Company sold its proprietary products primarily through direct sales efforts and relationships with certain regional dealers. By expanding its distribution capabilities using full-service turf products dealers, the Company has been able to leverage existing distributor relationships to more effectively sell its proprietary products. In early 1996, the Company initiated its strategy of consolidating its golf distribution network through acquiring independent products distributors and hiring key sales personnel. In May 1996, the Company acquired Turf Products, Ltd. ("Turf Products"), a Chicago-based company that markets and sells fertilizers, pesticides, grass seed and soil amendments to golf courses throughout the greater Chicago metropolitan area, and Turf Specialty, Inc. ("Turf Specialty"), a New Hampshire-based company that markets and sells similar products to golf courses and municipalities throughout the New England region. In February 1997, the Company acquired substantially all of the assets of Turfmakers, Inc. ("Turfmakers"), a turf products distributor in the Palm Springs area. In March 1998, the Company acquired Cannon, an Indianapolis-based company that markets and sells fertilizers, pesticides, grass seed and soil amendments to golf courses throughout the Midwest, and Benham, a Detroit-based company that markets and sells fertilizers, pesticides, grass seed and soil amendments to golf courses throughout Michigan. Prior to their consolidation into the Company's Turf Partners subsidiary, Turf Products, Turf Specialty, Turfmakers, Cannon and Benham were established in the turf maintenance industry for golf course markets in the greater Chicago, New England, Palm Springs, Midwest and Michigan areas, respectively. While other dealers in these markets generally compete for market share through aggressive pricing, the Company has adopted a value-added, customer service focus, which is essential for introducing technologically advanced proprietary products such as the BioJect system. The 9 10 Company expects to increase its market penetration in the geographic areas served by its dealers and distributors by hiring additional sales personnel as well as opening satellite warehouses to serve new customers. As of December 23, 1998, the Company consolidated its acquired turf market distributors through merger and the name of the surviving entity was changed to Turf Partners. Through Turf Partners, the Company serves the golf market in three regions covering the eastern, Midwestern and western parts of the United States. On July 28, 2000, the Company completed the Asset Sale. In connection with the Asset Sale, the Company entered into two distribution agreements with Simplot. In the first agreement, a Distribution and License Agreement, Simplot agreed to purchase and distribute a minimum of $5 million of the Company's proprietary FreshPack(TM) products during the first two years of the five-year agreement. In the parts of the U.S. that Simplot does not have a presence, the Company has hired salesmen to locate and work with new distributors in order to complete it's national distribution network. DISTRIBUTION TO AGRICULTURAL MARKETS In early 1998, the Company initiated its strategy of consolidating its agricultural distribution network through acquiring independent product distributors and hiring key sales personnel. In April 1998, the Company acquired Agricultural Supply (including a 50% interest in ASM), a distributor of micro-irrigation products in Southern California and Mexico. In June 1998, the Company acquired Yuma Sprinkler, a distributor of micro-irrigation products in Arizona and Mexico. Also in June 1998, the Company acquired Riegomex and the remaining 50% interest in ASM. By purchasing these distributors of micro-irrigation products, the Company believes that it can rapidly develop an integrated sales force that will allow it to penetrate the agricultural markets. The Company intends to hire selected personnel and to integrate them into a single sales organization in order to enhance the Company's ability to market and sell its proprietary products and increase its penetration into the agricultural market. RESEARCH AND DEVELOPMENT The Company has not engaged in its own research and development with respect to the discovery of microbial products. Instead, the Company has obtained rights to microbial products that have been proven effective for applications in the turf maintenance and agricultural crop and ornamental industries. Much of the Company's in-house research and development effort is targeted at determining which microbes will be suitable for distribution as FreshPack products or through the BioJect system and the engineering of the fermentation and product delivery features of the BioJect system. The Company spent approximately $608,000, $1,065,000 and $584,000 on research and development for the years ended December 31, 2000, 1999 and 1998, respectively. The Company believes its strategic objectives can best be met by combining its in-house product development efforts with the licensing of technology and the establishment of research collaborations with scientists at academic institutions and at companies working in related fields. See "Factors That Could Affect Future Performance--No Assurance that Rights to Additional Microbial Products Will Be Acquired." GOVERNMENT REGULATION The Company is subject to laws and regulations administered by federal, state and foreign governments, including those requiring registration or approval of fertilizers, pesticides, water treatment products and product labeling. Prior to 1998, the Company had only one registered pesticide with the EPA, Bacillus thuringiensis and had marketed its microbial products only as soil inoculants. In 1998, the Company received two EPA approvals. First, the Company registered with the EPA Pseudomonas aureofaciens TX-1 (Spot-less) as a biofungicide for use in turf across the United States and received EPA approval of the BioJect as a means of application of the microbe. Second, the Company received EPA approval to use Xanthomonas campestris pv poa (Xpo) as a bioherbicide in Experimental Use Permit ("EUP") trials for use in turf across the United States. In 1999, the Company applied for registration from the EPA for its AtEze product acquired from Agrium. The Company believes its future sales will be strengthened if the Company can secure approval of individual microbes as pesticides. In most countries, governmental authorities require registration of pesticides before sales are allowed. In the United States, the EPA regulates pesticides under the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA"). Pesticides are also regulated by the individual states such as California, which has its own extensive registration requirements. In order to market 10 11 pesticide products outside the United States, the Company must receive regulatory approval from the authorities of each applicable jurisdiction. In addition, the EPA under the Federal Food, Drug and Cosmetic Act ("FFDCA") establishes standards for residues in food to protect health. Detailed and complex procedures must be followed in order to obtain approvals under FIFRA to develop and commercialize a pesticide product. A separate registration application must be submitted to the EPA for each microbial product. Evaluation data for the registration include, but may not be limited to, non-target organism testing, environmental data, product analysis and residue chemistry, and toxicology (hazards to human beings and domestic animals). The EPA has established reduced testing requirements for registration of microbial pesticides, which are set out in Subdivision M of the EPA's Pesticide Assessment Guidelines. Microbial pesticides are currently subject to a three-tier toxicology testing procedure, and a four-tier environmental evaluation process. If results of toxicology and environmental Tier 1 tests do not suggest health and safety concerns, then subsequent tier testing is not required. Additional tests may be required, however, in response to any questions which may arise during any tier of testing. Registration of the Company's pesticidal products may take between twelve months and five years including the time necessary for collection of the necessary product data. If only Tier 1 testing is required, the cost of registration is typically less than $500,000. In contrast, synthetic chemical pesticides require much more extensive toxicology and environmental testing to verify product safety prior to receiving registration, which the Company estimates can take a total of five to seven years or longer and can cost $5 to $10 million or more. In July 1992, the EPA announced its "Reduced Risk Pesticide Policy" initiative and is in the process of developing criteria for streamlining the regulatory process. In June 1993, the Clinton Administration announced its commitment to reduce the use of pesticides and promote sustainable agriculture in the United States. The EPA, the United States Department of Agriculture (the "USDA") and the Food and Drug Administration (the "FDA") are all considering regulatory reforms. In testimony before Congress on September 21, 1993, the administrators of the USDA, the FDA and EPA stated their intentions to work jointly to reduce risk associated with pesticides and to facilitate the availability of alternative effective pest control products. These policy initiatives and legislative reviews could in the future accelerate the registration of biopesticides meeting "reduced risk" criteria, but there can be no assurance of the impact or timing of these initiatives. FIFRA allows laboratory and greenhouse testing and, usually, small-scale field-testing to be conducted prior to product registration, to evaluate product efficacy and to gather data necessary to support an application. An Experimental Use Permit ("EUP") must be obtained from the EPA to conduct large-scale field-testing prior to product registration. An EUP is required for testing in one or more land sites greater than ten cumulative acres. Issuance of an EUP normally requires satisfactory completion of certain toxicology and environmental studies. Field-testing of certain microbial agents may require the approval of the Animal and Plant Health Inspection Service ("APHIS"), an office of the USDA. APHIS approvals are granted on a site-specific basis, and additional state approvals may also be required. For marketing and use of its products outside the United States, the Company will be subject to foreign regulatory requirements. Such requirements vary widely from country to country. In some instances foreign government approval may require different or additional testing data than that required by the EPA. Failure to achieve such registration would prevent the Company from marketing its unregistered products as pesticides in those jurisdictions where approval is not granted. While the Company exports certain of its microbial products outside the United States, it does not currently market any of its products as pesticides in any foreign countries. In addition, the Company is currently subject to the Occupational Safety and Health Act, the National Environmental Policy Act, the Toxic Substance Control Act, the Resource Conservation and Recovery Act, the Clean Air Act and the Clean Water Act and may be subject to other present and potential future federal, state or local regulations. From time to time, governmental authorities review the need for additional laws and regulations for pesticide products that could, if adopted, apply to the business of the Company. The Company is unable to predict whether any such new regulations will be adopted or whether, if adopted, they will adversely affect its business. See "Factors That Could Affect Future Performance--Government Regulation." 11 12 PATENTS AND PROPRIETARY RIGHTS The Company's success is dependent in large measure upon its ability to obtain patent protection for its products and to maintain confidentiality and operate without infringing upon the proprietary rights of third parties. The Company has obtained both U.S. and foreign patents and is seeking additional foreign patents covering both the process of automatically inoculating irrigation water with biological products and the equipment, namely the BioJect system, used in such process. Specifically, in 1993 the Company was granted two U.S. patents that relate to the inoculation process and the related equipment. In 1995, the Company was granted an additional patent relating to the automatic inoculation of irrigation water through the use of a BioJect system designed to "cleanse" itself so that it may grow, culture and dispense distinct microbes or combinations of microbes on a daily basis. The 1995 patent also expanded the scope of the invention to include irrigation systems covering all types of vegetation, in addition to turf. In addition to the patent applications described above, the Company has registered or applied for or acquired registration of a number of trademarks used in its business, and has obtained registered trademarks for the names including the registration of the following trade names: BioJect, FreshPack, CleanRack, ReOpen, ReMove, ReCharge, AtEze, RhizUp, EcoBac, and Deliminate. The Company also relies on trade secrets and proprietary know-how. The USA patents have a duration of seventeen years and the remaining duration depends on the date of the patent, but those that the company now relies on to produce revenue would have a duration in excess of nine years. See "Factors That Could Affect Future Performance -- Patents, Proprietary Technology and Licenses." MANUFACTURING AND SUPPLY A majority of the parts and components utilized in the BioJect, CalJect and SoluJect systems are standardized industrial components. The computer controls and the fermentation tank used in the BioJect system are designed and manufactured to Company specifications by third parties. The Company has no contracts for supply of parts and components used in its systems. Instead, the Company submits purchase orders for such items as needed. Parts and components are shipped directly to the Company's third-party assemblers for assembly and testing, and the Company's product management team oversees the assembly and testing process. The assemblers ship the completed BioJect, CalJect and SoluJect systems to the Company's distributors or directly to customers. The Company believes that it is not dependent on any single manufacturer or source of supply. FreshPack assembly operations are conducted at Company headquarters in San Diego. In addition, in 1999, the Company began in-house fermentation of its Xanthomonas product, Xpo(TM). The Company has established relationships with third party fermentation specialists that prepare base cultures of microbes for fermentation and distribution through the BioJect system. The Company maintains starter cultures for each of its microbes to use for ongoing testing purposes and as a backup culture supply. The Company obtains distributed products directly from manufacturers. The Company does not have any long-term distribution agreements with distributed product manufacturers. The Company maintains an inventory of distributed products and submits purchase orders on an as-needed basis. COMPETITION The Company's principal competitors with respect to its primary products are described below: BioJect System. The Company's BioJect system competes against traditional chemical insecticides and fungicides, chemical soil penetrants, acid injection systems, and the direct, manual application of cultured microbial products. Although the Company believes that none of its competitors offers an automated means of regularly applying microbial products to turf and crops in an effective manner, many of the Company's competitors have substantially greater financial, technical and personnel resources than the Company and include such well-established companies as Novartis Corporation, Rhone-Poulenc AG Company, the Dow Chemical Company, Lesco, Inc., and The Toro Company, as well as a number of smaller local and regional competitors. The Company competes against traditional technologies on the basis of its delivery mechanism and bioaugmentation expertise. An important factor in the long-term competitiveness of the BioJect system may be the timing of and extent of the Company's penetration into golf and agricultural markets compared to the market penetration achieved by companies offering competing products for microbial distribution. Such timing will be based on the effectiveness with which the Company or the competition can complete product testing and approval processes and supply quantities of its products 12 13 to market. Competition among microbial distribution products is expected to be based on, among other things, product effectiveness, safety, reliability, cost, market capability and patent protection. FreshPack Products. In addition to the competitors listed for the above BioJect System, the FreshPack products compete directly with Sybron Biochemical, maker of Green Releaf(TM) products, and Plant Health Care, Inc., two companies focused on the production of packaged microbial products for the turf market. CalJect System and SoluJect System. The CalJect and SoluJect systems compete against a number of products for applying gypsum onto soil to improve water penetration through soil. At least one of the Company's competitors in the market for gypsum distribution, Soil Solutions Corporation ("Soil Solutions"), has greater name recognition in the soil amendments market and has significantly more installed units. Soil Solutions' machine, like the Company's CalJect and SoluJect systems, injects gypsum directly into customers' irrigation systems. Competition among gypsum distribution products is based on, among other things, cost, name recognition, product effectiveness and reliability. Distributed Products. In markets for distributed products, the Company competes against distributors of traditional chemical products. Many of these competitors have substantially greater financial, technical and personnel resources than the Company and include such well-established companies as Lesco, Inc., Terra Companies, Inc., Con-Agra, Inc. and Wilbur-Ellis Company. The Company competes on the basis of price, name recognition, convenience and customer service with distributors of traditional chemical products. See "Factors That Could Affect Future Performance--Competition." PERSONNEL As of December 31, 2000, the Company had 163 full-time employees, consisting of 11 in general management, 40 in sales and marketing, 32 in customer service, 6 in research and development, 32 in warehouse and operations and 42 in finance and general administrative activities. None of the Company's employees is represented by a labor union or is covered by a collective bargaining agreement. The Company has not experienced work stoppages and believes that it maintains good relations with its employees. FACTORS THAT COULD AFFECT FUTURE PERFORMANCE You should carefully consider the following risk factors, in addition to the other information included in this prospectus, before purchasing shares of common stock of Eco Soil. Each of these risks could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock. We have an indispensable need for capital, and the report of our independent accountants accompanying our financial statements contains an explanatory paragraph regarding our ability to continue as a going concern. Primarily because of our history of operating losses and because of our need to refinance our working capital line of credit with the First National Bank of San Diego, there is substantial doubt about our ability to continue as a going concern unless we are able to obtain additional debt and/or equity financing. We anticipate that without additional financing we would likely run out of cash to fund our operations during the second quarter of 2001. On June 30, 1999 the Company's wholly owned subsidiary Agricultural Supply, Inc. entered into a credit agreement with First National Bank (the "FNB Working Capital Facility"). The FNB Working Capital Facility is a $10 million, three-year credit facility based upon Agricultural Supply's eligible inventory and receivables and has an interest rate of prime plus .25%. Effective June 1, 2000, the following changes were made to the terms of the FNB Working Capital Facility: (a) fixed assets (BioJect(R) system units) were added to the description of collateral, (b) maturity date changed to December 31, 2000, (c) interest rate was changed to Prime plus 1.5%, and (d) personal guarantees were provided by key executives. As of December 31, 2000, of the $6.5 million availability (based on eligible receivables, inventory and fixed assets) under the FNB Working Capital Facility, Agricultural Supply had borrowed $5.2 million. On March 21, 2001 the Company entered into a Change in Terms Agreement with FNB that extended the working capital facility to March 31, 2001 and waived the covenant violations as of December 31, 2000. The Change in Terms Agreement further prohibits the Company from making any payments to subordinated debt holders, thereby putting the Company in default under its Term Loan Agreement with J.R. Simplot Company, its Convertible Subordinated Debentures and its Amended Senior Subordinated Notes. The extension provided by the Change in Terms Agreement expired on March 31, 2001. 13 14 On December 11, 2000, the Company entered into Amendment No. 1 to the Convertible Debentures and Warrants Purchase Agreement pursuant to which the Company sold the Convertible Subordinated Debentures, which amendment extended the maturity of a portion of the debentures to January 24, 2002. On March 7, 2001, the Company entered into Amendment No. 2 in which the Company agreed to repay in cash $1,500,000 in principal plus a 10% premium required under the terms of the Convertible Subordinated Debentures on or before March 30, 2001. In connection with Amendment No. 2, the Company issued warrants to purchase 500,000 shares of the Company's common stock with an exercise price of $1.10 per share to the holders of the Convertible Subordinated Debentures. Amendment No. 2 further provides that if the $1.5 million principal repayment is not made on or before March 30, 2001, the Company must issue warrants to purchase an additional 200,000 shares at the same $1.10 strike price and seek to enter into an additional extension agreement. We can give you no assurances that the Company will obtain additional extensions and waivers from FNB, the holders of the Convertible Subordinated Debentures or its other debt holders. We currently do not have any arrangements to obtain other sources of financing. There can be no assurance that Eco Soil will be successful in obtaining additional financing on acceptable terms or at all, which would result in a material adverse effect on our ability to meet our business objectives and continue as a going concern. The report of independent accountants on our financial statements included herein includes an explanatory paragraph to this effect. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note 1 of our Consolidated Financial Statements. We have a history of operating losses and an accumulated deficit, and we may not achieve or maintain profitability in the future. At December 31, 2000, we had an accumulated deficit of $46.6 million. Our loss from continuing operations for the year ended December 31, 2000 was $10.8 million. We have historically experienced losses due to significant expenditures for product development, sales, marketing and administrative costs, as well as amortization costs associated with our acquisitions of turf and agricultural products dealers. If we are unable to successfully enter new markets, our business will be adversely affected. Sales of our proprietary products remain in the early stages of market introduction and are subject to the risks inherent in the commercialization of new product concepts, particularly with respect to agricultural applications. There can be no assurance that our efforts to increase sales of proprietary products to turf and agricultural crop and ornamental markets will prove successful, that marketing partnerships will be established and will become successful, or that our intended customers will purchase our systems and products instead of competing products. In addition, there can be no assurance that we will be able to obtain significant customer satisfaction or market share with our proprietary products. Furthermore, the Company has begun selling and leasing Biojects to the end user, this is a new strategy and there can be no assurance that the Company will be successful with this new strategy. The market price of our common stock has fallen below the level required for continued listing on The Nasdaq Stock Market, and we may be delisted. As of March 28, 2001 our stock price had been less than $1 for 30 consecutive trading days, putting the Company in violation of Nasdaq qualification standards for continued listing. The Company has been notified by Nasdaq that it has until July 2, 2001 to raise its stock price above $1 for 10 consecutive trading days or be subject to de-listing following a de-listing hearing. We cannot give you any assurances that the Company's stock price will increase above $1 or, if not, that the Company will prevail in its de-listing hearing and thereby be able to avoid de-listing from the Nasdaq National Market. If Nasdaq were to delist our common stock, it would reduce the level of liquidity currently available to our stockholders. If our common stock were delisted, the price of the common stock would, in all likelihood, decline. In addition, it would be an event of default under our Convertible Subordinated Debentures if our shares were delisted from Nasdaq. If our common stock is delisted from the Nasdaq National Market, we could apply to have the common stock quoted on the Nasdaq SmallCap Market. The Nasdaq SmallCap Market has a similar set of criteria for initial and continued quotation. We may not, however, meet the requirements for initial or continued quotation on the Nasdaq SmallCap Market. If we were not able to meet the requirements of the Nasdaq SmallCap Market, trading of our common stock could be conducted on an electronic bulletin board established for securities that do not meet the Nasdaq SmallCap Market listing requirements, in what is commonly referred to as the "pink sheets." 14 15 We are dependent on sales to J.R. Simplot Company. On July 28, 2000, we completed the sale of substantially all of the assets of our Turf Partners subsidiary to the J.R.Simplot Company (the "Asset Sale"). In connection with the Asset Sale, we entered into two distribution agreements with Simplot. In the first agreement, a Distribution and License Agreement, Simplot agreed to purchase and distribute a minimum of $5 million of the Company's proprietary FreshPack products during the first two years of the five-year agreement. In the second agreement, Simplot agreed to distribute our proprietary products in Simplot's Soilbuilders stores. We and Simplot also entered into a field trials agreement pursuant to which Simplot will pay us to perform Field Trials of the Company's BioJect system and microbials on selected Simplot crops in 2001. Since the Asset Sale, our revenues have been concentrated on sales to Simplot. Simplot distributes our products in the upper Midwest, Northeast and Southwest. For the fiscal year 2000, sales to Simplot accounted for 11% of revenues, and we expect sales to Simplot to comprise a significantly greater percentage of our sales during 2001. As a result, any reduction in purchases by Simplot for any reason or delay in payment of amounts owed to us by Simplot for product would have a material adverse effect on our business and results of operations. If we fail to manage growth effectively, our business may suffer. Our ability to manage future growth, should it occur, will require us to implement and continually expand operational and financial systems, recruit additional employees and train and manage both current and new employees. In particular, our success depends in large part on our ability to attract and retain qualified technical, sales, financial and management personnel. We face competition for these persons from other companies, academic institutions, government entities and other organizations. We can give you no assurance that we will be successful in recruiting or retaining personnel of the requisite caliber or in adequate numbers to enable us to conduct our business as we propose to conduct it. We may need to raise additional capital that may not be available when needed. The continuing commercialization of our products requires the commitment of significant capital expenditures. We anticipate that we will require additional funds to support the rigorous testing of our products, other costs of obtaining government approval and for marketing of our products for agricultural applications. We anticipate that we will seek to obtain additional funds in the future through public or private equity or debt financing, collaborative or other arrangements with corporate partners or from other sources. We can give you no assurance that we will be able to obtain this additional financing on desirable terms, or at all. If additional funds are not available, we may be required to curtail our operations and marketing efforts in certain geographic areas or for one or more of our product lines. Patents and other proprietary rights provide uncertain protection of our proprietary information and our inability to protect a patent or other proprietary right may impact our business and operating results. Our success will depend in large measure upon our ability to obtain and enforce patent protection for our proprietary products, maintain confidentiality of our trade secrets and know-how and operate without infringing upon the proprietary rights of third parties. We have been granted three U.S. patents for the technology relating to the BioJect system. We do not have foreign patent protection with respect to the claims covered by the two U.S. patents issued in 1993, and we are precluded from obtaining these foreign rights due to the expiration of the period for filing such claims. However, in connection with a U.S. patent granted in 1995, we applied for foreign patent protection with respect to the BioJect system in selected countries. To date, we have successfully patented the technology relating to the BioJect system in several of these foreign countries. In addition, we have registered a number of trademarks we use in our business, including "BioJect" and "Fresh Pack" and have applied for registration of a number of additional trademarks. We also rely on trade secrets and proprietary know-how. We generally enter into confidentiality and nondisclosure agreements with our employees and consultants and attempt to control access to and distribution of our confidential documentation and other proprietary information. Despite the precautions described above, it may be possible for a third party to copy or otherwise use our products or technology without authorization, or to develop similar products or technology independently. We can give you no assurance that our patent or trademark applications will be granted, that the way we protect our proprietary rights will be adequate or that our competitors will not independently develop similar or competing products. Furthermore, there can be no assurance that we are not infringing other parties' rights. If any of our patents are infringed upon or if a third party alleges that we are violating their proprietary rights, we may not have sufficient resources to prosecute a lawsuit to defend our rights. In addition, an adverse determination in any litigation could subject us to significant liabilities to third parties, require us to seek licenses from or pay royalties to third parties or prevent us from manufacturing, selling or using our products, any of which could have a material adverse effect on our business, financial condition and results of operations. Even if we prevailed in litigation to protect our intellectual property rights, this litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial condition and results of operations. 15 16 We depend on third party contract manufacturers and suppliers. We currently do not have any manufacturing capability and rely on third parties to manufacture our products and components. We have more than one supplier for the manufacture of most of our products and components; however, we obtain some products or components from only one source. Although we believe that we will be able to contract production with alternate suppliers, we can give you no assurance that this will be the case or that the need to contract with additional suppliers will not delay our ability to have our products and components manufactured. We can give you no assurance that existing or future manufacturers will meet our requirements for quality, quantity and timeliness, and any such failure could have a material adverse effect on our business, financial condition and results of operations. We may be unable to acquire rights to additional microbial products. We plan to obtain the rights to additional microbial products. We currently do not engage in our own research and development with respect to the discovery of microbial products. As a result, we seek to license or acquire rights to microbial products discovered by others. We can give you no assurance that we will be successful in obtaining licenses for, or otherwise acquiring rights to, additional microbial products on terms acceptable to us, or at all. If we fail to acquire rights to additional products our business, financial condition and results of operations could be materially adversely affected. Potential product liability or environmental claims could adversely affect our financial condition and results of operations. We may be exposed to product liability or environmental liability resulting from the commercial use of our products. We currently carry liability insurance, which covers, among other things, product liability and environmental liability. A product liability, environmental or other claim with respect to uninsured liabilities or in excess of insured liabilities could have a material adverse effect on our business, financial condition and results of operations. We have obtained insurance of such types and in such amounts as we believe is necessary, including casualty insurance and workers' compensation insurance. However, we are exposed to certain risks that are not covered by our insurance policies and our policies are subject to limits, exceptions and qualifications. Consequently, we can give you no assurance that any losses will be covered by insurance, that any covered losses will be fully insured against or that any claim we make will be approved for payment by the insurer. We are subject to environmental liability. The federal government and some states have laws imposing liability for the release of fertilizers and other agents into the environment in certain manners or concentrations. Such liability could include, among other things, responsibility for cleaning up the damage resulting from such a release. In addition, the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), commonly known as the "Superfund" law, and other applicable laws impose liability on certain parties for the release into the environment of hazardous substances, which might include fertilizers and water treatment chemicals. We also are subject to certain other federal environmental laws, including the National Environmental Policy Act, the Toxic Substance Control Act, the Resource Conservation and Recovery Act, the Clean Air Act and the Clean Water Act and their state equivalents and may be subject to other present and potential future federal, state or local regulations. As noted above, we maintain insurance for environmental claims which might result from the release of our products into the environment, but there can be no assurance that any losses covered by insurance will be adequately covered. Thus, a claim for environmental liability could have a material adverse effect on the Company's business, financial condition and results of operations. Our products are subject to governmental regulations and approvals. We are subject to laws and regulations administered by federal, state and foreign governments, including those requiring registration or approval of fertilizers, pesticides, water treatment products and product labeling. Some of our current products are subject to regulation by the EPA, the USDA and by certain state environmental and agricultural departments. Prior to 1998, we had only one registered pesticide with the EPA, Bacillus thuringiensis, and had marketed it as well as other microbial products only as soil inoculants. In 1998, we received two EPA approvals. First, we registered Pseudomonas aureofaciens TX-1 (Spot-less(TM)) with the EPA as a biofungicide for use in turf across the United States and received EPA approval of the BioJect as a means of application of the microbe. Second, we received EPA approval to use Xanthomonas campestris pv poaannua (Xpo) as a bioherbicide in experimental use permit trials for use in turf across the United States. We are in the final process of receiving EPA approval on Pseudomonas Hororaphis, Strain 63-28 (AtEze(TM)) for use as a biofungicide on greenhouse and agricultural plants. We can give you no assurance that we will obtain EPA approval for sales of additional microbial products as biopesticides. In order to market a microbe as a pesticide, we must obtain EPA approval of a particular product containing that microbe, including EPA approval of the claims made in the product label and the method of application. Registration of our microbial 16 17 products as pesticides likely will be a lengthy and expensive process that may or may not result in EPA approval. Without the desired EPA approvals, we will not be able to market such unregistered microbes as pesticides, and our sales efforts will be limited to discussions of the soil inoculant features of the microbe. If the EPA determines that a microbial product has no significant commercially valuable use other than use as a pesticide, however, we will be precluded from selling the product entirely unless it is approved by the EPA. In addition, if we intend to sell a microbe as a pesticide for use on crops, we must also seek to have a tolerance level set by the EPA which would define the acceptable limit on the amount of microbes that could be present on a given raw agricultural commodity (food crop) at the time of harvest. We also may petition the EPA for tolerance exemptions that would not limit the residues of the microbial products on crops. If the EPA does not issue a tolerance exemption, we would be required to obtain a separate tolerance for each food product on which we intend to make our microbial pesticides available for use. As a result, we would incur costly application fees for each tolerance. We can give you no assurance that we will be successful in seeking such tolerances or tolerance exemptions, and any failure to obtain such tolerances or exemptions would prevent us from selling microbes as pesticides for use on crops. We may be subject to regulation in foreign countries. Compliance with such requirements likely would result in additional cost to us and delays in introducing our products in such foreign countries. Compliance with EPA and state environmental regulations as well as other laws and regulations will increase our costs and time necessary to allow us to operate successfully and may affect us in other ways not currently foreseeable. In addition, more stringent requirements for regulation or environmental controls may be imposed, which could have a material adverse effect on our business, financial condition and results of operations. The industry in which we compete is extremely competitive and if we are not able to compete effectively our business may suffer. The BioJect system and our Fresh Pack products compete against traditional chemical insecticides and fungicides, chemical soil penetrants, acid injection systems and the direct, manual application of cultured microbial products. Many of our competitors have substantially greater financial, technical and personnel resources than we do. Our competitors include such well-established companies as Novartis Corporation, Rhone-Poulenc AG Company, the Dow Chemical Company, O.M. Scotts & Sons, Inc., Lesco, Inc., and The Toro Company, as well as a number of smaller local and regional competitors. We compete against traditional technologies on the basis of our delivery mechanism and bioaugmentation expertise. We believe that the long-term competitiveness of the BioJect system may be affected by the timing and extent of our penetration into golf and agricultural markets compared to the market penetration achieved by companies offering competing products for microbial distribution. This timing, in turn, will be based on the effectiveness with which we or the competition can complete product testing and approval processes and supply products to the marketplace. Competition among microbial distribution products is expected to be based on, among other things, product effectiveness, safety, reliability, cost, market capability and patent protection. In markets for traditional chemical products, we compete against well-established distributors of such products. Many of these competitors have substantially greater financial, technical and personnel resources than us and include such companies as Lesco, Inc., Terra Companies, Inc., Con-Agra, Inc. and Wilbur-Ellis Company. We compete with distributors of traditional chemical products on the basis of price, name recognition, convenience and customer service. Our business is dependent in large part upon the growth and continued popularity of golf. Although we believe that golf markets will continue to grow, a decrease in the number of golfers, reduced participation rates or reduced consumer spending on golf could have a material adverse effect on our golf course customers and, in turn, on us. Specifically, the success of efforts to attract and retain members at private country clubs and the number of rounds played at public golf courses historically have been dependent upon discretionary spending by consumers, which may be adversely affected by general and regional economic conditions. In addition, the construction of additional golf courses is dependent upon growth in the number of golfers. If customer tastes or economic conditions cause golf courses to reduce their budgets or slow the development of additional golf courses, we may see a correlative decrease in sales of the BioJect system and our other products. Our efforts to sell our proprietary products for use in micro irrigation and greenhouse applications might not prove successful. We recently have begun selling our proprietary products to growers who will apply them to crops using micro irrigation methods. Our proprietary products have not been widely applied using micro irrigation methods or in greenhouses 17 18 and we may not achieve significant market share in these markets. We cannot provide any assurances that our revenues from sales of our proprietary products for application using micro irrigation methods or in greenhouses will exceed the sales, marketing and development costs we have incurred in an effort to penetrate these markets. Our efforts to sell our products outside the United States have had limited success to date and may not be successful in the future. We have devoted substantial resources to developing markets for our products outside the United States, particularly in Mexico where the Company has significant receivables, inventory and fixed assets held in the name of its subsidiary Agricultural Supply de Mexico. In addition, our strategic relationship with The Cargill Corporation calls for us to sell our proprietary products to the Canadian market. To date, our operations outside the United States have generated limited revenues, which have not been sufficient to cover our costs in seeking to penetrate foreign markets. While we are continuing to explore opportunities to sell our products outside the United States, we can give you no assurance that we will be successful. Our international sales efforts are subject to risks associated with operations in foreign countries that may increase our costs, lengthen our sales cycle and require significant management attention. These risks include: - fluctuations in currency exchange rates, which may make our products more expensive; - general economic conditions in international markets; - political risks; - additional costs of compliance with local regulations, including costs associated with unexpected changes in regulatory requirements resulting in unanticipated costs and delays; - tariffs, export controls and other trade barriers; and - longer accounts receivable payment cycles and difficulties in collecting accounts receivable. The costs related to our international operations could adversely affect our operations and financial results in the future. Our stock price has been and will continue to be volatile. Our common stock currently is quoted on the Nasdaq National Market. The market price of our common stock could be subject to significant fluctuations in response to operating results and other factors. In addition, the stock market in recent years has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of companies. These fluctuations, as well as general economic and market conditions, may adversely affect the market price of our common stock. In addition, in the event the listing of the common stock were discontinued for any reason, the liquidity and price of our common stock would be adversely affected. Our operating results may fluctuate significantly, and any failure to meet financial expectations may disappoint securities analysts or investors and result in a decline in our stock price. Our operating results vary from quarter to quarter as a result of seasonality and various factors. Virtually all of our customers are located in the Northern Hemisphere and purchase greater quantities of microbes and distributed products during the spring, summer and fall months. As a result of low customer activity during the winter, we typically market the BioJect system during the fourth and first quarters. As a result of these marketing efforts, we typically receive orders during the first and second quarters and install BioJect systems during the second and third quarters. BioJect revenues generally occur in the second and third quarters of the year. Because of this sales cycle, we expect to recognize a significant portion of our revenues during our second and third quarters. Operating expenses have tended to be independent of the quarterly sales cycle. As a result, operating expenses generally represent a higher percentage of sales in the first and fourth quarters as compared to the second or third quarters, and we may experience losses in the first and fourth quarters. Accordingly, results for any quarter are not necessarily indicative of results for any future period. The sales cycle for the BioJect system also makes it difficult to predict the number of BioJect systems that will be employed and the quantity of microbial products that we will sell until we receive orders during the first half of the year. Sales of our products also depend to some extent on the severity of weather patterns in the geographic areas we serve. Given these factors, it is difficult for us to accurately predict the level of demand for our products. 18 19 It is likely that in one or more future quarters our financial results will fall below the expectations of analysts and investors. If this happens, the trading price of our common stock would likely decrease. Many of the factors that cause our quarter to quarter financial results to be unpredictable are largely beyond our control. Loss of key personnel could hurt our business. We are dependent upon the active participation of William B. Adams, the chairman of our board of directors and our chief executive officer. The loss of the services of Mr. Adams could have a material adverse effect upon our business, financial condition and results of operations. We do not have an employment agreement with Mr. Adams. We can give you no assurance that Mr. Adams will continue to be employed by the Company. A small number of shareholders may be able to exercise effective control over us. As of December 31, 2000, our current principal shareholders and management owned more than 25% of the outstanding shares of our common stock, assuming the exercise of all outstanding options and warrants held by them and no exercise of options or warrants held by others. Accordingly, even though we currently have cumulative voting, the current principal shareholders and management, if voting in concert, may have the ability to effectively control the election of a majority of our directors or any other major decisions involving our assets or us. We have a large number of outstanding warrants and options, which could harm our ability to acquire additional capital. As of December 31, 2000, there were 10,413,497 shares of common stock subject to issuance pursuant to options and warrants we previously issued. Holders of warrants and options are likely to exercise them when, in all likelihood, we could obtain additional capital on terms more favorable than those provided by the warrants and options. While the warrants and options are outstanding, they may adversely affect the terms on which we can obtain additional capital. Anti-takeover provisions of our charter and Nebraska law could limit the ability of another party to acquire us, which could cause our stock price to decline. Certain provisions of our articles of incorporation, including provisions creating a staggered board of directors, and certain provisions of Nebraska law, including the Nebraska Shareholders Protection Act, could have the effect of deterring or delaying a takeover or other change in control of Eco Soil, could deny shareholders the receipt of a premium on their common stock and could result in a decline in the market price of our common stock. In addition, our board of directors is authorized, without any action by our shareholders, to issue up to 5,000,000 shares of authorized but undesignated preferred stock and to fix the powers, preferences, rights and limitations of this preferred stock or any class or series thereof. Persons acquiring preferred stock could have preferential rights with respect to voting, liquidation, dissolution or dividends over existing shareholders. ITEM 2. PROPERTIES The Company's headquarters consist of 39,700 square feet located in San Diego, California. The Company currently leases this building for warehouse, sales and marketing, product development and administrative purposes. The Company's lease for such space provides for base lease payments of $30,817 per month, plus operating expenses, and expires in December 2008. Simplot Partners sub-leases a portion of the building for $13,189 per month. The Company does not own any real property. The Company leases office and warehouse space in various locations in the U.S. including Agricultural Supply leases 20,449 square feet in California, 24,096 square feet in Arizona and 63,709 square feet in Mexico. Management believes that the properties leased by the Company and its subsidiaries are generally in good operating condition. ITEM 3. LEGAL PROCEEDINGS On March 12, 2001, an arbitrator formally ruled on an arbitration case between the Company and John C. Wells, William Wells and John Pothoff ("former owners") of Agricultural Supply, Inc., which was purchased by the Company in 1998. The result of the arbitration was that the Company was awarded an indemnification of $465,000 for uncollectible receivables included in the assets purchased from the former owners. However, the former owners were awarded an earn-out for the fiscal year 1999 of $449,000. The earn-out will be paid by offsetting it with the indemnification, plus a combination of cash and Company Common Stock. The earn-out is classified as an adjustment to the purchase price, effective January 1, 2000. Therefore, amortization of $53,000 was recognized in the fourth quarter of fiscal year 2000 operating results. 19 20 From time to time, the Company is involved in legal proceedings, claims and litigation arising in the ordinary course of business, the outcome of which, in the opinion of management, would not have a material adverse effect on the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the Company's security holders during the fourth quarter of the fiscal year ended December 31, 2000. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock, $.005 par value per share, trades on The Nasdaq National Market under the symbol "ESSI." From January 16, 1997, the date of the Company's initial public offering, to December 3, 1997 the Company's Common Stock traded on the NASDAQ SmallCap Market under the symbol "ESSI". The following table sets forth for the periods indicated the high and low sale prices for the Common Stock as reported by the Nasdaq National Market.

As of April 16, 2001 there were approximately 19,645,144 shares of Common Stock outstanding held by approximately 245 holders of record. The Company has never paid or declared any cash dividends on its Common Stock and does not intend to pay dividends on its Common Stock in the foreseeable future. The Company is currently prohibited from paying dividends by the terms of loan agreements between the Company and its lenders. The Company intends to retain any earnings for use in the operation and expansion of its business. 20 21 ITEM 6 SELECTED FINANCIAL DATA The following selected financial data of should be read in conjunction with Item 7: "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company and related notes thereto appearing elsewhere in this Report on Form 10-K. The data presented below has been restated to reflect the Revenues and Expenses excluding the Turf Partners distribution business sold to Simplot on July 28, 2000.

21 22 EARNINGS BEFORE INTEREST, INCOME TAXES, DEPRECIATION AND AMORTIZATION (EBITDA) EBITDA is net income (loss) excluding interest income, interest expense, depreciation and amortization expense. While EBITA should not be construed as a substitute for income (loss) from operations, net income (loss) or cash flows from operating activities in analyzing the Company's operating performance, financial condition or cash flows, the Company is reporting EBITDA because it is commonly used by certain users of the Company's financial statements to analyze and compare companies on the basis of operating performance, leverage and liquidity and to determine a company's ability to service debt. EBITDA of continuing operations is calculated as follows:

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with Item 6: "Selected Financial Data" and the Consolidated Financial Statements of the Company, related notes thereto, and other financial data appearing elsewhere in this Report on Form 10-K. Unless otherwise noted, the discussion refers to continuing operations. GENERAL The Company develops, markets and sells proprietary biological products, and their delivery systems, for the golf and agricultural industries. The Company's most unique delivery system is the BioJect(R), a patented and EPA-approved device that stimulates and dispenses biological products through irrigation systems. The Company's proprietary products are sold both direct and through traditional distribution channels into the turf market and through direct sales along with irrigation products into the agricultural market. On July 28, 2000, the Company completed the sale of substantially all of the assets of its Turf Partners subsidiary (the "Asset Sale") to the Simplot Company ("Simplot"). At the closing of the Asset Sale, Simplot made a cash payment of $23 million and assumed Turf Partners' exiting long-term debt and vendor payables totaling $37.3 million. Simplot also assumed Turf Partners' outstanding contracts and leases. The Asset Sale was consummated pursuant to an Amended and Restated Asset Purchase Agreement dated April 5, 2000, as amended by a First Amendment to Amended and Restated Asset Purchase Agreement dated June 9, 2000. 22 23 In connection with the Asset Sale, the Company entered into two distribution agreements with Simplot. In the first agreement, a Distribution and License Agreement, Simplot agreed to purchase and distribute a minimum of $5 million of the Company's proprietary FreshPack(TM) products during the first two years of the five-year agreement. In the second agreement, Simplot agreed to distribute the Company's proprietary products in Simplot's Soilbuilders stores. The Company and Simplot also entered into a field trials agreement pursuant to which Simplot will pay the Company to perform Field Trials of the Company's BioJect(R) system and microbials on selected Simplot crops in 2001. Following the Asset Sale the Company began invoicing the Bioject customers directly and paying a commission to the Simplot salesmen for renewed microbial and service contracts and the sale of Bioject units. YEAR ENDED DECEMBER 31, 2000 COMPARED TO 1999 REVENUES In 2000, revenues from continuing operations were $34.4 million, an increase of 2.9% versus $33.5 million in 1999. The overall increase in revenues reflects an increase in our proprietary revenues which was offset by a decrease in our distributed revenues. The increase/decrease in revenues in 2000 can be primarily attributed to changes in quantities sold. In 2000, proprietary revenues were $11.4 million, an increase of 32.8% versus $8.6 million in 1999. The increase in proprietary revenues is due to initial deliveries of our new RhizUp(TM) product, increased sales of our specialty chemical line of products and an increase in the sales of FreshPack(TM) products compared to 1999. In 2000, distributed revenues were $23.0 million, a decrease of 7.4% versus $24.9 million for 1999. The decrease in distributed revenues is primarily due to the closing of five unprofitable stores that were operated by the Company's Agricultural Supply subsidiary. GROSS PROFIT In 2000, the Company's gross profit was $9.8 million, an increase of 18% versus $8.3 million in 1999. In 2000, the Company's gross margin was 28% versus 25% in 1999. The increase in gross margin was due to a better mix of the high margin proprietary sales vs the lower margin distributed sales in 2000 compared to 1999. It is the strategy of the Company to continue this trend by emphasizing the high margin proprietary products in its allocation of marketing and sales resources. The gross margins of the distributed products were also impacted negatively by the liquidity problems of the Company that prohibited the taking of cash and volume purchase discounts and rebates. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE In 2000, SG&A expense was $15.2 million, a decrease of 14.3% versus $17.8 million in 1999. SG&A expense as a percentage of revenues was 44.2% in 2000 compared to 53.1% in 1999. The decrease in the SG&A is primarily due to the overall cost control efforts employed by the Company and the restructuring actions taken by the Company in the second quarter of 2000. The Company closed unprofitable stores and eliminated redundant positions between the Eco Soil and Ag Supply businesses in 2000. The Company expects the cost reduction efforts to continue until each store and business unit is individually profitable. RESEARCH AND DEVELOPMENT In 2000, R&D expense was $608,000, a decrease of 42.9% versus $1.1 million in 1999. The decrease in R&D is due to the Company being more selective in the R&D programs that are being supported. AMORTIZATION EXPENSE In 2000, amortization expense was $629,000, an increase of 16.4% versus $540,000 in 1999. The increase is primarily due to amortization associated with additional goodwill capitalized in 2000 as a result of an adjustment to the purchase price of the Agricultural Supply subsidiary. 23 24 INTEREST EXPENSE In 2000, interest expense was $3.4 million, an increase of 159.2% versus $1.3 million in 1999. The increase is primarily due to the amortization of additional $2.0 million of non-cash debt issuance costs incurred in 2000 associated with the warrants and beneficial conversion option granted to the Convertible Debenture and the Senior Subordinated Note holders. NET LOSS FROM CONTINUING OPERATIONS In 2000, net loss from continuing operations was $11.3 million or $0.60 per share versus a net loss of $12.3 million or $0.70 per share in 1999. LOSS FROM EXTRA ORDINARY ITEM In 2000 the Company incurred an extraordinary, non-cash charge of $3.8 million for the write-off of the debt issuance costs related to the early retirement of its Senior Subordinated Notes from the proceeds of the Asset Sale. LOSS FOR CUMULATIVE EFFECT IN ACCOUNTING FOR WARRANTS ISSUED WITH CONVERTIBLE DEBT. In the fourth quarter 2000 the Company incurred a charge of $0.75 million to comply with the position taken by the Securities and Exchange Commission on November 16, 2000 that applied retro-actively to the Convertible Debentures that the Company issued in January 2000 (see Note 1). YEAR ENDED DECEMBER 31, 1999 COMPARED TO 1998 REVENUES In 1999, our revenues were $33.5 million, an increase of 13.8% versus $29.4 million in 1998. The increase in revenues reflects an increase in distributed revenues offset by a decrease in proprietary revenues. . The increase/decrease in revenues in 2000 can be primarily attributed to changes in quantities sold. In 1999, proprietary sales were $8.6 million, a decrease of 1.3% versus $8.7 million in 1998. The decrease in proprietary sales was due to a decrease in BioJect usage as a result of the following: (i) a reorganization in the fall of 1998 that impaired sales momentum, (ii) new FreshPack programs challenged our sales force, while providing the customer with a cheaper alternative to the BioJect, (iii) the delay in approval of certain biocontrol products from the EPA, (iv) customers believed their improved turf, resulting from several seasons of BioJect programs, could manage without a 1999 program and (v) drought conditions in the Midwest and Northeast. However, the decreases noted above were offset with sales from the introduction of the Company's proprietary liquid fertilizer line of products. In 1999, distributed sales were $24.9 million, an increase of 20.0% versus $20.7 million in 1998. The increase was due to a full years activity of the 1998 acquisition of Agricultural Supply and the opening of new warehouses, which extended market penetration to new geographic areas. GROSS PROFIT In 1999, our gross profit was $8.3 million, a decrease of 19.1% versus $10.2 million for 1998. The decrease in gross profit was primarily due to a decrease in proprietary sales. In 1999, our gross margin was 24.7% versus 49.3% for 1998. The decrease in gross margin is attributed to the mix of proprietary and distributed revenues in 1999. Proprietary sales, which carry higher gross margins than distributed sales, decreased while distributed sales increased in 1999. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE In 1999, selling, general and administrative ("SG&A") expense was $17.8 million, an increase of 22% versus $14.6 million in 1998. SG&A expense as a percentage of revenues was 49.5% in 1999 and 1998. The increase in SG&A expense was primarily 24 25 due to additional overhead costs associated with the opening of additional warehouses and expenses of the Company spent on marketing the Company's proprietary technology as well as advancing strategic relationships to benefit the Company's future. RESEARCH AND DEVELOPMENT EXPENSE In 1999, research and development expense was $1.1 million, an increase of 82.4%, versus $584,000 in 1998. The increase in research and development expense was due to ongoing analysis and testing of proprietary technology by the Company. AMORTIZATION EXPENSE In 1999, amortization expense was $540,000, an increase of 18.8% versus $455,000 in 1998. The increase in amortization expense is due to a full year of amortization related to the 1998 acquisitions of Agricultural Supply, Inc., offset by the absence of amortization related to the Aspen Consulting operations, which was written-off in 1998. INTEREST EXPENSE In 1999, interest expense was $1.3 million, a decrease of 15.8% versus $1.6 million in 1998. The decrease is the net result of the following: (i) included in the 1998 interest expense are charges related to the replacement of a prior bank credit facility from Provident Bank with a new facility from Imperial Bank and (ii) additional interest expense associated with the increase in debt outstanding during 1999. NET LOSS FROM CONTINUING OPERATIONS For the year ended December 31, 1999, net loss from continuing operations was $12.3 million or $.71 per share compared to a net loss of $7.7 million or $.47 per share for the year ended December 31, 1998. SPECIAL CHARGES During the fourth quarter of 1998, the Company recorded the special charges of $3.9 million described above. Approximately $2.6 million of the special charges related to the discontinued operations. Details of the special charges (in thousands) through December 31, 2000 are as follows: Details of the restructuring charge (in thousands) are as follows:

25 26 During the fiscal year of 2000, the Company incurred a restructuring charge of $1.2 million as a result of the closure of five operating locations of the Agricultural Supply subsidiary located in the United States and Mexico. A total of 25 employees were terminated from these locations. The remaining accrued liabilities associated with these operations are expected to be recognized during the fiscal year 2001. Details of the restructuring charge (in thousands) are as follows:

The following is a summary of revenue and net operating losses (in thousands) for the locations that were closed:

LIQUIDITY AND CAPITAL RESOURCES We have financed our operations since inception from revenues from sales of our products, sales of our common stock, borrowing from our principal shareholders and other lenders and bank financing. Our net cash used in operating activities was $8.2 million and cash provided from investing activities was $18.7 million attributable to the net proceeds from the Asset Sale, together they provided net cash of $10.5 million during the year ended December 31, 2000. On August 25, 1998, the Company issued an aggregate of $15 million principal amount of the Company's Senior Subordinated Notes due 2003 (the "Notes") to two lenders. On July 28, 2000, the Company retired $14 million of the Notes from the proceeds of the Asset Sale. Also, the Company amended the Note and Warrant Purchase Agreements with the Lenders to eliminate financial covenants. The Company replaced the Notes with amended Senior Subordinated Notes (the "Amended Notes") with an aggregate principal amount of $1.4 million covering the principal and accrued interest of the Notes not paid on July 28, 2000. The Amended Notes bear interest at an annual rate of 14% and are due on January 28, 2002. Monthly payments of $87,000 in the aggregate began on August 28, 2000. As a result of the retirement, the Company wrote-off $3.8 million of unamortized debt issuance costs associated with the Notes. On June 30, 1999, our Turf Partners subsidiary entered into a credit agreement with Coast Business Credit (the "Coast Working Capital Facility"). The Coast Working Capital Facility was a $25 million three-year credit facility based upon Turf Partners' eligible inventory and receivables and has an interest rate of prime rate plus 1.00%. On July 2, 1999 the Company drew down on the facility and paid all amounts due under and terminated a line of credit with Imperial Bank. As of 26 27 December 31, 1999, Turf Partners had fully utilized the availability under the Coast Working Capital Facility based on eligible inventory and receivables. On July 28, 2000 at the closing of the Asset Sale the Coast Business Credit working capital facility was assumed by Simplot. On June 30, 1999 the Company's wholly owned subsidiary Agricultural Supply, Inc. entered into a credit agreement with First National Bank (FNB Working Capital Facility"). The FNB Working Capital Facility is a $10 million three-year credit facility based upon Agricultural Supply's eligible inventory and receivables and has an interest rate of prime plus .25%. As of December 31, 1999, Agricultural Supply had fully utilized the availability under the FNB Working Capital Facility based on eligible inventory and receivables. Effective June 1, 2000, the following changes were made to the terms of the FNB Working Capital Facility: (a) fixed assets (BioJect(R) system units) were added to the description of collateral, (b) maturity date changed to December 31, 2000, (c) interest rate was changed to Prime plus 1.5%, and (d) personal guarantees were provided by key executives. As of December 31, 2000, of the $6.5 million availability (based on eligible receivables, inventory and fixed assets) under the FNB Working Capital Facility, Agricultural Supply had borrowed $5.2 million. On March 21, 2001 the Company entered into a Change in Terms Agreement with FNB that extended the working capital facility to March 31, 2001 and waived the covenant violations as of December 31, 2000. The Change in Terms Agreement further prohibits the Company from making any payments to subordinated debt holders, thereby putting the Company in default with the Debentures (discussed below) and the Amended Notes. The Company has not obtained extensions and waivers from its debt holders beyond March 31, 2001 but is in the process of negotiating further extensions at this time. On July 31, 1999, the Company obtained a $2.5-million, two-year term loan from Coast Business Credit (The "Coast Term Loan"). The Coast Term Loan bears interest at coast's prime rate plus 2.25%, payable monthly. One third of the principal must be repaid in level monthly payments during the first year of the term, with the remainder due in level monthly payments during the second year of the term. The Coast Term Loan is secured by substantially all of the assets of the parent Company. effective January 5, 2001 Coast Business Credit drew on the Letter of Credit provided by Simplot as part of the Asset Sale and Term Loan agreement (discussed below). As a result, the debt to Coast Business Credit has been retired and the Company owes Simplot $1.2 million plus interest pursuant to Term Loan Agreement. Any draw on the Letter of Credit must be repaid from the proceeds of proprietary sales to Simplot, no time frame for the repayment is specified. The Company is negotiating a mutually acceptable repayment schedule with Simplot. Until the draw on the Letter of Credit is repaid, Simplot has the primary secured position on all assets of Eco Soil except for the Biojects that are pledged under the First National Bank working capital facility. On January 24, 2000, the Company issued $4.5 million of Senior Secured Convertible Debentures (the "Debentures") and warrants to purchase 356,436 shares of common stock. The Debentures were originally due January 24, 2001 and bear interest at a rate of 7% per annum, which is due quarterly beginning March 31, 2000, and is payable in cash or common stock at our option. In June 2000, the Company reduced the exercise price of the warrants to purchase 356,436 shares of common stock to $1.00 and issued additional warrants to purchase an aggregate of 75,000 shares of common stock with an exercise price of $2.50 per share to the Debenture holders in connection with obtaining the Debenture holders' consent to the Term Loan from Simplot described below. On December 11, 2000, the Company and the Debenture holders entered into Amendment No. 1 of the Debentures Agreement, which modified the maturity of the Debentures to $1.5 million (plus 10% premium thereon) due on January 24, 2001 and $2.9 million due January 24, 2002.. On March 7, 2000, the Company and the Debenture holders entered into Amendment No. 2 of the Debentures Agreement, which called for a closing prior to March 31, 2001 at which the maturity of the Debentures would be modified to $1.5 million (plus a 10% premium thereon) due on March 31, 2001 and $2.9 million due January 24, 2002. In connection with Amendment No. 2, the Debenture holders were issued additional warrants to purchase 500,000 shares of common stock with an exercise price of $1.10 per share. In addition, as part of the Amendment No. 2, the Company agreed that if the Company did not make the March 31, 2001 payment, the Debenture holders would be entitled to additional warrants to purchase an additional 200,000 shares of common stock with an exercise price of $1.10 per share. The contemplated closing did not occur, so the maturity of the Debentures has not changed. In addition, the Company did not meet the March 31, 2001 payment requirement. As a result the Company is required to issue the additional 200,000 warrants to the Debenture holders. On April 12, 2000, the Company entered into a Term Loan Agreement ("Term Loan") with Simplot. The $3 million Term Loan was paid to the Company in July 2000 and used for working capital purposes. The Term Loan was repaid in the same month, July 2000, from the proceeds of the Asset Sale, described above. 27 28 The Company's Coast Term Loan and the FNB Working Capital Facility contain certain restrictions and limitations on the Company's operations, including restrictions on capital expenditures, sale of assets, lease liabilities, mergers or other forms of business combinations, as well as the prohibition on the payments of cash dividends. The Coast Term Loan and the FNB Working Capital Facility also contain certain covenants which require the Company to maintain minimum levels of net worth, working capital and other financial ratios, as defined. As of December 31, 2000, the Company was not in compliance with certain of these covenants. Since the Coast Term Loan was paid-off by Simplot, a waiver for non-compliance was not required. First National Bank provided a waiver of such covenants through March 31, 2001. The Company intends to finance its future operations and growth through a combination of product revenues, borrowings available under lines of credit and public or private debt or equity financing. During 2001 the Company also intends to sell or lease all of the Biojects it presently has in service to the end user. This change in strategy will increase cash flows from operations over the previous method of renting the Biojects. There can be no assurance that Eco Soil will be successful in selling the Biojects or in obtaining additional financing on acceptable terms or at all, which would result in a material adverse effect on the Company's ability to meet its business objectives and continue as a going concern. See Note 1 to the Consolidated Financial Statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's foreign sales are principally to Mexico. All foreign transactions are denominated in U.S. dollars; therefore, the Company's exposure to foreign currency fluctuations is minimal. The Company's working capital facility with First National Bank is based on the prime rate of interest. A 200 basis point change in the prime rate of interest for one year would change the interest the Company would pay on the $5.2 million loan balance of $104,000 per year. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Please see Index to Consolidated Financial Statements on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 28 29 PART III As indicated in the following table, the information required to be presented in Part III of this report is hereby incorporated by reference from the Company's definitive Proxy Statement for its 2001 Annual Meeting of Shareholders to be prepared in accordance with Schedule 14A and filed with the Securities and Exchange Commission within 120 days of the end of the fiscal year covered by this report. Material in Proxy Statement for 2001 Annual Meeting that is incorporated herein by reference:

PART IV ITEM 14. EXHIBITS, LIST AND REPORTS ON FORM 8-K (A) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS REPORT: 1. Financial Statements: (See "Index to Consolidated Financial Statements" at page F-1) 2. Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts 3. Exhibits: The exhibits listed on the accompanying Exhibit Index are filed as part of this Annual Report. 29 30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 17th day of April 2001. ECO SOIL SYSTEMS, INC. By: /s/ William B. Adams -------------------------------------- William B. Adams Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

30 31 ECO SOIL SYSTEMS, INC. CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

F-1 32 REPORT OF MCGLADREY & PULLEN, LLP, INDEPENDENT AUDITORS To the Board of Directors and Shareholders Eco Soil Systems, Inc. San Diego, California We have audited the accompanying balance sheet of Eco Soil Systems, Inc. as of December 31, 2000 and the related statements of operations, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Eco Soil Systems, Inc. as of December 31, 2000, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that Eco Soil Systems, Inc. will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses and has limited working capital. In addition, the Company is currently seeking a new credit facility to replace the expired facility with the current lender. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty. /s/ MCGLADREY & PULLEN, LLP San Diego, California March 14, 2001 F-2 33 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders Eco Soil Systems, Inc. We have audited the accompanying consolidated balance sheet of Eco Soil Systems, Inc. as of December 31, 1999, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14 (a) for each of the two years in the period ended December 31, 1999. The financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Eco Soil Systems, Inc. at December 31, 1999, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. San Diego, California March 3, 2000 F-3 34 ECO SOIL SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) ASSETS

See accompanying notes. F-4 35 ECO SOIL SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)

See accompanying notes F-5 36 ECO SOIL SYSTEMS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARES)

See accompanying notes. F-6 37 ECO SOIL SYSTEMS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)

See accompanying notes F-7 38 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business The Company develops, markets and sells proprietary biological and traditional chemical products that provide solutions for a wide variety of turf and crop maintenance problems in the golf and agricultural industries. The Company has developed its patented BioJect system for the distribution of naturally occurring microbes that complement or reduce the need for many chemical products currently used in golf and agricultural markets. By fermenting microbes at the customer's site and distributing them through the customer's existing irrigation system, the BioJect system provides customers with cost savings and mitigates the adverse environmental effects associated with chemical products. The Company's sales and marketing are focused on the golf market, agricultural crop and ornamental markets. Basis of Presentation As of December 31, 2000, the consolidated financial statements have been prepared on a going concern basis, which contemplates, among other things, 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 relating to the recoverability and classification of recovered asset amounts or the amount and classification of liabilities or any other adjustments that might be necessary should the Company be unable to continue as a going concern. As of the filing date the Company is seeking to obtain credit approval for a new multi-year working capital facility. The working capital facility at First National Bank is only extended on a month-to-month basis. The Company anticipates significant new cost reduction efforts and the addition of new distribution in the southern United States that will improve the operating cash flows. The Company believes that those actions, the new three year $10,000,000 working capital facility, if obtained, coupled with the sale of the Biojects will provide adequate working capital for the next year and beyond. Management believes that the above-mentioned actions will allow the Company to continue as a going concern. Accordingly, the consolidated financial statements do not include any adjustments relating to the recoverability and classification of recovered asset amounts or the amount and classification of liabilities or any other adjustments that might be necessary should the Company be unable to continue as a going concern. Basis of Consolidation The accompanying financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been restated to reflect the results of the Turf Partners business as a discontinued operation. See Note 3. F-8 39 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including the allocation of the purchase price relating to acquired businesses, on-going analysis of recoverability of goodwill, valuation of warrants (by using the Black-Scholes method), and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from the estimates. Cash and Cash Equivalents The Company considers all highly liquid investments with original maturity of less than three months to be cash equivalents. Concentration of Credit Risk No individual customer accounted for more than 10% of revenues in 1999 and 1998. However, since July 28, 2000, when the Company sold the assets of Turf Partners, Inc. (see Note 3) to the J.R. Simplot Company ("Simplot"), the Company now has a concentration of risk in this new distributor that covers the upper Midwest, Northeast and Southwest. For the fiscal year 2000, sales to Simplot accounted for 11% of revenues. During the latter part of 2000, the Company added new sales and marketing personnel to develop new distribution in the areas of the U.S. that are not represented by Simplot. Also, the Company serves a wide variety of agricultural customers, primarily growers, who are concentrated principally in the southwestern U.S. and, to a lesser extent, in Mexico. The Company's Agricultural Supply segment has approximately $6.5 million of net assets located throughout various regions of Mexico. Also, the Company is not economically dependent upon any one supplier. Fair Value of Financial Instruments Financial instruments including cash and cash equivalents, accounts receivable, accounts payable, notes receivable, accrued expenses and long-term debt are carried at cost, which management believes approximates the fair value. The Company has determined that the long-term debt's cost approximates fair value since the maturities are less than two years. Inventories Inventories are carried at the lower of cost (first-in, first-out method) or market. Inventories attributable to continuing operations at the end of the respective years consist of the following (in thousands):

In 2000, BioJect systems previously leased to customers were transferred, at their net book value, from property, plant and equipment to inventory. The Company anticipates selling theses systems during fiscal year 2001. Other inventories consist primarily of proprietary products, non-proprietary chemical, fertilizer and irrigation equipment and other agricultural supplies. Equipment Under Construction Equipment under construction is comprised of BioJect systems that are completed or near completion. Units classified in this category have not been placed into service at a customer site. Independent third parties construct the BioJects and the Company performs final assembly and quality testing. F-9 40 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Property and Equipment Property and equipment are stated at cost. Depreciation is provided using the straight-line and accelerated methods over the estimated service lives of the assets, generally ranging from 3 to 5 years. Equipment under capital leases is amortized over the shorter of the estimated useful life of the assets or the lease term, and such amortization is included in depreciation in the accompanying financial statements. Intangible Assets Intangible assets consist primarily of the excess of the purchase price over the fair value of the assets acquired ("goodwill") related to the Company's various acquisitions (see Note 2). Such intangible assets are generally being amortized over a period of 10 years. Certain of the Company's acquisitions involved earn-out payments which were and some currently are payable to the former shareholders of the acquired businesses based on the post-acquisition performance of the acquired businesses. The Company evaluates such obligations in accordance with EITF 95-8, "Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination." To date, all such contingent consideration has been treated as additional purchase price due to various factors including, but not limited to, the following: (i) the contingent consideration in certain cases is payable to selling shareholders who were not employees of such businesses and are not ongoing employees of the Company, (ii) the contingent consideration is payable without regard to continuing employment of the selling shareholders or (iii) the compensation arrangements for selling shareholders who became employees of the Company are at a reasonable level in comparison to that of similar employees. The earn-out payments are based on annual (calendar year) results. The Company determines its obligations at the conclusion of the annual period. Amounts payable in cash are included in accrued expenses. Amounts payable in stock are included in shareholders' equity. Impairment of Assets In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121), the Company recognizes and records impairment losses on long-lived assets used in operations when indicators of impairment are present and the estimated undiscounted cash flows to be generated by those assets are less than the assets' carrying amount. SFAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. Management has evaluated long-lived assets for impairment and does not believe there is any impairment as of December 31, 2000. In the fourth quarter of 1998, the Company identified indicators that goodwill related to two acquisitions made in prior years was impaired. The indicators consisted of the resignation or termination of key management or sales personnel of such businesses, greater than expected attrition in the acquired customer bases, closure or relocation of the acquired distribution facilities and other factors. The Company estimated it will not likely realize positive future cash flows from these acquired businesses and, therefore, recorded a write-off of the goodwill related to such acquisitions (see Note 11). Deferred Debt Issuance Costs In November 1998, the Company terminated the line of credit entered into on August 1998 and entered into a new line of credit. Deferred debt issuance costs related to the terminated line of credit totaling $858,000 was expensed at that time. During 1999, the Company capitalized approximately $2.9 million of debt issuance costs related to the restructuring of the Senior Subordinated Notes and the Company's obtaining a term loan (see Note 6) from Coast Business Credit. During 2000, the Company capitalized and amortized approximately $2.3 million of debt issuance costs related to the Convertible Subordinated Debentures (the "Debentures"). The deferred debt issuance costs are amortized using a method approximating the interest method and is included in interest expense. F-10 41 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Deferred Rent Deferred rent consists of the gain on the sale/leaseback of the Company's principal facility in San Diego, California (see Note 9), which is being amortized against rent expense on the straight-line basis over the initial term of the leaseback. Revenue Recognition Proprietary sales revenue is derived primarily from the sale and rental of Bioject equipment and related microbial and service contracts, Fresh Pack and Specialty Chemical products, recognized upon shipment or performance of the service. In addition, the Agricultural Supply subsidiaries in the U.S. and Mexico, design drip irrigation systems. This design work is included in the proprietary sales when payment is received from the customer. Distributed sales revenue is derived primarily from sales of purchased products to the Company's Agricultural customers, which has historically not been very seasonal and is recognized upon shipment. The Company generally does not allow for sales returns, and returns have historically been minimal. The Company's export sales totaled $13,167,000, $16,283,000 and $13,156,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Such sales were principally to customers in Mexico. All foreign transactions are denominated in U.S. dollars. Cost of Revenues Cost of proprietary sales revenue includes the cost of the microbial products and depreciation on the rental equipment. The cost of the service component is expensed as incurred in selling, general and administrative expense. Stock-Based Compensation As permitted by the Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), the Company has elected to follow Accounting Principles Board Opinion No. 25 ("APB 25") and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Options granted to consultants and other non-employees are valued in accordance with SFAS 123 and EITF 96-18, and are expensed over the service period. Special Charges Amounts accrued in connection with the Company's restructuring (see Note 11) were measured and recorded in accordance with EITF 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." Net Loss Per Share In accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128), basic and diluted net loss per share is calculated using the weighted average number of common shares outstanding. Diluted net income per share is calculated using the weighted average number of common shares outstanding plus the dilutive effect of outstanding options and warrants, if any, using the treasury stock method. The Company has warrants, options and convertible debt who's effect on weighted average shares has not been included as they are anti-dilutive due to the losses reported. F-11 42 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Government Regulations Substantially all of the Company's facilities are subject to federal, state and local regulations relating to the discharge of materials into the environment. Compliance with these provisions has not had, nor does the Company expect such compliance to have, any material effect upon the operations, financial condition, capital expenditures or competitive position of the Company; however, there can be no assurance that compliance with such regulations would not have a material effect upon the Company's future results of operations or financial condition. Management believes that its current practices and procedures for the control and disposition of such materials comply with applicable federal and state requirements. Accounting Changes In December 1999, the staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. The Company adopted SAB 101 in the fourth quarter of 2000. The adoption of SAB 101 did not have a material impact on the financial position or the results of operations. In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation -- an interpretation of APB Opinion 25," ("Interpretation No. 44") which is generally effective July 1, 2000. Interpretation No. 44 clarifies the application of APB Opinion 25 for certain matters, specifically (a) the definition of an employee for purposes of applying APB Opinion 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. The adoption of Interpretation No. 44 resulted in a charge of $431,000 to the continuing operations, which was applicable to stock options effectively reissued and maintained by the former Turf Partners employees. The Emerging Issues Task Force is currently discussing Issue No. 00-27, Application of EITF Issue No. 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," to Certain Convertible Instruments ("Issue 00-27"). The Securities and Exchange Commission's position that certain of the components of Issue 00-27 should be applied to all transactions subject to Issue 98-5, including those transactions for which a commitment date occurred before November 16, 2000. Therefore, in the fourth quarter 2000, the Company applied the components of Issue 00-27 applicable to the 7% Senior Secured Convertible Debentures that were issued in January 2000. The proceeds were reallocated between the Debentures and the associated warrants based on the relative fair values before measuring the amount of the beneficial conversion feature. As a result, the Company recognized a cumulative effect adjustment of $752,000 in the fourth quarter of 2000. Reclassifications Certain prior-year amounts have been reclassified to conform to current-year classifications. 2. ACQUISITIONS In April 1998, the Company acquired all the outstanding stock of Agricultural Supply, Inc. ("AS"), a distributor of agricultural micro-irrigation and soil maintenance products located in Escondido, California, for $336,000 cash and 225,284 shares of the Company's common stock valued at $8.19 per share. The Company also agreed to make certain earn-out payments to the former shareholders of AS based on AS's EBITDA for the years ending December 31, 1998 and 1999. The 1998 earn-out value was $680,000, which was paid with 78,071 shares of the Company's common stock. As of December 31, 2000, an earn-out of $449,000 was accrued in connection with the fiscal year 1999 (see Note 13). The excess of purchase price over the net tangible assets acquired totaled $2,911,000, including the 1998 and 1999 earn-out payment and also including approximately $282,000 for legal and other costs incurred associated with the transaction. F-12 43 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. ACQUISITIONS (CONTINUED) In June 1998, the Company acquired all the outstanding stock of Yuma Sprinkler & Pipe Supply ("YSP"), a distributor of agricultural irrigation and soil maintenance products located in Yuma, Arizona, for $280,000 cash and 66,667 shares of the Company's common stock valued at $7.50 per share. The Company also agreed to make certain earn-out payments to the former shareholders of YSP based on YSP's EBITDA for the years ending December 31, 1998 and 1999. The 1998 earn-out value was $400,000, which was paid with 45,908 shares of the Company's common stock. There was no earn-out value in 1999. The excess of purchase price over the net tangible assets acquired totaled $1,094,000, including the 1998 earn-out payment and also including approximately $92,000 for legal and other costs incurred associated with the transaction. In June 2000, 42,146 shares of common stock initially issued in connection with the YSP acquisition were redeemed in settlement of an indemnification claim against the former shareholders. The redemption of shares was valued at the current market value on the date of the redemption and was credited to operations. In June 1998, the Company acquired all the outstanding stock of Riegomex S.A. de C.V. ("RM") for $45,943 cash. In June 1998, the Company acquired the remaining fifty percent interest of Agricultural Supply de Mexico ("ASM") which AS had not already owned for $200,000 cash, and agreed to pay an additional $1,100,000 in cash or stock, at the option of the selling shareholders, over the next five years. On September 2, 1999, the Company issued 91,548 shares of the Company's common stock to Agrium Inc. ("AG") pursuant to a Purchase Agreement dated as of July 29, 1999 ("Agrium Asset Purchase Agreement"). Pursuant to the Agrium Asset Purchase Agreement, the Company issued to AG 91,548 shares of the Company's common stock valued at $7.10 per share and $350,000 in cash in exchange for certain assets of AG. These assets consist of research equipment and the rights and technology to certain product lines. The results of operations of the acquired businesses are included in the consolidated financial statements from the respective dates of acquisition. Each of the acquisitions was accounted for as a purchase and, accordingly, the adjusted purchase price has been allocated to the assets acquired and the liabilities assumed based on the estimated fair market at the date of the acquisitions, as follows (in thousands):

F-13 44 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. ACQUISITIONS (CONTINUED) The following unaudited pro forma results as of December 31, 1998 assume the AS, ASM, YSP and RM acquisitions occurred on January 1, 1998. The pro forma results have been prepared utilizing the historical financial statements of the Company and the acquired businesses and has been adjusted to reflect the fact that certain businesses were sold in 2000.

In addition in 1998, the Company acquired two businesses that are included in discontinued operations. These businesses had an aggregate purchase price of $4.6 million. The unaudited pro forma results above give effect to pro forma adjustments related to the amortization of the excess of the purchase price over the fair value of the assets acquired, the increase in interest expense to reflect the notes payable issued to effect the acquisitions and related income tax adjustments. This pro forma information is not necessarily indicative of the actual results that would have been achieved had the above businesses been acquired on January 1, 1998, nor is it necessarily indicative of future results. 3. DISCONTINUED OPERATIONS On July 28, 2000, the Company completed the sale of substantially all of the assets of its Turf Partners subsidiary (the "Asset Sale") to the J.R. Simplot Company ("Simplot"). At the closing of the Asset Sale, Simplot made a cash payment of $23.0 million and assumed Turf Partners' existing long-term debt and vendor payables totaling $37.3 million. Simplot also assumed Turf Partners' outstanding contracts and leases. The Asset Sale was consummated pursuant to an Amended and Restated Asset Purchase Agreement dated April 5, 2000, as amended by a First Amendment to Amended and Restated Asset Purchase Agreement dated June 9, 2000. The results of the discontinued operations (in thousands) were as follows:

F-14 45 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. DISCONTINUED OPERATIONS (CONTINUED) For the periods presented, the Company borrowed funds from institutional lenders and accredited investors to provide working capital for the parent company and its subsidiaries. The interest expense associated with this debt was originally recorded by the parent company, but a portion of interest expense associate with this debt has been allocated to the discontinued operations noted above. Interest expense allocated to the discontinued operations totaled $2.8 million, $2.2 million and $832,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Also, selling, general and administrative expenses that were recorded by the parent company but were specifically an expense of the discontinued operations have been allocated to the discontinued operations as shown above. The amount of selling, general and administrative expenses allocated by the parent company to the discontinued operations totaled $907,000, $2.5 million and $0 for the years ended December 31, 2000, 1999 and 1998, respectively. Also, the Company recognized an aggregate special charge of $3.9 million in fiscal year 1998 (see Note 11); of this amount, $2.6 million was directly attributable to the discontinued operations, therefore, this amount was allocated to the discontinued operations. Due to the gain on the sale of the discontinued operations, the tax basis for calculating Alternative Minimum Tax resulted in an estimated payable of $80,000 for the fiscal year 2000. The historical consolidated balance sheets reflect the assets and liabilities of discontinued operations as current or non-current assets based on the original classification of the accounts, except that current liabilities are netted against current assets and non-current liabilities are netted against non-current assets. 4. EXTRAORDINARY ITEM From the proceeds of the Asset Sale, the Company retired $14 million of the Senior Subordinated Notes ("Notes"). The remaining $1 million (of the original issuance of $15 million), plus accrued interest, was converted into an amended Senior Subordinated Note. As a result, the Company wrote-off $3.8 million of unamortized debt issuance costs associated with the Notes. Approximately $1,035,000 of the debt issuance costs relates to the January 2000 transactions in which the Company issued 372,837 shares of common stock to the Note Holders in connection with a waiver that was provided to the Company for the Asset Sale. The unamortized portion of the original value was included in the $3.8 million of unamortized debt issuance cost written off. 5. BALANCE SHEET INFORMATION Property and equipment attributable to the continuing operations consists of the following at December 31, (in thousands):

F-15 46 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. BALANCE SHEET INFORMATION (CONTINUED) Intangible assets attributable to the continuing operations consist of the following at December 31, (in thousands):

6. LONG-TERM DEBT Long-term debt attributable to the continuing operations consists of the following at December 31, (in thousands):

F-16 47 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT (CONTINUED) On August 25, 1998, the Company issued an aggregate of $15.0 million principal amount of the Company's Senior Subordinated Notes due 2003 (the "Notes") to two lenders secured by substantially all the assets of Eco Soil Systems, Inc. and subsidiaries. On July 28, 2000, the Company retired $14.0 million of the Notes from the proceeds of the Asset Sale. Also, the Company amended the Note and Warrant Purchase Agreements with the Lenders to eliminate financial covenants. The Company replaced the Notes with amended Senior Subordinated Notes (the "Amended Notes") with an aggregate principal amount of $1.4 million covering the principal and accrued interest of the Notes not paid on July 28, 2000. The Amended Notes are unsecured and bear interest at an annual rate of 14% and are due on January 28, 2002. Monthly payments of $87,000 in the aggregate began on August 28, 2000. As a result of the retirement, the Company wrote-off $3.8 million of unamortized debt issuance costs associated with the Notes. On June 30, 1999, the Company's wholly owned subsidiary Agricultural Supply, Inc. entered into a credit agreement with First National Bank (the "FNB Working Capital Facility"). The FNB Working Capital Facility is a $10 million three-year credit facility based upon Agricultural Supply's eligible inventory and receivables and has an interest rate of prime plus .25%. Effective June 1, 2000, the following changes were made to the terms of the FNB Working Capital Facility: (a) fixed assets (BioJect system units) were added to the description of collateral, (b) maturity date changed to December 31, 2000, (c) interest rate was changed to Prime plus 1.5%, and (d) personal guarantees were provided by key executives. This facility is secured by substantially all the assets of Agricultural Supply and Agricultural Supply de Mexico and by all Biojects owned by the Company. On July 30, 1999, the Company obtained a $2.5 million, two-year term loan from Coast Business Credit (the "Coast Term Loan"). The Coast Term Loan bears interest at Coast's prime rate plus 2.25%, payable monthly. One third of the principal must be repaid in level monthly payments during the first year of the term, with the remainder due in level monthly payments during the second year of the term. The Coast Term Loan is secured by substantially all of the assets of the parent Company. Effective January 5, 2001, Coast Business Credit drew on the Letter of Credit provided by Simplot as part of the Asset Sale and Term Loan Agreement (discussed below). As a result, the debt to Coast Business Credit has been retired and the Company owes Simplot $1.2 million pursuant to the Term Loan Agreement that must be repaid from the future purchase of proprietary products by Simplot Partners. On January 24, 2000, the Company issued $4.5 million of Senior Secured Convertible Debentures (the "Debentures") and warrants to purchase 356,436 shares of common stock. The conversion price of the Debentures is the lower of 90% of the three lowest closing bid prices on the Principal Market during the fifteenth consecutive Trading Days ending with the last Trading Day prior to the date of conversion and $1.25. At the initial commencement date, the Company recorded $954,000 for beneficial conversion features. The Debentures were originally due January 24, 2001 and bear interest at a rate of 7% per annum, which is due quarterly beginning March 31, 2000, and is payable in cash or common stock at our option. In June 2000, the Company reduced the exercise price of the warrants to purchase 356,436 shares of common stock to $1.00 and issued additional warrants to purchase an aggregate of 75,000 shares of common stock with an exercise price of $2.50 per share to the Debenture holders in connection with obtaining the Debenture holders' consent to the Asset Sale. Effective January 24, 2001, the Company and the Debenture holders entered into Amendment No. 1 of the Debentures Agreement, which called for a closing at which the maturity of the Debentures would be modified to $1.5 million (plus 10% premium thereon) due on January 24, 2001 and $2.9 million due January 24, 2002. The closing did not take place (see Note 13). On April 12, 2000, the Company entered into a Term Loan Agreement ("Term Loan") with Simplot. The $3 million Term Loan was obtained in July 2000 and used for working capital purposes. The Term Loan was repaid from the proceeds of the Asset Sale, described above. The Company's Coast Term Loan and the FNB Working Capital Facility contain certain restrictions and limitations on the Company's operations, including restrictions on capital expenditures, sale of assets, lease liabilities, mergers or other forms of business combinations, as well as the prohibition on the payments of cash dividends. The Coast Term Loan and the FNB Working Capital Facility also contain certain covenants which require the company to maintain minimum levels of net worth, working capital and other financial ratios, as defined. As of December 31, 2000, the Company was not in compliance with certain of these covenants. Since the Coast Term Loan was paid-off by Simplot, a waiver for non-compliance was not required. First National Bank provided a waiver of such covenants through March 31, 2001. However, there can be no assurance that the Company will remain in compliance. F-17 48 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. LONG-TERM DEBT (CONTINUED) Aggregate maturities of long-term debt as of December 31, 2000 are as follows (in thousands):

7. SHAREHOLDERS' EQUITY Preferred Stock The Board of Directors is authorized, without any action by the Company's shareholders, to issue up to 5,000,000 shares of undesignated preferred stock and to fix the powers, preferences, rights and limitations of any such preferred shares or any class or series thereof. Stock Option Plans In February 1992, the Company established the Stock Option Plan (the "1992 Plan") for employees and consultants which, as amended, provides for the grant of options to purchase up to 1,100,000 shares of common stock, all of which options have been granted. Options granted under the 1992 Plan have a five-year term, and vest ratably over a three-year period. In December 1996, the Company established the 1996 Directors' Stock Option Plan (the "1996 Directors' Plan") for its independent directors, which provides for the grant of options to purchase up to 60,000 shares of common stock, all of which options have been granted. Options granted under the 1996 Directors' Plan have a ten-year term. In June 1998, the Company established the 1998 Stock Option Plan of Eco Soil Systems, Inc. (the "1998 Plan"). The 1998 Plan, as amended, provides for the issuance of up to 1,600,000 shares of common stock under incentive stock options and nonqualified stock options. The exercise price of options shall be set by the Company's Compensation Committee, provided that such price shall not be less than 85% of the fair market value at the date of the grant, or 110% in the case of any person possessing 10% combined voting power of all classes of stock of the Company. In the case of incentive stock options, such price shall not be less than 100% of the fair market value at the date of the grant. The Company's Compensation Committee also shall determine the vesting and other provisions of options granted under the 1998 Plan. In April 1999, the Company established the 1999 Equity Participation Plan (the "1999 Equity Plan"). The 1999 Equity Plan provides for the issuance of up to 1,600,000 shares of common stock under incentive stock options and nonqualified stock options. The exercise price of options shall be set by the Company's Compensation Committee, provided that such price shall not be less than 85% of the fair market value at the date of the grant, or 110% in the case of any person possessing 10% combined voting power of all classes of stock of the Company. In the case of incentive stock options, such price shall not be less than 100% of the fair market value at the date of the grant. The Company's Compensation Committee also shall determine the vesting and other provisions of options granted under the 1999 Equity Plan. In June 1999, the Company established the 1999 New Hire Stock Option Plan (the "1999 New Hire Plan"). The 1999 New Hire Plan provides for the issuance of up to 1,000,000 shares of common stock under nonqualified stock options. The Company's Compensation Committee shall set the exercise price of options, provided that such price shall not be less than 85% of the fair market value at the date of the grant. The Company's Compensation Committee shall determine the vesting and other provisions of options granted under the 1999 New Hire Plan. The Company granted options to purchase an aggregate of 1,378,059 shares of common stock through various nonqualified stock option agreements from May 1991 through April 1999 to consultants and employees. The exercise price, vesting and other provisions are determined by the individual nonqualified stock option agreement. F-18 49 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY (CONTINUED) In June 2000, the Company established the 2000 Employee Stock Option Plan (the "2000 Employee Plan"). The 2000 Employee Plan provides for the issuance of up to 800,000 shares of common stock under nonqualified stock options. The Company's Compensation Committee shall set the exercise price of options, provided that such price shall not be less than 85% of the fair market value at the date of the grant. The Company's Compensation Committee shall determine the vesting and other provisions of options granted under the 2000 Employee Stock Option Plan. Under the 2000 Employee Plan, there were 448,500 options granted and outstanding, as of December 31, 2000, that will vest based on performance criteria of Simplot salespersons. The options have a five-year life and an exercise price of $2.22. In February 2001, the performance related options were fully vested by the Board of Directors. A summary of the Company's stock option activity and related information for the years ended December 31 is as follows:

A summary of the Company's stock options outstanding as of December 31, 2000 is as follows:

Pro forma information regarding net loss and net loss per share is required by SFAS 123, and has been determined as if the Company has accounted for its employee stock plans under the fair value method of that statement. The fair value for options granted in 2000 was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: risk-free interest rates of 5.21% to 6.77%, dividend yield of 0%, volatility factor of 93.1% and a weighted-average expected life of the option of five years. F-19 50 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY (CONTINUED) The fair value for options granted in 1999 was estimated at the date of grant using the Black-Scholes method for option pricing with the following assumptions: risk-free interest rates of 4.55% to 6.25%, dividend yield of 0%, volatility factor of 79.0% and a weighted-average expected life of the option of three years. The fair value for options granted in 1998 was estimated at the date of grant using the Black-Scholes method for option pricing with the following assumptions: risk-free interest rates of 4.04% to 7.94%, dividend yield of 0%, volatility factor of 75.0%, and a weighted-average expected life of the option of three years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the fair value estimate; in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the vesting period of such options. The effects of applying SFAS 123 for pro forma disclosure purposes are not likely to be representative of the effects on pro forma net loss or net income in future years because they do not take into consideration pro forma compensation expense related to grants made prior to 1996. The Company's pro forma information follows ( in thousands, except per share data):

Other Options and Warrants At various dates since 1991, the Company has issued options and warrants outside of formal plans in connection with debt or equity financing and the acquisition of technology or marketing rights. As of December 31, 2000, warrants to purchase 3,153,883 shares of common stock were outstanding at a weighted average exercise price of approximately $2.77 per share. Such warrants generally are exercisable through 2004 or 2005. During the year ending December 31, 2000, the Company issued 561,436 of warrants with a fair value of $ 1.6 million. The fair value was determined using the Black-Scholes option pricing model with the following assumptions: risk free interest rates of 5.21% to 6.77%, dividend yield of 0% volatility factor of .93.1% and a weighted-average expected life of the option of five years, and was recorded in debt issue costs. In June 2000, the Company repriced 486,436 warrants resulting in an incremental charge of $143,000. Shares Reserved for Future Issuance Shares have been reserved at December 31, 2000 for the following: Stock option plans ........... 7,259,614 Warrants ..................... 3,153,883 ---------- 10,413,497 ==========

8. INCOME TAXES At December 31, 2000, the Company had federal and California tax net operating loss carryforwards of approximately $26 million and $7 million, respectively. The difference between the federal and California tax loss carryforwards is primarily attributable to the fifty-percent limitation on California loss carryforwards. The federal tax loss carryforward will begin expiring in 2008, unless previously utilized. California net operating losses of approximately $674,000 expired in 2000, and approximately $1.9 million of California tax loss carryforward will expire in 2001. In addition, the Company had federal and California research tax credits of $234,000 and $130,000, respectively. The tax credits will begin to expire in 2009. F-20 51 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) Pursuant to Internal Revenue Code Sections 382 and 383, use of the Company's net operating loss and credit carry forwards are limited because of cumulative changes in ownership of more than 50% which have occurred. However, the Company does not believe the limitations will have a material impact upon the future utilization of these carry-forwards. Significant components of the Company's deferred tax assets as of December 31, 2000 and 1999 are shown below. A valuation allowance has been provided as the realization of these assets is uncertain.

The reconciliation of income tax computed at the federal statutory rates to income tax expense is the following:

9. OPERATING LEASES The Company leases its office facilities and certain equipment under noncancelable operating lease agreements. Future minimum operating lease payments attributable to the continuing operations as of December 31, 2000 are as follows (in thousands):

Rent expense attributable to the continuing operations for the years ended December 31, 2000, 1999, and 1998 was approximately $919,000, $849,000 and $1,026,000 respectively, including $449,000, $433,000 and $351,000, respectively to related parties. F-21 52 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. OPERATING LEASES (CONTINUED) In June 1997, three officers and shareholders of the Company contracted to buy land and acquired an option to build on land the building, which currently houses the Company's headquarters. In December 1997, the officers and shareholders transferred the purchase option to the Company under an agreement whereby the Company would exercise the purchase option, sell the building to an independent party under a sale/leaseback transaction and allocate a specific portion of any gain on the sale to the officers and shareholders. In October 1998, the Company exercised the purchase option and acquired the building for $2.4 million. In December 1998, the Company sold the building to an independent party for a gain of $863,000, and signed a 10-year agreement to lease the facility back from the independent party. In accordance with the original transfer agreement, the Company allocated $282,000 of the gain to the officers and shareholders. The remaining gain of $581,000 has been deferred and will be recognized as a reduction of rent expense over the life of the lease. 10. LITIGATION In November 1998, the Company executed a term sheet with the Palladin Group, L.P. ("Palladin") concerning negotiations for a possible investment by Palladin in certain new classes of securities of the Company, which, at the time, the Company was considering issuing to a certain fund managed by Palladin. The Company subsequently terminated the negotiations in December 1998. An affiliate of Palladin, Halifax Fund, L.P. ("Halifax"), filed a lawsuit on or about March 19, 1999 in San Diego Superior Court alleging that the termination violated the duties owed by the Company to Halifax under the term sheet. The lawsuit sought compensatory damages of approximately $2.6 million and punitive damages of approximately $12.0 million. In July 1999, the Company executed Settlement and Release Agreements with Halifax Fund, L.P., Palladin Group, L.P., Granite Financial Group, Inc. and Midori Capital Corporation. These agreements mutually release and discharge all claims arising from this litigation. The Company paid termination charges and attorney's fees of $198,000 related to this settlement. On November 24, 1999, a purported class action securities complaint was filed against the Company and three of its officers and/or directors, William B. Adams, Douglas M. Gloff and Mark. D. Buckner, by Edward Wissinger. The suit was allegedly brought by Mr. Wissinger on behalf of all purchasers of Eco Soil common stock during the period from April 13, 1999 (the date Eco Soil filed its Annual Report on Form 10-K for the year ended December 31, 1998 with the Securities and Exchange Commission) and November 3, 1999 (the date on which Eco Soil issued its quarterly earnings release for the three months ended September 30, 1999). The complaint alleged that defendants failed to sufficiently identify certain risks associated with the Company's agricultural business in Mexico, thereby artificially inflating the Company's stock price. On July 11, 2000, the Court dismissed without prejudice the class action complaint. The Court found that the plaintiff had failed to allege sufficient facts to state a claim in light of the heightened pleading standards applicable to the allegations made in the complaint. Under the Court's order, the plaintiff was granted an opportunity to amend his complaint at any time within 30 days of the Court's order to attempt to state a cognizable claim. The parties subsequently entered into a stipulation to voluntarily dismiss the action, which was entered by the court on September 5, 2000. From time-to-time, the Company is involved in legal proceedings, claims and litigation arising from the ordinary course of business. Management believes, however, that the ultimate outcome of all pending litigation should not have material adverse effect on the Company's financial position or liquidity. 11. SPECIAL CHARGES During the fourth quarter of 1998, the Company incurred special charges, related to the continuing and discontinued operations, of $3.9 million as a result of the Company's action to reorganize certain of its operations. The restructuring activities (shown below in tabular format) primarily relate to: (a) reorganization of the Company into two separate operating segments, Turf Partners and Agricultural Supply, b) the write-off of impaired goodwill related to two businesses acquired in prior years and c) the shutdown of its Aspen Consulting, Inc. subsidiary. A total of 28 employees were terminated from almost all areas of the Company, with 12 having left the Company as of December 31, 1998. Additional employees left the Company during fiscal year 1999. The Company substantially completed the restructuring actions during fiscal 1999. The remainder of the accrued liabilities were recognized during fiscal 2000. F-22 53 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. SPECIAL CHARGES (CONTINUED) Details of the restructuring charge (in thousands) are as follows:

During the fiscal year of 2000, the Company incurred a restructuring charge of $1.2 million as a result of the closure of five operating locations of the Agricultural Supply subsidiary located in the United States and Mexico. A total of 25 employees were terminated from these locations. The remaining accrued liabilities associated with these operations are expected to be paid during the fiscal year 2001. Details of the restructuring charge (in thousands) are as follows:

F-23 54 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. SPECIAL CHARGES (CONTINUED) The following is a summary of revenue and net operating losses (in thousands) for the locations that were closed:

12. SEGMENT REPORTING For purposes of analyzing and understanding the financial statements, the Company's continuing operations have been classified into the following business segments: Proprietary: This segment enters into contracts with golf courses, turf maintenance service businesses and agricultural growers, or distributors that sell to those end-user markets to manage the health and productivity of their soil during their respective type of season. The contracts require the Company to perform a comprehensive soil analysis at the beginning of the season, develop a treatment regimen, install the Company's proprietary BioJect system at the customer's site and provide the microbials throughout the season. Distributed: This segment distributes a wide range of irrigation and other agricultural supplies to growers. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. The Company allocates resources and evaluates the performance of segments based on net profit or loss.

Depreciation that is separately identified to proprietary and distributed segments are charged to those segments. All other general and administrative costs are recognized by corporate. Foreign assets are included in segment assets. 13. SUBSEQUENT EVENTS Former Owners Indemnification On March 12, 2001, an arbitrator formally ruled on an arbitration case between the Company and John C. Wells, William Wells and John Pothoff ("former owners") of Agricultural Supply, Inc., which was purchased by the Company in 1998. The result of the arbitration was that the Company was awarded an indemnification of $465,000 for uncollectible receivables included in the assets purchased from the former owners. However, the former owners were awarded an earn-out for the fiscal year 1999 of $449,000. The earn-out will be paid by offsetting it with the indemnification plus a combination of cash and Company Common Stock. The earn-out is classified as an adjustment to the purchase price, effective January 1, 2000. Therefore, amortization of $53,000 was recognized in the fiscal year 2000 operating results. Debentures Amendment No. 2 On March 7, 2001, the Company and the Debenture holders entered into Amendment No. 2 of the Debentures Agreement, called for a closing at which the maturity of the Debentures would be modified to $1.5 million (plus a 10% premium thereon) due on March 31, 2001 and $2.9 million due January 24, 2002. The closing did not take place, and as a result, the maturity date of the Debentures has not been changed. In connection with Amendment No. 2, the Debenture holders were issued additional warrants to purchase an aggregate of 100,000 shares of common stock with an exercise price of $1.10 per share. In addition, as part of the Amendment No. 2 the Company agreed that if it did not make the March 31, 2001 payment, the Debenture holders would be entitled to additional warrants to purchase an aggregate of 200,000 shares of common stock with an exercise price of $1.10 per share. The Company did not meet the March 31, 2001 payment requirement, therefore, the additional 200,000 warrants will be issued to the Debenture holders. F-24 55 ECO SOIL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. QUARTERLY FINANCIAL DATA (UNAUDITED)

F-25 56

F-26 57 EXHIBIT INDEX

(1) Filed herewith (2) Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 333-15883) filed with the Commission on November 8, 1996. (3) Incorporated by reference to Amendment No. 3 to the Company's Registration Statement on Form SB-2 (File No. 333-15883) filed with the Commission on January 13, 1997. 59 (4) Incorporated by reference to Amendment No. 4 to the Company's Registration Statement on Form SB-2 (File No. 333-15883) filed with the Commission on January 16, 1997. (5) Incorporated by reference to the Company's Registration Statement on Form SB-2 (File No. 333-39399) filed with the Commission on November 4, 1997. (6) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement on Form SB-2 (File No. 333-39399) filed with the Commission on November 21, 1997. (7) Incorporated by reference to the Company's Periodic Report on Form 10-QSB (File No. 001-12653) filed with the Commission on August 13, 1998. (8) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 001-12653) filed with the Commission on September 11, 1998 (includes Schedule 1 showing additional party to and differing terms of substantially identical documents). (9) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 001-12653) filed with the Commission on December 30, 1998. (10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q (File No. 001-21975) filed with the Commission on May 17, 1999. (11) Incorporated by reference to the Company's Quarterly Report on Form 10-Q (File No. 001-21975) filed with the Commission on August 16, 1999. (12) Incorporated by reference to the Company's Current Report on Form 8-K filed January 26, 2000. (13) Incorporated by reference to Appendix A to the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Shareholders filed with the Commission on April 30, 1999. (14) Incorporated by reference to Appendix B to the Company's Definitive Proxy Statement for the 1999 Annual Meeting of Shareholders filed with the Commission on April 30, 1999. (15) Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on February 10, 2000. (16) Incorporated by reference to the Company's Annual Report on Form 10-K (File No. 001-21975) filed with the Commission on April 14, 2000. (17) Incorporated by reference to the Company's Periodic Report on Form 10-Q (File No. 001-21975) filed with the Commission on May 15, 2000. (18) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 001-12653) filed with the Commission on June 19, 2000. (19) Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on July 31, 2000 (20) Incorporated by reference to the Company's Periodic Report on Form 10-Q (File No. 001-21975) filed with the Commission on August 14, 2000. (21) Incorporated by reference to the Company's Periodic Report on Form 10-Q (File No. 001-21975) filed with the Commission on November 14, 2000.

ECO SOIL SYSTEMS INC 10-K