SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
-------------------------------------------
FORM 10-Q
(mark one)
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarter Ended July 4, 1998.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number 1-13572
THERMO ECOTEK CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 04-3072335
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
245 Winter Street, Suite 300
Waltham, Massachusetts 02451
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (781) 622-1000
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 the number of shares outstanding of each of the issuer's
classes of Common Stock, as of the latest practicable date.
Class Outstanding at July 31, 1998
---------------------------- ----------------------------
Common Stock, $.10 par value 35,862,110
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
THERMO ECOTEK CORPORATION
Consolidated Balance Sheet
(Unaudited)
Assets
July 4, September 27,
(In thousands) 1998 1997
- --------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents (includes $29,437
and $69,309 under repurchase agreement
with parent company) $ 38,069 $ 83,540
Restricted funds 10,387 20,773
Accounts receivable and unbilled revenues 44,165 33,039
Inventories:
Raw materials and supplies 16,351 11,886
Work in process and finished goods 8,708 2,030
Prepaid income taxes 4,505 4,298
Other current assets 3,013 1,728
-------- --------
125,198 157,294
-------- --------
Property, Plant, and Equipment, at Cost 379,581 328,837
Less: Accumulated depreciation and
amortization 82,087 65,770
-------- --------
297,494 263,067
-------- --------
Due from Parent Company 10,164 10,164
-------- --------
Long-term Available-for-sale Investments,
at Quoted Market Value (amortized cost
of $8,504 in fiscal 1998 and 1997) 11,945 12,497
-------- --------
Restricted Funds 25,737 20,905
-------- --------
Other Assets 19,451 21,378
-------- --------
$489,989 $485,305
======== ========
2
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THERMO ECOTEK CORPORATION
Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
July 4, September 27,
(In thousands except share amounts) 1998 1997
- --------------------------------------------------------------------------
Current Liabilities:
Current portion of long-term obligations $ 28,032 $ 35,012
Accounts payable 10,976 4,031
Lease obligations payable 5,637 1,736
Accrued interest 467 3,524
Other accrued expenses 18,261 21,022
Due to parent company - 1,255
-------- --------
63,373 66,580
-------- --------
Long-term Obligations:
Nonrecourse tax-exempt obligations 33,700 51,800
Subordinated convertible debentures
(includes $68,500 due to parent company
in fiscal 1997; Note 5) 47,400 130,648
Capital lease obligations 12,346 22,242
-------- --------
93,446 204,690
-------- --------
Deferred Income Taxes 58,777 49,934
-------- --------
Other Deferred Items 21,139 13,521
-------- --------
Minority Interest 14,056 3,304
-------- --------
Shareholders' Investment (Notes 4 and 5):
Common stock, $.10 par value, 50,000,000
shares authorized; 37,822,789 and
25,978,198 shares issued 3,782 2,598
Capital in excess of par value 176,182 95,573
Retained earnings 85,873 67,593
Treasury stock at cost, 1,960,679 and
1,477,250 shares (28,979) (20,872)
Cumulative translation adjustment 241 (52)
Net unrealized gain on available-for-sale
investments 2,099 2,436
-------- --------
239,198 147,276
-------- --------
$489,989 $485,305
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
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THERMO ECOTEK CORPORATION
Consolidated Statement of Income
(Unaudited)
Three Months Ended
------------------
July 4, June 28,
(In thousands except per share amounts) 1998 1997
- --------------------------------------------------------------------------
Revenues $50,748 $43,524
------- -------
Costs and Operating Expenses:
Cost of revenues (includes $752 and $903 to
related parties) 34,420 28,842
Selling, general, and administrative expenses
(includes $406 and $435 to related parties) 5,591 5,330
Research and development expenses 670 625
------- -------
40,681 34,797
------- -------
Operating Income 10,067 8,727
Interest Income 987 1,379
Interest Expense (includes $270 and $685 to
parent company) (2,669) (3,648)
Equity in Loss of Joint Venture (61) (99)
------- -------
Income Before Provision for Income Taxes and
Minority Interest 8,324 6,359
Provision for Income Taxes 3,173 2,398
Minority Interest Expense 327 363
------- -------
Net Income $ 4,824 $ 3,598
======= =======
Earnings per Share (Note 6):
Basic $ .15 $ .15
======= =======
Diluted $ .14 $ .11
======= =======
Weighted Average Shares (Note 6):
Basic 32,405 24,460
======= =======
Diluted 39,049 36,543
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
THERMO ECOTEK CORPORATION
Consolidated Statement of Income
(Unaudited)
Nine Months Ended
---------------------
July 4, June 28,
(In thousands except per share amounts) 1998 1997
- ---------------------------------------------------------------------------
Revenues $145,764 $120,712
-------- --------
Costs and Operating Expenses:
Cost of revenues (includes $3,718 and $3,508
to related parties) 99,460 83,977
Selling, general, and administrative expenses
(includes $1,262 and $1,234 to related
parties) 17,263 12,650
Research and development expenses 2,059 1,900
-------- --------
118,782 98,527
-------- --------
Operating Income 26,982 22,185
Interest Income 3,357 3,641
Interest Expense (includes $1,640 and $2,055 to
parent company) (9,437) (10,292)
Gain on Issuance of Stock by Subsidiary (Note 4) 6,269 -
Equity in Earnings of Joint Venture 62 27
-------- --------
Income Before Provision for Income Taxes and
Minority Interest 27,233 15,561
Provision for Income Taxes 7,782 5,756
Minority Interest Expense 1,171 955
-------- --------
Net Income $ 18,280 $ 8,850
======== ========
Earnings per Share (Note 6):
Basic $ .67 $ .36
======== ========
Diluted $ .52 $ .27
======== ========
Weighted Average Shares (Note 6):
Basic 27,109 24,669
======== ========
Diluted 39,190 37,391
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
THERMO ECOTEK CORPORATION
Consolidated Statement of Cash Flows
(Unaudited)
Nine Months Ended
---------------------
July 4, June 28,
(In thousands) 1998 1997
- ---------------------------------------------------------------------------
Operating Activities:
Net income $ 18,280 $ 8,850
Adjustments to reconcile net income to net
cash provided by operating activities:
Minority interest expense 1,171 955
Depreciation and amortization 17,821 15,560
Gain on issuance of stock by subsidiary
(Note 4) (6,269) -
Increase in deferred income taxes 7,782 5,757
Changes in current accounts, excluding
the effect of acquisitions:
Restricted funds 10,386 5,339
Accounts receivable and unbilled
revenues (10,957) (812)
Inventories (2,384) (1,145)
Other current assets (1,199) 588
Accounts payable 6,912 (843)
Lease obligations payable 3,507 3,508
Other current liabilities (6,158) 2,718
-------- --------
Net cash provided by operating activities 38,892 40,475
-------- --------
Investing Activities:
Acquisitions, net of cash acquired (Note 3) (19,100) (10,865)
Funding of long-term restricted funds (4,832) (6,523)
Increase in other deferred items 8,012 4,575
Increase in other assets (242) (2,655)
Purchases of property, plant, and equipment (38,343) (11,788)
-------- --------
Net cash used in investing activities (54,505) (27,256)
-------- --------
Financing Activities:
Repayment of long-term obligations (26,100) (16,000)
Payments under capital lease obligations (8,912) (5,842)
Proceeds from issuance of Company and
subsidiary common stock (Note 4) 15,602 1,622
Net proceeds from issuance of subordinated
convertible debentures - 48,470
Purchases of Company common stock (10,248) (21,779)
Distribution to minority partner (1,360) (1,227)
Capital contribution by minority partner 1,130 -
-------- --------
Net cash provided by (used in) financing
activities (29,888) 5,244
-------- --------
Exchange Rate Effect on Cash 30 (8)
-------- --------
Increase (Decrease) in Cash and Cash Equivalents (45,471) 18,455
Cash and Cash Equivalents at Beginning of Period 83,540 63,238
-------- --------
Cash and Cash Equivalents at End of Period $ 38,069 $ 81,693
======== ========
6
<PAGE>
THERMO ECOTEK CORPORATION
Consolidated Statement of Cash Flows (continued)
(Unaudited)
Nine Months Ended
--------------------
July 4, June 28,
(In thousands) 1998 1997
- ---------------------------------------------------------------------------
Noncash Activities:
Fair value of assets of acquired companies $ 20,025 $ 14,950
Cash paid for acquired companies (19,100) (11,223)
-------- --------
Liabilities assumed of acquired companies $ 925 $ 3,727
======== ========
Conversion of subordinated convertible
debentures (includes $68,500 converted by
parent company in fiscal 1998; Note 5) $ 83,248 $ 16,679
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
THERMO ECOTEK CORPORATION
Notes to Consolidated Financial Statements
1. General
The interim consolidated financial statements presented have been prepared
by Thermo Ecotek Corporation (the Company) without audit and, in the opinion of
management, reflect all adjustments of a normal recurring nature necessary for a
fair statement of the financial position at July 4, 1998, the results of
operations for the three- and nine-month periods ended July 4, 1998, and June
28, 1997, and the cash flows for the nine-month periods ended July 4, 1998, and
June 28, 1997. The nine-month periods ending July 4, 1998, and June 28, 1997,
include 40 weeks and 39 weeks, respectively. Interim results are not necessarily
indicative of results for a full year.
The consolidated balance sheet presented as of September 27, 1997, has been
derived from the consolidated financial statements that have been audited by the
Company's independent public accountants. The consolidated financial statements
and notes are presented as permitted by Form 10-Q and do not contain certain
information included in the annual financial statements and notes of the
Company. The consolidated financial statements and notes included herein should
be read in conjunction with the financial statements and notes included in the
Company's Annual Report on Form 10-K for the fiscal year ended September 27,
1997, filed with the Securities and Exchange Commission.
2. Presentation
Certain amounts in fiscal 1997 have been reclassified to conform to the
presentation in the fiscal 1998 financial statements.
3. Acquisition
In November 1997, the Company's Thermo Trilogy Corporation subsidiary
acquired the sprayable bacillus thuringiensis (Bt) - biopesticide business of
Novartis AG and its affiliates (the Bt business of Novartis) for $19.1 million
in cash and the assumption of certain liabilities.
This acquisition has been accounted for using the purchase method of
accounting, and the results of operations of the Bt business of Novartis have
been included in the accompanying financial statements from the date of
acquisition. The cost of this acquisition equaled the estimated fair value of
the net assets acquired. Allocation of the purchase price was based on an
estimate of the fair value of the net assets acquired and is subject to
adjustment upon finalization of the purchase-price allocation. The Company has
gathered no information that indicates the final allocation will differ
materially from the preliminary estimate. Based on unaudited data, the following
table presents selected financial information for the Company and the Bt
business of Novartis on a pro forma basis, assuming that the Bt business of
Novartis had been purchased at the beginning of fiscal 1997.
8
<PAGE>
3. Acquisition (continued)
Three
Months Ended Nine Months Ended
------------ --------------------
(In thousands except June 28, July 4, June 28,
per share amounts) 1997 1998 1997
- --------------------------------------------------------------------------
Revenues $ 49,058 $148,997 $135,769
Net income 4,096 18,451 10,205
Earnings per share:
Basic .17 .68 .41
Diluted .12 .52 .31
The pro forma results are not necessarily indicative of future operations
or the actual results that would have occurred had the acquisition of the Bt
business of Novartis been made at the beginning of fiscal 1997.
4. Issuance of Stock by Subsidiary
At the time a subsidiary sells its stock to unrelated parties at a price in
excess of its book value, the Company's net investment in that subsidiary
increases. If at that time the subsidiary is an operating entity and not engaged
principally in research and development, the Company records the increase as a
gain.
If gains have been recognized on the issuance of a subsidiary's stock and
shares of the subsidiary are subsequently repurchased either by the subsidiary,
the Company, or Thermo Electron Corporation, gain recognition does not occur on
issuances subsequent to the date of a repurchase until such time as shares have
been issued in an amount equivalent to the number of repurchased shares.
In fiscal 1998, the Company's Thermo Trilogy subsidiary sold 1,942,821
shares of its common stock in private placements at $8.25 per share for net
proceeds of $14.9 million, resulting in a gain of $6.3 million. Following the
private placements, the Company owned 80% of Thermo Trilogy's outstanding common
stock.
5. Conversion of Subordinated Convertible Debentures
In May 1998, Thermo Electron converted $68.5 million principal amount of
the Company's 4% subordinated convertible debentures into 10,815,846 shares of
the Company's common stock.
6. Earnings per Share
During the first quarter of fiscal 1998, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings per Share." As a result, all
previously reported earnings per share have been restated; however, diluted
earnings per share equals the Company's previously reported fully diluted
earnings per share for the fiscal 1997 periods presented. Basic earnings per
share have been computed by dividing net income by the weighted average number
of shares outstanding
9
<PAGE>
6. Earnings per Share (continued)
during the period. Diluted earnings per share have been computed assuming the
conversion of convertible obligations and the elimination of the related
interest expense, and the exercise of stock options, as well as their related
income tax effects. Basic and diluted earnings per share were calculated as
follows:
Three Months Ended Nine Months Ended
--------------------- -------------------
(In thousands except July 4, June 28, July 4, June 28,
per share amounts) 1998 1997 1998 1997
- --------------------------------------------------------------------------
Basic
Net income $ 4,824 $ 3,598 $18,280 $ 8,850
------- ------- ------- -------
Weighted average shares 32,405 24,460 27,109 24,669
------- ------- ------- -------
Basic earnings per share $ .15 $ .15 $ .67 $ .36
======= ======= ======= =======
Diluted
Net income $ 4,824 $ 3,598 $18,280 $ 8,850
Effect of:
Convertible debentures 474 418 2,053 1,254
Majority-owned
subsidiary's dilutive
securities (3) - (6) -
------- ------- ------- -------
Income available to
common shareholders,
as adjusted $ 5,295 $ 4,016 $20,327 $10,104
------- ------- ------- -------
Weighted average shares 32,405 24,460 27,109 24,669
Effect of:
Convertible debentures 6,341 11,770 11,752 12,317
Stock options 303 313 329 405
------- ------- ------- -------
Weighted average shares,
as adjusted 39,049 36,543 39,190 37,391
------- ------- ------- -------
Diluted earnings per
share $ .14 $ .11 $ .52 $ .27
======= ======= ======= =======
The computation of diluted earnings per share excludes the effect of
assuming the exercise of certain outstanding stock options because the effect
would be antidilutive. As of July 4, 1998, there were 44,000 of such options
outstanding, with exercise prices ranging from $19.23 to $19.25 per share.
In addition, the computation of diluted earnings per share for the three-
and nine-month periods ended June 28, 1997, excludes the effect of assuming the
conversion of $50.0 million principal amount of 4.875% subordinated convertible
debentures, convertible at $16.50 per share, because the effect would be
antidilutive.
10
<PAGE>
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Forward-looking statements, within the meaning of Section 21E of the
Securities Exchange Act of 1934, are made throughout this Management's
Discussion and Analysis of Financial Condition and Results of Operations. For
this purpose, any statements contained herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, the words "believes," "anticipates," "plans," "expects," "seeks,"
"estimates," and similar expressions are intended to identify forward-looking
statements. There are a number of important factors that could cause the results
of the Company to differ materially from those indicated by such forward-looking
statements, including those detailed under the heading "Risk Factors" contained
herein.
Overview
The Company reports its results in two business segments. The Energy segment
operates independent electric power-generation facilities through joint
ventures, limited partnerships, or wholly owned subsidiaries (the Operating
Companies) and also operates a subbituminous coal beneficiation facility (the
K-Fuel Facility). The Biopesticide segment manufactures and sells biopesticides
through the Company's majority-owned subsidiary, Thermo Trilogy Corporation.
In the Energy segment, each Operating Company in the United States sells
power under a long-term power-sales agreement. The profitability of operating
the Company's facilities depends on the price received for power under the power
sales agreements with power purchasers, on plant performance or availability,
and on the fuel, operating, and maintenance costs for the facilities. As of
January 1998, the Energy segment operates a 12-megawatt energy center and five
auxiliary boilers in the Czech Republic. The Energy segment earns a
disproportionately high share of its income in May to October due to the rate
structures under the power-sales agreements for its California plants, which
provide strong incentives to operate during this period of high demand.
Conversely, the Energy segment has historically operated at marginal
profitability during the second fiscal quarter due to the rate structure under
these agreements. The Energy segment's profitability is also dependent on the
amount of development expenses that it incurs.
The Company has also entered the field of engineered clean fuels through a
limited partnership agreement with KFx, Inc. The Company is a 95% partner in a
partnership established to develop, construct, and operate a subbituminous coal
beneficiation facility using the patented K-Fuel technology licensed from KFx.
This facility, located near Gillette, Wyoming, uses the K-Fuel technology, which
transforms low-energy, high- moisture coal into low-moisture, high-energy fuel
with reduced sulfur. A tax credit per ton of fuel produced and sold is available
with respect to qualifying alternative fuels from a facility placed in service
before June 30, 1998, pursuant to a binding written contract in effect before
11
<PAGE>
Overview (continued)
December 31, 1996. The economic returns of the K-Fuel Facility primarily result
from tax credits on the facility's production of K-Fuel. The Company expects
that the K-Fuel Facility will report operating losses for financial reporting
purposes, primarily as a result of recording depreciation over the expected life
of the tax credit. There can be no assurance that the K-Fuel Facility would be
determined to qualify for the tax credit or that the Company will realize a
benefit from the tax credit.
The Company has expanded its energy operations into international markets
and has begun business development efforts in Italy and the Czech Republic. In
January 1998, the Company, through a wholly owned subsidiary's participation in
a joint venture (EMD Ventures), indirectly acquired an 83% interest in the
assets of a 12-megawatt energy center near Tabor, Czech Republic, along with the
business of five auxiliary boilers in the town of Pribram, Czech Republic (the
Czech Republic operations). The Company has begun construction to expand the
12-megawatt facility to 50-megawatt capacity. The cost of business development
efforts is expected to increase as the Company expands into these markets due to
increased complexity inherent in foreign development. In addition, the amount of
cash required to fund equity investments is expected to increase, due to the
financing requirements of lenders in foreign markets.
Thermo Trilogy's biopesticide products include botanical extracts from the
seed of the tropical neem tree, microbial-based pesticides (fungal-based
insecticides and fungicides, bacterial-based insecticides, baculovirus, and
beneficial nematodes), insect pheromone-based products such as traps and lures,
and disease-free sugar cane planting stock. These biopesticide products are used
as alternatives or complements to conventional chemical-based pest-control
technologies. In January 1997 Thermo Trilogy acquired substantially all of the
assets of biosys, inc. In November 1997, Thermo Trilogy acquired the sprayable
bacillus thuringiensis (Bt) - biopesticide business of Novartis AG and its
affiliates (the Bt business of Novartis; Note 3).
Since its inception, the Company has derived a substantial majority of its
revenue from the development, construction, and operation of biomass
electric-generation facilities. While the Company's U.S. biomass energy business
is expected to continue to generate revenues for the foreseeable future, the
Company expects the aggregate revenues and profitability associated with this
business to decline significantly beginning in fiscal 2000. In addition, within
the next few years, the Company expects a substantial portion of its revenues to
be derived from new business ventures in clean-power resources, clean fuels, and
biopesticides. A major portion of the Company's efforts will be focused on
developing and acquiring new power projects, additional clean-fuel projects, and
its biopesticide business. The Company has had limited prior experience in the
repowering of power plants and the development and sale of clean fuels, and
there can be no assurance that the Company
12
<PAGE>
Overview (continued)
will be able to successfully develop, market, or sell its products and services
in these areas. The Company's future success will depend significantly on its
ability to develop, introduce, and integrate new products and services in these
areas. No assurance can be given that the Company will be successful in this
regard. Any failure or inability of the Company to implement these strategies
would have a material adverse effect on the Company's business, financial
condition, and results of operations.
Results of Operations
Third Quarter Fiscal 1998 Compared With Third Quarter Fiscal 1997
Total revenues in the third quarter of fiscal 1998 increased 17% to $50.7
million from $43.5 million in the third quarter of fiscal 1997. Revenues from
the Energy segment in the third quarter of fiscal 1998 increased to $42.9
million from $37.9 million in the third quarter of fiscal 1997. The increase was
primarily due to higher contractual energy rates at the Company's Delano,
Gorbell, and Whitefield facilities and, to a lesser extent, the inclusion of
$2.0 million of revenues from the Czech Republic operations, acquired in January
1998. From various dates in 1998 onward, no further rate increases will occur at
the Company's four California energy facilities.
Revenues at Thermo Trilogy in the third quarter of fiscal 1998 increased to
$7.8 million from $5.6 million in the third quarter of fiscal 1997. The increase
was primarily due to the inclusion of revenues from the Bt business of Novartis,
acquired in November 1997.
The gross profit margin decreased to 32% in the third quarter of fiscal 1998
from 34% in the third quarter of fiscal 1997. The gross profit margin for the
Energy segment decreased to 29% in the third quarter of fiscal 1998 from 32% in
the third quarter of fiscal 1997. The decrease was primarily due to the
inclusion of costs associated with the initial stages of operations at the
Company's K-Fuel Facility.
The gross profit margin for Thermo Trilogy increased to 52% in the third
quarter of fiscal 1998 from 45% in the third quarter of fiscal 1997, primarily
due to increased revenues from higher-margin international operations, offset in
part by the inclusion of lower-margin revenues from the Bt business of Novartis.
The power-sales agreements for the Company's Woodland, Mendota, and Delano
plants in California are so-called standard offer #4 (SO#4) contracts, which
require Pacific Gas & Electric (PG&E), in the case of Woodland and Mendota, and
Southern California Edison (SCE), in the case of Delano I and Delano II, to
purchase the power output of the projects at fixed rates until 2000 in the case
of Woodland and Mendota, and 2001 in the case of Delano. However, with respect
to Woodland and Mendota, PG&E has asserted that the fixed rates under its
agreements will terminate mid-1999, although the Company disputes this
assertion.
13
<PAGE>
Third Quarter Fiscal 1998 Compared With Third Quarter Fiscal 1997
(continued)
Thereafter, the utility will pay a rate based upon the costs that would have
otherwise been incurred by the purchasing utilities in generating their own
electricity or in purchasing it from other sources (avoided cost; as determined
from time to time by the California Public Utility Commission). Avoided cost is
determined pursuant to a formula that is intended to estimate the price that the
utility would, but for its contract with the power producer, be paying for the
same amount of energy. The rate fluctuates with the price of fuels and certain
other factors. At present, the avoided cost is substantially lower than the
payments currently being made by PG&E and SCE to the Company under the
fixed-rate portions of its contracts. In addition, although it is difficult to
predict future levels of avoided costs, based on current estimates, avoided cost
is expected to be substantially lower in 2000 than the rates currently being
paid by PG&E and SCE under its fixed-rate contracts. The Company expects, that
at current avoided cost rates, absent sufficient reductions in fuel prices and
other operating costs, the Company's Mendota and Delano plants would operate at
substantially reduced operating income levels or at a loss beginning in fiscal
2001. In fiscal 1997, the Mendota and Delano plants' aggregate operating income
was approximately $34.0 million. Further, if the Woodland plant were to operate
at projected avoided cost levels, substantial losses would result, primarily due
to nonrecourse lease obligations that extend beyond 2000. Absent sufficient
reductions in fuel prices and other operating costs, under such circumstances
the Company would draw down power reserve funds to cover operating cash
shortfalls and then, should such funds be depleted, either renegotiate its
nonrecourse lease for the Woodland plant or forfeit its interest in the plant.
During the first quarter of fiscal 1997, the Company began recording as an
expense the funding of reserves required under Woodland's nonrecourse lease
agreement to cover projected shortfalls in lease payments beginning in 2000.
Consequently, the results of the Woodland plant were greatly diminished during
1997 and the Company expects that such results will be reduced to approximately
breakeven in 1998 and thereafter. During fiscal 1997 and 1996, the Woodland
plant contributed $1.0 million and $5.1 million of operating income,
respectively.
The Company began reporting the K-Fuel Facility's results of operations in
April 1998. Although the facility has operated and produced commercially salable
product, the Company has encountered certain difficulties in optimizing its
performance to achieve optimal and sustained operation. The Company has
addressed and resolved certain problems previously encountered, including a fire
at the facility and certain construction problems, including issues relating to
the flow of materials within the facility and the design and operation of
certain pressure-release equipment. Currently, the Company is experiencing
certain operational problems relating to tar and fines residue build-up within
the system during production and other product-quality issues related to product
dusting. The Company is actively exploring solutions
14
<PAGE>
Third Quarter Fiscal 1998 Compared With Third Quarter Fiscal 1997
(continued)
to these problems. Because the technology being developed is new and untested,
no assurance can be given that other difficulties will not arise or that the
Company will be able to correct these problems and achieve optimal and sustained
performance.
Selling, general, and administrative expenses as a percentage of revenues
decreased to 11% in the third quarter of fiscal 1998 from 12% in the third
quarter of fiscal 1997, primarily due to lower business development costs in the
third quarter of fiscal 1998.
Research and development expenses represent Thermo Trilogy's ongoing new
product development and increased to $0.7 million in the third quarter of fiscal
1998 from $0.6 million in the third quarter of fiscal 1997 due to the
acquisition of the Bt business of Novartis.
Interest income decreased to $1.0 million in the third quarter of fiscal
1998 from $1.4 million in the third quarter of fiscal 1997. The decrease was
primarily due to lower average invested balances due to cash expended for the
acquisition of the Bt business of Novartis, the acquisition and expansion of the
Czech Republic operations, the repurchase of Company common stock, and
construction of the K-Fuel Facility.
Interest expense decreased to $2.7 million in the third quarter of fiscal
1998 from $3.6 million in the third quarter of fiscal 1997. The decrease was
primarily due to lower outstanding debt related to the Company's Delano and
Mendota plants and, to a lesser extent, the conversion by Thermo Electron of
$68.5 million principal amount of the Company's 4% subordinated convertible
debentures in May 1998.
Equity in loss of joint venture represents the Company's proportionate share
of loss from a joint venture.
The effective tax rate was 38% in the third quarter of fiscal 1998 and 1997.
The effective tax rate in both years exceeded the statutory federal income tax
rate primarily due to the impact of state income taxes, offset in part by the
exclusion of income taxed directly to a minority partner.
Minority interest expense represents the allocation of income from plant
operations to a minority partner in an Operating Company and, in fiscal 1998,
the minority shareholders' proportionate share of Thermo Trilogy's results.
The Company is currently assessing the potential impact of the year 2000 on
the processing of date-sensitive information by the Company's computerized
information systems and on products purchased by the Company. The Company
believes that its internal information systems are either year 2000 compliant or
will be so prior to the year 2000 without
15
<PAGE>
Third Quarter Fiscal 1998 Compared With Third Quarter Fiscal 1997
(continued)
incurring material costs. There can be no assurance, however, that the Company
will not experience unexpected costs and delays in achieving year 2000
compliance for its internal information systems, which could result in a
material adverse effect on the Company's future results of operations.
The Company is presently assessing whether its key suppliers are adequately
addressing the year 2000 issue and the effect this might have on the Company.
The Company has not completed its analysis and is unable to conclude at this
time that the year 2000 issue as it relates to products purchased from key
suppliers is not reasonably likely to have a material adverse effect on the
Company's future results of operations.
First Nine Months Fiscal 1998 Compared With First Nine Months Fiscal 1997
Revenues increased 21% to $145.8 million in the first nine months of fiscal
1998 from $120.7 million in the first nine months of fiscal 1997. Revenues from
the Energy segment in the first nine months of fiscal 1998 were $123.5 million,
compared with $110.4 million in the first nine months of fiscal 1997. The
increase was primarily due to higher contractual energy rates at several of the
Company's facilities. The increase was also due to the inclusion of $4.4 million
of revenues from the Czech Republic operations, purchased in January 1998, and,
to a lesser extent, higher electrical generation at all of the Company's
facilities due to the first nine months of fiscal 1998 including 40 weeks,
compared with 39 weeks in the first nine months of fiscal 1997.
Revenues at Thermo Trilogy in the first nine months of fiscal 1998 were
$22.3 million, compared with $10.3 million in the first nine months of fiscal
1997. The increase was primarily due to the inclusion of revenues from the Bt
business of Novartis and the biosys business, acquired in November 1997 and
January 1997, respectively.
The gross profit margin increased to 32% in the first nine months of fiscal
1998 from 30% in the first nine months of fiscal 1997. The increase in the total
gross profit margin resulted from an increase in the relative size of the
higher-margin revenues from Thermo Trilogy compared with revenues from the
Company's Energy segment. The gross profit margin for the Energy segment was
unchanged at 29% in the first nine months of fiscal 1998 and 1997.
The gross profit margin for Thermo Trilogy decreased to 45% in the first
nine months of fiscal 1998 from 47% in the first nine months of fiscal 1997. The
decrease resulted primarily from the inclusion in fiscal 1998 of lower-margin
revenues from the Bt business of Novartis as well as inclusion of lower-margin
revenues from the biosys business for nine months in fiscal 1998, compared with
six months in fiscal 1997.
Selling, general, and administrative expenses as a percentage of revenues
increased to 12% in the first nine months of fiscal 1998 from 10% in the first
nine months of fiscal 1997. The increase resulted primarily from the inclusion
of higher selling, general, and
16
<PAGE>
First Nine Months Fiscal 1998 Compared With First Nine Months Fiscal 1997
(continued)
administrative expenses as a percentage of revenues at Thermo Trilogy due to the
acquisitions of the Bt business of Novartis and the biosys business.
Research and development expenses represent Thermo Trilogy's ongoing new
product development and increased to $2.1 million in the first nine months of
fiscal 1998 from $1.9 million in the first nine months of fiscal 1997, due to
the acquisition of the Bt business of Novartis.
Interest income decreased to $3.4 million in the first nine months of fiscal
1998 from $3.6 million in the first nine months of fiscal 1997. A reduction in
average invested balances due to cash expended for the acquisition of the Bt
business of Novartis, the acquisition and expansion of the Czech Republic
operations, the repurchase of Company common stock, and construction of the
K-Fuel Facility was offset in part by interest income earned on invested
proceeds from the Company's April 1997 issuance of 4.875% subordinated
convertible debentures.
Interest expense decreased to $9.4 million in the first nine months of
fiscal 1998 from $10.3 million in the first nine months of fiscal 1997. A
decrease in interest expense resulting from lower outstanding debt related to
the Company's Delano and Mendota plants, as well as the May 1998 conversion by
Thermo Electron of $68.5 million principal amount of the Company's 4%
subordinated convertible debentures was offset in part by an increase in
interest expense related to the April 1997 issuance of the 4.875% subordinated
convertible debentures.
The Company and its parent, Thermo Electron, have adopted a strategy of
spinning out certain of their businesses into separate subsidiaries and having
these subsidiaries sell a minority interest to outside investors. The Company
believes that this strategy provides additional motivation and incentives for
the management of the subsidiaries through the establishment of subsidiary-level
stock option incentive programs, as well as capital to support the subsidiaries'
growth. As a result of the sale of stock by Thermo Trilogy, the Company recorded
a nontaxable gain on issuance of stock by subsidiary of $6.3 million in the
first nine months of fiscal 1998 (Note 4). The size and timing of these
transactions are dependent on market and other conditions that are beyond the
Company's control. In addition, in October 1995, the Financial Accounting
Standards Board (FASB) issued an exposure draft of a Proposed Statement of
Financial Accounting Standards, "Consolidated Financial Statements: Policy and
Procedures" (the Proposed Statement). The Proposed Statement would establish new
rules for how consolidated financial statements should be prepared. If the
Proposed Statement is adopted, there could be significant changes in the way the
Company records certain transactions of its controlled subsidiaries. Among those
changes, any sale of the stock of a subsidiary that does not result in a loss of
control would be accounted for as a transaction in the equity of the
consolidated entity with no gain or loss being recorded. The FASB continues to
deliberate on this issue and the timing and contents of any final statement are
17
<PAGE>
First Nine Months Fiscal 1998 Compared With First Nine Months Fiscal 1997
(continued)
uncertain. Accordingly, there can be no assurance that the Company will be able
to realize gains from such transactions in the future.
Equity in earnings of joint venture represents the Company's proportionate
share of income from a joint venture.
The effective tax rate was 29% in the first nine months of fiscal 1998 and
37% in the first nine months of fiscal 1997. The effective tax rate in the first
nine months of fiscal 1998 was below the statutory federal income tax rate due
to the nontaxable gain on issuance of stock by subsidiary and the exclusion of
income taxed directly to a minority partner. The effective tax rate in the first
nine months of fiscal 1997 exceeded the statutory federal income tax rate
primarily due to the impact of state income taxes, offset in part by the
exclusion of income taxed directly to a minority partner.
Liquidity and Capital Resources
Working capital was $61.7 million at July 4, 1998, compared with $90.7
million at September 27, 1997. The Company had cash, cash equivalents, and
current restricted funds of $48.5 million at July 4, 1998, compared with $104.3
million at September 27, 1997. Current restricted funds held in trust pursuant
to certain lease and debt agreements totaled $10.4 million and $20.8 million at
July 4, 1998, and September 27, 1997, respectively. In addition, cash and cash
equivalents include $7.2 million and $12.0 million at July 4, 1998, and
September 27, 1997, respectively, which are restricted by the terms of certain
lease and financing agreements. These restrictions limit the ability of the
Operating Companies to transfer funds to the Company in the form of dividends,
loans, advances, or other distributions. Further, until such time, if ever, as
projections of avoided-costs change, all cash flows from the Woodland Operating
Company, other than cash required for tax distributions, will be restricted from
distribution to the Company. During the first nine months of fiscal 1998, the
Company's operating activities provided cash and restricted funds of $28.5
million. Cash from the Company's operations was offset in part by $11.0 million
of cash used to fund an increase in accounts receivable. Cash of $6.9 million
was provided by an increase in accounts payable. These increases were in support
of increased volumes of business due to the acquisition of the Bt business of
Novartis in November 1997 and the purchase of the Czech Republic operations in
January 1998.
During the first nine months of fiscal 1998, the Company's investing
activities used cash of $54.5 million. In November 1997, the Company, through
Thermo Trilogy, acquired the Bt business of Novartis for $19.1 million in cash
and the assumption of certain liabilities (Note 3). In March 1998, the Company
acquired two power-generation facilities and related sites in California for
$9.5 million in cash and the assumption of certain liabilities. The Company,
through its Limited Partnership Agreement with KFx Wyoming, Inc., expended $9.7
million for the
18
<PAGE>
Liquidity and Capital Resources (continued)
construction of the K-Fuel Facility. In January 1998, the Company, through a
wholly owned subsidiary's participation in a joint venture, indirectly acquired
an 83% interest in certain power operations in the Czech Republic for $7.3
million in cash. The Company has begun construction on a 50-megawatt expansion
at the Czech Republic operations and has incurred $9.9 million in construction
costs. In addition, the Company expended $1.9 million on other capital
expenditures during the first nine months of fiscal 1998. During the remainder
of fiscal 1998, the Company expects to expend an additional $8.0 million on
capital expenditures.
During the first nine months of fiscal 1998, the Company's financing
activities used cash of $29.9 million. The Company used cash of $35.0 million
for the repayment of long-term obligations and payments under capital lease
obligations related to three of its California plants. In the first nine months
of fiscal 1998, Thermo Trilogy issued shares of its common stock in private
placements for net proceeds of approximately $14.9 million. Through a series of
transactions commencing in April 1997, the Company's Board of Directors has
authorized the repurchase, through various dates, of up to $30 million of its
own securities in the open market, or in negotiated transactions. Through July
4, 1998, the Company had repurchased $29.9 million in common stock under these
authorizations, including $10.2 million during the first nine months of fiscal
1998. Any such purchases are funded from working capital.
In September 1996, the Company, through a wholly owned subsidiary, formed a
joint venture with Marcegaglia Group of Mantova, Italy, to develop, own, and
operate biomass-fueled electric power facilities in that country, which may
require significant equity investments if development efforts are successful. In
January 1998, the Company, through a wholly owned subsidiary, entered into a
joint development agreement with EMD Praha Spol s.r.o. (EMD) in the Czech
Republic. Participation in the joint development agreement may require
significant equity investments if development efforts are successful.
The Company has commenced an expansion project of its Czech Republic
operations, acquired in January 1998. The Company estimates the cost of this
expansion will be $32.0 million, of which it expects approximately 60% will be
funded by bank financing and the remainder from internal funds. While the
Company does not currently have any firm available credit facilities, it does
not expect to require funding for currently existing operations in the
foreseeable future, with the exception of the financing required for the
expansion project at its Czech Republic operations. The Company is in the early
stages of developing projects in Italy, the Czech Republic, and Southern
California. Equity investments required by the Company for these development
efforts, if successful, are uncertain, but may be significant. Although the
Company's projects are designed to produce positive cash flow over the long
term, the Company will have to obtain significant additional funds from time to
time to complete acquisitions and to meet project development requirements,
including the funding of equity investments. As the Company acquires,
19
<PAGE>
Liquidity and Capital Resources (continued)
invests in, or develops future plants, the Company expects to finance them with
nonrecourse debt, internal funds, additional equity financing, or through
borrowings from third parties or Thermo Electron. Although Thermo Electron has
expressed its willingness to provide funds to the Company to help finance
acquisitions and equity investments in future projects, the Company has no
agreements with Thermo Electron or third parties that assure funds will be
available on acceptable terms, or at all.
Forward-looking Statements
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company wishes to caution readers that the
following important factors, among others, in some cases have affected, and in
the future could affect, the Company's actual results and could cause its actual
results in the remainder of fiscal 1998 and beyond to differ materially from
those expressed in any forward-looking statements made by, or on behalf of, the
Company.
General
Transition of Business Focus. Since its inception, the Company has derived a
substantial majority of its revenues from the development, construction, and
operation of biomass electric generation facilities. While the Company's U.S.
biomass energy business is expected to continue to generate revenues for the
foreseeable future, the Company expects the aggregate revenues and profitability
associated with this business to decline significantly beginning in fiscal 2000.
In addition, within the next few years, the Company expects a substantial
portion of its revenues to be derived from new business ventures in clean power
resources, clean fuels and biopesticides. A major portion of the Company's
efforts will be focused on developing and acquiring new power projects,
additional clean fuel projects, and its biopesticides business. The Company has
had limited prior experience in the repowering of power plants and the
development and sale of clean fuels, and there can be no assurance that the
Company will be able to successfully develop, market, or sell its products and
services in these areas. The Company's future success will depend significantly
on its ability to develop, introduce, and integrate new products and services in
these areas. No assurance can be given that the Company will be successful in
this regard. Any failure or inability of the Company to implement these
strategies would have a material adverse effect on the Company's business,
financial condition, and results of operations.
Risks Associated with Acquisition Strategy. The Company's strategy includes
the acquisition of businesses that complement or augment the Company's business
strategy or existing product lines. Promising acquisitions are difficult to
identify and complete for a number of reasons, including competition among
prospective buyers and the need for regulatory approvals, including antitrust
approvals. Any acquisitions completed by the Company may be made at substantial
premiums over the fair value of the net assets of the acquired companies that
would result in substantial expenses for the amortization of goodwill. There can
be no assurance that the Company will be able to complete future acquisitions
20
<PAGE>
Forward-looking Statements (continued)
or that the Company will be able to successfully integrate any acquired
businesses. In order to finance such acquisitions, it may be necessary for the
Company to raise additional funds through public or private financings. Any
equity or debt financing, if available at all, may be on terms that are not
favorable to the Company and may result in dilution in its earnings per share.
Risks Associated with Clean Power Resources Business
Development Risks
Uncertainty of Project Development. The process of locating, developing,
permitting, financing, and constructing power plants is complex, lengthy, and
expensive. Only a small percentage of the projects that the Company evaluates
and pursues ultimately results in operating projects. As a result, the Company
may not recover any expenses that it incurs in the evaluation and development of
many projects.
Although all the U.S. plants currently operated by the Company utilize
biomass as fuel, the Company is not currently considering the development of
further biomass-fueled projects in the U.S. due to high biomass fuel costs and
the relatively high costs of constructing and operating biomass fueled plants.
The Company is considering the development of biomass fueled projects
internationally in countries where market conditions may support profitable
biomass operations. The Company has also expanded its development focus to
include international clean power opportunities and other environmentally sound
technologies such as developing or repowering natural gas or coal fueled power
facilities. In this regard, the Company has established operations in the Czech
Republic and Italy. The completion or success of these projects and new ventures
is subject to a number of significant conditions, including obtaining financing,
negotiating key contracts with partners and other third parties, and other
material development activities such as obtaining required permits. No assurance
can be given that these projects or new ventures will be completed on a timely
basis, or at all. Any failure by the Company to successfully develop new
projects would have a material adverse effect on the future growth of the
Company.
Uncertainty of Access to Capital. The Company has sought to finance the debt
portion of each of its clean power projects in a manner that is substantially
nonrecourse to the Company. To minimize its equity commitment, the Company must
borrow substantial amounts from third party lenders. The borrowings are
typically secured only by the applicable project assets and the capital stock of
the appropriate entity, typically a joint venture or limited partnership in
which the Company has a majority interest or wholly owned subsidiary through
which the Company develops its projects and operates its facilities (an
Operating Company). The Company anticipates that it will require substantial
financing to fund both the equity and debt components of future projects. No
assurance can be given that financing for future projects will be available on a
nonrecourse basis or on acceptable terms, or at all. Any failure by the Company
to obtain adequate amounts of financing on acceptable terms would have a
material adverse effect on the future growth of the Company.
21
<PAGE>
Forward-looking Statements (continued)
Dependence on Terms of Power Sales Agreement. The profitability of any of
the Company's clean power facilities is heavily dependent upon the power sales
agreement that it has entered into with the electric utility or other customer.
Under certain of these agreements, in the event of service termination by the
Operating Company prior to the end of the applicable obligation period, the
Operating Company may be required to reimburse the utilities to the extent that
cumulative revenue calculated at established rates exceeds the amounts
calculated at the utilities avoided cost rates. Most of the Company's existing
power sales agreements were obtained as a direct negotiation with the purchasing
utility. However, in recent years, in the U.S. such agreements have increasingly
been awarded as a result of competitive bidding. Consequently, obtaining a power
sales agreement in the U.S. has become progressively more competitive and
expensive and, in many cases, less profitable. In the future, foreign power
sales agreements also may increasingly be subject to competitive bidding. In
addition, the passage of the National Energy Policy Act of 1992 has removed
certain barriers to entry into the independent power market by utilities and
others, and is expected to increase competition in that market. There can be no
assurance that power sales agreements, if any, entered into by the Company in
the future will be as profitable as the power sales agreements to which the
Operating Companies are currently parties.
Risks Associated with Doing Business Outside the United States. The Company
believes that significant growth opportunities in the power market exist outside
of the U.S. In that regard, the Company is currently pursuing projects in Italy
and the Czech Republic, and intends to identify other countries in which to
develop power projects. Doing business in many foreign countries exposes the
Company to many risks that are not present in the U.S., including political,
military, privatization, currency exchange and repatriation risks, and higher
credit risks related to the utility purchaser. In addition, it is possible that
legal obligations may be more difficult for the Company to enforce in foreign
countries and that the Company may be at a disadvantage in any legal proceeding
with the local entity. Local laws may also limit the ability of the Company to
hold a majority interest in some of the projects that it develops or acquires.
The Company's costs associated with business development efforts outside the
U.S. is expected to increase due to increased complexity inherent in foreign
development. In addition, the amount of cash required to fund equity investments
is expected to increase due to the financing requirements of lenders in foreign
markets.
Intense Competition for Projects. The Company believes that there are
approximately 200 companies that are actively engaged in the worldwide
nonutility power market. Many of the companies in the power market have
substantially greater financial and technical resources than those of the
Company. Domestic competition in this market is expected to intensify as a
result of deregulation at the federal and state levels, and due to the trend
toward awarding contracts based upon competitive bidding. Such competition may
reduce the ability of the Company to secure future
22
<PAGE>
Forward-looking Statements (continued)
projects and may have a material adverse effect on the profitability of
future projects.
Uncertainty of Regulatory or Community Support. Development, construction,
and operation of a clean power project requires numerous environmental, siting,
and other permits. The process of obtaining these permits can be lengthy and
expensive. In addition, local opposition to a particular project can
substantially increase the cost and time associated with developing a project,
and can potentially render a project unfeasible or uneconomic. The Company may
incur substantial costs or delays or may be unsuccessful in developing clean
power projects as a result of such opposition.
Operating Risks
Expected Price Reductions under California SO#4 Contracts. The power sales
agreements for the Company's Woodland, Mendota, and Delano plants in California
are so-called standard offer #4 (SO#4) contracts, which require Pacific Gas &
Electric (PG&E), in the case of Woodland and Mendota, and Southern California
Edison (SCE), in the case of Delano and Delano II, to purchase the power output
of the projects at fixed rates until 2000 in the case of Woodland and Mendota,
and 2001 in the case of Delano. However, with respect to Woodland and Mendota,
PG&E has asserted that the fixed rates under its agreements will terminate
mid-1999, although the Company disputes this assertion. Thereafter, the utility
will pay a rate based upon the costs that would have otherwise been incurred by
the purchasing utilities in generating their own electricity or in purchasing it
from other sources (avoided cost) (as determined from time to time by the
California Public Utility Commission (CPUC)). Avoided cost is determined
pursuant to a formula that is intended to estimate the price that the utility
would, but for its contract with the power producer, be paying for the same
amount of energy. The rate fluctuates with the price of fuels and certain other
factors. At present, avoided cost is substantially lower than the payments
currently being made by PG&E and SCE to the Company under the fixed rate
portions of its contracts. In addition, although it is difficult to predict
future levels of avoided cost, based on current estimates, avoided cost is
expected to be substantially lower in 2000 than the rates currently being paid
by PG&E and SCE under its fixed rate contracts. The Company expects, that at
current avoided cost rates, absent sufficient reductions in fuel prices and
other operating costs, the Company's Mendota and Delano plants would operate at
substantially reduced operating income levels or at a loss beginning in fiscal
2001. In fiscal 1997, the Mendota and Delano plants' aggregate operating income
was approximately $34.0 million. Further, if the Woodland plant were to operate
at projected avoided cost levels, substantial losses would result primarily due
to nonrecourse lease obligations that extend beyond 2000. Absent sufficient
reductions in fuel prices and other operating costs, under such circumstances
the Company would draw down power reserve funds to cover operating cash
shortfalls and then, should such funds be depleted, either renegotiate its
nonrecourse lease for the Woodland plant or forfeit its interest in the
23
<PAGE>
Forward-looking Statements (continued)
plant. During the first quarter of fiscal 1997, the Company began recording as
an expense the funding of reserves required under Woodland's nonrecourse lease
agreement to cover projected shortfalls in lease payments beginning in 2000.
Consequently, the results of the Woodland plant were greatly diminished during
1997 and the Company expects that such results will be reduced to approximately
breakeven in 1998 and thereafter. During fiscal 1997 and 1996, the Woodland
plant contributed $1.0 million and $5.1 million of operating income,
respectively.
Potential Decreased Power Sales due to Power Curtailments. The power sales
agreements between the Woodland and Mendota Operating Companies and PG&E allowed
PG&E to curtail the quantity of power purchased under each of these agreements
by up to 1,000 hours of generating capacity annually. PG&E generally exercised
its curtailment rights during periods when cheaper hydroelectric power was
available, which generally occurred following periods of heavy rain or snow.
Curtailment reduces the power payment received by the Operating Companies and,
therefore, has an adverse effect on the financial results of those Operating
Companies. During fiscal 1997, the Company experienced approximately 860 hours
of utility imposed curtailments at each of these plants. In 1997, the Company
renegotiated PG&E's curtailment rights, limiting PG&E to 500 hours per year.
Potential Increased Fuel Prices and Reduced Availability of Fuel. The
profitability of the Company's plants is dependent in part upon the difference
between the price the Company receives from its utility customers for power and
the price the Company pays for the fuel. The Company has typically entered into
long-term fuel supply agreements for a significant portion of its fuel
requirements. These agreements generally provide for prices based upon
predetermined formulas or indexes. If fuel prices rise significantly, the
Company will be required to pay higher prices on the spot market for the portion
of its fuel not covered by agreements. The Company's existing power sales
agreements do not adjust to account for changes in the Company's fuel prices.
Therefore, the profitability of these agreements, and any future power sales
agreement that do not provide for such an adjustment, could be materially
adversely affected by increases in the Company's fuel prices. In addition,
future fuel shortages could adversely affect the Company's ability to deliver
power, and therefore receive payments, pursuant to its power sales agreements.
Operating Difficulties. The financial performance of each of the Company's
plants depends to a significant extent upon the ability of each plant to be
capable of performing at or near capacity. If a plant is unable to perform at
these levels, payments under the power sales agreement will be reduced, possibly
significantly. The Company has in the past experienced mechanical problems with
the boilers at its Mendota and Woodland plants and suffered major equipment
damage at its Whitefield plant. Although the Company believes that these
problems have been corrected, no assurance can be given that these or other
plants will not experience operating problems in the future. No assurance can be
given that business interruption insurance will be adequate to cover all
24
<PAGE>
Forward-looking Statements (continued)
potential losses, or that such insurance will continue to be available on
reasonable terms.
Dependence on Utility Customers. Each of the current U.S. projects relies
upon one power sales agreement with a single electric utility customer for the
majority, if not all, of its revenues over the life of the power sales
agreement. During fiscal 1997, Public Service of New Hampshire (PSNH), SCE, and
PG&E accounted for 18%, 31%, and 32%, respectively, of the Company's revenues.
The failure of any one utility customer to fulfill its contractual obligations
could have a substantial negative impact on the Company. No assurance can be
given that a particular utility will not be unwilling or unable, at some time,
to make required payments under its power sales agreements. Further, in a
deregulated market, the Company may do business with customers of various sizes
and levels of credit-worthiness.
Potential Earthquake Damage. The Company's California plants are located in
areas where there is a risk of potentially significant earthquake activity.
Projects that the Company develops in the future may also be located in areas
where there is earthquake risk. The Company's earthquake insurance is not
sufficient to cover all potential losses and there can be no assurance that such
insurance will continue to be available on reasonable terms.
Regulatory Risks
Potential Rate Reduction by PSNH. In 1990, a plan of reorganization (the
Plan) for PSNH was approved by the U.S. Bankruptcy Court for the District of New
Hampshire. Pursuant to the Plan, Northeast Utilities (NU) acquired the assets of
PSNH. An agreement between NU and the State of New Hampshire contains language
to the effect that PSNH will seek to renegotiate some of the terms of certain
rate orders with small power producers, including the Whitefield and Hemphill
Operating Companies, and that the state will support PSNH in such efforts. PSNH
reached an agreement in principle with these two Operating Companies to settle
the renegotiation of their rate orders. The settlement agreement is subject to
the approval of the New Hampshire Public Utility Commission (NHPUC) on terms
acceptable to both PSNH and the Operating Companies. The principal terms of the
agreement generally call for the two Operating Companies to reduce the amount of
power sold annually to PSNH to 70% of the plants' capacities, and to reduce the
price per kilowatt paid by PSNH to $0.06 per kilowatt hour, escalating three
percent per year for the remainder of the term of the original, applicable rate
order. In consideration of these reductions, the Operating Companies would
receive certain cash settlement payments, paid over several years. The
settlement agreement has technically expired; however, no party to the
settlement agreement has notified the other that it would not proceed in
accordance with the terms thereof if approved by NHPUC nor were they required to
do so. The settlement, if approved and executed, is not expected to have a
material impact on the Company's results of operations or financial condition.
Should the matter not reach resolution, the Company does not believe that PSNH
has the right to take unilateral action to reduce the price of purchased power
under such arrangements. Rejection of the Company's rate
25
<PAGE>
Forward-looking Statements (continued)
orders would result in a claim for damages by the Company and could be the
subject of lengthy litigation. In January 1997, NU disclosed in a filing with
the Securities and Exchange Commission that if a proposed deregulation plan for
the New Hampshire electric utility industry were adopted, PSNH could default on
certain financial obligations and seek bankruptcy protection. In February 1997,
NHPUC voted to adopt a deregulation plan, and in March 1997, PSNH filed suit to
block the plan. In March 1997, the federal district court issued a temporary
restraining order which prohibits the NHPUC from implementing the deregulation
plan as it affects PSNH, pending a determination by the court whether PSNH's
claim could then be heard by the court. In April 1997, the court ruled that it
could now hear the case and ordered that the restraining order would continue
indefinitely pending the outcome of the suit. In addition, in March 1997, the
Company, along with a group of other biomass power producers, filed a motion
with the NHPUC seeking clarification of the NHPUC's proposed deregulation plan
regarding several issues, including purchase requirements and payment of current
rate order prices with respect to the Company's energy output. In May 1998,
NHPUC issued a written ruling rejecting the settlement agreements and
modifications that would impact PSNH's ability to finance and secure the
settlement contract to the Operating Companies. An unfavorable resolution of
this matter, including the bankruptcy of PSNH, could have a material adverse
effect on the Company's results of operations and financial position.
Potential Effects of Loss of QF Status or Changes to PURPA. The Company's
existing facilities are subject to the provisions of various laws and
regulations, including the Public Utility Regulatory Policies Act of 1978, as
amended (PURPA). PURPA provides to Qualifying Facilities (QFs) certain
exemptions from substantial federal and state legislation, including regulation
as public utilities. PURPA also requires electric utilities to purchase
electricity generated by QFs at prices not exceeding their avoided cost. Any
future changes to PURPA could have a material adverse effect on the Company.
Public Utility Holding Company Act. The Public Utility Holding Company Act
of 1935 (PUHCA) regulates public utility holding companies and their
subsidiaries. The Company is not and will not be subject to regulation as a
holding company under PUHCA as long as the domestic power plants it owns and/or
operates are QFs under PURPA or otherwise are exempt from regulation as public
utility holding companies under PUHCA. If a power plant were to lose such
status, the Operating Company owning or leasing that plant could become a public
utility company, which could result in the Company becoming a public utility
holding company. In addition, loss of QF status, regardless of the Company's
ability to avoid public utility holding company status, could be a default under
many of the Company's facility lease and power sales agreements. In the event of
any such default, the other parties to such agreements could seek various
remedies against the Company or could seek to renegotiate such agreements on
terms more favorable to such parties. In addition, to ensure that the Company
will not be subject to regulation as a holding company under PUHCA, the foreign
power plants it owns and/or operates also must be exempt from regulation as
public utility companies under PUHCA.
26
<PAGE>
Forward-looking Statements (continued)
Potential Increased Competition Due to Regulatory Changes. The Company
believes that certain regulatory changes are likely to have a significant impact
on the domestic power market over the next five years. The National Energy
Policy Act of 1992 exempts a new class of facilities, electric wholesale
generators (EWG), from certain federal utility regulation and liberalizes access
for nonutility generators to the utility power transmission grid. In addition,
many states are considering the elimination of many of the regulations that
currently limit the ability of power generators to negotiate power sales
agreements directly with industrial and commercial customers. The Company
believes that the effect of these regulatory changes will be to increase
competition for the sale of power.
The Evolving California Electric Utility Market. The electric utility market
in California has undergone a complex restructuring which is not yet complete.
The California Public Utility Commission (CPUC) and the California legislature
have required the creation of an Independent System Operator (ISO), which
operates transmission facilities owned by investor-owned utilities in the state,
and a Power Exchange (PX), which conducts hourly and daily auctions of electric
energy that are designed to set prices at market levels. The ISO and PX were
created in May 1997 and commenced operations on March 31, 1998. The activities
of the ISO and PX are subject to comprehensive Federal Energy Regulatory
Commission (FERC) regulation. FERC has approved tariffs and rates for the ISO
and PX, but these approvals are not final; they are subject to further FERC and
judicial review. In addition, the restructuring of the California electric
utility market may have an effect on avoided cost. Investor-owned utilities in
California are required to buy power through the PX. The avoided cost for such
utilities thus potentially will be determined based on market prices set through
the PX. These market prices may be lower than energy rates set in current QF
contracts which may adversely affect Operating Companies after the end of the
fixed price period in their contracts with utilities.
Limitations Imposed by Environmental Regulation. Federal, state, and local
environmental laws govern air emissions and discharges into water and the
generation, transportation, storage, and treatment and disposal of solid and
hazardous waste. These laws establish standards governing most aspects of the
construction and operation of the Company's facilities, and often require
multiple governmental permits before these facilities can be constructed,
modified, or operated. There can be no assurance that all required permits will
be issued for the Company's projects under development or for future projects,
or that the requirements for continued environmental regulatory laws and
policies governing their enforcement may change, requiring new technology or
stricter standards for the control of discharges of air or water pollutants, or
for solid or hazardous waste or ash handling and disposal. Such future
developments could affect the manner in which the Company operates its plants
and could require significant additional expenditures to achieve compliance with
such requirements. It is possible that compliance may not be technically or
economically feasible.
27
<PAGE>
Forward-looking Statements (continued)
Risks Associated with Clean Fuels Business
Uncertainty Regarding K-Fuel Facility. The Company has entered into a
limited partnership agreement with KFx Wyoming, Inc., a subsidiary of KFx, Inc.
(the K-Fuel Partnership), to develop, construct, and operate a subbituminous
coal beneficiation plant near Gillette, Wyoming. The plant will utilize certain
patented clean coal technology owned by KFx, Inc. and licensed to the K-Fuel
Partnership on a non-exclusive basis (the K-Fuel technology) which transforms
low energy, high moisture coal into low-moisture, high-energy fuel with reduced
sulfur. The Company has provided approximately $60 million for the design,
construction, and operation of the plant. A tax credit per ton of fuel produced
and sold is available with respect to qualifying alternative fuels from a
facility placed in service before June 30, 1998, pursuant to a binding written
contract in effect before December 31, 1996, and the credit is thereafter
available with respect to qualified fuel sold through December 31, 2007.
Although the facility has operated and produced commercially salable product,
the Company has encountered certain difficulties in optimizing its performance
to achieve optimal and sustained operation. The Company has addressed and
resolved certain problems previously encountered, including a fire at the
facility and certain construction problems, including issues relating to the
flow of materials within the facility and the design and operation of certain
pressure-release equipment. Currently, the Company is experiencing certain
operational problems relating to tar and fines residue build-up within the
system during production and other product quality issues related to product
dusting. The Company is actively exploring solutions to these problems. Because
the technology being developed at the facility is new and untested, no assurance
can be given that other difficulties will not arise or that the Company will be
able to correct these problems and achieve optimal and sustained performance. In
addition, there can be no assurance that the K-Fuel Facility would be determined
to be qualified for the tax credit, or that the Company will realize a benefit
from the tax credit. The economic returns of the K-Fuel Facility primarily
result from tax credits on the facility's production of K-Fuel. The Company
expects that the K-Fuel Facility will report operating losses for financial
reporting purposes primarily as a result of recording depreciation over the
expected life of this tax credit. Further, the Company currently has an
agreement for the sale of only 33% of the plant's anticipated output for the
first three years of operation and, at the purchaser's option, the plant's
entire output from the fourth through the tenth year of operation. No assurance
can be given that the purchaser of the fuel will exercise its option in years
four through ten or that the Company will be able to enter into additional
contracts for the sale of fuel on acceptable terms, or at all. Demand for the
fuel produced by the plant is expected to result in large part from the
requirement that coal-burning utilities comply with the future scheduled sulfur
dioxide emissions restrictions contained in the Clean Air Act. If the fuel
produced by the plant does not allow the achievement of desired emissions
reductions, or if regulations relating to emissions become less restrictive in
the future, demand for the plant's fuel output would be materially adversely
affected.
28
<PAGE>
Forward-looking Statements (continued)
Federal Regulation of Air Emissions. A significant factor driving the
creation of the U.S. market for K-Fuel and other beneficiated coal products is
the Clean Air Act. The Clean Air Act specifies certain air emission requirements
for electrical utility companies and industrial coal users. The Company believes
that compliance with such regulations by these coal users can be fully or
partially met through the use of clean-burning fuel technologies like the one
being employed at the Company's K-Fuel Facility. The Company is unable to
predict future regulatory changes and their impact on the demand for K-Fuel. A
full or partial repeal or revision of the Clean Air Act would have a material
adverse effect on the Company's clean fuel business.
Operating Hazards and Uninsured Risks. The Company's K-Fuel Facility is
subject to the risks inherent in the operation of high pressure, high
temperature equipment producing combustible fuels. These risks include the
possibility of fire, explosions, pollution and other environmental risks. These
risks could result in substantial losses to the Company's K-Fuel Facility and
revenues due to injury and loss of life; severe damage to, and destruction of,
property and equipment; pollution; and other environmental damage and suspension
of operations. The K-Fuel Facility maintains insurance of various types to cover
its operations. No assurance can be given that the Company will be able to
maintain adequate insurance in the future at rates the Company considers
reasonable. The occurrence of a significant event not fully insured or
indemnified against could materially and adversely affect the Company's
financial condition and results of operations.
Electric Utility Regulatory Changes. The U.S. electric utility market is
currently in the early stage of deregulation. The National Energy Policy Act of
1992 exempts a new class of facilities, EWG's, from certain federal utility
regulation and liberalizes access for nonutility generators to the utility power
transmission grid. In addition, the Federal government and many states are
considering the elimination of many regulations that currently limit the ability
of power generators to negotiate power sales agreements directly with industrial
and commercial customers. The Company believes that these regulatory changes
will result in utilities and other power generators placing a high emphasis on
reducing costs in their operations. This may result in increased competition
from other producers of beneficiated coal products or other fuel sources to the
extent that such competing fuels result in cost savings for utilities and other
power producers which will have a material adverse effect on the price the
Company can charge for K-Fuel and thus have a material adverse effect on the
Company's results of operations.
No Established Market for Beneficiated Fuel Products. Although the Company
believes that a substantial market will develop for clean coal fuel products, an
established market does not currently exist. As a result the availability of
accurate and reliable pricing information and transportation alternatives are
not fully known. The future success of the Company's K-Fuel business will be
determined by its ability to
29
<PAGE>
Forward-looking Statements (continued)
establish such a market among potential customers such as electrical utility
companies and industrial coal users. Many of such potential users of the
Company's products will be able to choose among alternative fuel supplies.
Competition. The Company will face competition from other companies in the
clean coal and alternative fuel technology industries. Some of these companies
have financial and managerial resources greater than those of the Company, and
therefore may be able to offer products more competitively priced and more
widely available than those of the Company. Also, such competitors' products may
make the Company's products obsolete or non-competitive. Furthermore, the
Company's license to the K-Fuel technology at the K-Fuel Facility is
non-exclusive and KFx may seek additional partners to develop other facilities
using the K-Fuel technology. In addition, demand for the Company's K-Fuel could
be adversely affected by potential customers' ability to purchase emissions
offsets as allowed under the November 1990 amendments to the Clean Air Act (the
1990 Amendments).
Natural Gas Business Operating Risks. The Company's proposed natural gas
business is subject to all of the operating risks normally associated with the
processing, transporting and storage of natural gas, including blowouts,
pollution, and fires, each of which could result in damage to or destruction of
processing and storage facilities or properties, or in personal injury. The
Company intends to obtain insurance coverage limiting financial loss resulting
from certain of these operating hazards. Losses and liabilities arising from
uninsured or underinsured events could reduce revenues and increase costs to the
Company and could materially adversely affect the Company's financial condition
and results of operations.
Volatility of Natural Gas Prices. Historically, the market for natural gas
has been volatile and is likely to continue to be volatile in the future. Prices
for natural gas are subject to wide fluctuation in response to relatively minor
changes in the supply of and demand for natural gas and oil, market uncertainty
and other factors over which the Company has no control. These factors include
the extent of domestic production and importation of foreign natural gas and/or
oil, political instability in oil and gas producing countries and regions, the
ability of members of the Organization of Petroleum Exporting Countries to agree
upon price and production levels for oil, the effect of federal regulation on
the sale of natural gas and/or oil in interstate commerce, and other
governmental regulation of the production and transportation of natural gas
and/or oil. Certain other factors outside the Company's control, such as
operational and transportation difficulties of pipeline or oil purchasing
companies, may also limit sales. In addition, the price level of natural gas
obtainable by the Company depends upon the needs of the purchasers to which the
producer has access. Depending on the purchasers' needs and the price obtainable
for natural gas which the Company is able to sell, the revenues of the Company
from its proposed natural gas business could be materially adversely affected.
30
<PAGE>
Forward-looking Statements (continued)
Risks Associated with the Biopesticides Business
Need for Regulatory Approval for Future Products. The Company's Thermo
Trilogy subsidiary's biopesticide products cannot be sold unless the U.S.
Environmental Protection Agency (the EPA) grants Thermo Trilogy a registration
for each pesticide product it intends to manufacture or sell. Thermo Trilogy
must submit extensive toxicological studies and results of field testing as well
as other studies to the EPA to apply for a product registration. Pesticide
registrations under state laws and regulations must also be obtained. In
addition, pesticide registrations must be obtained from foreign governments
before Thermo Trilogy's products can be sold in a particular country, and these
countries may also require costly and extensive studies to support the
registration applications some of which may be more stringent then current U.S.
regulations. Registration of Thermo Trilogy's new products likely will be
lengthy and expensive. There is no assurance that the EPA, states or foreign
governments will timely grant pesticide registrations to Thermo Trilogy, or at
all. Pesticide registrations may also be revoked if new regulations are adopted
or if Thermo Trilogy violates regulations regarding the manufacturing, sale or
labeling of Thermo Trilogy's products. Such regulation applies to all stages of
field testing and to the manufacture, sale and use of most of Thermo Trilogy's
products. There can be no assurance that Thermo Trilogy will continue to be able
to comply with EPA regulations or any changes thereto. The regulatory process or
private litigation contesting products of Thermo Trilogy may be costly and
time-consuming and may delay research, development, production and/or marketing
of such products and require costly and time-consuming procedures, all of which
may furnish an advantage to competitors. There can be no assurance that
requisite regulatory approvals and/or registrations of any or all of Thermo
Trilogy's products will be granted on a timely basis, if at all. In addition,
new or more stringent regulations may be adopted or imposed, which could have a
material adverse effect on Thermo Trilogy's business, financial condition and
results of operations.
Uncertainty of Market Acceptance and Penetration. Thermo Trilogy's sales
growth is dependent on the penetration of its products into new markets. The
primary competition to Thermo Trilogy's products are chemical pesticides, and
Thermo Trilogy must educate customers on the cost effectiveness and efficacy and
minimal environmental effects of Thermo Trilogy's products compared to chemical
pesticides in order to gain acceptance for application on new crop types in
different parts of the world. In addition, the rate of acceptance of Thermo
Trilogy's products in the U.S. will be substantially affected by ongoing EPA
review and registration of the use of currently available chemical insecticides
and biopesticides and the extent to which the EPA restricts or bans chemical
pesticides for which Thermo Trilogy has biopesticide alternatives. No assurance
can be given that Thermo Trilogy's products will gain increased acceptance in
new market segments.
31
<PAGE>
Forward-looking Statements (continued)
Highly Competitive Markets and Technological Change. Most of the markets in
which Thermo Trilogy operates are highly competitive and are subject to rapid
technological change. Several of Thermo Trilogy's products are in testing or
early marketing stages. Many of Thermo Trilogy's competitors are large chemical
and pharmaceutical companies with greater financial, marketing, and
technological resources than Thermo Trilogy. There is no assurance that
competitors will not develop new products that will render Thermo Trilogy's
products noncompetitive. The development of transgenic plants and seeds, which
are genetically engineered seeds or plants designed to improve resistance to
insects or disease or to improve product quality, may pose a competitive threat
to Thermo Trilogy's products in the future.
Reliance on Third-party Manufacturers and Producers. Thermo Trilogy relies
on overseas producers of the raw materials for its neem-based products and on
third parties to manufacture some of its products. In particular, Thermo
Trilogy's sole supplier of neem products is P.J. Margo Pvt. Ltd., a joint
venture in India in which Thermo Trilogy holds a fifty percent interest,
pursuant to an exclusive supply contract that expires in 2001. There is no
assurance that Thermo Trilogy will have an uninterrupted supply of raw materials
or that third-party manufacturers will produce the products at competitive
prices.
Uncertainty of Product Development and Commercialization. Thermo Trilogy's
products are at various stages of development and commercialization. The ability
of Thermo Trilogy to sell its products in large commercial markets will be
dependent upon continued product development to allow increased efficiency and
reduced costs in production. There can be no assurance that increased efficiency
and reduced costs of production can be achieved. Thermo Trilogy cannot
accurately predict whether any of its products under development can be produced
and marketed profitably.
Seasonality of Product Sales. Thermo Trilogy currently markets its products
predominantly for use in the northern hemisphere, where the growing season
generally runs from March to October; therefore, the seasonal nature of
agriculture will cause Thermo Trilogy's product sales to be concentrated during
such period and will result in substantial variations in quarter to quarter
financial results.
Perishability of Products. Certain of Thermo Trilogy's microbial products
are living organisms and thus have a limited shelf-life, may biodegrade quickly
when exposed to light and heat and are perishable. In addition, such products
may be perishable when exposed to hostile environments including severe or
changing weather patterns particularly during shipping and storage. Failure of
these products as a result of perishability could have a material adverse effect
on the business of the Company.
32
<PAGE>
Forward-looking Statements (continued)
Testing. Commercial introduction of additional products and the expansion of
label claims for current products to include additional insects are both
contingent upon, among other factors, completion of field testing. Unusual
weather conditions during field tests prior to the growing season or other tests
in subsequent growing seasons could result in delays in product development and
commercialization. Such delays could result in additional losses due to
increased operating expenses in the intervening period without significant
offsetting revenues.
Product and Warranty Liability. Thermo Trilogy faces an inherent business
risk of exposure to product liability and warranty claims in the event that the
use of its current products or prospective products lack efficacy or result in
adverse effects. Further, product liability claims could result in Company
exposure for crop damage or personal injury. Run-off excess concentrations of
pesticide products could also expose Thermo Trilogy to claims and liabilities
for water pollution, including governmental fines and penalties. There can be no
assurance that the scope of Thermo Trilogy's insurance coverage is sufficient,
that it can obtain additional coverage or that Thermo Trilogy will have
sufficient resources to satisfy any product liability and warranty claims.
Other Risks
Significant Quarterly Fluctuations in Operating Results. The Company's
operating results fluctuate significantly from quarter to quarter based on a
number of factors, primarily seasonal energy demand in California, which results
in higher payments under the Company's California power-sales agreements in the
months of May through October, and lower payments during the remainder of the
year, and seasonal demand for its biopesticide products. The Company
historically has operated at marginal profitability during its second fiscal
quarter due to the rate structure under these agreements. In addition, the
Company's operating results can be affected by utility imposed curtailments or
by any operating problems that cause a plant to operate at less than normal
capacity, and with respect to its biopesticide business, by agricultural
conditions such as pest infestation, amount of rain, and other adverse weather
conditions, the occurrence of natural resistance factors, and the increase or
decrease in agricultural plantings and produce prices.
Limitation on Access to Operating Company Assets and Cash Flow. The
Company's clean power resources operations are conducted through the Operating
Companies, and the Company's cash flow is contingent on the ability of the
Operating Companies to make dividends or other distributions to the Company. The
terms of certain leases and financial agreements to which the Operating
Companies are parties require that certain funds be held in trust and restricted
from distribution to the Company. As of July 4, 1998, the Company had funds
totaling $74.2 million of which approximately $36.1 million was restricted from
distribution by the terms of certain Operating Companies' lease and financing
agreements. In addition, until such time, if ever, as projections of avoided
cost change, all cash flows from the Woodland operation, other than cash
33
<PAGE>
Forward-looking Statements (continued)
required for tax distributions, will be restricted from distribution to the
Company. The inability of the Company to receive distributions from the
Operating Companies could have a material adverse effect on the future growth of
the Company. Furthermore, Thermo Trilogy is a majority-owned subsidiary of the
Company, therefore all Thermo Trilogy cash dividends, if any, must be
distributed on a pro rata basis to all shareholders of Thermo Trilogy, including
the minority shareholders.
Dependence on Proprietary Technology. Proprietary rights relating to the
Company's products will be protected from unauthorized use by third parties only
to the extent that they are covered by valid and enforceable patents or are
maintained in confidence as trade secrets. The Company has a number of U.S.
patents and also owns corresponding foreign patents in a number of jurisdictions
throughout the world. There can be no assurance that any patents now or
hereafter owned by the Company will afford protection against competitors.
Proceedings initiated by the Company to protect its proprietary rights could
result in substantial costs to the Company. There can be no assurance that
competitors of the Company, some of whom have substantially greater resources
than those of the Company, will not initiate litigation to challenge the
validity of the Company's patents, or that they will not use their resources to
design comparable products that do not infringe the Company's patents. The
Company could incur substantial costs and diversion of management resources with
respect to the defense of any such claims, which could have a material adverse
effect on the Company's business, financial condition, and results of operation.
Furthermore, parties making such claims could secure a judgment awarding
substantial damages, as well as injunctive or other equitable relief, which
could effectively block the Company's ability to make, use, sell, distribute, or
market its products and services in the U.S. and abroad. There may also be
pending or issued patents held by parties not affiliated with the Company that
relate to the Company's products or technologies. In the event that a claim
relating to proprietary technology or information is asserted against the
Company, the Company may need to acquire licenses to, or contest the validity
of, any such competitor's proprietary technology. It is likely that significant
funds would be required to contest the validity of any such competitor's
proprietary technology. There can be no assurance that any license required
under any such competitor's proprietary technology would be made available on
acceptable terms or that the Company would prevail in any such contest. There
can be no assurance that the steps taken by the Company to protect its
proprietary rights will be adequate to prevent misappropriation of its
technology or independent development by others of similar technology. In
addition, the laws of some jurisdictions do not protect the Company's
proprietary rights to the same extent as the laws of the U.S. There can be no
assurance that these protections will be adequate.
The Company relies on trade secrets and proprietary know-how which it seeks
to protect, in part, by confidentiality agreements with its collaborators,
employees, and consultants. There can be no assurance that these agreements will
not be breached, that the Company would have
34
<PAGE>
Forward-looking Statements (continued)
adequate remedies for any breach or that the Company's trade secrets will not
otherwise become known or be independently developed by competitors.
Potential Impact of Year 2000 on Processing Date-sensitive Information. The
Company is currently assessing the potential impact of the year 2000 on the
processing of date-sensitive information by the Company's computerized
information systems and on products purchased by the Company. The Company
believes that its internal information systems are either year 2000 compliant or
will be so prior to the year 2000 without incurring material costs. There can be
no assurance, however, that the Company will not experience unexpected costs and
delays in achieving year 2000 compliance for its internal information systems,
which could result in a material adverse effect on the Company's future results
of operations.
The Company is presently assessing whether its key suppliers are adequately
addressing the year 2000 issue and the effect this might have on the Company.
The Company has not completed its analysis and is unable to conclude at this
time that the year 2000 issue as it relates to its products purchased from key
suppliers is not reasonably likely to have a material adverse effect on the
Company's future results of operations.
Risks Associated With International Operations. International sales
accounted for 4.0% of the Company's total revenues in 1997. Over the next
several years, the Company intends to continue to significantly expand its
presence in international markets. International revenues are subject to a
number of risks, including the following: agreements may be difficult to enforce
and receivables difficult to collect through a foreign country's legal system;
foreign customers may have longer payment cycles; foreign countries may impose
additional withholding taxes or otherwise tax the Company's foreign income,
impose tariffs, or adopt other restrictions on foreign trade; fluctuations in
exchange rates may affect product demand and adversely affect the profitability
in U.S. dollars of products and services provided by the Company in foreign
markets where payment for the Company's products and services is made in the
local currency; U.S. export licenses may be difficult to obtain; and the
protection of intellectual property in foreign countries may be more difficult
to enforce. There can be no assurance that any of these factors will not have a
material adverse impact on the Company's business and results of operations.
Control by Thermo Electron. The Company's stockholders do not have the right
to cumulate votes for the election of directors. Thermo Electron, which owns
approximately 93% of the voting stock of the Company, has the power to elect the
entire Board of Directors of the Company and to approve or disapprove any
corporate actions submitted to a vote of the Company's stockholders.
35
<PAGE>
Forward-looking Statements (continued)
Potential Conflicts of Interest. The Company may be subject to potential
conflicts of interest from time to time as a result of its relationship with
Thermo Electron. For example, conflicts may arise in the determination of the
annual services fee payable by the Company pursuant to the Corporate Services
Agreement between the Company and Thermo Electron and in determining whether to
invest funds with or borrow funds from Thermo Electron pursuant to other
contractual arrangements. Certain officers of the Company, including John N.
Hatsopoulos and Paul F. Kelleher are also officers of Thermo Electron and/or
other subsidiaries of Thermo Electron, and are full-time employees of Thermo
Electron. These officers will devote only a small portion of their working time
(anticipated to be less than 5% in the case of Messrs. Hatsopoulos and Kelleher)
to the affairs of the Company. Further, it is an essential element of Thermo
Electron's career development program that successful executives and managers be
considered for positions of increased responsibility anywhere within the Thermo
Electron family of companies. Certain of the Company's executives and managers
were promoted to their present positions under this policy. There can be no
assurance that the Company's present executives and managers will not assume
other positions within the Thermo Electron family of companies, causing them to
be unavailable to serve the Company or to reduce the amount of time that they
devote to the affairs of the Company. For financial reporting purposes, the
Company's financial results are included in the consolidated financial
statements of Thermo Electron. Since the members of the Board of Directors of
the Company who are also affiliated with Thermo Electron have fiduciary duties
to the stockholders of the Company and the stockholders of Thermo Electron, or
both, as applicable, such individuals will consider not only the short-term and
the long-term impact of operating decisions on the Company, but also the impact
of such decisions on the consolidated financial results of Thermo Electron. In
some instances the impact of such decisions could be disadvantageous to the
Company while advantageous to Thermo Electron, or vice versa. For example,
conflicts may arise with respect to possible future acquisitions by the Company
of assets or businesses of Thermo Electron or another Thermo Electron affiliated
company in which the purchase price to be paid by the Company is subject to
negotiation between the Company and Thermo Electron or such other Thermo
Electron affiliated company. These negotiations will be subject to the potential
conflicts associated with related-party transactions. The Company is also a
party to various agreements with Thermo Electron that may limit the Company's
operating flexibility. There can be no assurance that these factors will not
have a material adverse effect on the Company's business, financial condition or
results of operations.
Potential Volatility of Stock Price. Since public trading of the Company's
common stock commenced in January 1995, the market price has fluctuated
considerably, and it may continue to fluctuate in the future. Factors such as
fluctuations in the Company's operating results, announcements of technological
innovations or new contracts or products by the Company or its competitors,
government regulation and approvals, developments in patent or other proprietary
rights and market conditions
36
<PAGE>
Forward-looking Statements (continued)
for stocks of companies similar to the Company could have a significant impact
on the market price of the common stock.
Lack of Dividends. The Company anticipates that for the foreseeable future
the Company's earnings, if any, will be retained for use in the business and
that no cash dividends will be declared or paid on the common stock. Declaration
of dividends on the common stock will depend upon, among other things, future
earnings, the operating and financial condition of the Company, its capital
requirements and general business conditions.
PART II - OTHER INFORMATION
Item 5 - Other Information
Pursuant to recent amendments to the rules relating to proxy statements
under the Securities Exchange Act of 1934, as amended (the Exchange Act),
shareholders of the Company are hereby notified that any shareholder proposal
not included in the Company's proxy materials for its 1999 Annual Meeting of
Shareholders (the Annual Meeting) in accordance with Rule 14a-8 under the
Exchange Act will be considered untimely for the purposes of Rules 14a-4 and
14a-5 under the Exchange Act if notice thereof is received by the Company after
December 9, 1998. Management proxies will be authorized to exercise
discretionary voting authority with respect to any shareholder proposal not
included in the Company's proxy materials for the Annual Meeting unless (a) the
Company receives notice of such proposal by December 9, 1998 and (b) the
conditions set forth in Rule 14a-4(c)(2)(i)-(iii) under the Exchange Act are
met.
Item 6 - Exhibits
See Exhibit Index on the page immediately preceding exhibits.
37
<PAGE>
THERMO ECOTEK CORPORATION
SIGNATURES
Pursuant to the requirements 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 as of the 13th day of August 1998.
THERMO ECOTEK CORPORATION
Paul F. Kelleher
---------------------------
Paul F. Kelleher
Chief Accounting Officer
John N. Hatsopoulos
---------------------------
John N. Hatsopoulos
Chief Financial Officer and
Senior Vice President
38
<PAGE>
THERMO ECOTEK CORPORATION
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- ---------------------------------------------------------------------------
27 Financial Data Schedule.
39
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THERMO
ECOTEK CORPORATION'S REPORT ON FORM 10-Q FOR THE PERIOD ENDED JULY 4, 1998 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-03-1998
<PERIOD-END> JUL-04-1998
<CASH> 38,069
<SECURITIES> 0
<RECEIVABLES> 44,432
<ALLOWANCES> 267
<INVENTORY> 25,059
<CURRENT-ASSETS> 125,198
<PP&E> 379,581
<DEPRECIATION> 82,087
<TOTAL-ASSETS> 489,989
<CURRENT-LIABILITIES> 63,373
<BONDS> 93,446
0
0
<COMMON> 3,782
<OTHER-SE> 235,416
<TOTAL-LIABILITY-AND-EQUITY> 489,989
<SALES> 145,764
<TOTAL-REVENUES> 145,764
<CGS> 99,460
<TOTAL-COSTS> 99,460
<OTHER-EXPENSES> 2,059
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,437
<INCOME-PRETAX> 27,233
<INCOME-TAX> 7,782
<INCOME-CONTINUING> 18,280
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 18,280
<EPS-PRIMARY> 0.67
<EPS-DILUTED> 0.52
</TABLE>
