SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------------------------------------------
AMENDMENT NO. 1 ON FORM 10-K/A TO FORM 10-K
(mark one)
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended October 3, 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 (I.R.S. Employer Identification No.)
of incorporation or organization)
245 Winter Street
Waltham, Massachusetts 02454-9046
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (781) 622-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of exchange on which registered
Common Stock, $.10 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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, and (2) has been subject to the filing requirements for
at least the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference into Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of October 30, 1998, was approximately $25,316,000.
As of October 30, 1998, the Registrant had 35,927,771 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Shareholders for the fiscal year
ended October 3, 1998, are incorporated by reference into Parts I and II.
Portions of the Registrant's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on March 10, 1999, are incorporated by reference into
Part III.
<PAGE>
FORM 10-K/A
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(c) Exhibits
13 Annual Report to Shareholders for the fiscal year ended October 3,
1998 (only those portions incorporated herein by reference).
23 Consent of Arthur Andersen LLP.
<PAGE>
THERMO ECOTEK CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 1 on
Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: January 13, 1999
THERMO ECOTEK CORPORATION
By: /s/ Paul F. Kelleher
Paul F. Kelleher
Chief Accounting Officer
Exhibit 13
Thermo Ecotek Corporation
Consolidated Financial Statements
Fiscal Year 1998
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Consolidated Statement of Income
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Year Ended
-------------------------------
(In thousands except per share amounts) Oct. 3, Sept. 27, Sept. 28,
1998 1997 1996
- --------------------------------------------------------------------------- --------- --------- ---------
Revenues (Notes 11 and 13) $ 208,971 $180,191 $ 150,076
--------- -------- ---------
Costs and Operating Expenses:
Cost of revenues (includes $4,668, $4,545, and $4,952 to related 135,506 114,610 101,883
parties; Notes 8 and 9)
Selling, general, and administrative expenses (includes $1,767, 21,950 16,845 11,525
$1,802, and $1,759 to related parties; Notes 8 and 9)
Research and development expenses 2,398 1,638 693
--------- -------- ---------
159,854 133,093 114,101
--------- -------- ---------
Operating Income 49,117 47,098 35,975
Interest Income 4,096 5,089 5,104
Interest Expense (includes $1,644, $2,740, and $2,740 to parent (11,040) (13,926) (14,727)
company)
Gain on Issuance of Stock by Subsidiary (Note 5) 6,269 - -
Equity in Earnings (Loss) of Joint Venture 150 33 (26)
--------- -------- ---------
Income Before Provision for Income Taxes and Minority Interest 48,592 38,294 26,326
Provision for Income Taxes (Note 7) 15,702 14,415 7,271
Minority Interest Expense 1,681 1,334 1,275
--------- -------- ---------
Net Income $ 31,209 $ 22,545 $ 17,780
========= ======== =========
Earnings per Share (Note 15)
Basic $ 1.07 $ .92 $ .76
========= ======== =========
Diluted $ .86 $ .64 $ .54
========= ======== =========
Weighted Average Shares (Note 15)
Basic 29,299 24,613 23,528
========= ======== =========
Diluted 39,152 38,740 36,292
========= ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Consolidated Balance Sheet
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands) Oct. 3, Sept. 27,
1998 1997
- -------------------------------------------------------------------------------------- --------- ---------
Assets
Current Assets:
Cash and cash equivalents (includes $21,207 and $69,309 under repurchase $ 41,371 $ 83,540
agreement with parent company)
Restricted funds 24,536 20,773
Accounts receivable and unbilled revenues 45,792 33,039
Inventories 23,640 13,916
Prepaid income taxes (Note 7) 11,724 4,298
Other current assets 2,335 1,728
--------- ---------
149,398 157,294
--------- ---------
Property, Plant, and Equipment, Net 301,930 263,067
--------- ---------
Due from Parent Company (Note 7) - 10,164
--------- ---------
Long-term Available-for-sale Investment, at Quoted Market Value (amortized 8,502 12,497
cost of $8,504; Note 2)
--------- ---------
Restricted Funds 26,177 20,905
--------- ---------
Other Assets 19,104 21,378
--------- ---------
$ 505,111 $ 485,305
========= =========
</TABLE>
3
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Consolidated Balance Sheet (continued)
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands except share amounts) Oct. 3, Sept. 27,
1998 1997
- -------------------------------------------------------------------------------------- ---------- ----------
Liabilities and Shareholders' Investment
Current Liabilities:
Current portion of long-term obligations (Note 12) $ 28,032 $ 35,012
Accounts payable 10,775 4,031
Lease obligations payable 1,648 1,736
Accrued interest 2,521 3,524
Accrued income taxes (Note 7) 5,378 2,057
Other accrued expenses 15,009 18,965
Due to parent company 2,446 1,255
--------- ---------
65,809 66,580
--------- ---------
Long-term Obligations (Note 12):
Nonrecourse tax-exempt obligations 33,700 51,800
Subordinated convertible debentures (includes $68,500 due to parent 47,400 130,648
company in 1997)
Capital lease obligations 12,346 22,242
--------- ---------
93,446 204,690
--------- ---------
Deferred Income Taxes (Note 7) 56,571 49,934
--------- ---------
Other Deferred Items 25,216 13,521
--------- ---------
Minority Interest 14,437 3,304
--------- ---------
Commitments and Contingencies (Notes 3, 8, 9, and 10)
Shareholders' Investment (Notes 4, 6, and 12):
Common stock, $.10 par value, 50,000,000 shares authorized; 37,822,789 3,782 2,598
and 25,978,198 shares issued
Capital in excess of par value 175,673 95,573
Retained earnings 98,802 67,593
Treasury stock at cost, 1,944,179 and 1,477,250 shares (28,735) (20,872)
Cumulative translation adjustment 112 (52)
Net unrealized gain (loss) on available-for-sale investment (Note 2) (2) 2,436
--------- ---------
249,632 147,276
--------- ---------
$ 505,111 $ 485,305
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Year Ended
-------------------------------
(In thousands) Oct. 3, Sept. 27, Sept. 28,
1998 1997 1996
- --------------------------------------------------------------------------- ---------- ---------- ---------
Operating Activities
Net income $ 31,209 $ 22,545 $ 17,780
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 23,903 21,618 20,425
Deferred income tax expense (Note 7) 6,919 10,715 3,086
Minority interest expense 1,681 1,334 1,275
Gain on issuance of stock by subsidiary (Note 5) (6,269) - -
Deferred revenue (Note 11) - (8,200) -
Changes in current accounts, excluding the effect of acquisitions:
Restricted funds (3,763) (1,837) (6,944)
Accounts receivable and unbilled revenues (12,493) (3,740) (2,130)
Inventories (799) (1,371) 1,584
Other current assets (7,854) 1,229 544
Accounts payable 6,355 2,457 148
Lease obligations payable (602) (602) 389
Due from parent company 12,631 3,170 5,319
Other current liabilities (843) 201 3,599
Other - - 26
--------- -------- ---------
Net cash provided by operating activities 50,075 47,519 45,101
--------- -------- ---------
Investing Activities
Acquisitions, net of cash acquired (Note 3) (19,100) (10,865) (8,088)
Purchases of property, plant, and equipment (48,423) (17,710) (36,587)
Funding of long-term restricted funds (5,272) (6,793) (2,073)
Increase in other deferred items 12,209 8,476 -
Increase in other assets (2,610) (2,452) (3,004)
--------- -------- ---------
Net cash used in investing activities (63,196) (29,344) (49,752)
--------- -------- ---------
Financing Activities
Net proceeds from issuance of subordinated convertible - 48,470 35,942
debentures
(Note 12)
Repayment of long-term obligations (26,100) (16,800) (14,100)
Payments under capital lease obligations (8,912) (8,006) (7,191)
Net proceeds from issuance of Company and subsidiary common 15,777 698 6,247
stock (Notes 4 and 5)
Payment of withholding taxes related to stock option exercises (319) (1,115) (1,221)
Purchases of Company common stock (10,248) (19,743) -
Distribution to minority partner (1,147) (1,346) (947)
Capital contribution by minority partner 1,961 - -
--------- -------- ---------
Net cash provided by (used in) financing activities $ (28,988) $ 2,158 $ 18,730
--------- -------- ---------
5
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Consolidated Statement of Cash Flows (continued)
Year Ended
-------------------------------
(In thousands) Oct. 3, Sept. 27, Sept. 28,
1998 1997 1996
- --------------------------------------------------------------------------- ---------- ---------- ---------
Exchange Rate Effect on Cash $ (60) $ (31) $ -
--------- -------- ---------
Increase (Decrease) in Cash and Cash Equivalents (42,169) 20,302 14,079
Cash and Cash Equivalents at Beginning of Year 83,540 63,238 49,159
--------- -------- ---------
Cash and Cash Equivalents at End of Year $ 41,371 $ 83,540 $ 63,238
========= ======== =========
Cash Paid For
Interest $ 12,727 $ 13,100 $ 14,267
Income taxes $ 38 $ 7 $ 101
Noncash Activities
Fair value of assets of acquired companies $ 20,025 $ 15,183 $ 8,983
Cash paid for acquired companies (19,100) (11,223) (8,088)
--------- -------- ---------
Liabilities assumed of acquired companies $ 925 $ 3,960 $ 895
========= ======== =========
Conversions of subordinated convertible debentures (includes $ 83,248 $ 19,579 $ 5,273
========= ======== =========
$68,500 converted by parent company in fiscal 1998; Note 12)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Consolidated Statement of Shareholders' Investment
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------- ---------- ---------- ---------
Common Stock, $.10 Par Value
Balance at beginning of year $ 2,598 $ 1,617 $ 1,551
Conversions of subordinated convertible debentures (Note 12) 1,183 145 26
Issuance of Company common stock under employees' and directors' 1 27 18
stock plans
Effect of three-for-two stock split - 809 -
Net proceeds from private placement of Company common stock (Note 4) - - 22
--------- -------- ---------
Balance at end of year 3,782 2,598 1,617
--------- -------- ---------
Capital in Excess of Par Value
Balance at beginning of year 95,573 74,740 64,188
Conversions of subordinated convertible debentures (Note 12) 81,701 18,991 5,107
Issuance of Company common stock under employees' and directors' (1,601) 204 503
stock plans
Tax benefit related to employees' and directors' stock plans - 2,447 -
Effect of three-for-two stock split - (809) -
Net proceeds from private placement of Company common stock (Note 4) - - 4,942
--------- -------- ---------
Balance at end of year 175,673 95,573 74,740
--------- -------- ---------
Retained Earnings
Balance at beginning of year 67,593 45,048 27,268
Net income 31,209 22,545 17,780
--------- -------- ---------
Balance at end of year 98,802 67,593 45,048
--------- -------- ---------
Treasury Stock
Balance at beginning of year (20,872) (481) (22)
Activity under employees' and directors' stock plans 2,385 (648) (459)
Purchases of Company common stock (10,248) (19,743) -
--------- -------- ---------
Balance at end of year (28,735) (20,872) (481)
--------- -------- ---------
Cumulative Translation Adjustment
Balance at beginning of year (52) - -
Translation adjustment 164 (52) -
--------- -------- ---------
Balance at end of year 112 (52) -
--------- -------- ---------
Net Unrealized Gain (Loss) on Available-for-sale Investment
Balance at beginning of year 2,436 8,763 -
Change in net unrealized gain (loss) on available-for-sale investment (2,438) (6,327) 8,763
(Note 2)
--------- -------- ---------
Balance at end of year (2) 2,436 8,763
--------- -------- ---------
Total Shareholders' Investment $ 249,632 $147,276 $ 129,687
========= ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Notes to Consolidated Financial Statements
1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Thermo Ecotek Corporation (the Company) is an environmental company
providing a range of environmentally responsible technologies and products,
including nonutility electric power generation using clean combustion processes,
engineered clean fuels, as well as environmentally friendly pest control
products through its biopesticides subsidiary, Thermo Trilogy Corporation (Note
3).
The Company develops and operates alternative-energy electrical-generation
facilities through joint ventures or limited partnerships in which the Company
has a majority interest, or through wholly owned subsidiaries (the Operating
Companies). The Company's interests in the Operating Companies range from 60% to
100% and, in each case, are held by wholly owned subsidiaries of the Company. Of
the facilities operated by the Company, four are owned by the Company and the
remainder are owned by unaffiliated parties who lease them to the Operating
Companies under long-term leases (Note 8).
Relationship with Thermo Electron Corporation
The Company was incorporated on November 30, 1989, as a wholly owned
subsidiary of Thermo Electron Corporation. At October 3, 1998, Thermo Electron
owned 33,696,106 shares of the Company's common stock, representing 94% of such
stock outstanding.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company,
its majority-owned and wholly owned Operating Companies, and its majority-owned
subsidiary. All significant intercompany accounts and transactions have been
eliminated in consolidation. The Company accounts for investments in businesses
in which it owns between 20% and 50% using the equity method.
Fiscal Year
The Company has adopted a fiscal year ending the Saturday nearest
September 30. References to fiscal 1998, 1997, and 1996 are for the years ended
October 3, 1998, September 27, 1997, and September 28, 1996, respectively.
Fiscal 1998 included 53 weeks; fiscal 1997 and 1996 each included 52 weeks.
Revenue Recognition
The Company earns revenues primarily from the operation of
alternative-energy facilities. Revenues from plant operations are recorded as
electricity is delivered. The Operating Companies have long-term power-supply
arrangements with local utilities, expiring between 2005 and 2020, to sell all
the output of the plants currently in operation at established or formula-based
defined rates (Note 10). Under certain of these arrangements, in the event of
service termination by the Operating Companies prior to the end of the
obligation period, the Operating Companies 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.
Management does not expect to incur any obligation under these provisions in the
foreseeable future. The Company recognizes revenue from its biopesticide
products upon shipment.
The Woodland plant has conditions in its nonrecourse lease agreement that
require the funding of a "power reserve" in years prior to 2000, based on
projections of operating cash flow shortfalls in 2000 and thereafter. The power
reserve represents funds available to make lease payments in the event that
revenues are not sufficient after the plant converts to avoided-cost rates in
March 2000. It has been asserted that the plant will convert to avoided cost
rates in mid-1999; however, the Company disputes this assertion. This funding
requirement significantly limits profit distributions that Woodland may make to
the Company. Accordingly, beginning 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
reduced to approximately breakeven in fiscal 1998. During fiscal 1997 and 1996,
the Woodland plant contributed $1.0 million and $5.1 million of operating
income, respectively.
8
<PAGE>
1. Nature of Operations and Summary of Significant Accounting Policies
(continued)
Repairs and Maintenance
The Company charges routine repairs and maintenance to expense in the
period the costs are incurred. The Company accrues for major maintenance and
overhauls in anticipation of scheduled outages. Other accrued expenses in the
accompanying balance sheet includes approximately $1.9 million and $3.9 million
at fiscal year-end 1998 and 1997, respectively, in anticipation of major
maintenance and overhauls.
Interest Rate Swap Agreements and Forward Contracts
The Company has entered into interest rate swap agreements in connection
with debt on certain alternative-energy facilities (Notes 12 and 14). The
interest rate swap agreements convert floating debt obligations to fixed rate
obligations. Interest rate swap agreements are accounted for under the accrual
method. Amounts to be received from or paid to the counter-parties of the
agreements are accrued during the period to which the amounts relate and are
reflected as interest expense. The related amounts payable to the
counter-parties are included in other accrued expenses in the accompanying
balance sheet. The fair value of the swap agreements is not recognized in the
accompanying financial statements since the agreements are accounted for as
hedges.
The Company enters into foreign currency agreements to manage specifically
identifiable risks. The Company's short-term foreign exchange contracts are part
of the Company's management of foreign currency exposures. Foreign currency
agreements are treated as a hedge on currency movements on certain customer
deposits received and held in foreign denominated currency. Gains and losses on
the forward contract offset gains and losses on the foreign- denominated
account.
The Company does not enter into speculative interest rate swap or foreign
currency agreements.
Gain on 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 issuances of a subsidiary's stock and
shares of the subsidiary are subsequently repurchased by the subsidiary, the
Company, or Thermo Electron, 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.
Stock-based Compensation Plans
The Company applies Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock-based compensation plans (Note 6). Accordingly, no
accounting recognition is given to stock options granted at fair market value
until they are exercised. Upon exercise, net proceeds, including tax benefits
realized, are credited to equity.
Income Taxes
The Company and Thermo Electron have a tax allocation agreement under
which the Company is included in the consolidated federal and certain state
income tax returns filed by Thermo Electron. The agreement provides that Thermo
Electron charges or pays the Company amounts based on the Company's relative
contribution to Thermo Electron's tax liability. If Thermo Electron's equity
ownership of the Company were to drop below 80%, the Company would be required
to file its own tax returns.
9
<PAGE>
1. Nature of Operations and Summary of Significant Accounting Policies
(continued)
In accordance with Statement of Financial Accounting Standards (SFAS) No.
109, "Accounting for Income Taxes," the Company recognizes deferred income taxes
based on the expected future tax consequences of differences between the
financial statement basis and the tax basis of assets and liabilities,
calculated using enacted tax rates in effect for the year in which the
differences are expected to be reflected in the tax return (Note 7).
Earnings per Share
During the first quarter of fiscal 1998, the Company adopted SFAS No. 128,
"Earnings per Share" (Note 15). 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 fiscal 1997.
Basic earnings per share have been computed by dividing net income by the
weighted average number of shares outstanding 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.
Cash and Cash Equivalents and Restricted Funds
At fiscal year-end 1998 and 1997, $21.2 million and $69.3 million,
respectively, of the Company's cash equivalents were invested in a repurchase
agreement with Thermo Electron. Under this agreement, the Company in effect
lends excess cash to Thermo Electron, which Thermo Electron collateralizes with
investments principally consisting of corporate notes, U.S. government-agency
securities, commercial paper, money market funds, and other marketable
securities, in the amount of at least 103% of such obligation. The Company's
funds subject to the repurchase agreement are readily convertible into cash by
the Company. The repurchase agreement earns a rate based on the 90-day
Commercial Paper Composite Rate plus 25 basis points, set at the beginning of
each quarter. Cash equivalents also include investments in money market
accounts. The use of cash and cash equivalents totaling $12.0 million and $10.8
million at fiscal year-end 1998 and 1997, respectively, was restricted by the
terms of certain Operating Companies' lease and financing agreements.
Restricted funds in the accompanying balance sheet represents amounts held
in trust for lease and debt payments and working capital requirements, as
required by certain of the Operating Companies' lease and financing agreements,
and are invested in money market accounts. Restricted funds that are not
expected to be used within the next fiscal year are classified as long-term in
the accompanying balance sheet.
All cash equivalents and restricted funds are carried at cost, which
approximates market value.
Inventories
Inventories consist of raw materials, fuel, operating supplies, spare
parts, materials, and overhead and are stated at the lower of cost (on a
first-in, first-out or average basis) or market value. The components of
inventories are as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands) 1998 1997
- ---------------------------------------------------------------------------------------- ------- ---------
Raw Materials and Supplies $13,843 $ 11,886
Work in Process 2,802 144
Finished Goods 6,995 1,886
------- --------
$23,640 $ 13,916
======= ========
</TABLE>
10
<PAGE>
1. Nature of Operations and Summary of Significant Accounting Policies
(continued)
Property, Plant, and Equipment
The costs of additions and improvements are capitalized. The Company
provides for depreciation and amortization primarily using the straight-line
method over the estimated useful lives of the property as follows: electric
generating facilities - 25 years; property under capital lease - the life of the
asset; leasehold improvements - the shorter of the term of the lease or the life
of the asset; and machinery and equipment - 3 to 7 years. The Company's
subbituminous coal-beneficiation facility is depreciated based on a rate per ton
of product produced that is computed by estimating total production over the
life of the facility. Property, plant, and equipment consists of the following:
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands) 1998 1997
- -------------------------------------------------------------------------------------- --------- ---------
Land $ 6,747 $ 3,479
Electric Generating and Coal-beneficiation Facilities (Notes 9 and 12) 282,315 200,573
Property Under Capital Lease 47,020 47,020
Machinery and Equipment 19,261 7,366
Leasehold Improvements 16,915 15,814
Construction in Process (Note 3) 17,295 54,585
--------- ---------
389,553 328,837
Less: Accumulated Depreciation and Amortization 87,623 65,770
--------- ---------
$ 301,930 $ 263,067
========= =========
</TABLE>
In March 1998, the Company purchased two power-generation facilities and
related sites in California for approximately $9.5 million and the assumption of
certain liabilities. As of October 3, 1998, these facilities were not in service
and, therefore, are not being depreciated by the Company.
Other Assets
Other assets in the accompanying balance sheet includes certain costs
associated with the development of the Company's alternative-energy facilities,
prepaid rent relating to an Operating Company's lease agreement, goodwill that
arose in connection with the acquisition of an Operating Company, deferred debt
expense relating to the Company's issuances of subordinated convertible
debentures, and patents, licenses, and other intangible assets arising from
acquisitions by Thermo Trilogy (Note 3). These assets are being amortized using
the straight-line method over their estimated useful lives, which range from 5
to 30 years. These assets were $17.5 million and $19.9 million, net of
accumulated amortization of $8.9 million and $8.2 million, at fiscal year-end
1998 and 1997, respectively.
In addition, other assets includes an investment in a joint venture of
$1.6 million and $1.5 million at fiscal year-end 1998 and 1997, respectively.
Other Deferred Items
Other deferred items in the accompanying balance sheet includes
obligations under an Operating Company lease to cover projected short-falls in
lease payments beginning in 2000, as described above under the caption "Revenue
Recognition." In addition, other deferred items includes rent that has been
recognized ratably for financial reporting purposes in connection with an
Operating Company's lease agreement (Note 8).
11
<PAGE>
1. Nature of Operations and Summary of Significant Accounting Policies
(continued)
Foreign Currency
All assets and liabilities of the Company's foreign subsidiaries are
translated at year-end exchange rates, and revenues and expenses are translated
at average exchange rates for the year in accordance with SFAS No. 52, "Foreign
Currency Translation." Resulting translation adjustments are reflected as a
separate component of shareholders' investment titled "Cumulative translation
adjustment." Foreign currency transaction gains and losses are included in the
accompanying statement of income and are not material for the three years
presented.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Presentation
Certain amounts in fiscal 1997 and 1996 have been reclassified to conform
to the presentation in the fiscal 1998 financial statements.
2. Available-for-sale Investment
In accordance with SFAS No. 115 "Accounting for Certain Investments in
Debt and Equity Securities," the Company's marketable equity securities are
considered available-for-sale investments in the accompanying balance sheet and
are carried at market value, with the difference between cost and market value,
net of related tax effects, recorded as a component of shareholders' investment
titled "Net unrealized gain (loss) on available-for-sale investment." At fiscal
year-end 1998 and 1997, the Company held one long-term available-for-sale
investment, an investment in the common stock of KFx, Inc., described below.
In fiscal 1995, the Company purchased 1,500,000 shares of KFx common stock
for $3.0 million, representing an approximate 7% equity interest in KFx. In
fiscal 1996, the Company purchased an additional 1,500,000 shares of KFx common
stock for $3.0 million, representing an additional 7% equity interest in KFx. In
fiscal 1997, the Company purchased an additional 1,250,000 shares of KFx common
stock for $2.5 million pursuant to the purchase agreement, bringing its total
equity interest in KFx to approximately 18%. The fair market value of this
investment at October 3, 1998, was $8.5 million. Simultaneously with the
execution of the purchase agreement, KFx granted to the Company a warrant to
purchase an additional 7,750,000 shares at $3.65 per share, as well as a warrant
to purchase further shares of the common stock of KFx at then market value,
defined so that the number, when added to all other shares of such common stock
owned by the Company, would result in the Company owning 51% of the common stock
of KFx on a diluted basis. These warrants are exercisable from January 1, 2000,
through July 1, 2001.
3. Acquisitions and Projects Under Development
Acquisitions
In November 1997, Thermo Trilogy 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. In January 1997, Thermo Trilogy acquired substantially all
of the assets of biosys, inc., a biopesticide company, for $11.2 million in cash
and the assumption of certain liabilities.
In May 1996, the Company, through Thermo Trilogy, acquired the assets of the
biopesticides division of W.R. Grace & Co. (the biopesticides business of
Grace), which develops, manufactures, and markets environmentally
12
<PAGE>
3. Acquisitions and Projects Under Development (continued)
friendly products used for pest control, for $8.1 million in cash and the
assumption of certain liabilities. In addition, the Company will pay a royalty
fee of seven percent on annual sales of the acquired business in excess of $14
million through the year 2000. As of October 3, 1998, no royalties were payable
under this provision.
These acquisitions have been accounted for using the purchase method of
accounting and their results have been included in the accompanying financial
statements from their respective dates of acquisition. The aggregate cost of
these acquisitions approximated the 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.
Based upon unaudited data, the following table presents selected financial
information for the Company, the Bt business of Novartis, and the biosys
business on a pro forma basis, assuming the Company and the Bt business of
Novartis had been combined since the beginning of fiscal 1997 and the Company
and the biosys business had been combined since the beginning of fiscal 1996.
The effect of the acquisition of the biopesticides business of Grace is not
included in the pro forma data as it was not material to the Company's results
of operations.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands except per share amounts) 1998 1997 1996
- --------------------------------------------------------------------------- ---------- ---------- ---------
Revenues $ 212,204 $205,199 $ 172,569
Net Income 31,380 17,272 3,931
Earnings per Share:
Basic 1.07 .70 .17
Diluted .86 .51 .15
</TABLE>
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 or the
acquisition of the biosys business been made at the beginning of fiscal 1996.
Projects Under Development
During April 1998, the Company commenced commercial operations at its
95%-owned coal-beneficiation facility, near Gillette, Wyoming, following
construction of the facility. In January 1998, the Company indirectly acquired,
through a joint venture, a majority interest in certain power operations in the
Czech Republic for $7.3 million in cash. The Company has begun construction on a
50-megawatt, $32 million expansion at the Czech Republic facility which it
expects to complete in fiscal 1999. During fiscal 1998, the Company expended
$16.6 million on the Czech Republic plant expansion.
4. Shareholders' Investment
In June 1996, the Company sold 330,000 shares of its common stock in a
private placement at $16.08 per share, for net proceeds of $5.0 million.
The net assets of certain Operating Companies are generally restricted as
to the amounts that can be transferred to the parent company in the form of
dividends, loans or advances, pursuant to certain lease or debt agreements. As
of October 3, 1998, net assets of certain subsidiaries of approximately $146.8
million were not restricted from distribution.
At October 3, 1998, the Company had reserved 4,442,826 unissued shares of
its common stock for possible issuance under stock-based compensation plans and
for issuance upon possible conversion of the Company's convertible obligations.
13
<PAGE>
5. Transactions in Stock of Subsidiary
In fiscal 1998, Thermo Trilogy 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.
6. Employee Benefit Plans
Stock-based Compensation Plans
Stock Option Plans
The Company has stock-based compensation plans for its key employees,
directors, and others. Two of these plans permit the grant of nonqualified and
incentive stock options. A third plan permits the grant of a variety of stock
and stock-based awards as determined by the human resources committee of the
Company's Board of Directors (the Board Committee), including restricted stock,
stock options, stock bonus shares, or performance-based shares. To date, only
nonqualified stock options have been awarded under these plans. The option
recipients and the terms of options granted under these plans are determined by
the Board Committee. Generally, options granted to date are exercisable
immediately, but are subject to certain transfer restrictions and the right of
the Company to repurchase shares issued upon exercise of the options at the
exercise price, upon certain events. The restrictions and repurchase rights
generally lapse ratably over periods ranging from one to ten years after the
first anniversary of the grant date, depending on the term of the option, which
may range from three to twelve years. Nonqualified stock options may be granted
at any price determined by the Board Committee, although incentive stock options
must be granted at not less than the fair market value of the Company's stock on
the date of grant. To date, all options have been granted at fair market value.
The Company also has a directors' stock option plan that provides for the grant
of stock options to outside directors pursuant to a formula approved by the
Company's shareholders. Options awarded under this plan are exercisable six
months after the date of grant and expire three to seven years after the date of
grant. In addition to the Company's stock-based compensation plans, certain
officers and key employees may also participate in the stock-based compensation
plans of Thermo Electron.
A summary of the Company's stock option information is as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
------------------- ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Price Price Price
Number Number Number
of of of
(Shares in thousands) Shares Shares Shares
- ----------------------------------------------- --------- ---------- -------- ---------- --------- ---------
Options Outstanding, Beginning of Year 1,281 $ 8.64 1,439 $ 6.55 1,491 $4.96
Granted 83 17.72 264 14.13 309 11.48
Exercised (205) 6.37 (369) 4.46 (349) 4.16
Forfeited (35) 9.33 (53) 8.21 (12) 6.98
----- ----- -----
Options Outstanding, End of Year 1,124 $ 9.70 1,281 $ 8.64 1,439 $6.55
===== ====== ===== ====== ===== =====
Options Exercisable 1,124 $ 9.70 1,281 $ 8.64 1,439 $6.55
===== ====== ===== ====== ===== =====
Options Available for Grant 305 353 365
===== ===== =====
</TABLE>
14
<PAGE>
6. Employee Benefit Plans (continued)
A summary of the status of the Company's stock options at October 3, 1998,
is as follows:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
----------------------------------------------
<S> <C> <C> <C>
Range of Exercise Prices Number Weighted Weighted
of Average Average
Shares Remaining Exercise
(In thousands) Contractual Life Price
- ------------------------------------------------------------- -------------- ---------------- --------------
$ 5.50 - $ 8.96 627 6.7 years $ 6.79
8.97 - 12.41 156 6.6 years 10.18
12.42 - 15.87 267 6.8 years 13.91
15.88 - 19.33 74 5.4 years 18.12
------
$ 5.50 - $19.33 1,124 6.6 years $ 9.70
=====
</TABLE>
Employee Stock Purchase Program
Substantially all of the Company's employees are eligible to participate
in an employee stock purchase program sponsored by the Company and Thermo
Electron, under which employees can purchase shares of the Company's and Thermo
Electron's common stock. Prior to November 1, 1996, the program was sponsored by
Thermo Electron. Under this program, the applicable shares of common stock can
be purchased at the end of a 12-month plan year at 95% of the fair market value
at the beginning of the period, and shares purchased are subject to a six-month
resale restriction. Effective November 1, 1998, the applicable shares of common
stock may be purchased at 85% of the lower of the fair market value at the
beginning or end of the plan year, and shares purchased are subject to a
one-year resale restriction. Shares are purchased through payroll deductions of
up to 10% of each participating employee's gross wages.
Pro Forma Stock-based Compensation Expense
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-based Compensation," which sets forth a fair-value
based method of recognizing stock-based compensation expense. As permitted by
SFAS No. 123, the Company has elected to continue to apply APB No. 25 to account
for its stock-based compensation plans. Had compensation cost for awards granted
after fiscal 1995 under the Company's stock-based compensation plans been
determined based on the fair value at the grant dates consistent with the method
set forth under SFAS No. 123, the effect on the Company's net income and
earnings per share would have been as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands except per share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------ -------- --------- --------
Net Income:
As reported $31,209 $ 22,545 $17,780
Pro forma 30,614 22,159 17,565
Basic Earnings per Share:
As reported 1.07 .92 .76
Pro forma 1.04 .90 .75
Diluted Earnings per Share:
As reported .86 .64 .54
Pro forma .84 .63 .53
</TABLE>
15
<PAGE>
6. Employee Benefit Plans (continued)
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to October 1, 1995, the resulting pro forma compensation
expense may not be representative of the amount to be expected in future years.
Compensation expense for options granted is reflected over the vesting period;
therefore, future pro forma compensation expense may be greater as additional
options are granted.
The weighted average fair value per share of options granted was $5.79,
$5.72, and $4.49 in fiscal 1998, 1997, and 1996, respectively.
The fair value of each option grant was estimated on the grant date using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1998 1997 1996
- -------------------------------------------------------------------------- ---------- ---------- ----------
Volatility 28% 26% 26%
Risk-free Interest Rate 5.5% 6.1% 6.0%
Expected Life of Options 4.2 years 6.4 years 6.1 years
</TABLE>
The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option-pricing models require the input of
highly subjective assumptions including expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
401(k) Savings Plans
Substantially all of the Company's corporate, full-time employees are
eligible to participate in Thermo Electron's 401(k) savings plan. Contributions
to the Thermo Electron 401(k) savings plan are made by both the employee and the
Company. Company contributions are based upon the level of employee
contributions. Employees of the Operating Companies who meet eligibility
requirements may participate in a separate defined contribution plan.
Contributions to the plan are made by both the employee and the Operating
Companies. The Operating Companies' contributions are based on the level of
employee contributions. The Company contributed and charged to expense for these
plans $536,000, $401,000, and $279,000 in fiscal 1998, 1997, and 1996,
respectively.
7. Income Taxes
The components of income before provision for income taxes and minority
interest are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands) 1998 1997 1996
- -------------------------------------------------------------------------- ---------- ---------- ----------
Domestic $46,992 $37,712 $26,326
Foreign 1,600 582 -
------- ------- -------
$48,592 $38,294 $26,326
======= ======= =======
</TABLE>
16
<PAGE>
7. Income Taxes (continued)
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands) 1998 1997 1996
- ------------------------------------------------------------------------------ -------- --------- --------
Currently Payable:
Federal $ 7,202 $ 3,214 $ 2,899
State 1,438 486 1,286
Foreign 143 - -
------- -------- -------
8,783 3,700 4,185
------- -------- -------
Deferred:
Federal 6,545 9,250 2,485
State 374 1,465 601
------- -------- -------
6,919 10,715 3,086
------- -------- -------
$15,702 $ 14,415 $ 7,271
======= ======== =======
</TABLE>
The Company receives a tax deduction upon exercise of nonqualified stock
options by employees for the difference between the exercise price and the
market price of the Company's common stock on the date of exercise. The
provision for income taxes that is currently payable does not reflect $1,012,000
and $1,435,000 of such benefits that have been allocated to capital in excess of
par value in fiscal 1997 and 1996, respectively.
The provision for income taxes in the accompanying statement of income
differs from the provision calculated by applying the statutory federal income
tax rate of 35% in fiscal 1998 and 1997 and 34% in fiscal 1996 to income before
provision for income taxes and minority interest due to the following:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands) 1998 1997 1996
- ------------------------------------------------------------------------------ -------- --------- --------
Provision for Income Taxes at Statutory Rate $17,007 $ 13,403 $ 8,951
Increases (Decreases) Resulting From:
State income taxes, net of federal tax 1,178 1,268 1,245
Minority interest expense (491) (466) (434)
Tax losses and credits benefited - - (2,528)
Nondeductible expenses 44 210 37
Nontaxable gain on issuance of stock by subsidiary (2,194) - -
Other 158 - -
------- -------- -------
$15,702 $ 14,415 $ 7,271
======= ======== =======
</TABLE>
Tax losses and credits benefited during fiscal 1996 relate to the
resolution of certain tax contingencies.
17
<PAGE>
7. Income Taxes (continued)
Prepaid and deferred income taxes in the accompanying balance sheet
consist of the following:
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands) 1998 1997
- ---------------------------------------------------------------------------------------- -------- ---------
Deferred (Prepaid) Income Taxes:
Depreciation $55,062 $ 48,377
State tax net operating loss carryforwards (2,811) (2,570)
Capitalized costs and other (2,097) (324)
Other reserves and accruals (9,959) (3,974)
Available-for-sale investments (2) 1,557
Intangible assets 1,502 -
Stock options not benefited 341 -
------- --------
42,036 43,066
Valuation allowance 2,811 2,570
------- --------
$44,847 $ 45,636
======= ========
</TABLE>
The valuation allowance relates principally to uncertainty surrounding the
realization of certain state tax loss carryforwards. State tax loss
carryforwards of approximately $29 million began expiring in 1998. Long-term due
from parent company in the accompanying fiscal 1997 balance sheet represents
amounts due from Thermo Electron for tax benefits arising from the Company's
operations. Due to parent company in the accompanying fiscal 1998 balance sheet
includes $2.5 million for the Company's liability for federal and state income
taxes.
The Company has not recognized a deferred tax liability for the difference
between the book basis and tax basis of its investment in the common stock of
its subsidiary (such difference relates primarily to unremitted earnings of
foreign subsidiaries and gain on issuance of stock by subsidiary) because the
Company does not expect this basis difference to become subject to tax at the
parent level.
A provision has not been made for U.S. or additional foreign taxes on $0.4
million of undistributed earnings of foreign subsidiaries that could be subject
to taxation if remitted to the U.S. because the Company currently plans to keep
those amounts reinvested overseas.
8. Commitments
Leases
Certain Operating Companies have operating lease agreements for their
facilities expiring in various years through 2010. The lease agreements provide
for renewal of each of the leases for additional periods ranging from one to
five years at the Operating Companies' option. In general, renewal options are
at the lower of a predetermined percentage of the average annual lease rental
during the lease terms or the fair market rental as determined by an independent
appraisal. In general, at the end of the lease terms or renewal terms, the
Operating Companies have a right of first refusal or an option to purchase the
facilities, at their fair market value, as determined by an independent
appraisal.
Lease payments under the operating leases are made to the owner of the
facility only to the extent that power revenues exceed essential operating
expenses, as defined, up to certain specified maximum levels (Note 9). Subject
to the foregoing, as of October 3, 1998, the contractual amounts payable
pursuant to the lease agreements total approximately $132.6 million over the
remaining initial lease terms, averaging approximately $16.0 million per year.
The Company recognizes rent expense ratably over the respective lease terms. The
accompanying statement of income includes expenses from operating leases for the
Operating Companies' facilities of $15.2 million, $15.5 million, and $15.2
million in fiscal 1998, 1997, and 1996, respectively.
18
<PAGE>
8. Commitments (continued)
In addition, the Company and a subsidiary lease office and production
facilities under operating lease arrangements expiring from fiscal 2002 through
fiscal 2005. The accompanying statement of income includes expenses from
operating leases excluding the related-party lease discussed below of $804,000,
$688,000, and $77,000 in fiscal 1998, 1997, and 1996, respectively. Future
minimum lease payments due under noncancellable operating leases as of October
3, 1998, net of annual sublease income of $178,000, are $604,000 in fiscal 1999;
$610,000 in fiscal 2000; $617,000 in fiscal 2001; $578,000 in fiscal 2002; and
$953,000 in fiscal 2003 and thereafter. Total future minimum lease payments are
$3,362,000.
During part of fiscal 1997 and 1996, the Company leased part of its office
facilities from Thermo Electron. The agreement called for the Company to pay
rent based on Thermo Electron's occupancy costs per square foot. The
accompanying statement of income included expenses of $27,000 and $177,000 in
fiscal 1997 and 1996, respectively, under the agreement with Thermo Electron.
Fuel Supply
The Operating Companies have entered into fuel supply agreements with
various suppliers guaranteeing the purchase of certain minimum quantities of
acceptable fuel at negotiated prices and terms. The Operating Companies
purchased $17.6 million, $20.4 million, and $20.0 million of fuel under such
contracts in fiscal 1998, 1997, and 1996, respectively. The agreements call for
price adjustments based on certain published indices or stated rates over their
terms expiring between calendar 1998 and 2005. See Note 9 for fuel supply
agreements with related parties.
9. Related-party Transactions
Corporate Service Agreement
The Company and Thermo Electron have a corporate services agreement under
which Thermo Electron's corporate staff provides certain administrative
services, including certain legal advice and services, risk management, certain
employee benefit administration, tax advice and preparation of tax returns,
centralized cash management, and certain financial and other services, for which
the Company currently pays Thermo Electron annually an amount equal to 0.8% of
the Company's revenues. In calendar years 1997 and 1996, the Company paid an
amount equal to 1.0% of the Company's revenues. Prior to January 1, 1996, the
Company paid an annual fee equal to 1.2% of the Company's revenues. For these
services, the Company was charged $1.8 million, $1.8 million, and $1.6 million
in fiscal 1998, 1997, and 1996, respectively. The annual fee is reviewed and
adjusted annually by mutual agreement of the parties. Management believes that
the service fee charged by Thermo Electron is reasonable and that such fees are
representative of the expenses the Company would have incurred on a stand-alone
basis. The corporate services agreement is renewed annually but can be
terminated upon 30 days' prior notice by the Company or upon the Company's
withdrawal from the Thermo Electron Corporate Charter (the Thermo Electron
Corporate Charter defines the relationships among Thermo Electron and its
majority-owned subsidiaries). For additional items such as employee benefit
plans, insurance coverage, and other identifiable costs, Thermo Electron charges
the Company based upon costs attributable to the Company.
Fuel Supply
A portion of the fuel used by the Operating Companies' facilities is
obtained under agreements with related parties of the Operating Companies or
their joint venture partners (Note 8). During fiscal 1998, 1997, and 1996, the
Company paid $4.2 million, $4.2 million, and $4.6 million, respectively, under
these agreements.
Management Fees
One of the Operating Companies has entered into management agreements with
a related party of its joint venture partner for the day-to-day operation of its
facility and the procurement and management of fuel. During fiscal 1998, 1997,
and 1996, the Company paid $386,000, $368,000, and $350,000, respectively, under
these agreements.
19
<PAGE>
9. Related-party Transactions (continued)
Thermo Electron Guarantees
Thermo Electron has issued an operating standards support agreement for
each of the facilities leased or financed by the Operating Companies. These
agreements provide that Thermo Electron will loan the Operating Companies, on a
subordinated basis, enough funds to meet their lease or debt payments in the
event the power plants are unable to generate power at a designated level and
such inability is related to the design, construction, operation, or maintenance
of the plants and not caused by certain uncontrollable circumstances.
Thermo Electron has also guaranteed the lease payments of one of the
Operating Companies under certain events. Under the terms of this guarantee,
Thermo Electron will loan funds to the Operating Company to cover any shortfall
in its lease payment in the event and to the extent the terms of the Operating
Company's power purchase agreements are changed by Public Service Company of New
Hampshire (PSNH; Note 10). No such payments have been required under this
guarantee.
The Company and Thermo Electron have entered into a Master Guarantee
Reimbursement Agreement through which the Company will reimburse Thermo Electron
in the event that Thermo Electron is required to make any payments pursuant to
guarantees, including those guarantees described above.
Operating Lease
See Note 8 for a description of the Company's operating lease with Thermo
Electron.
Long-term Obligations
See Note 12 for a description of long-term obligations of the Company held
by Thermo Electron.
Repurchase Agreement
The Company invests excess cash in a repurchase agreement with Thermo
Electron as discussed in Note 1.
10. Contingencies
Two of the Operating Companies have rate orders from the New Hampshire
Public Utilities Commission (NHPUC) to sell all of their power to 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 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 was any party
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 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
20
<PAGE>
10. Contingencies (continued)
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 as to whether PSNH's claim could then
be heard by the court. In April 1997, the court ruled that it could hear the
case and ordered that the restraining order 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 agreement. No assurances may
be made as to the outcome of this matter. 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.
The Company is contingently liable with respect to lawsuits and matters
that arose in the normal course of business. In the opinion of management, these
contingencies will not have a material adverse effect on the financial position
or results of operations of the Company.
11. Termination of Power-sales Agreement
In August 1993, in exchange for a cash payment, the Company agreed to
terminate a power-sales agreement with a utility, which required the utility to
purchase the power that was to be generated by the Company's 55-megawatt natural
gas cogeneration facility under development in Staten Island, New York.
Under the agreement, the Company received $18.0 million in a series of
payments through May 1997, plus interest at 5.8%. The Company would have been
obligated to return $8.2 million of this amount if the Company had elected to
proceed with the Staten Island facility and the plant were to commence
commercial operation before January 1, 2000. Accordingly, the Company deferred
recognition of $8.2 million through fiscal 1996, pending final determination of
the project's status.
During fiscal 1997, the Company determined that due to continuing economic
conditions in the domestic energy market it would not be feasible to design,
construct, and commence commercial operation of the Staten Island facility prior
to January 1, 2000. As a result, the refund obligation terminated and the
previously deferred revenue was recognized during fiscal 1997.
21
<PAGE>
12. Long-term Obligations
Long-term obligations consist of the following:
<TABLE>
<CAPTION>
<S> <C> <C>
(In thousands except per share amounts) 1998 1997
- -------------------------------------------------------------------------------------- ---------- ----------
8.3% Nonrecourse Tax-exempt Revenue Bonds, Series 1989 (payable in $ 17,400 $ 20,700
semi-annual installments, with a final payment in December 2000)
8.3% Nonrecourse Tax-exempt Revenue Bonds, Series 1990 (payable in 18,200 22,000
semi-annual installments, with a final payment in December 2000)
6.0% Nonrecourse Tax-exempt Revenue Bonds, Series 1991 (payable in 16,200 35,200
semi-annual installments, with a final payment in June 2000)
Noninterest-bearing Subordinated Convertible Debentures, due March 2001 2,450 12,148
(convertible at $13.56 per share)
4.875% Subordinated Convertible Debentures, due April 2004 (convertible at 44,950 50,000
$16.50 per share)
4.0% Subordinated Convertible Debentures, due January 2001 (convertible at - 68,500
$6.33 per share, due to Thermo Electron)
--------- ---------
99,200 208,548
Less: Current Portion of Long-term Obligations 18,100 26,100
--------- ---------
$ 81,100 $ 182,448
========= =========
The annual requirements for long-term obligations are as follows:
(In thousands)
- -------------------------------------------------------------------------------------- ---------- ----------
1999 $18,100
2000 19,200
2001 16,950
2002 -
2003 -
Thereafter 44,950
-------
$99,200
=========
</TABLE>
The Company's noninterest-bearing and 4.875% subordinated convertible
debentures are guaranteed on a subordinated basis by Thermo Electron.
In May 1998, Thermo Electron converted $68.5 million principal amount of
the 4.0% subordinated convertible debentures into 10,815,846 shares of the
Company's common stock. In fiscal 1998 and 1997, $14.7 million and $19.6 million
principal amount, respectively, of the noninterest-bearing and 4.875%
subordinated convertible debentures were converted into 1,021,244 shares and
1,443,869 shares, respectively, of the Company's common stock.
The tax-exempt revenue bonds were issued by the California Pollution
Control Financing Authority to finance the construction of the Delano I and
Delano II facilities. The obligations are credit-enhanced by a letter of credit
issued by a bank group. Repayment of the debt is an obligation of Delano and the
obligations are nonrecourse to the Company. As of October 3, 1998, Delano I and
Delano II plant and equipment totaling approximately $173.0 million were
collateral for this debt.
22
<PAGE>
12. Long-term Obligations (continued)
The Company leases the Mendota facility under a capital lease. The
carrying amount of the facility is $47.0 million, which is included in property,
plant, and equipment, net in the accompanying balance sheet.
The future minimum lease payments under the Mendota lease are as follows:
<TABLE>
<CAPTION>
<S> <C>
(In thousands)
- ------------------------------------------------------------------------------------- ---------- ----------
1999 $12,033
2000 12,868
-------
24,901
Less: Amount Representing Interest 2,623
-------
Present Value of Minimum Lease Payments 22,278
Less: Current Portion 9,932
-------
Long-term Capital Lease Obligations $12,346
=======
</TABLE>
See Note 14 for information pertaining to the fair value of the Company's
long-term obligations.
13. Business Segments, Significant Customers, and Concentrations of Credit
Risk
The Company's business is divided into two segments. The Energy segment
operates independent electric power-generation facilities, a subbituminous
coal-beneficiation facility, and a natural gas business. The Biopesticides
segment manufactures and sells biopesticides through the Company's
majority-owned Thermo Trilogy subsidiary.
Revenues from three electric utility customers as a percentage of total
revenues were approximately 16%, 30%, and 30% in fiscal 1998; 18%, 31%, and 32%
in fiscal 1997; and 21%, 36%, and 36% in fiscal 1996.
At fiscal year-end 1998 and 1997, a significant amount of accounts
receivable due to the Company was from its four electric utility customers. The
Company does not normally require collateral or other security to support its
accounts receivable. Management does not believe that this concentration of
credit risk has or will have a significant negative impact on the Company.
23
<PAGE>
13. Business Segments, Significant Customers, and Concentrations of Credit
Risk (continued)
Information for fiscal 1998, 1997, and 1996, with respect to the Company's
business segments, is shown in the following table.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands) 1998 1997 1996
- --------------------------------------------------------------------------- ---------- ---------- ---------
Revenues:
Energy $ 175,943 $164,261 $148,389
Biopesticides 33,028 15,930 1,687
--------- -------- ---------
$ 208,971 $180,191 $ 150,076
========= ======== =========
Income (Loss) Before Provision for Income Taxes and Minority
Interest:
Energy $ 55,257 $ 55,662 $ 44,146
Biopesticides 2,749 (146) (337)
Corporate (a) (8,889) (8,418) (7,834)
--------- -------- ---------
Total operating income 49,117 47,098 35,975
Interest and other expense, net (525) (8,804) (9,649)
--------- -------- ---------
$ 48,592 $ 38,294 $ 26,326
========= ======== =========
Identifiable Assets:
Energy $ 418,571 $384,002 $ 383,693
Biopesticides 50,620 29,338 8,814
Corporate (b) 35,920 71,965 56,638
--------- -------- ---------
$ 505,111 $485,305 $ 449,145
========= ======== =========
Depreciation and Amortization:
Energy $ 21,260 $ 20,106 $ 20,120
Biopesticides 2,385 1,000 125
Corporate 258 512 180
--------- -------- ---------
$ 23,903 $ 21,618 $ 20,425
========= ======== =========
Capital Expenditures:
Energy $ 46,261 $ 16,528 $ 36,579
Biopesticides 1,943 1,167 -
Corporate 219 15 8
--------- -------- ---------
$ 48,423 $ 17,710 $ 36,587
========= ======== =========
</TABLE>
(a) Primarily general and administrative expenses
(b) Primarily cash and cash equivalents
24
<PAGE>
14. Fair Value of Financial Instruments
The Company's financial instruments consist mainly of cash and cash
equivalents, restricted funds, accounts receivable, due from parent company,
long-term available-for-sale investment, current portion of long-term
obligations, accounts payable, due to parent company, long-term obligations,
forward exchange contracts, and interest rate swaps. The carrying amounts of
these financial instruments, with the exception of long-term available-for-sale
investments, due from parent company, long-term obligations, forward exchange
contracts, and interest rate swaps, approximate fair value due to their
short-term nature.
The Company's long-term available-for-sale investments are carried at fair
value in the accompanying balance sheet. The fair value was determined based on
a quoted market price. See Note 2 for the fair value information pertaining to
this financial instrument. The carrying amount of due from parent company in the
accompanying 1997 balance sheet approximates fair value.
During fiscal 1997, the Company entered into a forward exchange contract
to hedge certain customer deposits denominated in currencies other than its
foreign subsidiary's local currency. The purpose of the Company's foreign
currency hedging activities was to protect the Company's local currency cash
flows related to the customer deposits from fluctuations in foreign exchange
rates. The Company was not party to any foreign exchange contracts at year-end
1998. The carrying amount and fair value of the Company's long-term obligations
and off-balance sheet financial instruments are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
1998 1997
-------------------- ---------------------
Carrying Fair Carrying Fair
(In thousands) Amount Value Amount Value
- --------------------------------------------------------------- ---------- ---------- ---------- ----------
Long-term Obligations:
Convertible obligations $ 47,400 $47,617 $130,648 $ 224,294
Other long-term obligations 46,046 48,098 74,042 64,861
-------- ------- -------- ---------
$ 93,446 $95,715 $204,690 $ 289,155
======== ======= ======== =========
Off-balance-sheet Financial Instruments:
Interest rate swaps (receivable) payable $(2,052) $ 9,199
Foreign exchange contract payable - 69
</TABLE>
The fair value of long-term obligations was determined based on quoted
market prices and on borrowing rates available to the Company at the respective
year ends. The fair value of convertible obligations at fiscal year-end 1998 and
1997 exceeds the carrying amount primarily due to the market price of the
Company's common stock exceeding the conversion price of the convertible
obligations.
Interest rate swap agreements are in place on the borrowings associated
with the Delano I and Delano II facilities and are with a different
counter-party than the holders of the underlying debt. These swaps have terms
expiring in December 2000 commensurate with the final maturity of the debt. The
swaps have effectively converted floating rate debt to fixed rate borrowings.
Management believes any credit risk associated with the swaps is remote. The
notional amount of the swap agreements was $53.6 million and $77.7 million at
fiscal year-end 1998 and 1997, respectively. The fair value of such agreements
is the estimated amount that the Company would pay upon termination of the
contract, taking into account the change in market interest rates and
creditworthiness of the counterparties. During fiscal 1998 and 1997, the average
variable rate received under the swap agreement was 3.6% and 3.5%, respectively.
The fair value of forward exchange contracts in fiscal 1997 was the
estimated amount that the Company would be required to pay if it were to
terminate the contract, taking into account the change in foreign exchange
rates.
25
<PAGE>
15. Earnings per Share
Basic and diluted earnings per share were calculated as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(In thousands except per share amounts) 1998 1997 1996
- ------------------------------------------------------------------------------ -------- --------- --------
Basic
Net Income $31,209 $ 22,545 $17,780
------- -------- -------
Weighted Average Shares 29,299 24,613 23,528
------- -------- -------
Basic Earnings per Share $ 1.07 $ .92 $ .76
======= ======== =======
Diluted
Net Income $31,209 $ 22,545 $17,780
Effect of:
Convertible debentures 2,387 2,374 1,644
Majority-owned subsidiary's dilutive securities (13) - -
------- -------- -------
Income Available to Common Shareholders, as Adjusted $33,583 $ 24,919 $19,424
------- -------- -------
Weighted Average Shares 29,299 24,613 23,528
Effect of:
Convertible debentures 9,541 13,746 12,262
Stock options 312 381 502
------- -------- -------
Weighted Average Shares, as Adjusted 39,152 38,740 36,292
------- -------- -------
Diluted Earnings per Share $ .86 $ .64 $ .54
======= ======== =======
</TABLE>
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 October 3, 1998, there were 105,500 of such options
outstanding, with exercise prices ranging from $19.23 to $19.25 per share.
26
<PAGE>
16. Unaudited Quarterly Information
<TABLE>
<CAPTION>
(In thousands except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
1998 First(a) Second Third Fourth(b)
- --------------------------------------------------------------- --------- ------------ ---------- ----------
Revenues $47,809 $47,207 $50,748 $63,207
Gross Profit 16,414 13,562 16,328 27,161
Net Income 9,258 4,198 4,824 12,929
Earnings per Share:
Basic .38 .17 .15 .36
Diluted .25 .13 .14 .34
1997 First Second(c) Third Fourth(d)
- --------------------------------------------------------------- --------- ------------ ---------- ----------
Revenues $38,514 $38,674 $43,524 $59,479
Gross Profit 12,260 9,557 14,340 29,424
Net Income 4,300 952 3,598 13,695
Earnings per Share:
Basic .18 .04 .15 .56
Diluted .12 .04 .11 .37
</TABLE>
(a) Reflects the November 1997 acquisition of the Bt business of Novartis and a
nontaxable gain of $6.3 million from the issuance of stock by subsidiary
(b) Reflects the inclusion of $1.9 million of fees received from the release by
the Company of certain rights relating to power-generating equipment
(c) Reflects the January 1997 acquisition of the biosys business
(d) Reflects the inclusion of $8.2 million of previously deferred revenue in
connection with the termination of a power-sales agreement relating to a
cogeneration facility in Staten Island, New York
17. Subsequent Event
In November 1998, the Company's employees, excluding its officers and
directors, were offered the opportunity to exchange previously granted options
to purchase shares of Company common stock for an amount of options equal to
half of the number of options previously held, exercisable at a price equal to
the fair market value at the time of the exchange offer. Holders of options to
acquire 71,200 shares at a weighted average exercise price of $14.93 elected to
participate in this exchange and, as a result, received options to purchase
35,600 shares of Company common stock at $10.58 per share. The other terms of
the new options are the same as the exchanged options except that the holders
may not sell shares purchased pursuant to such new options for six months from
the exchange date.
27
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Report of Independent Public Accountants
To the Shareholders and Board of Directors of Thermo Ecotek Corporation:
We have audited the accompanying consolidated balance sheet of Thermo
Ecotek Corporation (a Delaware corporation and 94%-owned subsidiary of Thermo
Electron Corporation) and subsidiaries as of October 3, 1998, and September 27,
1997, and the related consolidated statements of income, shareholders'
investment, and cash flows for each of the three years in the period ended
October 3, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Thermo
Ecotek Corporation and subsidiaries as of October 3, 1998, and September 27,
1997, and the results of their operations and their cash flows for each of the
three years in the period ended October 3, 1998, in conformity with generally
accepted accounting principles.
Arthur Andersen LLP
Boston, Massachusetts November 9, 1998 (except with respect to the matter
discussed in Note 17, as to which the date is November 24, 1998)
28
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
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 immediately after this Management's
Discussion and Analysis of Financial Condition and Results of Operations under
the heading "Forward-looking Statements."
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) and a natural gas business (Star Natural Gas). The
Biopesticides 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 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 K-Fuel
Facility reports operating losses for financial reporting purposes, primarily as
a result of recording depreciation over the expected life of 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, indirectly acquired a majority 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.
During fiscal 1998, the Company established its Star Natural Gas
subsidiary in Dallas, Texas, to pursue opportunities in the natural gas
gathering, processing, storage, and marketing business.
29
<PAGE>
Overview (continued)
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, bacculovirus, 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). 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 results.
Since its inception, the Company has derived a substantial majority of its
revenue from the development, construction, and operation of biomass-fueled
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.
Results of Operations
Fiscal 1998 Compared With Fiscal 1997
Total revenues increased 16% to $209.0 million in fiscal 1998 from $180.2
million in fiscal 1997. Revenues from the Energy segment increased to $176.0
million in fiscal 1998 from $164.3 million in 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
$6.0 million of revenues from the Czech Republic operations, acquired in January
1998. Revenues in fiscal 1998 included $1.9 million of fees received from the
release by the Company of certain rights relating to power-generating equipment.
Revenues in fiscal 1997 included $8.2 million of previously deferred revenues
related to an August 1993 agreement with a utility (Note 11). From various dates
in 1998 onward, no further rate increases will occur at the Company's four
California energy facilities.
Revenues at Thermo Trilogy increased to $33.0 million in fiscal 1998 from
$15.9 million in fiscal 1997. The increase was primarily due to the inclusion of
$14.6 million of revenues from the Bt business of Novartis, acquired in November
1997.
The gross profit margin decreased to 35% in fiscal 1998 from 36% in fiscal
1997. The gross profit margin for the Energy segment decreased to 34% in fiscal
1998 from 36% in fiscal 1997. The decrease was primarily due to the effect on
gross profit in fiscal 1997 of recording $8.2 million of previously deferred
revenues and, to a lesser extent, losses in fiscal 1998 at the Company's K-Fuel
Facility associated with its early stages of operations. As discussed in the
overview, the economics of this facility arise from tax benefits and it reports
losses for financial reporting purposes.
The gross profit margin for Thermo Trilogy decreased to 42% in fiscal 1998
from 43% in fiscal 1997, primarily due to the inclusion of lower-margin revenues
from the Bt business of Novartis.
30
<PAGE>
Fiscal 1998 Compared With Fiscal 1997 (continued)
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. 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 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 1998, the Mendota and Delano plants'
aggregate operating income was approximately $43.0 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 reduced
to approximately breakeven in fiscal 1998. During fiscal 1997 and 1996, the
Woodland plant contributed $1.0 million and $5.1 million of operating income,
respectively. If PG&E ultimately prevails in its assertion that its obligation
to pay fixed rates ends in mid-1999, and if the Company is unsuccessful in
renegotiating the terms of its lease or its power purchase agreement with PG&E,
the Company's investment in its Woodland operating assets could be impaired by
approximately $3 to 5 million, based on projected cash flows. This impairment
and the operating losses that would arise in fiscal 1999 if the Woodland
facility's operating costs exceeded its revenues would adversely affect the
Company's future results of operations.
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. The Company continues to experience 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 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
increased to 11% in fiscal 1998 from 9% in fiscal 1997. The increase resulted
primarily from the inclusion of higher selling, general, and administrative
expenses as a percentage of revenues at Thermo Trilogy due to the acquisition of
the Bt business of Novartis.
Research and development expenses represent Thermo Trilogy's ongoing new
product development and increased to $2.4 million in fiscal 1998 from $1.6
million in fiscal 1997 due to the inclusion of expenses from the Bt business of
Novartis.
31
<PAGE>
Fiscal 1998 Compared With Fiscal 1997 (continued)
Interest income decreased to $4.1 million in fiscal 1998 from $5.1 million
in 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, construction of the K-Fuel Facility, and the
purchase of power-generation facilities and related sites in California.
Interest expense decreased to $11.0 million in fiscal 1998 from $13.9
million in 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.
The Company and 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 subsidiary through the establishment of subsidiary-level stock
option incentive programs, as well as capital to support the subsidiaries'
growth. As a result of the issuance of common stock by Thermo Trilogy in fiscal
1998, the Company recorded a gain of $6.3 million. This gain represents an
increase in the Company's proportionate share of the subsidiary's equity and is
classified as gain on issuance of stock by subsidiary in the accompanying
statement of income. 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 would 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 equity of the consolidated entity
with no gain or loss being recorded. The exposure draft addresses the
consolidation issues in two parts: consolidation procedures, which includes
proposed rule changes affecting the Company's ability to recognize gains on
issuances of subsidiary stock, and consolidation policy, which does not address
accounting for such gains. During 1997, the FASB decided to focus its efforts on
the consolidation policy part of the exposure draft and to consider resuming
discussion on consolidation procedures after completion of the efforts on
consolidation policy. The timing and content of any final statement are
uncertain.
Equity in earnings of joint venture represents the Company's proportionate
share of earnings from a joint venture.
The effective tax rates were 32% and 38% in fiscal 1998 and fiscal 1997,
respectively. The effective tax rate in 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,
offset in part by state income taxes. The effective tax rate in 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.
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.
Fiscal 1997 Compared With Fiscal 1996
Revenues increased 20% to $180.2 million in fiscal 1997 from $150.1
million in fiscal 1996. Revenues from the Energy segment increased to $164.3
million in fiscal 1997 from $148.4 million in fiscal 1996. During fiscal 1997,
the Company decided not to proceed in its development of a natural gas
cogeneration facility in Staten Island, New York and, accordingly, recorded $8.2
million of previously deferred revenues related to an August 1993 agreement with
a utility (Note 11). The increase in revenues was also due to higher contractual
energy rates at all of the Company's facilities, except the Hemphill plant.
32
<PAGE>
Fiscal 1997 Compared With Fiscal 1996 (continued)
Revenues at Thermo Trilogy increased to $15.9 million in fiscal 1997 from
$1.7 million in fiscal 1996. The increase was due to the inclusion of a full
year of operations of the biopesticide business of Grace, acquired in May 1996,
as well as the acquisition of the biosys business in January 1997.
The gross profit margin increased to 36% during fiscal 1997 from 32% in
fiscal 1996. The gross profit margin for the Energy segment increased to 36% in
fiscal 1997 from 32% in fiscal 1996. The improvement results primarily from the
effect of the Staten Island agreement and, to a lesser extent, the effect of
higher contractual energy rates. The increases were offset in part by lower
profitability at the Company's Woodland plant as discussed in the results of
operations for fiscal 1998.
The gross profit margin for Thermo Trilogy decreased to 43% in fiscal 1997
from 59% in fiscal 1996, primarily due to the inclusion of lower-margin revenues
from the biosys business.
Selling, general, and administrative expenses as a percentage of revenues
increased to 9% in fiscal 1997 from 8% in fiscal 1996. The increase resulted
primarily from the inclusion of higher selling, general, and administrative
expenses as a percentage of revenues at the biopesticide business of Grace for a
full year, offset in part by higher revenues.
Research and development expenses represent Thermo Trilogy's ongoing new
product development and increased to $1.6 million in fiscal 1997 from $0.7
million in fiscal 1996 due to the inclusion of a full year of expenses of the
biopesticide business of Grace in fiscal 1997, as well as the inclusion of
expenses from the biosys business.
Interest income was unchanged at $5.1 million in fiscal 1997 and fiscal
1996. Increases in fiscal 1997 invested balances as a result of the Company's
April 1997 issuance of 4.875% subordinated convertible debentures and operating
cash flows were offset by amounts expended for the repurchase of the Company's
common stock, construction of the Gillette, Wyoming, coal-beneficiation
facility, and the January 1997 acquisition of biosys. Interest expense decreased
to $13.9 million in fiscal 1997 from $14.7 million in fiscal 1996, due to lower
outstanding debt related to the Company's Delano and Mendota plants, offset in
part by an increase in interest expense due to the April 1997 issuance of 4.875%
subordinated convertible debentures.
Equity in earnings (loss) of joint venture represents the Company's
proportionate share of the results of a joint venture.
The effective tax rates were 38% and 28% in fiscal 1997 and 1996,
respectively. The fiscal 1997 rate exceeded the statutory federal income tax
rate as a result of the impact of state income taxes, offset in part by the
exclusion of income taxed directly to a minority partner. The effective tax rate
in fiscal 1996 was lower than the statutory federal income tax rate due to the
full utilization of tax loss and credit carryforwards as a result of the
resolution of certain tax contingencies, offset in part by the impact of state
income taxes.
Minority interest expense represents the allocation of income from plant
operations to a minority partner in an Operating Company.
Liquidity and Capital Resources
Working capital was $83.6 million at October 3, 1998, compared with
$90.7 million at September 27, 1997. The Company had cash, cash equivalents, and
current restricted funds of $65.9 million at October 3, 1998, compared with
$104.3 million at September 27, 1997. Current restricted funds held in trust
pursuant to certain lease and debt agreements totaled $24.5 million and $20.8
million at October 3, 1998, and September 27, 1997, respectively. In addition,
cash and cash equivalents in the accompanying balance sheet include $12.0
million and $10.8 million at October 3, 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 fiscal 1998, the Company's operating activities provided
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Liquidity and Capital Resources (continued)
cash and restricted funds of $53.8 million. Cash from the Company's operations
was offset in part by $12.5 million of cash used to fund an increase in accounts
receivable. Cash of $6.4 million was provided by an increase in accounts
payable. These increases were primarily 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 fiscal 1998, the Company's investing activities used cash of $63.2
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). The Company expended $48.4 million for purchases of
property, plant, and equipment, as follows: In fiscal 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 $10.5 million for
the construction of the K-Fuel Facility. In January 1998, the Company, through a
wholly owned subsidiary's participation in a joint venture, indirectly acquired
a majority 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 $16.6 million in construction
costs. During fiscal 1999, the Company expects to make capital expenditures of
approximately $22 million, primarily for the expansion of the Czech Republic
operations.
During fiscal 1998, the Company's financing activities used cash of $29.0
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 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 October 3, 1998, the Company had repurchased $29.9 million in common
stock under these authorizations, including $10.2 million during 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. 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 total cost of
this expansion will be $32 million, of which it expects approximately 50% will
ultimately 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. In addition, the Company is
in the early stages of developing projects in Italy 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, invests in, or
develops future plants, the Company may seek 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.
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Market Risk
The Company is exposed to market risk from changes in equity prices,
foreign currency exchange rates, and interest rates, which could affect its
future results of operations and financial condition. The Company manages its
exposure to these risks through its regular operating and financing activities.
Equity Prices
The Company's long-term available-for-sale investment includes an equity
security that is sensitive to fluctuations in price. In addition, the Company's
convertible obligations are sensitive to fluctuations in the price of Company
common stock into which the obligations are convertible. Changes in equity
prices would result in changes in the fair value of the Company's long-term
available-for-sale investment and convertible obligations due to the difference
between the current market price and the market price at the date of purchase or
issuance of the financial instrument. A 10% increase in the fiscal year-end 1998
market equity prices would result in a negative impact of $6.2 million on the
net fair value of the Company's price-sensitive equity financial instruments.
Foreign Currency Exchange Rates
The Company generally views its investment in foreign subsidiaries with a
functional currency other than the Company's reporting currency as long-term.
The Company's investment in foreign subsidiaries is sensitive to fluctuations in
foreign currency exchange rates. The functional currencies of the Company's
foreign subsidiaries are principally denominated in Czech koruna and British
pounds sterling. The effect of a change in foreign exchange rates on the
Company's net investment in foreign subsidiaries is recorded as a separate
component of shareholders' investment. A 10% depreciation in fiscal year-end
1998 functional currencies, relative to the U.S. dollar, would result in a $0.8
million reduction of shareholders' investment.
Interest Rates
The Company's long-term obligations and interest rate swap agreements are
sensitive to changes in interest rates. Interest rate changes would result in a
change in the fair value of these financial instruments due to the difference
between the market interest rate and the rate at the date of purchase or
issuance of the financial instrument. A 10% decrease in fiscal year-end 1998
market interest rates would result in a negative impact of $0.4 million on the
net fair value of the Company's interest-sensitive financial instruments.
Year 2000
The Company continues to assess the potential impact of the year 2000 on
the Company's internal business systems, products, and operations. The Company's
year 2000 initiatives include: (i) testing and upgrading internal business
systems and facilities; (ii) contacting key suppliers, vendors, and customers to
determine their year 2000 compliance status; and (iii) developing contingency
plans.
The Company's State of Readiness
The Company is in the process of testing and evaluating its critical
information technology systems for year 2000 compliance, including its
significant computer systems, software applications, and related equipment. The
Company is also currently in the process of upgrading or replacing its
noncompliant systems. The Company expects that all of its material information
technology systems will be year 2000 compliant by the end of 1999. The Company
is also in the process of hiring a consultant to evaluate the potential year
2000 impact on its facilities, including its buildings and utility systems. Any
problems that are identified will be prioritized and remediated based on their
assigned priority. The Company will continue periodic testing of its critical
internal business systems and facilities in an effort to minimize operating
disruptions due to year 2000 issues.
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Year 2000 (continued)
The Company is in the process of identifying and contacting suppliers,
vendors, and customers that are believed to be significant to the Company's
business operations, including its most significant electric utility customers,
in order to assess their year 2000 readiness. As part of this effort, the
Company is developing and will be distributing questionnaires relating to year
2000 compliance to its significant suppliers, vendors, and customers. The
Company intends to follow-up and monitor the year 2000 compliant progress of
significant suppliers, vendors, and customers that indicate that they are not
year 2000 compliant or that do not respond to the Company's questionnaires.
Contingency Plan
The Company intends to develop a contingency plan that will allow its
primary business operations to continue despite disruptions due to year 2000
problems. This plan may include identifying and securing other suppliers,
increasing inventories, and modifying production facilities and schedules. As
the Company continues to evaluate the year 2000 readiness of its business
systems and facilities, significant suppliers, vendors, and customers, it will
modify and adjust its contingency plan as may be required.
Estimated Costs to Address the Company's Year 2000 Issues
To date, costs incurred in connection with the year 2000 issue have not
been material. The Company does not expect total year 2000 remediation costs to
be material, but there can be no assurance that the Company will not encounter
unexpected costs or delays in achieving year 2000 compliance.
Risks of the Company's Year 2000 Issues
While the Company is attempting to minimize any negative consequences
arising from the year 2000 issue, there can be no assurance that year 2000
problems will not have a material adverse impact on the Company's business,
operations, or financial condition. While the Company expects that upgrades to
its internal business systems will be completed in a timely fashion, there can
be no assurance that the Company will not encounter unexpected costs or delays.
If any of the Company's material suppliers, vendors, or customers experience
business disruptions due to year 2000 issues, the Company might also be
materially adversely affected. The Company's research and development,
production, distribution, financial, administrative, and communications
operations might be disrupted. There is expected to be a significant amount of
litigation relating to the year 2000 issue and there can be no assurance that
the Company will not incur material costs in defending or bringing lawsuits. Any
unexpected costs or delays arising from the year 2000 issue could have a
significant adverse impact on the Company's business, operations, and financial
condition.
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Thermo Ecotek Corporation 1998 Financial Statements
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 fiscal 1999 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 revenue from the development, construction, and
operation of biomass-fueled 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 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.
The Company owns and operates seven U.S. facilities that 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
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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.
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. are 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 projects and may have a
material adverse effect on the profitability of future projects.
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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 1998, the Mendota and Delano plants' aggregate operating income
was approximately $43.0 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 reduced to approximately
breakeven in fiscal 1998. During fiscal 1997 and 1996, the Woodland plant
contributed $1.0 million and $5.1 million of operating income, respectively. If
PG&E ultimately prevails in its assertion that its obligation to pay fixed rates
ends in mid-1999, and if the Company is unsuccessful in renegotiating the terms
of its lease or its power purchase agreement with PG&E, the Company's investment
in its Woodland operating assets could be impaired by approximately $3 to 5
million, based on projected cash flows. This impairment and the operating losses
that would arise in fiscal 1999 if the Woodland facility's operating costs
exceeded its revenues would adversely affect the Company's future results of
operations.
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 at each plant. PG&E
normally 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. In November 1997, the Company renegotiated
PG&E's curtailment rights, limiting PG&E to 500 hours per year effective January
1, 1998. During fiscal 1998, the Company experienced approximately 780 hours of
utility imposed curtailments at each of these plants.
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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
agreements 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
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 1998, Public Service of New Hampshire (PSNH), SCE, and
PG&E accounted for 16%, 30%, and 30%, 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
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accordance with the terms thereof if approved by NHPUC nor was any party
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 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 as to whether
PSNH's claim could then be heard by the court. In April 1997, the court ruled
that it could hear the case and ordered that the restraining order 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.
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.
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<PAGE>
The Evolving California Electric Utility Market. The electric utility
market in California has undergone a complex restructuring which is not yet
complete. The 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.
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 K-Fuel Facility). The plant
utilizes 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 believes that the K-Fuel Facility qualifies for
a federal tax credit 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. 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.
The Company continues to experience 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 Company will be able to 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 K-Fuel Facility reports
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
42
<PAGE>
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.
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 establish such a market among potential customers
such as electrical utility companies and industrial coal users. Many 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.
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<PAGE>
Furthermore, the Company's license to the K-Fuel technology at the K-Fuel
Facility is nonexclusive 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.
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.
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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.
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 50% 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.
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.
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<PAGE>
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 biopesticides 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 October 3, 1998, the Company and its
subsidiaries had funds totaling $92.1 million of which approximately $62.7
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
operations, other than cash 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,
46
<PAGE>
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 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.
While the Company is attempting to minimize any negative consequences arising
from the year 2000 issue, there can be no assurance that year 2000 problems will
not have a material adverse impact on the Company's business, operations, or
financial condition. While the Company expects that upgrades to its internal
business systems will be completed in a timely fashion, there can be no
assurance that the Company will not encounter unexpected costs or delays. If any
of the Company's material suppliers, vendors, or customers experience business
disruptions due to year 2000 issues, the Company might also be materially
adversely affected. The Company's research and development, production,
distribution, financial, administrative, and communications operations might be
disrupted. There is expected to be a significant amount of litigation relating
to the year 2000 issue and there can be no assurance that the Company will not
incur material costs in defending or bringing lawsuits. Any unexpected costs or
delays arising from the year 2000 issue could have a significant adverse impact
on the Company's business, operations, and financial condition.
Risks Associated With International Operations. International sales
accounted for 7% of the Company's total revenues in fiscal 1998. 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.
47
<PAGE>
Thermo Ecotek Corporation 1998 Financial Statements
Selected Financial Information
<TABLE>
<CAPTION>
Nine
Months Year
Year Ended Ended Ended
------------------------------------------ -------- ---------
<S> <C> <C> <C> <C> <C> <C>
(In thousands except per share amounts) Oct. 3, Sept. 27, Sept. 28, Sept. 30, Sept. 30, Dec. 31,
1998 (a) 1997 (b) 1996 (c) 1995 1995 (d) 1994
- ------------------------------------------- ---------- --------- ---------- ---------- ---------- ----------
(Unaudited)
Statement of Income Data
Revenues $ 208,971 $180,191 $ 150,076 $ 139,319 $ 107,139 $ 134,261
Net Income 31,209 22,545 17,780 12,540 10,264 9,651
Earnings per Share:
Basic 1.07 .92 .76 .58 .46 .49
Diluted .86 .64 .54 .43 .34 .37
Weighted Average Shares:
Basic 29,299 24,613 23,528 21,796 22,477 19,824
Diluted 39,152 38,740 36,292 33,014 33,815 30,934
Balance Sheet Data
Working Capital $ 83,589 $ 90,714 $ 76,217 $ 58,361 $ 28,418
Total Assets 505,111 485,305 449,145 390,476 285,970
Long-term Obligations 93,446 204,690 209,281 202,360 163,800
Shareholders' Investment 249,632 147,276 129,687 92,985 55,146
</TABLE>
(a) Reflects the November 1997 acquisition of the Bt business of Novartis, a
nontaxable gain of $6.3 million from the issuance of stock by a subsidiary,
and the conversion by Thermo Electron of $68.5 million principal amount of
4% subordinated convertible debentures.
(b) Reflects the January 1997 acquisition of the business of biosys, inc. and
the April 1997 issuance of $50.0 million principal amount of 4.875%
subordinated convertible debentures.
(c) Reflects the March 1996 issuance of $37.0 million principal amount of
noninterest-bearing subordinated convertible debentures and the May 1996
acquisition of the biopesticides division of W.R. Grace & Co.
(d) In June 1995, the Company changed its fiscal year end from the Saturday
nearest December 31 to the Saturday nearest September 30. Accordingly, the
Company's 39-week transition period ended September 30, 1995, is presented.
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Thermo Ecotek Corporation 1998 Financial Statements
Common Stock Market Information
The Company's common stock is traded on the American Stock Exchange under
the symbol TCK. The following table sets forth the high and low sale prices of
the Company's common stock for fiscal 1998 and 1997, as reported in the
consolidated transaction reporting system.
<TABLE>
<CAPTION>
1998 1997
-------------------- ----------------------
<S> <C> <C> <C> <C>
Quarter High Low High Low
- --------------------------------------------------------------- ---------- ---------- ---------- -----------
First $18 1/2 $13 $16 1/4 $14 1/2
Second 19 3/4 16 3/4 15 3/4 14 1/8
Third 19 3/4 15 5/8 16 11 3/8
Fourth 16 7/8 14 1/8 15 1/2 13 1/4
</TABLE>
As of October 30, 1998, the Company had 666 holders of record of its
common stock. This does not include holdings in street or nominee names. The
closing market price on the American Stock Exchange for the Company's common
stock on October 30, 1998, was $12 7/16 per share.
Stock Transfer Agent
American Stock Transfer & Trust Company is the stock transfer agent and
maintains shareholder activity records. The agent will respond to questions on
issuance of stock certificates, change of ownership, lost stock certificates,
and change of address. For these and similar matters, please direct inquiries
to:
American Stock Transfer & Trust Company
Shareholder Services Department
40 Wall Street, 46th Floor
New York, New York 10005
(718) 921-8200
Shareholder Services
Shareholders of Thermo Ecotek Corporation who desire information about the
Company are invited to contact the Investor Relations Department, Thermo Ecotek
Corporation, 81 Wyman Street, P.O. Box 9046, Waltham, Massachusetts 02454-9046,
(781) 622-1111. A mailing list is maintained to enable shareholders whose stock
is held in street name, and other interested individuals, to receive quarterly
reports, annual reports, and press releases as quickly as possible. Quarterly
distributions of printed reports are limited to the second quarter report only.
All quarterly reports and press releases are available through the Internet from
Thermo Electron's home page (http://www.thermo.com/subsid/tck1.html).
Dividend Policy
The Company has never paid cash dividends because its policy has been to
use earnings to finance expansion and growth. Payment of dividends will rest
within the discretion of the Board of Directors and will depend upon, among
other factors, the Company's earnings, capital requirements, and financial
condition. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of certain restrictions applicable to
the use of certain funds.
Form 10-K Report
A copy of the Annual Report on Form 10-K for the year ended October 3,
1998, as filed with the Securities and Exchange Commission, may be obtained
without charge by writing to the Investor Relations Department, Thermo Ecotek
Corporation, 81 Wyman Street, P.O. Box 9046, Waltham, Massachusetts 02454-9046.
Annual Meeting
The annual meeting of shareholders will be held on Wednesday, March 10,
1999, at Thermo Electron Corporation, 81 Wyman Street, Waltham, Massachusetts.
Exhibit 23
Consent of Independent Public Accountants
As independent public accountants, we hereby consent to the
incorporation by reference of our reports dated November 9, 1998 (except
with respect to the matter discussed in Note 17, as to which the date is
November 24, 1998), included in or incorporated by reference into Thermo
Ecotek Corporation's Form 10-K for the fiscal year ended October 3, 1998,
into the Company's previously filed Registration Statement on Form S-8
(No. 33-91538), Registration Statement on Form S-8 (No. 33-91542),
Registration Statement on Form S-8 (No. 33-91546), Registration Statement
on Form S-8 (No. 33-91544), Registration Statement on Form S-8 (No.
33-91548), and Registration Statement on Form S-8 (No. 33-80753).
Arthur Andersen LLP
Boston, Massachusetts
January 8, 1999
