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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X]Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended December 31, 1997.
[_]Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from to
.
COMMISSION FILE NUMBER
0-20819
THERMATRIX INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C> <C>
DELAWARE 94-2958515
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
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101 METRO DRIVE, SUITE 248
SAN JOSE, CALIFORNIA 95110
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 453-0490
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK,
$.001 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for at least the past 90 days:
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Paragraph 229.405 of this Chapter) is not contained
herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. X
On February 28, 1998, there were issued and outstanding 7,641,842 shares of
Common Stock. The aggregate market value of Common Stock held by non-
affiliates of the Registrant on that date was approximately $11,780,000, based
on the closing sale price of the Common Stock, as reported by the NASDAQ
National Market.
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PART I
ITEM 1. BUSINESS
FORWARD-LOOKING INFORMATION
Statements in this Report concerning expectations for the future constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
statements are subject to a number of known and unknown risks, uncertainties
and other factors which may cause actual results, performance or achievements
of the Company to differ materially from those expressed or implied by such
forward-looking statements. Relevant risks and uncertainties include, among
others, those discussed in Item 1 of Part I under the heading "Risk Factors"
and elsewhere in this Report and those described from time to time in the
Company's other filings with the Securities and Exchange Commission, press
releases and other communications.
DESCRIPTION OF BUSINESS
Thermatrix Inc. ("Thermatrix" or the "Company") is a global industrial
technology company engaged in the development, manufacture and sale of
industrial process equipment for the destruction of volatile organic compounds
and hazardous air pollutants (collectively, "VOCs"). The core component of the
Company's technology is its proprietary flameless thermal oxidizer ("FTO"),
which is capable of treating virtually all VOCs while achieving destruction
removal efficiency ("DRE") of 99.99% or higher with de minimis formation of
hazardous by-products such as oxides of nitrogen ("NOx"), carbon monoxide
("CO") and products of incomplete combustion ("PICs"). The Company sells its
flameless thermal oxidizer as a stand-alone unit or as an integrated system.
In addition, the Company's product line also includes PADRE(R), a proprietary
technology used to capture and recover very low concentration VOCs from low-
to-medium vapor streams, and through its exclusive marketing agreement with
White Horse Technologies, Inc., B.O.S.S.(TM), a proprietary Boiler Oxidizer
Steam System that destroys VOCs and produces steam for process applications.
To date, the Company has focused on the industrial VOC market where it
believes the Company's FTO system offers the greatest economic and
environmental advantages over other treatment methods. These advantages
include: (i) low operating and maintenance costs; (ii) product safety; (iii)
application to a wide range of VOCs, including difficult-to-treat chlorinated,
sulfonated and fluorinated compounds; (iv) the ability to economically treat
fume streams with variable flows and concentrations; (v) high operating
reliability; (vi) high DRE; and (vii) de minimis formation of hazardous by-
products.
The Company's strategy is to expand the use and application of its
proprietary FTO technology and to become a leading global supplier of
industrial VOC treatment systems by: (i) increasing market penetration for
established applications; (ii) broadening application of the Company's
proprietary FTO technology for new industrial VOC applications; and (iii)
expanding the Company's product line to include complementary technologies.
The Company has achieved a number of significant milestones in
commercializing its technology in the industrial VOC market, including: (i)
establishing the application of its proprietary FTO technology in the
petroleum, chemical/petrochemical, pulp and paper, medical sterilization and
pharmaceutical industries with "market leader" customers, and for soil and
groundwater remediation; (ii) selling more than 70 commercial-scale systems;
(iii) establishing a global sales and marketing organization; and (iv) the
receipt of regulatory approvals by the Company's customers for the use of the
Company's systems in the United States, Canada, England, Ireland, France and
Taiwan. The Company's customers in 1997 included: Chesebrough-Pond's USA Co.,
Formosa Petrochemical Corporation, Mobil Chemical Company, PPG Industries,
Inc., Bayer Corporation, Zeneca, Ltd., B.F. Goodrich, Marathon Oil, BASF, Shin
Foong, Sorex Medical, Zeon Chemicals and Warner-Lambert as well as the United
States Departments of Defense and Energy (the "DOD" and the "DOE",
respectively).
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The Company is pursuing a strategy to selectively provide complementary
technologies in order to expand its presence in the VOC treatment market. In
April 1996, the Company acquired all rights to the PADRE VOC adsorption
technology from Purus, Inc. and in April 1997 the Company entered into an
exclusive marketing agreement with White Horse Technologies, Inc. pursuant to
which the Company has the exclusive right to sell B.O.S.S.(TM).
In addition to its core industrial VOC emissions control business, the
Company has embarked on a strategy of working with strategic partners to
evaluate the feasibility of applying the Company's FTO technology to other
markets. In light of the recent technological advances in the diesel program
and the significant amount of federal and international attention being
focused on particulate matter ("PM") reductions from diesel engines, the
Company is currently focusing its development activities on the application of
the Company's FTO technology to the treatment of emissions from stationary and
mobile diesel engines.
INDUSTRIAL VOC EMISSIONS
VOCs are an unavoidable by-product of many manufacturing and process
industries worldwide and must be controlled due to significant health, safety
and environmental risks. The primary conventional industrial VOC treatment
methods are flame-based thermal oxidation, activated carbon adsorption and
scrubbing systems, which are installed in many industries, including
petroleum, chemical/petrochemical, pulp and paper and pharmaceutical.
In the United States, the health, safety and environmental risks presented
by VOCs have led to significant federal regulations, which are enforced by the
Occupational Safety and Health Administration ("OSHA"), the United States
Environmental Protection Agency ("U.S. EPA") and various state and local
agencies. Non-compliance with these regulations carries substantial civil and
criminal penalties. The United States Clean Air Act Amendments of 1990 (the
"CAAA") significantly expanded the scope of air pollution regulations
established in the 1970s, and required the reduction and control of a wide
range of air pollutants, including 189 hazardous air pollutants ("HAPs"), most
of which are VOCs. The CAAA also addressed for the first time the reduction of
NOx that, in combination with VOCs, produce smog. The CAAA introduced new
regulatory requirements and timetables for the abatement of VOCs and NOx for
most geographic areas that become progressively more stringent through the
year 2010.
In addition, international demand for VOC control equipment is rapidly
growing. While many European nations have comprehensive health, safety and
environmental regulations in force, certain Asian and Latin American nations
have only recently begun to recognize the need to more stringently control VOC
emissions. In addition, many multinational companies have recognized the
benefits of global health, safety and environmental standards and are
collaborating in the development of comprehensive voluntary environmental
performance standards such as ISO 14000.
THE THERMATRIX SYSTEM FOR INDUSTRIAL VOC CONTROL
The core component of the Company's system is its proprietary FTO, a highly
engineered, insulated vessel packed with ceramic material. Due to its
flameless design and consistent temperature profile (between 1600(degrees) and
1800(degrees)F), the Company's FTO system achieves high destruction with very
low energy usage and with de minimis formation of NOx and CO. The FTO system
can also be combined with an energy recovery system if the waste stream
contains a surplus of energy over and above that required for VOC destruction.
Recovery of usable materials from halogenated or sulfonated fume streams is
also possible due to the high DRE of the FTO system.
The Thermatrix technology has the following attributes, which individually
or in combination provide advantages over competing methods for industrial VOC
treatment:
Energy Efficiency. The FTO system can operate effectively on VOC fume
streams of moderate-to-high concentrations with less than 30% of the energy
required for flame-based systems. The FTO's energy efficiency
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is particularly significant in geographic locations where the cost of energy
is many times higher than in the United States.
Safety. The FTO is certified for use in flameproof areas where conventional
flame-based systems are prohibited.
Flexibility. The FTO can process a broad range of VOCs, including difficult-
to-treat compounds and those with variable flows and concentrations.
Reliability. The FTO operates within wide tolerance limits, is fully
automatic, has no moving parts, no catalysts and requires little off-line
maintenance.
High DRE. The Thermatrix system consistently achieves DRE of 99.99% or
higher, which exceeds the DRE achieved by competing technologies. The high DRE
of the Thermatrix system makes it particularly useful in applications
involving the most highly toxic and complex VOCs.
De minimis By-products. The absence of a flame minimizes the formation of
by-products generated by flame-based systems, including NOx, CO and PICs. The
reduced energy requirement for the FTO system also results in a corresponding
reduction in the formation of greenhouse gases.
Regulatory Advantages. The Company's systems often exceed regulatory
performance requirements because of the high DRE and the de minimis formation
of by-products.
In February 1998, the Company successfully completed six months of full-
scale testing of a new FTO design. The oxidizer was reconfigured to create an
almost spherical flameless reaction front within the reactor's ceramic matrix,
as compared to the planar flameless reaction front, which until now was a
signature feature of the Company's technology. The Company believes the new
development will result in the following business advantages and design
features:
. A greater than 60% reduction in the size of a typical non-recuperative
flameless thermal oxidizer for the same processing capability.
. A hot-wall reactor with the ability to process chlorinated, sulfonated and
fluorinated waste streams without the need for expensive and exotic
materials of construction to prevent corrosion.
. The ability to use horizontal as well as vertical vessels, which will
extend the applicable range of non-recuperative oxidizers to over 40,000
scfm.
. The incorporation of electric-assisted preheat, which will enable the
Company to offer flameless startup and operation.
. The ability to offer, for the first time, a flameless thermal oxidizer for
the destruction of hazardous liquids by direct injection into the oxidizer.
. The ability to offer, for the first time, a flameless oxidizer using liquid
fuels such as diesel, kerosene or waste solvents rather than other fuels
such as natural gas or propane, which are not available in all areas.
VOC BUSINESS STRATEGY
The Company seeks to expand the use and application of its proprietary FTO
technology and to become a leading global supplier of industrial VOC treatment
systems. The Company's strategy in the industrial VOC market is to: (i)
increase market penetration for established applications; (ii) broaden
application of the Company's technology in the industrial VOC market; and
(iii) selectively provide complementary technologies in order to expand its
presence in the VOC treatment market. Key elements of the Company's industrial
VOC strategy are as follows:
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Increase Market Penetration for Established Applications. Thermatrix systems
have now been successfully installed in the petroleum, chemical/petrochemical,
pharmaceutical, medical sterilization, and pulp and paper industries, and for
soil and groundwater remediation, at facilities operated by customers such as
Chevron U.S.A. Inc., Dow Chemical Company, PPG Industries, Inc., Simpson Paper
and Bayer Corporation, as well as facilities operated by the DOD and DOE. Many
of these customers have already purchased multiple units. The Company is using
these reference accounts to promote follow-on sales to the same customers and
to expand sales within these industries, both in the United States and
overseas.
Broaden Application of the Company's Technology in the Industrial VOC
Market. The Company is continuing to identify new customers within industrial
VOC applications not currently served by the Company, such as the electronics
and semiconductor industries. In addition, there is an increasing demand from
customers for the Company to supply turnkey systems that combine the Company's
FTO technology with other technologies. These "hybrid" systems may provide
energy recovery or product recovery, as well as treatment of the customer's
fume stream.
Provide Complementary Technologies. Customers are increasingly seeking
suppliers who can solve a wide range of VOC problems. To provide such
solutions the Company continues to seek opportunities to expand its technology
portfolio through joint ventures, selective marketing arrangements and
acquisitions. In April 1996, the Company acquired all rights from Purus, Inc.
to a VOC adsorption technology known as PADRE, which uses a regenerative
synthetic adsorption resin to capture and recover very low concentration VOCs
from low-to-medium flow vapor streams. In April 1997 the Company entered into
an exclusive marketing agreement with White Horse Technologies, Inc. to market
their products, including B.O.S.S.(TM), a proprietary Boiler Oxidizer Steam
System that destroys VOCs and produces steam for process applications, and
other thermal oxidizers for the treatment of VOCs.
The Company believes that its installed base and proven applications provide
a solid foundation for growth in both the United States and overseas. The
Company received its first order from Europe in 1995. The percentage of sales
to international customers increased to 14% in 1996 and 35% in 1997. The
Company expects this trend to continue and anticipates that over 60% of its
1998 sales will be for overseas installations. During 1997, the Company
relocated its European operation from London to an expanded facility near
Hull, England. The Company's United Kingdom capabilities now include sales,
applications engineering, project management and service. The Company has
established relationships with qualified subcontractors for fabrication and
assembly in Europe and has agreements with engineering partners in Asia for
construction and installation support.
INDUSTRIAL VOC CONTROL COMPETITIVE ENVIRONMENT
The industrial VOC control equipment market is mature and highly fragmented
among a large number of competitors, none of whom have a significant industry-
wide market share. The Company currently competes primarily with suppliers of
flame-based thermal oxidation systems, carbon adsorption systems and scrubbing
systems. Within each of these categories, the technologies are generally
undifferentiated and characterized by commodity pricing. Since many of these
technologies have been in use for over thirty years, these technologies are
familiar and predictable to companies requiring VOC controls and to
regulators, and are available from and promoted by a large number of
suppliers. In addition, some of the Company's competitors have substantially
greater financial resources, operating experience and market presence than the
Company. There can be no assurance that the Company's existing competitors or
new market entrants will not develop new technologies or modifications to
existing technologies that are superior to or more cost-effective than the
Company's FTO technology. In addition, increased competition could result in
price reductions and reduced gross margins and could limit the Company's
market share.
The Company believes that the major considerations in selecting industrial
VOC control systems are safety; capital, operating and maintenance costs; high
DRE; ease of permitting; process stream characteristics; unit location; and
on-line reliability. The Company believes it competes favorably with respect
to these factors.
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INDUSTRIAL VOC REGULATORY ENVIRONMENT
VOCs are an unavoidable by-product of many manufacturing and process
industries worldwide and must be controlled due to the significant health,
safety and environmental risks. Many of these VOCs are flammable, explosive or
highly toxic. To control these significant health and safety risks,
regulations have been promulgated and enforced in the United States and
overseas. These regulatory requirements are expanding globally into developing
nations.
The United States Clean Air Act Amendments of 1990 (the "CAAA")
significantly expanded the scope of air pollution regulations established in
the 1970s, and required the reduction and control of a wide range of air
pollutants, including 189 hazardous air pollutants, most of which are VOCs.
The CAAA also addressed the reduction of NOx that, in combination with VOCs,
produces smog. The CAAA introduced new regulatory requirements and timetables
for the abatement of VOCs and NOx for most geographic areas that become
progressively more stringent through the year 2010. Specifically, Title I and
Title III of the CAAA address emissions of VOCs. Principal provisions of these
titles are discussed below.
Title I establishes requirements for attaining and maintaining national
ambient air quality standards ("NAAQS"). Key provisions of Title I are aimed
at bringing cities and other areas which are not in attainment in line with
NAAQS in most areas by the year 2000 and all cities by 2010. In addition,
measures for all regions require the application of technological controls to
reduce emissions of ozone precursors, such as VOCs, from a broad range of
industrial activities, including chemicals production, petroleum refining,
pharmaceutical production, gasoline distribution, wastewater treatment,
solvent use, coating operations, hazardous waste treatment storage and
disposal facilities, solid waste landfills and marine terminal loading and
unloading.
Title III establishes a new program for the regulation of toxic air
pollutants. The combined federal and state program provided for in the
legislation creates a comprehensive and coordinated nationwide effort to deal
with these pollutants. Title III specifically lists 189 substances as
hazardous air pollutants, of which most are VOCs. Title III defines three
significant programs that will require substantial pollution control
expenditures by industry across the nation: (i) control of routine releases of
air toxins from major industrial and commercial sources; (ii) control of air
toxic releases from area sources, primarily in urban areas; and (iii) control
of accidental releases of air toxins from industrial and commercial sources.
To reduce emissions of the 189 listed toxic hazardous air pollutants, the
application of the maximum achievable control technology at major air emitting
sources may be required.
The Company works with regulatory agencies both domestically and overseas to
inform these agencies about the Company's FTO technology in order to
facilitate the permitting process for its customers. In England, Her Majesty's
Inspectorate of Pollution has issued Technical Note ITN/IPCX/02 identifying
the flameless oxidation process benefits of high destruction (greater than
99.99%) and low formation of NOx and CO. The Company's FTO system was selected
for inclusion in the Texas Natural Resource Conservation Commission's list of
innovative environmental technologies. Thermatrix is currently under review
for certification by the California Environmental Protection Agency ("CalEPA")
as a flameless thermal destruction technology. The CalEPA program is closed to
incineration technologies. Also, the U.S. EPA and its equivalent agencies in
the U.K., Ireland, Italy and the Netherlands have recognized the Company's FTO
technology as not being incineration.
CURRENT THERMATRIX INDUSTRIAL VOC CUSTOMERS
The Company has identified industries that are large generators of VOCs and
where it believes its FTO technology provides significant competitive
advantages over existing treatment methods. The Company has sought acceptance
of its systems, in each of its initial target markets, through the utilization
of "market leader" customers. To date, the Company has sold over 70 systems
across a range of industries including petroleum, chemical/petrochemical,
pharmaceutical, pulp and paper manufacturing, medical sterilization and for
soil and groundwater remediation. The following table sets forth the Company's
target markets, representative customers and the types of VOCs treated by its
systems:
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TARGET MARKETS REPRESENTATIVE CUSTOMER VOCS TREATED
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Petroleum/Refining Chevron, Marathon Oil Hydrocarbons
Chemical/Petrochemical Dow Chemical, Bayer Corporation, Chlorinated and
Manufacturing Mobil Chemical Company, Formosa Fluorinated Compounds
Petrochemical Corporation, BASF,
PPG Industries, Inc., B.F. Goodrich
Pharmaceuticals Zeneca, Warner-Lambert, Chlorinated Compounds
Manufacturing Chesebrough-Pond's USA Co.
Pulp and Paper Georgia Pacific, Simpson Paper Sulfonated Compounds
Manufacturing
Medical Sterilization Sorex Medical Ethylene Oxide
Soil and Groundwater DOD, DOE, Thermo Remediation Chlorinated Compounds and
Remediation Hydrocarbons
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SALES AND MARKETING
The Company has experienced a shift in market demand for its products, both
in terms of the geographic distribution of the orders it has received and the
complexity of the systems ordered.
The Company has experienced an increase in order volume from overseas as
orders from the United States declined. The Company expects this trend to
continue and anticipates that over 60% of its sales in 1998 will be for
overseas installations, up from 35% in 1997.
In addition, the Company's clients have increasingly outsourced the process
design of air pollution control systems. Instead of sourcing components
individually, clients are seeking a design partner willing to provide an
integrated system on a turnkey basis coupled with appropriate system
performance guarantees. In response to this shift in demand, the Company
restructured its sales organization in 1997 to replace most outside
manufacturers' representatives with direct selling by the Company's process
and application engineers in order to increase focus on marketing and account
management.
Two sales directors manage the Company's sales efforts. Sales for North
America and Asia are managed from San Jose, California and those for Europe
are managed from Hull, England. The sales directors hold engineering degrees
and have an average of ten years of industrial selling experience.
In addition, where cost effective, the Company has selectively retained some
of its independent commissioned sales representatives in the United States and
Canada and currently has agreements with eight representative organizations
with over 26 sales agents selling the Company's FTO system. In Asia, the
Company has agreements with ICI Taiwan Limited for sales representation in
Taiwan and the Peoples' Republic of China, with ICI Japan in Japan, and with
Miju Entech in South Korea. All independent representatives are paid solely on
commission, which is calculated on a sliding scale as a percentage of sales
revenues. The Company retains responsibility for pricing and terms and
conditions.
ENGINEERING AND MANUFACTURING
The Company's Engineering group, located in Knoxville, Tennessee, provides
global support to the Company's customers. The Company's project management
and assembly operations for the United States and Asia are managed from
Knoxville, Tennessee and those for Europe are based in Hull, England. In
addition, the Company has agreements with engineering partners in Asia for
construction and installation support of the Company's systems. These partners
include Toray Engineering Co. and Nittetu Chemical Engineering Ltd. in Japan
and Miju Entech in South Korea. The Company will continue to engineer and
assemble the proprietary components of its FTO systems, but will utilize its
Asian partners to supply the balance of plant. The Company had maintained its
own assembly facility in Knoxville, Tennessee but closed that facility at the
end of 1997 due to the decrease in United States sales.
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The Company has focused on modularizing and standardizing components of its
technology and utilizes sophisticated software to integrate these components
into comprehensive air pollution control systems. This system's integration
expertise allows the Company to provide comprehensive systems centered on the
Company's FTO technology. The engineers utilize state-of-the-art, PC-based,
computer-aided engineering and database management tools, including three-
dimensional design tools.
The Company manufactures its systems to customer order. Qualified
subcontractors specializing in the manufacture of the particular component
carry out component fabrication. These specialized subcontractors adhere to
and carry formal certification with national and international codes and
standards for electrical and mechanical construction. The Company's
subcontractors have been selected to allow the Company to expand its capacity
to manufacture additional systems while minimizing the Company's investment in
fixed costs. The Company uses qualified subcontractors throughout the United
States and overseas and is not dependent on any one or subset of these
subcontractors.
In the fabrication process, no one subcontractor is exposed to the entire
technology package and final assembly of the systems is completed by a
separate subcontractor. Throughout the delivery cycle, the manufacturing
process is managed to conform to ISO 9001.
During the period that the technology was developed, an extensive empirical
database of performance characteristics for waste flows of different volumes
and compositions was compiled. The Company has used this database to develop a
proprietary, software-based design tool. In the design process, the software
tools analyze the characteristics of the customer's fume flow and determine
the optimal system configuration and size. Not only does this process specify
the correct system characteristics, but also it automates the task of
generating budget proposals. The Company is continuing to expand this database
as new systems are installed.
RESEARCH AND DEVELOPMENT
The Company believes that its continued commitment to developing new
applications and refining its technology is critical to remaining competitive
in the industry. During 1997, the Company devoted its technical resources to
product development. The Company achieved a significant breakthrough in the
reconfiguration of its basic proprietary FTO technology, which the Company
believes will result in new, lower cost products and will enable the Company
to expand into liquid waste disposal. Also, the Company designed a modified
recuperative oxidizer to improve the operability and increase the range of the
FTO. In addition, the Company introduced a continuous adsorption product based
on its proprietary PADRE technology.
The Company's industrial VOC applications development efforts are managed by
the Engineering group located in Knoxville, Tennessee. The group's primary
mission is to optimize the Company's technology for new applications in the
industrial VOC control market. The Company's research and development
activities are now primarily focused on its diesel engine emission control
program. The Technology Development group, located in San Jose, California,
carries out these activities in conjunction with selected strategic partners.
When areas of specialized expertise are required, such as advanced metallurgy
or numerical modeling, the Company relies on consulting relationships with a
number of top tier research institutes, including SRI International, Lawrence
Berkeley National Laboratory and Oak Ridge National Laboratory.
POTENTIAL APPLICATIONS UNDER DEVELOPMENT
The Company's strategy to expand its presence in the VOC market is to work
with strategic partners to evaluate the feasibility of applying the Company's
technology to other industries. During 1996 and 1997, the Company initiated
joint development programs with leading organizations to explore the
application of the Company's FTO technology to the control of diesel engine
emissions and the treatment of radioactive mixed wastes and sought a
development partner to pursue destruction of chemical weapons. By the end of
1997, the Company decided to focus its development business interests on its
diesel engine emission control activities due to the recent technological
advances in the diesel program, coupled with the uncertainties in the timing
and the withdrawal of federal funding for new technologies in the other areas.
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The engineering challenges involved in treating diesel emissions are
different in a number of respects from the conditions in which the Thermatrix
system has been used in the past, and there can be no assurance that the
Thermatrix technology will prove successful in this new application.
Diesel Engine Emission Control. The fume and soot emissions from static and
mobile diesel engines create a serious environmental problem. In late 1997,
the Company signed a joint development agreement with Lucas Diesel Systems, a
division of LucasVarity plc, for the application of the FTO technology to the
treatment of diesel engine emissions from mobile sources. Initial testing in
1997 indicated that the FTO technology could destroy a wide size range of soot
particles while lowering NOx missions. The joint development agreement will
determine whether the technology can be employed economically at a size
suitable for mobile applications.
Market Overview
The market for diesel engine emission control is separate and distinct
from the industrial VOC market. Approximately eight million diesel vehicles
are manufactured each year and there are approximately 40 million diesel
vehicles in operation worldwide. Diesel engines provide improved fuel
economy, ease of serviceability and greater durability over gasoline
engines and are commonly used for medium and heavy-duty trucks, buses,
industrial, agricultural, construction, mining, recreational and marine
applications, but the VOC and particulate matter ("PM") emissions from
diesel engines create a serious environmental problem, which is being
addressed in new proposed regulations by the U.S. EPA and its counterparts
in Europe and Asia.
The Thermatrix System
Many of the advantages of the Thermatrix system for industrial VOC
emission control are equally applicable to the destruction of VOCs in
diesel engine emissions. Preliminary tests conducted during 1997
demonstrated that the FTO technology could destroy a wide size range of PM
while lowering NOx emissions, in addition to destroying VOCs.
The Company believes the new FTO design announced in February 1998, with
its horizontal/vertical configuration, reduced size and all electric
preheat design, could accelerate the timetable for the potential
commercialization of the Company's technology for the control of fumes from
diesel engines, both mobile and stationary.
Competition
There are a number of companies working toward diesel emissions reduction
solutions. For example, in the post-combustion or exhaust after-treatment
sector there are companies such as Englehard Corporation and Johnson-
Matthey plc that currently supply a majority of the market with their
existing catalyst systems. However, there has been, and continues to be, a
need for improvement in the use of catalysts for heavy-duty engine
applications. The Company's new FTO design offers the potential for an
innovative, non-catalytic solution for diesel engine emission control.
Regulation
Diesel engine manufacturers have faced continually increasing governmental
regulation of their products especially in the environmental area. In
particular, engine manufacturers will have to achieve lower emissions
levels in terms of unburned hydrocarbons, PM and NOx. These regulations
have imposed and will continue to impose significant research, design and
tooling costs on engine manufacturers.
Specific emissions standards for engines are imposed by the U.S. EPA and
by other regulatory agencies such as the California Air Resources Board
("CARB"). Many of the manufacturers believe that their engine products
comply with all applicable emissions requirements currently in effect.
Their ability to comply with emissions requirements that may be imposed in
the future is an important element in maintaining and improving their
position in the engine marketplace.
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The CAAA established the United States emissions standards for on-highway
engines produced through 2001. For light and medium to heavy-duty engines,
the CARB standards are similar to those adopted by the U.S. EPA. In North
America, both Canada and Mexico are expected to adopt United States
emissions standards. Various diesel engine manufacturers have voluntarily
signed a memorandum of understanding with the Canadian government, pursuant
to which these manufacturers agreed to sell only United States certified
engines in Canada beginning in 1995. In June 1993, Mexico proposed a
regulatory program that incorporates United States standards and test
procedures. Similar programs are in place throughout Europe and Japan.
Diesel engines are primarily regulated for PM and NOx. Federal standards
for 1998 for buses and trucks for PM are 0.10 grams per brakehorsepower
hour, and 5.0 for NOx. These are expected to decrease to 0.05 for PM and
2.0 for NOx by Year 2004. California standards are even stricter.
The CAAA gave individual states the option to mandate the new federal
requirements or the CARB plan in their states. Twelve Northeast states and
Texas have agreed to adopt the CARB rules. The vehicles in operation in those
thirteen states comprise more than one-third of the United States vehicle
population.
Radioactive Mixed Wastes. In October 1996, the Company announced the
formation of Formatrix, LLC ("Formatrix"), a joint venture with ThermoChem,
Inc., a Maryland-based leader in steam reforming systems, to combine, under
license, the patented technologies from Thermatrix and ThermoChem to create a
treatment system for significantly reducing the volume of the radioactive
wastes prior to their encapsulation or vitrification for long-term burial. A
prototype Thermatrix-ThermoChem system was constructed under a contract with
the DOE and successfully and reliably treated a number of non-radioactive
surrogate mixed wastes. However, the likelihood of short-term deployment of
the Formatrix system for radioactive mixed waste processing appears to be
receding as federal funding for new technologies has been postponed. In view
of these uncertainties, the Company plans to discontinue its joint venture
arrangement and will undertake any future projects for the processing of
radioactive mixed waste on a teaming basis. Accordingly, the Company wrote off
its investment in the joint venture in 1997.
Chemical Demilitarization. Chemical demilitarization refers to the safe
disassembly and destruction of stockpiled chemical warfare agents such as
mustard and nerve gases. The chemical makeup of many of these agents is
similar to compounds that the Company is currently destroying in the
commercial industrial market. As an example, the Company has built and brought
on-line in 1997 a full-scale commercial facility for the destruction of
phosgene and its derivatives associated with the manufacture of specialty
chemicals. The Company had been seeking a strategic operating partner to
pursue this market, but is no longer actively pursuing this area due to the
withdrawal of federal funding for new technologies.
INTELLECTUAL PROPERTY
As of February 28, 1998, the Company owned 10 United States and 11
international patents, had received notice of allowance for two additional
United States patent applications and two additional international patent
applications, and had a further nine United States and 36 international patent
applications pending relating to its thermal treatment technology. All issued
United States patents expire during the period between July 31, 2005 and July
13, 2015. The Company has granted a license of its patents to Formatrix for
restricted use in the field of low-level radioactive spent ion exchange
resins.
The Company's twelve issued and allowed United States patents include
several hundred claims of varying scope relating to many of the Company's
inventive methods and apparatuses. These patents cover fundamental aspects of
flameless thermal oxidation that are the bases of the Company's technology and
their application. Aspects of the technology, including the use and
maintenance of a "flameless reaction wave" of gases or vapors in a matrix of
heat resistant materials, are covered under a variety of claiming formats.
10
<PAGE>
In addition to patents, the Company relies on trade secrets and proprietary
know-how, which it seeks to protect, in part, through appropriate
confidentiality and proprietary information agreements. The confidentiality
and proprietary information agreements generally provide that all confidential
information developed or made known to individuals by the Company during the
course of the relationship with the Company is to be kept confidential and not
disclosed to third parties, except in specific circumstances. The agreements
also generally provide that all inventions conceived by the individual in the
course of rendering services to the Company shall be the exclusive property of
the Company.
In addition to the foregoing patents and patent applications, the Company
has four issued United States trademarks, and has received notice of allowance
for one additional United States trademark. The Company also has an additional
five international trademark applications pending for certain of the Company's
tradenames and other intellectual property.
EMPLOYEES
As of February 28, 1998, the Company had 62 full-time employees, 16 of whom
hold advanced degrees. The Company believes that it has been successful in
attracting experienced and capable engineering, operations and management
personnel. None of the Company's permanent, full-time employees is covered by
collective bargaining agreements.
RISK FACTORS
Operating Losses and Accumulated Deficit; Uncertainty of Future
Profitability. The Company had a net loss of approximately $9.6 million in
1997 and an accumulated deficit of approximately $36.7 million at December 31,
1997. Since 1992 when the Company restructured its operations, the Company has
financed its operations primarily through private placements of equity
securities totaling approximately $20.3 million, an initial public offering of
its common stock with net proceeds totaling approximately $22.1 million, and a
credit facility with its bank of $4.0 million. The Company does not expect to
be profitable unless and until sales of its systems generate sufficient
revenues with an appropriate gross margin to fund its operations. There can be
no assurance that the Company will achieve such revenues or margins.
Ability to Compete Against Lower Cost Technologies. To date, FTO systems
have been installed in a small segment of a number of industries. There can be
no assurance that the Company's FTO technology will receive broad market
acceptance as an economically and environmentally acceptable means of
destroying VOCs. The Company's ability to compete will depend upon the
Company's ability to persuade potential customers to adopt its FTO technology
in place of certain, more established, competing technologies, including
flame-based destruction and carbon adsorption systems. The failure of the
Company to persuade a significant number of potential customers to adopt its
FTO technology would have a material adverse effect on the growth of the
Company's business, results of operations and financial condition.
Sensitivity to Major Projects. In 1997, two projects accounted for 38% of
the Company's revenues. In 1996, three projects accounted for 38% of the
Company's revenues and in 1995, two projects accounted for 59% of the
Company's revenues. Although the Company is expanding the number of its
customers and installations, the average size and dollar volume of each
installation has been increasing. The Company anticipates the size of turnkey
projects in 1998 will range from $1 million to $4 million, up from an average
of $850,000 in 1996. As a result, the Company's results of operations are
likely to continue to be dependent on major projects. Such a reliance on major
orders is likely to lead to fluctuations in, and to reduce the predictability
of, quarterly results.
Larger projects also pose other challenges. The sales cycle for larger
projects tends to be longer than for smaller projects, and, when orders are
received, projects may be delayed by factors outside the Company's control,
including customer budget decisions, design changes and delays in obtaining
permits. Orders for large systems often have tight delivery schedules and the
customer will often attempt to negotiate penalties for late delivery and/or
the ability to assess liquidated damages for lost production if the delivery
schedule is not met.
11
<PAGE>
Also, because the dollar volumes are larger, the costs of providing warranty
services could increase. The Company's business, results of operations and
financial condition could be materially adversely affected if the Company were
to fail to obtain major project orders, if such orders were delayed, if
installations of such systems were delayed, or if such installations
encountered operating, warranty or other problems.
Management of Growth. Although it relies on subcontractors to fabricate
subassemblies and to assemble and install completed systems, the Company uses
its own employees to design, test and commission systems. The Company seeks to
maintain engineering and design staffing levels adequate for current and near-
term demand. During periods of rapid growth, such as that experienced by the
Company during 1996, the Company's engineering and design personnel generally
operate at full capacity. As a result, future growth, if any, is limited by
the Company's ability to recruit and train additional engineering, design and
project management personnel and by the ability and performance of the
individual employees in managing more and larger projects. Furthermore, any
failure to maintain quality or to meet customer installation schedules could
damage relationships with important customers, damage the Company's reputation
generally and result in contractual liabilities. There can be no assurance
that the Company will be able to effectively manage an expansion of its
operations or that the Company's systems or controls will be adequate to
support the Company's operations if expansion occurs. In such event, any
failure to manage growth effectively could have a material adverse effect on
the Company's business, results of operations and financial condition.
Risks Associated with International Operations and Sales. In 1997, sales to
international customers in Europe and Asia increased to 35%, up from 14% in
1996. The Company plans to increase its revenues, in part, through an
expansion of its overseas operations. Expansion internationally encompasses
the need to provide an infrastructure for operations, sales and
administration. The Company's overseas growth has placed, and could continue
to place, a significant strain on its managerial, operational and financial
resources. There can be no assurance that the Company will be able to attract,
hire and train personnel or to continue to develop the infrastructure needed
on a timely basis, which may have an adverse impact on the Company's business,
results of operations and financial condition.
Additionally, the Company's business, results of operations and financial
condition may be materially adversely affected by fluctuations in currency
exchange rates and duty rates, and therefore its ability to maintain or
increase prices due to competition. The Company denominates international
sales in either U.S. dollars or local currencies. Sales in Europe have been
primarily denominated in pounds sterling. Since some expenses in connection
with international contracts are often incurred in U.S. dollars, there can be
a short-term exchange risk created. If the Company has significant
international sales in the future denominated in foreign currencies, the
Company may purchase hedging instruments to mitigate the exchange risk on
these contracts.
Risks Associated with Fixed Price Contracts. A majority of the Company's
contracts are performed using "fixed-price" rather than "cost-plus" terms.
Under fixed-price terms, the Company quotes firm prices to its customers and
bears the full risk of cost overruns caused by estimates that differ from
actual costs incurred or manufacturing delays during the course of the
contract. Some costs, including component costs, are beyond the Company's
control and may be difficult to predict. If manufacturing or installation
costs for a particular project exceed anticipated levels, gross margins would
be materially adversely affected, and the Company could experience losses. In
addition, the manufacturing process may be subject to significant change
orders. However, in some cases the cost of these change orders may not be
negotiated until after the system is installed. The failure of the Company to
recover the full cost of these change orders could materially adversely affect
gross margins and also cause the Company to experience losses.
Dependence on Key Personnel. The Company's success depends to a significant
extent upon its executive officers and key engineering, sales, marketing,
financial and technical personnel, both in the United States and overseas.
Employees may voluntarily terminate their employment with the Company at any
time, and none of the Company's employees is subject to any term employment
contract with the Company. The Company has
12
<PAGE>
limited personnel resources available to address the different activities in
its business. The loss of the services of one or more of the Company's key
employees could have a material adverse effect on the Company's business,
results of operations and financial condition.
The Company also believes that its future success will depend in large part
upon its ability to attract and retain additional highly skilled personnel,
particularly design and process engineers. Because of the technical
sophistication of the Company's systems and the sophisticated engineering
software utilized by the Company, design and process engineers who join the
Company generally are required to have advanced technical knowledge and
significant training to perform efficiently and productively. The availability
of such personnel is limited, and the Company has at times experienced
difficulty in locating new employees with the requisite level of expertise and
experience. In addition, the Company believes its ability to manage the
anticipated increase in customer orders for the Company's products in Europe
will depend in a large part on its success in attracting and retaining skilled
engineers or project managers in Europe. There can be no assurance that the
Company will be successful in retaining its existing key personnel or in
attracting and retaining the personnel it requires in the future.
The Company maintains key employee life insurance on the life of its
Chairman, President and Chief Executive Officer, John T. Schofield, in the
amount of $2,000,000. There can be no assurance that such amount will be
sufficient to compensate the Company for the loss of the services of such
individual.
Dependence on the Reliability and Performance of Subcontractors. The Company
relies on subcontractors to build system components and to assemble and
install systems, both in the United States and overseas. The Company's ability
to deliver high quality systems on time will depend upon the reliability and
performance of its subcontractors. The failure of a subcontractor to meet
delivery schedules could cause the Company to default on its obligations to
its customers, which could materially adversely affect the Company's
reputation, business, results of operations and financial condition. In
addition, the Company's reliance on subcontractors for manufacturing, assembly
and installation places a significant part of the Company's quality control
responsibilities on these subcontractors. There can be no assurance that the
Company will be able to continue to contract for the level of quality control
required by the Company's customers. The failure to provide such quality
control could result in manufacturing and installation delays, which could
have a material adverse effect on the Company's business, results of
operations and financial condition.
Dependence on Customer Information. The Company is highly dependent upon
information provided by its customers concerning the type, volume and flow
rate of VOC emissions to be treated by the Company's systems. If the
customer's information is inaccurate or the customer operates the facility
outside its design parameters, a malfunction in the Company's FTO system could
occur, resulting in damage to the customer's facilities or personal injury. In
addition, incorrect information could cause delays in the design, manufacture
and installation of the customer's system. Through no fault of its own, the
Company could then be held liable for damages resulting from such malfunction
or delay. Any of these factors could have a material adverse effect on the
Company's business, results of operations and financial condition.
Fluctuations in Quarterly Operating Results. The Company's quarterly
revenues and operating results have varied significantly in the past and may
fluctuate significantly in the future as a result of a variety of factors,
many of which are outside the Company's control. Such factors include the size
and timing of individual orders, the timing and amount of project change
orders, customer delays, order cancellations, general economic and industry
conditions, the amount of first-time engineering needed, the introduction of
new products or services by the Company or its competitors or the introduction
of the Company's products to new markets, changes in the levels of operating
expenses, including development costs, and the amount and timing of other
costs relating to the expansion of the Company's operations.
Furthermore, the purchase of the Company's products, particularly for major
projects, may involve a significant commitment of capital, with the attendant
delays frequently associated with large capital expenditures and authorization
procedures within its customers' organization. For these and other reasons,
the sales cycle for the Company's products can be lengthy (up to two years)
and subject to a number of significant risks over which
13
<PAGE>
the Company has little or no control, including customer budgetary
constraints. The Company historically has operated with little backlog because
most customer orders are placed with relatively short lead times, usually from
four to thirty weeks. Variations in the timing of recognition of specific
revenues due to changes in project scope and timing may adversely and
disproportionately affect the Company's operating results for a quarter
because the Company establishes its expenditure levels on the basis of
expected future revenues, and a significant portion of the Company's expenses
do not vary with current revenues.
Uncertain Regulatory Environment. The Company's customers are required to
comply with environmental laws and regulations in the United States and
elsewhere which limit the emission of VOCs and other chemicals. The level of
enforcement activities by environmental protection agencies and changes in
laws and regulations will affect demand for the Company's systems. To the
extent that the burden of complying with such environmental laws and
regulations may be eased, the demand for the Company's systems could be
materially adversely affected.
Although the Company believes that its FTO technology does not come under
the United States Environmental Protection Agency's ("U.S. EPA") current
definitions of incineration, there can be no assurance that the U.S. EPA will
not classify the Company's FTO technology as an incineration technology in the
future. Classification as an incineration technology could significantly
increase the length of time and cost of the permitting process for customers
because of the requirement for a public hearing, especially where community
sentiment is opposed to incineration technology. A lengthier permitting
process could reduce the competitive advantages of the Company's technology
and materially adversely affect the Company's business, results of operations
and financial condition.
Proprietary Technology and Unpredictability of Patent Protection. The
Company relies on patents, trade secrets and proprietary know-how, which it
seeks to protect, in part, through appropriate confidentiality and proprietary
information agreements with its strategic partners, employees and consultants.
There can be no assurance that the proprietary information or confidentiality
agreements will not be breached, that the Company will have adequate remedies
for any breach, or that the Company's trade secrets and proprietary know-how
will not otherwise become known to or be independently developed by others.
Possible Product Liability. The Company's FTO systems are designed to
destroy VOCs, which are highly toxic and flammable. If the Company's systems
are improperly designed or operated outside of design parameters and operating
instructions provided by the Company, there is a risk of system failure or
release of VOCs, which could require the Company to defend itself against a
product liability or personal injury claim. Although the Company has product
liability and commercial general liability insurance in scope and amount that
it believes to be sufficient for the conduct of its business, there can be no
assurance that such insurance will cover or be adequate to cover such claims.
In addition, the Company's general liability insurance is subject to coverage
limits and excludes coverage for losses or liabilities relating to
environmental damage or pollution. Accordingly, the Company's efforts to
defend itself against such claims could have a material adverse effect on the
Company's business, results of operations and financial condition.
Potential Environmental Liability. Although the Company does not believe
that its activities would directly expose it to liabilities under local, state
or federal environmental laws and regulations, if the Company were to
improperly design, manufacture or test its systems or fail to properly train
its customer's employees in the operation of the systems, it could be exposed
to possible liability for investigation and clean-up costs under such
environmental laws.
Under some environmental laws and various theories of tort and contract law,
it is also possible that the Company could be liable for damages to its
customers and third parties resulting from the actions of its customers or
arising from the failure or malfunction, or the design, construction or
operation of, the Company's FTO systems or products, even if the Company were
not at fault. The Company's general liability insurance is subject to coverage
limits and generally excludes coverage for losses or liabilities relating to
or arising out of environmental damage or pollution. The Company's business,
results of operations and financial condition could be materially adversely
affected by an uninsured or partially insured claim.
14
<PAGE>
Risks Associated With the Diesel Engine Emission Control Development
Program. The engineering challenges involved in treating diesel emissions are
different in a number of respects from the conditions in which the Thermatrix
system has been used in the past, and there can be no assurance that the
Thermatrix technology will prove successful in this development area.
Moreover, the Company's extensive database of test results that it uses to
design systems for industrial installations may not be relevant to diesel
engine emission control. Although pilot test results to date have been
positive, the Company will need to engage in extensive and costly applications
development and engineering in order to commercialize its system for such use,
and there can be no assurance as to the success of any such effort.
ITEM 2. PROPERTIES
The Company leases approximately 5,000 square feet of office space in San
Jose, California under a three-year lease terminating in July 1998, which the
Company uses as its research and development, and United States and Asia sales
offices. The Company has a remaining two-year lease for approximately 15,000
square feet of office space in Knoxville, Tennessee, which it primarily uses
for design engineering, project management and accounting offices.
In addition, the Company leases approximately 5,000 square feet of office
space in Hull, England under a six-year lease, accommodating all European
activities, including sales, operations and engineering. The Company also
leases approximately 1,000 square feet of office space in London, England
under a five-year lease, which the Company is currently subletting on a month-
to-month basis.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various routine legal proceedings incident to the
ordinary course of its business. Management believes that the outcome of all
pending legal proceedings in the aggregate will not have a material effect on
the Company's business, financial condition or result of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth
quarter of the Company's fiscal year.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company is traded on the NASDAQ National Market
under the symbol "TMXI." The following table sets forth, for the periods
indicated, the high and low sales prices of the common stock (as reported by
NASDAQ):
<TABLE>
<CAPTION>
PERIOD HIGH LOW
------ ----- -----
<S> <C> <C>
First Quarter 1997............................................... 9.375 3.375
Second Quarter 1997.............................................. 5.750 3.000
Third Quarter 1997............................................... 3.250 1.875
Fourth Quarter 1997.............................................. 3.250 1.125
</TABLE>
As of February 28, 1998, there were over 1,000 holders of the Company's
Common Stock. The Company has never declared or paid dividends on its stock.
The Company currently intends to finance the growth and development of its
business and does not anticipate paying dividends in the foreseeable future.
15
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below with respect to the
Company's statements of operations for each of the three years in the period
ended December 31, 1997 and with respect to the Company's balance sheets as of
December 31, 1997 and 1996 are derived from the consolidated financial
statements included elsewhere in this report and should be read in conjunction
with those financial statements and related notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
statement of operations data for the years ended December 31, 1994 and 1993
and the balance sheet data as of December 31, 1995, 1994 and 1993 are derived
from audited financial statements not included in this report.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues................ $ 7,011 $13,605 $ 6,494 $ 3,135 $ 881
Cost of revenues........ 8,351 12,002 6,064 3,099 966
-------- ------- ------- ------- -------
Gross margin............ (1,340) 1,603 430 36 (85)
-------- ------- ------- ------- -------
Research and
development............ 1,203 748 1,084 1,326 483
Selling, general and
administrative......... 7,705 6,168 4,740 4,503 2,100
-------- ------- ------- ------- -------
Loss from operations.... $(10,248) $(5,313) $(5,394) $(5,793) $(2,668)
======== ======= ======= ======= =======
Net loss................ $ (9,640) $(4,876) $(5,194) $(5,821) $(2,621)
======== ======= ======= ======= =======
Basic net loss per
share(/1/)............. $ (1.28) $ (1.22) $(65.75) $(95.43) $(72.81)
======== ======= ======= ======= =======
Basic weighted average
common shares.......... 7,548 3,994 79 61 36
======== ======= ======= ======= =======
<CAPTION>
DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994 1993
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET
DATA
Cash, cash equivalents
and short-term
investments............ $ 7,577 $16,199 $ 981 $ 6,930 $ 1,730
Total assets............ 13,987 24,009 4,228 9,223 2,072
Redeemable convertible
preferred stock........ -- -- 11,321 11,321 --
Stockholders' equity
(deficit)................ 11,949 21,398 (9,345) (4,209) 1,611
</TABLE>
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements--Summary of
Significant Accounting Policies--Basic Net Loss Per Share.
16
<PAGE>
THERMATRIX INC.
SUPPLEMENTARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Quarterly Financial Data (Unaudited)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Sales................... $ 1,084 $ 2,250 $ 2,304 $ 1,373
Gross Margin................ (322) (233) (7) (778)
Net Loss.................... (1,952) (2,291) (2,050) (3,347)
Basic Net Loss Per Share.... $ (0.26) $ (0.30) $ (0.27) $ (0.44)
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
----------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Sales................... $ 2,735 $ 3,406 $ 4,402 $ 3,062
Gross Margin................ 229 441 817 116
Net Loss.................... (1,243) (1,249) (836) (1,548)
Basic Net Loss Per Share.... $ (9.61) $ (1.31) $ (0.11) $ (0.21)
</TABLE>
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Thermatrix Inc. is a global industrial technology company engaged in the
development, manufacture and sale of industrial process equipment for the
destruction of volatile organic compounds and hazardous air pollutants
(collectively, "VOCs"). The core component of the Company's technology is its
proprietary flameless thermal oxidizer ("FTO"). The Company's product line
also includes PADRE(R), a proprietary technology used to capture and recover
very low concentration VOCs from low-to-medium vapor streams. The Company also
distributes and sells B.O.S.S.(TM), a proprietary Boiler Oxidizer Steam System
that destroys VOCs and produces steam for process applications, and other
thermal oxidizers for the treatment of VOCs, through its exclusive marketing
agreement with White Horse Technologies, Inc.
The Company derives its revenues from contracts to design, develop,
manufacture, and install systems for the treatment of VOCs. The Company uses
the percentage-of-completion method of accounting to recognize contract
revenues. Losses on contracts are charged to cost of revenues as soon as such
losses become known.
The Company's core technology has been successfully commercialized in the
industrial VOC control market for applications in the petroleum,
chemical/petrochemical, pharmaceutical, medical sterilization and pulp and
paper industries, and for soil and groundwater remediation, and the Company is
continuing to expand into additional segments of the industrial VOC control
market. Because the Company's technology has been commercialized, the Company
does not expect that costs associated with further research and development of
its core FTO technology for the industrial VOC control market will be material
to the Company's results of operations.
In 1997, the Company experienced a shift in market demand for its products.
The United States VOC market has declined, reflecting, the Company believes,
low capital expenditures in new process facilities. However, the Company has
experienced an increase in demand for its products overseas, primarily due to
the continued globalization of the chemical and pharmaceutical industries,
increased adoption of ISO 14000 standards, and capital expenditures by
overseas companies. In 1997, the Company responded to this shift by reducing
its United States sales and operations staff and increasing its presence
overseas. The Company increased its own staff in Europe and has also added
engineering and manufacturing partners in Asia.
In addition to its primary focus on the industrial VOC emission control
market, the Company is currently working with strategic partners to evaluate
the feasibility of applying the Company's technology to other markets. For
example, the Company is engaged in a joint development program with Lucas
Diesel Systems, a division of LucasVarity plc, for the development of a system
to treat emissions from diesel engines. The strategic partners generally share
some, but not all, of the evaluation costs. Evaluation expenses incurred by
the Company, primarily labor and equipment operation costs, are generally
recorded as research and development expenses. To the extent the strategic
partner reimburses such research and development expenses, these amounts are
reflected as a reduction of research and development expenses. If evaluation
costs are reimbursed under the terms of a purchase contract, these amounts are
reflected as cost of revenues. In addition, the Company, may provide an
evaluation system as part of a joint development program. The capital cost of
the evaluation system is amortized over the estimated useful life of the
evaluation system. In 1997, expenses incurred by the Company for these recent
development programs have not been material. However, due to the positive
preliminary test results in the diesel emissions program, the Company
anticipates that more extensive development and engineering will be needed in
order to commercialize its technology for such use. There can be no assurance
as to the outcome of such evaluation programs or, if initiated, the outcome of
any such applications development and engineering effort.
The Company's quarterly revenues and operating results have varied
significantly in the past and may fluctuate significantly in the future as a
result of a variety of factors, many of which are outside the Company's
control. Such factors include general economic and industry conditions, the
size and timing of individual orders, the timing and amount of project change
orders, the amount of first-time engineering needed, the introduction of
18
<PAGE>
new products or services by the Company or its competitors or the introduction
of the Company's products to new markets, changes in the levels of operating
expenses, including development costs, and the amount and timing of other
costs relating to the expansion of the Company's operations.
Furthermore, the purchase of the Company's products, particularly for major
projects, may involve a significant commitment of capital, with the attendant
delays frequently associated with large capital expenditures and authorization
procedures within its customers' organization. For these and other reasons,
the sales cycle for the Company's products can be lengthy (up to two years)
and subject to a number of significant risks over which the Company has little
or no control, including customer budgetary constraints. The Company
historically has operated with little backlog because most customer orders are
placed with relatively short lead times, usually from four to thirty weeks.
Variations in the timing of recognition of specific revenues due to changes in
project scope and timing may adversely and disproportionately affect the
Company's operating results for a quarter because the Company establishes its
expenditure levels on the basis of expected future revenues, and a significant
portion of the Company's expenses do not vary with current revenues.
Although the Company is expanding the number of its customers and
installations, the average size and dollar volume of each installation is
increasing. As a result, the Company's results of operations are likely to
continue to be dependent on major projects. Such a reliance on major orders is
likely to lead to fluctuations in, and to reduce the predictability of,
quarterly results. Larger projects also pose other challenges. The sales cycle
for larger projects tends to be longer than for smaller projects, and, when
orders are received, projects may be delayed by factors outside the Company's
control, including customer budget decisions, design changes and delays in
obtaining permits. Orders for large systems often have tight delivery
schedules and the customer will often attempt to negotiate penalties for late
delivery and/or the ability to assess liquidated damages for lost production
if the delivery schedule is not met. Also, because the dollar volumes are
larger, the costs of providing warranty services could increase. The Company's
business, results of operations and financial condition could be materially
adversely affected if the Company were to fail to obtain major project orders,
if such orders were delayed, if installations of such systems were delayed, or
if such installations encountered operating, warranty or other problems.
RESULTS OF OPERATIONS
Fiscal years Ended December 31, 1997 and 1996
Revenues. Revenues decreased 49% to $7.0 million in 1997 from $13.6 million
in 1996. The decrease in revenues reflects the decline in the United States
VOC market, as well as the cancellation of three orders in three different
countries due to changing customer circumstances after engineering work had
been completed. In 1997, two customers accounted for 28% and 10% of revenues,
respectively. Sales to international customers increased to 35% of revenues in
1997, up from 14% in 1996.
Gross Margin. The Company had a gross margin loss of $1.3 million in 1997
versus a gross margin contribution of $1.6 million, or 11.8%, in 1996. The
decrease in gross margin was primarily attributable to lower revenues, which
were insufficient to absorb the ongoing fixed costs of engineering and
operations in the United States and Europe. As of December 31, 1997, the
Company also recorded a charge to cost of revenues of $500,000 to establish a
reserve against the costs accumulated in connection with certain change orders
and contracts that had not been settled as of December 31, 1997. The Company
is in various stages of negotiations with the parties to the respective
contracts and will continue to pursue collection of such balances, including
taking legal action when necessary. Historically, the Company has been
successful in recovering substantially all charges incurred with respect to
change orders. However, given the passage of time from the incurrence of the
related costs, the Company felt it was prudent to take the reserve to address
the Company's legal and other costs relating to the closing out of these
projects. In addition, gross margin was also impacted by increased overhead
costs incurred as the Company put infrastructure in place to increase its
presence in Europe and to manage the anticipated increase in customer orders
for the Company's products. Also, gross margin was impacted by first-time
shipments to foreign countries, as the Company had to comply with the
different construction and regulatory codes of those countries, the full
design cost of which was charged to the first project in a given country.
19
<PAGE>
The Company anticipates that gross margins will continue to be adversely
affected by numerous factors including growth of the operations
infrastructure, international expansion, initial systems addressing new
industries or new applications, larger, more complex systems and the extent
and timing of change orders. As the Company grows, the Company will need to
hire additional design engineers, instrumentation and control engineers and
project management personnel. Significant training and familiarization with
the Company's FTO technology will result in these new individuals not being
fully engaged in revenue producing activities, which reduces gross margin
percentages. As the Company grows internationally, operations infrastructure
needs to be added to support the sales activities. New industry and/or fume
characteristics require the Company to expend significantly greater
engineering resources in process and system design. Also such new applications
are usually sold at lower initial gross margins as the customer and the
Company make investments in the development effort. As systems get larger and
more complex with hybrid technologies and purchased components, overall gross
margin percentages are affected by the Company's ability to mark up the
purchased components in the final system. Project change orders can be nominal
or can be significant. The Company does not recognize change orders as revenue
until the customer accepts the implemented change order or acceptance is
probable. Depending upon the magnitude of the change order, gross margins can
also be affected.
Research and Development. Research and development expenses include
applications engineering expenses not chargeable to specific customer
projects, personnel costs related to patent activities, and the expenses
incurred in connection with the Company's development programs to evaluate the
feasibility of applying the Company's technology to markets other than
industrial VOC emissions control. Research and development expenses during
1997 and 1996 were $1.2 million and $748,000, respectively. The increase in
research and development expenses in 1997 is attributable to a significant
increase in product development activities in 1997. A modified recuperative
oxidizer was designed and installed to improve the operability and increase
the range of the FTO. A portion of the increase in research and development
expenses is attributable to the design of a continuous PADRE system. Also, the
first test unit for the treatment of emissions from dry cleaning operations
was completed and shipped. In addition, a new FTO design with an almost
spherical flameless reaction front within the reactor's ceramic matrix was
constructed and tested.
Selling, General and Administrative. Selling, general and administrative
expenses increased 25% to $7.7 million in 1997 as compared with $6.2 million
in 1996. The increase is primarily attributable to the 1997 fourth quarter
charge of $891,000 recorded for certain nonrecurring items including $472,000
for the costs relating to (i) the move of the Company's administrative center
from San Jose, California to Knoxville, Tennessee, (ii) the closure of the
Knoxville fabrication and assembly facility, and (iii) the relocation of the
Company's European operations from London to an expanded facility near Hull,
England. The charge also includes severance and other related closure and
relocation costs associated with these activities. Another component of the
nonrecurring charges relates to the non-cash provision of approximately
$390,000 recorded to write off the Company's minority interest position in the
Formatrix, LLC joint venture with ThermoChem, Inc.
In addition to the nonrecurring charge taken in 1997, the increase in
selling, general and administrative expenses reflects the impact of increased
staffing and related costs incurred in Europe and Asia as a result of the
higher level of sales activity in those regions, which was partially offset by
the decrease in the Company's United States sales staff. The increase is also
reflective of the full-year costs of being a public company. The Company's IPO
was completed June 20, 1996.
Interest Income. Interest income increased to $697,000 in 1997, from
$548,000 in 1996. The increase primarily resulted from the investment of the
net proceeds from the Company's initial public offering completed in June
1996.
Income Taxes. As a result of recurring losses, the only income taxes
provided for relate to certain state taxes not fully offset by net operating
losses.
20
<PAGE>
Fiscal years Ended December 31, 1996 and 1995
Revenues. Revenues grew 110% to $13.6 million in 1996, from $6.5 million in
1995, with three customers accounting for 13%, 13% and 12% of revenues in
1996. The increase in revenues from 1995 to 1996 is primarily attributable to
an increased acceptance of the Company's technology resulting in contracts for
systems used in chemical/petrochemical, petroleum, and pulp and paper industry
applications, orders for systems used in remediation projects, and the first
unit for use in medical sterilization. Revenues in 1996 also reflected the
Company's first sales of PADRE units, the technology acquired from Purus, Inc.
in April 1996.
Gross Margin. Gross margin as a percentage of revenues for 1996 and 1995 was
11.8% and 6.6%, respectively. The increase in gross margin in 1996 was
attributable in part to an increase in follow-on sales for existing
applications, increased pricing as the Company began to value price its
systems and, to a lesser extent, reductions in costs from repeat sales of
systems for established applications.
Research and Development. Research and development expenses during 1996 and
1995 were $748,000 and $1.1 million, respectively. The reduction in research
and development expenses from 1995 to 1996 was primarily due to the Company's
success in developing collaborative efforts with its core industrial VOC
customers, thereby reducing its own independent expenditures for applications
development.
Selling, General and Administrative. Selling, general and administrative
expenses increased to $6.2 million in 1996 as compared with $4.7 million in
1995. The increase in selling, general and administrative expenses from 1995
to 1996 was primarily a result of increased sales commissions, proposal
activity, liability insurance and other costs related to the increased level
of sales. The increase is also reflective of the costs of being a public
company. The Company's IPO was completed June 20, 1996.
LIQUIDITY AND CAPITAL RESOURCES
In February 1996, the Company sold 284,594 shares of its Series D Preferred
Stock at $7.50 per share to existing investors for next cash of $2.1 million.
In June 1996, the Company completed its initial public offering raising net
proceeds of $22.1 million. The Company used the proceeds of these prior equity
issuances to finance its operations throughout 1996 and 1997. At December 31,
1997, the Company had an accumulated deficit of $36.7 million, and working
capital of $9.9 million.
At December 31, 1997, the Company had cash and cash equivalents and short-
term investments totaling $7.6 million, as compared to $16.2 million in
December 31, 1996. The $8.6 million decrease in 1997 resulted primarily from
$7.7 million of cash used in operating activities, and $1.1 million of cash
used in the purchase of property and equipment, the acquisition of other
assets and the prosecution of patents, offset by $191,000 of cash provided by
the sale and issuance of common stock.
In addition to cash used for operating activities in 1998, the Company
expects to spend approximately $1 million in 1998 to fund additional research
and development activities relating to the treatment of emissions from diesel
engines. However, the Company is actively seeking strategic partners to assist
in the funding of the diesel engine emission control program and if the
Company is successful in finding a strategic partner, its research and
development expenditures could total less than the $1 million forecasted. The
Company is not contractually committed to provide any fixed level of funding
for the diesel program and had no other capital commitments at December 31,
1997.
In February 1997, the Company entered into an Amended and Restated Loan and
Security Agreement (the "1997 Agreement"), which provides for a $4,000,000
accounts receivable line of credit and a $2,500,000 acquisition facility. The
committed line bears interest at the prime interest rate plus 0.50% and will
be subject to certain financial and non-financial covenants. Any borrowings
under the acquisition facility bore interest at the prime interest rate plus
1.00%. No amounts were outstanding under the 1997 Agreement as of December 31,
1997.
In January 1998, the Company entered into an Amended and Restated Loan and
Security Agreement (the "1998 Agreement"), which replaced the 1997 Agreement
and which provides for a $4,000,000 accounts receivable line of credit with a
$2,000,000 letter of credit sub-limit. The 1998 Agreement was renegotiated in
21
<PAGE>
March 1998 when certain financial covenants were amended. The committed line
will bear interest at the prime interest rate plus 0.50% and will be subject
to certain financial and non-financial covenants. There are no interest
bearing borrowings outstanding under the line of credit as of February 28,
1998. The Company has a stand-by letter of credit issued under the sub-
facility in the amount of $280,000.
The Company anticipates satisfying its 1998 cash requirements from, among
other things, (i) its cash and short-term investments, (ii) increased revenues
and positive gross margin, (iii) the timely collection of accounts receivable,
and (iv) the line of credit facility. These strategies are dependent on the
Company's ability to meet its forecasts, including developing increased sales
and generating positive gross margins therefrom, the timely collection of
amounts due to the Company and compliance with the line of credit agreement
covenants. The Company believes that its existing cash and short-term
investments and line of credit facility will provide sufficient liquidity for
it to meet its obligations throughout 1998.
YEAR 2000 COMPLIANCE
The Year 2000 issue arises from computer programs that use two digits rather
than four to define the applicable year. Such computer programs may cause
computer systems to recognize a date using "00" as the calendar year 1900
rather than the calendar year 2000. Systems that do not properly recognize
such information could generate erroneous dates or cause a system to fail.
The Company has conducted a preliminary review of its products and internal
computer systems to identify the systems that could be affected by the Year
2000 issue. The Company believes its products and most of its management
information systems are already Year 2000 compliant, however its existing
accounting system is not. The Company plans to upgrade to a Year 2000
compliant version of its accounting system and does not anticipate that the
cost of such a conversion will be material.
While the Company currently expects the Year 2000 issue will not pose
significant operational problems, failure to fully identify all Year 2000
dependencies in the Company's systems could have a material adverse effect on
the Company's business, results of operations and financial condition. In
addition, the Company cannot be sure that systems of other companies on which
the Company relies will be converted in a timely manner. The failure of other
companies to convert systems on which the Company relies may have a material
adverse effect on the Company's business, results of operations or financial
condition.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages 24 through 38.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
22
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of December 31, 1997, the executive officers of the Company, who are
elected by and serve at the discretion of the Board of Directors, are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
John T. Schofield........... 60 Chairman, President and Chief Executive
Officer
Barbara E. Krimsky.......... 37 Acting Chief Financial Officer, Vice
President, Finance and Administration and
Secretary
Richard J. Goodier.......... 51 Director, European Engineering and
Operations
</TABLE>
John T. Schofield. Mr. Schofield has been President and Chief Executive
Officer of the Company since April 1992, and Chairman of the Board since
December 1993. From April 1981 to September 1991, Mr. Schofield served in
various executive positions at International Technology Corporation, an
environmental management company, where he directed technical services,
business activities, strategic planning and development. Mr. Schofield holds a
BSc Honours in Chemistry from the University of Manchester, England.
Barbara E. Krimsky. Ms. Krimsky has been Acting Chief Financial Officer and
Vice President, Finance and Administration of the Company since January 1998.
She was Vice President, Administration of the Company from November 1993 to
December 1997. In April 1996, Ms. Krimsky was appointed Secretary of the
Corporation. From February 1990 through October 1993, Ms. Krimsky was the
Director, Contracts Management for Quotron Systems, Inc., a financial
information services company. Ms. Krimsky holds a B.A. in Economics and
Computer Science from Duke University and a M.M. from Northwestern
University's Kellogg Graduate School of Management.
Richard J. Goodier. Mr. Goodier joined the Company as Director, European
Engineering and Operations, in February 1997. Prior to joining Thermatrix, he
held a variety of senior management positions in Hickson International PLC,
AltMarks, AE&CI (South Africa), Amoco Europe and Shell Chemicals. Mr. Goodier
holds a B.Sc. in Mechanical Engineering and is a Chartered Engineer with the
Institution of Mechanical Engineers in London.
Information concerning the Company's Directors and compliance with Section
16 of the Securities Exchange Act is incorporated herein by reference to the
Company's definitive proxy statement for its Annual Meeting of Stockholders to
be held on June 11, 1998, which is intended to be filed with the Securities
and Exchange Commission no later than 120 days after the close of the fiscal
year ended December 31, 1997.
ITEMS 11, 12 AND 13
The information called for by Part III (Items 11, 12 and 13) is incorporated
herein by reference to the Company's definitive proxy statement for its Annual
Meeting of Stockholders to be held on June 11, 1998, which is intended to be
filed with the Securities and Exchange Commission no later than 120 days after
the close of the fiscal year ended December 31, 1997.
23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Thermatrix Inc.:
We have audited the accompanying consolidated balance sheets of Thermatrix
Inc. (a Delaware corporation) and subsidiary as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility
is to express an opinion on these 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 also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Thermatrix Inc. and
subsidiary as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed under
Item 14(a) is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not a required part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic consolidated financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth in relation to the basic consolidated
financial statements taken as a whole.
/S/ ARTHUR ANDERSEN LLP
San Jose, California
March 5, 1998
24
<PAGE>
THERMATRIX INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
-------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................... $ 3,990 $ 4,781
Short-term investments.................................. 3,587 11,418
Accounts receivable, net................................ 3,520 4,899
Costs of uncompleted contracts in excess of billings,
net.................................................... 547 809
Prepaid expenses and other current assets............... 250 334
-------- -------
Total current assets.................................. 11,894 22,241
-------- -------
PROPERTY AND EQUIPMENT:
Machinery and equipment................................. 857 750
Furniture and fixtures.................................. 322 307
Demonstration equipment................................. 506 179
-------- -------
1,685 1,236
Less--Accumulated depreciation.......................... (749) (423)
-------- -------
Net property and equipment.................................. 936 813
-------- -------
PATENTS AND OTHER ASSETS, net............................. 1,157 955
-------- -------
$13,987 $24,009
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable........................................ $ 1,055 $ 1,779
Billings on uncompleted contracts in excess of costs and
revenue recognized..................................... 181 8
Accrued liabilities..................................... 802 824
-------- -------
Total current liabilities............................. 2,038 2,611
-------- -------
COMMITMENTS AND CONTINGENCIES (Note 4)
STOCKHOLDERS' EQUITY:
Convertible preferred stock: $0.001 par value
Authorized--5,000,000 shares
Outstanding--None..................................... -- --
Common stock: $0.001 par value
Authorized--50,000,000 shares
Outstanding--7,627,674 and 7,466,683 shares, respec-
tively............................................... 8 7
Additional paid-in capital.............................. 48,644 48,454
Accumulated deficit..................................... (36,703) (27,063)
-------- -------
Total stockholders' equity.............................. 11,949 21,398
-------- -------
$ 13,987 $24,009
======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
25
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
REVENUES.................................... $ 7,011 $13,605 $ 6,494
COST OF REVENUES............................ 8,351 12,002 6,064
------- ------- -------
Gross margin.............................. (1,340) 1,603 430
------- ------- -------
OPERATING EXPENSES:
Research and development.................. 1,203 748 1,084
Selling, general and administrative....... 7,705 6,168 4,740
------- ------- -------
Total operating expenses................ 8,908 6,916 5,824
------- ------- -------
Loss from operations.................... (10,248) (5,313) (5,394)
INTEREST INCOME (EXPENSE):
Interest income........................... 697 548 231
Interest expense.......................... (23) (48) --
------- ------- -------
Total interest income (expense)......... 674 500 231
------- ------- -------
Net loss before provision for income
taxes.................................. (9,574) (4,813) (5,163)
PROVISION FOR INCOME TAXES.................. 66 63 31
------- ------- -------
Net loss................................ $(9,640) $(4,876) $(5,194)
======= ======= =======
BASIC NET LOSS PER SHARE.................... $ (1.28) $ (1.22) $(65.75)
======= ======= =======
BASIC WEIGHTED AVERAGE COMMON SHARES........ 7,548 3,994 79
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
26
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK
------------------ ----------------
TOTAL
ADDITIONAL STOCKHOLDERS'
PAID-IN ACCUMULATED EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT (DEFICIT)
---------- ------ --------- ------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1994................... 2,554,631 $9,304 61,841 $-- $ 3,480 $(16,993) $(4,209)
Exercise of stock op-
tions at $0.30 to
$1.50 per share....... -- -- 57,549 -- 43 -- 43
Stock bonus at $1.50
per share............. -- -- 9,968 -- 15 -- 15
Net loss............... -- -- -- -- -- (5,194) (5,194)
---------- ------ --------- --- ------- -------- -------
BALANCE, DECEMBER 31,
1995................... 2,554,631 9,304 129,358 -- 3,538 (22,187) (9,345)
Common stock issued in
initial public offer-
ing at $12.50 per
share, net of issuance
costs of $2,940....... -- -- 2,000,000 2 22,058 -- 22,060
Exercise of stock op-
tions at $0.30 to
$3.00 per share....... -- -- 44,430 -- 33 -- 33
Exercise of warrants at
$3.00 to $5.25 per
share................. -- -- 21,415 -- 72 -- 72
Common stock issued for
cash at $12.00 per
share................. -- -- 4,167 -- 50 -- 50
Conversion of redeem-
able convertible pre-
ferred stock.......... -- -- 2,712,682 3 13,401 -- 13,404
Conversion of convert-
ible preferred stock.. (2,554,631) (9,304) 2,554,631 2 9,302 -- --
Net loss............... -- -- -- -- -- (4,876) (4,876)
---------- ------ --------- --- ------- -------- -------
BALANCE, DECEMBER 31,
1996................... -- -- 7,466,683 7 48,454 (27,063) 21,398
Exercise of stock op-
tions at $0.30 to
$3.00 per share....... -- -- 109,613 1 72 -- 73
Common stock issued for
cash at $2.76 per
share................. -- -- 19,695 -- 54 -- 54
Common stock issued for
cash at $2.02 per
share................. -- -- 31,683 -- 64 -- 64
Net loss............... -- -- -- -- -- (9,640) (9,640)
---------- ------ --------- --- ------- -------- -------
BALANCE, DECEMBER 31,
1997................... -- $ -- 7,627,674 $ 8 $48,644 $(36,703) $11,949
========== ====== ========= === ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
27
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................ $ (9,640) $ (4,876) $(5,194)
Adjustments to reconcile net loss to net cash
used in operating activities--
Depreciation and amortization................. 453 281 162
Provision for doubtful accounts............... 220 190 229
Provision for uncollectible costs of
uncompleted contracts in excess of billings.. 500 -- --
Write-off of investment in joint venture...... 390 -- --
Stock bonus compensation expense.............. -- -- 15
Changes in assets and liabilities--
(Increase) decrease in accounts receivable.. 1,160 (2,949) (910)
(Increase) decrease in costs of uncompleted
contracts in excess of billings............ (238) (724) 223
(Increase) decrease in prepaid expenses and
other current assets....................... 84 (153) (130)
Increase (decrease) in accounts payable..... (724) 292 29
Increase (decrease) in billings on
uncompleted contracts in excess of costs
and revenue recognized..................... 173 (332) 149
Increase (decrease) in accrued liabilities.. (90) 399 (37)
-------- -------- -------
Net cash used in operating activities....... (7,712) (7,872) (5,464)
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............. (465) (408) (381)
Purchase of short-term investments.............. (27,887) (11,844) --
Proceeds from sale of short-term investments.... 35,718 426 3,801
Increase in patents and other assets............ (636) (800) (147)
-------- -------- -------
Net cash (used in) provided by investing
activities................................. 6,730 (12,626) 3,273
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under line of credit................. -- 1,000 --
Repayment of line of credit borrowing........... -- (1,000) --
Net proceeds from sale of Series D redeemable
preferred stock................................ -- 2,083 --
Net proceeds from sale/issuance of common stock. 191 22,215 43
-------- -------- -------
Net cash provided by financing activities... 191 24,298 43
-------- -------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.. (791) 3,800 (2,148)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.. 4,781 981 3,129
-------- -------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD........ $ 3,990 $ 4,781 $ 981
======== ======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.......................... $ 23 $ 48 $ --
======== ======== =======
Cash paid for income taxes...................... $ 104 $ 13 $ 26
======== ======== =======
Non-cash conversion of redeemable preferred
stock.......................................... $ -- $ 13,404 $ --
======== ======== =======
Non-cash conversion of convertible preferred
stock.......................................... $ -- $ 9,304 $ --
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
28
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Thermatrix Inc. (the "Company") is a global industrial technology company
primarily engaged in the development, manufacture and sale of industrial
process equipment for the destruction of volatile organic compounds and
hazardous air pollutants (collectively, "VOCs"). The Company markets its
products to a wide variety of industries, including petroleum,
chemical/petrochemical, pharmaceutical, pulp and paper, and medical
sterilization and for soil and groundwater remediation, throughout the world.
In June 1996, the Company completed an initial public offering of 2,000,000
shares of common stock at $12.50 per share. Total proceeds to the Company, net
of underwriting discounts and other direct expenses, were approximately $22.1
million.
The Company is subject to certain risks that include, but are not limited
to, the history of operating losses and uncertainty of future profitability;
sensitivity to major projects; fixed price contracts; and dependence on a
limited set of customers and key employees. At December 31, 1997, the Company
had an accumulated deficit of approximately $36.7 million and expects to incur
additional losses in the future. The Company does not expect to be profitable
unless and until such time as sales of flameless thermal oxidation systems at
appropriate gross margins generate sufficient revenue to fund its operations.
There can be no assurance that the Company will achieve such revenues or
margins. The Company's operating results are sensitive to major projects such
that results of operations and financial condition could be adversely affected
if the Company failed to obtain major projects, if a major project order was
delayed, if the Company was unable to complete the project within its cost
estimate or if such installations encountered operating or warranty problems.
The Company anticipates satisfying its 1998 cash requirements from, among
other things, (i) its cash and short-term investments, (ii) increased revenues
and positive gross margin, (iii) the timely collection of accounts receivable,
and (iv) the line of credit facility (Note 9). These strategies are dependent
on the Company's ability to meet its forecasts, including developing increased
sales and generating positive gross margin therefrom, the timely collection of
amounts due to the Company and compliance with the line of credit agreement
covenants. The Company believes that its existing cash and short-term
investments and line of credit facility will provide sufficient liquidity for
it to meet its obligations throughout 1998.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
period. The Company prepares and evaluates ongoing cost to complete estimates
in order to monitor its project costs. These estimates form the basis for
calculating revenues and gross margins for each project under the percentage-
of-completion method of accounting. Due to uncertainties inherent in the
estimation process, estimated total costs are subject to revision on an on-
going basis as additional information becomes available. The estimates are
subject to change and actual results could be materially different from these
estimates.
Principles of Consolidation and Foreign Currency Translation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary. The functional currency of the subsidiary is
the U.S. dollar. Accordingly, all translation gains and losses resulting from
transactions denominated in currencies other than the U.S. dollar are included
in the statement of operations. To date, the translation gains and losses have
not been material. All intercompany accounts and transactions have been
eliminated.
29
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Joint Venture
In October 1996, the Company entered into an agreement with ThermoChem, Inc.
to establish a joint venture, Formatrix, LLC, to combine, under license, the
patented technologies of the joint venture partners. The Company owns 40% of
Formatrix, LLC. Formatrix, LLC has had no operations in the period from its
inception to December 31, 1997. In December 1997, the Company recorded a non-
cash provision of $390,000 to write-off its investment in this area due to the
uncertainties in the timing of the deployment of its technology for the
processing of radioactive mixed waste. In view of these uncertainties, the
Company plans to discontinue its joint venture arrangement and will undertake
any future projects for the processing of radioactive mixed waste on a teaming
basis.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
short-term investments purchased with a maturity of three months or less to be
cash equivalents.
Short-term Investments
Under Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" the Company
classifies its short-term investments as "held to maturity." Therefore all of
these investments are carried at amortized cost. As of December 31, 1997,
short-term investments mature at various dates through March 1998.
The amortized cost, aggregate fair value and gross unrealized holding gains
(losses) by major security type at December 31 were as follows (in thousands):
<TABLE>
<CAPTION>
1997
----------------------------------
AMORTIZED AGGREGATE UNREALIZED
COST FAIR VALUE GAINS (LOSSES)
--------- ---------- -------------
<S> <C> <C> <C>
Certificates of deposit.............. $ 1,000 $ 1,000 $--
Corporate debt securities............ 5,108 5,106 (2)
Money market instruments............. 1,154 1,154 --
------- ------- ----
$ 7,262 $ 7,260 $ (2)
======= ======= ====
</TABLE>
<TABLE>
<CAPTION>
1996
----------------------------------
AMORTIZED AGGREGATE UNREALIZED
COST FAIR VALUE GAINS (LOSSES)
--------- ---------- -------------
<S> <C> <C> <C>
Certificates of deposit.............. $ 2,022 $ 2,022 $--
Corporate debt securities............ 8,247 8,251 4
Money market instruments............. 1,149 1,149 --
------- ------- ----
$11,418 $11,422 $ 4
======= ======= ====
</TABLE>
Revenue Recognition
The Company principally uses the percentage-of-completion method of
accounting for contract revenues. The percentage-of-completion method is based
on total costs incurred to date compared with estimated total costs upon
completion of contracts. The completed contract method of accounting is used
for certain contracts when the Company does not have sufficient historical
data to enable it to prepare dependable cost estimates. Losses on
30
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
contracts are charged to cost of revenues as soon as such losses become known.
Due to uncertainties inherent in the estimation process, estimated total costs
are subject to revision on an ongoing basis as additional information becomes
available. The Company recognizes revenue and costs attributable to priced and
unpriced change orders when it is probable that the contract price will be
adjusted and the amount of the change order can be reliably estimated. When
acceptance of the contract change order is not probable or the amount of the
change order cannot be reliably estimated, the Company treats the change order
costs as costs of uncompleted contracts in excess of billing and defers
revenue recognition until the change order is accepted or acceptance is
probable. The Company generally warrants only new systems manufactured by the
Company for defective workmanship and/or materials for a period of 12 months
from initial operation of the system or 18 months after shipment or
notification that the system is ready for shipment, whichever occurs first. A
provision for estimated warranty costs is provided for each unit produced by
the Company.
Accounts Receivable
Accounts receivable consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1997 1996
------ ------
<S> <C> <C>
Billed, subject to retainer provisions................... $ -- $ 19
Billed................................................... 3,003 3,389
Unbilled, including unpriced change orders............... 860 1,756
------ ------
Total receivables........................................ 3,863 5,164
Less: Allowance for doubtful accounts.................... (343) (265)
------ ------
$3,520 $4,899
====== ======
</TABLE>
The unbilled amounts represent revenues recognized under the percentage-of-
completion method of accounting which exceed the amounts that are billable
according to contract terms. The unbilled amounts are generally billable as
contract milestones and deliverables are accepted by the customer or as change
orders are submitted and approved. As of December 31, 1997 and 1996, accounts
receivable included approximately $793,000 of unpriced change orders.
As of December 31, 1997, 59% of accounts receivable was concentrated with
eight customers. As of December 31, 1996, approximately 61% of accounts
receivable was concentrated with five customers.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of short-term cash investments and accounts
receivable. The Company has cash investment policies that limit its
investments to short-term, low risk investments. With respect to accounts
receivable, the Company performs ongoing credit evaluations of its customers'
financial condition. Additionally, the Company establishes an allowance for
doubtful accounts based upon factors surrounding the credit risk of specific
customers, historical trends and other information.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated lives of the assets of three to
five years. Leasehold improvements are amortized over the shorter of the
related lease term or the estimated useful life of the asset. Betterments,
renewals and extraordinary repairs that extend the life of the asset are
capitalized; other repairs and maintenance are expensed.
31
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As required by SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," the Company regularly
evaluates the remaining life and recoverability of its equipment. The Company
adopted the provisions of this statement in 1995. The adoption did not have a
significant effect on the Company's financial position and results of
operations. Given the emerging nature of its markets, it is possible that the
Company's estimate that it will recover the net carrying value of the
equipment from future operations could change in the future.
Patent Costs
Direct costs incurred in connection with the filing of the Company's patent
claims are capitalized as patent costs. Such amounts are amortized over the
estimated economic useful lives of the patents (generally ten years).
Accumulated amortization as of December 31, 1997 and 1996 was approximately
$137,000 and $88,000, respectively.
Significant Customers
Sales to significant customers as a percentage of total revenues for the
years ended December 31, 1997, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER
31,
----------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Customer A................................................ -- -- 2%
Customer B................................................ -- -- --
Customer C................................................ -- -- 7%
Customer D................................................ -- -- 1%
Customer E................................................ -- 5% 41%
Customer F................................................ -- -- 18%
Customer G................................................ 3% 13% --
Customer H................................................ -- 13% --
Customer I................................................ 2% 12% --
Customer J................................................ 28% -- --
Customer K................................................ 10% -- --
</TABLE>
Revenues from government contracts as a percentage of total revenues were
10%, 15% and 19% for the years ended December 31, 1997, 1996, and 1995,
respectively. The principal government agencies to which the Company sells are
the Department of Defense and the Department of Energy. Revenues from
international customers as a percentage of total revenues were 35% for the
year ended December 31, 1997, 14% for the year ended December 31, 1996 and
less than 10% for the year ended December 31, 1995.
Basic Net Loss Per Share
Basic net loss per share is computed using the weighted average number of
shares of common stock outstanding. No diluted loss per share information has
been presented in the accompanying statements of operations since potential
common shares from conversion of convertible preferred stock, stock options
and warrants are antidilutive.
As a result of the adoption of Statement of Financial Accounting Standards
(SFAS) No. 128 "Earnings Per Share," net loss per share amounts for the fiscal
years 1996 and 1995 have been restated and historical per share information
has been presented. The effect of this accounting change on previously
reported net loss per share data was as follows:
32
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
1996
-------
<S> <C>
Primary net loss per share as previously reported.................. $ (0.73)
Effect of SFAS No. 128............................................. $ (0.49)
-------
Basic net loss per share......................................... $ (1.22)
=======
<CAPTION>
1995
-------
<S> <C>
Pro forma net loss per share as previously reported................ $ (0.91)
Effect of SFAS No. 128............................................. $(64.84)
-------
Basic net loss per share......................................... $(65.75)
=======
</TABLE>
Effect of Recent Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board issued SFAS No.
129, "Disclosure of Information about Capital Structures," which will be
adopted by the Company in fiscal 1998. SFAS No. 129 requires companies to
disclose certain information about their capital structure. The Company does
not anticipate that SFAS No. 129 will have a material impact on its
consolidated financial statement disclosures.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which will be adopted by the Company in
fiscal 1998. SFAS No. 130 requires companies to disclose certain information
regarding the nature and amounts of comprehensive income included in the
financial statements. The Company does not anticipate that SFAS No. 130 will
have a material impact on its consolidated financial statement disclosures.
In June 1997, the Financial Accounting Standards Board also issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
(SFAS No. 131) which will be adopted by the Company in fiscal 1998. SFAS No.
131 establishes standards for disclosures about operating segments, products
and services, geographical areas and major customers. Management believes the
adoption of SFAS No. 131 will not have a material effect on the Company's
financial statements.
3. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER
31,
---------
<S> <C> <C>
1997 1996
---- ----
Commissions payable............................................... $139 $242
Accrued employee compensation cost................................ 167 --
Other............................................................. 496 582
---- ----
$802 $824
==== ====
</TABLE>
4. COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain equipment under operating
leases that expire through January 2003. Rent expense was approximately
$492,000, $338,000 and $269,000 for the years ended December 31,
33
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1997, 1996 and 1995, respectively. As of December 31, 1997, future minimum
payments are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1998.................................................................... $406
1999.................................................................... 302
2000.................................................................... 90
2001.................................................................... 84
2002 and thereafter..................................................... 9
----
$891
====
</TABLE>
In April 1996, the Company purchased all of the respective assets, rights
and properties of Purus Inc.'s VOC adsorption technology ("PADRE"). Concurrent
with the purchase, the Company entered into a License Agreement ("License")
with Purus to manufacture, sell and distribute VOC treatment systems utilizing
the PADRE technology. Under this License, the Company is required to make
quarterly royalty payments of 7% on the aggregate net invoice value of all
PADRE VOC equipment sales. Royalty payments will continue until the earlier of
(i) five years from the date of the License or (ii) such date that Purus has
received $2.0 million in aggregate royalty payments. Royalties paid by the
Company under the License totaled approximately $80,000 and $63,000 for the
years ended December 31, 1997 and 1996, respectively.
5. PREFERRED STOCK
Convertible Preferred Stock
Upon the closing of the Company's initial public offering in June 1996, each
of the 2,554,631 shares of preferred stock then outstanding converted
automatically into common stock.
Redeemable Convertible Preferred Stock
Redeemable convertible preferred stock outstanding as of December 31, 1995,
consisted of 1,614,284 shares of Series D redeemable preferred stock. In
February 1996, the Company sold 284,594 shares of Series D redeemable
preferred stock at $7.50 per share.
Pursuant to the terms of the preferred stock agreement, the conversion price
of Series D redeemable preferred stock was adjusted to $5.25 per share. The
Series D preferred stock was automatically converted into 2,712,682 shares of
common stock upon the closing of the Company's initial public offering.
In connection with a bridge financing in 1994, warrants to purchase 20,672
shares of convertible Series D redeemable preferred stock at $5.25 per share
(as adjusted) were issued. Subsequent to the Company's initial public
offering, these warrants were convertible into warrants to purchase common
stock. The warrants are exercisable at any time and expire in 1999. Warrants
to purchase 3,558 shares of common stock were exercised during 1996.
Preferred Stock
The Company is authorized to issue 5,000,000 shares of $.001 par value
undesignated preferred stock. Upon issuance, the Board of Directors will have
the authority to fix the rights, preferences, privileges and restrictions
thereof.
34
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. COMMON STOCK
As of December 31, 1997, the Company had reserved shares of its common stock
for issuance as follows:
<TABLE>
<S> <C>
Warrants to purchase common stock.................................. 45,685
Stock options under 1987 Stock Option Plan......................... 500,214
Stock options under 1996 Stock Plan................................ 333,334
Stock options under 1996 Director Option Plan...................... 83,334
Employee Stock Purchase Plan....................................... 65,289
---------
Total shares reserved............................................ 1,027,856
=========
</TABLE>
In May 1996, the Board of Directors approved a one-for-three reverse stock
split of all common stock and all designated series of preferred stock
outstanding. The effect of the stock split has been retroactively applied in
the consolidated financial statements.
7. STOCK OPTION PLANS
1987 Stock Option Plan ("1987 Plan")
Under the 1987 Plan, the Board of Directors may grant to employees and
consultants options to purchase the Company's common stock at terms and prices
determined by the Board. Options granted under the 1987 Plan generally expire
ten (10) years from the date of grant. During 1996, the Company adopted new
stock plans (see below); accordingly, the Company does not plan to issue
further options to purchase common stock under the 1987 Plan.
1996 Stock Plan ("1996 Plan")
A total of 333,334 shares of common stock has been reserved for issuance
under the 1996 Plan. The 1996 Plan provides that options and stock purchase
rights may be granted to employees and consultants to the Company. Options
granted under the 1996 Plan may be either incentive stock options or non-
statutory stock options. The Company may also grant stock purchase rights
under the 1996 Plan. The exercise price and vesting of all grants are to be
determined by the Board of Directors or its designee. Options granted under
the 1996 Plan expire 10 years from the date of grant. The 1996 Plan will
terminate in 2006.
The Board of Directors adopted a sub-plan of the 1996 Plan for the purpose
of qualifying for preferred tax treatment under UK tax laws. The UK Inland
Revenue approved the sub-plan effective January 30, 1998.
1996 Director Option Plan ("Directors Plan")
A total of 83,334 shares of common stock has been reserved for issuance
under the Directors Plan. The Directors Plan provides for an automatic grant
to each director of an initial option to purchase 6,667 shares of common stock
("First Option") upon the date on which such person becomes a non-employee
director, and an additional option to purchase 1,667 shares of common stock
("Subsequent Option") each year, if the director has served on the Company's
Board of Directors for at least six months. Options granted under the
Directors Plan expire ten years after the date of grant. Twelve and one-half
percent of the shares subject to a First Option will vest six months after its
date of grant and an additional twelve and one-half percent will vest at the
end of each six-month period thereafter. One-half of the shares subject to a
Subsequent Option will vest six months after the date of the option grant and
as to the remaining one-half, one year after the date of grant. The exercise
35
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
price per share of all options shall be equal to the fair market value of the
Company's common stock on the date of grant. The Directors Plan will terminate
in 2006.
The following option activity occurred in all stock option plans during the
three years ended December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS WEIGHTED
AVAILABLE OUTSTANDING PER SHARE AVERAGE
FOR GRANT OPTIONS PRICE EXERCISE PRICE
--------- ----------- ------------ --------------
<S> <C> <C> <C> <C>
Balance, December 31, 1994.... 68,834 670,261 $0.30-$ 5.25 $1.99
Authorized.................. 107,317 -- --
Granted..................... (262,020) 262,020 $ 1.50 1.50
Exercised................... -- (57,549) $0.30-$ 1.50 0.75
Canceled.................... 320,255 (320,255) $0.30-$ 5.25 3.55
-------- --------
Balance, December 31, 1995.... 234,386 554,477 $0.30-$ 1.50 0.98
Authorized.................. 416,668 -- --
Granted..................... (273,522) 273,522 $3.00-$12.50 5.74
Exercised................... -- (44,430) $0.30-$ 3.00 0.74
Expired..................... (47,254) -- --
Canceled.................... 5,388 (5,388) $0.75-$ 7.50 2.67
-------- --------
Balance, December 31, 1996.... 335,666 778,181 $0.30-$12.50 2.66
Granted..................... (57,469) 57,469 $3.00-$9.00 5.24
Exercised................... -- (109,613) $0.30-$ 3.00 0.66
Expired..................... (87,352) -- --
Canceled.................... 106,978 (106,978) $0.75-$12.50 4.23
-------- --------
Balance, December 31, 1997.... 297,823 619,059 $0.30-$12.50 2.98
======== ========
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- -----------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER AVERAGE
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE EXERCISE
EXERCISE PRICES AS OF 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AS OF 12/31/97 PRICE
--------------- -------------- ---------------- -------------- -------------- --------
<S> <C> <C> <C> <C> <C>
$ 0.30-- $0.75 165,105 5.69 $ 0.59 138,477 $ 0.56
$ 1.50 226,965 7.40 $ 1.50 167,237 $ 1.50
$ 3.00-- $10.125 193,654 8.49 $ 5.12 59,616 $ 5.20
$12.50 33,335 8.47 $12.50 12,505 $ 12.50
------- ---- ------ ------- --------
619,059 7.34 $ 2.98 377,835 $ 2.10
======= ==== ====== ======= ========
</TABLE>
Employee Stock Purchase Plan ("Purchase Plan")
A total of 116,667 shares of common stock were initially reserved for
issuance under the Purchase Plan. The Purchase Plan enables eligible employees
to purchase common stock at the lower of 85% of the fair market value of the
Company's common stock on the first or last day of each six-month offering
period. The first offering period began on June 19, 1996. The Purchase Plan
will terminate in 2006. As of December 31, 1997, 51,378 shares of common stock
had been issued under the Purchase Plan.
36
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company applies Accounting Principles Board Opinion No. 25. "Accounting
for Stock Issued to Employees" and related interpretations in accounting for
its plans. Accordingly, no compensation cost has been recognized for its stock
option plans. Had compensation cost for the Company's plans been determined
based on the fair value at the grant dates for awards under the plans
consistent with the method of SFAS No. 123, "Accounting for Stock-Based
Compensation", the Company's net loss and net loss per share would have been
changed to the pro forma amounts indicated below (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Net loss
As reported..................................... $(9,640) $(4,876) $(5,194)
Pro forma....................................... $(9,978) $(5,087) $(5,220)
Basic net loss per share
As reported..................................... $ (1.28) $ (1.22) $(65.75)
Pro forma....................................... $ (1.32) $ (1.27) $(66.08)
</TABLE>
For the purpose of SFAS No. 123, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes multiple option-pricing
model with the following weighted-average assumptions used for grants in 1997,
1996, and 1995:
<TABLE>
<CAPTION>
1997 1996 AND 1995
---- -------------
<S> <C> <C>
Dividend Yield 0% 0%
Expected Volatility 125% 0% prior to the initial public offering and 85% thereafter
Risk-free Interest Rate 5.59-6.50% 5.20-6.80%
Expected Lives for Each
Grant 2.5 to 3 years 1 to 2 years
</TABLE>
8. INCOME TAXES
The Company follows SFAS No. 109 which prescribes an asset and liability
approach to income taxes under which deferred income taxes are provided based
upon enacted tax laws and rates applicable to the periods in which the taxes
become payable.
The provision for income taxes differs from the statutory United States
Federal income tax rate due to the following:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Benefit at U.S.
statutory rate......... (34.0)% (34.0)% (34.0)%
State income taxes, net
of Federal benefit..... (5.8) (6.1) (6.1)
Increase (decrease) in
valuation allowance.... 39.7 40.0 40.0
Other................... 0.1 0.1 0.1
------ ------ ------
-- % -- % -- %
====== ====== ======
</TABLE>
The provision for income taxes for the years ended December 31, 1997 and
1996 relates to state taxes against which no net operating loss can be
applied.
37
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The net deferred income tax asset consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1996
------- ------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards.......................... $12,719 $9,406
Tax credit carryforwards.................................. 280 193
Cumulative temporary differences.......................... 484 381
------- ------
13,483 9,980
Valuation allowance......................................... (13,483) (9,980)
------- ------
Net deferred income tax asset............................... $ -- $ --
======= ======
</TABLE>
As of December 31, 1997, the Company had net operating loss carryforwards
for Federal and state income tax purposes of approximately $34.9 million and
$18.3 million, respectively. The net operating loss carryforwards and tax
credit carryforwards expire on various dates through 2012. The Internal
Revenue Code contains provisions which may limit the net operating loss and
tax credit carryforwards to be used in any given year upon the occurrence of
certain events. Certain of the Company's net operating loss and tax credit
carryforwards are limited due to an ownership change that occurred in June
1996. Cumulative temporary differences consist of reserves and accruals
currently deductible for financial reporting purposes, but not for tax
purposes. The Company believes sufficient uncertainty exists regarding the
realizability of the operating loss and credit carryforwards and, accordingly,
has provided a valuation allowance against the deferred income tax asset.
9. LOAN AND SECURITY AGREEMENT
In December 1995, the Company entered into a Loan and Security Agreement
(the "Agreement") with a bank which provided for a $3,000,000 bridge loan,
available in two equal parts of $1,500,000, and bore interest at the bank's
prime interest rate plus 2.5%. The Agreement was extended past its original
expiration date while new terms and conditions were negotiated. No amounts
were outstanding under the Agreement as of December 31, 1997 and 1996.
In consideration for the Agreement, the Company granted the bank a warrant
to purchase 28,571 shares of Series D redeemable convertible preferred stock
at $5.25 per share (as adjusted). The fair value of the warrants at the date
of issuance was not significant and, therefore, no value was assigned to the
warrants for accounting purposes. Subsequent to the Company's initial public
offering, these warrants were convertible into warrants to purchase common
stock.
In February 1997, the Company entered into an Amended and Restated Loan and
Security Agreement (the "1997 Agreement") with the same bank, which provides
for a $4,000,000 accounts receivable line of credit and a $2,500,000
acquisition facility. The committed line bears interest at the prime interest
rate plus 0.50% and will be subject to certain financial and non-financial
covenants. Any borrowings under the acquisition facility bore interest at the
prime interest rate plus 1.00%. No amounts were outstanding under the 1997
Agreement during 1997.
In January 1998, the Company entered into an Amended and Restated Loan and
Security Agreement (the "1998 Agreement"), which replaced the 1997 Agreement
and which provides for a $4,000,000 accounts receivable line of credit with a
$2,000,000 letter of credit sub-limit. The 1998 Agreement was renegotiated in
March 1998 when certain financial covenants were amended. The committed line
will bear interest at the prime interest rate plus 0.50% and will be subject
to certain financial and non-financial covenants. There are no interest
bearing borrowings outstanding under the line of credit as of March 5, 1998.
The Company has a stand-by letter of credit issued under the sub-facility in
the amount of $280,000.
38
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)The following documents are filed as a part of this Report:
1. Financial Statements. The following Consolidated Financial Statements of
Thermatrix Inc. and Report of Independent Public Accountants are filed as a
part of this Report:
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Public Accountants.............................. 24
Consolidated Balance Sheets--As of December 31, 1997 and 1996......... 25
Consolidated Statements of Operations--For the Three Years Ended
December 31, 1997.................................................... 26
Consolidated Statements of Stockholders' Equity (Deficit)--For the
Three Years Ended December 31, 1997.................................. 27
Consolidated Statements of Cash Flows--For the Three Years Ended
December 31, 1997.................................................... 28
Notes to Consolidated Financial Statements............................ 29-38
</TABLE>
2. Financial Statement Schedules. For years ended December 31, 1997, 1996 and
1995:
<TABLE>
<S> <C>
Schedule II. Valuation and Qualifying Accounts and Reserves.............. 40
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements or
notes thereto.
3. Exhibits:
<TABLE>
<C> <S>
3.3 Restated Certificate of Incorporation of Registrant.(**)
3.4 Amended and Restated Bylaws of Registrant.(*)
4.2 Amended and Restated Investor Rights Agreement.(*)
10.1 Form of Indemnification Agreement between the Registrant and each of
its directors and executive officers.(*)
10.2 1987 Incentive Stock Plan, as amended and related agreements.(*)
10.3 1996 Stock Plan and form of Stock Option Agreement thereunder.(*)
10.4 Employee Stock Purchase Plan and forms of agreement thereunder.(*)
10.5 1996 Director Option Plan and form of Director Stock Option Agreement
thereunder.(*)
10.6 Asset Purchase Agreement between the registrant and Purus, Inc. dated
January 4, 1996.(*)
10.7 Lease dated June 12,1995 between the Registrant and Spieker
Properties, L.P., as amended.(*)
10.8 Lease dated June 24, 1995 between the Registrant and American General
Life Insurance Company.(*)
10.11 Amended and Restated Loan and Security Agreement between the
Registrant and Venture Banking Group, a Division of Cupertino National
Bank, dated January 21, 1998.
10.12 1996 Stock Plan: UK Rules for Employees.
10.13 First Amendment to the Amended and Restated Loan and Security
Agreement between Registrant and Venture Banking Group, a Division of
Cupertino National Bank.
21.1 Subsidiary of the Registrant.(*)
23.1 Consent of Indepent Public Accountants.
27.1 Financial Data Schedule.
</TABLE>
- --------
(*) Incorporated by reference to exhibits filed with the Registrant's
Registration Statement on Form S-1 (No. 333- 4370) which became effective
June 19, 1996.
(**) Incorporated by reference to exhibits filed with the Registrant's
Quarterly Report on Form 10-Q for the quarter ending September 30, 1997.
(b)Reports on Form 8-K
None.
TRADEMARK ACKNOWLEDGMENTS
. Thermatrix and PADRE are registered trademarks of the Company.
. B.O.S.S. is a registered trademark of White Horse Technologies, Inc.
39
<PAGE>
SCHEDULE II
THERMATRIX INC.
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO BALANCE
AT BEGINNING COSTS AND AT END
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) OF PERIOD
- ----------- ------------ ---------- ------------- ---------
<S> <C> <C> <C> <C>
Year ended December 31, 1995
Allowance for doubtful
accounts.................... $150 $229 $(189) $190
Reserve for costs of
uncompleted contracts in
excess of billings.......... $200 -- $ 200 --
Year ended December 31, 1996
Allowance for doubtful
accounts.................... $190 $190 $(115) $265
Reserve for costs of
uncompleted contracts in
excess of billings.......... -- -- -- --
Year ended December 31, 1997
Allowance for doubtful
accounts.................... $265 $220 $(142) $343
Reserve for costs of
uncompleted contracts in
excess of billings.......... -- $500 -- $500
</TABLE>
- --------
(1) Deductions represent accounts receivable and inventory amounts that were
considered doubtful and previously reserved for that became uncollectible
and were written off in the year.
40
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
THERMATRIX INC.
/s/ John T. Schofield Date: March 31, 1998___________
By: ___________________________
John T. Schofield
Chairman of the Board
President and CEO
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints John T. Schofield and Barbara Krimsky, jointly
and severally, their attorney-in-fact, each with full power of substitution,
for him in any and all capacities, to sign on behalf of the undersigned any
amendments to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, and each of the undersigned does hereby ratifying and
confirming all that each of said attorneys-in-fact, of his substitutes, may do
or cause to be done by virtue hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES AND EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
/s/ John T. Schofield Chairman, President and March 31, 1998
_______________________________ Chief Executive Officer
John T. Schofield (Principal Executive
Officer)
/s/ Barbara E. Krimsky Chief Financial Officer, March 31, 1998
_______________________________ Vice President, Finance
Barbara E. Krimsky and Administration, and
Secretary (Principal
Financial and Accounting
Officer)
/s/ Robi Blumenstein Director March 31, 1998
_______________________________
Robi Blumenstein
/s/ Harry J. Healer, Jr. Director March 31, 1998
_______________________________
Harry J. Healer, Jr.
/s/ Charles R. Kokesh Director March 31, 1998
_______________________________
Charles R. Kokesh
/s/ Rebecca P. Mark Director March 31, 1998
_______________________________
Rebecca P. Mark
41
<PAGE>
/s/ Frank R. Pope Director March 31, 1998
_______________________________
Frank R. Pope
/s/ John M. Toups Director March 31, 1998
_______________________________
John M. Toups
/s/ James M. Strock Director March 31, 1998
_______________________________
James M. Strock
42
<PAGE>
EXHIBIT 10.11
================================================================================
THERMATRIX INC.
AMENDED AND RESTATED
LOAN AND SECURITY AGREEMENT
================================================================================
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
1. DEFINITIONS AND CONSTRUCTION...................... 1
1.1 Definitions....................................... 1
1.2 Accounting Terms.................................. 6
2. LOAN AND TERMS OF PAYMENT................................. 6
2.1 Revolving Advances................................ 6
2.2 Overadvances...................................... 8
2.3 Interest Rates, Payments, and Calculations........ 8
2.4 Crediting Payments................................ 9
2.5 Fees.............................................. 9
2.6 Additional Costs.................................. 9
2.7 Term.............................................. 10
3. CONDITIONS OF LOANS 10
3.1 Conditions Precedent to Initial Advance........... 10
3.2 Conditions Precedent to all Advances.............. 10
4. CREATION OF SECURITY INTEREST 11
4.1 Grant of Security Interest........................ 11
4.2 Delivery of Additional Documentation Required..... 11
4.3 Right to Inspect.................................. 11
5. REPRESENTATIONS AND WARRANTIES 11
5.1 Due Organization and Qualification................ 11
5.2 Due Authorization; No Conflict.................... 11
5.3 No Prior Encumbrances............................. 11
5.4 Bona Fide Eligible Accounts....................... 11
5.5 Merchantable Inventory............................ 11
5.6 Name; Location of Chief Executive Office.......... 11
5.7 Litigation........................................ 12
5.8 No Material Adverse Change in Financial Statements 12
5.9 Solvency.......................................... 12
5.10 Regulatory Compliance............................. 12
5.11 Environmental Condition........................... 12
5.12 Taxes............................................. 12
5.13 Subsidiaries...................................... 12
5.14 Government Consents............................... 12
5.15 Full Disclosure................................... 13
6. AFFIRMATIVE COVENANTS 13
6.1 Good Standing..................................... 13
6.2 Government Compliance............................. 13
6.3 Financial Statements, Reports, Certificates....... 13
6.4 Inventory; Returns................................ 14
6.5 Taxes............................................. 14
6.6 Insurance......................................... 14
6.7 Principal Depository.............................. 14
6.8 Quick Ratio....................................... 14
6.9 Debt-Net Worth Ratio.............................. 14
6.10 Tangible Net Worth................................ 14
</TABLE>
i
<PAGE>
<TABLE>
<S> <C> <C>
6.11 Profitability................................. 14
6.12 Registration of Intellectual Property Rights.. 15
6.13 Further Assurances............................ 15
7. NEGATIVE COVENANTS.................................. 15
7.1 Dispositions.................................. 15
7.2 Change in Business............................ 15
7.3 Mergers or Acquisitions....................... 15
7.4 Indebtedness.................................. 15
7.5 Advances to Employees or Shareholders......... 15
7.6 Encumbrances.................................. 16
7.7 Distributions................................. 16
7.8 Investments................................... 16
7.9 Transactions with Affiliates.................. 16
7.10 Subordinated Debt............................. 16
7.11 Inventory..................................... 16
7.12 Compliance.................................... 16
8. EVENTS OF DEFAULT................................... 16
8.1 Payment Default............................... 16
8.2 Covenant Default.............................. 16
8.3 Material Adverse Change....................... 17
8.4 Attachment.................................... 17
8.5 Insolvency.................................... 17
8.6 Other Agreements.............................. 17
8.7 Subordinated Debt............................. 17
8.8 Judgments..................................... 17
8.9 Misrepresentations............................ 17
9. BANK'S RIGHTS AND REMEDIES.......................... 17
9.1 Rights and Remedies........................... 17
9.2 Power of Attorney............................. 18
9.3 Accounts Collection........................... 19
9.4 Bank Expenses................................. 19
9.5 Bank's Liability for Collateral............... 19
9.6 Remedies Cumulative........................... 19
9.7 Demand; Protest............................... 19
10. NOTICES............................................. 19
11. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER.......... 20
12. GENERAL PROVISIONS.................................. 20
12.1 Successors and Assigns........................ 20
12.2 Indemnification............................... 20
12.3 Time of Essence............................... 21
12.4 Severability of Provisions.................... 21
12.5 Amendments in Writing, Integration............ 21
12.6 Counterparts.................................. 21
12.7 Survival...................................... 21
12.8 Confidentiality............................... 21
</TABLE>
ii
<PAGE>
This AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT is entered into as of
January 21, 1998, by and between VENTURE BANKING GROUP, a division of Cupertino
National Bank & Trust ("Bank") and THERMATRIX INC. ("Borrower").
RECITALS
Borrower and Bank are parties to an Amended and Restated Loan and Security
Agreement dated as of February 25, 1997, as amended ("The Original Agreement").
Borrower and Bank desire to amend and restate the Original Agreement on the
terms stated herein. This Agreement amends and restates in its entirety the
Original Agreement, and sets for the terms on which Bank will advance credit to
Borrower, and Borrower will repay the amounts owing to Bank.
AGREEMENT
The parties agree as follows:
1. DEFINITIONS AND CONSTRUCTION
1.1 Definitions. As used in this Agreement, the following terms shall
have the following definitions:
"Accounts" means all presently existing and hereafter arising
accounts, contract rights, and all other forms of obligations owing to Borrower
arising out of the sale or lease of goods (including, without limitation, the
licensing of software and other technology) or the rendering of services by
Borrower, whether or not earned by performance, and any and all credit
insurance, guaranties, and other security therefor, as well as all merchandise
returned to or reclaimed by Borrower and Borrower's Books relating to any of the
foregoing.
"Advance" or "Advances" means a cash advance under the Revolving
Facility.
"Affiliate" means, with respect to any Person, any Person that
owns or controls directly or indirectly such Person, any Person that controls or
is controlled by or is under common control with such Person, and each of such
Person's senior executive officers, directors, and partners.
"Bank Expenses" means all: reasonable costs or expenses
(including reasonable attorneys' fees and expenses) incurred in connection with
the preparation, negotiation, administration, and enforcement of the Loan
Documents; and Bank's reasonable attorneys' fees and expenses incurred in
amending, enforcing or defending the Loan Documents, whether or not suit is
brought.
"Borrower's Books" means all of Borrower's books and records
including: ledgers; records concerning Borrower's assets or liabilities, the
Collateral, business operations or financial condition; and all computer
programs, or tape files, and the equipment, containing such information.
"Borrowing Base" has the meaning set forth in Section 2.1 hereof.
"Business Day" means any day that is not a Saturday, Sunday, or
other day on which banks in the State of California are authorized or required
to close.
"Closing Date" means the date of this Agreement.
"Code" means the California Uniform Commercial Code.
1
<PAGE>
"Collateral" means the property described on Exhibit A attached
hereto.
"Committed Line" means Four Million Dollars ($4,000,000).
"Contingent Obligation" means, as applied to any Person, any
direct or indirect liability, contingent or otherwise, of that Person with
respect to (i) any indebtedness, lease, dividend, letter of credit or other
obligation of another, including, without limitation, any such obligation
directly or indirectly guaranteed, endorsed, co-made or discounted or sold with
recourse by that Person, or in respect of which that Person is otherwise
directly or indirectly liable; (ii) any obligations with respect to undrawn
letters of credit issued for the account of that Person; and (iii) all
obligations arising under any interest rate, currency or commodity swap
agreement, interest rate cap agreement, interest rate collar agreement, or other
agreement or arrangement designated to protect a Person against fluctuation in
interest rates, currency exchange rates or commodity prices; provided, however,
that the term "Contingent Obligation" shall not include endorsements for
collection or deposit in the ordinary course of business. The amount of any
Contingent Obligation shall be deemed to be an amount equal to the stated or
determined amount of the primary obligation in respect of which such Contingent
Obligation is made or, if not stated or determinable, the maximum reasonably
anticipated liability in respect thereof as determined by such Person in good
faith; provided, however, that such amount shall not in any event exceed the
maximum amount of the obligations under the guarantee or other support
arrangement.
"Current Liabilities" means, as of any applicable date, all
amounts that should, in accordance with GAAP, be included as current liabilities
on the consolidated balance sheet of Borrower and its Subsidiaries, as at such
date, plus, to the extent not already included therein, all outstanding Advances
made under this Agreement, including all Indebtedness that is payable upon
demand or within one year from the date of determination thereof unless such
Indebtedness is renewable or extendable at the option of Borrower or any
Subsidiary to a date more than one year from the date of determination, but
excluding Subordinated Debt and deferred income.
"Daily Balance" means the amount of the Obligations owed at the
end of a given day.
"Eligible Accounts" means those Accounts that arise in the
ordinary course of Borrower's business that comply with all of Borrower's
representations and warranties to Bank set forth in Section 5.4; provided that
standards of eligibility may be fixed and revised from time to time by Bank in
Bank's reasonable judgment and upon notification thereof to Borrower in
accordance with the provisions hereof. Unless otherwise agreed to by Bank,
Eligible Accounts shall not include the following:
(a) Accounts that the account debtor has failed to pay within
ninety (90) days of invoice date;
(b) Accounts with respect to an account debtor, fifty percent
(50%) of whose Accounts the account debtor has failed to pay within ninety (90)
days of invoice date;
(c) Accounts with respect to which the account debtor is an
officer, employee, or agent of Borrower;
(d) Accounts with respect to which goods are placed on
consignment, guaranteed sale, sale or return, sale on approval, bill and hold,
or other terms by reason of which the payment by the account debtor may be
conditional;
(e) Accounts with respect to which the account debtor is an
Affiliate of Borrower;
2
<PAGE>
(f) Accounts with respect to which the account debtor does not
have its principal place of business in the United States, except for Eligible
Foreign Accounts;
(g) Accounts with respect to which the account debtor is the
United States or any department, agency, or instrumentality of the United
States, other than Government Accounts;
(h) Accounts with respect to which Borrower is liable to the
account debtor for goods sold or services rendered by the account debtor to
Borrower, but only to the extent of any amounts owing to the account debtor
against amounts owed to Borrower;
(i) Accounts with respect to an account debtor, including
Subsidiaries and Affiliates, whose total obligations to Borrower exceed thirty
percent (30%) of all Accounts, to the extent such obligations exceed the
aforementioned percentage, except for Accounts with respect to Fortune 500
companies to which the applicable percentage shall be fifty percent (50%) and as
approved in writing by Bank;
(j) Accounts with respect to which the account debtor disputes
liability or makes any claim with respect thereto as to which Bank believes, in
its sole discretion, that there may be a basis for dispute (but only to the
extent of the amount subject to such dispute or claim), or is subject to any
Insolvency Proceeding, or becomes insolvent, or goes out of business;
(k) Accounts with respect to which the account debtor is a
distributor, unless pre-approved by Bank in writing; and
(1) Accounts the collection of which Bank reasonably determines
to be doubtful.
"Eligible Foreign Accounts" means Accounts with respect to which
the account debtor does not have its principal place of business in the United
States and that are: (1) supported by one or more letters of credit either
advised or negotiated through Bank or in favor of Bank as beneficiary, in an
amount and of a tenor, and issued by a financial institution, acceptable to
Bank; or (2) that Bank approves on a case-by-case basis; in each case that are
not excluded by any of clauses (a) through (1) under the defined term, "Eligible
Accounts." Bank acknowledges that Accounts owed by BASF and Warner Lambert are
approved, provided that such Accounts are not otherwise excluded by any of
clauses (a) through (1) under the defined term, "Eligible Accounts."
"Equipment" means all present and future machinery, equipment,
tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments
in which Borrower has any interest.
"ERISA" means the Employment Retirement Income Security Act of
1974, as amended, and the regulations thereunder.
"Foreign Exchange Reserve" has the meaning set forth in Section
2.1.2 hereof.
"Fortune 500 Companies" means those corporations listed in
Fortune Magazine as its "Fortune 500," including the Subsidiaries or Affiliates
of such corporations.
"GAAP" means generally accepted accounting principles as in
effect from time to time.
"Government Accounts" means Accounts with respect to which the
account debtor is the United States or any department, agency or instrumentality
of the United States that
3
<PAGE>
Bank approves on a case-by-case basis and that are not excluded by any of
clauses (a) through (e) or (h) through (1) under the defined term, "Eligible
Accounts."
"Indebtedness" means (a) all indebtedness for borrowed money or
the deferred purchase price of property or services, including without
limitation reimbursement and other obligations with respect to surety bonds and
letters of credit, (b) all obligations evidenced by notes, bonds, debentures or
similar instruments, (c) all capital lease obligations and (d) all Contingent
Obligations.
"Insolvency Proceeding" means any proceeding commenced by or
against any person or entity under any provision of the United States Bankruptcy
Code, as amended, or under any other bankruptcy or insolvency law, including
assignments for the benefit of creditors, formal or informal moratoria,
compositions, extension generally with its creditors, or proceedings seeking
reorganization, arrangement, or other relief.
"Inventory" means all present and future inventory in which
Borrower has any interest, including merchandise, raw materials, parts,
supplies, packing and shipping materials, work in process and finished products
intended for sale or lease or to be furnished under a contract of service, of
every kind and description now or at any time hereafter owned by or in the
custody or possession, actual or constructive, of Borrower, including such
inventory as is temporarily out of its custody or possession or in transit and
including any returns upon any accounts or other proceeds, including insurance
proceeds, resulting from the sale or disposition of any of the foregoing and any
documents of title representing any of the above, and Borrower's Books relating
to any of the foregoing.
"Investment" means any beneficial ownership of (including stock,
partnership interest or other securities) any Person, or any loan, advance or
capital contribution to any Person.
"IRC" means the Internal Revenue Code of 1986, as amended, and
the regulations thereunder.
"Lien" means any mortgage, lien, deed of trust, charge, pledge,
security interest or other encumbrance.
"Loan Documents" means, collectively, this Agreement, any note or
notes executed by Borrower, and any other agreement entered into between
Borrower and Bank in connection with this Agreement, all as amended or extended
from time to time.
"Material Adverse Effect" means a material adverse effect on (i)
the business operations or condition (financial or otherwise) of Borrower and
its Subsidiaries taken as a whole or (ii) the ability of Borrower to repay the
Obligations or otherwise perform its obligations under the Loan Documents.
"Negotiable Collateral" means all of Borrower's present and
future letters of credit of which it is a beneficiary, notes, drafts,
instruments, securities, documents of title, and chattel paper, and Borrower's
Books relating to any of the foregoing.
"Obligations" means all debt, principal, interest, Bank Expenses
and other amounts owed to Bank by Borrower pursuant to this Agreement or any
other agreement, whether absolute or contingent, due or to become due, now
existing or hereafter arising, including any interest that accrues after the
commencement of an Insolvency Proceeding and including any debt, liability, or
obligation owing from Borrower to others that Bank may have obtained by
assignment or otherwise.
4
<PAGE>
"Periodic Payments" means all installments or similar recurring
payments that Borrower may now or hereafter become obligated to pay to Bank
pursuant to the terms and provisions of any instrument, or agreement now or
hereafter in existence between Borrower and Bank.
"Permitted Indebtedness" means:
(a) Indebtedness of Borrower in favor of Bank arising under this
Agreement or any other Loan Document;
(b) Indebtedness existing on the Closing Date and disclosed in
the Schedule;
(c) Subordinated Debt;
(d) Indebtedness in an aggregate principal amount of up to One
Hundred Thousand Dollars ($100,000) for the purpose of leasing or acquiring new
equipment;
(e) Indebtedness to trade creditors incurred in the ordinary
course of business.
"Permitted Investment" means:
(a) Investments existing on the Closing Date disclosed in the
Schedule;
and
(b) (i) marketable direct obligations issued or unconditionally
guaranteed by the United States of America or any agency or any State thereof
maturing within one (1) year from the date of acquisition thereof, (ii)
commercial paper maturing no more than one (1) year from the date of creation
thereof and currently having the highest rating obtainable from either Standard
& Poor's Corporation or Moody's Investors Service, Inc., (iii) certificates of
deposit maturing no more than one (1) year from the date of investment therein
issued by Bank, and {iv) Investments made in accordance with Borrower's
investment policies, as approved from time to time by Borrower's Board of
Directors.
"Permitted Liens" means the following:
(a) Any Liens existing on the Closing Date and disclosed in the
Schedule or arising under this Agreement or the other Loan Documents;
(b) Liens for taxes, fees, assessments or other governmental
charges or levies, either not delinquent or being contested in good faith by
appropriate proceedings, provided the same have no priority over any of Bank's
security interests;
(c) Liens (i) upon or in any equipment acquired or held by
Borrower or any of its Subsidiaries to secure the purchase price of such
equipment or indebtedness incurred solely for the purpose of financing the
acquisition of such equipment, or (ii) existing on such equipment at the time of
its acquisition, provided that the Lien is confined solely to the property so
acquired and improvements thereon, and the proceeds of such equipment;
(d) Liens incurred in connection with the extension, renewal or
refinancing of the indebtedness secured by Liens of the type described in
clauses (a) through (c) above, provided that any extension, renewal or
replacement Lien shall be limited to the property encumbered by the existing
Lien and the principal amount of the indebtedness being extended, renewed or
refinanced does not increase.
5
<PAGE>
"Person" means any individual, sole proprietorship, partnership,
limited liability company, joint venture, trust, unincorporated organization,
association, corporation, institution, public benefit corporation, firm, joint
stock company, estate, entity or governmental agency.
"Prime Rate" means the variable rate of interest, per annum, most
recently published in the Western Edition of The Wall Street Journal, as the
"prime rate," whether or not such rate is the lowest rate available from Bank.
"Quick Assets" means, at any date as of which the amount thereof
shall be determined, the consolidated cash, cash-equivalents, accounts
receivable and investments, with maturities not to exceed 90 days, of Borrower
determined in accordance with GAAP.
"Responsible Officer" means each of the Chief Executive Officer,
the Chief Financial Officer and the Controller of Borrower.
"Revolving Facility" means the facility under which Borrower may
request Advances pursuant to Section 2.1.
"Revolving Maturity Date" means the day before the first
anniversary of the Closing Date.
"Schedule" means the schedule of exceptions attached hereto, if
any.
"Subordinated Debt" means any debt incurred by Borrower that is
subordinated to the debt owing by Borrower to Bank on terms acceptable to Bank
(and identified as being such by Borrower and Bank).
"Subsidiary" means any corporation or partnership in which (i)
any general partnership interest or (ii) more than 50% of the stock of which by
the terms thereof ordinary voting power to elect the Board of Directors,
managers or trustees of the entity shall, at the time as of which any
determination is being made, be owned by Borrower, either directly or through an
Affiliate.
"Tangible Net Worth" means at any date as of which the amount
thereof shall be determined, the consolidated total assets of Borrower and its
Subsidiaries minus without duplication, (i) the sum of any amounts attributable
to (a) goodwill, (b) intangible items such as unamortized debt discount and
expense, patents, trade and service marks and names, copyrights and research and
development expenses except prepaid expenses, and (c) all reserves not already
deducted from assets, and (ii) Total Liabilities.
"Total Liabilities" means at any date as of which the amount
thereof shall be determined, all obligations that should, in accordance with
GAAP be classified as liabilities on the consolidated balance sheet of Borrower,
including in any event all Indebtedness, but specifically excluding Subordinated
Debt and deferred income.
1.2 Accounting Terms. All accounting terms not specifically defined
herein shall be construed in accordance with GAAP and all calculations made
hereunder shall be made in accordance with GAAP. When used herein, the terms
"financial statements" shall include the notes and schedules thereto.
2. LOAN AND TERMS OF PAYMENT
2.1 Revolving Advances. Subject to and upon the terms and conditions
of this Agreement, Bank agrees to make Advances to Borrower in an aggregate
amount not to exceed the
6
<PAGE>
lesser of (i) the Committed Line, minus the face amount of all outstanding
Letters of Credit (including drawn but unreimbursed Letters of Credit), minus
the Foreign Exchange Reserve or (ii) the Borrowing Base, minus the face amount
of all outstanding Letters of Credit (including drawn but unreimbursed Letters
of Credit), minus the Foreign Exchange Reserve. For purposes of this Agreement,
"Borrowing Base" shall mean an amount equal to (i) eighty percent (80%) of
Eligible Accounts plus (ii) fifty percent (50%) of Eligible Foreign Accounts
plus (iii) fifty percent (50%) of Government Accounts. Subject to the terms and
conditions of this Agreement, amounts borrowed pursuant to this Section 2.1 may
be repaid and reborrowed at any time prior to the Revolving Maturity Date.
Whenever Borrower desires an Advance, Borrower will notify Bank by
facsimile transmission or telephone no later than 3:00 p.m. California time, on
the Business Day that the Advance is to be made. Each such notification shall be
promptly confirmed by a Payment/Advance Form in substantially the form of
Exhibit B hereto. Bank is authorized to make Advances under this Agreement,
based upon instructions received from a Responsible Officer, or without
instructions if in Bank's discretion such Advances are necessary to meet
Obligations which have become due and remain unpaid. Bank shall be entitled to
rely on any telephonic notice given by a person who Bank reasonably believes to
be a Responsible Officer, and Borrower shall indemnify and hold Bank harmless
for any damages or loss suffered by Bank as a result of such reliance. Bank will
credit the amount of Advances made under this Section 2.1 to Borrower's deposit
account.
Borrower's obligations under the Revolving Facility shall be evidenced by
this Agreement and by a promissory note in substantially the form of Exhibit C
hereto. The Revolving Facility shall terminate on the Revolving Maturity Date,
at which time all Advances under this Section 2.1 and other amounts due under
this Agreement shall be immediately due and payable.
2.1.1 Letters of Credit.
(a) Subject to the terms and conditions of this Agreement, Bank
agrees to issue or cause to be issued letters of credit for the account of
Borrower in an aggregate face amount not to exceed the lesser of the Committed
Line or the Borrowing Base minus in each case the then outstanding principal
balance of the Advances, and minus the Foreign Exchange Reserve; provided that
the face amount of outstanding Letters of Credit (including drawn but
unreimbursed Letters of Credit) shall not in any case exceed Two Million Dollars
($2,000,000). Each such letter of credit shall have an expiry date no later than
the Revolving Maturity Date; provided that such letter of credit may have an
expiry date up to sixty (60) days after the Revolving Maturity Date for so long
as Borrower secures all reimbursement and other obligations owing to Bank with
cash or cash-equivalents on terms acceptable to Bank. All such letters of credit
shall be, in form and substance, acceptable to Bank in its sole discretion and
shall be subject to the terms and conditions of Bank's form of application and
letter of credit agreement. All amounts actually paid by Bank in respect of a
letter of credit shall, when paid, constitute an Advance under this Agreement.
(b) The obligation of Borrower to immediately reimburse Bank for
drawings made under Letters of Credit shall be absolute, unconditional and
irrevocable, and shall be performed strictly in accordance with the terms of
this Agreement and such Letters of Credit, under all circumstances whatsoever.
Borrower shall indemnify, defend and hold Bank harmless from any loss, cost,
expense or liability, including, without limitation, reasonable attorneys' fees,
arising out of or in connection with any letters of credit.
(c) Borrower may request that Bank issue a letter of credit
payable in a currency other than United States Dollars. If a demand for payment
is made under any such letter of credit, Bank shall treat such demand as an
advance to Borrower of the equivalent of the amount thereof (plus cable charges)
in United States currency at the then prevailing rate of exchange in San
Francisco, California, for sales of that other currency for cable transfer to
the country of which it is the currency. Upon the issuance of any letter of
credit payable in a currency other than United States Dollars, Bank shall create
a reserve under the Committed
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Line for letters of credit against fluctuations in currency exchange rates, in
an amount equal to twenty percent (20%) of the face amount of such letter of
credit. The amount of such reserve may be amended by Bank from time to time to
account for fluctuations in the exchange rate. The availability of funds under
the Committed Line shall be reduced by the amount of such reserve for so long as
such letter of credit remains outstanding.
2.1.2 Foreign Exchange Contract; Foreign Exchange Settlements.
(a) Borrower may utilize up to One Million Dollars ($1,000,000)
under the Committed Line for foreign exchange contracts (the "Exchange
Contracts"), pursuant to which Bank shall sell to or purchase from Borrower
foreign currency on a spot or future basis. All Exchange Contracts must provide
for delivery or settlement on or before the Revolving Maturity Date; provided
that settlement or delivery may occur up to sixty (60) days after the Revolving
Maturity Date for so long as Borrower secures all obligations owing to Bank with
cash or cash-equivalents on terms reasonably acceptable to Bank. The limit
available at any time shall be reduced by the following amounts (the "Foreign
Exchange Reserve") on each day (the "Determination Date"): (i) on all
outstanding Exchange Contracts on which delivery is to be effected or settlement
allowed more than two business days from the Determination Date, 10% of the
gross amount of the Exchange Contracts; plus (ii) on all outstanding Exchange
Contracts on which delivery is to be effected or settlement allowed within two
business days after the Determination Date, 100% of the gross amount of the
Exchange Contracts. In lieu of the Foreign Exchange Reserve for 100% of the
gross amount of any Exchange Contract, Borrower may request that Bank treat such
amount as an Advance under the Committed Line.
(b) Bank may, in its discretion, terminate the Exchange Contracts
at any time (a) that an Event of Default occurs or (b) that there is no
sufficient availability under the Committed Line and Borrower does not have
available funds in its bank account to satisfy the Foreign Exchange Reserve. If
Bank terminates the Exchange Contracts, and without limitation of any applicable
indemnities, Borrower agrees to reimburse Bank for any and all fees, costs and
expenses relating thereto or arising in connection therewith.
(c) Borrower shall execute all standard form applications and
agreements of Bank in connection with the Exchange Contracts and, without
limiting any of the terms of such applications and agreements, Borrower will pay
all standard fees and charges of Bank in connection with the Exchange Contracts.
2.2 Overadvances. If the amount of Obligations owed by Borrower to
Bank pursuant to Section 2.1 of this Agreement is greater than the lesser of (i)
the Committed Line or (ii) the Borrowing Base, Borrower shall immediately pay to
Bank, in cash, the amount of such excess.
2.3 Interest Rates, Payments and Calculations.
(a) Interest Rate. Except as set forth in Section 2.3(b), any
Advances shall bear interest, on the average Daily Balance, at a rate equal to
one-half of one (0.5) percentage point above the Prime Rate.
(b) Default Rate. All Obligations shall bear interest, from and
after the occurrence of an Event of Default, at a rate equal to five (5)
percentage points above the interest rate applicable immediately prior to the
occurrence of the Event of Default.
(c) Payments. Interest on Advances under this Agreement hereunder
shall be due and payable on the twentieth (20th) calendar day of each month
during the term hereof. Bank shall, at its option, charge such interest, all
Bank Expenses, and all Periodic Payments against
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any of Borrower's deposit accounts or against the Committed Line, in which case
those amounts shall thereafter accrue interest at the rate then applicable
hereunder. Any interest not paid when due shall be compounded by becoming a part
of the Obligations, and such interest shall thereafter accrue interest at the
rate then applicable hereunder.
(d) Computation. In the event the Prime Rate is changed from time
to time hereafter, the applicable rate of interest hereunder shall be increased
or decreased effective as of 12:01 a.m. on the day the Prime Rate is changed, by
an amount equal to such change in the Prime Rate. All interest chargeable under
the Loan Documents shall be computed on the basis of a three hundred sixty (360)
day year for the actual number of days elapsed.
2.4 Crediting Payments. Prior to the occurrence of an Event of
Default, Bank shall credit a wire transfer of funds, check or other item of
payment to such deposit account or Obligation as Borrower specifies. Unless
otherwise agreed in writing by Bank, after the occurrence of an Event of
Default, the receipt by Bank of any wire transfer of funds, check, or other item
of payment shall be immediately applied to conditionally reduce Obligations, but
shall not be considered a payment on account unless such payment is of
immediately available federal funds or unless and until such check or other item
of payment is honored when presented for payment. Notwithstanding anything to
the contrary contained herein, any wire transfer or payment received by Bank
after 12:00 noon California time shall be deemed to have been received by Bank
as of the opening of business on the immediately following Business Day.
Whenever any payment to Bank under the Loan Documents would otherwise be due
(except by reason of acceleration) on a date that is not a Business Day, such
payment shall instead be due on the next Business Day, and additional fees or
interest, as the case may be, shall accrue and be payable for the period of such
extension.
2.5 Fees. Borrower shall pay to Bank the following:
(a) Facility Fee; Extension Fee. A Facility Fee equal to Ten
Thousand Dollars ($10,000), which fee shall be payable, fully earned and
nonrefundable as of the date hereof.
(b) Financial Examination and Appraisal Fees. Bank's customary
fees and out-of-pocket expenses for Bank's audits of Borrower's Accounts, and
for each appraisal of Collateral and financial analysis and examination of
Borrower performed from time to time by Bank or its agents;
(c) Bank Expenses. Upon the date hereof, all Bank Expenses
incurred through the Closing Date, including reasonable attorneys' fees and
expenses, which fees shall not exceed Five Thousand Dollars ($5,000), and, after
the date hereof, all Bank Expenses, including reasonable attorneys' fees and
expenses, as and when they become due.
2.6 Additional Costs. In case any change in any law, regulation,
treaty or official directive or the interpretation or application thereof by any
court or any governmental authority charged with the administration thereof or
the compliance with any guideline or request of any central bank or other
governmental authority (whether or not having the force of law), in each case
after the date of this Agreement:
(a) subjects Bank to any tax with respect to payments of
principal or interest or any other amounts payable hereunder by Borrower or
otherwise with respect to the transactions contemplated hereby (except for taxes
on the overall net income of Bank imposed by the United States of America or any
political subdivision thereof);
(b) imposes, modifies or deems applicable any deposit insurance,
reserve, special deposit or similar requirement against assets held by, or
deposits in or for the account of, or loans by, Bank; or
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(c) imposes upon Bank any other condition with respect to its
performance under this Agreement,
and the result of any of the foregoing is to increase the cost to Bank, reduce
the income receivable by Bank or impose any expense upon Bank with respect to
any loans, Bank shall notify Borrower thereof. Borrower agrees to pay to Bank
the amount of such increase in cost, reduction in income or additional expense
as and when such cost, reduction or expense is incurred or determined, upon
presentation by Bank of a statement of the amount and setting forth Bank's
calculation thereof, all in reasonable detail, which statement shall be deemed
true and correct absent manifest error.
2.7 Term. This Agreement shall become effective on the Closing Date
and, subject to Section 12.7, shall continue in full force and effect for a term
ending on the Revolving Maturity Date. Notwithstanding the foregoing, Bank shall
have the right to terminate its obligation to make Advances under this Agreement
immediately and without notice upon the occurrence and during the continuance of
an Event of Default. Notwithstanding termination, Bank's Lien on the Collateral
shall remain in effect for so long as any Obligations are outstanding.
3. CONDITIONS OF LOANS
3.1 Conditions Precedent to Initial Advance. The obligation of Bank
to make the initial Advance is subject to the condition precedent that Bank
shall have received, in form and substance satisfactory to Bank, the following:
(a) this Agreement;
(b) a certificate of the Secretary of Borrower with respect to
incumbency and resolutions authorizing the execution and delivery of this
Agreement;
(c) an intellectual property security agreement;
(d) an audit of Borrower's Accounts;
(e) insurance certificate;
(f) payment of the fees and Bank Expenses then due specified in
Section 2.5 hereof; and
(g) such other documents, and completion of such other matters,
as Bank may reasonably deem necessary or appropriate.
3.2 Conditions Precedent to all Advances. The obligation of Bank to
make each Advance, including the initial Advance, is further subject to the
following conditions:
(a) timely receipt by Bank of the Payment/Advance Form as
provided in Section 2.1; and
(b) the representations and warranties contained in Section 5
shall be true and correct in all material respects on and as of the date of such
Payment/Advance Form and on the effective date of each Advance as though made at
and as of each such date, and no Event of Default shall have occurred and be
continuing, or would result from such Advance. The making of each Advance shall
be deemed to be a representation and warranty by Borrower on the date of such
Advance as to the accuracy of the facts referred to in this Section 3.2(b).
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4. CREATION OF SECURITY INTEREST
4.1 Grant of Security Interest. Borrower grants and pledges to Bank a
continuing security interest in all presently existing and hereafter acquired or
arising Collateral in order to secure prompt repayment of any and all
Obligations and in order to secure prompt performance by Borrower of each of its
covenants and duties under the Loan Documents. Except as set forth in the
Schedule, such security interest constitutes a valid, first priority security
interest in the presently existing Collateral, and will constitute a valid,
first priority security interest in Collateral acquired after the date hereof.
4.2 Delivery of Additional Documentation Required. Borrower shall
from time to time execute and deliver to Bank, at the request of Bank, all
Negotiable Collateral, all financing statements and other documents that Bank
may reasonably request, in form satisfactory to Bank, to perfect and continue
perfected Bank's security interests in the Collateral and in order to fully
consummate all of the transactions contemplated under the Loan Documents.
4.3 Right to Inspect. Bank (through any of its officers, employees,
or agents) shall have the right, upon reasonable prior notice, from time to time
during Borrower's usual business hours, to inspect Borrower's Books and to make
copies thereof and to check, test, and appraise the Collateral in order to
verify Borrower's financial condition or the amount, condition of, or any other
matter relating to, the Collateral.
5. REPRESENTATIONS AND WARRANTIES
Borrower represents and warrants as follows.
5.1 Due Organization and Qualification. Borrower and each Subsidiary
is a corporation duly existing and in good standing under the laws of its state
of incorporation and qualified and licensed to do business in, and is in good
standing in, any state.. in which the conduct of its business or its ownership
of property requires that it be so qualified.
5.2 Due Authorization; No Conflict. The execution, delivery, and
performance of the Loan Documents are within Borrower's powers, have been duly
authorized, and are not in conflict with nor constitute a breach of any
provision contained in Borrower's Articles of Incorporation or Bylaws, nor will
they constitute an event of default under any material agreement to which
Borrower is a party or by which Borrower is bound. Borrower is not in default
under any agreement to which it is a party or by which it is bound, which
default could have a Material Adverse Effect.
5.3 No Prior Encumbrances. Borrower has good and indefeasible title
to the Collateral, free and clear of Liens, except for Permitted Liens.
5.4 Bona Fide Eligible Accounts. The Eligible Accounts are bona fide
existing obligations. The property giving rise to such Eligible Accounts has
been delivered to the account debtor or to the account debtor's agent for
immediate shipment to and unconditional acceptance by the account debtor.
Borrower has not received notice of actual or imminent Insolvency Proceeding of
any account debtor that is included in any Borrowing Base Certificate as an
Eligible Account.
5.5 Merchantable Inventory. All Inventory is in all material respects
of good and marketable quality, free from all material defects.
5.6 Name; Location of Chief Executive Office. Except as disclosed in
the Schedule, Borrower has not done business under any name other than that
specified on the signature page hereof. The chief executive office of Borrower
is located at the address indicated in Section 10 hereof.
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5.7 Litigation. Except as set forth in the Schedule, there are no
actions or proceedings pending by or against Borrower or any Subsidiary before
any court or administrative agency in which an adverse decision could have a
Material Adverse Effect or a material adverse effect on Borrower's interest or
Bank's security interest in the Collateral. Borrower does not have knowledge of
any such pending or threatened actions or proceedings.
5.8 No Material Adverse Change in Financial Statements. All
consolidated financial statements related to Borrower and any Subsidiary that
have been delivered by Borrower to Bank fairly present in all material respects
Borrower's consolidated financial condition as of the date thereof and
Borrower's consolidated results of operations for the period then ended. There
has not been a material adverse change in the consolidated financial condition
of Borrower since the date of the most recent of such financial statements
submitted to Bank.
5.9 Solvency. Borrower is solvent and able to pay its debts
(including trade debts) as they mature.
5.10 Regulatory Compliance. Borrower and each Subsidiary has met the
minimum funding requirements of ERISA with respect to any employee benefit plans
subject to ERISA. No event has occurred resulting from Borrower's failure to
comply with ERISA that is reasonably likely to result in Borrower's incurring
any liability that could have a Material Adverse Effect. Borrower is not an
"investment company or a company "controlled" by an "investment company" within
the meaning of the Investment Company Act of 1940. Borrower is not engaged
principally, or as one of the important activities, in the business of extending
credit for the purpose of purchasing or carrying margin stock (within the
meaning of Regulations G, T and U of the Board of Governors of the Federal
Reserve System). Borrower has complied with all the provisions of the Federal
Fair Labor Standards Act. Borrower has not violated any statutes, laws,
ordinances or rules applicable to it, violation of which could have a Material
Adverse Effect.
5.11 Environmental Condition. None of Borrower's or any Subsidiary's
properties or assets has ever been used by Borrower or any Subsidiary or, to the
best of Borrower's knowledge, by previous owners or operators, in the disposal
of; or to produce, store, handle, treat, release, or transport, any hazardous
waste or hazardous substance other than in accordance with applicable law; to
the best of Borrower's knowledge, none of Borrower's properties or assets has
ever been designated or identified in any manner pursuant to any environmental
protection statute as a hazardous waste or hazardous substance disposal site, or
a candidate for closure pursuant to any environmental protection statute; no
lien arising under any environmental protection statute has attached to any
revenues or to any real or personal property owned by Borrower or any
Subsidiary; and neither Borrower nor any Subsidiary has received a summons,
citation, notice, or directive from the Environmental Protection Agency or any
other federal, state or other governmental agency concerning any action or
omission by Borrower or any Subsidiary resulting in the releasing, or otherwise
disposing of hazardous waste or hazardous substances into the environment.
5.12 Taxes. Borrower and each Subsidiary has filed or caused to be
filed all tax returns required to be filed, and has paid, or has made adequate
provision for the payment of, all taxes reflected therein.
5.13 Subsidiaries. Borrower does not own any stock, partnership
interest or other equity securities of any Person, except for Permitted
Investments.
5.14 Government Consents. Borrower and each Subsidiary has obtained
all consents, approvals and authorizations of, made all declarations or filings
with, and given all notices to, all governmental authorities that are necessary
for the continued operation of Borrower's business as currently conducted.
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5.15 Full Disclosure. No representation, warranty or other statement
made by Borrower in any certificate or written statement furnished to Bank
contains any untrue statement of a material fact or omits to state a material
fact necessary in order to make the statements contained in such certificates or
statements not misleading.
6. AFFIRMATIVE COVENANTS
Borrower covenants and agrees that, until payment in full of all
outstanding Obligations, and for so long as Bank may have any commitment to make
an Advance hereunder, Borrower shall do all of the following:
6.1 Good Standing. Borrower shall maintain its and each of its
Subsidiaries' corporate existence and good standing in its jurisdiction of
incorporation and maintain qualification in each jurisdiction in which the
failure to so qualify could have a Material Adverse Effect Borrower shall
maintain, and shall cause each of its Subsidiaries to maintain, to the extent
consistent with prudent management of Borrower's business, in force all
licenses, approvals and agreements, the loss of which could have a Material
Adverse Effect.
6.2 Government Compliance. Borrower shall meet, and shall cause each
Subsidiary to meet, the minimum funding requirements of ERISA with respect to
any employee benefit plans subject to ERISA. Borrower shall comply, and shall
cause each Subsidiary to comply, with all statutes, laws, ordinances and
government rules and regulations to which it is subject, noncompliance with
which could have a Material Adverse Effect or a material adverse effect on the
Collateral or the priority of Bank's Lien on the Collateral.
6.3 Financial Statements. Reports. Certificates. Borrower shall
deliver to Bank: (a) as soon as available, but in any event within forty five
(45) days after the end of each fiscal quarter, a company prepared consolidated
balance sheet and income statement covering Borrower's consolidated operations
during such period, certified by a Responsible Officer; (b) as soon as
available, but in any event within one hundred twenty (120) days after the end
of Borrower's fiscal year, audited consolidated financial statements of Borrower
prepared in accordance with GAAP, consistently applied, together with an
unqualified opinion on such financial statements of an independent certified
public accounting firm reasonably acceptable to Bank; (c) within five (5) days
upon becoming available, copies of all statements, reports and notices sent or
made available generally by Borrower to its security holders or to any holders
of Subordinated Debt and all reports on Form 10-K and 10-Q filed with the
Securities and Exchange Commission; (d) promptly upon receipt of notice thereof,
a report of any legal actions pending or threatened against Borrower or any
Subsidiary that could result in damages or costs to Borrower or any Subsidiary
of Two Hundred Thousand Dollars ($200,000) or more; and (e) such budgets, sales
projections, operating plans or other financial information as Bank may
reasonably request from time to time.
Prior to any extension of credit under any of Sections 2.1, 2.1.1 or 2.1.2,
and within thirty (30) days after the last day of each month in which any such
extension is outstanding, Borrower shall deliver to Bank a Borrowing Base
Certificate signed by a Responsible Officer in substantially the form of Exhibit
D hereto, together with aged listings of accounts receivable and accounts
payable.
Borrower shall deliver to Bank with the quarterly financial statements a
Compliance Certificate signed by a Responsible Officer in substantially the form
of Exhibit E hereto within forty-five (45) days of the last day of each fiscal
quarter.
Prior to any extension of credit under any of Sections 2.1, 2.1.1 or 2.1.2,
and so long as any such extension is outstanding, Bank shall have a right from
time to time hereafter to audit Borrower's Accounts at Borrower's expense,
provided that such audits will be conducted no more often than every six (6)
months unless an Event of Default has occurred and is continuing.
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6.4 Inventory; Returns. Borrower shall keep all Inventory in good and
marketable condition, free from all material defects. Returns and allowances, if
any, as between Borrower and its account debtors shall be on the same basis and
in accordance with the usual customary practices of Borrower, as they exist at
the time of the execution and delivery of this Agreement. Borrower shall
promptly notify Bank of all returns and recoveries and of all disputes and
claims, where the return, recovery, dispute or claim involves more than Fifty
Thousand Dollars ($50,000).
6.5 Taxes. Borrower shall make, and shall cause each Subsidiary to
make, due and timely payment or deposit of all material federal, state, and
local taxes, assessments, or contributions required of it by law, and will
execute and deliver to Bank, on demand, appropriate certificates. attesting to
the payment or deposit thereof; and Borrower will make, and will cause each
Subsidiary to make, timely payment or deposit of all material tax payments and
withholding taxes required of it by applicable laws, including, but not limited
to, those laws concerning F.I.C.N., F.U.T.A., state disability, and local,
state, and federal income taxes, and will, upon request, furnish Bank with proof
satisfactory to Bank indicating that Borrower or a Subsidiary has made such
payments or deposits; provided that Borrower or a Subsidiary need not make any
payment if the amount or validity of such payment is contested in good faith by
appropriate proceedings and is reserved against (to the extent required by GAAP)
by Borrower.
6.6 Insurance.
(a) Borrower, at its expense, shall keep the Collateral insured
against loss or damage by fire, theft, explosion, sprinklers, and all other
hazards and risks, and in such amounts, as ordinarily insured against by other
owners in similar businesses conducted in the locations where Borrower's
business is conducted on the date hereof. Borrower shall also maintain insurance
relating to Borrower's ownership and use of the Collateral in amounts and of a
type that are customary to businesses similar to Borrower's.
(b) All such policies of insurance shall be in such form, with
such companies, and in such amounts as reasonably satisfactory to Bank. All such
policies of property insurance shall contain a lender's loss payable
endorsement, in a form satisfactory to Bank, showing Bank as an additional loss
payee thereof and all liability insurance policies shall show the Bank as an
additional insured, and shall specify that the insurer must give at least twenty
(20) days notice to Bank before canceling its policy for any reason. Upon Bank's
request, Borrower shall deliver to Bank certified copies of such policies of
insurance and evidence of the payments of all premiums therefor. All proceeds
payable under any such policy shall, at the option of Bank, be payable to Bank
to be applied on account of the Obligations.
6.7 Principal Depository. Borrower shall maintain its principal
depository and operating accounts with Bank.
6.8 Quick Ratio. Borrower shall maintain, as of the last day of each
fiscal quarter, a ratio of Quick Assets to Current Liabilities of at least 1.0
to 1.0.
6.9 Debt-Net Worth Ratio. Borrower shall maintain, as of the last day
of each fiscal quarter, a ratio of Total Liabilities to Tangible Net Worth of
not more than 1.5 to 1.0.
6.10 Tangible Net Worth. Borrower shall maintain, as of the last day
of each fiscal quarter, a Tangible Net Worth of not less than Seven Million Five
Hundred Thousand Dollars ($7,500,000).
6.11 Profitability. Borrower shall not suffer a loss in excess of
$1,550,000 for the fiscal quarter ending March 31, 1998, a loss in excess of
$1,500,000 for the fiscal quarter ending June 30, 1998, a loss in excess of
$100,000 for the fiscal quarter ending September 30, 1998, or a
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loss in excess of $2,000,000 for the fiscal quarter ending December 31, 1998.
Borrower shall be profitable for each fiscal quarter thereafter.
6.12 Registration of Intellectual Property Rights. Borrower shall
register or cause to be registered (to the extent not already registered) with
the United States Patent and Trademark Office or the United States Copyright
Office, as applicable, those intellectual property rights listed on Exhibits A,
B and C to the Collateral Assignment, Patent Mortgage and Security Agreement
delivered to Bank by Borrower in connection with this Agreement within thirty
(30) days of the date of this Agreement. Borrower shall register or cause to be
registered with the United States Patent and Trademark Office or the United
States Copyright Office, as applicable, those additional intellectual property
rights developed or acquired by Borrower from time to time in connection with
any product prior to the sale or licensing of such product to any third party,
including without limitation revisions or additions to the intellectual property
rights listed on such Exhibits A, B and C. Borrower shall execute and deliver
such additional instruments and documents from time to time as Bank shall
reasonably request to perfect Bank's security interest in such additional
intellectual property rights.
6.13 Further Assurances. At any time and from time to time Borrower
shall execute and deliver such further instruments and take such further action
as may reasonably be requested by Bank to effect the purposes of this Agreement.
7. NEGATIVE COVENANTS
Borrower covenants and agrees that, so long as any credit hereunder
shall be available and until payment in full of the outstanding Obligations or
for so long as Bank may have any commitment to make any Advances, Borrower will
not do any of the following without the prior written consent of Bank which Bank
may grant or withhold in its sole discretion:
7.1 Dispositions. Convey, sell, lease, transfer or otherwise dispose
of (collectively, a "Transfer"), or permit any of its Subsidiaries to Transfer,
all or any part of its business or property, other than: (i) Transfers of
Inventory in the ordinary course of business; (ii) Transfers of non-exclusive
licenses and similar arrangements for the use of the property of Borrower or its
Subsidiaries; or (iii) Transfers of worn-out or obsolete Equipment.
7.2 Change in Business. Engage in any business, or permit any of its
Subsidiaries to engage in any business, other than the businesses currently
engaged in by Borrower and any business substantially similar or related thereto
(or incidental thereto), or suffer a material change in Borrower's ownership.
Borrower will not, without thirty (30) days prior written notification to Bank,
relocate its chief executive office.
7.3 Mergers or Acquisitions. Merge or consolidate, or permit any of
its Subsidiaries to merge or consolidate, with or into any other business
organization, or acquire, or permit any of its Subsidiaries to acquire, all or
substantially all of the capital stock or property of another Person.
7.4 Indebtedness. Create, incur, assume or be or remain liable with
respect to any Indebtedness, or permit any Subsidiary so to do, other than
Permitted Indebtedness.
7.5 Advances to Employees or Shareholders. Advance by way of payment,
credit or other manner, any unearned funds to employees or shareholders of
Borrower except that Borrower may make advances to its employees or shareholders
as long as the aggregate amount of all such advances does not exceed Fifty
Thousand Dollars ($50,000).
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7.6 Encumbrances. Create, incur, assume or suffer to exist any Lien
with respect to any of its property, or assign or otherwise convey any right to
receive income, including the sale of any Accounts, or permit any of its
Subsidiaries so to do, except for Permitted Lens.
7.7 Distributions. Pay any dividends or make any other distribution
or payment on account of or in redemption, retirement or purchase of any capital
stock.
7.8 Investments. Directly or indirectly acquire or own, or make any
Investment in or to any Person, or permit any of its Subsidiaries so to do,
other than Permitted Investments.
7.9 Transactions with Affiliates. Directly or indirectly enter into
or permit to exist any material transaction with any Affiliate of Borrower
except for transactions that are in the ordinary course of Borrower's business,
upon fair and reasonable terms that are no less favorable to Borrower than would
be obtained in an arm's length transaction with a nonaffiliated Person.
7.10 Subordinated Debt. Make any payment in respect of any
Subordinated Debt, or permit any of its Subsidiaries to make any such payment,
except in compliance with the terms of such Subordinated Debt, or amend any
provision contained in any documentation relating to the Subordinated Debt
without Bank's prior written consent.
7.11 Inventory. Store the Inventory with a bailee, warehouseman, or
similar party unless Bank has received a pledge of the warehouse receipt
covering such Inventory. Except for Inventory sold in the ordinary course of
business and except for such other locations as Bank may approve in writing,
Borrower shall keep the Inventory only at the location set forth in Section 10
hereof and such other locations of which Borrower gives Bank prior written
notice and as to which Borrower signs and files a financing statement where
needed to perfect Bank's security interest.
7.12 Compliance. Become an "investment company" controlled by an
"investment company," within the meaning of the Investment Company Act of 1940,
or become principally engaged in, or undertake as one of its important
activities, the business of extending credit for the purpose of purchasing or
carrying margin stock, or use the proceeds of any Advance for such purpose. Fail
to meet the minimum funding requirements of ERISA, permit a Reportable Event or
Prohibited Transaction, as defined in ERISA, to occur, fail to comply with the
Federal Fair Labor Standards Act or violate any law or regulation, which
violation could have a Material Adverse Effect or a material adverse effect on
the Collateral or the priority of Bank's Lien on the Collateral, or permit any
of its Subsidiaries to do any of the foregoing.
8. EVENTS OF DEFAULT
Any one or more of the following events shall constitute an Event of
Default by Borrower under this Agreement:
8.1 Payment Default. If Borrower fails to pay the principal of, or
any interest on, any Advances when due and payable; or fails to pay any portion
of any other Obligations not constituting such principal or interest, including
without limitation Bank Expenses, within thirty (30) days of receipt by Borrower
of an invoice for such other Obligations;
8.2 Covenant Default. If Borrower fails to perform any obligation
under Article 6 or violates any of the covenants contained in Article 7 of this
Agreement, or fails or neglects to perform, keep, or observe any other material
term, provision, condition, covenant, or agreement contained in this Agreement,
in any of the Loan Documents, or in any other present or future agreement
between Borrower and Bank and as to any default under such other term,
provision, condition, covenant or agreement that can be cured, has failed to
cure such default within ten (10)
16
<PAGE>
days after Borrower receives notice thereof or any officer of Borrower becomes
aware thereof (provided that no Advances will be required to be made during such
cure period);
8.3 Material Adverse Change. If there occurs a material adverse
change in Borrower's business or financial condition, or if there is a material
impairment of the prospect of repayment of any portion of the Obligations or a
material impairment of the value or priority of Bank's security interests in the
Collateral;
8.4 Attachment. If any material portion of Borrower's assets is
attached, seized, subjected to a writ or distress warrant, or is levied upon, or
comes into the possession of any trustee, receiver or person acting in a similar
capacity and such attachment, seizure, writ or distress warrant or levy has not
been removed, discharged or rescinded within ten (10) days, or if Borrower is
enjoined, restrained, or in any way prevented by court order from continuing to
conduct all or any material part of its business affairs, or if a judgment or
other claim becomes a lien or encumbrance upon any material portion of
Borrower's assets, or if a notice of lien, levy, or assessment is filed of
record with respect to any of Borrower's assets by the United States Government,
or any department, agency, or instrumentality thereof, or by any state, county,
municipal, or governmental agency, and the same is not paid within ten (10) days
after Borrower receives notice thereof, provided that none of the foregoing
shall constitute an Event of Default where such action or event is stayed or an
adequate bond has been posted pending a good faith contest by Borrower (provided
that no Advances will be required to be made during such cure period);
8.5 Insolvency. If Borrower becomes insolvent, or if an Insolvency
Proceeding is commenced by Borrower, or if an Insolvency Proceeding is commenced
against Borrower and is not dismissed or stayed within ten (10) days (provided
that no Advances will be made prior to the dismissal of such Insolvency
Proceeding);
8.6 Other Agreements. If there is a default in any agreement to which
Borrower is a party with a third party or parties resulting in a right by such
third party or parties, whether or not exercised, to accelerate the maturity of
any Indebtedness in an amount in excess of Two Hundred Fifty Thousand Dollars
($250,000) or that could have a Material Adverse Effect;
8.7 Subordinated Debt. If Borrower makes any payment on account of
Subordinated Debt, except to the extent such payment is allowed under any
subordination agreement entered into with Bank;
8.8 Judgments. If a judgment or judgments for the payment of money in
an amount, individually or in the aggregate, of at least Two Hundred Fifty
Thousand Dollars ($250,000) shall be rendered against Borrower and shall remain
unsatisfied and unstayed for a period of ten (10) days (provided that no
Advances will be made prior to the satisfaction or stay of such judgment); or
8.9 Misrepresentations. If any material misrepresentation or material
misstatement exists now or hereafter in any warranty or representation set forth
herein or in any certificate delivered to Bank by any Responsible Officer
pursuant to this Agreement or to induce Bank to enter into this Agreement or any
other Loan Document.
9. BANK'S RIGHTS AND REMEDIES
9.1 Rights and Remedies. Upon the occurrence and during the
continuance of an Event of Default, Bank may, at its election, without notice of
its election and without demand, do any one or more of the following, all of
which are authorized by Borrower:
(a) Declare all Obligations, whether evidenced by this Agreement,
by any of the other Loan Documents, or otherwise, immediately due and payable
(provided that upon the
17
<PAGE>
occurrence of an Event of Default described in Section 8.5 all Obligations shall
become immediately due and payable without any action by Bank);
(b) Cease advancing money or extending credit to or for the
benefit of Borrower under this Agreement or under any other agreement between
Borrower and Bank;
(c) Demand that Borrower (i) deposit cash with Bank in an amount
equal to the amount of any Letters of Credit remaining undrawn, as collateral
security for the repayment of any future drawings under such Letters of Credit,
and Borrower shall forthwith deposit and pay such amounts, and (ii) pay in
advance all Letters of Credit fees scheduled to be paid or payable over the
remaining term of the Letters of Credit;
(d) Settle or adjust disputes and claims directly with account
debtors for amounts, upon terms and in whatever order that Bank reasonably
considers advisable;
(e) Without notice to or demand upon Borrower, make such payments
and do such acts as Bank considers necessary or reasonable to protect its
security interest in the Collateral. Borrower agrees to assemble the Collateral
if Bank so requires, and to make the Collateral available to Bank as Bank may
designate. Borrower authorizes Bank to enter the premises where the Collateral
is located, to take and maintain possession of the Collateral, or any part of
it, and to pay, purchase, contest, or compromise any encumbrance, charge, or
lien which in Bank's determination appears to be prior or superior to its
security interest and to pay all expenses incurred in connection therewith. With
respect to any of Borrower's owned premises, Borrower hereby grants Bank a
license to enter into possession of such premises and to occupy the same,
without charge, for up to one hundred twenty (120) days in order to exercise any
of Bank's rights or remedies provided herein, at law, in equity, or otherwise;
(f) Without notice to Borrower set off and apply to the
Obligations any and all (i) balances and deposits of Borrower held by Bank, or
(ii) indebtedness at any time owing to or for the credit or the account of
Borrower held by Bank;
(g) Ship, reclaim, recover, store, finish, maintain, repair,
prepare for sale, advertise for sale, and sell (in the manner provided for
herein) the Collateral. Bank is hereby granted a license or other right, solely
pursuant to the provisions of this Section 9.1, to use, without charge,
Borrower's labels, patents, copyrights, rights of use of any name, trade
secrets, trade names, trademarks, service marks, and advertising matter, or any
property of a similar nature, as it pertains to the Collateral, in completing
production of, advertising for sale, and selling any Collateral and, in
connection with Bank's exercise of its rights under this Section 9.1, Borrower's
rights under all licenses and all franchise agreements shall inure to Bank's
benefit;
(h) Sell the Collateral at either a public or private sale, or
both, by way of one or more contracts or transactions, for cash or on terms, in
such manner and at such places (including Borrower's premises) as Bank
determines is commercially reasonable, and apply any proceeds to the Obligations
in whatever manner or order Bank deems appropriate;
(i) Bank may credit bid and purchase at any public sale; and
(j) Any deficiency that exists after disposition of the
Collateral as provided above will be paid immediately by Borrower.
9.2 Power of Attorney. Borrower hereby irrevocably appoints Bank (and
any of Bank's designated officers, or employees) as Borrower's true and lawful
attorney to: (a) send requests for verification of Accounts or notify account
debtors of Bank's security interest in the Accounts; (b) endorse Borrower's name
on any checks or other forms of payment or security that
18
<PAGE>
may come into Bank's possession; (c) sign Borrower's name on any invoice or bill
of lading relating to any Account, drafts against account debtors, schedules and
assignments of Accounts, verifications of Accounts, and notices to account
debtors; (d) make, settle, and adjust all claims under and decisions with
respect to Borrower's policies of insurance; and (e) settle and adjust disputes
and claims respecting the accounts directly with account debtors, for amounts
and upon terms which Bank determines to be reasonable; provided Bank may
exercise such power of attorney to sign the name of Borrower on any of the
documents described in Section 4.2 regardless of whether an Event of Default has
occurred. The appointment of Bank as Borrower's attorney in fact, and each and
every one of Bank's rights and powers, being coupled with an interest, is
irrevocable until all of the Obligations have been fully repaid and performed
and Bank's obligation to provide advances hereunder is terminated.
9.3 Accounts Collection. At any time from the date of this Agreement,
Bank may notify any Person owing funds to Borrower of Bank's security interest
in such funds and verify the amount of such Account. Borrower shall collect all
amounts owing to Borrower for Bank, receive in trust all payments as Bank's
trustee, and immediately deliver such payments to Bank in their original form as
received from the account debtor, with proper endorsements for deposit.
9.4 Bank Expenses. If Borrower fails to pay any amounts or furnish
any required proof of payment due to third persons or entities, as required
under the terms of this Agreement, then Bank may do any or all of the following:
(a) make payment of the same or any part thereof; (b) set up such reserves under
the Revolving Facility as Bank deems necessary to protect Bank from the exposure
created by such failure; or (c) obtain and maintain insurance policies of the
type discussed in Section 6.6 of this Agreement, and take any action with
respect to such policies as Bank deems prudent. Any amounts so paid or deposited
by Bank shall constitute Bank Expenses, shall be immediately due and payable,
and shall bear interest at the then applicable rate hereinabove provided, and
shall be secured by the Collateral. Any payments made by Bank shall not
constitute an agreement by Bank to make similar payments in the future or a
waiver by Bank of any Event of Default under this Agreement.
9.5 Bank's Liability for Collateral. Bank shall not in any way or
manner be liable or responsible for: (a) the safekeeping of the Collateral; (b)
any loss or damage thereto occurring or arising in any manner or fashion from
any cause; (c) any diminution in the value thereof or (d) any act or default of
any carrier, warehouseman, bailee, forwarding agency, or other person
whomsoever. All risk of loss, damage or destruction of the Collateral shall be
borne by Borrower.
9.6 Remedies Cumulative. Bank's rights and remedies under this
Agreement, the Loan Documents, and all other agreements shall be cumulative.
Bank shall have all other rights and remedies not inconsistent herewith as
provided under the Code, by law, or in equity. No exercise by Bank of one right
or remedy shall be deemed an election, and no waiver by Bank of any Event of
Default on Borrower's part shall be deemed a continuing waiver. No delay by Bank
shall constitute a waiver, election, or acquiescence by it. No waiver by Bank
shall be effective unless made in a written document signed on behalf of Bank
and then shall be effective only in the specific instance and for the specific
purpose for which it was given.
9.7 Demand; Protest. Borrower waives demand, protest, notice of
protest, notice of default or dishonor, notice of payment and nonpayment, notice
of any default, nonpayment at maturity, release, compromise, settlement,
extension, or renewal of accounts, documents, Instruments, chattel paper, and
guarantees at any time held by Bank on which Borrower may in any way be liable.
10. NOTICES
Unless otherwise provided in this Agreement, all notices or demands by
any party relating to this Agreement or any other agreement entered into in
connection herewith shall be in writing and (except for financial statements and
other informational documents which may be sent
19
<PAGE>
by first-class mail, postage prepaid) shall be personally delivered or sent by a
recognized overnight delivery service, certified mall, postage prepaid, return
receipt requested, or by telefacsimile to Borrower or to Bank, as the case may
be, at its addresses set forth below:
If to Borrower: Thermatrix Inc.
101 Metro Drive, Suite 248
San Jose, CA 95110
Attn: John Schofield
FAX: (408) 453-1032
If to Bank: Venture Banking Group
Three Palo Alto Square, Suite 150
Palo Alto, California 94306
Attn: Jon Krogstad
FAX: (650) 843-6969
The parties hereto may change the address at which they are to receive
notices hereunder, by notice in writing in the foregoing manner given to the
other.
11. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER
This Agreement shall be governed by, and construed in accordance with,
the internal laws of the State of California, without regard to principles of
conflicts of law. Each of Borrower and Bank hereby submits to the exclusive
jurisdiction of the state and Federal courts located in the County of Santa
Clara, State of California. BORROWER AND BANK EACH HEREBY WAIVE THEIR RESPECTIVE
RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT
OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN,
INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER
COMMON LAW OR STATUTORY CLAIMS. EACH PARTY RECOGNIZES AND AGREES THAT THE
FOREGOING WAIVER CONSTITUTES A MATERIAL INDUCEMENT FOR IT TO ENTER INTO THIS
AGREEMENT. EACH PARTY REPRESENTS AND WARRANTS THAT IT HAS REVIEWED THIS WAIVER
WITH ITS LEGAL COUNSEL AND THAT IT KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY
TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL.
12. GENERAL PROVISIONS
12.1 Successors and Assigns. This Agreement shall bind and inure to
the benefit of the respective successors and permitted assigns of each of the
parties; provided however that neither this Agreement nor any rights hereunder
may be assigned by Borrower without Bank's prior written consent, which consent
may be granted or withheld in Bank's sole discretion. Bank shall have the right
without the consent of or notice to Borrower to sell, transfer, negotiate, or
grant participation in all or any part of, or any interest in, Bank's
obligations, rights and benefits hereunder.
12.2 Indemnification. Borrower shall defend, indemnify and hold
harmless Bank and its officers, employees, and agents against: (a) all
obligations, demands, claims, and liabilities claimed or asserted by any other
party in connection with the transactions contemplated by this Agreement; and
(b) all losses or Bank Expenses in any way suffered, incurred, or paid by Bank
as a result of or in any way arising out of, following, or consequential to
transactions between Bank and Borrower whether under this Agreement, or
otherwise (including without limitation reasonable attorneys fees and expenses),
except for losses caused by Bank's gross negligence or willful misconduct.
20
<PAGE>
12.3 Time of Essence. Time is of the essence for the performance of
all obligations set forth in this Agreement.
12.4 Severability of Provisions. Each provision of this Agreement
shall be severable from every other provision of this Agreement for the purpose
of determining the legal enforceability of any specific provision.
12.5 Amendments in Writing Integration. This Agreement amends and
restates the terms of an Amended and Restated Loan and Security Agreement
existing on the Closing Date between Borrower and Bank. The security interest
granted under the terms of that agreement continues to secure the Obligations,
as defined herein, and the financing statement and Collateral Assignment Patent
Mortgage and Security Agreement filed in connection with such agreement continue
to perfect such security interest This Agreement cannot be amended or terminated
orally. All prior agreements, understandings, representations, warranties, and
negotiations between the parties hereto with respect to the subject matter of
this Agreement, if any, are merged into this Agreement and the Loan Documents.
12.6 Counterparts. This Agreement may be executed in any number of
counterparts and by different parties on separate counterparts, each of which,
when executed and delivered, shall be deemed to be an original, and all of
which, when taken together, shall constitute but one and the same Agreement.
12.7 Survival. All covenants, representations and warranties made in
this Agreement shall continue in full force and effect so long as any
Obligations remain outstanding. The obligations of Borrower to indemnify Bank
with respect to the expenses, damages, losses, costs and liabilities described
in Section 12.2 shall survive until all applicable statute of limitations
periods with respect to actions that may be brought against Bank have run.
12.8 Confidentiality. In handling any confidential information Bank
shall exercise the same degree of care that it exercises with respect to its own
proprietary information of the same types to maintain the confidentiality of any
non-public information thereby received or received pursuant to this Agreement
except that disclosure of such information may be made (i) to the subsidiaries
or affiliates of Bank in connection with their present or prospective business
relations with Borrower, (ii) to prospective transferees or purchasers of any
interest in the Loans, provided that they have entered into a comparable
confidentiality agreement in favor of Borrower and have delivered a copy to
Borrower, (iii) as required by law, regulations, rule or order, subpoena,
judicial order or similar order, (iv) as may be required in connection with the
examination, audit or similar investigation of Bank and (v) as Bank may
determine in connection with the enforcement of any remedies hereunder.
Confidential information hereunder shall not include information that either:
(a) is in the public domain or in the knowledge or possession of Bank when
disclosed to Bank, or becomes part of the public domain after disclosure to Bank
through no fault of Bank; or (b) is disclosed to Bank by a third party, provided
Bank does not have actual knowledge that such third party is prohibited from
disclosing such information.
21
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the date first above written.
THERMATRIX INC.
By: __________________________________
Title: VP, FINANCE & ADMINISTRATION
VENTURE BANKING GROUP, a division of
Cupertino National Bank
By: __________________________________
Title: ACCOUNT OFFICER
22
<PAGE>
EXHIBIT A
The Collateral shall consist of all right, title and interest of Borrower
in and to the following:
(a) All goods and equipment now owned or hereafter acquired, including,
without limitation, all machinery, fixtures, vehicles (including motor vehicles
and trailers), and any interest in any of the foregoing, and all attachments,
accessories, accessions, replacements, substitutions, additions, and
improvements to any of the foregoing, wherever located;
(b) All inventory, now owned or hereafter acquired, including, without
limitation, all merchandise, raw materials, parts, supplies, packing and
shipping materials, work in process and finished products including such
inventory as is temporarily out of Borrower's custody or possession or in
transit and including any returns upon any accounts or other proceeds, including
insurance proceeds, resulting from the sale or disposition of any of the
foregoing and any documents of title representing any of the above, and
Borrower's Books relating to any of the foregoing;
(c) All contract rights and general intangibles now owned or hereafter
acquired, including, without limitation, goodwill, trademarks, servicemarks,
trade styles, trade names, patents, patent applications, leases, license
agreements, franchise agreements, blueprints, drawings, purchase orders,
customer lists, route lists, infringements, claims, computer programs, computer
discs, computer tapes, literature, reports, catalogs, design rights, income tax
refunds, payments of insurance and rights to payment of any kind;
(d) All now existing and hereafter arising accounts, contract rights,
royalties, license rights and all other forms of obligations owing to Borrower
arising out of the sale or lease of goods, the licensing of technology or the
rendering of services by Borrower, whether or not earned by performance, and any
and all credit insurance, guaranties, and other security therefor, as well as
all merchandise returned to or reclaimed by Borrower and Borrower's Books
relating to any of the foregoing;
(e) All documents, cash, deposit accounts, securities, securities
entitlements; securities accounts, investment property, letters of credit,
certificates of deposit, instruments and chattel paper now owned or hereafter
acquired and Borrower's Books relating to the foregoing;
(f) All copyright rights, copyright applications, copyright registrations
and like protections in each work of authorship and derivative work thereof,
whether published or unpublished, now owned or hereafter acquired; all trade
secret rights, including all rights to unpatented inventions, know-how,
operating manuals, license rights and agreements and confidential information,
now owned or hereafter acquired; all mask work or similar rights available for
the protection of semiconductor chips, now owned or hereafter acquired; all
claims for damages by way of any past, present and future infringement of any of
the foregoing; and
(g) Any and all claims, rights and interests in any of the above and all
substitutions for, additions and accessions to and proceeds thereof.
23
<PAGE>
EXHIBIT B
LOAN PAYMENT/ADVANCE TELEPHONE REQUEST FORM
DEADLINE FOR SAME DAY PROCESSING IS 3:00 P.M., P.S.T.
TO: VENTURE BANKING GROUP DATE: __________________________________
FAX#: (415) 843-6969 TIME: __________________________________
- ---------------------------------------------------------------------------
FROM:_____________________________________________________________________
CLIENT NAME (BORROWER)
REQUESTED BY:
_____________________________________________________________
AUTHORIZED SIGNER'S NAME
AUTHORIZED SIGNATURE:______________________________________________________
PHONE NUMBER:______________________________________________________________
FROM ACCOUNT # _______________ TO ACCOUNT # _______________________________
REQUESTED TRANSACTION TYPE REQUEST DOLLAR AMOUNT
PRINCIPAL INCREASE (ADVANCE) $_______________________________________
PRINCIPAL PAYMENT (ONLY) $_______________________________________
INTEREST PAYMENT (ONLY) $_______________________________________
PRINCIPAL AND INTEREST (PAYMENT)$ $_______________________________________
OTHER INSTRUCTIONS: _______________________________________________________
___________________________________________________________________________
All representations and warranties of Borrower stated in the Loan Agreement are
true, correct and complete in all material respects as of the date of the
telephone request for and Advance confirmed by this Borrowing Certificate;
provided, however, that those representations and warranties expressly referring
to another date shall be true, correct and complete in all material respects as
of such date.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
BANK USE ONLY
TELEPHONE REQUEST:
The following person is authorized to request the loan payment transfer/loan
advance on the advance designated account and is known to me.
_______________________________ ______________________________________
Authorized Requester Phone #
_______________________________ ______________________________________
Received By (Bank) Phone #
______________________________________
Authorized Signature (Bank)
- --------------------------------------------------------------------------------
24
<PAGE>
EXHIBIT C
Revolving Promissory Note
$4,000,000 Palo Alto, California
January 21, 1998
FOR VALUE RECEIVED, the undersigned, Thermatrix Inc. (the "Borrower"),
promises to pay to the order of Venture Banking Group, a division of Cupertino
National Bank ("Bank"), at such place as the holder hereof may designate, in
lawful money of the United States of America, the aggregate unpaid principal
amount of all advances ("Advances") made by Bank to Borrower under the Loan
Agreement (as defined below), provided such Advances shall not exceed Four
Million Dollars ($4,000,000). Borrower shall also pay interest on the aggregate
unpaid principal amount of such Advances at a rate equal to the Prime Rate plus
one half of one (0.5) percentage point, all in accordance with the terms of the
Amended and Restated Loan and Security Agreement between Borrower and Bank of
even date herewith, as amended from time to time (the "Loan Agreement") on the
twentieth (20th) day of each month. The entire principal amount and all accrued
interest shall be due and payable on the Revolving Maturity Date.
Bank is hereby authorized by Borrower to endorse on Bank's books and
records each Advance made by Bank under this Note and the amount of each payment
or prepayment of principal of each such Advance received by Bank; it being
understood, however, that failure to make any such endorsement (or any errors in
notation) shall not affect the obligations of Borrower with respect to Advances
made hereunder, and payments of principal by Borrower shall be credited to
Borrower notwithstanding the failure to make a notation (or any errors in
notation) thereof on such books and records.
Borrower promises to pay Bank all costs and expenses of collection of this
Note and to pay all reasonable attorneys' fees incurred in such collection or in
any suit or action to collect this Note or in any appeal thereof. Borrower
waives presentment, demand, protest, notice of protest, notice of dishonor,
notice of nonpayment, and any and all other notices and demands in connection
with the delivery, acceptance, performance, default or enforcement of this Note.
No delay by Bank in exercising any power or right hereunder shall operate as a
waiver of any power or right. Time is of the essence as to all obligations
hereunder.
This Note is issued pursuant to the Loan Agreement, which shall govern the
rights and obligations of Borrower with respect to all obligations hereunder.
BORROWER HEREBY WAIVES ITS RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF
ACTION BASED UPON OR ARISING OUT OF THIS NOTE, INCLUDING CONTRACT CLAIMS, TORT
CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS.
This Note shall be deemed to be made under, and shall be construed in accordance
with and governed by, the laws of the State of California, excluding conflicts
of laws principles.
THERMATRIX INC.
By: ___________________________________________
Title:______________________________________
25
<PAGE>
EXHIBIT D
BORROWING BASE CERTIFICATE
- --------------------------------------------------------------------------------
Borrower: Thermatrix Inc. Lender: Venture Banking Group
Commitment Amount: $4,000,000
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<C> <S> <C>
ACCOUNTS RECEIVABLE
1. Accounts Receivable Book Value as of $____________
2. Additions (please explain on reverse) $____________
3. TOTAL ACCOUNTS RECEIVABLE $____________
ACCOUNTS RECEIVABLE DEDUCTIONS (without duplication)
4. Amounts over 90 days due $____________
5. Balance of 50% over 90 day accounts $____________
6. Concentration Limits $____________
7. Foreign Accounts $____________
8. Governmental Accounts $____________
9. Contra Accounts $____________
10. Promotion or Demo Accounts $____________
11. Intercompany/Employee Accounts $____________
12. Other (please explain on reverse) $____________
13. TOTAL ACCOUNTS RECEIVABLE DEDUCTIONS $____________
14. Eligible Accounts (#3 minus #13) $____________
15. LOAN VALUE OF ACCOUNTS (80% of #14) $____________
ELIGIBLE FOREIGN AND GOVERNMENT ACCOUNTS
16. Value as of ______________ $____________
17. LOAN VALUE (50% of #16) $____________
BALANCES
18. Maximum Loan Amount $ 4,000,000
-----------
19. Total Funds Available [Lesser of #18 or (#15 plus #17)] $____________
20. Present balance owing on Line of Credit $____________
21. Outstanding under Sublimits (Letters of Credit and Foreign Exchange) $____________
22. RESERVE POSITION (#19 minus #20 and #21) $____________
</TABLE>
The undersigned represents and warrants that the foregoing is true, complete and
correct, and that the information reflected in this Borrowing Base Certificate
complies with the representations and warranties set forth in the Loan and
Security Agreement between the undersigned and Venture Banking Group..
-----------------------------
COMMENTS: BANK USE ONLY
---- --- ----
Rec'd By: ____________
Auth. Signer
Thermatrix Inc. Date: ________________
By: __________________________ Verified: ____________
Authorized Signer Auth. Signer
Date: ________________
______________________
-----------------------------
26
<PAGE>
EXHIBIT 10.12
THERMATRIX INC.
1996 STOCK PLAN: UK RULES FOR EMPLOYEES
As the duly authorized signatory of the Administrator of the 1996 Stock
Plan (the "Plan") established by Thermatrix Inc. (the "Company"), which is
organised and existing under the General Corporation Law of the State of
Delaware, USA, I hereby state and affirm that the Rules of the Plan apply to the
grant of all Options save that the following provisions are applicable in the
administration of the Plan with regard to such Options to which these UK Rules
for Employees (the "UK Rules") are expressed to extend at the time when the
Option is granted. Unless the context requires otherwise, all expressions used
in the UK Rules have the same meaning as in the Plan, provided that all other
words and terms not otherwise defined shall have the meaning attributed by
Schedule 9 which for the purposes hereof (but for no other purpose) shall take
precedence. The Plan and the UK Rules taken together are referred to
hereinafter as "the Sub-Plan." References in the UK Rules to "Schedule 9" mean
Schedule 9 to the Income and Corporation Taxes Act 1988 ("ICTA 1988") and
references to any statutory enactment shall be construed as a reference to that
enactment as for the time being amended or re-enacted. For the avoidance of
doubt the UK Rules are not intended to provide rights with respect to Options to
which the UK Rules apply in addition to those rights granted under the Plan.
Rather, the UK Rules have been adopted for the purpose of ensuring that Options
to which the UK Rules apply will satisfy the requirements of Schedule 9 ICTA
1988.
1. The shares of Common Stock ("Shares") to be used in the Sub-Plan form part
of the ordinary share capital (as defined in section 832(l) ICTA 1988) of
the Company.
2. For the purposes of the UK Rules the companies which may participate in the
Sub-Plan are the Company and companies controlled by the Company within the
meaning of section 840 ICTA 1988, and no others. The Company and any
company which is now or hereafter becomes so controlled by the Company
shall be a participating company.
3. The Shares are quoted on the Nasdaq National Market which is a recognized
stock exchange as defined in section 841 ICTA 1988.
4. The Shares to be acquired on exercise of the Option will:
(a) be fully paid up;
(b) be not redeemable;
(c) not be subject to any "restrictions" other than restrictions which
attach to all shares of the same class. For the purposes of the UK
Rules, "restrictions" include restrictions which are deemed to attach
to the Shares under any contract, agreement, arrangement or condition
as referred to in paragraph 13 of Schedule 9; and
(d) satisfy the requirements of paragraph 14 of Schedule 9.
<PAGE>
5. All Options will be granted with respect to the Shares, or any shares
representing the same, of the Company.
6. No Option will be granted to an Employee under the Sub-Plan, or where an
Option has previously been granted, no Option shall be exercised by an
Optionee, if at that time he has, or at any time within the preceding 12
months has had, a material interest for the purposes of Schedule 9 in
either the Company being a close company within the meaning of Chapter I of
Part XI of ICTA 1988, or in a company being a close company which has
control of the Company or in a company being a close company and a member
of a consortium (as defined in section 187(7) ICTA 1988) which owns the
Company. In determining whether a company is a close company for this
purpose section 414(l)(a) ICTA 1988 (exclusion of companies not resident in
the United Kingdom) and section 415 ICTA 1988 (exclusion of certain
companies with listed shares) shall be disregarded.
7. For the avoidance of doubt it is stated that the Company is the grantor as
defined in paragraph l(l) of Schedule 9.
8. For the purposes of the Sub-Plan, Fair Market Value determined in
accordance with Section 2(n) of the Plan has the meaning given to Market
Value in Part VIII of the Taxation of Chargeable Gains Act 1992 and must be
agreed upon in advance with the Inland Revenue. The exercise price of an
Option subject to the UK Rules shall be the greater of the Fair Market
Value as determined in accordance with this Rule 9 or the nominal value of
a share. In addition, the exercise price of an Option subject to the UK
Rules is also subject to Rule 15 below.
9. An Option which is subject to the UK Rules shall not be capable of
surrender pursuant to an Option Exchange Program or subject to a repricing
pursuant to Section 4(b)(vii) of the Plan.
10. Subject to Section 5 of the Plan an Option may be granted under the Sub-
Plan to any employee or director of the Company or a company participating
in the Sub-Plan provided that in the case of a director his or her hours of
work are at least 25 hours per week exclusive of meal breaks. No option
shall be granted to Consultants under this Sub-Plan pursuant to the Plan
and all references in the Plan to Consultants shall be disregarded.
11. No Option shall be granted under the Sub-Plan if that would cause the
limits of paragraph 28 of Schedule 9 to be exceeded. The United Kingdom
Sterling equivalent of the aggregate Fair Market Value of Shares subject to
Options at the relevant dates of grant shall be ascertained by taking the
highest buying rate of the spread for the day as shown in the Financial
Times or by taking any other published conversion rate which the United
Kingdom Board of Inland Revenue has agreed is acceptable.
12. Upon exercise of an Option under the Sub-Plan payment shall be made in full
in cash from the Optionee's own resources or from the proceeds of a loan
from the Company or a third party and notwithstanding the provisions of
Section 9(c) of the Plan payment may not be
<PAGE>
made by delivery of Shares or a promissory note. Section 9(c)(iii) and
9(c)(iv) of the Plan shall be disregarded for the purposes of the Sub-Plan.
Nothing in the UK Rules shall prohibit an Optionee from pledging Shares to
secure a loan with which to exercise his or her Option.
13. The Company shall, as soon as practicable but not later than 30 days after
the date on which the Option is exercised, cause to be registered in the
Optionee's name the number of Shares and shall deliver or mail to the
Optionee a share certificate or certificates representing the Shares then
purchased subject to any delay necessary to complete (a) the listing of
such Shares on any stock exchange upon which shares of the same class are
then listed, (b) such registration or other qualification of such Shares
under any state or federal law, rule or regulation as the Company may
determine to be necessary or advisable and (c) the making of provision for
the payment or withholding of any taxes required to be withheld pursuant to
any applicable law, in respect of such Shares. Except for restrictions
which are permitted under paragraph 13(2) of Schedule 9 and those imposed
under any applicable federal or state law or requirements of any stock
exchange Shares shall be identical and rank pari passu in all respects with
shares of the same class then in issue.
14. Whilst the Sub-Plan remains approved under Schedule 9 ICTA 1988 no
adjustment pursuant to any of the provisions of the Plan shall be made to
any Option which is subject to the UK Rules unless such adjustment would be
permitted under paragraph 29 of Schedule 9 and where so permitted no such
adjustment shall take effect unless and until the approval of the United
Kingdom Board of Inland Revenue shall have been obtained thereto. An
Option which is subject to the UK Rules shall not be assumed or substituted
under Section 13(c) of the Plan and may be exercised to the extent
permitted by the Administrator.
15. For purposes of the Sub-Plan, Section 13(a) of the Plan shall be
disapplied. Instead, under the Sub-Plan, in the event of any
capitalization issue, rights issue, sub-division, consolidation or
reduction of share capital or any other variation in capital, the Board and
(as appropriate) the Company may make such adjustments as shall be fair and
reasonable in all of the circumstances to: (a) the number or nominal
value of a Share in any Option and/or (b) the Exercise Price for a Share
subject to any Option. The aggregate amount payable on the exercise of an
Option in full shall not thereby be increased, no adjustment shall cause
any of the conditions of the approval of the Plan to be thereby breached
and the Exercise Price payable on subscription for new stock shall never
be less than the nominal value of the Share to which it relates. No
adjustment shall take effect without prior confirmation in writing by the
Board of the Inland Revenue approving such proposed adjustment. As soon as
reasonably practicable after making any adjustment, the Board and (as
appropriate) the Company shall give notice in writing to every Optionee
thereby affected specifying the adjustments made insofar as they affect him
or her and such notice shall be binding upon the Optionee in the absence of
manifest error; provided that, where an adjustment is made to the terms of
an Option prior to the issue of an Option Certificate, the certificate
shall set out details of the Option as so adjusted and shall be deemed to
be sufficient notice of the adjustment for these purposes.
<PAGE>
16. Notwithstanding Section 14 of the Plan the date of grant of an Option to
which the UK Rules apply shall be a date which is no later than 30 days
after the date on which the exercise price for the Shares is determined.
17. If the approval status of the Sub-Plan granted under Schedule 9 ICTA 1988
is to be retained then no amendment or modification to the UK Rules or to
the Plan in so far as it relates to Options granted or to be granted under
the Sub-Plan shall take effect until such amendment or modification shall
have been approved by the United Kingdom Board of Inland Revenue. The
Company undertakes to provide to the United Kingdom Board of Inland Revenue
details of any amendments to the Sub-Plan as soon as possible for this
purpose.
18. Stock Purchase Rights, as provided for in Section 11 of the Plan, shall not
be granted pursuant to the Sub-Plan.
19. The Company shall not require an investment representation statement in
connection with the exercise of an Option under the Sub-Plan.
20. For purposes of Options granted pursuant to the Sub-Plan only, Sections
4(b)(x), 9(c)(v), 9(c)(vi) and 10(e) of the Plan shall be disapplied.
21. The exercise of an Option which is subject to the UK Rules shall not be
based on performance criteria.
<PAGE>
1996 STOCK PLAN: UK RULES FOR EMPLOYEES
(together referred to as the "Sub-Plan")
STOCK OPTION AGREEMENT
Unless otherwise defined herein, the terms defined in the 1996 Stock Plan
(the "Plan") as extended by the UK Rules for Employees (the "UK Rules") shall
have the same defined meaning in this Option Agreement.
I. NOTICE OF STOCK OPTION GRANT
Name of Optionee
You have been granted an option to purchase Common Stock of the Company,
subject to the terms and conditions of the Sub-Plan and this Stock Option
Agreement, as follows:
GRANT NUMBER: _________________________________
DATE OF GRANT: _________________________________
VESTING COMMENCEMENT DATE: _________________________________
EXERCISE PRICE PER SHARE: $_________________________________
TOTAL NUMBER OF SHARES GRANTED: _________________________________
TYPE OF OPTION: Qualified Stock Option [ ]
Nonqualified Stock Option [ ]
TERM/EXPIRATION DATE: _________________________________
VESTING SCHEDULE
----------------
This Option may be exercised, in whole or in part, in accordance with the
following schedule:
TERMINATION PERIOD
------------------
This Option may be exercised for ninety (90) days after termination of
employment, or such longer period as may be applicable upon death or Disability
of the Optionee as provided in the Sub-Plan, but in no event later than the
Term/Expiration Date as provided above.
<PAGE>
II. AGREEMENT
---------
1. Grant of Option. The Plan Administrator of the Company hereby grants
---------------
to the Optionee named in the Notice of Grant attached as Part I of this
Agreement (the "Optionee"), an option (the "Option") to purchase a number of
Shares, as set forth in the Notice of Grant, at the exercise price per share set
forth in the Notice of Grant (the "Exercise Price"), subject to the terms and
conditions of the Sub-Plan, which is incorporated herein by reference. Subject
to Section 15(c) of the Plan, in the event of a conflict between the terms and
conditions of the Sub-Plan and the terms and conditions of this Option
Agreement, the terms and conditions of the Sub-Plan shall prevail.
2. Exercise of Option.
------------------
(a) Right to Exercise. This Option is exercisable during its term in
-----------------
accordance with the Vesting Schedule set out in the Notice of Grant and the
applicable provisions of the Sub-Plan and this Option Agreement. In the event
of the Optionee's death, Disability or other termination of the Optionee's
employment, the exercisability of the Option is governed by the applicable
provisions of the Sub-Plan and this Option Agreement.
(b) Method of Exercise. This Option is exercisable by delivery of an
------------------
exercise notice, in the form attached as Exhibit A (the "Exercise Notice"),
which shall state the election to exercise the Option, the number of Shares in
respect of which the Option is being exercised (the "Exercised Shares"), and
such other representations and agreements as may be required by the Company
pursuant to the provisions of the Sub-Plan. The Exercise Notice shall be signed
by the Optionee and shall be delivered in person or by certified mail to the
Secretary of the Company. The Exercise Notice shall be accompanied by payment
of the aggregate Exercise Price as to all Exercised Shares. This Option shall
be deemed to be exercised upon receipt by the Company of such fully executed
Exercise Notice accompanied by such aggregate Exercise Price.
No Shares shall be issued pursuant to the exercise of this Option
unless such issuance and exercise complies with all relevant provisions of law
and the requirements of any stock exchange upon which the Shares are then
listed. The Exercised Shares shall be transferred to the Optionee within 30
days of the later of (i) the date on which the Option is exercised and (ii) the
date on which all provisions of any applicable law and the requirements of any
relevant stock exchange are complied with.
3. Method of Payment. Payment of the aggregate Exercise Price shall be
-----------------
by any of the following, or a combination thereof, at the election of the
Optionee:
(a) cash or check; or
(b) delivery of a properly executed exercise notice together with such
other documentation as the Administrator and the Optionee's broker, if
applicable, shall require to effect an
-2-
<PAGE>
exercise of Option and delivery to the Company of the loan proceeds required to
pay the exercise price.
4. Non-Transferability of Option. This Option may not be transferred in
-----------------------------
any manner during the lifetime of the Optionee and may on the death of the
Optionee be exercised by the executors, administrators, heirs and successors of
the deceased's estate. The terms of the Sub-Plan and this Option Agreement
shall be binding upon the executor's administrators, heirs and successors of the
Optionee.
5. Term of Option. This Option may be exercised only within the term set
--------------
out in the Notice of Grant, and may be exercised during such term only in
accordance with the Sub-Plan and the terms of this Option Agreement.
6. Tax Consequences upon Exercise. This Option is exercisable subject to
------------------------------
and in accordance with the terms of the Sub-Plan and this Agreement. In
addition, if the exercise of the Option meets the following criteria, there will
be no income tax liability upon exercise of the Option: (i) the exercise is
made at a time when the Plan retains Inland Revenue approval; (ii) the exercise
is not earlier than three (3) years or later than ten (10) years after the
Option was granted; and (iii) the exercise is not earlier than three (3) years
following the latest previous exercise by the participant of an Option (obtained
under this or any other option plan (except a Savings Related Share Option
scheme approved by the Inland Revenue) which enjoyed relied from income tax.
The Optionee should consult with his or her tax advisor as to the tax
consequences of the exercise of the Option and the subsequent disposition of the
Shares.
OPTIONEE: THERMATRIX INC.
____________________________________ By:_____________________________
Signature Title: Chairman, President & CEO
____________________________________
Print Name
____________________________________
(Employee Number)
HOME ADDRESS (Please Print)
_____________________________________
_____________________________________
-3-
<PAGE>
EXHIBIT 10.13
THERMATRIX INC.
FIRST AMENDMENT TO THE
AMENDED AND RESTATED
LOAN AND SECURITY AGREEMENT
This Amendment to the Amended and Restated Loan and Security Agreement,
dated as of March 18, 1998, (the "Amendment"), is entered into by and between
THERMATRIX INC. ("Borrower") and VENTURE BANKING GROUP, A DIVISION OF CUPERTINO
NATIONAL BANK ("Bank"). Capitalized terms used herein without definition shall
have the same meanings as is given to them in the Agreement (defined below).
RECITALS
--------
A. The Borrower and the Bank have entered into that certain Amended and
Restated Loan and Security Agreement dated as of January 21, 1998, (as amended
or modified from time to time, the "Agreement") pursuant to which the Bank has
agreed to extend and make available to the Borrower certain advances of money.
B. Borrower has requested certain modification(s) to the Agreement, and
desires that the Bank amend the Agreement upon the terms and conditions more
fully set forth herein.
C. Subject to the representations and warranties of the Borrower herein
and upon the terms and conditions set forth in this Amendment, the Bank is
willing to amend the Agreement.
AGREEMENT
---------
NOW, THEREFORE, in consideration of the foregoing Recitals and intending to
be legally bound, the parties hereto agree as follows:
SECTION 1. THE BORROWER'S REPRESENTATIONS AND WARRANTIES. The Borrower
represents and warrants that:
(a) the execution, delivery, and performance of the Loan Documents
are within Borrower's powers, have been duly authorized, and are not in conflict
with nor constitute a breach of any provision contained in Borrower's Amended
and Restated Articles of Incorporation or Bylaws, nor will they constitute an
event of default under any material agreement to which Borrower is a party or by
which Borrower is bound. Borrower is not in default under any agreement to which
it is a party or by which it is bound, which default could have a Material
Adverse Effect; and
(b) immediately before and immediately after giving effect to this
Amendment, no event shall have occurred and be continuing which constitutes an
Event of Default that has not been disclosed to Bank.
SECTION 2. AMENDMENTS TO THE LOAN AND SECURITY AGREEMENT.
2.1 Section 6.3 entitled Financial Statements, Reports,
Certificates, is hereby amended to include the following paragraph:
"Borrower shall deliver to Bank with the quarterly financial
statements a Backlog Report".
2.2 Section 6.10 entitled Tangible Net Worth, is hereby deleted and
amended to read in its entirety as follows:
1
<PAGE>
"6.10 Tangible Net Worth. Borrower shall maintain a Tangible Net
------------------
Worth of not less than $7,500,000 for the fiscal quarter ending March 31, 1998,
not less than $7,500,000 for the fiscal quarter ending June 30, 1998, not less
than $7,000,000 for the fiscal quarter ending September 31, 1998, or not less
than $5,800,000 for the fiscal quarter ending December 31, 1998".
2.3 Section 6.11 entitled Profitability, is hereby deleted and
amended to read in its entirety as follows:
"6.11 Profitability. Borrower shall not suffer a loss in excess of
-------------
$1,550,000 for the fiscal quarter ending March 31, 1998, a loss in excess of
$1,500,000 for the fiscal quarter ending June 30, 1998, a loss in excess of
$1,500,000 for the fiscal quarter ending September 30, 1998, or a loss in excess
of $1,750,000 for the fiscal quarter ending December 31, 1998. Borrower shall be
profitable for each fiscal quarter thereafter".
2.4 Exhibit E to the Agreement is replaced with Exhibit E hereto.
--------- ---------
SECTION 3. LIMITATION. The amendments and waivers set forth in this
----------
Amendment shall be limited precisely as written and shall not be deemed (a) to
be a modification of any other term or condition of the Agreement or of any
other instrument or agreement referred to therein or to prejudice any right or
remedy which the Bank may now have or may have in the future under or in
connection with the Agreement or any instrument or agreement referred to
therein; or (b) to be a consent to any future amendment or waiver to any
instrument or agreement the execution and delivery of which is consented to
hereby, or to any waiver of any of the provisions thereof. Except as expressly
amended hereby, the Agreement shall continue in full force and effect.
SECTION 4. EFFECTIVENESS. This Amendment shall become effective upon:
(1) The execution and delivery of a copy hereof by Borrower to the
Bank; and
(2) Bank shall have received, in form and substance satisfactory to
Bank, such other documents, and completion of such other matters, as Bank may
reasonably deem necessary or appropriate.
SECTION 5. RELEASE AND WAIVER. BORROWER HEREBY REPRESENTS AND WARRANTS TO
THE BANK THAT IT HAS NO KNOWLEDGE OF ANY FACTS THAT WOULD SUPPORT A CLAIM,
COUNTERCLAIM, DEFENSE OR RIGHT OF SET-OFF, AND HEREBY RELEASES BANK FROM ALL
LIABILITY ARISING UNDER OR WITH RESPECT TO AND WAIVES ANY AND ALL CLAIMS,
COUNTERCLAIMS, DEFENSES AND RIGHTS OF SET-OFF, AT LAW OR IN EQUITY, THAT
BORROWER MAY HAVE AGAINST BANK EXISTING AS OF THE DATE OF THIS AMENDMENT ARISING
UNDER OR RELATED TO THIS AMENDMENT, THE AGREEMENT OR ANY OF THE OTHER LOAN
DOCUMENTS OR TO THE LOANS CONTEMPLATED HEREBY OR THEREBY OR TO ANY ACT OR
OMISSION TO ACT BY THE BANK WITH RESPECT HERETO OR THERETO.
SECTION 6. COUNTERPARTS. This Amendment may be signed in any number of
------------
counterparts, and by different parties hereto in separate counterparts, with the
same effect as if the signatures to each such counterpart were upon a single
instrument. All counterparts shall be deemed an original of this Amendment.
2
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
executed as of the date first written above.
THERMATRIX INC. VENTURE BANKING GROUP, a division of
Cupertino National Bank
By: /s/ Barbara Krimsky By: /s/ J. Schellenberg
--------------------------- -------------------------------
Title: VP, Finance & Administration Title: Account Officer
--------------------------- -------------------------------
3
<PAGE>
EXHIBIT E
COMPLIANCE CERTIFICATE
TO: Venture Banking Group
FROM: Thermatrix Inc.
The undersigned authorized officer of Thermatrix Inc. hereby certifies that
in accordance with the terms and conditions of the Loan and Security Agreement
between Borrower and Bank (the "Agreement"), (i) Borrower is in complete
compliance for the period ending _______________________________ with all
required covenants except as noted below and (ii) all representations and
warranties of Borrower stated in the Agreement are true correct in all material
respects as of the date hereof. Attached herewith are the required documents
supporting the above certification. The Officer further certifies that these
are prepared in accordance with Generally Accepted Accounting Principles (GAAP)
and are consistently applied from one period to the next except as explained in
an accompanying letter or footnotes.
Please indicate compliance status by circling Yes/No under "Complies"
column.
<TABLE>
<CAPTION>
Reporting Covenant Required Complies
------------------ -------- --------
<S> <C> <C>
Quarterly financial statements Quarterly within 45 days Yes No
Quarterly Backlog Report Quarterly within 45 days Yes No
Annual CPA Audited FYE within 120 days Yes No
10Q and 10K Within 5 days of filing Yes No
Borrowing Base, A/R & A/P Agings Monthly within 30 days Yes No
A/R Audit Initial and Semi-Annual Yes No
</TABLE>
<TABLE>
<CAPTION>
Financial Covenant Required Actual Complies
------------------ -------- ------ --------
<S> <C> <C> <C>
Maintain on a Quarterly Basis:
Minimum Quick Ratio 1.0:1.0 ___:1.0 Yes No
Minimum Tangible Net Worth $______1 $______ Yes No
Maximum Debt/Tangible Net Worth 1.5:1.0 ___:1.0 Yes No
Profitability $______2 $______ Yes No
</TABLE>
2 Permitted Tangible Net Worth not less than $7,500,000 for quarter ending
3/31/98; $7,500,000 for quarter ending 6/30/98; $7,000,000 for quarter ending
9/30/98; and $5,800,000 for quarter ending 12/31/98.
1 Permitted losses not to exceed: $1,550,000 for quarter ending 3/31/98;
$1,500,000 for quarter ending 6/30/98, $1,500,000 for quarter ending 9/30/98;
and $1,750,000 for quarter ending 12/31/98. Preliability required for each
fiscal quarter thereafter.
Comments Regarding Exceptions: See Attached.
Sincerely,
______________________________________
SIGNATURE
______________________________________
TITLE
______________________________________
DATE
- --------------------------------------------------
BANK USE ONLY
Received by:______________________________
AUTHORIZED SIGNER
Date:_____________________________________
Verified:_________________________________
AUTHORIZED SIGNER
Date:_____________________________________
Compliance Status: Yes No
- --------------------------------------------------
4
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included on this Form 10-K, into the Company's previously filed
Registration Statement on Form S-8, File No. 333-4370.
/S/ ARTHUR ANDERSEN LLP
San Jose, California
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1996 DEC-31-1997
<PERIOD-START> JAN-01-1995 JAN-01-1996 JAN-01-1997
<PERIOD-END> DEC-31-1995 DEC-31-1996 DEC-31-1997
<CASH> 981 4,781 3,990
<SECURITIES> 0 11,418 3,587
<RECEIVABLES> 2,330 5,164 3,863
<ALLOWANCES> 190 265 343
<INVENTORY> 85 809 547
<CURRENT-ASSETS> 3,387 22,241 11,894
<PP&E> 828 1,236 1,685
<DEPRECIATION> 233 423 749
<TOTAL-ASSETS> 4,228 24,009 13,987
<CURRENT-LIABILITIES> 2,252 2,611 2,038
<BONDS> 0 0 0
11,321 0 0
9,304 0 0
<COMMON> 0 7 8
<OTHER-SE> (18,649) 21,391 11,949
<TOTAL-LIABILITY-AND-EQUITY> (4,228) 24,009 13,987
<SALES> 6,494 13,605 7,011
<TOTAL-REVENUES> 6,494 13,605 7,011
<CGS> 6,064 12,002 8,351
<TOTAL-COSTS> 6,064 12,002 8,351
<OTHER-EXPENSES> 5,824 6,916 8,908
<LOSS-PROVISION> 229 190 220
<INTEREST-EXPENSE> 231 500 674
<INCOME-PRETAX> (5,163) (4,813) (9,574)
<INCOME-TAX> (31) (63) (66)
<INCOME-CONTINUING> (5,194) (4,876) (9,640)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (5,194) (4,876) (9,640)
<EPS-PRIMARY> (65.75) (1.22) (1.28)
<EPS-DILUTED> (65.75) (1.22) (1.28)<FN>
<FN>All per share information has been retroactively adjusted to reflect a one
for three reverse stock split that was approved in May, 1996.
</TABLE>
