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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998.
[_] 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)
Delaware 94-2958515
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2025 Gateway Place, Suite 132
San Jose, California 95110
(Address of principal executive (Zip Code)
offices)
(Registrant's telephone number, including area code) (408) 453-0490
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 _______
-------
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, 1999, there were issued and outstanding 7,711,401 shares of
Common Stock. The aggregate market value of Common Stock held by non-
affiliates of the Registrant on that date was approximately $23,134,203, 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., a Delaware Corporation formed in 1992, (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.
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 80 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 through 1998 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, Pfizer and Warner
Lambert as well as the United States Departments of Defense and Energy (the
"DOD" and the "DOE", respectively).
The Company is also 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(R) VOC adsorption
technology from Purus, Inc.
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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.
During 1998 the Company (i) entered into a Demonstration Project Partnership
Agreement with the Massachusetts Executive Office of Environmental Affairs and
the Massachusetts Executive Office of Transportation and Construction to
demonstrate the application of the FTO technology to treat the exhaust of a
diesel locomotive operated by the Massachusetts Bay Transportation Authority
("MBTA"); (ii) received a grant award of $1.65 million from the Advanced
Technology Program ("ATP") of the National Institute of Standards and
Technology, an agency of the U.S. Department of Commerce, for the development
of a four-way diesel emissions treatment device; and (iii) entered into an
agreement with the Diesel Emission Evaluation Program ("DEEP") to conduct a
series of performance tests on an emissions control prototype for underground
mining vehicles.
On January 13, 1999 the Company acquired all of the outstanding common
shares of Wahlco Environmental Systems, Inc. ("Wahlco"), a Delaware
corporation formerly traded on the NASDAQ bulletin board. Wahlco designs,
manufactures, and sells combined cycle gas turbine products, metallic and
fabric bellows, air pollution control equipment, and related products and
services to electric utilities, independent power producers, co-generation
plants, and industrial manufacturers worldwide. Wahlco also provides
mechanical plant installation services and rents associated equipment to users
in the U.K. Management believes that the business and market synergies between
the Company and Wahlco in the air pollution control industry are excellent and
the combination of the two firms will provide a more balanced business with
global presence and performance.
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.
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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 NO\\x\\ 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 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.
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. 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.
During 1998, the Company received one order totalling approximately $800,000
for the supply of the new FTO design. The Company is currently in the process
of completing the delivery of this order.
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:
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., Warner
Lambert, Pfizer, 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(R), which uses a regenerative
synthetic adsorption resin to capture and recover very low concentration VOCs
from low-to-medium flow vapor streams.
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, 35% in 1997 and 60% in
1998. The Company expects that sales from overseas installations will continue
in 1999 at approximately the same level experienced during 1998. 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
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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.
Based on its sales experience, 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.
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
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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 being distinguishable from
incineration.
During 1998, two regulatory events occurred in California that are
significant to the Company's development activity relating to diesel
emissions. First, the California Air Resources Board ("CARB") identified
particulate emissions from diesel-fueled engines as a toxic air contaminant
and initiated a process to implement new control strategies. Second, CARB
approved the elimination of less stringent emission standards for light-duty
trucks beginning in 2004 which, according to CARB, will likely preclude diesel
engines without suitable pollution control devices in vehicles with a gross
vehicle weight below 8500 pounds. In 1997, light trucks (including vans and
sport utility vehicles) comprised 46% of all new car sales in California and
an increasing proportion of these vehicles are being equipped with diesel
engines because of the higher fuel economy.
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 80 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:
<TABLE>
<CAPTION>
TARGET MARKETS REPRESENTATIVE CUSTOMER VOCS TREATED
- -------------- ----------------------- ------------
<S> <C> <C>
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, Pfizer Chlorinated Compounds
Manufacturing.......... Chesebrough-Pond's USA Co.
Pulp and Paper
Manufacturing.......... Georgia Pacific, Simpson Paper Sulfonated Compounds
Medical Sterilization... Sorex Medical Ethylene Oxide
Soil and Groundwater DOD, DOE, Thermo Remediation Chlorinated Compounds
Remediation............ and Hydrocarbons
</TABLE>
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. During 1998, the Company continued to
experience a high volume of orders from overseas installations. During 1999,
the Company expects that sales from overseas installations will comprise 60%
of total sales, which is similar to the percentage experienced in 1998.
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
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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 are managed from Knoxville, Tennessee and those for Europe and Asia
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 seven representative organizations
with over 24 sales agents selling the Company's FTO system. In Asia, the
Company has agreements with Cinchem Enterprise Limited for sales
representation in Taiwan and the Peoples' Republic of China, with Toray
Engineering Co. Limited and Nittetu Chemical Engineering Limited in Japan, and
with Miju Plant Companies Limited 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.
In April 1997, the Company entered into an Exclusive Sales and Marketing
Agreement (the "White Horse Agreement") with White Horse Technologies Inc.
("White Horse") to facilitate penetration of the air pollution control market
by offering potential customers a wider array of products. In July 1998, the
Company declared White Horse to be in default of the White Horse Agreement and
on August 25, 1998 suspended any further commercial dealings with the firm. In
October 1998, the Company filed a claim against White Horse for damages
related to the default and White Horse filed a bankruptcy petition in November
1998. The Company does not expect to recover the investment it made in White
Horse and has provided in full against all White Horse investments and
receivables.
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. Ltd. and Nittetu Chemical Engineering Ltd. in
Japan and with Miju Plant Companies Ltd. 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 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.
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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 1998, the Company focused its technical resources on
product development in the diesel emissions area while continuing to make
product improvements in its core business of industrial air pollution control.
The successful construction and testing of four diesel prototypes in 1998 led
the Company to conclude that its FTO technology could efficiently destroy
diesel particulate and odors. Based upon the success of these early
initiatives, the business unit Thermatrix Diesel Systems was formed to focus
internal resources on the diesel emissions market.
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, the Company relies on
consulting relationships with a number of top tier research institutes,
including Lawrence Berkeley National Laboratory, Oak Ridge National Laboratory
and Southwest Research Institute.
As announced in the 1997 Annual Report, the Company has successfully
completed the dissolution of its joint venture arrangement with ThermoChem,
Inc., which had been established for the processing of radioactive mixed
waste. Any future projects for such processing will be undertaken on a teaming
basis.
POTENTIAL APPLICATIONS UNDER DEVELOPMENT
During 1998, the Company began to focus development efforts on applications
in two general market areas:
Industrial and Diesel. The Company's strategy to expand its presence in
these markets is to work with strategic partners to evaluate the feasibility
of applying the Company's technology to other uses.
Industrial VOC Emission Control. The Company received its first orders for
the reconfigured, reduced-cost version of its straight-through FTO in 1998,
and will be commissioning them during 1999. The Company has also delivered the
first two modified recuperative FTO systems into the pharmaceutical industry,
where the featured range and operability improvements are vital. One benefit
derived from the diesel development efforts is a newly designed recuperative
FTO for small to medium industrial applications that will see its first trial
at a large European plant where NOx minimization and VOC abatement are
required simultaneously. A strategic partner and host site for the first
flameless liquid waste FTO is currently being sought.
The Company has ceased to commercially offer the continuous bed improvement
to its PADRE product line because of technical issues that arose during the
fielding of a prototype of the improved system. In 1998, a significant R&D
expense was incurred in responding to these technical issues and no timetable
has been established for their resolution. The Company continues to
successfully offer its commercially proven fixed bed system to the
marketplace.
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Diesel Engine Emission Control. An important stage in the diesel development
program was a joint assessment the Company carried out with a major
manufacturer of diesel fuel injection systems in 1998. The parties' intent at
the onset of the program was to jointly develop a system comprising both
parties' technologies in such a way that reductions in both PM and NO\\x\\
emissions would occur in an energy-neutral system. Although the FTO was shown
to reduce PM to non-detectable levels under many conditions during the course
of that program, both parties concluded that fundamental market forces
rendered no advantage to linking their technologies together and joint
activity ended.
During 1998, several partnerships were formed with potential end users of
diesel aftertreatment systems, and three agreements were concluded for
prototype demonstration testing.
Locomotives. In the third quarter, the Company entered into a Demonstration
Project Partnership Agreement with the Massachusetts Executive Office of
Environmental Affairs working with the Massachusetts Executive Office of
Transportation and Construction whose jurisdiction includes the MBTA. The goal
of the project is to demonstrate the application of the FTO technology to
treat the exhaust of a diesel locomotive owned and operated by the MBTA, to
validate the performance of the technology on a locomotive, and to evaluate
the cost effectiveness of this particular application. The program also
includes demonstrating the integration of various NO\\x\\ reduction
technologies to achieve as complete destruction as possible of all the
undesirable components contained in this diesel engine emission exhaust.
Four-Way Converter. In the fourth quarter, the Company received a grant of
$1.65 million from the ATP of the National Institute of Standards and
Technology, an agency of the U.S. Department of Commerce for the development
of a four-way diesel emissions treatment device. The grant will be received
over a two-year period based on the level of research and development incurred
by Thermatrix on this project and the availability of federal funding for year
two. The project seeks to develop and test a device capable of reducing or
eliminating all four key pollutants in diesel engine exhaust by combining the
FTO technology for the reduction of PM, CO and HC with a proprietary Lean
NO\\x\\ Catalyst developed by Southwest Research Institute of San Antonio,
Texas. The ATP provides funding to industry for research and development
projects that have the potential to provide direct broad-based economic
benefits to the United States. The initial market will be urban buses.
Mining Vehicles. In the fourth quarter, the Company also received approval
from DEEP to demonstrate the FTO's ability to destroy PM and organic vapors
from diesel vehicles in underground mines. DEEP is a consortium of Canadian
and U.S. mining interests, whose mission is to reduce miners' exposure to
diesel exhaust contaminants, particularly fine particles that are suspected
carcinogens. The focus of the DEEP demonstration is to quantify the amount of
particulate mass destroyed by the FTO and prove that the FTO eliminates
"ultrafine" particles that have greater detrimental health consequences and
are a by-product of some diesel oxidation catalysts and traps.
Intellectual Property
As of February 28, 1999, the Company owned 13 United States and 48
international patents, had received notice of allowance for two additional
United States patent applications, and had a further 10 United States and 126
international patent applications pending relating to its thermal treatment
technology. All issued United States patents expire during the period between
August 17, 2003 and March 19, 2018.
The Company's 15 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.
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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 five issued international
trademarks, and has received notice of allowance for one additional United
States trademark. The Company also has an additional eight international
trademark applications pending for certain of the Company's tradenames and
other intellectual property.
EMPLOYEES
As of December 31, 1998, the Company had 57 full-time employees, 13 of whom
hold advanced degrees. The Company believes that it has been successful in
attracting experienced and capable engineering, operations and management
personnel. As of December 31, 1998, none of the Company's permanent, full-time
employees are covered by collective bargaining agreements.
SIGNIFICANT SUBSEQUENT EVENT
On January 13, 1999, pursuant to an Agreement and Plan of Merger, dated
November 9, 1998 (the "Merger Agreement"), among Wahlco Environmental Systems,
Inc., ("Wahlco"), the Company and TMX Acquisition Sub I, Inc., a wholly owned
subsidiary of the Company ("Merger Sub"), Merger Sub merged with and into
Wahlco (the "Merger"), and Wahlco became a wholly owned subsidiary of the
Company at the effective time of the Merger.
The Company paid approximately $1.9 million in cash to acquire all of the
common shares and warrants of Wahlco. The Wahlco shareholders are also
entitled to receive certain Contingent Payments as defined in the Merger
Agreement. The Contingent Payments are dependent upon the resolution of
certain contingencies not relating to future operating results of the Company.
The Company believes, but can provide no assurances, that the Contingent
Payments will not exceed $2,000,000 in total and may be substantially less
than that amount.
In connection with the Merger, the Company agreed to guaranty to Wexford
Management LLC ("Wexford"), as Agent for certain lenders which are affiliates
of Wexford (the "Lenders"), the obligations of Wahlco to the Lenders under an
amended and restated credit agreement dated January 30, 1998 (the "1998 Credit
Agreement") and to The Chase Manhattan Bank under a non-committed line of
credit (the "Chase Facility") and to grant to the Lenders a security interest
in all existing and future assets of the Company.
On February 25, 1999 the Company entered into the Second Amended and
Restated Credit Agreement among Wahlco and the Company, as Borrowers, and the
Lenders and Wexford as Agent for the Lenders (the "1999 Credit Agreement"). As
of March 31, 1999, the debt amounts to slightly more than $5.7 million and
bears interest at the rate of 13% per annum, payable monthly in advance. The
debt matures on August 24, 1999, and may, with the payment of an additional
fee of $100,000, be extended until November 22, 1999. As a further condition
to the Lenders' execution and delivery of the 1999 Credit Agreement, the
Company agreed to confirm its grant to the Lenders of a security interest in
all existing and future assets and to cause all its significant subsidiaries
to enter into guarantees and grant to the Lenders additional security
interests and mortgages in all existing and future assets of the Borrowers and
significant subsidiaries.
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The Company believes this merger to be strategically significant. The
business and market synergies between the Company and Wahlco in the air
pollution control industry are excellent and the combination of the two firms
will provide a more balanced business with a stable base, above-average
growth, and global presence and performance.
In recent years the air pollution control and air-and gas-handling
industries have been experiencing enormous change and consolidation. The
biggest change has been that customers in all sectors, including industrial,
energy and government, are increasingly purchasing complete turnkey systems
from global vendors rather than component equipment from regional suppliers.
As a result, the number of original equipment manufacturers ("OEM's") has
begun to decrease as those that have not been able to make the successful
transformation to global system vendors have failed or are being acquired by
others that can. In the past several years the Company has been able to
successfully develop the capability to deliver complete systems on a global
basis and began to seek targeted acquisitions such as Wahlco.
Currently, the air pollution control industry is structured into three
discrete market segments: stationary sources, mobile sources and indoor air
quality. In the stationary and mobile sources segments, the pollutants of
concern are particulate matter ("PM"), volatile organic compounds and
hazardous air pollutants (collectively, "VOCs"), oxides of nitrogen
("NO\\x\\"), and sulfur dioxide ("SO2"). The primary global sources of the
foregoing emissions are industrial facilities, utilities and engines.
The Company is a system supplier and has a particular focus on VOCs and
NO\\x\\ from industrial facilities. While the current business is 100% from
the industrial sector, recent activities involving the destruction of
emissions from diesel engines has begun to diversify the company into a larger
segment of the air pollution control marketplace. Wahlco is primarily an OEM
directed at handling flue gas and treating the emission of PM and NO\\x\\.
Wahlco's market is approximately 70% from the utilities and energy sector and
30% from the industrial sector. A combination of the two companies would
result in an enterprise with unaudited combined 1998 sales of approximately
$50 million with approximately 55% being derived from the utilities and energy
sector and approximately 45% from the industrial sector. Geographically,
approximately 55% of the revenues will be derived from European operations and
approximately 45% will be derived from North American operations.
Business activities of the two companies are similar except that the Company
has not had a dedicated fabrication facility since the Knoxville, Tennessee
plant was closed in December 1997. Both the Company and Wahlco have resources
and facilities for engineering design and specification, purchasing,
installation, commissioning and servicing. The Company employs 57 people and
has 80 installations worldwide and Wahlco employs 354 people and has over
1,000 installations around the world. Of the Company's current business, 60%
is derived from Europe and 40% is derived from North America while Wahlco's
business is divided equally between Europe and North America.
DESCRIPTION OF THE WAHLCO BUSINESS
Wahlco designs, manufactures, and sells combined cycle gas turbine products,
metallic and fabric bellows, air pollution control equipment, and related
products and services to electric utilities, independent power producers, co-
generation plants, and industrial manufacturers worldwide. Wahlco also
provides mechanical plant installation services and rents associated equipment
to users in the U.K. Wahlco operates through several subsidiaries that focus
on specific geographical regions or products.
Wahlco Engineered Products, Inc. (U.S.) designs, manufactures and sells gas
flow diverters, dampers and fabric and metallic expansion joints used by
electric utilities and other industrial companies. Wahlco Inc. (U.S.) designs,
manufactures, sells, leases and services equipment used by electric utilities
and others to reduce and control air pollution. Products and services include
flue gas conditioning systems, NO\\x\\ reduction systems and industrial
electric heaters and thermocouples.
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Wahlco Engineered Products, Ltd. (U.K.) designs and sells gas flow diverters
which control and direct the flow of gases from a gas turbine exhaust to a
waste heat recovery boiler in a gas-turbine combined-cycle power-generation
plant. Pentney Engineering Ltd. (U.K.) provides mechanical pipework and plant
installation, hydraulic equipment manufacture, and general fabrication to
utilities and industrial companies. Teddington Bellows Ltd. (U.K.) designs,
manufactures and sells specialized high performance metallic expansion joints
for industrial and utility applications. Treste Plant Hire, Ltd. (U.K.) rents
mechanical equipment to the United Kingdom construction industry.
PRODUCTS AND SERVICES
Wahlco's products and services are sold in the coal-fired utility after-
boiler market, the gas-turbine power-generation market, the market for
elimination of VOCs, and other industrial markets.
DAMPERS, DIVERTERS, EXPANSION JOINTS, PIPING SYSTEMS, HYDRAULIC EQUIPMENT AND
OTHER SERVICES
Gas flow diverters divert the flow of exhaust gases from gas turbines either
to the atmosphere via stacks or to boilers for steam production. The steam
produced is principally used for power generation by combined cycle steam
turbines. In some cases, the steam is used as process steam in district
heating systems, water desalination, or operations such as liquefying oil to
assist in its extraction from the ground (co-generation). Gas flow diverters
are supplied to the power generation industry, industrial power plant systems,
and similar process industries of gas type isolation equipment. Diverters are
sold to customers in Europe, Southeast Asia, the Far East and to the United
States.
Dampers control the flow of air and gas by directing, throttling and/or
channeling air and gas through a single path. They are used by power
generating utilities, petrochemical plants, refineries, chemical plants,
cement plants, paper and steel mills, and other industrial companies.
Expansion joints are produced from various fabrics and metals, in a variety
of configurations, and are used with diverters and other ducting systems.
These products are provided to a wide range of industries.
Metallic expansion joints are installed in liquid and gas piping, pressure
systems and exhaust systems in the chemical, petrochemical, utility power
generation, aviation, nuclear, shipbuilding, heating and other general
industries. Expansion joints are used primarily to counteract the negative
effect of the expansion and contraction of pipes and ducts caused by extreme
temperature changes from a production process such as electric power
production and petroleum refining.
Only a small portion of these businesses are driven by environmental
regulations.
Warranties for the foregoing products generally average from 12 to 24 months
from the date of sale and provide for the repair or replacement, without
charge, of any parts found to be defective in material or workmanship under
normal and proper use (except wear and tear for abrasion or corrosion). The
useful life for this group of products ranges from 3 to 20 years under normal
and proper use.
FGC SYSTEMS, HEATERS AND THERMOCOUPLES, AND RELATED PRODUCTS AND SERVICES
Wahlco is the leading provider of flue gas conditioning ("FGC") systems
worldwide. The FGC business is principally driven by environmental regulations
that require electric utilities to meet certain emissions standards for
particulate matter and sulfur oxides.
To comply with these regulations, many utilities previously burning high
sulfur coal have switched to low sulfur coal. While the conversion from high
sulfur to low sulfur coal enables utilities to meet existing sulfur oxide
emissions standards, the conversion generally results in an increase in
particulate
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emissions. FGC systems increase the collection efficiency of electrostatic
precipitators ("ESPs"), which abate particulate (fly ash) emissions. Wahlco's
FGC technologies include sulfur trioxide, ammonia and dual conditioning (both
sulfur trioxide and ammonia conditioning). FGC systems may be installed on
existing or new ESPs.
The ability of Wahlco's customers to purchase low sulfur coal economically
is an important factor in the continuing demand for Wahlco's FGC business.
Experts in the field of coal resources expect this trend to continue.
Originally, low sulfur coal was thought to be more difficult to obtain and
transport when planning for the Clean Air Act began in the early 1990's.
Wahlco's Staged NO\\\x\ Reduction System ("SNRS") relies on two NO\\x\\
reduction technologies: selective non-catalytic reduction ("SNCR") and
selective catalytic reduction ("SCR"). The system uses the customer's existing
air heater to further reduce NOx emissions. The air heater SCR process is
covered by U.S. and foreign patents owned by Wahlco.
Thermocouples are heat-sensing devices used in conjunction with a
temperature controller or indicator to convert an electrical signal to a
temperature readout. Wahlco's electrical heaters include: (1) tubular heaters
for plastic injection molding and extrusion, pipe heating and die heating; (2)
immersion heaters for heating liquids in the chemical and process industries;
(3) duct heaters for heating large quantities of air or gas passing through
ducts; (4) tubular elements for specialty heating applications; and (5)
silicone rubber heaters for drum and tank heating used for food processing,
medical equipment and other applications.
Warranties for FGC systems generally provide for the repair or replacement,
without charge, of any parts found to be defective in material or workmanship
under normal and proper use (excepting wear and tear from abrasion or
corrosion) within 18 months from the date of shipment or 12 months from the
date of initial operation, whichever occurs first. In addition, under certain
circumstances, Wahlco guarantees that proper operation of its FGC systems will
not exceed certain effluent opacity or emission levels over an initial
acceptance period.
Warranties for heaters and thermocouples generally provide that Wahlco will
repair or replace, without charge, any parts found to be defective in material
or workmanship under normal and proper use (excepting wear and tear from
abrasion or corrosion) within 12 months from the date of sale. Wahlco believes
the useful life of each of these products exceeds five years under normal and
proper use.
Patents and Trademarks
As of December 31, 1998, Wahlco held 24 U.S. patents and corresponding
foreign patents and/or applications. Existing patents expire between 1999 and
2015. Although initially enhanced by its patent rights, Wahlco believes its
ability to compete effectively in the FGC market depends primarily upon its
engineering, scientific and technological expertise and its reputation for
successful installations. This includes a database of information relating to
coal and ash analysis and precipitator size and operating conditions. In
addition, Wahlco has competed successfully in the sale of its sulfur dioxide-
based and ammonia conditioning systems, which are not protected by patents,
and in the sale of its sulfur-burning FGC systems in foreign countries in
which it does not have significant patent protection.
Marketing
Wahlco markets its products, technologies and services to electric utilities
and industrial customers worldwide. The principal export markets for Wahlco's
products are Asia, Europe and Canada.
Wahlco has a dedicated sales force for each subsidiary. Coordination among
these groups has aided the development of relationships and future business
prospects for all products.
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Wahlco's FGC sales organization is headquartered in Santa Ana, California. A
sales manager oversees approximately 40 independent sales representative
organizations in North America that sell to utility customers and industrial
customers, primarily in the steel, cement, pulp and related process
industries. The international sales function operates through a network of 42
representatives in 57 countries in Africa, Asia, the Pacific Rim, the
Caribbean, Europe, the Middle East and Central and South America. In addition
to this sales organization, Wahlco markets its products through sales and/or
service offices located in California and Illinois.
Wahlco's FGC marketing efforts are targeted primarily at coal-fired power
plants operated by electric utilities. Repeat business for FGC systems is
limited because individual customers typically have a small number of
electrostatic precipitators and because FGC systems operate for many years
without the need for replacement.
In recent years, Wahlco has increased its international marketing efforts
for FGC systems. While U.S. environmental regulations, mandating lower
emissions levels for power generating plants, have been in place for several
years, many other countries have not yet adopted or enforced strict
regulations aimed at reducing emissions from coal fired power plants. Asia,
Europe, and Africa, may enact stricter regulations to control power plant
emissions. It is impossible to predict with certainty, however, whether such
regulations will be enacted or, if enacted, enforced, or the effect of such
regulations upon Wahlco's business.
Marketing and sales for Wahlco Engineered Products, Inc. is based in
Lewiston, Maine and focuses on customers in the power, pulp and paper, cement,
metals, and petrochemical industries in North, Central and South America
through a network of approximately 28 independent sales representative
organizations. Wahlco Engineered Products, Inc. also markets dampers and
expansion joints to customers in Europe and Asia through a network of 18
independent sales representative organizations in Europe and Asia. In
addition, WEP, Inc. sells diverters to U.S. based customers for projects in
Europe and Asia.
Wahlco Engineered Products, Ltd.'s products are marketed internationally by
direct and independent sales representatives in 34 countries. Sales,
engineering and technical support are performed from the Chesterfield, U.K.
facility.
Teddington Bellows Ltd. uses a combination of its own and several of
Wahlco's international sales and marketing representatives.
Customers
No customer accounted for more than 10% of Wahlco's revenues in 1998.
Raw Materials
The materials used in the production of Wahlco's product lines are generally
available through a number of sources, and Wahlco does not anticipate
difficulty in obtaining the materials and components used in its operations.
Most of the materials used by Wahlco are ordered to a number of standards,
including ASME, ASTM and DIN.
Certain materials and components must withstand extreme operating conditions
and because only relatively few component suppliers consistently meet
necessary specifications, Wahlco purchases from a limited number of suppliers.
Generally, Wahlco has not experienced difficulty in obtaining the necessary
materials and components and has several alternative sources of supply.
Pentney Engineering Ltd., Teddington Bellows Ltd., and Wahlco Engineered
Products, Ltd. have achieved ISO 9000 standards. The remaining subsidiaries
continue to work toward achieving ISO 9000 accreditation or equivalent
standards.
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Competition
Wahlco, Inc. competes primarily on its engineering, scientific and
technological expertise. Since 1990, Wahlco Inc.'s domestic FGC business has
experienced increased price competition as domestic utilities attempted to
reduce the overall costs of compliance with state and federal regulations.
Several smaller domestic manufacturers including Chemithon, Inc. and Wilhelm
Environmental Technologies, Inc., have been successful in securing some FGC
contracts.
As a result of price competition, Wahlco Inc. has experienced a decline in
market share and in overall FGC margins. Since 1993-1996, Wahlco Inc.
confronted competitive pricing pressures by reducing certain engineering and
manufacturing costs and by reconfiguring various products to better meet
customer demand. Based upon internal market information, Wahlco Inc. believes
that it still continues to be the leading provider for FGC systems in the
United States and maintains a strong market position internationally.
Since there are several alternatives to FGC systems, Wahlco Inc. faces
substantial competition from companies providing devices that reduce
particulate emissions generally without the need for FGC systems. Examples of
such devices are scrubbers, certain ESPs, and baghouses. Numerous factors may
be considered by an electric utility in determining whether to install FGC
systems or an alternative technology to achieve compliance. These include the
amount of initial capital expenditures, issues and policies related to fuel
sources, related on-going operating and maintenance costs, availability and
associated costs of low and/or high sulfur coal, the particular emission
standards applicable to the public utility, and the value of any credits or
allowances which may be available.
One of the largest factors affecting the market and its competitive nature
has been the electric utilities' strategy to postpone adding FGC and other
compliance equipment by blending coals. Electric utilities have mixed high and
low sulfur coal or burned low sulfur coal containing enough sulfur content to
reduce sulfur emissions without impairing the effectiveness of the particulate
control devices.
Wahlco Inc. faces substantial competition with respect to its thermocouple
and electrical heater products and serves a relatively small portion of the
total market. In addition to a few large companies that market such products
nationally, there are also several regional suppliers that compete with
Wahlco. In establishing a market niche, Wahlco targets customers requiring
specially engineered and customized products.
Wahlco Engineered Products, Inc. faces significant competition in the sale
of its dampers, diverters, and expansion joints. Although these products are
differentiated by design, sophistication, reliability, and customer service,
many purchasing decisions are made on the basis of price and delivery.
Wahlco Engineered Products, Ltd. continues to win a significant share of the
international market for gas flow diverters. Pentney Engineering Ltd., Treste
Plant Hire, Ltd. and Teddington Bellows Ltd. compete in the U.K. construction
market. The recent strength of the U.K. pound has adversely affected the U.K.
market. Recent problems in Southeast Asian markets have had a negative effect
on sales of Wahlco's products to that region.
As a group, Wahlco Engineered Products, Inc. and Wahlco Engineered Products,
Ltd. command a significant share of the global market for gas flow diverters
and dampers. Significant competitors in this market include Rappold, Braden,
Effox, and Stober & Morlock. Domestically, Wahlco Engineered Products, Inc.
faces competition in the damper market from Effox, American Warming &
Ventillating, ACDC, DDI, and others. In the expansion joint market, Wahlco
Engineered Products, Inc. competes with Pathways, EJS, Senior Flexonics,
Badger, and others.
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EMPLOYEES
On December 31, 1998, Wahlco employed a total of 354 persons.
THERMATRIX INC. RISK FACTORS
Operating Losses and Accumulated Deficit; Uncertainty of Future
Profitability. The Company had a net loss of approximately $7.9 million in
1998 and an accumulated deficit of approximately $44.6 million at December 31,
1998. Since the Company restructured its operations in 1992, it has financed
its operations primarily through private placements of equity securities
totaling approximately $20.3 million and an initial public offering of its
common stock with net proceeds totaling approximately $22.1 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. See further discussion at Item 7--Management's Discussion
and Analysis of Financial Condition and Results of Operations.
Ability to Compete Against Lower Cost Technologies. To date, FTO systems
have been installed in an increasing 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 1998, three projects for two customers
accounted for 62% of the Company's revenues. In 1997, two projects accounted
for 38% of the Company's revenues and in 1996, three projects accounted for
38% 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 1999 will continue to range from $1 million to $4 million. 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.
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 1998, 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
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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 1998, sales to
international customers in Europe and Asia increased to 60%, up from 35% in
1997. 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 either in United States 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 United States
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 only one of the Company's employees is subject to a term employment
contract with the Company which will expire April 30, 1999. The Company has
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
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its ability to manage 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 unexpected loss of the services
of Mr. Schofield.
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.
The materials used in the production of the Company's product lines are
generally available through a number of sources, and the Company does not
anticipate difficulty in obtaining the materials and components used in its
operations.
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. The Company might then be held
liable for damages resulting from such malfunction or delay beyond its
control. 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 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
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<PAGE>
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 U.S. EPA's 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. The Company
has applied for certification of its FTO technology under the California
Department of Toxic Substances Control. This certification is not available to
incineration-based technologies. The Department's decision will be published
in mid-April 1999.
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 directly at fault. The Company's general liability insurance is subject to
coverage limits and generally excludes coverage for losses or
20
<PAGE>
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.
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 Company's
system has been used in the past, and there can be no assurance that the
Company's 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.
ADDITIONAL RISKS ASSOCIATED WITH THE ACQUISITION OF WAHLCO
Debt. As a result of the acquisition of Wahlco, the Company agreed to become
the co-obligor for the outstanding obligations of Wahlco. This debt is payable
to Wexford Management LLC ("Wexford") and several lenders affiliated with
Wexford. As of March 31, 1999, the debt amounts to slightly more than $5.7
million and bears interest at the rate of 13% per annum, payable monthly. The
debt becomes due August 24, 1999 and can, with the payment of an additional
fee of $100,000, be extended until November 22, 1999. A comprehensive security
interest in all of the Company's existing and future assets (to include the
assets of its significant direct and indirect subsidiaries in the US and UK)
was granted in connection with this Agreement. Failure to repay the debt or to
secure alternative financing would permit Wexford to assert its rights to the
underlying assets. There can be no assurance that the Company will be
successful in generating sufficient resources to repay the debt when it
becomes due, or that it will be successful in finding long-term replacement
financing.
Ability to Integrate the Two Businesses. The Company believes that effective
integration of Wahlco's business with the Company's can yield significant
synergies. Failure to realize the full potential of integration, or an
unanticipated delay in the integration could have a significant adverse impact
on the business, the results of operations and financial condition of the
Company. There can be no guarantee that the potential will be fully or
partially realized or that it will be realized in a timely manner.
Liquidity. As a result of the net losses incurred by the Company, the
acquisition of Wahlco and the significant cash demands required to meet
ongoing operational obligations (including certain restructuring events to be
incurred related to obtaining synergies from the Wahlco acquisition), the
Company continues to experience negative cash flow. The Company anticipates it
will continue to experience negative cashflows from operations and will need
to issue additional equity or debt to provide funds for operations and to
repay debt obligations that will become due and payable in 1999. There can be
no guarantee that sufficient funds will be generated to cover the negative
cash flow position. Failure to correct the situation will directly impact the
ability to secure new orders, the ability to attract and retain quality staff
and the ability to meet all existing obligations, all of which will have
serious negative consequences for the Company's business, results of
operations and financial condition.
Performance Bonds. Wahlco has experienced operating losses for each of the
past six years, and losses have continued in 1998. For 1998, unaudited losses
totaled approximately $6.4 million. In 1996 and 1997, the independent public
accountants of Wahlco qualified their report on the company's financial
statements expressing the substantial doubt as to the company's ability to
continue as a going concern. One result of these continued operating losses
and the going concern opinion is that customers have required letters of
credit or performance bonds prior to placing orders. There can be no guarantee
that the Company will be able to secure such credit instruments sufficient to
meet customer requirements and this can have a serious impact on winning new
orders.
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<PAGE>
Potential Puerto Rican Tax Liability. The Company has determined that there
may be a tax liability associated with Wahlco's past repatriation of capital
from the Commonwealth of Puerto Rico. Wahlco has recorded a reserve of $1.1
million for this potential liability. The Company is attempting to resolve
this potential tax liability and believes it will be able to settle this
matter without additional commitment above what is currently reserved by
Wahlco.
ITEM 2. PROPERTIES
The Company sub-leases approximately 4,464 square feet of office space in
San Jose, California under a 27-month sublease terminating on October 31,
2000, which the Company uses as its registered, and research and development
and Thermatrix Diesel Systems offices. The Company is in the final year of a
lease for approximately 15,000 square feet of office space in Knoxville,
Tennessee, which it primarily uses for corporate management and
administration, design engineering, project management and accounting offices.
The Company is currently investigating a renewal lease or leasing other
premises.
In addition, the Company leases approximately 5,000 square feet of office
space in Hull, England under a six-year lease expiring January 27, 2003,
accommodating all European activities, including sales, operations and
engineering. The Company also leased approximately 1,000 square feet of office
space in London, England under a five-year lease that expired March 24, 1999.
In the United States, Wahlco owns two properties. The first, located in
Lewiston Maine, is a 13.27 acre site with a 50,864 square foot manufacturing
plant and offices. The second, located in Thornton, Illinois is a 32,000
square foot site with a 5,233 square foot office and storage building. The
second site is currently for sale. In addition to the property it owns, Wahlco
leases an approximately 46,000 square foot manufacturing and office facility
in Santa Ana, California under a ten-year lease expiring on July 31, 2001.
In the United Kingdom, Wahlco owns a 4.25 acre facility in Pontardulais,
South Wales with a 79,200 square foot manufacturing plant and office complex.
In addition to the owned property, Wahlco leases two facilities in the
Chesterfield area on 15 year leases that expire in August 2006 but each lease
has a break clause in August 2001. The first facility is on a 1.5 acre site
with 15,174 square feet of warehouse and office space. Approximately 6,294
square feet are subleased to a tenant. The sublease expires November 17, 2001
. The second facility is a 3.5 acre site with 98,826 square feet of
manufacturing and office space.
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.
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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, in U.S. dollars, of the common stock
(as reported by NASDAQ):
<TABLE>
<CAPTION>
Period High Low
- ------ ----- -----
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
<CAPTION>
Period High Low
- ------ ----- -----
<S> <C> <C>
First Quarter 1998.................................................. 3.062 1.000
Second Quarter 1998................................................. 6.000 2.500
Third Quarter 1998.................................................. 5.250 2.313
Fourth Quarter 1998................................................. 4.500 2.375
</TABLE>
As of February 28, 1999, there were over 1,000 holders of record 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 with retained earnings and does not anticipate paying
dividends in the foreseeable future.
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<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, 1998 and with respect to the Company's balance sheets as of
December 31, 1998 and 1997 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, 1995 and 1994
and the balance sheet data as of December 31, 1996, 1995 and 1994 are derived
from audited financial statements not included in this report.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996 1995 1994
------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues........................ $13,614 $ 7,011 $13,605 $ 6,494 $ 3,135
Cost of revenues.............. 13,056 8,351 12,002 6,064 3,099
------- -------- ------- ------- -------
Gross margin.................. 558 (1,340) 1,603 430 36
------- -------- ------- ------- -------
Research and development...... 1,658 1,203 748 1,084 1,326
Selling, general and
administrative............... 7,108 7,705 6,168 4,740 4,503
------- -------- ------- ------- -------
Loss from operations............ $(8,208) $(10,248) $(5,313) $(5,394) $(5,793)
======= ======== ======= ======= =======
Interest income................. 413 697 548 231 44
Interest expense................ (12) (23) (48) -- (72)
======= ======== ======= ======= =======
Net loss........................ $(7,873) $ (9,640) $(4,876) $(5,194) $(5,821)
======= ======== ======= ======= =======
Basic net loss per share(1)..... $ (1.03) $ (1.28) $ (1.22) $(65.75) $(95.43)
======= ======== ======= ======= =======
Basic weighted average common
shares......................... 7,677 7,548 3,994 79 61
======= ======== ======= ======= =======
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and
short-term investments......... $ 3,214 $ 7,577 $16,199 $ 981 $ 6,930
Total assets.................... 10,092 13,987 24,009 4,228 9,223
Redeemable convertible preferred
stock.......................... -- -- -- 11,321 11,321
Stockholders' equity (deficit).. 4,246 11,949 21,398 (9,345) (4,209)
</TABLE>
- --------
(1) See Note 2 of Notes to Consolidated Financial Statements--Summary of
Significant Accounting Policies Basic Net Loss Per Share.
24
<PAGE>
THERMATRIX INC.
SUPPLEMENTARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
----------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net Sales.................................. $ 2,882 $ 2,796 $ 3,964 $ 3,972
Gross Margin............................... 355 176 259 (232)
Net Loss................................... (1,241) (1,537) (1,306) (3,789)
Basic Net Loss Per Share................... $ (0.16) $ (0.20) $ (0.17) $ (0.49)
<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)
</TABLE>
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<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 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 1998, the Company continued to experience 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. As a result of the
collapse of the markets in Asia, the Company's primary focus on overseas
markets was in Europe, primarily the United Kingdom.
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. The
strategic partners generally share some, but not all, of the evaluation costs.
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 1998, expenses
incurred by the Company for these development programs were not significant.
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 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
26
<PAGE>
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, 1998 and 1997
Revenues. Revenues increased 94% to $13.6 million in 1998 from $7.0 million
in 1997. The increase in revenues reflects the Company's successful
transformation to a supplier of turn key systems for VOC control on a
worldwide basis, the receipt of two large orders from a customer in Ireland,
and the decision to focus sales and marketing attention on capital investment
activity in Europe, especially Ireland. In 1998, two customers (Warner Lambert
and Pfizer) accounted for 51% and 11% of revenues, respectively. Sales to
international customers increased to 60% of revenues in 1998, up from 35% in
1997.
Gross Margin. The Company had a gross margin contribution of $558,000 in
1998 versus a gross margin loss of $1.3 million in 1997. The increase in gross
margin was primarily attributable to higher revenues, which were sufficient to
absorb the fixed and semi-fixed costs of engineering and operations in the
U.S. and Europe, and to a lesser extent, reduction in costs from repeat sales
of systems for established applications.
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 become 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
27
<PAGE>
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
1998 and 1997 were $1.7 million and $1.2 million, respectively. The increase
in research and development expenses in 1998 is primarily attributable to
expenditures for the development and testing of a prototype system utilizing
the Company's patented FTO technology for the treatment of diesel engine
emissions from mobile sources, the development of a prototype of a new FTO
configuration, and PADRE(R) product development.
Selling, General and Administrative. Selling, general and administrative
expenses decreased 8% to $7.1 million in 1998 as compared with $7.7 million in
1997. The decrease in 1998 over 1997 is primarily attributable to reduced
staffing and related costs, lower sales commissions and marketing expenses,
and a decrease in travel expenses. The decrease was partially offset, however,
by higher consulting and legal fees.
The total selling, general and administrative expenses also reflect $1.6
million recorded to write off accounts receivable amounts incurred in
connection with certain project change orders and contracts, the majority of
which relate to prior years, that had not been settled as of December 31,
1998, including amounts due from White Horse pursuant to the Exclusive Sales
and Marketing Agreement. The Company is in various stages of negotiations and
litigation with the parties to the respective contracts and will continue to
pursue collection of such balances, including further legal action when
necessary. Historically, the Company has been successful in recovering
substantial portions of the 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 write off the amounts at this time. The
Company also included an amount in the write-off related to a reasonable
estimate of the legal costs to be incurred to collect the amounts in dispute.
Interest Income. Interest income decreased to $413,000 in 1998 from $697,000
in 1997. The decrease primarily resulted from a decrease in the amount
available for investment as investments were liquidated and used throughout
1998 for working capital purposes.
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.
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. In addition, gross margin was also impacted by increased
overhead costs
28
<PAGE>
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.
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(R) 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 24.9% to $7.7 million in 1997 as compared with $6.2 million
in 1996. The increase in 1997 over 1996 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.
29
<PAGE>
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.
LIQUIDITY AND CAPITAL RESOURCES
In February 1996, the Company sold 284,594 shares of its Series D Preferrred
Stock at $7.50 per share to existing investors for net cash of $2.1 million.
In June 1996, the Company completed its initial public offering raising net
proceeds of $22.1 million. In 1998, 1997 and 1996, the Company used the
proceeds of these prior equity issuances to finance its cash used in operating
activities of $4.1 million, $7.7 million and $7.9 million, respectively.
At December 31, 1998, the Company had an accumulated deficit of $44.6
million, cash and short-term investments aggregating $3.2 million, and working
capital of $2.3 million. In addition, the Company incurred a net loss during
1998 of $7.9 million. On January 13, 1999, the Company paid approximately $1.9
million to acquire all of the common shares and warrants of Wahlco. In
addition to the cash payments, the Company agreed at the time to guarantee
certain Wahlco debts owed to, or guaranteed by, Wexford and several lenders
affiliated with Wexford and granted a security interest in all existing and
future assets to Wexford and the lenders. In addition, under certain
conditions, the Company may be required to make an additional payment of up to
$2 million to Wahlco's former shareholders. On an unaudited combined basis,
after this transaction, the Company has cash and cash equivalents of
approximately $1.5 million and current liabilities of approximately $24.0
million, excluding severance and other costs that may be accrued relating to
the transaction.
On February 25, 1999 the Company entered into the Second Amended and
Restated Credit Agreement among Wahlco and the Company, as Borrowers, and
certain Wexford affiliates as Lenders and Wexford as Agent for the Lenders
(the "1999 Credit Agreement"). As of March 31, 1999, the debt amounts to
slightly more than $5.7 million and bears interest at the rate of 13% per
annum, payable monthly in advance. The debt matures on August 24, 1999, and
may, with the payment of an additional fee of $100,000, be extended until
November 22, 1999. As a further condition to the Lenders' execution and
delivery of the 1999 Credit Agreement, the Company agreed to confirm its grant
to the Lenders of a security interest in all existing and future assets and to
cause all its significant subsidiaries to enter into guarantees and grant to
the Lenders additional security interests and mortgages in all existing and
future assets of the Borrowers and significant subsidiaries.
The Company expects to spend approximately $1 million in 1999 to fund
additional research and development activities relating to the treatment of
emissions from diesel engines. However, under the ATP grant award the Company
expects to receive funding to cover a substantial portion of the expense that
will be incurred and its actual research and development expenses could total
less than the $1 million forcasted. For the first year of this grant award,
the Company is obligated to contribute direct costs of approximately $85,000
to this program. The Company is not contractually obligated to provide any
additional fixed level of funding for the diesel program and had no other
capital commitments at December 31, 1998.
In February 1997, the Company entered into an Amended and Restated Loan and
Security Agreement (the "1997 Agreement") which provided for a $4,000,000
accounts receivable line of credit and a $2,500,000 acquisition facility. 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 provided 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.
30
<PAGE>
No cash advances were ever made under either the 1997 Agreement or the 1998
Agreement. The 1998 Agreement was terminated on January 20, 1999 and the
stand-by letter of credit in the amount of $280,000 that had been issued under
the sub-facility was collateralized with cash at that time.
It has always been the Company's intention to obtain additional financing to
carry out the acquisition of Wahlco. The Company intends to finance its
ongoing operations, including the restructuring and integration of Wahlco,
primarily by raising equity and debt in the second quarter of fiscal 1999. The
Company has engaged an investment advisory firm as its exclusive agent to
assist with the structure and placement of a $6 million to $8 million equity
offering and a $10 million to $15 million senior term and revolving credit
facility. In concert with this engagement, the investment advisory firm has
committed to invest a minimum of $2 million in the equity offering contingent
upon appropriate due diligence and legal review. As consideration to the
Company, the investment advisory firm will provide its initial investment in
the form of convertible debt prior to the equity offering in order to
immediately improve the Company's working capital position. If necessary, the
investment advisory firm will also provide and/or arrange additional debt or
mezzanine financing. The Company's financing is dependent upon the ability to
attract additional equity investors and to provide sufficient security for
credit facilities. There can be no assurances as to the timing or ultimate
outcome of this financing.
Management is currently evaluating the Company's alternatives to fund its
fiscal 1999 cash requirements. Such alternatives include, among other things,
consideration of (i) increased revenues and positive gross margins, (ii) the
timely collection of accounts receivable and, (iii) divesting a portion or
portions of the Company's business. These strategies are dependent upon the
Company's ability to meet its forecasts, to develop increased sales and
generate positive gross margins, to achieve the timely collection of amounts
due to the Company and to identify parties willing and able to purchase a
portion or portions of the Company's business. There can be no assurances as
to the timing or ultimate outcome of any of these alternatives.
Year 2000 Compliance
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 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 the overwhelming majority of its
management information systems are, or will be, compliant. Expenditures to
date have not been material and the Company does not anticipate that costs of
remedial actions going forward will be material. To date, no Year 2000
problems have been encountered and no IT projects have been, nor are any
expected to be, deferred.
The Company's program to assess and, where necessary, remediate significant
information systems readiness includes the following phases:
. Phase 1--Identification of significant systems. This phase was completed
on February 1, 1999.
. Phase 2--Assessment of each system's compliance status by contacting
manufacturers via telephone, web pages, or testing, as appropriate. This
phase was completed on March 1, 1999.
. Phase 3--Identification of remedial steps to be taken and associated
worst-case costs in cases of non-compliance. This includes hardware and
software upgrades, patches, or replacement. This phase was completed on
March 30th, 1999.
. Phase 4--Implementation and testing of remedies. The target date for
completion of Phase 4 is October 15, 1999.
31
<PAGE>
. Phase 5 Development of contingency plans. The target completion date for
this phase is October 29, 1999.
Significant information systems include:
. Network systems hardware and operating systems, including file servers,
applications servers, and associated operating system software.
. Applications software accounting/ERP, design, office suite, e-mail
. Communications systems telephone, voice mail, fax
Discussion of compliance status of significant information systems. All
network hardware has been assessed and is believed to be 100% compliant.
Patches available from manufacturers at no cost have been applied to those
operating systems deemed non-compliant. All applications servers are in
compliance; these include accounting and e-mail hardware. Testing has included
setting system dates forward to 12/31/99 and allowing them to roll over to
January 1, 2000 and in certain cases, compliance testing programs available
from manufacturers have been run. In all cases, date testing was successful.
The corporate and Thermatrix Ltd. offices utilize the same accounting
system, and a compliant version has been supplied by the manufacturer as part
of the annual maintenance contract. The update was installed in the corporate
office in June and testing is expected to be complete at that location by July
15th. Installation and testing are expected to be completed in the UK office
by September 15th. To date, accounting systems at Wahlco are 33% compliant.
Two systems are not currently Y2K compliant; the expected completion date for
upgrade installation and testing is October 15th. The design software used at
all divisions company-wide does not perform date calculations; date stamping
of drawings is dependent upon system dates.
Office suite applications at Thermatrix will have no-cost compliant updates
applied and tested by September 15th. E-mail client software is currently 33%
compliant; client computers running non-compliant software are being updated
with no-cost upgrades; the expected completion date is August 15th. E-mail
software for Wahlco is believed to be in compliance at this time; any required
updates have been applied. Office suite software is believed to be compliant
at all Wahlco locations except one; critical need at that facility is
currently being evaluated.
For all divisions, equipment including fax machines and telephone systems
have been tested and found to be compliant, and manufacturers and vendors have
verified that compliance. Voice mail systems for Thermatrix and Wahlco are
each currently 66% compliant; each has one non-compliant system scheduled for
upgrade in September.
Discussion of significant non-information systems. Significant non-
information systems include environmental, power, and alarm systems at Company
physical facilities.
The Company has received assurances from building owners and/or property
management companies that they are working to ensure no disruptions in
facilities systems by contacting equipment and service vendors. These
companies have been included in questionnaire distributions and their progress
toward compliance assessment and testing is being monitored. Electronic alarm
systems and locks procured by the Company (all divisions) are in compliance.
Discussion of third party compliance. The Company's business may be
disrupted in other ways by Year 2000 problems of third parties, which may
affect, for example, the Company's ability to obtain needed materials or
deliver its products. The Company is in the process of determining whether its
domestic and international vendors, equipment manufacturers, customers, and
others with whom it deals are Year 2000 compliant and has requested that such
persons complete and return surveys with respect to their Year 2000 issues.
32
<PAGE>
Surveys requesting the compliance review status of key suppliers and
manufacturers of products, services, internal systems, and status of their key
third party providers have been distributed. Key suppliers are defined as
those companies or individuals whose Y2K non-compliance could have a material
adverse effect on the Company's business. To date, 49% of the surveys have
elicited a response; all have indicated that compliance review and testing
will be completed in time to assure no disruption in service to the Company.
Wahlco has received a 56% response rate to telephone and mail surveys. The
Company's vendor compliance program includes the following tasks: assessing
vendor compliance status, tracking vendor compliance progress, and developing
contingency plans, including identifying alternate suppliers, as needed.
Tracking of vendor compliance will be ongoing. Failure to respond will result
in follow-up contact through further mail or phone correspondence, contingency
plan development or vendor/product replacement.
Contingency plans. Beyond ensuring that its own systems are compliant and
identifying alternative suppliers to avert disruptions, the Company has not
developed contingency plans aimed at ensuring the continuity of critical
business operations before and after December 31, 1999. The target date for
identification of possible problem areas and completion of contingency plans
is October 29th, 1999.
Because of its readiness and its reliance on a broad and diverse network of
suppliers and vendors, the Company does not anticipate that Year 2000 issue
will pose significant operational problems. In any reasonable assessment of
the risk involved, the Company feels that it will be able to work around any
disruptions caused by Year 2000 issues. However, 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market
risks is included in Item 1--Description of Business, Item 7--Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
in Note 2 to the Consolidated Financial Statements.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See pages 44 through 68
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None
33
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
As of December 31, 1998, 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
- ---- --- --------
<S> <C> <C>
John T. Schofield..... 61 Chairman, President and Chief Executive Officer
Daniel S. Tedone...... 50 Executive Vice President and Chief Financial Officer
Edward E. Greene...... 50 Vice President, Administration and Secretary
Richard J. Goodier.... 52 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.
Daniel S. Tedone. Mr. Tedone joined the Company in April 1998 as Executive
Vice President and assumed responsibility for the operation of the Company's
core VOC business. In June 1998 Mr. Tedone assumed the additional
responsibilities of Chief Financial Officer. From 1992, Mr. Tedone was CEO of
Pollution Control Technologies Inc., which was acquired by TRC Companies, Inc.
in 1995 and where he served as President and CEO of TRC Process Engineering,
Inc. from 1995 until joining Thermatrix. Previously, Mr. Tedone served as
President of Vericon Corporation and held positions at Connecticut Resources
Recovery Authority and Hartford National Bank & Trust Company. Mr. Tedone
holds a Bachelor of Arts degree and an M.B.A. in Finance from the University
of Connecticut.
Edward E. Greene. Mr. Greene has been Vice President, Administration of
Thermatrix Inc. since December 1998. He was appointed Secretary of the Company
in July 1998 and has been Director of Administrative Services since June 1996.
Between 1970 and 1996 Mr. Greene was a career Regular Army Officer. Mr. Greene
holds a Bachelor of Science degree in Economics from Gannon College and a
Master of Arts in Economics from the University of Oklahoma.
Richard J. Goodier. Mr. Goodier joined the Company as Director, European
Engineering and Operations, in February 1997 and manages the European
engineering and operations. Prior to joining Thermatrix, he held a variety of
senior management positions in Hickson International PLC, A.H. Marks & Co.
Ltd., AE&CI (South Africa), Amoco Europe and Shell Chemicals. Mr. Goodier
holds a B.Sc. Honours in Mechanical Engineering and is a Chartered Engineer
with the Institution of Mechanical Engineers in London.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely on its review of copies of filings under Section 16(a) of the
Securities Exchange Act of 1934, as amended, received by it, or written
representations from certain reporting persons, the Company believes that
during fiscal 1998, all Section 16 filing requirements were met.
34
<PAGE>
BOARD OF DIRECTORS
The members of the Board of Directors of the Company and their ages as of
June 30, 1999, are as listed below.
<TABLE>
<CAPTION>
NAME OF DIRECTOR AGE PRINCIPAL OCCUPATION
- ---------------- --- --------------------
<S> <C> <C>
John T. Schofield.............. 61 President, CEO and Chairman of the Board
Robi Blumenstein............... 42 Managing Director, CIBC Capital Partners
Charles R. Kokesh.............. 51 Managing General Partner, Technology Funding
Frank R. Pope.................. 49 Managing Director, Verdigris Capital
James M. Strock................ 42 Principal, Stock Enterprises Inc.
Joseph W. Sutton............... 51 President and CEO, Enron International
John M. Toups.................. 73 Retired
</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
B.Sc. Honours in Chemistry from the University of Manchester, England.
Robi Blumenstein. Mr. Blumenstein has been a Director of the Company since
November 1994. Mr. Blumenstein has been with CIBC Capital Partners, the
merchant banking division of the Canadian Imperial Bank of Commerce, since
January 1994, most recently as a Managing Director. Mr. Blumenstein holds a
B.A. and an LL.B. from the University of Toronto and an M.B.A from Harvard
Business School.
Charles R. Kokesh. Mr. Kokesh has been a Director of the Company since March
1998. Mr. Kokesh is the founder and managing general partner of Technology
Funding, a professional venture capital firm headquartered in Silicon Valley.
He has served in this capacity since 1979. Mr. Kokesh also serves on the board
of directors of Adesso Specialty Services Inc. Mr. Kokesh received an A.B.
from Harvard College, an M.B.A. from Harvard Business School, and a J.D. from
Boalt Hall School of Law, University of California at Berkeley.
Frank R. Pope. Mr. Pope has been a Director of the Company since 1994. Mr.
Pope has been the Managing Director of Verdigris Capital, an environmental
investment banking firm since October 1996. From 1981 until October 1996, Mr.
Pope was a general partner of Technology Funding, a professional venture
capital firm. Mr. Pope currently serves on the board of directors of Medstone
International, Inc. and Advanced BioCatalytics Corp. where Mr. Pope also
serves as Vice President, Corporate Development. Mr. Pope holds a B.A. from
Stanford University, an M.B.A. from the University of Santa Clara Graduate
School of Business and a J.D. from the University of Santa Clara School of
Law.
James M. Strock. Mr. Strock has been a Director of the Company since October
1997. Since June 1997, Mr. Strock has been the Principal of Strock Enterprises
Inc., a management and public affairs consultancy based in San Francisco. Mr.
Strock served as California's first Secretary for Environmental Protection
from 1991-1997. He was chief law enforcement officer of the U.S. Environmental
Protection Agency from 1989 to 1991. Mr. Strock is a member of the Council on
Foreign Relations. He holds an A.B. and J.D. from Harvard University.
Joseph W. Sutton. Mr. Sutton has been a Director of the Company since
September 1998. Since 1992, Mr. Sutton has been with Enron International, the
international developing markets arm of Enron Corp., most recently as
President and Chief Executive Officer. Mr. Sutton serves on the board of
directors of National Bureau of Research and the US-India Business Council,
among several others. Mr. Sutton also
35
<PAGE>
serves on several Enron affiliate boards of directors throughout the world and
is a member of the Management Committee of Entrol Corp. Prior to joining
Enron, Mr. Sutton was a Career Army officer. Mr. Sutton obtained a B.B.A. from
Ohio University and holds an M.S. and M.B.A. from Indiana and Long Island
Universities.
John M. Toups. Mr. Toups has been a Director of the Company since November
1994. From January 1978 until his retirement in February 1987, Mr. Toups was
the Chief Executive Officer of Planning Research Corporation (PRC), an
information technology services company. Mr. Toups currently serves on the
board of directors of CACI International Inc., NVR, Inc., Halifax Corporation,
Government Technology Services, Inc., and Telepad Corporation. Mr. Toups holds
a B.S. in Civil Engineering from the University of California at Berkeley.
36
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION
The following table shows, as to the Chief Executive Officer and each of the
other five most highly compensated executive officers, information concerning
compensation awarded to, earned by or paid for services to the Company in all
capacities during the three years ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------------- SECURITIES
ALL OTHER UNDERLYING
NAME AND PRINCIPAL POSITION YEAR COMPENSATION(2) OPTIONS(#)(3) SALARY BONUS(1)
- --------------------------- ---- --------------- ------------- --------- ------------
<S> <C> <C> <C> <C> <C>
John T. Schofield........ 1998 $220,000 $-- $5,280 150,000
Chairman, President and 1997 220,000 -- 1,636 --
Chief Executive Officer 1996 215,625 -- 3,235 33,334
Daniel S. Tedone(4)...... 1998 137,890 -- 24,909 50,000
Executive Vice
President, 1997 -- -- -- --
Chief Financial Officer 1996 -- -- -- --
Alexander G. Baldwin(5).. 1998 121,250 -- 2,910 2,500
Director, Engineering 1997 125,000 -- 952 --
and
Operations, US and Asia 1996 123,542 -- 900 10,000
Richard J. Goodier(6).... 1998 138,050 -- 3,313 5,000
Director, Engineering & 1997 120,546 -- 768 5,000
Operations, Europe 1996 -- -- -- --
Edward E. Greene(7)...... 1998 95,000 -- 2,280 10,000
Vice President,
Administration 1997 -- -- -- --
and Secretary 1996 -- -- -- 7,000
Barbara E. Krimsky(8).... 1998 125,000 -- 28,500 10,000
Vice President,
Administration 1997 120,000 -- 916 --
1996 115,625 -- 833 11,667
</TABLE>
- --------
(1) No Bonuses were granted.
(2) "All Other Compensation" includes premiums for life insurance policies, a
non-qualified relocation payment to Mr. Tedone, and a severance payment
to Ms. Krimsky in the amount of $25,000 related to the termination of her
employment.
(3) These shares are subject to exercise under stock options granted under
the Company's stock option plans.
(4) Mr. Tedone joined the Company April 13, 1998 and, therefore, his salary
from April 13, 1998 to December 31, 1998 reflects less than a full year.
(5) Mr. Baldwin ceased being an executive officer of the Company as of August
31, 1997 although he is still an employee of the Company.
(6) Mr. Goodier is paid in pounds sterling which have been converted into
U.S. dollars at the exchange rate for the applicable fiscal year of
$1.65.
(7) Mr. Greene was appointed Secretary of the Corporation on September 15,
1998 and became Vice President, Administration on December 1, 1998.
(8) Ms. Krimsky ceased being an executive officer of the Company as of
October 31, 1998 and left the Company as of April 30, 1999.
37
<PAGE>
STOCK OPTION GRANTS AND EXERCISES
The following table shows, as to the Named Executive Officers, information
concerning stock options granted during the fiscal year ended December 31,
1998.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM($)(1)
OPTIONS EMPLOYEES PRICE PER EXPIRATION ----------------------
NAME GRANTED(#)(2) IN FISCAL YEAR SHARE($) DATE(3) 5% 10%
- ---- ------------- -------------- --------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
John T. Schofield....... 37,500 12.36% $4.50 06/12/2008 $ 106,126 $ 268,944
37,500 12.36% 5.00 06/12/2008 87,376 250,194
37,500 12.36% 5.50 06/12/2008 68,626 231,444
37,500 12.36% 6.00 06/12/2008 49,876 212,694
Daniel S. Tedone........ 50,000 16.48% 2.63 04/14/2008 92,723 225,390
Alexander G. Baldwin.... 2,500 0.82% 4.50 06/12/2008 7,075 17,930
Richard J. Goodier...... 5,000 1.65% 1.50 01/30/2008 4,717 11,953
Edward E. Greene........ 3,000 1.00% 1.50 01/30/2008 2,830 7,172
7,000 2.31% 2.50 03/17/2008 11,006 27,890
Barbara E. Krimsky...... 10,000 3.30% 1.50 01/30/2008 9,433 23,906
</TABLE>
- --------
(1) Potential realizable value is based on the assumption that the Common
Stock of the Company appreciates at the annual rate shown (compounded
annually) from the date of grant until the expiration of the ten-year
option term. These numbers are calculated based on the requirements
promulgated by the Securities and Exchange Commission. Actual gains, if
any, on option exercises are dependent on the future performance of the
Company's Common Stock and overall market conditions.
(2) Option grants generally vest over a 48-month period. Initial grants vest
and become exercisable as to 1/48th of the shares subject to the grant
twelve months after the vesting commencement date and as to an additional
1/48th of the shares at the end of each month thereafter provided the
optionee continues to serve as an employee on such date. Subsequent
grants vest and become exercisable as to 1/48th of the shares subject to
the subsequent grant one month after the vesting commencement date and as
to an additional 1/48th of the shares at the end of each month
thereafter, provided the optionee continues to serve as an employee on
such date.
(3) Options may terminate before their expiration date if the optionee's
status as an employee is terminated.
38
<PAGE>
The following table shows, as to the Named Executive Officers, information
concerning stock options exercised during the fiscal year ended December 31,
1998 and the value of unexercised options at such date.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARS AT IN-THE-MONEY OPTIONS
DECEMBER 31, 1998(#) DECEMBER 31, 1998($)(1)
---------------------- -----------------------
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
- ---- --------------- ----------- ---------------------- -----------------------
<S> <C> <C> <C> <C>
John T. Schofield....... -- -- 278,005/164,584 $647,022/20,834
Daniel S. Tedone........ -- -- 0/50,000 0/49,750
Alexander G. Baldwin.... 5,833 $15,276 8,855/5,728 7,318/3,463
Richard J. Goodier...... -- -- 3,438/6,562 2,435/8,190
Edward E. Greene........ -- -- 2,001/7,999 2,939/11,311
Barbara E. Krimsky...... -- -- 36,668/0 70,420/0
</TABLE>
- --------
(1) Based on the fair market value of the Company's Common Stock at December
31, 1998 of $3.625 per share, less the exercise price to be paid for such
shares.
EMPLOYMENT AGREEMENTS
The Company has no employment contracts with any of its officers and has no
compensatory plan or arrangement which is activated upon resignation,
termination or retirement of any such officer upon a change in control of the
Company other than required by law. Under certain circumstances both the 1996
Stock Plan and the Director Plan provide for the accelerated vesting of all
outstanding options upon a change in control.
OTHER EMPLOYEE BENEFIT PLANS
1987 Incentive Stock Plan
The Company's 1987 Incentive Stock Plan, as amended (the "1987 Stock Plan")
was adopted by the Board of Directors in August 1987 and approved by the
stockholders in February 1988. The 1987 Stock Plan provided for grants of
incentive stock options to employees (including officers and employee
directors) and non-statutory stock options to non-employees (including non-
employee directors) and consultants of the Company. A total of 907,651 shares
of Common Stock was reserved for issuance under the 1987 Stock Plan. As of
August 13, 1999, 374,556, shares of Common Stock had been issued upon the
exercise of options granted under the 1987 Stock Plan and options to purchase
372,935 shares of Common Stock at a weighted average exercise price of $1.47
per share were outstanding. The Plan terminated in 1997 and no further options
will be granted under the 1987 Stock Plan. Options under the 1987 Stock Plan
become exercisable at varying rates over vesting periods determined by the
Board of Directors (generally one to ten years), and as of August 13, 1999,
339,380 options were exercisable.
1996 Stock Plan
The Company's 1996 Stock Plan (the "1996 Plan") was adopted by the Board of
Directors in March 1996 and approved by the stockholders in April 1996. 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. A total of 333,334
shares of Common Stock has been reserved for issuance under the 1996 Plan. As
of August 13, 1999, 13,542 shares of Common Stock had been issued upon the
exercise of options granted under the 1996 Plan, options to purchase 290,235
shares of Common Stock at a weighted average exercise price of $4.21 per share
were outstanding, 96,149 options were exercisable and 29,557 shares were
available for issuance.
39
<PAGE>
401(k) Savings Plan
The Company maintains the Thermatrix Inc. 401(k) Plan, a defined
contribution retirement plan with a cash or deferred arrangement as described
in Section 401(k) of the Internal Revenue Code (the "401(k) Plan"). The 401(k)
Plan is intended to be qualified under Section 401(a) of the Code. All
employees of the Company are eligible to participate in the 401(k) Plan. The
401(k) Plan provides that each participant make elective contributions of a
percentage of his or her compensation, subject to statutory limits.
REPORT OF THE COMPENSATION COMMITTEE
OF THE BOARD OF DIRECTORS
Notwithstanding anything to the contrary set forth in any of the Company's
previous filings under the Securities Exchange Act of 1933, as amended, or the
Securities Act of 1934, as amended, that might incorporate future filings,
including this Proxy Statement, in whole or in part, the following report and
the Performance Graph on page 26 shall not be incorporated by reference into
any such filings.
GENERAL
The Compensation Committee (the "Committee") of the Board of Directors
establishes the overall executive compensation strategies of the Company and
approves compensation elements for the chief executive officer, other
executive officers, and employees earning in excess of $100,000 per year. The
Committee also recommends stock option awards for employees to the Board. The
Committee is comprised of three of the independent, non-employee members of
the Board of Directors, none of whom have interlocking relationships as
defined by the Securities and Exchange Commission. The Committee has available
to it such external compensation advice and data as the Committee deems
appropriate to obtain.
The compensation philosophy of the Committee is to provide a comprehensive
compensation package for each executive officer that is tailored to the
Company's accomplishment of business strategies, objectives and initiatives.
Accordingly, the Committee follows a compensation strategy which utilizes
vesting terms to incentivize and reward executives as the Company addresses
the challenges associated with growth. As the Committee applies this
compensation philosophy in determining appropriate executive compensation
levels and other compensation factors, the Committee reaches its decisions
with a view towards the Company's overall financial performance. The Committee
strives to structure each officer's overall compensation package to enable the
Company to attract, retain and reward personnel who contribute to the success
of the Company.
EXECUTIVE OFFICER COMPENSATION
The Committee's executive compensation policies are designed to enhance the
financial performance of the Company and thus stockholder value, by aligning
the financial interests of the key executives with those of the stockholders.
The executive compensation program is viewed in total considering all of its
component parts: an annual compensation component, which consists of base
salaries that are generally competitive with those offered by other companies
in the industry at similar phases of growth, and a long-term incentive
component, which consists of stock options and stock ownership. In determining
individual salaries, the Committee considers the individual experience,
performance and breadth of responsibilities of each executive officer within
the Company in light of the accomplishment of business strategies, objectives
and initiatives set forth by the Board periodically. These factors are
reviewed for each executive officer annually.
The Company's 1996 Stock Plan and the ESPP are long-term incentive plans for
all employees. These plans are intended to align stockholder and employee
interest by creating a direct link between long-term rewards and the value of
the Company's shares. The Committee believes that long-term stock ownership
40
<PAGE>
by executive officers and all employees is an important factor in achieving
both above average growth in share value and retaining valued employees. Since
the value of an option bears a direct relationship to the Company's stock
price, the Committee believes that options motivate executive officers to
manage the Company in a manner which will benefit all stockholders.
The Option Plans authorize the Committee to award available stock options to
employees at any time. Options for executive officers are generally granted at
the time of initial employment with the Company, and at later dates at the
discretion of the Committee. The size of the initial and later grants are
determined by a number of factors including comparable grants to executive
officers and employees by other companies which compete in the Company's
industry. The exercise price per share of the stock options is normally equal
to the prevailing market value of a share of the Company's Common Stock on the
date the options are granted.
The Company has adopted certain broad-based employee benefit plans in which
all employees, including the executive officers, are permitted to participate
on the same terms and conditions relating to eligibility and generally subject
to the same limitations on the amounts that may be contributed or the benefits
payable under those plans. See "Other Employee Benefit Plans--401(k) Savings
Plan."
CEO COMPENSATION
Compensation for the Chief Executive Officer aligns with the philosophies
and practices described above for executive officers in general. Mr.
Schofield's base salary was increased to $220,000 from $205,000 in April 1996.
Mr. Schofield received no salary increase in 1998. Mr. Schofield received
option grants totaling 150,000 shares on June 12, 1998. This was the first
grant of options to Mr. Schofield since January 1996. The Company currently
does not have a bonus plan for its Chief Executive Officer or any of its other
executive officers.
COMPENSATION COMMITTEE
Robi Blumenstein
Frank R. Pope
James M. Strock
41
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of the Record Date by (i) each of
the Company's executive officers named in the Summary Compensation Table
appearing herein (the "Named Executive Officers"), (ii) each director, (iii)
all of the Company's executive officers and directors as a group, and (iv)
each person (or group of affiliated persons) known to the Company to be the
beneficial owner of more than 5% of the Company's Common Stock. The Company
knows of no agreements among its stockholders that relate to voting or
investment power of its shares of Common Stock.
Named Executive Officers, Directors, and All Directors and Named Executive
Officers as a Group
<TABLE>
<CAPTION>
Beneficial Ownership(1)
------------------------
Number of Percent of
Shares Total
------------- ----------
<S> <C> <C>
John T. Schofield(2)........................................ 453,614 5.58
Daniel S. Tedone(3)......................................... 19,708 *
Alexander G. Baldwin(4)..................................... 10,347 *
Richard J. Goodier(5)....................................... 5,312 *
Edward E. Greene(6)......................................... 8,200 *
Barbara E. Krimsky(7)....................................... 15,444 *
Robi Blumenstein(8)(9)...................................... 841,074 10.68
Charles R. Kokesh(10)(11)................................... 1,210,152 15.44
Frank R. Pope(12)........................................... 96,354 1.23
James M. Strock(13)......................................... 3,335 *
Joseph W. Sutton(14)........................................ 2,501 *
John M. Toups(15)........................................... 49,969 *
All named executive officers and directors as a
group (12 persons)(16)..................................... 2,716,010 32.64
5% Stockholders:
Charles River Partnerships VI, L.P. and Charles River
Partnership VI-A, L.P. .................................... 417,939 5.36
10 Post Office Square, Suite 1330, Boston, MA 02109
CIBC WMV Inc.(8)............................................ 831,906 10.57
425 Lexington Ave., 2nd Floor, New York, NY 10017-3903
Denise Hale, George T. Cronin and Thomas M. Peterson as
Successor Co-trustees of the Prentis Cobb Hale Trust U/A
dated 7/13/93, as amended.................................. 420,863 5.40
Brobeck Phelger & Harrison L.L.P., Attn: Thomas M.
Peterson
One Market Plaza, Spear Street Tower, San Francisco, CA
94105
Technology Funding Partners III, L.P. and Technology Funding
Venture Partners IV, an Aggressive Growth Fund, L.P.(10)... 1,206,817 15.41
2000 Alamada de las Pulgas, Suite 250, San Mateo, CA 94403
Newco, Vencap, Inc., and Onex Corporation(17)
240-222 Baseline Road, Suite 9B........................... 394,329 5.06
Sherwood Park, Alberta T8H 1S8, CANADA
The Venture Capital Fund of New England II, L.P. and
The Venture Capital Fund of New England III, L.P.(18)..... 639,304 8.20
160 Federal Street, 23rd Floor, Boston, MA 02110
Ventana Environmental Partnership L.P.
18881 Van Karman Ave. Tower 17, Suite 350................. 533,429 6.84
Irvine, CA 92715
Wexford Management LLC,
411 W. Putnam Ave., Greenwich, CT 06830(19)............... 450,000 5.46
</TABLE>
- --------
*Less than 1%
42
<PAGE>
(1) Beneficial ownership is determined in accordance with the rules and
regulations of the Securities and Exchange Commission and generally
includes voting or investment power with respect to securities. Options
to purchase shares of Common Stock which are currently exercisable or
will become exercisable within 60 days of the Record Date, are deemed to
be outstanding for purposes of computing the percentage of the shares
held by an individual but are not outstanding for purposes of computing
the percentage of any other person. Except as indicated otherwise in the
footnotes below, and subject to community property laws where applicable,
the persons named in the table above have sole voting and investment
power with respect to all shares of Common Stock shown as beneficially
owned by them.
(2) Includes 344,256 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(3) Includes 17,708 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(4) Includes 10,347 shares subject to stock options that are exercisable
within 60 days of August 13, 1999. Mr. Baldwin ceased being an executive
officer of the Company as of August 31, 1997 although he is still an
employee of the Company.
(5) Includes 5,312 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(6) Includes 3,875 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(7) Ms. Krimsky ceased being an executive officer of the Company as of
October 31, 1998, and left the Company effective April 30, 1999.
(8) Mr. Blumenstein is a director and officer of CIBC WMV Inc. and,
therefore, may be deemed to beneficially own the shares held by CIBC WMV
Inc. (831,906). Mr. Blumenstein disclaims beneficial ownership of the
761,906 shares. This total includes 70,000 warrants but does not include
2000 shares of Series E Preferred Stock.
(9) Includes 9,168 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(10) Mr. Kokesh is a managing general partner of Technology Funding and,
therefore, may be deemed to beneficially own the shares held by
Technology Funding Partners. Includes 62,772 shares held by Technology
Funding Partners, which pursuant to an agreement between Mr. Pope and
Technology Funding Partners, Mr. Pope is entitled to receive at such time
as Technology Funding Partners distributes the assets of the partnership
to its limited partners. See footnote (12). This total (1,206,817)
includes 35,000 warrants but does not include 1000 shares of Series E
Preferred Stock.
(11) Includes 3,335 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(12) Includes 9,168 shares subject to stock options that are exercisable
within 60 days of August 13, 1999 but does not include 62,772 shares held
by Technology Funding Partners and which Mr. Pope is entitled to receive
upon distribution. See footnote (10).
(13) All 3,885 shares are subject to stock options that are exercisable within
60 days of August 13, 1999.
(14) All 2,501 shares are subject to stock options that are exercisable within
60 days of August 13, 1999.
(15) Includes 19,169 shares subject to stock options that are exercisable
within 60 days of August 13, 1999.
(16) Includes 418,174 shares subject to stock options and warrants that are
exercisable within 60 days of August 13, 1999.
(17) Based on information provided pursuant to Schedule 13G filed with the
Securities and Exchange Commission on February 12, 1999. The Company has
become aware of the fact that all 394,329 shares have been purchased by
Landmark Secondary Partners L.P. of Simsbury, CT. Effective July 22,
1999.
(18) Includes 4,000 shares of common stock and 9,168 shares of common stock
subject to options that are exercisable within 60 days of August 13, 1999
belonging to Mr. Harry J. Healer, Jr., a former Director of the Company
and a general partner of the Venture Capital Fund of New England. Also
includes warrants to purchase 2,726 common shares.
(19) Includes 450,000 warrants exercisable for 450,000 shares of the Company's
common stock at any time prior to 5:00 p.m (EST) February 25, 2004.
43
<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, 1998, and
1997, 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, 1998. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred significant operating losses
and has negative working capital as a result of the acquisition of Wahlco
Environmental Systems, Inc. ("Wahlco") in January 1999. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
As discussed in Note 1, as part of its plan for financing the Wahlco
acquisition, the Company has engaged an investment advisory firm to raise
equity and debt financing during the second quarter of fiscal 1999. There can
be no assurances as to the timing or ultimate outcome of this financing. Refer
to Note 1 for further discussion of the Company's 1999 financing plan. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
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.
ARTHUR ANDERSEN LLP
San Jose, California
March 30, 1999
44
<PAGE>
THERMATRIX INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................ $ 1,544 $ 3,990
Short-term investments................................... 1,670 3,587
Accounts receivable, net................................. 4,668 3,520
Costs of uncompleted contracts in excess of billings,
net..................................................... -- 547
Prepaid expenses and other current assets................ 232 250
-------- --------
Total current assets................................... 8,114 11,894
-------- --------
PROPERTY AND EQUIPMENT:
Machinery and equipment.................................. 814 857
Furniture and fixtures................................... 439 322
Demonstration equipment.................................. 496 506
-------- --------
1,749 1,685
Less--Accumulated depreciation........................... (1,177) (749)
-------- --------
Net property and equipment............................. 572 936
======== ========
PATENTS AND OTHER ASSETS, net.............................. 1,406 1,157
-------- --------
$ 10,092 $ 13,987
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable......................................... $ 4,881 $ 1,055
Billings on uncompleted contracts in excess of costs and
revenue recognized...................................... 409 181
Accrued liabilities...................................... 556 802
-------- --------
Total current liabilities.............................. 5,846 2,038
======== ========
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--7,711,401 and 7,627,674 shares,
respectively............................................ 8 8
Additional paid-in capital............................... 48,795 48,644
Accumulated other comprehensive income................... 19 --
Accumulated deficit...................................... (44,576) (36,703)
-------- --------
Total stockholders' equity............................. 4,246 11,949
-------- --------
$ 10,092 $ 13,987
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
45
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
REVENUES............................................ $13,614 $ 7,011 $13,605
COST OF REVENUES.................................... 13,056 8,351 12,002
------- ------- -------
Gross margin...................................... 558 (1,340) 1,603
------- ------- -------
OPERATING EXPENSES:
Research and development.......................... 1,658 1,203 748
Selling, general and administrative............... 7,108 7,705 6,168
------- ------- -------
Total operating expenses........................ 8,766 8,908 6,916
------- ------- -------
Loss from operations.............................. (8,208) (10,248) (5,313)
INTEREST INCOME (EXPENSE):
Interest income................................... 413 697 548
Interest expense.................................. (12) (23) (48)
------- ------- -------
Total interest income (expense)................. 401 674 500
------- ------- -------
Net loss before provision for income taxes........ (7,807) (9,574) (4,813)
PROVISION FOR INCOME TAXES.......................... 66 66 63
------- ------- -------
Net loss.......................................... $(7,873) $(9,640) $(4,876)
BASIC NET LOSS PER SHARE............................ $ (1.03) $ (1.28) $ (1.22)
======= ======= =======
BASIC WEIGHTED AVERAGE COMMON SHARES................ 7,677 7,548 3,994
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
46
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE FOREIGN TOTAL COMPRE-
PREFERRED STOCK COMMON STOCK ADDITIONAL CURRENCY STOCKHOLDERS' HENSIVE
------------------ ----------------- PAID-IN ACCUMULATED TRANSLATION EQUITY INCOME
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT AGREEMENT (DEFICIT) (LOSS)
---------- ------ ---------- ------ ---------- ----------- ----------- ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1995................. 2,554,631 $9,304 129,358 $-- $ 3,538 $(22,187) $ -- $(9,345) $(22,187)
Common stock issued in
initial public
offering at $12.50
per share, net of
issuance costs of
$2,940............... -- -- 2,000,000 2 22,058 -- -- 22,060 --
Exercise of stock
options 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
redeemable
convertible preferred
stock................ -- -- 2,712,682 3 13,401 -- -- 13,404 --
Conversion of
convertible preferred
stock................ (2,554,631) (9,304) 2,554,631 2 9,302 -- -- -- --
Net loss.............. -- -- -- -- -- (4,876) (4,876) (4,876) (4,876)
---------- ------ ---------- ---- ------- -------- ------ ------- --------
BALANCE, DECEMBER 31,
1996................. -- -- 7,466,683 7 48,454 (27,063) -- 21,398 (27,063)
Exercise of stock
options 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) (9,640)
---------- ------ ---------- ---- ------- -------- ------ ------- --------
BALANCE, DECEMBER 31,
1997................. -- -- 7,627,674 $ 8 $48,644 $(36,703) -- $11,949 $(36,703)
Exercise of stock
options at $0.75 to
$4.125 per share..... -- -- 35,995 -- 41 -- -- 41 --
Common stock issued
for cash at $2.18 per
share................ -- -- 32,203 -- 70 -- -- 70 --
Common stock issued
for cash at $2.55 per
share................ -- -- 15,529 -- 40 -- -- 40 --
Equity adjustment from
foreign currency
translation.......... -- -- -- -- -- -- 19 -- 19
Net loss.............. -- -- -- -- -- (7,873) -- (7,873) (7,873)
---------- ------ ---------- ---- ------- -------- ------ ------- --------
BALANCE, DECEMBER 31,
1998................. -- -- $7,711,401 $ 8 $48,795 $(44,576) $ 19 $ 4,246 $(44,557)
========== ====== ========== ==== ======= ======== ====== ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
47
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................... $(7,873) $(9,640) $(4,876)
Adjustments to reconcile net loss to net cash used
in operating activities--
Depreciation and amortization................... 505 453 281
Provision for doubtful accounts................. 1,813 220 190
Provision for uncollectible costs of uncompleted
contracts in excess of billings................ -- 500 --
Write-off of investment in joint venture........ -- 390 --
Changes in assets and liabilities--
(Increase) decrease in accounts receivable...... (2,961) 1,160 (2,949)
(Increase) decrease in costs of uncompleted
contracts in excess of billings................ 547 (238) (724)
(Increase) decrease in prepaid expenses and
other current assets........................... 18 84 (153)
Increase (decrease) in accounts payable......... 3,826 (724) 292
Increase (decrease) in billings on uncompleted
contracts in excess of costs and revenue
recognized..................................... 228 173 (332)
Increase (decrease) in accrued liabilities...... (246) (90) 399
------- ------- -------
Net cash used in operating activities......... (4,143) (7,712) (7,872)
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............... (64) (465) (408)
Purchase of short-term investments................ (2,702) (27,887) (11,844)
Proceeds from sale of short-term investments...... 4,619 35,718 426
Increase in patents and other assets.............. (326) (636) (800)
------- ------- -------
Net cash (used in) provided by investing
activities................................... 1,527 6,730 (12,626)
------- ------- -------
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... 151 191 22,215
------- ------- -------
Net cash provided by financing activities..... 151 191 24,298
------- ------- -------
CUMULATIVE EFFECT OF FOREIGN EXCHANGE RATES ON
CASH............................................... 19 -- --
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.... (2,446) (791) 3,800
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.... 3,990 4,781 981
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.......... $ 1,544 $ 3,990 $ 4,781
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest............................ $ 10 $ 23 $ 48
======= ======= =======
Cash paid for income taxes........................ $ 51 $ 104 $ 13
======= ======= =======
Conversion of redeemable preferred stock.......... $ -- $ -- $13,404
======= ======= =======
Conversion of convertible preferred stock......... $ -- $ -- $ 9,304
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
48
<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.
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, 1998, the Company
had an accumulated deficit of approximately $44.6 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. 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.
At December 31, 1998, the Company had an accumulated deficit of $44.6
million, cash and short-term investments aggregating $3.2 million, and working
capital of $2.3 million. In addition, the Company incurred a net loss during
1998 of $7.9 million. As discussed in Note 10, on January 13, 1999, the
Company paid approximately $1.9 million to acquire all of the outstanding
common shares of Wahlco Environmental Systems, Inc ("Wahlco"). In addition to
the cash payments, the Company agreed at the time to guarantee certain Wahlco
debts owed to, or guaranteed by, Wexford management LLC ("Wexford") and
several lenders affiliated with Wexford and granted a security interest in all
existing and future assets to Wexford and the lenders. On an unaudited
combined basis, after this transaction, the Company has cash and cash
equivalents of approximately $1.5 million and current liabilities of
approximately $24.0 million, excluding severance and other costs that may be
accrued relating to the transaction.
It has always been the Company's intention to obtain additional financing to
carry out the acquisition of Wahlco. The Company intends to finance its
ongoing operations, including the restructuring and integration of Wahlco,
primarily by raising equity and debt in the second quarter of fiscal 1999. The
Company has engaged an investment advisory firm as its exclusive agent to
assist with the structure and placement of a $6 million to $8 million equity
offering and a $10 million to $15 million senior term and revolving credit
facility. In concert with this engagement, the investment advisory firm has
committed to invest a minimum of $2 million in the equity offering, contingent
upon appropriate due diligence and legal review. As consideration to the
Company, the investment advisory firm will provide its initial investment in
the form of convertible debt prior to the equity offering in order to
immediately improve the Company's working capital position. If necessary, the
investment advisory firm will also provide and/or arrange additional debt or
mezzanine financing. The Company's financing is dependent upon the ability to
attract additional equity investors and to provide sufficient security for
credit facilities. There can be no assurances as to the timing or ultimate
outcome of this financing.
Management is also currently evaluating other Company alternatives to fund
its fiscal 1999 cash requirements. Such alternatives include, among other
things, (i) increased revenues and improved gross margins, (ii) the timely
collection of accounts receivable and, (iii) divesting a portion or portions
of the Company's business. These strategies are dependent upon the Company's
ability, to meet its forecasts, to
49
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
develop increased sales and generate positive gross margins, to achieve the
timely collection of amounts due to the Company and to identify parties
willing and able to purchase a portion or portions of the Company's business.
There can be no assurances as to the timing or ultimate outcome of any of
these alternatives.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company's
ability to continue as a going concern is dependent upon completing the
contemplated equity and debt transactions in the second quarter of 1999. The
accompanying financial statements do not include any adjustments that might
result from the outcome of these uncertainties.
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 British Pound Sterling. Accordingly, all translation gains and losses
resulting from transactions denominated in currencies other than the U.S.
dollar are included in shareholders' equity. To date, the translation gains
and losses have not been material. All intercompany accounts and transactions
have been eliminated.
Cash and Cash Equivalents and Short-term Investments
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.
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. Unrealized holding gains or
losses as of December 31, 1998 and December 31, 1997 were not material. As of
December 31, 1998, short-term investments mature at various dates through
April 1999.
50
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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>
AGGREGATE UNREALIZED
AMORTIZED COST FAIR VALUE GAINS (LOSSES)
-------------- ---------- ---------- -------
<S> <C> <C> <C>
1998
Certificates of deposit.................... $1,670 $1,670 $--
Money market instruments................... 58 58 --
------ ------ ----
$1,728 $1,728 $--
====== ====== ====
1997
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>
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. Estimated losses on
contracts are charged in full 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 work in progress inventory 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.
Warranty costs of approximately $324,000 were charged to cost of revenues
for the year ended December 31, 1998. The Company charged $212,000 against the
reserve for warranty costs and $6,000 directly to warranty costs during fiscal
1998. Accrued warranty obligation amounted to $171,000 and $65,000 as of
December 31, 1998 and 1997, respectively, and are included in other accrued
liabilities in the accompanying balance sheets.
Accounts Receivable
Accounts receivable consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1998 1997
------ ------
<S> <C> <C>
Billed....................................................... $3,274 $3,003
Unbilled, including unpriced change orders................... 1,494 860
------ ------
Total receivables............................................ 4,768 3,863
Less: Allowance for doubtful accounts........................ (100) (343)
------ ------
$4,668 $3,520
====== ======
</TABLE>
51
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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, 1998, accounts
receivable did not include any unpriced change orders. As of December 31,
1997, accounts receivable included approximately $793,000 of unpriced change
orders.
As of December 31, 1998, 61% of accounts receivable was concentrated with
three customers. As of December 31, 1997, approximately 59% of accounts
receivable was concentrated with eight 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.
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, 1998 and 1997 was approximately
$214,000 and $137,000, respectively.
Significant Customers
Sales to significant customers as a percentage of total revenues for the
years ended December 31, 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
FOR THE
YEARS ENDED
DECEMBER 31,
----------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Customer A................................................... -- -- 5%
Customer B................................................... -- 3% 13%
Customer C................................................... -- -- 13%
Customer D................................................... 5% 2% 12%
Customer E................................................... 2% 28% --
Customer F................................................... 1% 10% --
Customer G................................................... 11% -- --
Customer H................................................... 51% -- --
</TABLE>
52
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Revenues from government contracts as a percentage of total revenues was 6%,
10%, and 15% for the years ended December 31, 1998, 1997, and 1996,
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 60% for the
year ended December 31, 1998, 35% for the year ended December 31, 1997 and 14%
for the year ended December 31, 1996.
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.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130
(SFAS 130), Reporting Comprehensive Income, which establishes standards for
reporting and display of comprehensive income and its components (revenue,
expenses, gains and losses) in a full set of general-purpose financial
statements. The Company has integrated the presentation of comprehensive
income (loss) with the Consolidated Statement of Stockholders' Equity
(deficit).
Effect of Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. The Statement
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheets as either an asset or liability
measured at its fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Statement 133 is effective for fiscal years
beginning after June 15, 1999. The Company does not expect the adoption of
Statement 133 to have a material effect on the financial statements.
3. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER
31,
---------
1998 1997
---- ----
<S> <C> <C>
Commissions payable............................................... $ 45 $139
Accrued employee compensation cost................................ 120 167
Other............................................................. 391 496
---- ----
$556 $802
==== ====
</TABLE>
53
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain equipment under operating
leases that expire through January 2003. Rent expense was approximately
$428,000, $492,000 and $338,000 for the years ended December 31, 1998, 1997
and 1996, respectively. As of December 31, 1998, future minimum payments are
as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1999............................................................... 446
2000............................................................... 209
2001............................................................... 85
2002............................................................... 9
2003 and thereafter................................................ 0
----
$749
====
</TABLE>
In April 1996, the Company purchased all of the respective assets, rights
and properties of Purus Inc.'s VOC adsorption technology ("PADRE(R)").
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(R) technology. Under this License the Company is
required to make quarterly royalty payments of 7% on the aggregate net invoice
value of all PADRE(R) 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 $34,000
and $80,000 for the years ended December 31, 1998 and 1997, 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.
54
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
6. COMMON STOCK
As of December 31, 1998, the Company had remaining for issuance the
following number of reserved shares of its common stock:
<TABLE>
<S> <C>
Warrants to purchase common stock................................. 45,685*
Stock options under 1987 Stock Option Plan........................ 440,529
Stock options under 1996 Stock Plan............................... 352,605
Stock options under 1996 Director Option Plan..................... 83,334
Employee Stock Purchase Plan...................................... 117,557
---------
Total shares reserved............................................. 1,019,710
=========
</TABLE>
--------
* 450,000 warrants to purchase common stock at $3.046875 were issued in
conjunction with interim debt financing related to the Wahlco
acquisition.
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.
55
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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
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, 1998:
<TABLE>
<CAPTION>
OPTIONS
WEIGHTED AVERAGE
AVAILABLE OUTSTANDING EXERCISE
FOR GRANT OPTIONS PRICE
--------- ----------- --------
<S> <C> <C> <C>
Balance, December 31, 1995................... 234,386 554,477 0.98
Authorized................................. 416,668 -- --
Granted.................................... (273,522) 273,522 5.74
Exercised.................................. -- (44,430) 0.74
Expired.................................... (47,254) -- --
Canceled................................... 5,388 (5,388) 2.67
--------
Balance, December 31, 1996................... 335,666 778,181 2.66
Granted.................................... (57,469) 57,469 5.24
Exercised.................................. -- (109,613) 0.66
Expired.................................... (87,352) -- --
Canceled................................... 106,978 (106,978) 4.23
-------- --------
Balance, December 31, 1997................... 297,823 619,059 2.98
Granted.................................... (318,469) 318,469 3.95
-------- --------
Exercised.................................. -- (35,995) 1.17
Expired.................................... (24,419) -- --
Canceled................................... 83,921 (83,921) 7.42
--------
Balance, December 31, 1998................... 38,856 817,612 2.98
======== ========
</TABLE>
56
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF EXERCISE PRICES AS OF 12/31/98 CONTRACTUAL LIFE EXERCISE PRICE AS OF 12/31/98 EXERCISE PRICE
------------------------ -------------- ---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$0.30--$0.75............ 145,493 4.63 $ 0.56 129,382 $ 0.54
$1.50................... 241,808 6.82 $ 1.50 217,046 $ 1.50
$1.625--$3.00........... 178,111 8.16 $ 2.76 52,136 $ 2.86
$4.125--$7.50........... 218,864 9.28 $ 5.06 37,152 $ 4.71
$9.00--$12.50........... 33,336 7.58 $11.80 23,336 $11.50
------- ---- ------ ------- ------
817,612 7.41 $ 2.98 459,052 $ 2.15
======= ==== ====== ======= ======
</TABLE>
As of December 31, 1997, the number of options exercisable and the weighted
average exercise price were 377,835 and $2.10, respectively. As of December
1996, the number of options exercisable and the weighted average exercise
price were 373,212 and $1.77, respectively.
Employee Stock Purchase Plan ("Purchase Plan")
A total of 116,667 shares of common stock were initially reserved for
issuance under the Purchase Plan with an additional 100,000 being added as a
result of the vote at the 1998 Annual Shareholders Meeting on June 11, 1998.
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, 1998, 99,110 shares of common stock had been issued under the
Purchase Plan.
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>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net loss
As reported.................................... $(7,873) $(9,640) $(4,876)
Pro forma...................................... $(8,344) $(9,978) $(5,087)
Basic net loss per share As reported........... $ (1.03) $ (1.28) $ (1.22)
Pro forma...................................... $ (1.09) $ (1.32) $ (1.27)
</TABLE>
57
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 1998,
1997, and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------------------------- ------------
<S> <C> <C> <C>
Dividend Yield.......... 0% 0% 0%
Expected Volatility..... 152%-256% 125% prior to the initial public 0%
offering and 85% thereafter
Risk-free Interest 5.38-5.67% 5.59-6.50% 5.20-6.80%
Rate...................
Expected Lives for Each 3.5 to 7 years 2.5 to 3 years 1 to 2 years
Grant..................
</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,
---------------------
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Provision (benefit) at
U.S. statutory rate.................................... (34.0)% (34.0)% (34.0)%
State income taxes, net
of Federal benefit..................................... (5.8) (5.8) (6.1)
Increase (decrease) in
valuation allowance.................................... 39.8 39.8 40.0
Other................................................... -- 0.1 0.1
----- ----- -----
-- % -- % -- %
===== ===== =====
</TABLE>
The provision for income taxes for the years ended December 31, 1998 and
1997 relates to state taxes against which no net operating loss can be
applied.
The net deferred income tax asset consisted of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1998 1997
------- -------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards......................... $15,645 $12,719
Tax credit carryforwards................................. 303 280
Cumulative temporary differences......................... 493 484
------- -------
16,441 13,483
Valuation allowance........................................ (16,441) (13,483)
------- -------
Net deferred income tax asset.............................. $ -- $ --
======= =======
</TABLE>
58
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 1998, the Company had net operating loss carryforwards
for Federal and state income tax purposes of approximately $42.9 million and
$23.2 million, respectively. The net operating loss carryforwards and tax
credit carryforwards expire on various dates through 2018. The Internal
Revenue Service 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 would be limited due to possible ownership changes.
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 continued to
provide a valuation allowance against the deferred income tax asset.
9. LOAN AND SECURITY AGREEMENTS
In December 1995, the Company entered into a Loan and Security Agreement
("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 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
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. No amounts were outstanding
under the 1998 Agreement as of December 31, 1998. The 1998 Agreement matured
on January 20, 1999.
10. SUBSEQUENT EVENTS
Acquisition of Wahlco Environmental Systems, Inc.
On January 13, 1999, the Company completed the acquisition of Wahlco
Environmental Systems, Inc. ("Wahlco") for the payment of approximately $1.9
million in cash. If certain other conditions are met, the Company may be
required to make additional payments of up to approximately $2 million to
Wahlco shareholders. Also, in conjunction with the acquisition, the Company
agreed to guarantee repayment by Wahlco of approximately $4.9 million owed to
affiliates of Wexford, Wahlco's largest shareholder at the time of the
acquisition, or guaranteed by Wexford to other parties. The Company has
subsequently
59
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
entered into a new credit agreement with Wexford as referred to below. The
acquisition will be accounted for as a purchase in the first quarter of fiscal
1999. The Company has embarked on a plan to close duplicate and/or inefficient
Wahlco facilities and is reducing headcount accordingly. The costs involved to
close facilities and terminate employees will be recognized as liabilities
assumed at the time of the Wahlco acquisition.
Wexford Credit Agreement
On February 25, 1999, the Company entered into the Second Amended and
Restated Credit Agreement among Wahlco and the Company, as Borrowers, and
certain Wexford affiliates as Lenders and Wexford as Agent for the Lenders
(the "1999 Credit Agreement"). As of March 31, 1999, the debt amounts to
slightly more than $5.7 million and bears interest at the rate of 13% per
annum, payable monthly in advance. The debt matures on August 24, 1999, and
may, with the payment of an additional fee of $100,000, be extended until
November 22, 1999. As a condition to the Lenders' execution and delivery of
the 1999 Credit Agreement, the Company agreed to confirm its grant to the
Lenders of a security interest in all existing and future assets and to cause
all its significant subsidiaries to enter into guarantees and grant to the
Lenders additional security interests and mortgages in all existing and future
assets of the Borrowers and significant subsidiaries.
As a further condition to the 1999 Credit Agreement, the Company issued to
Wexford a warrant to acquire 450,000 shares of common stock. The warrants can
be exercised at any time on or before February 25, 2004 at an exercise price
equal to the lesser of (i) $3.875 per share and (ii) the average closing price
of the Company's common stock for the ten trading days immediately following
the issuing date. The fair value of the warrant at the date of issuance will
be recorded as additional interest cost over the period that the Wexford debt
is outstanding.
SUBSEQUENT EVENTS (UNAUDITED):
EQUITY PLACEMENT:
On June 30, 1999 the Company closed a private placement of 6,000 shares of
Series E 8% Convertible Preferred Stock, (the "Series E Stock") at a purchase
price of $1,000 per share in the aggregate amount of $6,000,000. The two
largest existing shareholders of the Company's Common Stock ("Common Stock")
combined to purchase $3 million of the Series E Stock and a single new
investor purchased the remainder (the "Investors"). The Series E Stock is
convertible into Common Stock on certain terms and at a conversion price to be
determined at the time of conversion in accordance with the Company's
Certificate of Designation. The issuance of the Series E Stock was made
pursuant to an exemption from the registration requirements of the Securities
Act of 1933, as amended, provided by Section 4(2) thereof. On July 9, 1999,
the Nasdaq National Market required 10-day notification period to shareholders
was completed and the Company received net proceeds of approximately $5.6
million after costs of issuance totaling approximately $400,000.
SETTLEMENTS:
In July and August 1999, the Company reached a full and final settlement of
two separate project related disputes with two separate customers. One
settlement involved payment by the Company of approximately $189,000 to one
customer and the other settlement involved receipt by the Company of
approximately $300,000 from the other customer. The Company will record a net
credit to income in the quarter ending September 30, 1999 as a result of these
settlements.
60
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
OFFICE CLOSINGS:
On August 26, 1999 the Company announced the closing of its San Jose,
California office and its Lakewood, Colorado sales office. Company sales
activities have been consolidated in the Knoxville, Tennessee office and
California operations have been consolidated in the Santa Ana office.
On September 24, 1999 the Company announced its decision to close its
Chesterfield, England site and combine the sales and engineering efforts from
its Hull, England office with those of Chesterfield at a new site. Treste
Services Division will relocate to more suitable premises nearby and the
manufacturing facility will be closed, with those operations relocated to
either the Company's facilities in Wales or the US or possibly carried out
through arrangements with fabricators in England, Europe or Asia.
DELISTING:
On September 17, 1999 the Company was notified that, as a result of its
failure to meet the Nasdaq National Market continued listing requirements, its
securities had been delisted from the National Market. The securities now
trade under the symbol TMXI.OB on the OTC Bulletin Board. The Company intends
to request a review of the delisting of its securities. Further, the Company
is actively taking steps, through its previously announced three-phase
financial restructuring, that it believes will result in compliance with the
Nasdaq National Market continued listing requirements.
Pursuant to the provisions of the Certificate of Designation of the Series E
Stock (the "Certificate of Designation), if the Company's common stock is
delisted from the Nasdaq Stock Market and remains delisted for 45 consecutive
days, unconverted shares of Series E Stock may be converted at the sole option
of the holder at a conversion price per share equal to 65% of the Market Price
(as defined in the Certificate of Designation) of the common stock.
Pursuant to a Letter Agreement dated June 30, 1999, between the Shaar Fund
Ltd. and the Company, the Shaar Fund currently has the option to require the
Company to redeem for cash all of the shares of Series E Stock held by the
Shaar Fund at the Optional Redemption Price, as defined in the Certificate of
Designation.
AMENDMENT TO AGREEMENT AND PLAN OF MERGER:
On September 17, 1999, the Company and Wexford Management LLC (Wexford)
agreed to amend certain provisions of the November 9, 1998 Agreement and Plan
of Merger in connection Wexford's withdrawal of default claims made relating
to the Second Amended & Restated Credit Agreement.
11. SEGMENTS
During 1998, the Company adopted Statement of Financial Accounting Standards
SFAS No. 131 "Disclosures About Segments of an Enterprise and Related
Information." SFAS 131 requires a new basis of determining reportable business
segments, i.e. the management approach. This approach requires that business
segment information used by management to assess performance and manage
company resources be the source for information disclosure. On this basis, the
Company is organized and operates as one business segment, the development,
manufacture and sale of proprietary industrial process equipment for the
destruction of volatile organic compounds and hazardous air pollutants. As a
result, the adoption of SFAS 131 had no impact on the Company's disclosures or
financial statements. The Company incurred approximately $1 million in
research and development expenses during 1998 relating to its diesel engine
emission reduction technology.
61
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company's operations by geographic area are as follows:
<TABLE>
<CAPTION>
ADJUSTMENTS
UNITED UNITED AND
STATES KINGDOM ELIMINATORS CONSOLIDATED
------- ------- ----------- ------------
<S> <C> <C> <C> <C>
1998
Revenues............................ $ 5,881 $7,733 $13,614
Loss from Operations................ $ 7,868 $ 340 $(8,208)
Total identifiable assets........... $10,842 $4,187 $(4,937) $10,092
</TABLE>
Prior to January 1, 1998, the Company had accounted for United Kingdom
assets, liabilities and operations as a branch of the U.S. entity. Effective
January 1, 1998, the Company transferred the United Kingdom net assets to a
United Kingdom subsidiary.
The Company's export revenues accounted for 2%, 35% and 14% of total
revenues for the years ended December 31, 1998, 1997 and 1996, respectively.
The Company's export revenue by geographic regions is as follows ($000):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31
------------------
1998 1997 1996
---- ------ ------
<S> <C> <C> <C>
Europe.................................................... $ 6 $ 243 $1,813
Asia...................................................... 223 2,156 133
---- ------ ------
$229 $2,399 $1,946
</TABLE>
62
<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............................. 44
Consolidated Balance Sheets--As of December 31, 1998 and 1997........ 45
Consolidated Statements of Operations--For the Three Years Ended
December 31, 1998................................................... 46
Consolidated Statements of Stockholders' Equity (Deficit)--For the
Three Years Ended December 31, 1998................................. 47
Consolidated Statements of Cash Flows--For the Three Years Ended
December 31, 1998................................................... 48
Notes to Consolidated Financial Statements........................... 49-61
2. Financial Statement Schedules. For years ended December 31, 1998, 1997 and
1996:
Schedule II. Valuation and Qualifying Accounts and Reserves.......... 68
</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:
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 the Registrant and Venture Banking Group, a
Division of Cupertino National Bank.(***)
10.14 Sublease dated May 7, 1998 between Registrant and Clinimetrics
Research Associates, Inc.
10.15 Form 8K with exhibits filed January 27, 1999 regarding the
acquisition of Wahlco Environmental Systems, Inc.
63
<PAGE>
The following Exhibits to the Form 8K filed January 27, 1999 are
incorporated by reference.
2.1 Agreement and Plan of Merger dated November 9, 1998 by and among
Thermatrix Inc., TMX Acquisition Sub I, Inc. and Wahlco Environmental
Systems, Inc.
2.2 Security Agreement dated January 13, 1999 by and among Thermatrix,
Inc., Wexford Capital Partners II, L.P., Wexford Overseas Partners I,
L.P., Wexford Special Situations 1996, L.P., Wexford Special
Situations 1996 Institutional, L.P., Wexford Special Situations 1996
Limited, Wexford-Euris Special Situations 1996, L.P. and Wexford
Management LLC.
2.3 Guaranty dated January 13, 1999 by and among Thermatrix Inc., Wexford
Capital Partners II, L.P., Wexford Overseas Partners I, L.P., Wexford
Special Situations 1996, L.P., Wexford Special Situations 1996
Institutional, L.P., Wexford Special Situations 1996 Limited, Wexford
Special Situations 1996, L.P. and Wexford Management LLC.
10.16 Form 8K with exhibits filed March 12, 1999 regarding the Second
Amended and Restated Credit Agreement related to interim debt
financing arrangements with Wexford.
The following Exhibits to the Form 8K filed March 12, 1999 are incorporated
by reference:
10.1 Second Amended and Restated Credit Agreement dated February 25, 1999
by and among Wahlco Environmental Systems, Inc., Thermatrix Inc.,
Wexford Capital Partners II, L.P., Wexford Overseas Partners I, L.P.,
Wexford Special Situations 1996, L.P., Wexford Special Situations
1996 Institutional, L.P., Wexford Special Situations 1996 Limited,
Wexford-Euris Special Situations 1996, L.P. and Wexford Management
LLC, as Agent.
10.2 General Release dated February 25, 1999 by and among Wahlco
Environmental Systems, Inc., Thermatrix Inc., Wexford Capital
Partners II, L.P., Wexford Overseas Partners I, L.P., Wexford Special
Situations 1996, L.P., Wexford Special SItuations 1996 Institutional,
L.P., Wexford Special Situations 1996 Limited, Wexford-Euris Special
Situations 1996, L.P. and Wexford Management LLC, as Agent.
10.3 Amended and Restated Guaranty dated February 25, 1999 by and among
Bachmann Companies, Inc., Wahlco Engineered Products Group, LTD.,
Wahlco, Inc., WES Property, LTD., Wahlco Engineered Products, Inc.,
Wahlco Engineered Products, Ltd., Pentney Engineering, LTD.,
Teddington Bellows (Holdings), LTD., Teddington Bellows, Ltd., Treste
Plant Hire, LTD., Thermatrix, LTD. and Wexford Management LLC, as
Agent.
10.4 Mortgage, Security Agreement Assignment of Rents and Leases and
Fixture Filing dated February 25, 1999 by and between Wahlco
Engineered Products, Inc. and Wexford Management LLC, as Agent.
10.5 Mortgage, Security Agreement Assignment of Rents and Leases and
Fixture Filing dated February 25, 1999 by and between Wahlco, Inc.
and Wexford Management LLC, as Agent.
10.6 Promissory Note dated February 25, 1999 in the principal amount of
$5,720,585.64, delivered by Thermatrix Inc. and Wahlco Environmental
Systems, Inc. to Wexford Management LLC, as Agent.
10.7 Registration Rights Agreement dated February 25, 1999 by and between
Thermatrix Inc. and Wexford Management LLC
10.8 Amended and Restated Security Agreement dated February 25, 1999 by
and among Wahlco Environmental Systems, Inc., Bachmann Companies,
Inc., Wahlco, Inc., Wahlco Engineered Products, Inc. and Wexford
Management LLC as Agent.
10.9 Amended and Restated Security Agreement dated February 25, 1999 by
and between Thermatrix Inc., Wexford Capital Partners II, L.P.,
Wexford Overseas Partners I, L.P., Wexford Special Situations 1996
Institutional, L.P., Wexford Special Situations 1996 Limited,
Wexford-Euris Special Situations 1996, L.P. and Wexford Management
LLC, as Agent.
64
<PAGE>
10.10 Form of U.K. Debenture entered into by and between Wexford
Management LLC and each of Pentney Engineering Limited, Teddington
Bellows (Holdings) LTD., Teddington Bellows Ltd., Thermatrix, LTD.,
Treste Plant Hire, LTD., WES Property, LTD., Wahlco Engineered
Products Group, LTD. and Wahlco Engineered Products LTD.,
respectively.
10.11 Stock Pledge Agreement dated February 25, 1999 by and among
Thermatrix Inc., Wahlco Environmental Systems, Inc., Bachmann
Companies, Inc., Wahlco Engineered Products Group LTD., Wahlco
Engineered Products LTD., Teddington Bellows (Holdings), LTD., and
Wexford Management LLC, as Agent.
10.12 Warrant to purchase up to 450,000 shares of Common Stock of
Thermatrix Inc. issued to Wexford Management LLC on February 25,
1999.
10.17 Form 10K with exhibits filed March 30, 1998 by Wahlco Environmental
Systems, Inc.
The following exhibits to the Wahlco Environmental Systems, Inc. Form 10-K
for the year ended December 31, 1998 filed March 30, 1998 are incorporated
by reference:
3.1 Certificate of Incorporation of the Company. (Filed as an exhibit to
the Company's Registration Statement No. 33-33698, as amended.)
3.2 Bylaws of the Company. (Filed as an exhibit to the Company's
Registration Statement No. 33-33698, as amended.)
10.1 Grant of Industrial Tax Exemption by the Commonwealth of Puerto Rico
to Wahlco International, Inc., a Delaware corporation, dated as of
March 10, 1982. (Filed as an exhibit to the Company's Registration
Statement No. 33-33698, as amended.)
10.2 Order of Conversion of Grant of Puerto Rico Industrial Tax Exemption
to Wahlco International, Inc. dated as of October 29, 1987, and as
amended on March 8, 1989. (Filed as an exhibit to the Company's
Registration Statement No. 33-33698, as amended.)
10.3 Redemption and Indemnification Agreement, dated as of October 28,
1987, by and among Pacific Diversified Capital Company, Wahlco, Inc.,
Robert R. Wahler, as Trustee of the Wahler Family Trust, Triple R,
John H. McDonald, Westfore, a California limited partnership and
Corona Properties, a California limited partnership. (Filed as an
exhibit to the Company's Registration Statement No. 33-33698, as
amended.)
10.4 Form of Indemnity Agreement between the Company and each of its
directors and officers. (Filed as an exhibit to the Company's
Registration Statement No. 33-33698, as amended.)
10.5 Standard Industrial Lease, dated as of September 3, 1991, by and
between Triple R, a California general partnership and Wahlco Inc., a
California corporation. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1991.)
10.6 First Addendum to Standard Industrial Lease, dated as of September 3,
1991 between Triple R and Wahlco, Inc. (Filed as an exhibit to the
Company's Annual Report on Form 10-K for the year ended December 31,
1991.)
10.7 Second amendment to Office Lease, dated as of December 16, 1991, by
and between BCG and the Company. (Filed as an exhibit to the
Company's Annual Report on Form 10-K for the year ended December 31,
1991.)
10.8 Installment Note, dated as of July 20, 1992, by and between Wahlco,
Inc. and Sanwa business Credit Corporation, a Delaware corporation.
(Filed as an exhibit to the Company's Quarterly Report on Form 10-Q
for the Quarter ended September 30, 1992.)
10.9 Guaranty Agreement, dated as of July 20, 1992, by and between the
Company and Sanwa. (Filed as an exhibit to the Company's Quarterly
Report on Form 10-Q for the Quarter ended September 30, 1992.)
65
<PAGE>
10.10 Security Agreement, dated as of July 20, 1992, by and between
Wahlco, Inc. and Sanwa, with accompanying Consent and
Acknowledgement of the Company, as Guarantor. (Filed as an exhibit
to the Company's Quarterly Report on Form 10-Q for the Quarter ended
September 30, 1992.)
10.11 First Amended and Restated 1990 Incentive Award Plan. (Filed as an
exhibit to the Company's Quarterly Report on Form 10-Q for the
Quarter ended September 30, 1992.)
10.12 Letter Agreement dated August 31, 1993, by and between the Company,
Wahlco, Inc., Wahlco Power Products, Inc., a Delaware corporation,
Bachmann Companies, Inc., and Sanwa. (Filed as an exhibit to the
Company's Quarterly Report on Form 10-Q for the Quarter ended
September 30, 1993.)
10.13 Settlement Agreement, dated as of October 7, 1994, by and between
Wahlco Power Products, Inc. and ABB Air Preheater, Inc. (Filed as an
exhibit to the Company's Quarterly Report on Form 10-Q for the
Quarter ended September 30, 1994.)
10.14 Mutual Release, dated as of October 6, 1994, between Wahlco Poer
Products, Inc. and ABB Air Preheater, Inc. (Filed as an exhibit to
the Company's Quarterly Report on Form 10-Q for the Quarter ended
September 30, 1994.)
10.15 Assignment of Note, Loan Agreement and collateral Documents. (Filed
as an exhibit to the Company's Annual REport on Form 10-K for the
year ended December 31, 1994.)
10.16 Promissory Note, dated as of May 15, 1995, between the Company and
WES Acquisition Corp. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1994.)
10.17 Commitment letter, dated as of May 15, 1995, from WES Acquisition
Corp. to the Company for a secured term loan in the principal amount
of $2 million. (Filed as an exhibit to the Company's Annual REport
on Form 10-K for the year ended December 31, 1994.)
10.18 Employment Agreement between the Company and C. Stephen Beal dated
as of May 5, 1995. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
10.19 Employment Agreement between the Company and A. Noel DeWinter dated
as of May 16, 1995. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995)
10.20 Employment Agreement between the Company and Barry J. Southam dated
June 1, 1995. (Filed as an exhibit to the Company's Annual REport on
Form 10--K for the year ended December 31, 1995.)
10.21 Loan and Security Agreement between Wahlco, Inc. and Silicon Valley
Bank. (Filed as an exhibit to the Company's Annual Report on Form
10-K for the year ended December 31, 1995.
10.22 Amendment and Forbearance Agreement, dated as of May 9, 1996, by and
between Silicon Valley Bank and Wahlco, Inc. (Filed as an exhibit to
the Company's quarterly Report on Form 10-Q for the Quarter ended
June 30, 1996.)
10.23 Term Loan Agreement and Warrant Agreement and Form of Warrant
between the Company and WES Acquisition Corp. dated August 28, 1996.
(Filed as an exhibit to the Company's quarterly Report on Form 10-Q
for the Quarter ended September 30, 1996.)
10.24 Letter Agreement dated March 12, 1997 between the Company and WES
Acquisition Corp. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.)
66
<PAGE>
10.25 Letter Agreement dated April 12, 1996 made by the Company and WES
Acquisition Corp. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.)
10.26 Promissory Note dated as of May 9, 1996 made by the Company's to WES
Acquisition Corp. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.)
10.27 Promissory Note dated as of November 15, 1996 made by the Company to
WES Acquisition Corp. (Filed as an exhibit to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.)
10.28 Warrant dated as of November 15, 1996 issued by the Company to
Wexford Special Situations 1996, L.P. (Filed as an exhibit to the
Company's Annual Report on Form 10-K for the year ended December 31,
1996.)
10.29 Warrant dated as of November 15, 1996 issued by the Company to
Wexford Special Situations 1996 Institutional, L.P. (Filed as an
exhibit to the Company's Annual Report on Form 10-K for the year
ended December 31, 1996.)
10.30 Warrant dated as of November 15, 1996 issued by the Company to
Wexford Special Situations 1996 Limited. (Filed as an exhibit to the
Company's Annual Report on Form 10-K for the year ended December 31,
1996.)
10.31 Warrant dated as of November 15, 1996 issued by the Company to
Wexford-Euris Special Situations 1996, L.P. (Filed as an exhibit to
the Company's Annual Report on Form 10-K for the year ended December
31, 1996.)
10.32 Term Loan Agreement, dated as of July 28, 1995, between WES
Acquisition Corp. and the Company for a secured term loan in the
principal amount of $2.0 million. (Filed as an exhibit to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1996.)
10.33 Restructuring Agreement dated as of January 30, 1998 among the
company, WES Acquisition Corp., the other parties named therein and
Wexford Management LLC, as Agent. (Filed as an exhibit to the
Company's Registration Statement No. 333-42805.)
10.34 Amended and Restated Credit Agreement dated as of January 30, 1998
among the Company, as Borrower, the Lenders and the Individual
Parties thereto and Wexford Management LLC, as agent. (Filed as an
exhibit to the Company's Registration Statement No. 333-42805.)
10.35 Agreement between the Company and ChaseMellon Shareholder Services,
Inc. re Subscription Agency. (Filed as an exhibit to the Company's
Registration Statement No. 333-42805.)
10.36 $750,000 Promissory Note dated as of July 2, 1997 between the
Company and the Chase Manhattan Bank. (Filed as an exhibit to the
Company's Registration Statement No. 333-42805.)
10.37 $1,000,000 Promissory Note dated as of October 13, 1997 between the
Company and the Chase Manhattan Bank. (Filed as an exhibit to the
Company's Registration Statement No. 333-42805.)
10.38 $400,000Promissory Note dated as of November 17, 1997 between the
Company and The Chase Manhattan Bank. (Filed as an exhibit to the
Company's Registration Statement No. 333-42805.)
10.39 Waiver letter of Silicon Valley Bank dated as of December 19, 1997
re: extension of maturity and waiver of covenants. (Filed as an
exhibit to the company's Registration Statement No. 333-42805.)
67
<PAGE>
10.40 Wahlco Environmental Systems, Inc. 1996 Employee Stock Option Plan.
(Filed as an exhibit to the Company's Registration Statement No.
333-42805.)
21 Subsidiaries of the Company. (Filed as an exhibit to the Company's
Annual Report on Form 10-K for the year ended December 31, 1995.)
*27 Financial Data Schedule (EDGAR filing only)
10.18 Form 8K/A filed March 27, 1999 regarding the acquisition of Wahlco
Environmental Systems, Inc.
The following Exhibits to Form 8K/A, filed March 27, 1999 are incorporated
by reference:
2.1 Agreement and Plan of Merger dated November 9, 1998 by and amon
Thermatrix Inc., TMX Acquisition Sub I, Inc. and Wahlco Environmental
Systems, Inc. (Incorporated by reference herein to Registrant's
Current Report on Form 8-K filed on January 28, 1999, File
No. 000-20819.
2.2 Security Agreement dated January 13, 1999 by and among Thermatrix,
Inc., Wexford Capital Partners II L.P., Wexford Overseas Partners I,
L.P., Wexford Special Situations 1996, L.P., Wexford Special
Situations 1996 Institutional L.P., Wexford Special Situations 1996
Limited, Wexford-Euris Special Situations 1996, L.P. and Wexford
Management LLC. (Incorporated herein by reference to Registrant's
Current Report on Form 8-K filed on January 28, 1999, File No. 000-
20819.)
2.3 Guaranty dated January 13, 1999 by and among Thermatrix Inc., Wexford
Capital Partners II, L.P., Wexford Overseas Partners I, L.P., Wexford
Special Situations 1996, L.P., Wexford Special Situations 1996
Institutional, L.P., Wexford Special Situations 1996 Limited, Wexford
Special Situations 1996, L.P. and Wexford Management LLC.
(Incorporated herein by reference to Registrant's Current Report on
Form 8-K filed on January 28, 1999, File No. 000-20819.)
10.19 Employment Agreement with Ms. Krimsky dated March 9, 1998.
(*) 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.
(***) Incorporated by reference to exhibits filed with the Registrants Annual
Report on Form 10-K for the fiscal year ended December 31, 1997.
(b) Reports on Form 8-K
(Incorporated into exhibit list above)
Trademark Acknowledgments
Thermatrix and PADRE(R) are registered trademarks of the Company.
68
<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
Year ended December 31, 1998
Allowance for doubtful
accounts.................... $343 $249 $ 492 $100
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.
69
<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: September 30, 1999 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 Daniel S. Tedone, 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.
September 30, 1999 /s/ John T. Schofield
By: ____________________________________
John T. Schofield
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
September 30, 1999 /s/ Daniel S. Tedone
By:_____________________________________
Daniel S. Tedone
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
/s/ Robi Blumenstein
September 30, 1999 By:_____________________________________
Robi Blumenstein
Director
September 30, 1999 /s/ Charles R. Kokesh
By:_____________________________________
Charles R. Kokesh
Director
September 30, 1999 /s/ Frank R. Pope
By:_____________________________________
Frank R. Pope
Director
70
<PAGE>
September 30, 1999 /s/ James M. Strock
By:_____________________________________
JAMES M. STROCK
DIRECTOR
/s/ Joseph W. Sutton
September 30, 1999 By:_____________________________________
JOSEPH W. SUTTON
DIRECTOR
September 30, 1999 /s/ John M. Toups
By:_____________________________________
JOHN M. TOUPS
DIRECTOR
71
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K/A into the Company's previously filed
Registration Statements on Form S-8 (File No. 333-12363 and File No. 333-
66285).
San Jose, California
September 29, 1999
