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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 1999.
[ ] 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 (IRS Employer
incorporation or organization) Identification Number)
2025 Gateway Place, Suite 132
San Jose, California 95110
(Address of principal executive offices)
(408) 453-0490
(Registrant's telephone number, including area code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class Outstanding at March 31, 1999
----- -----------------------------
Common stock, $.001 par value 7,712,735
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THERMATRIX INC.
This report contains 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. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth under "Certain Business Considerations" in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in, or incorporated by reference into, this report.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements........................................... 3-5
Condensed Consolidated Balance Sheets.......................... 3
Condensed Consolidated Statements of Operations................ 4
Condensed Consolidated Statements of Cash Flows................ 5
Notes to Condensed Consolidated Financial Statements........... 6-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 19
Item 2. Changes in Securities.......................................... 19
Item 3. Defaults Upon Senior Securities................................ 19
Item 4. Submission of Matters to a Vote of Security Holders............ 19
Item 5. Other Information.............................................. 19
Item 6. Exhibits and Reports on Form 8-K............................... 19-20
SIGNATURE...................................................... 21
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THERMATRIX INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
----------- ----------
ASSETS (Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS
Cash, short-term investments and restricted cash $ 439 $ 3,214
Accounts receivable, net 9,645 4,668
Costs of uncompleted contracts, net 1,984 ---
Inventories 2,684 ---
Prepaid expenses and other current assets 1,957 232
-------- --------
Total current assets 16,709 8,114
PROPERTY AND EQUIPMENT, net 5,898 572
GOODWILL, net 9,862 ---
PATENTS and Other Assets, net 1,976 1,406
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TOTAL ASSETS $ 34,445 $ 10,092
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes Payable $ 5,721 $ ---
Current Portion of Long Term Debt 329 ---
Accounts Payable 12,432 4,881
Accrued Payroll & Related Expenses 872 ---
Accrued Liabilities and Reserves 11,036 965
-------- --------
Total current liabilities 30,390 5,846
LONG TERM LIABILITIES
Long Term Debt 356 ---
Other Liabilities 1,720 ---
-------- --------
TOTAL LONG-TERM LIABILITIES 2,076 ---
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value 8 8
Additional paid-in capital 49,077 48,795
Accumulated Deficit (44,576) (36,703)
Current Year Income (Loss) (1,906) (7,873)
Other Accumulated Comprehensive Income (624) 19
-------- --------
Total stockholders' equity 1,979 4,246
-------- --------
TOTAL LIABILITIES & STOCKHOLDERS EQUITY $ 34,445 $ 10,092
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
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THERMATRIX INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Thousands of Dollars except for per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
1999 1998
-------- -------
<S> <C> <C>
REVENUES $10,901 $ 2,882
COST OF REVENUES 9,432 2,527
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Gross margin 1,469 355
------- -------
OPERATING EXPENSES:
Research and development 211 255
Selling, general and administrative 3,387 1,430
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Total operating expenses 3,598 1,685
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Loss from operations (2,129) (1,330)
OTHER INCOME:
Interest income (expense), net (41) 105
Other income 263 0
------- -------
Total other income 222 105
------- -------
Net loss before income taxes (1,907) (1,225)
BENEFIT (PROVISION) FOR INCOME TAXES 1 (16)
------- -------
Net loss $(1,906) $(1,241)
======= =======
BASIC NET LOSS PER SHARE $ (0.25) $ (0.16)
======= =======
BASIC WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING 7,713 7,636
======= =======
</TABLE>
See notes to condensed consolidated financial statements.
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THERMATRIX INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of Dollars)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------
March 31, March 31,
1999 1998
--------- --------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,906) $(1,241)
Adjustments to reconcile net loss to net cash used in
operating activities -
Depreciation and amortization 312 207
Provision for doubtful accounts 579 60
Changes in assets and liabilities -
Accounts receivable (5,556) 40
Costs of uncompleted contracts (4,668) 281
Prepaid expenses and other (1,725) 16
Goodwill (9,985) ---
Accounts payable 7,551 477
Accrued liabilities 19,443 106
Billings on uncompleted contracts in excess of costs (374) 367
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Net cash used in operating activities 3,671 313
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CASH FLOWS FROM INVESTING ACTIVITIES
Sale of short-term investments 1,670 2,552
Purchases of property and equipment (5,441) (32)
Increase in patents and other assets (644) (31)
------- -------
Net cash provided (used) by investing activities (4,415) 2,489
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CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from sale of common stock 282 13
------- -------
INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS (462) 2,815
CUMULATIVE EFFECT OF FOREIGN EXCHANGE RATES ON CASH (643) 17
CASH & CASH EQUIVALENTS BEGINNING OF PERIOD 1,544 3,990
------- -------
CASH & CASH EQUIVALENTS END OF PERIOD $ 439 $ 6,822
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest 16 10
Cash paid for income taxes 40 36
</TABLE>
See notes to condensed consolidated financial statements.
5
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THERMATRIX INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiary. The condensed
consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read
in conjunction with the consolidated financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1998.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments) which
are, in the opinion of management, necessary to state fairly the results for the
three months ended March 31, 1999 and 1998. 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, the disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. The results for the three months ended March 31, 1999 are not
necessarily indicative of the results expected for the full fiscal year.
2. 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 stock options and warrants are antidilutive.
3. SHORT-TERM INVESTMENTS
In accordance with the Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," the Company
has classified all marketable debt securities as held-to-maturity and has
accounted for these investments at amortized cost. As of December 31, 1998, the
Company held short-term investments with original maturities greater than three
months and less than one year. As of March 31, 1999, the Company had no short-
term investments.
4. 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
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statements. The following table reconciles comprehensive income under the
provisions of SFAS 130 for the three months ended March 31, 1999 and 1998.
For the Three Months Ended
March 31,
($000)
----------------------------
1999 1998
----------------------------
Net Income (Loss) $(1,906) $(1,306)
Other Comprehensive Income(Loss), net of tax
Unrealized Currency Gain $ (624) $ 37
Comprehensive Income (Loss) $(2,530) $(1,269)
5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
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. The Statement requires that changes in the
derivative's 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.
6. 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 will be
required to make additional payments of up to approximately $2.0 million to
Wahlco shareholders. Also, in conjunction with the acquisition, the Company
agreed to guarantee repayment by Wahlco of approximately $4.6 million of debt
owed to affiliates of Wexford Management, LLC ("Wexford"), Wahlco's largest
shareholder at the time of the acquisition, or guaranteed by Wexford to other
parties. The Company had subsequently entered into a new credit agreement with
Wexford (See Note 8). The acquisition was accounted for as a purchase. 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 has been recognized as liabilities assumed at
the time of the Wahlco acquisition.
The allocation of the purchase price to the net assets acquired is preliminary
based on management's estimate of fair value. Any changes in the allocation of
purchase price will have an effect on the amount of goodwill that has been
initially recorded. The amount of goodwill recorded on the preliminary
allocation of purchase price is $9,985,000, which will be amortized over a 20-
year period.
The Company is providing the following unaudited pro forma operating data as if
the acquisition occurred on January 1, 1998. The pro forma information for the
three months ended March 31, 1999 is not provided as the results of Wahlco for
the period from January 1, 1999 to January 13, 1999 are not material to results
of operations for the three months ended March 31, 1999.
The pro forma information is unaudited and is not necessarily indicative of the
consolidated results that would have occurred if the transaction and adjustment
reflected therein had been consummated in the
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period presented, or at any particular date in the future, nor does it purport
to represent the financial position, results of operations or changes in cash
flows for future periods.
For the Three Months Ended
March 31, 1998
----------------------------
($000 except per share data)
Revenue $ 12,098
Net Income (Loss) $ (2,660)
Basic Net Income (Loss) Per Share $ (0.35)
7. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market
risks is included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 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. Information regarding
quantitative and qualitative disclosures about market risks is also included in
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained herein.
8. 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. Although the Company is
currently being organized operationally into eight divisions, at the present
time management is reviewing financial information on a geographic basis. The
Company incurred approximately $211,000 in research and development expenses
during the first quarter of fiscal 1999 relating to its diesel engine emission
reduction technology.
The Company's operations by geographic area are as follows:
<TABLE>
<CAPTION>
For the three months ended United United Adjustments &
March 31, 1999 States Kingdom Eliminations Consolidated
- ------------------------------------- -------- ------- ------------- ------------
($000)
<S> <C> <C> <C> <C>
Revenues $ 5,758 $5,143 $10,901
Income (Loss) from Operations $ (1,472) $ (657) $(2,129)
Total Identifiable Assets $126,855 $7,582 $(99,992) $34,445
</TABLE>
9. 1999 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 the Lenders and
Wexford as Agent for the Lenders (the "1999 Credit Agreement"). As of March 31,
1999, the debt outstanding was $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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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 of
$3.05 per share. The fair value of the warrant at the date of issuance is being
recorded as additional interest cost over the period that the Wexford debt is
outstanding.
9
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THERMATRIX INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion contains forward-looking information that involves
known and unknown risks and uncertainties which may cause the Company's actual
results in future periods to differ materially from those indicated herein as a
result of certain factors, including those set forth under "Certain Business
Considerations."
The following discussion should be read in conjunction with the unaudited
condensed consolidated financial statements and the notes thereto included in
Item 1 of this Quarterly Report and the audited consolidated financial
statements and notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
1998, contained in the Company's Annual Report on Form 10-K.
General
- -------
Thermatrix Inc. is a global technology company engaged in the development,
design, manufacture, installation, commissioning and sale of industrial process
and utility equipment and systems to industrial manufacturers, electric
utilities, independent power producers and co-generation plants. The Company
also provides mechanical plant installation services and rents associated
equipment.
The core component of the Company's technology is its proprietary flameless
thermal oxidizer ("FTO") for the destruction of volatile organic compounds and
hazardous air pollutants (collectively "VOCs"). The Company's products also
include PADRE(R), a proprietary technology used to capture and recover very low
concentration VOCs from low-to-medium flow vapor streams. In addition to its
primary focus on the industrial VOC emissions control market, the Company is
currently focusing its development activities on the application of its FTO
technology to treat emissions from both mobile and stationary diesel engines.
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, which are not related to future operating results of the
Company, will only be made to the Wahlco shareholders in the event that (i) the
Company is able to collect monies owed to the Company by third parties, or (ii)
a fully-reserved liability currently recorded on the books of the Company is
substantially reduced. The Company believes, but can provide no assurances,
that the Contingent Payments will not exceed $2 million 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
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assets of the Company. The 1998 Credit Agreement was subsequently replaced with
the 1999 Credit Agreement.
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.
The combined Company is organized operationally into eight divisions. The two
Thermatrix Divisions are located in Knoxville, Tennessee and Hull, England and
supply turnkey VOC abatement systems including design, engineering,
manufacturing, installation and startup. The Thermatrix Divisions offer a wide
range of solutions to VOC abatement including its patented FTO and adsorption
suitable for a broad range of flow and wide variation in composition.
Thermatrix Diesel Systems Division, located in San Jose, California, represents
the predominant research and development team of the Company. Following an
extensive test program which proved that the FTO technology could destroy over
90% of the noxious emissions from diesel engines, the team has reconfigured the
FTO technology to permit the product development of smaller devices suitable for
use on mobile applications. Partnerships are being developed with potential end
users of diesel after-treatment systems, and three agreements were entered into
during fiscal year 1998 for prototype testing on locomotives, buses, and
underground mining equipment.
The two Wahlco Metroflex Divisions are located in Lewiston, Maine and
Chesterfield, England and design and manufacture gas flow diverters and dampers
for the control and direction of gas flows in power generation facilities. In
addition, it supplies fabric and metallic expansion joints and carries out
fabrication for external clients as well as the Thermatrix Divisions.
Wahlco Air Systems Division, located in Santa Ana, California, designs and
manufactures equipment to reduce and control air pollution at power generation
facilities. Products and services include flue gas conditioning and equipment,
NOx reduction systems, and industrial electric heaters and thermocouples,
primarily for use in gas turbines.
Teddington Bellows Division, located in Pontardulais, South Wales, specializes
in the design and manufacture of metallic bellows and expansion joints for use
in pressurized piping systems. Teddington Bellows Division supplies external
customers as well as the Thermatrix Divisions, for which it also carries out
specialist fabrication.
Treste Services Division, located in Chesterfield, England, provides supplies
and leases mechanical and industrial equipment required for maintenance and
installation work. Treste Services Division provides these services externally
as well as to all other divisions of the Company.
During the first quarter of fiscal 1999, the Company announced its intention to
purchase Ferguson International Inc., a leading supplier of ammonia storage and
handling systems used by power companies to reduce emissions of NOx, a major
contributor to smog formation. Subsequent to March 31, 1999, the Company
completed the acquisition on a cashless basis. The Ferguson business will
operate as part of the Wahlco Air Systems Division in Santa Ana, California.
Subsequent to March 31, 1999, the Company also announced its intention to
acquire the Brockington and Scott Group, comprising Brockington and Scott
Holdings Limited and its wholly owned subsidiary, Brockington and Scott Limited.
Brockington and Scott, which is located in Llandeilo, Carmarthenshire, South
Wales, designs and manufactures expansion joints and bellows for applications
with diameters from 20 millimeters to 4,000 millimeters. Brockington and Scott
markets its products to the power
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industry and for use in marine, locomotive and diesel vehicle applications. The
Brockington and Scott operation is expected to be combined with the Teddington
Bellows Division.
Results of Operations
- ---------------------
Revenues were $10.9 million for the three months ended March 31, 1999, up from
$2.9 million for the three months ended March 31, 1998. The increase in
revenues was primarily attributable to the acquisition of Wahlco. Revenues from
European operations for the three months ended March 31, 1999 were 47% compared
to 56% of revenues for the three months ended March 31, 1998.
The Company had a gross margin contribution of $1,419,000 in the three months
ended March 31, 1999 compared to a gross margin contribution of $355,000 in the
comparable period in 1998. The increase in gross margin was primarily
attributable to higher revenues as a result of the acquisition of Wahlco, which
were sufficient to absorb the fixed and semi-fixed costs of engineering and
operations in the United States and Europe.
Research and development expenses were $211,000 in the three months ended March
31, 1999, compared to $255,000 for the comparable period in 1998. The decrease
in research and development expense was primarily attributable to the benefits
of the grant award received from the Advanced Technology Program of the National
Institute of Standards and Technology, an agency of the U.S. Department of
Commerce. Research and development expenses were largely 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.
Selling, general and administrative expenses increased to $3.4 million for the
three months ended March 31, 1999, compared to $1.4 million in the comparable
period in 1998. The increase in selling, general and administrative expenses
reflects the higher costs of operating the combined entity after the Wahlco
acquisition.
Restructuring and integration activities during the first quarter of fiscal 1999
proceeded ahead of plan. The corporate offices of Wahlco located in Santa Ana,
California and Chesterfield, England were closed and all senior executive
positions in the two locations were eliminated. Actions were taken to make the
necessary changes to produce Thermatrix units at the Wahlco fabrication
facilities in Lewiston, Maine and Chesterfield. Actions were also taken to
close and sell the Wahlco property located in Thornton, Illinois.
Liquidity and Capital Resources
- -------------------------------
Total cash was $439,000 at March 31, 1999, down from $3.2 million of cash and
short-term investments at December 31, 1998. This decrease was primarily due to
cash used for the acquisition of Wahlco and cash used in operations. The
Company paid approximately $1.9 million in cash to acquire all the common shares
and warrants of Wahlco. Net cash used in operating activities was $3.7 million
in the three months ended March 31, 1999, compared to $313,000 used in operating
activities during the three months ended March 31, 1998. 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.
The Company intends to finance its ongoing operations, including the
restructuring and integration of Wahlco, primarily by raising a combination of
up to $23 million in equity and debt in the second quarter of fiscal 1999. This
financing is also intended to pay the outstanding debt, which has a maturity
date of
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August, 1999 pursuant to the terms of the 1999 Credit Agreement. 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.
The Company is also pursuing other alternatives to fund its fiscal 1999 cash
requirements. Such alternatives include, among other things, consideration of
divestiture of a portion or portions of the Company's business or real estate
assets. 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
- --------------------
The Year 2000 issue arises from computer programs that use two digits rather
than four to define the applicable year. Such computer programs may cause
computer systems to recognize a date using "00" as the calendar year 1900 rather
than the calendar year 2000. Systems that do not properly recognize such
information could generate erroneous dates or cause a system to fail.
The Company has conducted a preliminary review of its products and internal
computer systems to identify the systems that could be affected by the Year 2000
issue. The Company believes its products and most of its management information
systems are already Year 2000 compliant, however, its existing accounting system
is not. The Company plans to upgrade to a Year 2000 compliant version of its
accounting system and does not anticipate that the cost of such a conversion
will be material.
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 key vendors are Year 2000 compliant and has requested
that such vendors complete and return surveys with respect to their Year 2000
issues.
While the Company currently expects the Year 2000 issue will not pose
significant operational problems, failure to fully identify all Year 2000
dependencies in the Company's systems could have a material adverse effect on
the Company's business, results of operations and financial condition. In
addition, the Company cannot be sure that systems of other companies on which
the Company relies will be converted in a timely manner. The failure of other
companies to convert systems on which the Company relies may have a material
adverse effect on the Company's business, results of operations or financial
condition.
Certain Business Considerations
- -------------------------------
The Company's business is subject to the following risks and uncertainties, in
addition to those described elsewhere.
Operating Losses and Accumulated Deficit; Uncertainty of Future Profitability.
The Company had a net loss of approximately $1.9 million in the quarter ended
March 31, 1999 and an accumulated deficit of approximately $44.6 million at
March 31, 1999. 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.
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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. Although the Company is expanding the number of
its customers and installations, the average size and dollar volume of each
installation has been 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.
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 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
14
<PAGE>
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 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
15
<PAGE>
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 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
16
<PAGE>
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. In
April 1999 the California Environmental Protection Agency's Department of Toxic
Substances Control issued a decision to certify the FTO technology under its
Environmental Technology Certification Program. The Program validates the
performance of innovative treatment technologies that can help address some of
the world's environmental challenges, but the certification is not available to
incineration-based technologies.
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 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
17
<PAGE>
to commercialize its system for such use, and there can be no assurance as to
the success of any such effort.
Based upon the acquisition of Wahlco, the Company's business is also subject to
the following risks and uncertainties.
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 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 U.S. and U.K.) 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 cash flows 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 before
year-end adjustments and write-offs 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.
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.
18
<PAGE>
PART II OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, the Company has been, or may become, involved in litigation
proceedings incidental to the conduct of its business. The Company does not
believe that any such proceedings presently pending will have a material adverse
effect on the Company's financial position or its results of operations.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) 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.(*)
10.8 Lease dated June 24, 1995 between the Registrant and American
General Life Insurance Company.(*)
10.11 Amended and Restated Loan and Security Agreement between the
Registrant and Venture Banking Group, a Division of Cupertino
National Bank, dated January 21, 1998.(***)
10.12 1996 Stock Plan: UK Rules for Employees.(***)
10.13 First Amendment to the Amended and Restated Loan and Security
Agreement between Registrant and Venture Banking Group, a Division
of Cupertino National Bank.(***)
19
<PAGE>
10.14 Sublease dated May 7, 1998 between Registrant and Clinimetrics
Research Associates, Inc.
10.17 Form 10-K with exhibits filed March 30, 1998 by Wahlco Environmental
Systems, Inc.
27.1 Financial Data Schedule.
------------
(*) 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 ended September 30,
1997.
(***) Incorporated by reference to exhibits filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1998.
(b) Reports on Form 8-K
Form 8-K with exhibits filed January 13, 1999 regarding the acquisition
of Wahlco Environmental Systems, Inc.
Form 8-K filed February 25, 1999 regarding the Second and Amended
Restated Credit Agreement related to interim debt financing arrangements
with Wexford.
Form 8-K with exhibits filed March 12, 1999 regarding the Second and
Amended Restated Credit Agreement related to interim debt financing
arrangements with Wexford.
Form 8-K/A dated March 29, 1999 Pro Forma Financial Statements related to
Acquisition of Wahlco Environmental Systems, Inc.
Trademark Acknowledgments
. Thermatrix and PADRE(R) are registered trademarks of the Company.
20
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities and 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.
Date: March 14, 1999 By: /s/ Daniel S. Tedone
----------------------
Daniel S. Tedone
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
21
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