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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 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 (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)
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
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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
NO\x\ 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(degree) and
1800(degree)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 NO\\x\\, CO and PICs. The
reduced energy requirement for the FTO system also results in a corresponding
reduction in the formation of greenhouse gases.
Regulatory Advantages. The Company's systems often exceed regulatory
performance requirements because of the high DRE and the de minimis formation of
by-products.
In February 1998, the Company successfully completed six months of full-scale
testing of a new FTO design. The oxidizer was reconfigured to create an almost
spherical flameless reaction front within the reactor's ceramic matrix, as
compared to the planar flameless reaction front, which until now was a signature
feature of the Company's technology. The Company believes the new development
will result in the following business advantages and design features:
. A greater than 60% reduction in the size of a typical non-recuperative
flameless thermal oxidizer for the same processing capability.
. A hot-wall reactor with the ability to process chlorinated, sulfonated and
fluorinated waste streams without the need for expensive and exotic
materials of construction to prevent corrosion.
. The ability to use horizontal as well as vertical vessels, which will extend
the applicable range of non-recuperative oxidizers to over 40,000 scfm.
. The incorporation of electric-assisted preheat, which will enable the
Company to offer flameless startup and operation.
. The ability to offer, for the first time, a flameless thermal oxidizer for
the destruction of hazardous liquids by direct injection into the oxidizer.
. The ability to offer, for the first time, a flameless oxidizer using liquid
fuels such as diesel, kerosene or waste solvents rather than other fuels
such as natural gas or propane, which are not available in all areas.
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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 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
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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 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.
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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
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<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 Manufacturing Zeneca, Warner Lambert, Pfizer Chlorinated Compounds
Chesebrough-Pond's USA Co.
Pulp and Paper Manufacturing Georgia Pacific, Simpson Paper Sulfonated Compounds
Medical Sterilization Sorex Medical Ethylene Oxide
Soil and Groundwater Remediation DOD, DOE, Thermo Remediation Chlorinated Compounds and
Hydrocarbons
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Sales and Marketing
The Company has experienced a shift in market demand for its products, both in
terms of the geographic distribution of the orders it has received and the
complexity of the systems ordered. 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
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.
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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.
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
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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.
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 NOx 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.
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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 devlopement 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.
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.
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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.
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
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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, manufacturers 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.
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,
manufacturers 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.
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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 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
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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.
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
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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.
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.
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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.
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
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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 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.
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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 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
18
<PAGE>
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 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
19
<PAGE>
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
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 belives 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.
20
<PAGE>
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.
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 leases approximately 1,000 square feet of office
space in London, England under a five-year lease expiring March 24, 1999, which
the Company is currently subletting on a month-to-month basis.
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.
21
<PAGE>
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
------ ----- -----
<S> <C> <C>
First Quarter 1997 9.375 3.375
Second Quarter 1997 5.750 3.000
Third Quarter 1997 3.250 1.875
Fourth Quarter 1997 3.250 1.125
Period High Low
------ ----- -----
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.
22
<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
-------------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(In thousands, except per share amounts)
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
======= ======== ======= ======= =======
December 31,
----------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- --------
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.
23
<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)
Year ended December 31, 1997
-------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
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>
24
<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 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
25
<PAGE>
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 a 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 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 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
26
<PAGE>
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 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
27
<PAGE>
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.
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
28
<PAGE>
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. 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 margin (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 timimg or ultimate outcome of any of these alternatives.
29
<PAGE>
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.
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 32 through 51
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None
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>
30
<PAGE>
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. Prior to joining the Company, 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. 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.
Information concerning the Company's Directors and compliance with Section 16
of the Securities Exchange Act is incorporated herein by reference to the
Company's definitive proxy statement for its Annual Meeting of Stockholders to
be held on June 10, 1999, which is intended to be filed with the Securities and
Exchange Commission no later than 120 days after the close of the fiscal year
ended December 31, 1998.
Items 11, 12 and 13
The information called for by Part III (Items 11, 12 and 13) is incorporated
herein by reference to the Company's definitive proxy statement for its Annual
Meeting of Stockholders to be held on June 10, 1999, which is intended to be
filed with the Securities and Exchange Commission no later than 120 days after
the close of the fiscal year ended December 31, 1998.
31
<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
32
<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.
33
<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.
34
<PAGE>
THERMATRIX INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
Convertible Additional 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)
---------- ------- --------- ------ ------- ---------- -------- ------- ----------
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.
35
<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.
36
<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 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.
37
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
38
<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>
1998
-------------------------------------
Amortized Aggregate Unrealized
Cost Fair Value Gains (Losses)
--------- ---------- --------------
<S> <C> <C> <C>
Certificates of deposit $1,670 $1,670 $ --
Money market instruments 58 58 --
------ ------ -----
$1,728 $1,728 $ --
====== ====== =====
1997
-------------------------------------
Amortized Aggregate Unrealized
Cost Fair Value Gains (Losses)
--------- ---------- -------------
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.
39
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
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.
40
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
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).
41
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
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
42
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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>
<CAPTION>
<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>
43
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
*450,000 warrants to purchase common stock at $3.046875 were issued in
conjunction with interim debt financing related to the Wahlco acquisition.
7. Stock Option Plans
1987 Stock Option Plan ("1987 Plan")
Under the 1987 Plan, the Board of Directors may grant to employees and
consultants options to purchase the Company's common stock at terms and prices
determined by the Board. Options granted under the 1987 Plan generally expire
ten (10) years from the date of grant. During 1996, the Company adopted new
stock plans (see below); accordingly, the Company does not plan to issue further
options to purchase common stock under the 1987 Plan.
1996 Stock Plan ("1996 Plan")
A total of 333,334 shares of common stock has been reserved for issuance under
the 1996 Plan. The 1996 Plan provides that options and stock purchase rights may
be granted to employees and consultants to the Company. Options granted under
the 1996 Plan may be either incentive stock options or non-statutory stock
options. The Company may also grant stock purchase rights under the 1996 Plan.
The exercise price and vesting of all grants are to be determined by the Board
of Directors or its designee. Options granted under the 1996 Plan expire 10
years from the date of grant. The 1996 Plan will terminate in 2006.
The Board of Directors adopted a sub-plan of the 1996 Plan for the purpose of
qualifying for preferred tax treatment under UK tax laws. The UK Inland Revenue
approved the sub-plan effective January 30, 1998.
1996 Director Option Plan ("Directors Plan")
A total of 83,334 shares of common stock has been reserved for issuance under
the Directors Plan. The Directors Plan provides for an automatic grant to each
director of an initial option to purchase 6,667 shares of common stock ("First
Option") upon the date on which such person becomes a non-employee director, and
an additional option to purchase 1,667 shares of common stock ("Subsequent
Option") each year, if the director has served on the Company's Board of
Directors for at least six months. Options granted under the Directors Plan
expire ten years after the date of grant. Twelve and one-half percent of the
shares subject to a First Option will vest six months after its date of grant
and an additional twelve and one-half percent will vest at the end of each six-
month period thereafter. One-half of the shares subject to a Subsequent Option
will vest six months after the date of the option grant and as to the remaining
one-half, one year after the date of grant. The exercise 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.
44
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following option activity occurred in all stock option plans during the
three years ended December 31, 1998:
<TABLE>
<CAPTION>
Options Weighted
Available Outstanding Average
For Grant Options Exercise 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
========= ========
The following table summarizes information about stock options outstanding at
December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------
Weighted
Number Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
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.
45
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company applies Accounting Principles Board Opinion No. 25.
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its plans. Accordingly, no compensation cost has been recognized
for its stock option plans. Had compensation cost for the Company's plans been
determined based on the fair value at the grant dates for awards under the plans
consistent with the method of SFAS No. 123, "Accounting for Stock-Based
Compensation", the Company's net loss and net loss per share would have been
changed to the pro forma amounts indicated below (in thousands):
<TABLE>
<CAPTION>
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>
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% 0% prior to the
initial public offering
and 85% thereafter
Risk-free Interest Rate 5.38-5.67% 5.59-6.50% 5.20-6.80%
Expected Lives for Each Grant 3.5 to 7 years 2.5 to 3 years 1 to 2 years
</TABLE>
8. Income Taxes
The Company follows SFAS No. 109 which prescribes an asset and liability
approach to income taxes under which deferred income taxes are provided based
upon enacted tax laws and rates applicable to the periods in which the taxes
become payable.
The provision for income taxes differs from the statutory United States
Federal income tax rate due to the following:
<TABLE>
<CAPTION>
For the Years
Ended
December 31,
---------------------------
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>
46
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
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.
47
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 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.
48
<PAGE>
Thermatrix Inc.
Notes to Consolidated Financial Statements -- (Continued)
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.
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:
<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>
49
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 Independent Public
Accountants are filed as a Financial Statements of Thermatrix Inc. and
Report of part of this Report:
Page
----
Report of Independent Public Accountants............................. 32
Consolidated Balance Sheets -- As of December 31, 1998 and 1997...... 33
Consolidated Statements of Operations -- For the Three Years Ended
December 31, 1998.................................................. 34
Consolidated Statements of Stockholders' Equity (Deficit) -- For
the Three Years Ended December 31, 1998............................ 35
Consolidated Statements of Cash Flows -- For the Three Years Ended
December 31, 1998.................................................. 36
Notes to Consolidated Financial Statements........................... 37-51
2. Financial Statement Schedules. For years ended
December 31, 1998, 1997 and 1996:
Schedule II. Valuation and Qualifying Accounts and Reserves......... 52
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.(*)
50
<PAGE>
THERMATRIX INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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.
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
10.17 Form 10K with exhibits filed March 30, 1998 by Wahlco Environmental
Systems, Inc.
10.18 Form 8K/A filed March 27, 1999 regarding the acquisition of 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 ending September 30, 1997.
(b) Reports on Form 8-K
None
Trademark Acknowledgments
. Thermatrix and PADRE(R) are registered trademarks of the Company.
51
<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.
52
<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.
By: /s/ John T. Schofield Date: March 30, 1999
---------------------
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.
/s/ John T. Schofield Chairman, President and March 30, 1999
- ---------------------------- Chief Executive Officer
John T. Schofield (Principal Executive Officer)
/s/ Daniel S. Tedone Executive Vice President and March 30, 1999
- ---------------------------- Chief Financial Officer (Principal
Daniel S. Tedone Financial and Accounting Officer)
/s/ Robi Blumenstein Director March 30, 1999
- ----------------------------
Robi Blumenstein
/s/ Harry J. Healer, Jr. Director March 30, 1999
- ----------------------------
Harry J. Healer, Jr.
/s/ Charles R. Kokesh Director March 30, 1999
- ----------------------------
Charles R. Kokesh
/s/ Frank R. Pope Director March 30, 1999
- ----------------------------
Frank R. Pope
/s/ James M. Strock Director March 30, 1999
- ----------------------------
James M. Strock
/s/ Joseph W. Sutton Director March 30, 1999
- ----------------------------
Joseph W. Sutton
/s/ John M. Toups Director March 30, 1999
- ----------------------------
John M. Toups
53
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 DEC-31-1998
<CASH> 3,990 1,544
<SECURITIES> 3,587 1,670
<RECEIVABLES> 3,863 4,768
<ALLOWANCES> 343 100
<INVENTORY> 547 0
<CURRENT-ASSETS> 11,894 8,114
<PP&E> 1,685 1,749
<DEPRECIATION> 749 1,177
<TOTAL-ASSETS> 13,987 10,092
<CURRENT-LIABILITIES> 2,038 5,846
<BONDS> 0 0
0 0
0 0
<COMMON> 8 8
<OTHER-SE> 11,949 4,246
<TOTAL-LIABILITY-AND-EQUITY> 13,987 10,092
<SALES> 7,011 13,614
<TOTAL-REVENUES> 7,011 13,614
<CGS> 8,351 13,056
<TOTAL-COSTS> 8,351 13,056
<OTHER-EXPENSES> 8,908 8,766
<LOSS-PROVISION> 220 249
<INTEREST-EXPENSE> 674 401
<INCOME-PRETAX> (9,574) (7,807)
<INCOME-TAX> (66) (66)
<INCOME-CONTINUING> (9,640) (7,873)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (9,640) (7,873)
<EPS-PRIMARY> (1.28) (1.03)
<EPS-DILUTED> (1.28) (1.03)<F1>
<FN>
<F1>All per share information has been retroactively adjusted to reflect a one for
three reverse stock split that was approved in May, 1996.
</FN>
</TABLE>
