-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SmB78qu2inRaBndbFLQXDbpTiBhBANa+U06fT3U36dfjaLACB31+5nGb+71AHvMg Ae0mOWXKupPbl+9nYSGo7A== 0000912057-99-002856.txt : 19991101 0000912057-99-002856.hdr.sgml : 19991101 ACCESSION NUMBER: 0000912057-99-002856 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19991029 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KTI INC CENTRAL INDEX KEY: 0000931581 STANDARD INDUSTRIAL CLASSIFICATION: COGENERATION SERVICES & SMALL POWER PRODUCERS [4991] IRS NUMBER: 222665282 STATE OF INCORPORATION: NJ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-25490 FILM NUMBER: 99737890 BUSINESS ADDRESS: STREET 1: 7000 BLVD E CITY: GUTTENBERG STATE: NJ ZIP: 07093 BUSINESS PHONE: 2018547777 MAIL ADDRESS: STREET 1: 7000 BOULEVARD EAST CITY: GUTTENBERG STATE: NJ ZIP: 07093 10-K/A 1 10-K/A _______________________________________________________________________________ _______________________________________________________________________________ SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 _________________ FORM 10-K/A ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 Commission File No. 0-25490 KTI, INC. New Jersey 22-2665282 7000 Boulevard East Guttenberg, New Jersey 07093 (201) 854-7777 Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common stock, no 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 the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. State the aggregate market value of the voting stock held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing: $121,950,025 at May 12, 1999 Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: 13,916,238 _______________________________________________________________________________ _______________________________________________________________________________ TABLE OF CONTENTS
ITEM NUMBER PAGE AND CAPTION NUMBER - ----------- ------ PART I Item 1. Business................................................................................ 2 Item 2. Properties.............................................................................. 16 Item 3. Legal Proceedings....................................................................... 17 Item 4. Submission of Matters to a Vote of Security Holders..................................... 18 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................... 19 Item 6. Selected Historical Consolidated Financial Information.................................. 20 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................................. 22 Item 7a. Quantitative and Qualitative Disclosure about Market Risk............................... 36 Item 8. Financial Statements and Supplementary Data............................................. 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............................................................................. 37 PART III Item 10. Directors and Executive Officers of the Registrant...................................... 37 Item 11. Executive Compensation.................................................................. 39 Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 46 Item 13. Certain Relationships and Related Transactions.......................................... 47 PART IV Item 14. Exhibits, Financial Statement Schedules................................................. 48
PART I Item 1. Business COMPANY OVERVIEW KTI was incorporated in New Jersey in 1985. KTI is a holding company that owns substantially all of its operating assets through corporate and partnership subsidiaries. KTI's operations include majority-owned consolidated subsidiaries and wholly-owned consolidated subsidiaries. MAJORITY-OWNED CONSOLIDATED SUBSIDIARIES WHOLLY-OWNED SUBSIDIARIES - Maine Energy Recovery Company, Limited - Timber Energy Resources, Inc. Partnership - K-C International, Ltd. - American Ash Recycling of Tennessee, - Manner Resins, Inc. Ltd. - Penobscot Energy Recovery Company, - Data Destruction Services, Inc. Limited Partnership - KTI Recycling of New Jersey, Inc. - KTI Recycling of New England, Inc. - KTI Specialty Waste Services, Inc. - FCR, Inc. - KTI New Jersey Fibers, Inc. - KTI Energy of Virginia, Inc.
KTI provides integrated waste handling services, including processing and recycling of wood, paper, metals, plastic and glass, municipal solid waste processing and disposal, specialty waste disposal, ash residue recycling and the manufacturing of finished products using recyclable materials. KTI's business emphasizes the use of low-cost processing to add value to the waste products delivered and, in some cases, the generation of electric power and steam. KTI operates its business under four reportable segments: - waste-to-energy; - residential recycling; - commercial recycling; and - finished products. Each reportable segment is a business unit that offers different products or services. Each is managed separately and provides distinct products or services using different production facilities. The waste-to-energy segment consists of the operations of the following: - Maine Energy Recovery Company; - Penobscot Energy Recovery Company; - Timber Energy Resource's two facilities; - Speciality Waste; - American Ash Recycling; - KTI BioFuels, Inc.; - Total Waste Management Corporation (acquired January 1998); - Multitrade Group, Inc. (acquired June 1998); - Russell Stull (acquired October 1998); and - KTI Recycling of Canada (acquired November 1998). 2 The residential recycling segment consists of the sixteen facilities that process and market recyclable materials under long-term contracts with municipalities and commercial customers which KTI acquired as part of the acquisition of FCR in August 1998. In addition, the Boston Recycling plants acquired in 1997 are included in this segment. The commercial recycling segment consists of the operations of the following: - K-C International (acquired September 1997); - KTI Recycling of New Jersey; - KTI Recycling of New England; and - KTI New Jersey Fibers, which consists of the operations of the following: - Gaccione Bros., Inc. & Co. and PGC Corporation (collectively, "Gaccione") (acquired August 1998); and - Atlantic Coast Fibers, Inc. (acquired August 1998). These operations process and market paper fibers obtained from commercial customers and broker paper fibers for KTI's processing facilities and external customers. The finished products segment consists of the operations of the following: - Power Ship Transport; - Manner (acquired November 1996); - the cellulose insulation plants and the plastic reprocessing plants acquired with FCR; - the plastic reprocessing operations of First State Recycling, Inc. (acquired August 1998); and - the glass pellet processor Seaglass, Inc. (formed in February 1998 and 80% owned by KTI). These operations manufacture or distribute finished products that use recyclable materials as their primary raw material. KTI evaluates performance and allocates resources based on profit or loss from operations before interest and income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies section of the KTI financial statements. KTI records intersegment sales at cost plus an agreed-upon profit. Please refer to the segment reporting information in KTI's notes to consolidated financial statements. WASTE-TO-ENERGY SEGMENT KTI developed and currently owns majority interests in two waste-to-energy facilities in Maine. The first facility is an 83.75% owned subsidiary, Maine Energy, a Maine limited partnership, which is located in Biddeford, Maine. The other facility is a 70.04% owned subsidiary, Penobscot, a Maine limited partnership, located in Orrington, Maine. These two facilities use non-hazardous solid waste from residential, commercial and industrial sources as their source of fuel. A third facility, part of Timber Energy Resources, located in Telogia, Florida, uses biomass waste as its source of fuel to be combusted for the production of electricity for sale to the local electric utility. KTI also operates two wood processing facilities, BioFuels in Lewiston, Maine and Timber Chip, also a part of Timber Energy Resources, in Cairo, Georgia. Total Waste Management operates an emergency response and hazardous waste site assessment and clean-up business. In addition, it also provides hazardous and non-hazardous waste management in the New England area. 3 Multitrade owns and operates three waste-to-energy facilities in Martinsville, Virginia. These facilities use biomass and coal to produce steam for sale to industrial users under long-term contracts. Russell Stull is a commercial hauler of non-hazardous waste in the state of Maine, with revenues of approximately $2.5 million in 1997. KTI Recycling of Canada produces crumb rubber from used tires using a proprietary cryogenic technology in a plant in Ontario. On December 28, 1998, the bankruptcy court in Delaware approved a Plan of Reorganization, which provided for KTI, on the one hand, and Grace Brothers, Ltd. and SC Fundamental Investments L.P., the majority bond holders of the Ford Heights, Illinois Waste Tire to Energy project, on the other hand, each to own 50% of New Heights Recovery & Power, LLC and its facility, which was built in 1996 at a cost of approximately $110 million for the purpose of combusting waste rubber to produce electricity. The bondholders converted $80 million in bonds and other claims into equity in New Heights, and KTI committed to investing up to $17 million in equity for working capital and retrofitting and upgrading of the facility. KTI holds a 35% stake in Oakhurst Company Inc., which owns two distributors in the automotive aftermarket. KTI has assigned its interest in and obligations to New Heights to Oakhurst and agreed to assign KTI Recycling of Canada's proprietary cryogenic rubber technology to Oakhurst, for use at the New Heights facility. In return, Oakhurst agreed to purchase an unspecified number of crumb rubber systems and entered into a royalty agreement with KTI to pay $0.0075 cents per tire processed by Oakhurst using these crumb rubber systems. Oakhurst also agreed to engage a subsidiary of KTI to be the operating manager of New Heights and to pay the subsidiary of KTI management fees for each facility operated. KTI has completed the acquisition of AFA Group, Inc., which is now integrated into its business. KTI also owns a 60% limited partnership interest in American Ash Recycling, a limited partnership that operates a permitted municipal waste combustor ash recycling facility in Nashville, Tennessee. This facility, which commenced operations in 1993, is the first commercially operational municipal waste combustor ash recycling facility in the United States. The waste-to-energy segment also engages in other waste management and processing activities, including commercial hauling, non-hazardous waste management, ash recycling and tire recycling. These activities are complementary extensions of the waste-to-energy facilities that enable KTI to provide a wider range of services to customers and provide strategic opportunities for future growth through vertical integration. MAINE ENERGY POWER PURCHASE AGREEMENT The electricity produced by the Maine Energy facility is sold to Central Maine Power pursuant to the power purchase agreement with Central Maine. Central Maine serves more than 490,000 customers in an 11,000 square mile service area in central and southern Maine and purchases substantial amounts of power from Canadian utilities as well as independent power producers such as Maine Energy. In 1998, Maine Energy derived approximately $16.1 million, or 54.2% of its revenues, from the sale of electricity to Central Maine. In May 1996, Maine Energy restructured its agreement with Central Maine by entering into a series of agreements with CL Power Sales One, L.L.C. and Central Maine that provided for the purchase of Maine Energy's available power generation capacity by CL Power Sales, and by amending the Central Maine agreement. CL Power Sales made an initial payment of $85 million and agreed to make additional quarterly payments through May 31, 2007 to Maine Energy as a portion of the purchase price and for reimbursement to Maine Energy of certain expenses. In consideration of its payments to Maine Energy, CL Power Sales was assigned all rights to capacity from the Maine Energy 4 facility through May 31, 2007. In the restructuring, the term of the Central Maine agreement was extended from May 31, 2007 to December 31, 2012. Under its agreements, Maine Energy has agreed to sell energy to Central Maine through May 31, 2007 at an initial rate of 7.18 cents per kilowatt-hour ("kWh"), which escalates annually by 2%. From June 1, 2007 until the expiration date of the Central Maine agreement, Maine Energy is to be paid market value for both its energy and capacity by Central Maine. Under the terms of the Central Maine restructuring, a $45.0 million letter of credit was issued to Central Maine by ING (US) Capital Corporation. - If, in any year, Maine Energy fails to produce 100,000,000 kWh of electricity and Maine Energy does not have a force majeure defense, such as physical damage to the plant and other similar events, Maine Energy must pay approximately $3.8 million to Central Maine as liquidated damages. This payment obligation is secured by the ING letter of credit. In each year in which 100,000,000 kWh is produced, the balance of the ING letter of credit is to be reduced by approximately $3.8 million. - If, in any year, Maine Energy fails to produce 15,000,000 kWh of electricity and Maine Energy does not have a force majeure defense, Maine Energy must pay the then balance of the ING letter of credit to Central Maine as liquidated damages. In 1998, the 15,000,000 kWh test was met in February and the 100,000,000 kWh test was met in August, resulting in a reduction of the amount of the ING letter of credit by approximately $3.8 million. With respect to 1999, the 15,000,000 kWh test was met in February; however, Maine Energy's past performance is no indication of its future performance. MAINE ENERGY LONG-TERM WASTE HANDLING AGREEMENTS Approximately 28% of the municipal solid waste provided to Maine Energy is delivered pursuant to waste handling agreements with 18 charter municipalities with terms expiring on June 30, 2007 or later. The agreements are substantially similar in content except that: - 16 charter municipalities are entitled to various concessions as a result of having participated in the financial restructuring of Maine Energy in 1991; and - the two "host" charter municipalities of Biddeford and Saco pay tipping fees in the amount of one-half of those paid by the other charter municipalities. Approximately 9.4% of Maine Energy's total revenue in 1998 was attributable to these long-term waste handling agreements. Under the Maine Energy long-term waste handling agreements, each municipality agrees to deliver acceptable waste to the Maine Energy facility in an amount equal to its guaranteed annual tonnage. Maine Energy is required to accept up to 110% of each municipality's guaranteed annual tonnage. A municipality is required to pay to Maine Energy the tipping fee for the amount of any shortfall from its guaranteed annual tonnage. As a corollary to the "put-or-pay" delivery guarantee, each municipality enacted a flow control ordinance pursuant to Maine law that designates the Maine Energy facility as the exclusive disposal or reclamation facility to which all acceptable waste generated within the municipality must be delivered regardless of which entity picks up waste in such municipality. See "Governmental Regulations--Flow Control." Each municipality has the right, once a year, to terminate its long-term waste handling agreement on one year's prior notice. PENOBSCOT POWER PURCHASE AGREEMENT The Penobscot facility sells the electricity it produces to Bangor Hydro under a power purchase agreement. Bangor Hydro serves approximately 97,000 customers in a 4,900 square mile service area in 5 portions of the counties of Penobscot, Hancock, Washington, Waldo, Piscataquis and Aroostook, Maine. In 1998, Penobscot derived approximately $18.9 million, or 58.7% of its revenues, from the sale of electricity to Bangor Hydro. On June 26, 1998 the Bangor Hydro agreement was restructured. Under the terms of the new power purchase agreement, Bangor Hydro agreed to purchase all the electricity generated by the Penobscot facility up to 25 megawatts (the practical limit of the facility's equipment) through 2018. Under the agreement, Penobscot is required to deliver at least 105,000,000 kWh to Bangor Hydro in any calendar year. If Penobscot fails to deliver this output, Penobscot must pay Bangor Hydro $4,000 for each 1,000,000 kWh that the deliveries fall below 105,000,000 kWh. The restructured power purchase agreement did not change this delivery obligation. PENOBSCOT LONG-TERM WASTE HANDLING AGREEMENTS As of December 31, 1998, Penobscot had in place 130 long-term waste handling agreements, of which 85 cover approximately 200 charter municipalities with terms expiring on March 31, 2018, unless terminated sooner, and all of which are substantially similar in content. The agreements provide Penobscot with approximately 195,000 tons per year of municipal solid waste. In addition, Penobscot receives approximately 18,000 tons per year of municipal solid waste from municipalities with whom Penobscot has short-term waste handling agreements, 20,000 tons per year from commercial haulers and 30,000 tons per year from the spot market. Total waste processing revenues of Penobscot in 1998 were approximately $13.7 million of which approximately 42.9% is attributable to municipal solid waste received from charter municipalities. The Penobscot long-term waste handling agreements with the charter municipalities are substantially similar to the Maine Energy long-term waste handling agreements, including the inclusion of guaranteed annual tonnages and "put-or-pay" provisions and a variable tipping fee for "pass through" and change in law costs. The performance credit received by each charter municipality may be used to reduce future tipping fee payments at the option of the charter municipalities in lieu of cash payment. The amended waste disposal agreements generally provide that the charter municipalities, Bangor Hydro, and partners in Penobscot would each receive one-third of Penobscot's cash flows. Prior to this amendment, the municipalities received one-half Penobscot's distributable cash. Based on Penobscot's cash flow, distributable cash of approximately $4.6 million was payable for 1998 and approximately $1.1 million for 1997. Of these amounts, approximately $0.4 million as of December 31, 1998 and approximately $1.1 million as of December 31, 1997 remained unpaid and was included in accrued expenses. On one year's notice, a Penobscot charter municipality may terminate its long-term waste handling agreement as of March 31, 2000 or March 31, 2002. If the termination notices received from charter municipalities cause the aggregate guaranteed annual tonnage of non-terminating municipalities to fall below 180,000 tons, Penobscot may elect to terminate all waste handling agreements with charter municipalities. No charter municipality has given a termination notice for March 31, 2000. The waste disposal agreements permit the charter municipalities to: - make equity contributions to Penobscot, only and to the extent of the Municipal Review Committee's share of distributable cash from Penobscot and one-half of the Bangor Hydro quarterly payment, of up to $31.0 million, which will be used to prepay the outstanding municipal bonds (if all $31.0 million is contributed the municipalities will own a 50% partnership interest in Penobscot); - purchase all of the remaining Penobscot interests in 2018 at the then fair market value, in lieu of the existing right to purchase Penobscot at its then book value in 2004; and - extend the term of the waste disposal agreements to 2018. 6 TIMBER ENERGY RESOURCES POWER PURCHASE AGREEMENT The Telogia facility sells the electricity that it generates to Florida Power Corporation under a power purchase agreement with Florida Power. Florida Power serves more than 1.3 million customers in a 20,000 square mile service area in central and northern Florida. During 1998, approximately 81.6% of the Telogia facility's revenue was derived from the sale of electricity to Florida Power, with the majority of the remainder from tipping fees paid by third parties. Under the power purchase agreement, Florida Power has agreed to purchase all of the energy generated by the Telogia facility, except for the energy consumed by the facility. CUSTOMERS Under the terms of their contracts, Maine Energy must sell all of the electricity generated at its facilities to Central Maine, Timber Energy Resources must sell all of its electricity to Florida Power and Penobscot must sell all of its electricity to Bangor Hydro. The loss of these customers would have a material adverse affect on the business and financial condition of KTI. COMPETITION KTI faces significant competition in each of its waste handling markets. Maine Energy and Penobscot compete with landfills and several waste-to-energy facilities and municipal incinerators in Maine and the New England region. KTI believes that the refuse derived fuel technology employed by the Maine Energy and Penobscot facilities compares favorably with the mass-burn technology used by many other waste-to-energy facilities. In refuse derived fuel systems, municipal solid waste is preprocessed to remove various non-combustible items that are recycled or landfilled. This results in a significantly reduced volume of ash residue, thereby lowering ultimate disposal costs, and is also complementary to current recycling programs. The Telogia facility competes for biomass fuel supply with paper companies that employ on-site power generation. The Telogia facility is permitted to combust 100% of tipping fee-based fuels. Competition for tipping fee based material will come principally from landfills whose cost structure is believed by KTI to be greater than that of the Telogia facility. RAW MATERIALS The raw material demands of the Penobscot facility currently are met mainly by Penobscot's long-term waste handling agreements with approximately 200 municipalities in Maine. Penobscot received approximately 75% of its raw materials in 1998 from these municipalities. Maine Energy received 28% of its raw materials in 1998 from 18 Maine municipalities under long-term waste handling agreements and the majority of the balance from commercial and private waste haulers and municipalities with short-term contracts. The Telogia facility uses biomass fuels that are a by-product of the paper pulp woodchip industry as its raw material. KTI plans to supplement and replace this raw material with tipping fee based biomass waste, such as construction and demolition debris and non-recyclable paper products. SEASONALITY The municipal solid waste market in Maine Energy's and Penobscot's market areas is seasonal, with one-third more municipal solid waste generated in the summer months than is generated during the rest of the year. 7 EMPLOYEES As of December 31, 1998, the waste-to-energy segment had a total of 255 full-time employees. The employees of the Penobscot facility and the Nashville facility are not KTI employees. The employees of Maine Energy have elected to be represented by the Operating Engineer's Union. Negotiations to enter into a collective bargaining agreement between Maine Energy and the union began on September 1, 1999. KTI considers its employee relations to be good. RESIDENTIAL RECYCLING SEGMENT The residential recycling segment consists of seventeen facilities that process and market recyclable materials under long-term contracts with municipalities and commercial customers. The recyclable materials consist principally of old newspapers, old corrugated containers, mixed paper and commingled bottles and cans consisting of steel, aluminum, plastic and glass. On August 28, 1998, KTI acquired the stock of FCR. FCR is a diversified recycling company, headquartered in Charlotte, North Carolina that provides residential and commercial recycling, processing and marketing services and manufactures finished products, such as cellulose insulation, using recyclable materials. FCR owns and operates seventeen material recycling facilities, six cellulose insulation manufacturing facilities and three plastic reprocessing facilities located in 12 states. The material recycling facilities are included in the residential recycling segment while the insulation and plastic facilities are in the finished products segment. The aggregate purchase price of approximately $63.6 million consisted of 1,714,285 shares of KTI common stock and approximately $31.1 million in cash. A significant portion of the material provided to the residential recycling segment is delivered pursuant to long-term contracts with municipal customers. The contracts generally have a term of five to ten years and these contracts expire at various times between 1999 and 2018. The terms of each of the contracts vary but all the contracts provide that the municipality or a third party deliver materials to KTI's facility. In approximately 41% of the contracts, the municipalities agree to deliver a guaranteed tonnage and the municipality pays a fee for the amount of any shortfall from the guaranteed tonnage. Under the terms of the individual contracts, KTI pays or charges the municipality a fee for each ton of material delivered. Some contracts contain revenue sharing arrangements under which KTI pays the municipality a specified percentage of the revenue from the sale of the recovered materials. The residential recycling segment derives a significant portion of its revenues from the sale of recyclable materials. The resale and purchase prices of the recyclable materials, particularly newspaper, corrugated containers, plastic, ferrous and aluminum metals, can fluctuate based upon market conditions. KTI uses long-term supply contracts with customers with floor price arrangements to reduce the commodity risk for certain recyclables, particularly newspaper and aluminum metals. Under such contracts, KTI obtains a guaranteed minimum price for the recyclable materials along with a commitment to receive additional amounts if the current market price rises above the floor price. The contracts are generally with large domestic companies that use the recyclable materials in their manufacturing process. In 1998, 66% of the revenues from the sale of recyclable materials of the residential recycling segment were derived from sales under these long-term contracts. COMPETITION The residential recycling industry is highly competitive and requires substantial capital resources and prior experience to bid on municipal contracts. Competition is both national and regional in nature. Some of the markets in which KTI competes are served by one or more of the large national solid waste companies, such as Waste Management, BFI, Allied Waste and Republic Services, as well as numerous regional and local competitors that offer competitive prices and quality service. 8 RAW MATERIALS In 1998, the residential recycling segment received 74.2% of its material under long-term agreements with municipalities. These contracts generally provide that all recyclables collected from the municipal recycling programs be delivered to a facility that is owned or operated by KTI. The quantity of material delivered by these communities is dependent on the participation of individual households in the recycling program. SEASONALITY The residential recycling segment experiences increased volumes of newspaper in November and December due to increased newspaper advertising and retail activity during the holiday season. Additionally, the facilities located in Florida experience increased volumes of recyclable materials during the winter months followed by decreases in the summer months in connection with seasonal changes in population. EMPLOYEES As of December 31, 1998, the residential recycling segment had a total of 522 full-time employees. None of the residential recycling segment's employees have collective bargaining agreements, and KTI considers its employee relations to be good. COMMERCIAL RECYCLING SEGMENT The commercial recycling segment processes and markets paper fibers obtained from commercial customers and brokers paper fibers for KTI's processing facilities and external customers. KTI has merged I. Zaitlin and Sons, Inc., a wholly-owned operating subsidiary acquired in August 1997, into KTI Recycling of New England, which remains as the surviving entity. On June 4, 1999, KTI sold all of the operating assets of KTI Recycling of Illinois, Inc. to a third party. KTI Recycling of Illinois operated a facility located in Chicago, Illinois, which served the low-grade, post-consumer recycling market. COMPETITION KTI's waste paper brokerage business and waste paper processing plants face extensive competition. Principal attributes of these markets contributing to such competition are industry-wide overcapacity and continual price pressures. CUSTOMERS The commercial recycling segment processing facilities provide recycling services to: - municipalities; - commercial haulers; and - commercial waste generators within the geographic proximity of the processing facilities. KTI acts as a broker of products, including recyclable material processed at facilities operated by the residential and commercial recycling segments, principally to paper and box board manufacturers in the United States, Canada, Pacific Rim countries, Europe and South America. RAW MATERIALS The raw materials for KTI's commercial recycling segment generally come from printers and publishing houses and other recyclers and haulers. The waste paper brokered by KTI is generated 9 principally from the commercial recycling segment, the New England facility within the residential recycling segment, from waste generators, and from third party processors. SEASONALITY The commercial recycling segment experiences increased quantities of newspaper and corrugated containers in November and December, followed by reduced quantities in January, due to increased newspaper advertising and retail activity during the holiday season. EMPLOYEES As of December 31, 1998, the commercial recycling segment had a total of 480 full time employees. The employees at KTI New Jersey Fibers in Passaic, New Jersey are represented by the Laborers' International Union under three separate collective bargaining agreements. The collective bargaining agreements expire on dates ranging from February 2000 to November 2000. On July 30, 1999, a vote was held among the employees of KTI Recycling of New Jersey to determine whether the employees would be represented by the Laborer's International Union in the collective bargaining process. The employees voted against representation by the union, but there can be no assurance that the union will not challenge the outcome of the vote or that, if challenged, the outcome will be upheld. KTI considers its employee relations to be good. FINISHED PRODUCTS SEGMENT The finished products segment consists primarily of cellulose insulation plants and plastic reprocessing plants. INSULATION DIVISION The insulation division manufactures cellulose insulation, which is primarily used in the construction of manufactured housing and single family residential homes. KTI believes it is the second largest producer of cellulose insulation in the United States and operates six manufacturing facilities located in Ronda, North Carolina; Tampa, Florida; Phoenix, Arizona; Clackamas, Oregon; Delphos, Ohio; and Waco, Texas. KTI primarily sells the insulation produced by the insulation division to the makers of manufactured housing and insulation contractors throughout the country. PLASTICS DIVISION The plastics division is a reprocessor of high density polyethylene ("HDPE") plastics collected primarily from residential recycling programs and industrial suppliers. The plastics division obtains a majority of its raw materials from the residential recycling segment. Until August 1998, the plastics division operated three manufacturing facilities located in Reidsville, North Carolina; Rockingham, North Carolina; and Hamlet, North Carolina. In August 1998, KTI closed the Rockingham plant and relocated the equipment to Reidsville and Hamlet. The plastics division has a long-term contract with its largest customer that expires on August 31, 2000. This contract requires the customer to purchase a specified quantity of plastic at prices determined by a tolling formula defined in the contract. Sales to this customer in 1998 represented 47.7% of the net revenues of the plastics division (11% of total revenues of the finished products segment). On December 23, 1998 KTI signed a long-term contract with another significant customer. COMPETITION The insulation industry is highly competitive and requires substantial capital and labor resources. 10 - In its insulation manufacturing activities, KTI primarily competes with manufacturers of fiberglass insulation such as Owens Corning, Certainteed and Schuller International. The fiberglass insulation manufacturers currently have a significant market share and are substantially better capitalized than KTI. - The largest producer of cellulose insulation is Louisiana Pacific, a large building products manufacturer. - KTI believes that it competes with cellulose and fiberglass insulation manufacturers by charging competitive prices and offering a quality product and excellent customer service support. The plastics industry is highly competitive and requires substantial capital investment in equipment. - The plastics division's primary competition comes from other reprocessors of recycled plastics, as well as suppliers of virgin HDPE resin. These competitors have significantly greater financial and other resources than KTI. - The plastics division competes primarily by obtaining a guaranteed stream of quality raw material from KTI's residential recycling segment. KTI believes that it offers competitive pricing because the cost to reprocess plastics requires a lower amount of investment in capital than the manufacturing of virgin plastic resin and usually sells at a lower price per pound. This enables the plastics division to obtain long-term supply contracts with customers to ensure a consistent sales volume for its facilities. KTI also competes with several other recycled plastic brokers and direct marketing from plastic recycling plants for post-industrial plastic scrap, and with materials recovery facilities for post-consumer plastics. KTI believes that it will continue to be competitive because of its knowledge of the plastic recycling market and its reputation and relationship with its customers. CUSTOMERS The insulation division sells its products to manufacturers of manufactured homes, insulation contractors, and retail home improvement stores throughout the United States. The plastics division sells the majority of its products under long-term contracts with two customers located adjacent to the KTI facility. RAW MATERIALS The primary raw material for the insulation division is newspaper collected from residential recycling programs, including those operated by KTI's residential recycling segment. In 1998, the insulation division purchased 9.1% of the newspaper used by it from the residential recycling segment. It purchased the remaining newspaper from municipalities, commercial haulers, and paper brokers. The chemicals used to make the newspaper fire retardant are purchased from industrial chemical manufacturers located in the United States and South America. The plastics division's primary raw materials are baled plastic containers collected from residential recycling programs, such as those operated by KTI's residential recycling segment, and ground material from industrial customers. In 1998, the plastics division purchased 53.0% of its raw material from KTI's residential recycling facilities. SEASONALITY The insulation division experiences lower sales in November and December because of lower production of manufactured housing due to holiday plant shut downs. EMPLOYEES As of December 31, 1998, the finished products segment had a total of 258 full time employees. None of the finished product segment's employees have collective bargaining agreements and KTI considers its employee relations to be good. 11 GOVERNMENTAL REGULATION GENERAL The operations of KTI's waste handling businesses are subject to extensive governmental regulations at the federal, state, local and provincial levels. KTI believes that its operations are in material compliance with existing laws and regulations material to its business. The laws, rules and regulations that govern the waste handling businesses are very broad and are subject to continuing change and interpretation. KTI cannot assure you that it will be able to obtain or maintain the licenses, permits and approvals necessary to conduct its current business or possible future expansions of its business. The failure to obtain or maintain requisite licenses, permits and approvals or otherwise to comply with existing or future laws, rules and regulations or their interpretations could have a material adverse effect on the operations of the combined company following the merger. The following discussions of statutes, regulations and court decisions are brief summaries, are not intended to be complete and are qualified in their entirety by reference to such statutes, regulations and court decisions. ENERGY AND UTILITY REGULATION Each of the Maine Energy facility, the Penobscot facility and the Telogia facility has been certified by the Federal Energy Regulatory Commission as a "qualifying small power production facility" under the Public Utility Regulatory Policies Act of 1978, as amended ("PURPA"). PURPA grants an exemption for qualifying facilities from most federal and state laws governing electric utility rates and financial organization. A qualified small power production facility is exempt from the Public Utility 12 Holding Company Act of 1935 and from certain state laws and regulations governing electric utility rates and financial organization. The rates charged by Maine Energy and Penobscot for acceptance of waste at their facilities are not subject to regulation under existing state and federal law. PURPA requires that electric utilities purchase electricity generated by qualifying facilities at a price equal to the purchasing utility's full "avoided cost". Avoided costs are defined by PURPA as the incremental costs to the utility of electric energy or capacity that the utility would generate itself or purchase from another source if it could not purchase from the qualifying facility. KTI's waste-to-energy business, which accounted for approximately 42.8% of KTI's revenue during 1998, is dependent upon electric utilities that purchase energy produced at KTI's waste-to-energy plants. Under the Central Maine agreement, the Bangor Hydro agreement and the Florida Power agreement, these utilities have agreed to purchase electricity generated by the KTI waste-to-energy facility at contractually agreed rates. Sales of electricity to these utilities accounted for approximately 54.2% of Maine Energy's, 58.7% of Penobscot's and 81.6% of the Telogia facility's revenues in 1998. In the event of the deregulation of electric utilities, certain electric companies may no longer be financially viable. If the electric utilities with whom KTI has contracts are adversely impacted by deregulation, the utilities may not be able to perform their obligations under their purchase power agreements. The State of Maine has recently enacted deregulation legislation that will require the local utilities to transfer their contracts with Maine Energy and Penobscot to newly formed regulated transmission and distribution companies. The costs of the contracts will be passed through to rate-payers beginning in the year 2000 through these transmission and distribution companies. FLOW CONTROL From time to time state and local governments have enacted to flow control ordinances. These ordinances generally require that all waste generated in a municipality be directed to a specified disposal site. The enactment of flow control ordinances was authorized by Maine law, and most of the municipalities that Maine Energy and Penobscot serve enacted such ordinances. From the municipality's perspective, having the ordinance in place was a corollary to its agreement to a "put-or-pay" waste handling agreement that requires the municipality to pay a guaranteed annual minimum fee to the waste-to-energy facility regardless of the actual amount of municipal solid waste delivered to the facility. In May 1994, in C&A Carbone, Inc. v. Town of Clarkstown, the United States Supreme Court struck down, as an unlawful violation of the "commerce clause" of the United States Constitution, a flow control ordinance enacted by the Town of Clarkstown, New York. KTI does not believe that loss of flow control provisions would adversely impact operations at either the Maine Energy facility or the Penobscot facility. The long-term waste handling agreements for such facilities contractually require the municipalities to pay for waste disposal whether or not the waste is delivered. ENVIRONMENTAL LAWS While increasing environmental regulation often presents new business opportunities to KTI, it likewise often results in increased operating costs as well. KTI strives to conduct its operations in compliance with applicable laws and regulations, including environmental rules and regulations. This effort requires programs to promote compliance, such as training employees and customers, purchasing health and safety equipment, and in some cases hiring outside consultants and lawyers. Even with these programs, KTI believes that in the ordinary course of doing business, companies in the environmental services and waste disposal industry are faced with governmental enforcement proceedings resulting in fines or other sanctions and will likely be required to pay civil penalties or to expend funds for remedial work on waste management facilities. In March 1999, KTI voluntarily disclosed to civil regulatory authorities at the Florida Department of Environmental Protection ("FDEP") violations of a condition of its Clean Water Act waste water discharge permit and related reporting obligations at its Telogia, Florida facility. On July 28, 1999, KTI 13 entered into an administrative consent order with FDEP resolving the state civil aspects of those violations. The violations involved the temperature of the water discharged from the cooling process. Under the consent order, KTI was required to pay penalties and expenses totaling $131,000 and must satisfy certain interim waste water discharge monitoring and reporting requirements, submit and implement a plan of study for the purpose of obtaining a revised permit, and either obtain a revised permit or install additional cooling equipment at the facility. KTI believes it is currently in compliance with the interim requirements. Substantial expenditures could result from governmental proceedings. In addition, federal, state and local regulators have the power to suspend or revoke permits or licenses needed for operation of our plants, equipment, and vehicles or any of our operating subsidiaries based on its compliance record. Also, customers may decide not to use a particular disposal facility or do business with a company because of concerns about its compliance record. Suspension or revocation of permits or licenses would have a negative impact on our business and operations and could have a material adverse impact on our financial results. KTI's waste-to-energy, ash recycling and wood processing business activities at its facilities and its transportation and waste disposal business activities are regulated pursuant to federal, state and local environmental laws. Federal laws such as the Clean Air Act of 1990 as amended, and the Clean Water Act and their state analogs govern discharges of pollutants from waste-to-energy facilities to air and water, and other federal, state and local laws such as the Resource Conservation and Recovery Act of 1976, as amended ("RCRA"), comprehensively govern the generation, transportation, storage, treatment and disposal of solid waste. These environmental regulatory laws, and others such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended ("CERCLA"), may make KTI potentially liable in the event of environmental contamination associated with its activities, facilities or properties. The environmental regulatory laws and regulations or licenses and permits issued thereunder also establish operational standards, including specific limitations on emissions of certain air and water pollutants. Failure to meet these standards could subject the facilities to enforcement actions and, unless excused by particular circumstances, fines or other liabilities. Standards established pursuant to the environmental regulatory laws and governmental policies governing their enforcement may change. For example, new technology may be required or stricter standards may be established for the control of discharges of air or water pollutants or for solid waste or ash handling and disposal. Such future developments could affect the manner in which KTI operates its facilities and could require significant additional capital expenditures to achieve compliance with such requirements or policies and other environmental remediation laws may subject KTI to strict joint and several liability for the costs of remediating contamination associated with contaminated sites, including landfills, at which there has been disposal of residue or other waste handled, transported or processed by KTI and real property owned by KTI that may be contaminated. Applications have been made for the air emissions permits for the Maine Energy, Penobscot and Telogia facilities. Under Maine regulatory law, a permit continues in effect provided that a timely application for renewal is made. In Maine Energy's case, the application was submitted in compliance with state mandate during August 1996. In December 1996, a public hearing was held by the Maine Department of Environmental Protection on the application and to address the favorable results of an independently conducted health risk assessment pertaining to Maine Energy. In the case of Penobscot, a renewal application was submitted in advance of the deadline. Penobscot is awaiting notification from the state of Maine to finalize approval of the air emission permit. KTI believes that the Maine Energy, Penobscot and Telogia facilities are in compliance with the federal Clean Air Act, its implementing regulations and all other applicable regulations and, therefore, KTI anticipates that the permits will be renewed following the hearings. There can be no assurance, however, that new conditions will not be imposed in the permits or that the permits will be renewed. 14 In City of Chicago v. Environmental Defense Fund, a case interpreting provisions of RCRA, the United States Supreme Court determined that the generation of ash residue from waste-to-energy facilities in the incineration process is not exempt from hazardous waste regulation. The ash produced at the Maine Energy, Penobscot and the Telogia facilities is typically tested for hazardous wastes and has generally met the requirements of non-hazardous material according to the regulations implementing RCRA promulgated by the Environmental Protection Agency since their adoption. Any ash residue that is designated as hazardous material is disposed of according to regulations governing the disposal of such material. Moreover, KTI's ash residue is disposed in landfills segregated to accept ash residue only, and, to KTI's knowledge, the landfill facilities at which the ash residue is disposed meet or exceed the applicable standards for such facilities under RCRA. Further, KTI has been indemnified by Waste Management of Maine, Inc. with respect to potential environmental liabilities relating to ash residue delivered for disposal by Maine Energy. There can be no assurance, however, that the current regulations governing the testing and disposition of ash residue will not be modified and made more stringent and require operational or technological adjustments at the Maine Energy, Penobscot and the Telogia facilities, which adjustments could have a material adverse effect on the operation of such facilities and the financial viability or profitability of the combined company. Maine Energy's waste handling agreements with its host communities of Biddeford and Saco prescribe a set of standards for noise, odor and ash emissions from the Maine Energy facility and impose penalties in the event of non-compliance. Since the Maine Energy facility is sited directly in the commercial area of Biddeford, KTI has implemented stringent operational practices to mitigate the escape of odors from the Maine Energy facility including the use of air lock doors at the waste-hauling trucks' entrance to, and exit from, the facility's tipping floor. KTI's Total Waste Management subsidiary is involved in the transportation of both liquid and solid waste. Total Waste Management is a hazardous waste transporter and operates both a hazardous waste and a special waste transfer facility at its Newington, New Hampshire site. Total Waste Management also operates a 700,000 gallon used oil processing and marketing facility at the Newington site. FORWARD-LOOKING STATEMENTS All statements contained herein and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" that are not historical facts, including but not limited to statements regarding the Company's current business strategy, prospective joint ventures, and plans for future development and operations and predictions of future tipping fees, management fees payable to KTI, future compliance with applicable laws and governmental regulations, future capacity and processing amounts and cash flow and its uses, are based upon current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties, many of which are not within the Control of the Company. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: (i) the availability of sufficient capital to finance the Company's business plan and its other capital needs on terms satisfactory to the Company, (ii) competitive factors such as availability of less expensive waste disposal outlets or expanded recycling programs that may significantly reduce the amount of waste products available to the Company's facilities; (iii) changes in labor, equipment and capital costs; (iv) the ability of the Company to consummate any contemplated joint ventures and/or restructuring on terms satisfactory to the Company; (v) changes in regulations affecting the waste disposal and recycling industries; (vi) the ability of the Company to comply with the restrictions imposed upon it in connection with its outstanding indebtedness; (vii) future acquisitions or strategic partnerships; (viii) general business and economic conditions; and (ix) other factors described from time to time in the Company's reports filed with the Securities and Exchange Commission. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which statements are made pursuant to the Private Litigation Reform Act of 1995 and, as such, speak only as of the date made. 15 ITEM 2. PROPERTIES The following is a summary of the principal properties of KTI as of July 31, 1999.
SQUARE FACILITY TYPE LOCATION FEET STATUS - --------------------------- --------------------------- ---------------- --------- --------------------------- WASTE-TO-ENERGY Maine Energy (majority Power Generation Biddeford, ME 137,000 Owned owned) Penobscot (majority owned) Power Generation Orrington, ME 177,000 Owned Telogia Facility Power Generation Telogia, FL 73,000 Owned Multitrade-Martinsville Steam Generation Martinsville, VA 24,000 Owned Multitrade-Martinsville Steam Generation Martinsville, VA 11,000 Owned Multitrade-Dupont Steam Generation Martinsville, VA 1,300 Lease expiring 2015 American Ash Recycling Ash Recycling Nashville, TN 15,000 Note 1 (majority owned) Total Waste Management and Waste Processing Newington, NH 6,500 Owned Specialty Waste BioFuels Waste Processing Lewiston, ME 14,700 Lease expiring 2015 Cairo Facility Wood Processing Cairo, GA 6,000 Owned KTI Recycling of Canada Tire Processing Cambridge, 32,000 Owned Ontario, Canada Administrative Office Space Saco, ME 5,800 Lease expiring 2003 AFA Group Mulch Processing Newark, NJ 70,000 Lease expiring 2004 RESIDENTIAL RECYCLING Boston Commercial Recycling MRF Charlestown, MA 62,000 Lease expiring 2002 Plant Boston Recycling Plant MRF Charlestown, MA 75,000 Lease expiring 2002 Stratford MRF Stratford, CT 46,000 Note 2 Mecklenburg County MRF Charlotte, NC 90,000 Note 2 Greensboro MRF Greensboro, NC 42,000 Lease expiring 2003 Camden MRF Camden, NJ 45,000 Lease expiring 2003 Lee County MRF Ft. Myers, FL 45,000 Note 2 Morris County MRF Mine Hill, NJ 26,000 Lease expiring 2000 Memphis MRF Memphis, TN 40,000 Note 1 Washington MRF Alexandria, VA 50,000 Lease expiring 2005 Hartford MRF Hartford, CT 45,000 Note 1 Greenville MRF Greenville, SC 60,000 Lease expiring 2002 West Palm Beach MRF West Palm, FL 70,000 Note 2 Ann Arbor MRF Ann Arbor, MI 30,000 Note 2 Saginaw MRF Saginaw, MI 25,000 Owned Columbia County MRF Claverack, NY 18,000 Owned Athen/Clarke MRF Athens, GA 22,000 Owned Sarasota MRF Sarasota, FL 33,000 Owned Administration Office Space Charlotte, NC 20,000 Lease expiring 2003 COMMERCIAL RECYCLING KTI Recycling of New MRF/Warehouse Biddeford, ME 30,000 Owned England KTI Recycling of New MRF Biddeford, ME 12,000 Owned England KTI Recycling of New Jersey MRF Newark, NJ 135,000 Lease expiring 2007 KTI New Jersey Fibers MRF/Office Passaic, NJ 85,000 Lease expiring 2006 K-C International Office Portland, OR 2,352 Lease expiring 2000 K-C International Office Lakewood, NJ 1,865 Lease expiring 2000 FINISHED PRODUCTS Ronda Insulation Ronda, NC 77,000 Lease expiring 2005 Tampa Insulation Tampa, FL 70,759 Lease expiring 2018 Clackamas Insulation Clackamas, OR 10,000 Lease expiring 2002 Delphos Insulation Delphos, OH 26,000 Lease expiring 2003 Phoenix Insulation Phoenix, AZ 31,820 Lease expiring 2004 Waco Insulation Waco, TX 60,000 Lease expiring 2006 Reidsville Plastic Reprocessing Reidsville, NC 80,000 Lease expiring 2007 Hamlet Plastic Reprocessing Hamlet, NC 46,400 Lease expiring 2000 First State Plastic Reprocessing Wilmington, DE 40,000 Lease expiring 2003 Manner, Power Ship Office Annapolis, MD 2,000 Lease expiring 2003 Seaglass Glass Processing Newark, NJ 5,000 Lease expiring 2007 CORPORATE Executive Office Office Guttenberg, NJ 5,000 Lease expiring 2001
- ------------------------ Note 1: The facility is owned and operated by a subsidiary of KTI; however, the land on which the facility is located is owned by the municipality. Note 2: These properties are owned by the municipalities and operated by a subsidiary of KTI 16 ITEM 3. LEGAL PROCEEDINGS On May 11, 1994, Maine Energy filed a suit in a Maine state court against United Steel Structures, Inc. under a warranty to recover the costs which were, or will be incurred to replace the roof and walls of the Maine Energy tipping and processing building. The judge in the case entered an order awarding Maine Energy approximately $3.3 million plus interest from May 10, 1994, to the date of the filing of the lawsuit, and court costs. The defendant filed an appeal on December 19, 1997. In February 1999, the appellate court reversed the trial court's verdict in favor of KTI and returned the case to the trial court, which ordered a new trial. On September 30, 1997 and March 6, 1998, Capital Recycling of Connecticut filed two suits in a Connecticut state court against K-C International, certain officers of K-C International and other parties. The suits allege fraud, tortious interference with business expectancy and violations of the Connecticut Unfair Trade Practices Act. The actions are based on two contracts between Capital and K-C International. The contracts require all disputes to be resolved by arbitration in Portland, Oregon. Pursuant to this requirement, K-C International initiated the arbitration process in Portland, Oregon. Subsequently, the parties agreed to arbitrate the dispute in Hartford, Connecticut. Discovery is now in process and the parties are currently attempting to mediate the dispute before going to arbitration. The plaintiffs are seeking approximately $1.9 million in damages. KTI believes it has meritorious defenses to these claims. If, however, the damages claimed by the plaintiffs are awarded, KTI's business, financial condition and results of operations could be materially adversely affected. On September 30, 1998, the Equal Employment Opportunity Commission filed a lawsuit against FCR Tennessee, Inc. in the United States District Court for the Western District of Tennessee, alleging sexual harassment by two managers and a sexually hostile work environment. The complainants seek compensation for past and future pecuniary and non-pecuniary losses as well as punitive damages and potential reinstatement of employment for Valerie L. Jacobs. FCR has retained counsel to defend this suit and has reported the lawsuit to FCR's director's and officer's insurance carrier. Management is currently reviewing the lawsuit. The plaintiffs have demanded $105,000 and KTI has offered $30,000 in settlement. No agreement on a settlement has been reached. KTI's insurance carrier has agreed to defend the case. On April 1, 1999, William F. Kaiser, a former Executive Vice President and Treasurer of KTI, filed a lawsuit against KTI in the U.S. District Court for the District of New Jersey. The suit alleges breach of contract, wrongful termination, breach of the implied covenant of good faith and fair dealing, misrepresentation of employment terms and failure to pay wages, all arising out of Mr. Kaiser's employment agreement with KTI. The suit also alleges that KTI inaccurately reported its financial results for the first quarter of 1998 and failed to properly disclose the change of control provision in Mr. Kaiser's employment agreement. Mr. Kaiser is seeking a declaratory judgment that, upon closing of the merger, the change of control provision entitles him to receive a severance payment of two years' salary, in the amount of $320,000, and to exercise 132,000 unvested options for KTI common stock. Mr. Kaiser is also seeking damages in the amount of $40,000 for an additional severance payment, as well as undisclosed damages for outstanding salary, bonus and other payments and from his sale of approximately 50,000 shares of KTI common stock resulting from KTI's allegedly inaccurate financial reports. On April 6, 1999, Dennis McDonnell filed a lawsuit in a Florida state court against U.S. Fiber, Inc., a subsidiary of FCR. Mr. McDonnell, a former employee of U.S. Fiber, seeks a declaratory judgment regarding his rights and obligations under an employment non-competition agreement and an employment agreement that he previously had signed with two corporations that subsequently were merged with and into U.S. Fiber. KTI is defending the suit and believes it has meritorious defenses. On April 15, 1999, C.H. Lee, a former employee of FCR and a former majority shareholder of Resource Recycling, Inc., commenced arbitration proceedings in Charlotte, North Carolina against KTI, FCR and FCR Plastics, Inc. in connection with the acquisition of Resource Recycling by FCR. Mr. Lee alleges that FCR and FCR Plastics acted to frustrate the "earn-out" provisions of the acquisition 17 agreement and thereby precluded Mr. Lee from receiving, or alternatively, reduced, the sums to which he was entitled to under the agreement. He also alleges that FCR and FCR Plastics wrongfully terminated his employment agreement. The claim for arbitration alleges direct charges in excess of $5.0 million and requests punitive damages, treble damages and attorneys fees. KTI, FCR and FCR Plastics responded to the demand, denying liability, and filed a counterclaim for $1.0 million for misrepresentations. KTI believes it has meritorious defenses to these claims. If, however, the damages and charges claimed by Mr. Lee are awarded, KTI's business, financial condition and results of operation could be materially adversely affected. On or about April 26, 1999, Salvatore Russo filed an action in the U.S. District Court, District of New Jersey against KTI and two of its principal officers, Ross Pirasteh and Martin J. Sergi, purportedly on behalf of all shareholders who purchased KTI common stock from May 4, 1998 through August 14, 1998. Melanie Miller filed an identical complaint on May 14, 1999. The complaints allege that the defendants made material misrepresentations in KTI's quarterly report on Form 10-Q for the period ended March 31, 1998 in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, concerning KTI allowance for doubtful accounts and net income. The plaintiffs are seeking undisclosed damages. KTI believes it has meritorious defenses to these complaints. On June 15, 1999, Mr. Russo and Ms. Miller, together with Fransisco Munero, Timothy Ryan and Steven Storch, moved to consolidate the two complaints. This motion is currently pending in the District Court of New Jersey. On July 1, 1999, Michael P. Kuruc filed a demand for arbitration in Charlotte, North Carolina, seeking approximately $1.0 million for compensation due under an employment agreement that he alleges he has with KTI and losses allegedly suffered in connection with his sale of KTI common stock. KTI believes that it has meritorious defenses and has retained counsel to defend this suit. If, however, the damages claimed by Mr. Kuruc are awarded, KTI's business, financial condition and results of operation could be materially adversely affected. KTI is a defendant in certain other lawsuits alleging various claims incurred in the ordinary course of business, none of which, either individually or in the aggregate, KTI believes are material to its financial condition, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS Not applicable. 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCK HOLDER MATTERS The following table sets forth the high and low sale prices for the Common Stock for the periods indicated, as reported on the NASDAQ Company's National Market System under the symbol KTIE.
High Low Price Price ------- -------- January 1, 1997 through March 31, 1997................................................ 9 1/2 7 9/64 April 1, 1997 through June 30, 1997................................................... 9 1/2 7 3/8 July 1, 1997 through September 30, 1997............................................... 14 7/8 8 7/8 October 1, 1997 through December 31, 1997............................................. 17 1/2 14 1/8 January 1, 1998 through March 31, 1998................................................ 17 3/16 15 3/16 April 1, 1998 through June 30, 1998................................................... 23 3/4 16 1/2 July 1, 1998 through September 30, 1998............................................... 25 1/2 15 October 1, 1998 through December 31, 1998............................................. 24 3/8 15 3/4
On May 12, 1999, the last reported sale price of the Common Stock as reported on the NASDAQ National Market System was $11 3/8 per share. There were 242 record owners of the Company's 13,916,238 outstanding shares of Common Stock as of May 12, 1999. The Company has not paid any cash dividends on its Common Stock or the Series A Convertible Preferred Stock. On February 28, 1997, a 5% stock dividend was declared, payable on March 28, 1997 to holders of Common Stock of record on March 14, 1997. The Company's bank credit facility contains restrictions on the payment of cash dividends on the Common Stock. It is anticipated that for the foreseeable future, the Company will use its capital for strategic opportunities and to reduce debt and not pay cash dividends on its Common Stock. 19 ITEM 6. SELECTED HISTORICAL FINANCIAL INFORMATION
FISCAL YEAR ENDED DECEMBER 31, ------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenues............................. $ 179,007 $ 98,587 $ 35,717 $ 38,083 $ 37,783 Cost of operations................... 144,885 69,296 19,499 18,634 22,656 Selling, general and administrative..................... 5,977 2,978 2,389 2,941 2,401 Restructuring charge................. -- -- -- -- -- Asset impairment charge.............. -- -- -- -- -- Depreciation and amortization........ 13,749 6,786 6,694 7,505 2,843 ---------- --------- --------- --------- --------- 164,611 79,060 28,582 29,080 27,900 ---------- --------- --------- --------- --------- Income from operations............... 14,396 19,527 7,135 9,003 9,883 Other expense, net................... 10,667 4,696 4,427 9,044 9,391 ---------- --------- --------- --------- --------- Income (loss) from continuing operations before minority interest, provision (benefit) for income taxes, extraordinary item and cumulative effect of change in accounting principle............... 3,729 14,831 2,708 (41) 492 Minority interest(1)................. (3,702) (7,244) (1,185) (1,287) (1,920) ---------- --------- --------- --------- --------- Income (loss) from continuing operations before provision (benefit) for income taxes, extraordinary item and cumulative effect of change in accounting principle.......................... 27 7,587 1,523 (1,328) (1,428) Provision (benefit) for income taxes.............................. (3,023) (2,586) -- 65 -- Extraordinary item................... 351 -- 2,248 (148) -- Loss from discontinued operations.... -- -- 714 86 -- Cumulative effect of change in accounting principle............... -- -- -- -- -- ---------- --------- --------- --------- --------- Net income (loss).................... 2,699 10,173 (1,439) (1,331) (1,428) Accretion and paid and accrued dividends on preferred stock....... (1,133) (1,408) -- -- -- ---------- --------- --------- --------- --------- Net income (loss) available to common stockholders....................... $ 1,566 $ 8,765 $ (1,439) $ (1,331) $ (1,428) ---------- --------- --------- --------- --------- ---------- --------- --------- --------- --------- Per Share Data: Basic: Income (loss) from continuing operations....................... $ 0.18 $ 1.18 $ 0.25 $ (0.26) $ (0.42) Loss from discontinued operations.. (0.12) (0.02) ---------- --------- --------- --------- --------- Income (loss) before extraordinary item............................. 0.18 1.18 0.13 (0.28) (0.42) Extraordinary item................. (0.03) (0.37) 0.03 ---------- --------- --------- --------- --------- Net income (loss).................. $ 0.15 $ 1.18 $ (0.24) $ (0.25) $ (0.42) ---------- --------- --------- --------- --------- ---------- --------- --------- --------- --------- Weighted average number of shares used in computation............... 10,549 7,404 6,091 5,264 3,409 ---------- --------- --------- --------- --------- ---------- --------- --------- --------- --------- Diluted: Income (loss) from continuing operations....................... $ 0.17 $ 1.08 $ 0.24 $ (0.26) $ (0.42) Loss from discontinued operations.. 0.11 (0.02) ---------- --------- --------- --------- --------- Income (loss) before extraordinary item............................. 0.17 1.08 0.13 (0.28) (0.42) Extraordinary item................. (0.03) (0.36) 0.03 ---------- --------- --------- --------- --------- Net income (loss).................. $ 0.14 $ 1.08 $ (0.23) $ (0.25) $ (0.42) ---------- --------- --------- --------- --------- ---------- --------- --------- --------- --------- Weighted average number of shares used in computation............... 11,398 8,426 6,255 5,264 3,409 ---------- --------- --------- --------- --------- ---------- --------- --------- --------- ---------
20
DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents......................................... $ 9,426 $ 11,181 $ 5,227 $ 6,454 $ 7,386 Working capital (deficit)(4)...................................... 42,826 21,957 9,084 8,713 8,517 Property and equipment, net....................................... 213,669 164,753 99,126 86,363 91,989 Total assets...................................................... 436,485 252,487 133,615 132,906 131,383 Long-term obligations, less current maturities.................... 202,153 74,473 34,949 107,398 121,979 Redeemable preferred stock........................................ -- 25,132 -- -- -- Total stockholders' equity (deficit).............................. 98,187 59,716 10,599 6,881 (3,911)
- ------------------------------ (1) Minority interest for the year ended December 31, 1997, includes $4,620 and $102 for preacquisition earnings of PERC and AARNE, respectively. Minority interest for the year ended December 31, 1994 includes $1,367 of preacquisition earnings of Maine Energy. (2) An adjustment for shares issued during the twelve month period prior to the Company's initial registration statement has been made. (3) All periods reflect the effect of a 5% common stock dividend declared by the Board of Directors on February 28, 1997 and paid March 28, 1997. (4) See "ITEM 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of factors such as accounting changes, business combinations and dispositions of business operations that materially affect the comparability of information reflected herein. 21 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (ALL AMOUNTS IN THOUSANDS UNLESS OTHERWISE INDICATED) GENERAL The Company is a holding company that derives its earnings from its subsidiaries. During 1998, as part of its integrated waste management strategy, the Company acquired several businesses and additional partnership interests. The Company continued the expansion of its capabilities in the Waste-to-Energy segment with the acquisitions of TWM, Multitrade, RTI, New Heights and Russell Stull. These acquisitions expanded the scope of the Company's waste processing capabilities as well as increased the number of waste-to-energy facilities. The Company also continued to execute its strategy of increasing its ownership of its existing waste-to-energy plants with the increase in its ownership in Maine Energy to 83.75% through the purchase of a 9.6% limited partnership from CNA. This transaction was not completed until December 30, 1998; thus, it does not have a significant impact on the results of operations for 1998. To expand into additional post-industrial and post-consumer recycling and the manufacture of finished products using recyclable materials, the Company acquired FCR. FCR is headquartered in Charlotte, North Carolina and operates seventeen material recycling facilities, six cellulose insulation manufacturing facilities, and three plastic reprocessing facilities located in 12 states. The Company also acquired Atlantic Coast and 22 Gaccione which increased the Company's processing capabilities with the addition of a recycling facility in Passaic, New Jersey. Atlantic Coast and Gaccione also strengthen the Company's capabilities in the marketing of paper fibers. To supplement its plastics recycling and processing capabilities, the Company acquired First State. WASTE-TO-ENERGY SEGMENT The Company, since inception, has developed and managed waste-to-energy facilities. The Company's subsidiaries, Maine Energy and PERC, both take in municipal solid waste and the Telogia Facility takes in bio-mass waste and convert it into fuel which is consumed in the generation of electric power. A subsidiary of the Company is the operator of Maine Energy on a cost-plus basis and a co-operator of PERC on an annual fee basis. The waste-to-energy facilities principally derive their revenues from sale of electric power and steam generated from the combustion of waste products which is sold under long-term contracts with local utilities or commercial customers. Maine Energy and PERC also receive tipping fees under long-term, short-term, and commercial waste disposal contracts with municipalities and spot market waste received from commercial haulers. The remaining waste-to-energy facilities obtain a low percentage of their fuel supply under short-term tipping fee contracts with biomass waste generators and haulers. The Company's MSW waste disposal operations are subject to seasonal fluctuations. Reduced volumes of waste are generated during the winter months. The Company's Maine facilities are located in summer vacation areas. The waste-to-energy facilities also have periodic scheduled shutdowns each year, usually two weeks in April or May, for major maintenance and capital projects. In June 1998, PERC refinanced its bonds payable. In connection with the refinancing of PERC's bonds payable, the Bangor Hydro PPA was amended whereby BHE, which purchases the power from PERC, made a one-time payment of $6.0 million in cash and issued a non-interest bearing note due in 16 quarterly payments of $250,000 commencing on October 1, 1998 (the "BHE Payments") and issued warrants to a subsidiary of the Company to purchase shares of BHE common stock. The $6.0 million payment, the present value of the BHE payments (approximately $3.6 million) and the warrants valuation of approximately $3.8 million were deferred and are being amortized over the term of the BHE Power Purchase Agreement (19 years). Beginning as of the date of the amended waste disposal agreement, BHE is entitled to receive a one-third share of PERC's distributable cash. Concurrent with the refinancing of the bonds payable and the amendment to the Bangor Hydro PPA, the Waste Disposal Agreements with certain municipalities ("Amending Charter Municipalities") were amended to extend the term of such agreements to the year 2019. In addition, PERC granted the Amending Charter Municipalities the right to purchase up to a 50% limited partnership interest in PERC for $31.0 million. Such purchases may only be made to the extent of their share of distributable cash from PERC, as defined, and one-half of the BHE Payments. Such amounts paid must be used to prepay the portion of the 1998 bonds then outstanding. The Amending Charter Municipalities were also granted the right to purchase the remaining partnership interest in 2018 at the then fair market value, as defined in the partnership agreement. The Waste Disposal Agreements were further amended to provide that the Amending Charter Municipalities would receive a one-third share of PERC's distributable cash, as defined, as a Performance Credit. Prior to this amendment, the municipalities received a Performance Credit equal to one-half PERC's distributable cash, as defined. The restructuring of the Bangor Hydro PPA and the Waste Disposal Agreements improve the long-term prospects for PERC through securing the volume of MSW delivered to the facility for an extended period and providing a competitive PPA for BHE. This enables BHE to remain competitive in the changing competitive market for electric power. 23 RESIDENTIAL RECYCLING SEGMENT In August 1998, the Company expanded its capabilities in the processing of post-consumer materials from residential recycling programs with the acquisition of FCR. This acquisition provided a management team with operating expertise which will enable the Company to add additional facilities in the future. Approximately 74.2% of the material processed by the Residential Recycling facilities is delivered pursuant to long-term contracts with municipal customers with terms from five to ten years. The Company pays or charges the municipality a fee for each ton of material delivered. These contracts also frequently contain revenue sharing arrangements, under which the Company pays the municipality a specified percentage of the revenue from the sale of the recovered materials. The Residential Recycling facilities generate additional revenues from the sale of the recyclable materials. The revenues received from the sale of recyclable materials fluctuate with the changes in the market prices. The Company utilizes long-term supply contracts with customers with floor price arrangements to minimize commodity volatility and risk for certain recyclables. Under such contracts, the Company obtains a guaranteed minimum price ("floor price") for the recyclable materials along with a commitment to receive additional amounts if current market prices rise above the floor price. In general, the Company's strategy is to utilize long-term supply contracts with its customers to support the long-term contracts with municipalities and thus support the profitability of each contract. COMMERCIAL RECYCLING SEGMENT In August, 1998, the Company expanded its capabilities to process post-industrial and post-consumer paper fibers with the acquisition of Atlantic Coast and Gaccione. This acquisition also increased the Company's market share in the northern New Jersey market. This will enable the Company to integrate its existing facility in Newark, New Jersey into the marketing efforts of Atlantic Coast and Gaccione in an effort to increase volumes and improve the profitability of the Newark facility. The operations of the Commercial Recycling segment have continued to fall below management's expectations due to low volumes in the processing plants, reduced brokerage volumes as a result of the economic situation in the Pacific Rim, and lower commodity prices which reduced profit margins in this segment. The Company continues its efforts to improve the overall profitability of the remaining commercial plants located in Charlestown, Massachusetts, Franklin Park, Illinois and Biddeford, Maine. Subsequent to December 31, 1998, the Company began negotiating with a third party to sell the Franklin Park facility for an amount which approximates the carrying cost of this facility. Management expects to complete this transaction in 1999, though there can be no guarantee that this transaction can be successfully completed. The Commercial Recycling segment contains K-C, which operates a worldwide secondary fiber and pulp brokerage operation. K-C markets the majority of the materials processed and exported by the commercial recycling facilities. The Company's strategy is to integrate the marketing capabilities of K-C, Atlantic Cost and Gaccione to improve the prices available for the recyclable materials and reduce costs by streamlining the operations of these units. The Company is also focused on improving profitability through analysis of the profitability of individual customer accounts and the installation of new information systems. FINISHED PRODUCTS SEGMENT The Company entered into a new line of business with the addition of the manufacturing capabilities of FCR and First State. The Company's strategy is to expand its capabilities in the creation of finished products which utilize recyclable materials as a primary raw material in the manufacturing process. This reduces the risk of commodity price fluctuations by offsetting changes in the price of the recyclable materials produced by the Residential Recycling segment with changes in the cost to manufacture the finished products produced by the Finished Products segment. This strategy also offers the finished products segment a secure supply of quality raw materials. The Insulation Division manufactures cellulose insulation which is primarily used in the construction of manufactured housing and single family residential homes. The Company is the second largest producer of 24 cellulose insulation in the country. Throughout 1998, the Company operated five manufacturing facilities located in Ronda, North Carolina; Tampa, Florida; Phoenix, Arizona; Clackamas, Oregon and Delphos, Ohio. The Company constructed a sixth plant in Waco, Texas, which began operations in February 1999. The insulation produced by the Insulation Division is primarily sold to the manufacturers of manufactured housing and insulation contractors throughout the country. The primary raw material for the Insulation Division is ONP collected from residential programs such as those operated by the Residential Recycling segment. The ONP is received in a bale or loose form and processed through a system of mills, screens, and filtration systems. It is chemically treated utilizing a proprietary technique during the manufacturing process in order to comply with all federal and state governmental requirements regarding fire retardance. The Plastics Division is a reprocessor of HDPE plastics collected primarily from residential recycling programs and industrial suppliers. The majority of the Plastics Division's raw materials are obtained from the Residential Recycling segment. For most of the year, the Plastics Division operated three manufacturing facilities located in Reidsville, North Carolina; Rockingham, North Carolina; and Hamlet, North Carolina. However the Rockingham, North Carolina plant was closed and the equipment relocated to Reidsville and Hamlet during 1998. Plastics products are substitutes for "virgin" HDPE plastic resin. Accordingly, the price of the Company's reprocessed plastics materials varies based on the market price for "virgin" HDPE resin. In order to reduce its vulnerability to price swings, the Company sells its reprocessed plastics under a "tolling" arrangement. Under this arrangement, the price charged by the Company fluctuates with the market price of the recycled plastics. Thus, the risk of fluctuating prices for the recycled plastics is borne by the Company's suppliers and customers. The Plastics Division has a long-term contract with its largest customer, which expires on August 31, 2000. This contract requires the customer to purchase a specified quantity of plastic at prices determined by a tolling formula defined in the contract. On December 23, 1998, the Company signed a long-term contract with another large customer. Both customers produce finished products adjacent to the Plastics Division facility in Reidsville, North Carolina. The Plastic Division manufacturing plants are complementary to Manner which is a broker of post-industrial and post-consumer plastics. The combination of these capabilities will enable the Company to expand its capabilities in plastic recycling and maintain its prominence in an expanding portion of the recycling industry. The Company's strategy is to continue expansion of its processing capabilities in the Finished Products segment. This expansion will further mitigate the impact of commodity price fluctuations on the Company's margins. It also offers the Company the opportunity to continue its growth by entering markets which are extensions of its capabilities in other business segments. DISCONTINUED OPERATIONS On July 19, 1996, DataFocus, a wholly owned subsidiary of the Company, executed an agreement with CIBER. Pursuant to the Agreement, DataFocus sold substantially all of the assets of DataFocus' Business Systems Division, other than cash and accounts receivable, to CIBER for $5.0 million, subject to customary prorations. DataFocus retained cash, accounts receivables and substantially all of the liabilities of its Business Systems Division that arose prior to July 26, 1996. The net proceeds of such sale, including cash and accounts receivable retained, less related liabilities, were approximately $4.3 million. Additionally, on July 29, 1996, the Company sold the stock of DataFocus to certain members of the management of DataFocus. Pursuant to the sale, the Company received $5,000 in cash, the cancellation of stock options issued to DataFocus management to purchase 132,328 shares of the Company's Common Stock, the cancellation of an option to purchase 20% of the common stock of DataFocus and a royalty agreement. The Company received royalties of $60,000 in 1998 and 1997. A loss from discontinued operations of approximately $0.7 million for the year ended December 31, 1996 resulted from the sale and disposal of the Company's computer service division. 25 COMPARISON OF YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
YEAR ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ------------------------------------------------------------------ 1998 1997 1996 --------------------- -------------------- --------------------- Revenues...................................... $ 179,007 100.0% $ 98,587 100.0% $ 35,717 100.0% Cost of operations............................ 156,664 87.5% 75,864 77.0% 26,048 72.9% ---------- --------- --------- --------- ---------- --------- Gross Profit................................ 22,343 12.5% 22,723 23.0% 9,669 27.1% Selling, general and administrative........... 7,947 4.4% 3,196 3.2% 2,534 7.1% ---------- --------- --------- --------- ---------- --------- Income from operations........................ 14,396 8.1% 19,527 19.8% 7,135 20.0% Interest expense, net......................... 10,667 6.0% 5,086 5.2% 4,464 12.5% Other income, net............................. -- (390) (0.4)% (37) (0.1)% ---------- --------- --------- --------- ---------- --------- Income from continuing operations before minority interest, benefit for income taxes and extraordinary item.............. 3,729 2.1% 14,831 15.0% 2,708 7.6% Minority interest............................. 3,702 2.1% 2,522 2.6% 1,185 3.3% Pre-acquisition earnings...................... -- 4,722 4.8% -- ---------- --------- --------- --------- ---------- --------- Income from continuing operations before benefit for income taxes and extraordinary item........................................ 27 0.0% 7,587 7.6% 1,523 4.3% Benefit for income taxes...................... (3,023) (1.7)% (2,586) (2.6)% -- ---------- --------- --------- --------- ---------- --------- Income before extraordinary item............ 3,050 1.7% 10,173 10.2% 1,523 4.3% Discontinued operations--Loss from discontinued operations (including a loss on disposal of $549 and a provision for income taxes of $200).............................. -- -- 714 2.0% ---------- --------- --------- --------- ---------- --------- Income (loss) before extraordinary item...................................... 3,050 1.7% 10,173 10.2% 809 2.3% Extraordinary item--Loss on early extinguishment of debt, net of minority interest and taxes.......................... 351 0.2% -- 2,248 6.3% ---------- --------- --------- --------- ---------- --------- Net income (loss)........................... 2,699 1.5% 10,173 10.2% (1,439) (4.0)% Accretion and accrued and paid dividends on preferred stock............................. (1,133) (0.6)% (1,408) (1.4)% -- ---------- --------- --------- --------- ---------- --------- Net income (loss) available to common shareholders.............................. $ 1,566 0.9% $ 8,765 8.8% $ (1,439) (4.0)% ---------- --------- --------- --------- ---------- --------- ---------- --------- --------- --------- ---------- ---------
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997 REVENUES Consolidated revenue for the year ended December 31, 1998, compared with the same period in 1997, increased approximately $80.4 million or 81.6%. 26 WASTE-TO-ENERGY SEGMENT The total revenues for the waste-to-energy segment were approximately $76.7 million for the year ended December 31, 1998, compared to approximately $74.2 million for the same period in 1997. This is an increase of approximately $2.5 million or 3.4%. Revenues in the waste-to-energy segment were primarily produced from waste processing and electric power sales. Total tons received by Maine Energy and Penobscot increased 2.0% and 4.1%, respectively, in 1998, compared to 1997. These increases were due to higher municipal solid waste disposal rates in the areas close to the facilities, which improved the competitive pricing position for Maine Energy and Penobscot. Waste processing revenues decreased by approximately $2.0 million or 8.3% for the year. This decrease was due to higher performance credits due to the restructuring of the Bangor Hydro power purchase agreement. This decrease was reduced by an approximately 5.0% increase in the prices charged per ton during 1998 versus 1997 and additional revenues from the Total Waste Management acquisition, offset by a 12.2% decrease in volume versus 1997 as a result of lower volumes at Timber Energy Resources' Cairo facility. Electric power revenues increased about $8.0 million or 20.4% during the year. Revenue for the year increased due to the restructuring of the Bangor Hydro power purchase agreement in the second quarter. In connection with the restructuring of the Bangor Hydro power purchase agreement, we received $6.0 million in cash and an agreement from Bangor Hydro to pay us $250,000 per quarter over the next four years, a total of $4.0 million. Bangor Hydro also issued warrants to purchase one million shares of Bangor Hydro common stock to the partners of Penobscot. Our share, which was based upon our ownership percentage at Penobscot, was approximately 713,000 warrants. The estimated fair market value of these warrants at the date of issue was $5.35 per warrant. The $6.0 million in cash, the present value of the payments from Bangor Hydro of approximately $3.6 million, and the fair value of the warrants of approximately $3.8 million were recorded as a customer advance and are being amortized over the life of the Bangor Hydro power purchase agreement. The amount recorded as revenue for the year ended December 31, 1998 was $0.5 million. The remaining increase in revenues resulted from the acquisition of Multitrade, the 3% increase in the price per kilowatt hour charged during 1998, and the 1% increase in kilowatt hours as a result of a shorter down period for Timber Energy Resources' Cairo Facility in 1998. RESIDENTIAL RECYCLING SEGMENT This segment includes the residential recycling plants of FCR. This segment posted revenues of approximately $11.8 million for 1998. This segment had no revenues for the same period in 1997 because the acquisition was completed in 1998. COMMERCIAL RECYCLING SEGMENT Total revenue for this segment for the year ended December 31, 1998 was approximately $68.1 million compared to $17.7 million for the same period in 1997. This is an increase in sales of approximately $50.4 million compared to the same period in 1997. The increase in revenues is primarily the result of a full year of operations in 1998 compared to five months of operations for K-C International and six weeks of operations for KTI Recycling of Illinois, KTI Recycling of New England and KTI Recycling of New Jersey in 1997, and the KTI New Jersey Fibers acquisitions. These increases were partially offset by lower commodity prices for paper fibers in 1998. FINISHED PRODUCTS SEGMENT Total revenue for this segment for the year ended December 31, 1998 was approximately $22.3 million compared to approximately $6.5 million for the same period in 1997. This represents an increase of approximately $15.8 million. The increase in revenues primarily resulted from the 27 acquisitions discussed above, which were partially offset by lower revenues at Manner due to decreases in plastic prices in 1998. COSTS AND EXPENSES WASTE-TO-ENERGY SEGMENT Cost of operations in this segment was approximately $59.1 million during the year ended December 31, 1998, compared to approximately $54.4 million during 1997. This represents an increase of approximately $4.7 million or 8.6%. The increase was primarily a result of the Total Waste Management and Multitrade acquisitions discussed above, which had total costs of operations of approximately $5.3 million. These increases were offset by a decrease in costs at Timber Energy Resources of approximately $1.1 million. Timber Energy Resources incurred additional costs during 1997 due to an extended shutdown at its Telogia Facility. RESIDENTIAL RECYCLING SEGMENT Cost of operations in this segment was approximately $10.4 million for 1998. We acquired the FCR facilities during 1998. COMMERCIAL RECYCLING SEGMENT Cost of operations in this segment for the year ended December 31, 1998 was approximately $68.6 million in 1998 compared to approximately $17.2 million in 1997. This represents an increase of approximately $51.4 million compared to the same period in 1997. This increase is due primarily to the acquisition of KTI New Jersey Fibers in August 1998 as well as the inclusion of K-C International and the KTI Recycling of Illinois, KTI Recycling of New England and KTI Recycling of New Jersey facilities for a full year in 1998 compared to five months of operations for K-C International and six weeks of operations for each of the Illinois, New England and New Jersey facilities in 1997. FINISHED PRODUCTS Cost of operations in this segment for the year ended December 31, 1998 was approximately $21.5 million compared to approximately $6.4 million in 1997. The increase was primarily a result of the acquisitions discussed above and was partially offset by lower purchase prices at Manner due to decreases in plastics prices in 1998. OTHER ITEMS Selling, general and administrative expenses increased by approximately $4.8 million during 1998 compared to 1997. Other than costs added through recent acquisitions, we have added administrative staff to develop and install corporate-wide information systems; to develop and support a formal strategic planning and budgeting process; to support company-wide credit and collection efforts; to identify and pursue potential mergers and acquisitions; and to develop internal analytical systems to identify revenue enhancement and cost savings programs in newly acquired entities. Interest expenses increased approximately $5.6 million or 109.7% during 1998 compared to the same periods in 1997. These increases are principally related to increased borrowings on our line of credit in order to fund several acquisitions, the conversion of the Series B Preferred Stock to convertible debt, and the premium of approximately $1.4 million on the conversion of the debt to equity. These increases were partially offset by lower interest rates at Penobscot because of the refinancing of the outstanding bonds and lower debt levels at Maine Energy. The income tax benefit was approximately $3.0 million for 1998 compared to approximately $2.6 million in 1997. The income tax benefit includes a credit of approximately $3.2 million in 1998 and $5.1 million in 1997, due to the reduced valuation allowance for deferred tax assets as a result of the determination that we will be able to utilize net operating loss carryforwards. 28 The extraordinary loss represents the loss on early retirement of the Penobscot bonds of approximately $0.4 million net of minority interest and income tax benefits. YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996 REVENUES WASTE-TO-ENERGY Revenue increased by approximately $38.5 million during the year ended December 31, 1997 compared to 1996. The net increase was a result of both increased sales of approximately $30.8 million and the consolidation of Penobscot for financial reporting purposes during 1997, which includes approximately $23.6 million of revenues from the period prior to the date we acquired our controlling interest in Penobscot, and approximately $4.5 million for a full year effect of certain acquisitions during 1997. COMMERCIAL RECYCLING Sales of recyclables increased to approximately $24.2 million in 1997 as a result of acquiring I. Zaitlin & Sons, K-C International and the KTI Recycling of Illinois, KTI Recycling of New England and KTI Recycling of New Jersey facilities in 1997. COSTS AND EXPENSES WASTE-TO-ENERGY Electric power waste handling operating costs increased by approximately $28.3 million, for the year ended December 31, 1997 compared to 1996. The increase was a result of consolidation of Penobscot in 1997, which led to costs and expenses of approximately $17.8 million in 1997, which includes approximately $13.1 million of costs and expenses from the period prior to the date we acquired our controlling interest in Penobscot, and a full year effect of certain acquisitions. COMMERCIAL RECYCLING The approximately $23.6 million increase in recycling costs was primarily caused by the 1997 acquisitions of K-C International, Zaitlin and the KTI Recycling of Illinois, KTI Recycling of New England and KTI Recycling of New Jersey facilities, as well as the inclusion of Manner for the entire year of 1997 compared to only one month in 1996. These costs primarily reflect the costs of acquired recyclables for resale. OTHER ITEMS Expenses related to sales, administrative and general items increased by approximately $0.7 million or 26.1% for the year ended December 31, 1997 compared to 1996. This increase was primarily caused by salaries of additional management personnel and associated expenses resulting from the acquisitions of K-C International, Zaitlin and the KTI Recycling of Illinois, KTI Recycling of New England and KTI Recycling of New Jersey facilities in 1997, as well as the inclusion of Timber Energy Resources and Manner for a full year in 1997 compared to only five weeks for 1996. Depreciation and amortization for the year ended December 31, 1997 increased by approximately $2.7 million or 40.4% compared to 1996. The increase resulted from the consolidation of Penobscot in 1997, which includes approximately $3.0 million of depreciation and amortization from the period prior to the date we acquired our controlling interest in Penobscot, and the full year effect in 1997 of certain acquisitions, offset by a decrease in depreciation at Maine Energy due to the full year effect of the change in estimated useful lives of property, plant and equipment beginning in the fourth quarter of 1996. 29 Interest, net increased by approximately $0.6 million or 13.9% for the year ended December 31, 1997 compared to 1996. This increase resulted from consolidating Penobscot, which includes approximately $2.2 million of interest from the period before the date when we acquired our controlling interest, and including a full year of interest for acquisitions during the fourth quarter of 1996. These increases were partially offset by a decrease in interest expense as a result of the repayments of $64.5 million in outstanding bonds and $29.5 million in subordinated debt at Maine Energy and a continued reduction in our outstanding debt. Equity in net income of Penobscot was eliminated as a result of the consolidation of Penobscot for 1997. Pre-acquisition minority earnings of approximately $4.6 million for the nine month period ended September 30, 1997 are included in minority interest in 1997. Loss on sale of investments in 1996 was related to sales of securities in connection with the early retirement of debt at Maine Energy. None of these transactions occurred in 1997. The tax benefit of approximately $2.6 million in 1997 is the result of a reduction in our valuation allowance on net deferred tax assets. Our ability to use our net operating loss carry forwards is limited as discussed below. The tax benefit recorded in 1997 is based on management's evaluation that we will be able to use all net operating loss and alternative minimum credit carry forwards that are available to offset 1998 and 1999 income. LIQUIDITY AND CAPITAL RESOURCES We are a holding company and receives certain of its cash flows from its subsidiaries. Receipt of cash flow from PERC is currently restricted by covenants under loan agreements, distribution restrictions under partnership agreements with PERC's equity investors, and put-or-pay agreements with municipalities. Maine Energy's cash flow is required to retire the remaining outstanding subordinated debt balance of approximately $12.9 million as of December 31, 1998 before partners' cash distributions can begin (approximately $8.6 million of these notes are owned by the Company). TERI's cash flow is restricted by covenants under its bond agreements. As a result, the following discussion is organized to present liquidity and capital resources of the Company separate from Maine Energy, PERC and TERI and liquidity and capital resources of each of Maine Energy, PERC and TERI independently. We operate in industries that require high levels of capital investment. Our capital requirements basically stem from (i) our working capital for ongoing operations, (ii) capital expenditures for new plants and equipment and (iii) business acquisitions. Our strategy has been to meet these capital needs from internally generated funds that are not contractually restricted, drawings under our lines of credit, collateralized equipment financing and proceeds from the sale of our common stock. On May 28, 1998 KeyBank increased its credit line to the Company from $22.0 million to $30.0 million. On July 10, 1998, KTI closed on a $150.0 million acquisition credit line from KeyBank. This line of credit can be utilized to fund acquisitions, capital expenditures and for working capital. As of December 31, 1998, the Company was out of compliance with one of the covenants of the agreement with KeyBank, for which a waiver was received prior to December 31, 1998. On May 12, 1999, the Company signed an amendment to the agreement with KeyBank in which the covenants were amended. Management of the Company believes that the Company will remain in compliance with the covenants in the amended agreement. However, the Company's ability to meet these covenants is dependent on its ability to substantially achieve its operating plan. Upon the consummation of the merger, this line of credit will be replaced by the credit facility of the combined company. However, no assurances can be given that the conditions of the merger will be satisfied or that the merger will be consummated. If the merger is not consummated, KTI will be required to modify the financial covenants or obtain an additional waiver from the lender. The lender is under no obligation to amend the financial covenants or provide such a waiver. KTI management believes that KTI will either obtain an additional waiver or an amendment to the financial covenants; however, there can be no assurances that this can be accomplished. 30 As of December 31, 1998, the Company had working capital of approximately $42.8 million (ratio of current assets to current liabilities of 2.11:1) and a cash balance of approximately $9.4 million which compared to working capital of approximately $22.0 million (a ratio of current assets to current liabilities of 1.65:1) and a cash balance of approximately $11.2 million at December 31, 1997. As of December 31, 1998, the Company had working capital and cash on hand without regard to Maine Energy, PERC and TERI of approximately $12.9 million (ratio of current assets to current liabilities of 1.41:1) and approximately $3.9 million, respectively, which compared to a working capital deficit of approximately $18,000 (a ratio of current assets to current liabilities of 0.99:1) and a cash balance of approximately $2.4 million at December 31, 1997. As of December 31, 1998, the Company had approximately $9.1 million of availability on the revolving credit agreement. As of April 30, 1999, the Company had approximately $22,000 available under the revolving credit agreement. Though management of the Company believes that cash flows from its subsidiaries will meet its current needs for working capital and capital expenditures, the ability of the Company to expand its current operations is dependent on cash flow from its subsidiaries. Management believes that the Company has the ability to access additional facilities to fund capital expenditures if needed; although no assurance can be given in this regard. The Company's ability to make future acquisitions is also dependent on its ability to increase its line of credit. The ability to increase the line of credit is dependent on the Company's ability to raise additional equity or raise capital from financial instruments which are subordinated to the KeyBank credit line. Management believes that the Company has the ability to raise additional capital if needed; however, there can be no assurances that this can be accomplished at terms and conditions that would be acceptable to the Company. The Company and its subsidiaries, other than Maine Energy, PERC and TERI, at December 31, 1998 had indebtedness maturing in 1999 of approximately $6.4 million, including borrowings under existing revolving credit facilities. During 1998, the Company, other than Maine Energy, PERC and Timber Energy increased net borrowings on the Company's line of credit facilities by approximately $133.6 million, primarily for business acquisitions and the refinancing of debt assumed from these acquisitions. In general, the Company's capital expenditures and working capital requirements have increased as a result of the Company's business strategy of growth through acquisitions. Management of the Company believes that cash flow from operations will meet its current needs for liquidity. MAINE ENERGY Maine Energy has financed its operations and capital expenditures from cash flows from operations. Cash provided by operations was approximately $5.3 million in 1998 compared to approximately $3.2 million in 1997. Maine Energy's capital expenditures were approximately $2.8 million and $2.6 million during 1998 and 1997, respectively. As of December 31, 1998 and December 31, 1997, Maine Energy had operating cash of approximately $2.4 million and $0.7 million, respectively, and as required under the terms of the credit agreement underlying its letter of credit, Maine Energy has on account approximately $6.0 million and $7.7 million, respectively, of additional reserves to be used under certain circumstances for capital improvements, debt service, operating shortfalls and working capital requirements. As of December 31, 1998, Maine Energy had total indebtedness of approximately $12.9 million. We believe Maine Energy's cash flows from operations and cash resources available will be sufficient to fund anticipated capital expenditures and debt service requirements. Capital expenditures for Maine Energy for the year ended December 31, 1999 are expected to be approximately $1.0 million, of which $0.2 million has been set aside in the above mentioned reserve accounts. PENOBSCOT PERC has financed its operations and capital expenditures primarily by cash flow from operations. Cash provided by operations was approximately $5.8 million in 1998 compared to approximately $11.3 million in 1997. PERC's capital expenditures were approximately $0.8 million and $0.4 million during 1998 and 1997, respectively. 31 On June 26, 1998 KTI completed a major restructuring of the various contracts and obligations of PERC, which included refinancing PERC's tax exempt bonds. The refinancing was made possible through the sale of approximately $45.0 million in Electric Rate Stabilization Revenue Refunding Bonds issued by FAME. The proceeds, plus certain funds from operations were utilized to repay the outstanding Revenue Bonds. The interest rate on the bonds ranges from 3.75% for one-year bonds to 5.20% for 20-year term bonds. The refinancing will reduce PERC's debt service costs while extending its payment obligation over 20 years. As of December 31, 1998, in addition to PERC's operating cash of approximately $2.3 million, PERC, as required under the terms of the trust indenture governing the FAME Bonds, had on account approximately $14.2 million of additional cash reserves to be used for capital improvements, debt service, operating shortfalls and working capital requirements. We believe Penobscot's cash flows from operations and cash resources available will be sufficient to fund anticipated capital expenditures and debt service requirements. Penobscot plans capital expenditures for the year ending December 31, 1999 of approximately $1.1 million, which has largely been set aside in the reserve accounts. TIMBER ENERGY RESOURCES TERI has financed its operations and capital expenditures primarily by cash flows from operations. Cash provided by operations was approximately $2.1 million in 1998 and approximately $1.8 million in 1997. TERI's capital expenditures were approximately $0.4 million during 1998 and approximately $1.3 million during 1997. During 1997, TERI retired $13.4 million of variable rate revenue bonds and paid certain debt financing costs with $13,708 of proceeds from two 1997 Industrial Development Revenue Bond issues (the "1997 Bonds") and cash on hand. The outstanding 1997 Bonds carry interest at a fixed rate of 7% and have annual sinking fund payments due each December 1 with a final payment due December 1, 2002. As of December 31, 1998, TERI had total indebtedness of approximately $11.6 million. As of December 31, 1998 and 1997, in addition to TERI's operating cash of approximately $0.8 million and $0.9 million, respectively, TERI, as required under the terms of its then-existing debt agreements, had on account approximately $2.1 million of reserves to be used under certain circumstances for capital improvements, debt service, operating shortfalls and working capital requirements at December 31, 1998 and 1997. We believe Timber Energy Resources' cash flows from operations and cash resources available will be sufficient to fund anticipated capital expenditures and debt service requirements. We expect capital expenditures for Timber Energy Resources for the year ending December 31, 1999 to be approximately $0.4 million. Timber Energy Resources intends to finance the requirements through cash flow from operations. TAX LOSS CARRYFORWARDS At December 31, 1998, we had net operating loss carryforwards of approximately $51.0 million for income tax purposes that expire in years 2002 through 2018 and are subject to the limitations described below. In addition, we have general business credit carryforwards of approximately $0.5 million that expire in the years 1999 through 2006 and alternative minimum tax credit carryforwards of approximately $0.9 million that are not subject to limitation. The Tax Reform Act of 1986 enacted a complex set of rules limiting the potential utilization of net operating loss and tax credit carryforwards in periods following a corporate "ownership change." In general, for federal income tax purposes, an ownership change occurs if the percentage of stock of a loss corporation owned, actually, constructively and, in some cases, deemed, by one or more "5% shareholders" increases by more than fifty (50) percentage points over the lowest percentage of such stock owned during a three-year testing period. 32 During 1994, we had such a change in ownership. As a result of the change, our ability to use our net operating loss carryforwards and general business credits will be limited to approximately $1.2 million of taxable income, or approximately $0.4 million of equivalent credit per year. This limitation may be increased if we recognize a gain on the disposition of an asset that had a fair market value greater than its tax basis on the date of the ownership change. In connection with the acquisition of Timber Energy Resources, FCR and Total Waste Management, we recorded net operating loss carryforwards of approximately $25.6 million, $12.5 million and $0.5 million, respectively, which are included in the total of $55.4 million in loss carryforwards and which are also subject to a corporate "ownership change". As a result of the change, our ability to use the net operating loss carryforwards related to these entities is limited to approximately $1.0 million, $3.2 million and $0.1 million, respectively, per year. ENVIRONMENTAL CONTINGENCIES While increasing environmental regulation often presents new business opportunities to us and our subsidiaries, it likewise often results in increased operating costs as well. We and our subsidiaries strive to conduct our operations in full compliance with applicable laws and regulations, including environmental rules and regulations. This effort requires programs to promote compliance, such as training employees and customers, purchasing health and safety equipment, and in some cases hiring outside consultants and lawyers. Even with these programs, we believe that in the ordinary course of doing business, companies in the environmental services and waste disposal industry face governmental enforcement proceedings resulting in fines or other sanctions and will likely be required to pay civil penalties or to expend funds for remedial work on waste management facilities. In March 1999, KTI voluntarily disclosed to civil regulatory authorities at the Florida Department of Environmental Protection ("FDEP") violations of a condition of its Clean Water Act waste water discharge permit and related reporting obligations at its Telogia, Florida facility. On July 28, 1999, KTI entered into an administrative consent order with FDEP resolving the state civil aspects of those violations. The violations involved the temperature of the water discharged from the cooling process. Under the consent order, KTI was required to pay penalties and expenses totaling $0.1 million and must satisfy certain interim waste water discharge monitoring and reporting requirements, submit and implement a plan of study for the purpose of obtaining a revised permit, and either obtain a revised permit or install additional cooling equipment at the facility. KTI believes it is currently in compliance with the interim requirements. As of June 30, 1999, no pending governmental environmental enforcement proceedings exist for which we or any of our subsidiaries believe that potential monetary sanctions will exceed $0.1 million. The possibility always exists that substantial expenditures could result from governmental proceedings, which would have a negative impact on our earnings for a particular reporting period. More importantly, federal, state and local regulators have the power to suspend or revoke permits or licenses needed for the operation of our or our subsidiaries' plants, equipment, and vehicles based on the applicable company's compliance record, and customers may decide not to use a particular disposal facility or do business with a company because of concerns about its compliance record. Suspension or revocation of permits or licenses would negatively impact our business and operations and could have a material adverse impact on our financial results. INFLATION Inflation has had a minimal effect on our operating costs in the past three years. Most of our operating expenses are inflation sensitive, with increases in inflation generally resulting in increased costs of operation. The effect of inflation-driven cost increases on each of our project's overall operating costs is not expected to be greater for such projects than for our competitor's projects. In 33 addition, each of Maine Energy's and Penobscot's contracts and the majority of our residential recycling contracts allow us to increase waste processing fees paid by municipal customers annually based on inflation. YEAR 2000 ISSUE Year 2000 compliance is the ability of computer hardware and software to respond to the problems posed by the fact that computer programs have traditionally been written using two digits rather than four to define the applicable year. As a consequence, unless modified, computer systems will not be able to differentiate between the year 2000 and 1900. Systems must also recognize the Year 2000 as a leap year. Failure to address this problem could result in system failures and the generation of erroneous data. This could potentially impact our ability to perform our obligations under long-term contracts, which could result in legal and other liabilities that would have a material adverse effect. We are in the process of contacting our customers and vendors and have received letters from each of our applications vendors stating that the majority of our information technology systems, such as accounting, data processing, plant operations systems and telephone/PBX systems, are Year 2000 compliant. Several insignificant software applications that represent 20% of our applications are not Year 2000 compliant. We plan to replace or upgrade these applications with compliant versions by the end of the third quarter of 1999. We have also begun an assessment of our non-information technology systems, such as our security systems and telephones, to determine if they are Year 2000 compliant. We plan to initiate formal communications with the vendors of our remaining non-information technology systems. Based on our assessment to date, we believe that our non-information technology systems will be Year 2000 compliant prior to the Year 2000. We have also begun an assessment of our significant vendors, suppliers, and service providers to determine the extent to which we are vulnerable to those third parties' failure to remediate their own Year 2000 compliance issues. To date, we believe, based on information published or otherwise provided by the third parties, that all of their systems are or will be Year 2000 compliant. We plan to initiate formal communications with significant remaining third parties. Based on our assessment to date, we believe that our significant vendors, suppliers and service providers will be Year 2000 compliant prior to the Year 2000. 34 The following table summarizes the status of our Year 2000 compliance program:
ASSESSMENT REMEDIATION TESTING IMPLEMENTATION ------------------ ------------------ ------------------ ------------------ Information Technology........ 85% Complete 65% Complete 65% Complete 65% Complete Expected Expected Expected completion date, completion date, completion date, September 1999 September 1999 September 1999 Operating Equipment with 75% Complete 60% Complete 60% Complete 60% Complete Embedded Chips or Software.... Expected Expected Expected completion date, completion date, completion date, June 1999 June 1999 June 1999 3(rd) Party................... 80% Complete for 80% Complete for 80% Complete for 80% Complete for system interface. system interface. system interface. system interface. 66% Complete for all other material Develop Expected Expected exposures. contingency plans completion date completion date as appropriate, for system for system June 1999. interface work, interface work, June 1999 June 1999 Expected Implement completion date contingency plans for surveying all or other remaining third alternatives as parties, June necessary, 1999 June 1999.
We have also conducted tests of all of our internal information and non-information technology systems and all of our system interfaces with significant vendors, suppliers and service providers to ensure Year 2000 compliance. All of our accounting and data processing equipment is based on microcomputer hardware and related software. 80% of this equipment has been certified as Year 2000 compliant by the applicable manufacturer or developer. However, we have determined that the plant control systems may contain embedded technology that is not Year 2000 compliant. We have ordered the vendor of the hardware containing the embedded logic boards to replace the hardware that is not Year 2000 compliant with hardware that is Year 2000 compliant. In addition, these systems will be tested during scheduled shutdown periods at the plants during the second and third quarters of 1999. However, despite our efforts to ensure that our internal systems and the systems of our significant vendors, suppliers and service providers are Year 2000 compliant, we cannot guarantee that the failure of certain systems will not have a material adverse effect on us. To date, we have used internal resources to reprogram or replace, test, and implement the software and hardware modifications for Year 2000. Our only costs have been the salary costs of our internal staff of four. To date, we have incurred approximately $0.05 million (30% expensed and 70% capitalized for new systems and equipment), related to all phases of the Year 2000 project. We estimate that the remaining project costs will be less than $0.1 million for the purchase of new software and hardware and approximately $0.1 million of internal resources. Although we currently expect to be able to complete our Year 2000 compliance program using only internal resources, we cannot guarantee that we be able to do so. The most significant risk identified by us is the inability of the power plants to generate electric power. We have received assurances that the process control systems will be Year 2000 compliant with the installation of new hardware components. We will perform a complete test of the systems during the planned shutdown periods that are to be completed by the end of the third quarter of 1999. In addition, we have developed contingency plans for this risk as well as other internal and external 35 applications which involve manual workarounds, increasing inventories and adjusting staffing strategies. This risk could cause a default under our power purchase agreements with customers or a loss of electric power revenue. We are unable to reasonably estimate the impact of this risk; however, there can be no guarantee that this risk will not have a material adverse effect on us. We also cannot guarantee that we have identified all the significant risks associated with Year 2000 compliance. RECENT ACCOUNTING PRONOUNCEMENTS Recent accounting pronouncements that are not required to be adopted as of June 30, 1999, include the following Statement of Financial Accounting Standards ("SFAS") and the American Institute of Certified Public Accountants Statements of Position ("SOP"): SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which we will be required to adopt as of January 1, 2001, establishes standards for derivative instruments including those embedded in other contracts and for hedging activities. The new standard requires us to recognize all derivatives as either assets or liabilities and measure those instruments at fair value. We believe that the adoption of SFAS No. 133 will not have a material impact on our financial statements. SOP 98-1, ACCOUNTING FOR COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE will be required to be adopted by us as of January 1, 2000. Our current policy falls within the guidelines of SOP 98-1. ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK KTI currently utilizes no material derivative financial instruments which expose it to significant market risk. KTI is exposed to cash flow and fair value risk due to changes in interest rates with respect to its debt. The table below presents principal cash flows and related weighted average interest rates of the KTI's debt at June 30, 1999 by expected maturity dates. Weighted average variable rates are based on forward rates in United States Government Treasury Constant Maturities at June 30, 1999. Forward rates should not be considered a predictor of actual future interest rates. INTEREST RATE SENSITIVITY PRINCIPAL AMOUNT BY EXPECTED MATURITY (IN THOUSANDS)
1999 2000 2001 2002 2003 THEREAFTER FAIR VALUE ---------- --------- ---------- --------- --------- ----------- ---------- Fixed Rate Debt............ $ 5,696 $ 8,071 $ 7,509 $ 8,153 $ 3,088 $ 50,466 $ 83,115 Average Interest Rate...... 6.60% 6.50% 7.30% 6.30% 6.27% 5.04% Variable Rate Debt......... 155,092 $ 155,092 Average Interest Rate...... 8.53%
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENATARY DATA The consolidated financial statements of the Company for the year ended December 31, 1998 and 1997 with regard to consolidated balance sheets, and the years ended December 31, 1998, 1997 and 1996, with regard to consolidated statements of income, shareholders' equity and cash flows, together with the reports of independent auditors thereon and related schedules appear on pages F-1 to S-7. 36 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth information concerning the directors and executive officers of the Company.
Name Age Position - ---- --- -------- Ross Pirasteh.................. 61 Chairman of the Board of Directors Paul A. Garrett................ 52 Vice Chairman of the Board of Directors Martin J. Sergi................ 41 President and Director Brian J. Noonan................ 39 Chief Financial Officer David E. Hill.................. 57 Chief Operating Officer and Senior Vice President Robert E. Wetzel............... 61 Senior Vice President, General Counsel & Secretary Samuel M. Zaitlin.............. 50 Senior Vice President Dibo Attar..................... 59 Director Ken (Kook Joo) Choi............ 56 President of K-C International and Director Paul Kleinaitis................ 40 Director Jack Polak..................... 86 Director Wilbur L. Ross, Jr. ........... 61 Director George Mitchell................ 64 Director Carlos Aguero.................. 46 Director
Ross Pirasteh has been employed by the Company since January 1, 1996 and became a director of the Company on May 14, 1996. Mr. Pirasteh was elected as the Chairman of the Executive Committee of the Board of Directors on February 28, 1997 and as Chairman of the Board of Directors on September 16, 1997. Mr. Pirasteh was also appointed to the board of directors of Oakhurst on January 19, 1999. Mr. Pirasteh served as a management consultant to KTI from 1995 to 1996, providing consulting with respect to bank financing and structural organization. In 1994, he also acted as a consultant for various other companies, with respect to bank financing and capital funding. Mr. Pirasteh has also been an entrepreneurial investor for the past five years, investing his personal funds in real estate and privately held companies. Paul Garrett has been employed by the Company since August 28, 1998, when the acquisition of FCR was completed. Currently, he serves as the Company's Vice Chairman of the Board of Directors as well as the Executive Committee and actively manages the Company's recycling activities. Prior to the acquisition of FCR, Mr. Garrett had served as FCR's President and Chief Executive Officer for 7 years. Martin J. Sergi has been a senior executive officer and director of the Company since 1985 and currently serves as Director and President of the Company. He also serves as President of each of the Company's subsidiaries other than Data Destruction Services, Inc., K-C, Manner, Power Ship, Seaglass and TWM. Mr. Sergi is a Member of the Nominating and Executive Committees of the Board. Mr. Sergi was also appointed to the board of directors of Oakhurst on January 19, 1999. He is licensed as a certified public accountant in New York. Brian Noonan has been employed by the Company since August, 1998, when the acquisition of FCR was completed. Currently, he is the Company's Chief Financial Officer. Prior to the acquisition of FCR, 37 Mr. Noonan had been FCR's Chief Financial Officer, a position he had held for two years. He had held other senior management positions since joining FCR in 1994. David E. Hill has been affiliated with the Company since January 1994 when he was employed as the Company's Senior Vice President, Business Development. Mr. Hill was elected to the position of Chief Operating Officer on September 16, 1997. Robert E. Wetzel has been employed by the Company as Senior Vice President, Secretary and General Counsel on July 31, 1995. From 1991 until June 30, 1995, Mr. Wetzel was a Vice President and Associate General Counsel of Continental Casualty Company, a subsidiary of CNA Financial Corporation. Samuel M. Zaitlin has been a Senior Vice President of the Company since 1997 and is the President of Zaitlin. Prior to the acquisition of Zaitlin by the Company, Mr. Zaitlin was President of Zaitlin since 1981. Dibo Attar had served as a director of CSI from April 1989 until its merger with and into the Company on February 8, 1995 (the "Merger"). He has been a director of the Company since February 8, 1995. Mr. Attar is an investor and a business consultant to domestic and international companies including various companies which have extended financing to KTI. Mr. Attar is Chairman of the Board of Directors of T.H. Lehman & Co., Incorporated, which is engaged in medical accounts receivable financing and a director of Newpark Resources, Inc., which is engaged in providing oil field services. Mr. Attar is a member of the Audit Committee and the Nominating Committee. Ken (Kook Joo) Choi has been the President and chief executive officer of K-C since 1974. He has served as a director of the Company since the acquisition of K-C by the Company. Paul Kleinaitis is a Vice President of First Analysis Corporation and has been employed in such position since 1990. Mr. Kleinaitis is a member of the Audit Committee and the Compensation Committee. He has served as a director of the Company since 1997. Jack Polak had served as a director of CSI from August 1993 until the Merger. He has been a director of the Company since February 8, 1995. He has been a private investment consultant since April 1982. Since 1955, Mr. Polak has served in various positions for Equity Interest, Inc., a registered investment advisor located in New York City, most recently as President, to supervise the liquidation of that company, which is currently in the final stages of liquidation. He serves as a director of C.C.A. Industries, Inc., a public company from East Rutherford, N.J., which is engaged in the manufacture and distribution of health and beauty aid products. Mr. Polak holds a tax consultant certification in the Netherlands. Mr. Polak is a member of the Audit Committee and the Compensation Committee. George J. Mitchell has been a director of KTI since 1998. Senator Mitchell is special counsel to the law firm of Verner, Liipfert, Bernhard, McPherson & Hand in Washington, D.C. and senior counsel to the firm of Preti, Flaherty, Beliveau & Pachios in Portland, Maine. He also serves as an advisor to B.T. Wolfensohn, an investment banking firm. He served as a United States Senator for fifteen years beginning in 1980, and was Senate Majority Leader from 1989 to 1995. Senator Mitchell is a member of the board of directors of UNUM Corporation, a disability insurance company, FDC corporation, an international provider of transportation and delivery services, Xerox Corporation, a manufacturer of photocopier equipment, The Walt Disney Company, an entertainment company, and Staples, Inc., an office supply company. He is also a trustee to Starwood Hotels & Resorts. He has also served as chairman of the peace negotiations in Northern Ireland, the ethics committee of the U.S. Olympic Committee and the National Health Care Commission. Wilbur L. Ross, Jr. has been a director of KTI since 1997. Mr. Ross has been a Managing Director of Rothschild Inc., an investment banking firm, since 1976 and senior managing director since 1988. He is chief executive officer and director of News Communications, Inc., a publisher of community oriented newspapers. He is a member of the board of Mego Financial Corp., a premier developer of timeshare properties, and Syms Corp., a clothing retailer. Mr. Ross is a member of the Compensation Committee. Carlos E. Aguero joined the Board of Directors in August of 1998. Prior to that, he had been on the Board of Directors of FCR since May, 1997. Mr. Aguero is also the founder, Chairman, and CEO of Metalico, Inc., a privately held company in the metals recycling, refining, smelting, and manufacturing business. From 38 1988 to 1997, Mr. Aguero was President, Chief Executive Officer, and Director of Continental Waste Industries, Inc., a firm which he had founded. W. Chris Hegele joined the Board of Directors in August of 1998. Prior to that, he had been on the Board of Directors of FCR since 1990. Mr. Hegele has been a general partner of Kitty Hawk Capital since 1984 after spending seven years with Arthur Andersen LLP. Mr. Hegele is on the Board of Directors of several privately owned companies in which Kitty Hawk Capital is an investor. He is a member of several venture capital and entrepreneurship associations. Mr. Hegele is a graduate of the University of North Carolina at Wilmington, and received his MBA from the University of North Carolina at Chapel Hill. All directors of the Company hold office until their respective successors are elected and qualified, or until their death, resignation or removal. Officers of the Company serve at the discretion of the Board of Directors. There are no family relationships between any directors or executive officers of the Company. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to the Company pursuant to Exchange Act Rule 16a-3(e) during its fiscal year ended December 31, 1998, Form 5 and amendments thereto furnished to the Company with respect to its fiscal year ended December 31, 1998, and any written representation from a reporting person that no Form 5 was required to be filed, no person who was a director, officer, beneficial owner of more than ten percent (10%) of Common Stock or otherwise subject to Section 16 of the Exchange Act with respect to the Company failed to file on a timely basis, as disclosed in the above Forms, reports required by Section 16(a) of the Exchange Act during the Company's fiscal year ended December 31, 1998. ITEM 11. EXECUTIVE COMPENSATION The following summary compensation table sets forth certain information with respect to compensation paid by KTI during the three year period ended December 31, 1998 to the chief executive officer and the four other most highly compensated executive officers during KTI's fiscal year ended December 31, 1998. SUMMARY COMPENSATION (1)(2)
LONG-TERM COMPENSATION AWARDS (3) SECURITIES ALL OTHER UNDERLYING COMPENSATION NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($)(4) OPTIONS (#) ($)(5) --------------------------- ---- ---------- ------------ ----------- ------ Martin J. Sergi ............... 1998 $227,885 0 100,000 $490,447 President 1997 210,000 0 75,000 7,000 1996 203,461 $145,000 26,250 6,000 Ross Pirasteh ................. 1998 $227,885 0 100,000 0 Chairman of the Board 1997 208,750 $50,000 75,000 $7,000 1996 155,000 0 26,250 0 Ken (Kook Joo) Choi ........... 1998 $170,912 0 5,000 0 Senior Vice President 1997 76,154 0 0 0 1996 0 0 0 0 David E. Hill ................. 1998 $152,385 0 25,000 $56,394 Senior Vice President 1997 132,115 0 20,000 7,000 1996 114,038 $32,303 21,000 5,854
39
LONG-TERM COMPENSATION AWARDS (3) SECURITIES ALL OTHER UNDERLYING COMPENSATION NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($)(4) OPTIONS (#) ($)(5) --------------------------- ---- ---------- ------------ ----------- ------------ Robert E. Wetzel .............. 1998 $152,885 0 25,000 $53,662 Senior Vice President, 1997 152,885 0 15,000 7,000 Secretary, & General Counsel 1996 151,923 0 10,500 3,115
- ---------------- (1) The Company did not pay nor provide other forms of annual compensation (such as perquisites) to any of the named executive officers having a value exceeding the lesser of $50,000 or 10% of the total annual salary and bonus reported for such officers. (2) The compensation actually paid to Mr. Sergi for the two years 1996 and 1997 was $200,911 and $314,038, respectively. The balance of his salary was accrued. Accrued and unpaid salary and, for 1996, the bonus, were applied against unpaid sums due to the Company by Mr. Sergi pursuant to certain notes, in the following amounts: $38,524 for the year 1996 and $2,650 for the year 1997. Mr. Choi joined the Company upon the acquisition of K-C in September of 1997. The 1997 figure includes his salary from that point onward. (3) In 1996, Mr. Sergi was granted 26,250 options under the 1994 Long-Term Incentive Award Plan. In 1997 and 1998, Mr. Sergi was granted 25,000 options under the same Plan. The additional 50,000 options in 1997 and 75,000 options in 1998 were non-plan options. In 1996, Mr. Pirasteh was granted 26,250 options under the 1994 Long-Term Incentive Award Plan. In 1997 and 1998, Mr. Pirasteh was granted 25,000 options under the same Plan. The additional 50,000 options in 1997 and 75,000 options in 1998 were non-plan options. The options granted to Mr. Hill, Mr. Wetzel and Mr. Choi in all years were granted under the 1994 Long-Term Incentive Award Plan. The number of shares indicated give effect to the 5% stock dividend paid on March 28, 1997. (4) Mr. Sergi was to be paid a bonus aggregating approximately $500,000 for 1996 under the formula in his employment agreement with the Company. Pursuant to a letter agreement with the Board of Directors, Mr. Sergi agreed to reduce such bonus to $145,000. Mr. Sergi was entitled to receive a bonus of approximately $120,000 and $250,000 for 1997 and 1998 pursuant to his employment agreement, but Mr. Sergi waived receipt of such bonuses. (5) The other compensation for Mr. Sergi in 1998 is comprised of $490,447 in earnings on the exercise of stock options at prices below the market value of the Common Stock. Mr. Sergi also received a $6,000 contribution to the Savings Plan (as described below) for 1996 and $7,000 in 1997. Mr. Pirasteh received contributions of $7,000 to the Savings Plan in 1997. The other compensation for Mr. Hill in 1996 is comprised of $56,394 in earnings on the exercise of stock options at prices below the market value of the Common Stock. Mr. Hill received a $5,854 contribution to the Savings Plan in 1996 and a $7,000 contribution for 1997. The other compensation for Mr. Wetzel in 1998 is comprised of $53,662 in earnings on the exercise of stock options at prices below the market value of the Common Stock. Mr. Wetzel received contributions of $3,115 to the Savings Plan in 1996 and $7,000 in 1997. The employment agreement with Martin J. Sergi provides for his employment as President of the Company. His annual base salary was increased from $185,000 to $210,000, effective as of May 1996, and from $210,000 to $250,000 effective as of August 1998. Prior to the most recent amendment, Mr. Sergi was entitled to a bonus of 2% of pre-tax consolidated net income of the Company and its subsidiaries of between $3,000,000 and $4,000,000; 4% of pre-tax consolidated net income of the Company and its subsidiaries between $4,000,001 and $5,000,000; and 6% of pre-tax consolidated net income of the Company and its subsidiaries over $5,0000,000. Mr. Sergi was entitled to a bonus of approximately $500,000 for 1996 under the formula in his employment agreement with the Company. Pursuant to a letter agreement with the Board of Directors, such bonus was reduced to $145,000. For 1997, Mr. Sergi was entitled to a bonus of approximately $120,000, but Mr. Sergi waived receipt of such bonus. Currently, Mr. Sergi will receive a bonus based on the attainment of certain goals set by the Board of Directors. The agreement has a three (3) year term and may be extended for additional one-year periods. The agreement also provides that Mr. Sergi shall participate in any 40 employee benefit plans established for senior management of the Company, that he is entitled to payments not in excess of $700 per month as an automobile allowance, that the Company will pay premiums for $250,000 of term life insurance on his life and that he will be entitled to participate in a disability plan maintained by the Company. The Company has also agreed that Mr. Sergi will be entitled to participate in an incentive stock option plan for senior management. The Company has agreed with Mr. Sergi that if his employment terminates other than by reason of his death, retirement, disability or for cause, or if he should elect to terminate his employment as a result of "good reason," he is entitled to continue receiving his annual base salary for a period of three (3) years and is also entitled to receive payment of an amount intended to compensate him for retirement benefits he would have received had he remained in the Company's employ until retirement. "Good reason" is defined to mean, among other things, (i) the assignment to the employee of materially different duties than those existing at the commencement of the agreement or which require travel significantly more time consuming than that required at the commencement of the agreement and (ii) the reduction of employee's authority as a senior executive officer. However, Mr. Sergi may not terminate the employment agreement for reasons specified in clause (i) above more than six (6) months following a "change-of-control" of the Company, as defined in the employment agreement. COMPENSATION OF DIRECTORS In 1998, the Company paid each non-employee director a fee of $12,500 per annum. In 1997 and 1996, the Company paid each non-employee director a fee of $7,500 per annum. Non-employee directors also participate in the KTI, Inc. Directors' Stock Option Plan. See "Plans -- KTI, Inc. Directors' Stock Option Plan". Employee directors currently do not receive an additional fee for their services as directors. PLANS 1994 LONG-TERM INCENTIVE AWARD PLAN. The Company has adopted the 1994 Long-Term Incentive Award Plan (the "KTI Incentive Plan") covering 383,333 shares of Common Stock pursuant to which officers and key employees of the Company and its subsidiaries designated as senior executives are eligible to receive incentive andor nonstatutory stock options, awards of shares of Common Stock and stock appreciation rights (a "Right"). An additional 500,000 shares of Common Stock were made available to be granted under the KTI Incentive Plan in 1997. A further 500,000 shares were made available in 1998. The KTI Incentive Plan, which expires on July 6, 2004 (the "Termination Date"), is administered by the Compensation Committee of the Board of Directors (the "Committee"). The purposes of the KTI Incentive Plan are to assist in attracting, retaining, and motivating senior executives and to promote the identification of their interests with those of the shareholders of the Company. Incentive stock options granted under the KTI Incentive Plan are exercisable during the period commencing six (6) months from the date of the grant of the option and terminating not more than ten (10) years from the date of grant at an exercise price which is not less than the fair market value of the Common Stock of the Company on the date of the grant. To the extent that the aggregate fair market value, as of the date of grant, of the shares into which incentive stock options become exercisable for the first time by an optionee during the calendar year exceeds $100,000, the portion of such option which is in excess of the $100,000 limitation will be treated as a nonstatutory stock option. Rights granted under the KTI Incentive Plan are exercisable during the period commencing six (6) months from the date of the grant of the Right (except in event of death or disability of the holder) and terminating not more than ten (10) years from the date of the grant of the Right, or in the case of a Right related to an option, the expiration of the related option. In addition, a Right may be exercised only when the fair market value of a share exceeds either the fair market value per share on the date of grant of the Right or the base price of the Right (which is determined by the Committee) if it is not a Right related to an option. A Right related to an option may be exercised only when and to the extent the option is able to be exercised. Incentive shares may be issued as provided in the agreement with the recipient, based upon the achievement of the performance standards set forth in the agreement. The Committee must certify in writing 41 prior to the issuance of the incentive shares that the standards set forth in the agreement were satisfied. The standards may be based on earnings or earnings growth, return on assets, equity or investment, specified improvement of financial ratings, achievement of specified balance sheet or income statement objectives, or stock price, sales or market share and may be based on changes in such factors or measured against or in relationship to the same objective factors of other companies comparably or similarly situated. No options, Rights or incentive shares may be granted under the KTI Incentive Plan after the Termination Date. The options and Rights are presently non-transferable during the life of the grantee. No participant in the KTI Incentive Plan is currently entitled to receive grants of options and Rights and awards of incentive shares in the aggregate exceeding 25,000 shares per year. The Committee has the authority to interpret the provisions of the KTI Incentive Plan, to prescribe, amend and rescind rules and regulations relating to it and to make all determinations deemed necessary or advisable for its administration, including the individuals to whom grants are made and the type, vesting, timing, amount, exercise price and other terms of such grants. The Board of Directors may amend or terminate the KTI Incentive Plan except that shareholder approval is required to effect any change to increase materially the aggregate number of shares that may be issued under the KTI Incentive Plan (unless adjusted to reflect changes such as a stock dividend, stock split, recapitalization, merger or consolidation of the Company), to modify materially the requirements as to eligibility to receive options, Rights or incentive shares or to increase materially the benefits accruing to participants. No action taken by the Board may materially and adversely affect any outstanding grant or award without the consent of the holder. The Committee may also modify, extend or renew outstanding options or Rights or accept the surrender of outstanding options or Rights granted under the KTI Incentive Plan and authorize the granting of new options and Rights pursuant to the KTI Incentive Plan in substitution thereof, including specifying a longer term than the surrendered options or Rights, provided that the Committee may not specify or lower the exercise price further than the surrendered option or Right. Further, the Committee may modify the terms of any outstanding agreement providing for the award of incentive shares. In no event, however, may modifications adversely affect the grantee without the grantee's consent. As of December 31, 1998, there were options to acquire 1,163,098 shares of Common Stock outstanding under the KTI Incentive Plan. KTI, INC. DIRECTORS' STOCK OPTION PLAN. In July 1995, the Company adopted the KTI, Inc. Directors' Stock Option Plan. Under this plan, non-employee Directors are automatically granted nonstatutory stock options on August 1 of each year, commencing on August 1, 1995. Effective as of May 14, 1997, the amount of the automatic option issuable yearly to each eligible director was increased to 7,500 shares of Common Stock. Options were granted on August 1, 1995, August 1, 1996, August 1, 1997 and on August 1, 1998 to purchase in the aggregate 115,800 shares of Common Stock. A total of 21,324 of these options have been exercised, leaving 94,476 outstanding as of December 31, 1998. Options to purchase 84,200 shares currently remain available for grant under this plan. Options may not be exercised until one (1) year after the date of grant and expire ten (10) years after the date of grant. NON-PLAN OPTIONS. In addition to options granted under the KTI Incentive Plan, in 1997 the Board of Directors granted to each of Messrs. Sergi and Pirasteh options to acquire 50,000 shares of Common Stock. The non-plan options have a ten (10) year term, were issued with exercise prices equal to the then-prevailing market price of the Common Stock, and vested in full of the date of the grant. In 1998, the Board of Directors granted to each of Messrs. Sergi and Pirasteh options to acquire 75,000 shares of Common Stock. Two-thirds, or 50,000 of the options, vested immediately. The remainder vest monthly over a 60-month period, beginning one month from the grant date. They, also, were issued with an exercise price equal to the then-prevailing market price of the Common Stock. As of December 31, 1998, there were outstanding plan and non-plan options to acquire a total of 1,735,447 shares of Common Stock. 42 Upon the exercise of an option or Right, payment must be made in full together with payment for any withholding taxes then required to be paid. The receipt of shares of Common Stock upon exercise of an option or Right is subject to full payment by the recipient of any withholding taxes required to be paid. 401(k) PLAN. In 1993, the Company adopted a salary deferral and savings plan for all KTI employees (the "Savings Plan") which is qualified under Section 401(k) of the Internal Revenue Code (the "Code"). Subject to limits set forth in the Code, an employee who meets certain age and service requirements may participate in the Savings Plan by contributing through payroll deductions up to 15% of the employee's total annual compensation into an account established for the participating employee and may allocate amounts in such account among a variety of investment vehicles. On January 1, 1997, the Company began making matching contributions to the Savings Plan of up to the lesser of (a) 10% of the employee's contribution, or (b) 6.67% of the employee's annual salary. Matching contributions made by the Company vest in equal annual installments over a five-year period. The Savings Plan also provides for loans to, and withdrawals by, participating employees, subject to certain limitations. Certain recently acquired subsidiaries have similar 401(k) plans with different terms, generally less generous to employees. When these employees have been with the Company for at least one (1) year and otherwise meet the eligibility requirements of the Company, they will be permitted to join the Savings Plan and roll over their existing balances in their plans into the Savings Plan. OPTION GRANTS IN 1998 The following information is furnished for the fiscal year ended December 31, 1998 with respect to the named executive officers of the Company named in the Compensation Table above for stock options granted during such fiscal year. OPTION GRANTS IN LAST FISCAL YEAR INDIVIDUAL GRANTS
POTENTIAL REALIZABLE % OF TOTAL VALUE AT ASSUMED ANNUAL NUMBER OF OPTIONS RATES OF STOCK PRICE SECURITIES GRANTED TO APPRECIATION FOR OPTION UNDERLYING EMPLOYEES EXERCISE OF TERM OPTIONS IN FISCAL BASE PRICE ------------------------ GRANTED YEAR ($/SHARE) EXPIRATION DATE 5% ($) 10% ($) - ------------------- ----------- ---------- ------------ --------------- -------- ------------ Martin J. Sergi ............ 6,000 0.44% $ 18.2875 January 2, 2008 $ 52,757 $ 149,001 19,000 1.39% 16.6250 January 2, 2008 198,652 503,423 75,000 5.50% 16.6250 January 2, 2008 784,153 1,987,198 Ross Pirasteh .............. 6,000 0.44% 16.6250 January 2, 2008 $ 62,732 $ 158,977 19,000 1.39% 16.6250 January 2, 2008 198,652 503,423 75,000 5.50% 16.6250 January 2, 2008 784,153 1,987,198 Ken (Kook Joo) Choi ........ 5,000 0.37% 16.6250 January 2, 2008 $ 52,277 $ 132,480 David E. Hill .............. 6,000 0.44% 16.6250 January 2, 2008 $ 62,732 $ 158,976 9,000 0.66% 16.6250 January 2, 2008 94,099 238,464 Robert E. Wetzel ........... 6,000 0.44% 16.6250 January 2, 2008 $ 62,732 $ 158,976 9,000 0.66% 16.6250 January 2, 2008 94,099 238,464
AGGREGATE OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES The following information is furnished for the year ended December 31, 1998 with respect to each of the executive officers of the Company named in the Compensation Table above, for unexercised stock options at December 31, 1998. 43 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED IN-THE-MONEY OPTIONS EXERCISED OPTIONS AT FISCAL OPTIONS AT FISCAL IN 1998 YEAR END (#) YEAR END ($)(1) ---------------------------------- ----------------- -------------------- SHARES ACQUIRED ON EXERCISABLE/ EXERCISABLE/ EXERCISE VALUE REALIZED ($) UNEXERCISABLE UNEXERCISABLE -------- ------------------ ------------- ------------- Martin J. Sergi ............... 68,381 $ 630,644 87,525 97,842 $ 700,054 $971,321 Ross Pirasteh ................. 0 $ -- 124,318 76,931 $1,144,264 $688,994 Ken (Kook Joo) Choi ........... 0 $ -- 916 4084 $ 4,580 $ 20,420 David E. Hill ................. 32,458 $ 453,956 13,700 51,351 $ 169,679 $598,130 Robert E. Wetzel .............. 7,875 $ 83,527 17,824 41,050 $ 217,235 $466,050
- ------------------- (1) The closing price of the Common Stock ($21.625) as quoted on the Nasdaq National Market System on December 31, 1998 was used to determine the value of unexercised in-the-money status of these options. The following table sets forth certain information with respect to long-term incentive compensation awarded to the chief executive officer and the four most highly compensated executive officers during KTI's fiscal year ending December 31, 1998. LONG-TERM INCENTIVE PLAN
NAME OF SECURITIES UNDERLYING OPTIONS NAME (#) - ----- ----------- Ross Pirasteh ........................................ 100,000 Chairman of the Board Martin J. Sergi ...................................... 100,000 President Ken (Kook Joo) Choi .................................. 5,000 Senior Vice President David E. Hill ........................................ 25,000 Senior Vice President Robert E. Wetzel ..................................... 25,000 Senior Vice President, General Counsel and Secretary
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During the fiscal year ended December 31, 1998, Messrs. Kleinaitis, Polak and Ross served on the Compensation Committee. No member of the Compensation Committee was involved in an interlocking relationship or insider participation with respect to the Compensation Committee. REPORT OF COMPENSATION COMMITTEE The Compensation Committee of the Board of Directors of the Company presents this report on the compensation policies of the Company for its executive officers. This report sets forth the major components of the Company's executive compensation policies and the bases by which the compensation of the Company's Chairman, Vice Chairman and President for the fiscal year ended December 31, 1998 was determined. The Compensation Committee consists entirely of directors who are not and have never been employees of the Company. 44 EXECUTIVE OFFICER COMPENSATION POLICIES The Company's compensation policies for its executive officers are intended to provide compensation packages designed to attract, motivate, reward, and retain qualified executives, to encourage the achievement of the Company's long-term performance objectives, and to increase the value of the Company for the benefit of its shareholders. Annual compensation for each executive officer of the Company is based on three main components: (i) a base salary based on an individual's position and responsibility in the Company, experience and expertise, and performance, in addition to internal pay equity, (ii) a bonus based on the corporate performance of the Company, which is based on definitive performance criteria for certain executive officers and is subjective for all other executive officers; and (iii) stock options to purchase Common Stock of the Company, including incentive stock options granted by the Compensation Committee pursuant to the KTI Incentive Plan, a long-term incentive award plan, and stock options granted by the Board of Directors to the Company's executive officers outside of the KTI Incentive Plan, which options are designed to encourage ownership of the Common Stock by the Company's executive officers and promote the identification of the interests of the executive officers with those of the shareholders of the Company. The Company has employment agreements with Messrs. Pirasteh, Garrett and Sergi which reflect the Company's compensation policies as set forth above. The compensation of the Chief Executive Officer, Vice Chairman and President are based upon the same elements and measures of performance as is the compensation for the Company's other executive officers. During 1998, Mr. Pirasteh's and Mr. Sergi's salary were each increased to $250,000 effective during August, 1998 as a result of successfully directing the acquisitions of FCR and Atlantic Coast during 1998. TAX DEDUCTIBILITY OF EXECUTIVE COMPENSATION Section 162(m) of the Internal Revenue Code of 1986, as amended, generally limits the corporate tax deduction for compensation paid to certain executive officers in excess of $1,000,000 per year, unless the payments are made under a performance based plan as set forth in Section 162(m). For the fiscal year ended December 31, 1997, none of the executive officers of the Company received compensation that exceeded the threshold for deductibility under Section 162(m), and therefore all executive officer compensation paid by the Company during such fiscal year will be fully tax deductible. COMPENSATION COMMITTEE PAUL KLEINAITIS JACK POLAK WILBUR L. ROSS, JR. STOCK PRICE PERFORMANCE GRAPH The following performance graph compares the cumulative total return from February 9, 1995 to December 31, 1998 on each of the Company's common stock ("KTIE"), Standard & Poor's 500 Index ("SPX"), and the ECO-FAC Environmental Index ("ECO-FAC"). The Company has been a public company since February 8, 1995. The total cumulative dollar returns are based on the assumption that $100 was invested in Company Common Stock and each index on February 9, 1995 and all dividends were reinvested, and represent the value that such investments would have had at the end of each quarter from February 9, 1995 through December 31, 1998. On March 31, 1999, the closing sale price of the Common Stock was $10.3125. 45 KTI STOCK PRICE PERFORMANCE INDEX VALUE (FEBRUARY 9, 1995 = 100)
DATE KTIE INDEX SPX INDEX ECO-FAC INDEX ---- ---------- --------- ------------- 2/9/95 100.00 100.00 100 3/31/95 102.36 104.27 101 6/30/95 102.36 113.44 112 9/30/95 159.49 121.70 113 12/30/95 159.49 128.27 116 3/31/96 145.21 134.43 106 6/30/96 147.59 139.66 109 9/30/96 161.87 143.13 110 12/31/96 142.83 154.26 116 3/31/97 174.97 157.67 129 6/30/97 174.97 184.34 148 9/30/97 277.44 197.27 157 12/30/97 327.43 202.09 151 3/31/98 343.68 299.44 156 6/30/98 432.41 236.12 164 9/30/98 364.93 211.79 131 12/31/98 432.41 255.99 149
QUARTER ENDING ECO-FAC Index includes 78 Companies in the environmental business, including Haulers, Environmental consulting firms, Water Treatment firms, etc. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth stock ownership information as of March 31, 1999 concerning (i) each person (including any "group" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) who is known to the Company to own beneficially more than 5% of the outstanding shares of the Company's Common Stock, (ii) each of the Company's directors and named executive officers, and (iii) all directors and executive officers of the Company as a group. Each shareholder had sole voting and investment power with respect to such shares. Except as otherwise indicated, the address of each party listed below is co KTI, Inc., 7000 Boulevard East, Guttenberg, New Jersey 07093.
AMOUNT AND NATURE OF BENEFICIAL PERCENTAGE NAME AND ADDRESS OF BENEFICIAL OWNER OWNERSHIP (1) BENEFICIALLY OWNED - ------------------------------------ ------------- ------------------ Ross Pirasteh..................................... 551,714(2) 4.0% Paul A. Garrett................................... 392,716(3) 2.9% Martin J. Sergi................................... 1,035,514(4) 7.5% David E. Hill..................................... 36,108(5) * Robert E. Wetzel.................................. 105,199(6) * Carlos Aguero..................................... 8,084 * Dibo Attar........................................ 30,773(7) * Ken (Kook Joo) Choi............................... 207,123(8) 1.5% W. Chris Hegele................................... 118,389(9) * Paul Kleinaitis................................... 14,227(10) * Jack Polak........................................ 30,956(11) * Wilbur Ross....................................... 7,500(12) * All executive officers and directors as a group (14 persons)..................................... 2,726,584 19.2%
- ------------------ * Less than one percent. (1) For purposes of this table, a person or group of persons is deemed to be the "beneficial owner" of any shares that such person has the right to acquire within 60 days. For purposes of computing the 46 percentage of outstanding shares held by each such person or group of persons named above on a given date, any security that such person or group of persons has the right to acquire within 60 days is deemed to be outstanding, but is not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. (2) Includes 126,840 shares of Common Stock which can be acquired by Mr. Pirasteh pursuant to stock options which are currently exercisable and 26,250 shares pursuant to a warrant to purchase Common Stock at $8.50 per share. (3) Includes 11,665 shares of Common Stock which may be acquired by Mr. Garrett pursuant to stock options which are currently exercisable. (4) Includes 603,389 shares of Common Stock previously held in escrow for Martin J. Sergi. These shares were acquired by Mr. Sergi on May 10, 1994, from an institutional investor. Includes 92,680 shares which may be acquired by Mr. Sergi pursuant to stock options which are currently exercisable. (5) Includes 16,200 shares of Common Stock which may be acquired by Mr. Hill pursuant to stock options which are currently exercisable. (6) Includes 18,574 shares of Common Stock which can be acquired by Mr. Wetzel pursuant to stock options which are currently exercisable, 18,060 shares pursuant to a warrant to purchase Common Stock at $5.71 per share and 15,750 shares pursuant to a warrant to purchase Common Stock at $8.10 per share. (7) Includes 28,324 shares of Common Stock which may be acquired pursuant to Directors' Stock Options which are currently exercisable. Mr. Attar beneficially owns 2,449 shares over which he has sole voting power. Mr. Attar disclaims beneficial ownership of all shares of Common Stock owned by certain entities to which he provides investment advice, other than the shares referred to above. (8) Includes 205,957 shares of Common Stock held in the name of Ken (Kook Joo) Choi and Myungki Choi, as Trustees of the Choi Family Trust under an agreement dated March 22, 1993. Also includes 1,166 shares of Common Stock which may be acquired by Mr. Choi pursuant to stock options which are currently exercisable. (9) Includes 118,389 shares of Common Stock held by Kitty Hawk Capital Limited Partnership II, of which Mr. Hegele is the managing partner. (10) Includes 7,500 shares of Common Stock which may be acquired by Mr. Kleinaitis pursuant to Directors' Stock Options which are currently exercisable. (11) Includes 17,826 shares of Common Stock which may be acquired by Mr. Polak pursuant to Directors' Stock Options which are currently exercisable and 1,573 shares held by corporations and partnerships controlled by Mr. Polak. Includes warrants to purchase 5,250 shares. Excludes 700 shares held in trust for the benefit of Mr. Polak's wife of which Mr. Polak disavows beneficial ownership. (12) Includes 7,500 shares of Common Stock which may be acquired by Mr. Ross pursuant to a warrant to purchase shares at $16.25 per share. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS TRANSACTIONS WITH NICHOLAS MENONNA, JR. AND MARTIN J. SERGI The Company leases office space from the Mall at the Galaxy, Inc. (the "Mall"), a corporation which is 72% owned by Nicholas Menonna, Jr., a principal shareholder and former Chairman and Chief Executive Officer of the Company, and Martin J. Sergi, a principal shareholder and President of the Company. The Mall leases space to 27 tenants under long-term operating leases. The Company made rental payments to the Mall of $96,000 in fiscal year 1998. The Company believes that the lease for the office space was made on terms comparable to those which could have been obtained from an unaffiliated lessor. The Company held a promissory note of the Mall at the Galaxy, Inc. dated January 1, 1994 in the original principal amount of $121,581, with a balance including interest accrued as of December 31, 1998 of $62,486. 47 This note was issued in replacement of a note dated May 30, 1989 in the original principal amount of $74,076. The note bears interest at 10% per annum. PRIVATE PLACEMENTS OF NOTES, LETTER OF CREDIT During 1996, the Company made private placements of $2,003,314 of 8% notes due July 31, 1996 together with 333,882 warrants to purchase Common Stock at $6.00 per share, subject to adjustment, which expire five (5) years from the date of issue. Certain directors and executive officers of the Company or affiliates thereof participated in the private placement in the amounts as follows: Mr. Menonna, $129,000 in notes and 22,575 warrants; Mr. Wetzel, $103,314 in notes and 18,080 warrants; Mr. Pirasteh, $60,000 in notes and 10,500 warrants (which were registered in the names of others); and Mr. Polak, $60,000 in notes and 10,500 warrants. In connection with the purchase of the assets of Prins Recycling Corp. in 1997, a letter of credit was provided to the secured lender to Prins. Three individuals, including Mr. Wetzel, provided the collateral supporting the letter of credit. As consideration for providing such collateral, such individuals received a fee, equal to 1.5% of the face amount of the letter of credit and warrants to purchase shares of common stock of the Company. Mr. Wetzel received a fee of $4,500 and a warrant to purchase 9,450 shares at an exercise price of $8.10 per share. PART IV ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) The following financial statements are filed as a part of this report: Consolidated Financial Statements of KTI, Inc.: Report of Independent Auditors Consolidated Balance Sheets at December 31, 1998 and 1997 Consolidated Statements of Income for each of the three years in the period ended December 31, 1998 Consolidated Statements of Changes in Shareholders Equity for each of the three years in the period ended December 31, 1998 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1998 Notes to Consolidated Financial Statements Financial Statements of Penobscot Energy Recovery Company: Report of Independent Auditors Statement of Income for the year ended December 31, 1996 Statement of Changes in Partners' Capital for the year ended December 31, 1996 Statement of Cash Flows for the year ended December 31, 1996 Notes to Financial Statements (b) The following consolidated financial statement schedule of the Company is filed as part of this report: Schedule I -- Condensed Financial Information of Registrant Schedule II -- Valuation of Qualifying Accounts All other schedules for which provision is made in the applicable accounting regulations of the Securities Exchange Act of 1934 are not required under the related instructions or are inapplicable, and therefore have been omitted. 48 (c) The following exhibits which are furnished with this report or incorporated herein by reference, are filed as part of this report: EXHIBIT INDEX 2.1 Agreement of Reorganization and Merger among KTI, Inc., a New Jersey corporation, K-C Industries, Inc., an Oregon corporation and KES, Inc., a Delaware corporation, dated September 22, 1997(1) 3.1 Certificate of Amendment to Registrant's Restated Certificate of Certificate of Incorporation, filed August 8, 1997(3) 3.2 Certificate of Correction to Certificate of Amendment to Registrant's Restated Certificate of Certificate of Incorporation, filed October 31, 1997(23) 4.1 Specimen Form of Common Stock Certificate(2) 10.1 Loan Agreement dated as of June 1, 1985 between City of Biddeford, Maine and Maine Energy Recovery Company, as amended(4) 10.2 Subordinated Note of Maine Energy Recovery Company dated as of December 1, 1990 in the original principal amount of $14,252,338.39 payable to CNA Realty Corp.(4) 10.3 Subordinated Note of Maine Energy Recovery Company dated as of December 1, 1990 in the original principal amount of $9,495,327.45 payable to Energy National, Inc.(4) 10.4 Subordinated Note of Maine Energy Recovery Company dated as of December 1, 1990 in the original principal amount of $4,737,517.54 payable to Project Capital 1985(4) 10.5 Loan Agreement dated as of April 1, 1986 between Town of Orrington, Maine and Penobscot Energy Recovery Company, as amended(4) 10.6 Credit Agreement dated as of May 15, 1986 by and among Penobscot Energy Recovery Company, PERC Management Company and Energy National, Inc. and The Banking Institutions Signatory Hereto and Bankers Trust Company, as Agent, as amended(4) 10.7 Second Amended and Restated Agreement and Certificate of Limited Partnership of Penobscot Energy Recovery Company dated May 15, 1986, as amended(2) 10.8 Agreement between Penobscot Energy Recovery Company and Bangor Hydro-Electric Company dated June 21, 1984, as amended(2) 10.9 Form of Penobscot Energy Recovery Company Waste Disposal Agreement (City of Bangor) dated April 1, 1991 and Schedule of Substantially Identical Waste Disposal Agreements(2) 10.10 Operation and Maintenance Agreement Between Esoco Orrington, Inc. and Penobscot Energy Recovery Company dated June 30, 1989(2) 10.11 Residue Disposal Agreement between Penobscot Energy Recovery Company and Sawyer Environmental Recovery Facilities, Inc. dated September 19, 1985, as amended(2) 10.12 Amended and Restated Bypass Agreement between Sawyer Environmental Recovery Facilities, Inc. and Penobscot Energy Recovery Company dated April 4, 1994(2) 10.13 Second Amended and Restated Agreement and Certificate of Limited Partnership of Maine Energy Recovery Company dated June 30, 1986, as amended(2) 10.14 Power Purchase Agreement between Maine Energy Recovery Company and Central Maine Power Company dated January 12, 1984, as amended(2) 10.15 Operation and Maintenance Agreement between Maine Energy Recovery Company and KTI Operations, Inc. dated December 1, 1990(2) 10.16 Host Municipalities' Waste Handling Agreement among Biddeford-Saco Solid Waste Committee, City of Biddeford, City of Saco and Maine Energy Recovery Company dated June 7, 1991(2)
49 10.17 Form of Maine Energy Recovery Company Waste Handling Agreement (Town of North Berwick) dated June 7, 1991 and Schedule of Substantially Identical Waste Disposal Agreements(2) 10.18 Material Disposal and Transportation Agreement among Consolidated Waste Service, Inc., Waste Management of New Hampshire and Maine Energy Recovery Company dated October 21, 1991(2) 10.19 Front-End Process Residue Agreement between Arthur Schofield, Inc. and Maine Energy Recovery Company dated May 27, 1994(2) 10.20 Second Amended and Restated Agreement and Certificate of Limited Partnership of FTI Limited Partnership dated December 11, 1986, as amended(2) 10.21 Land Lease dated November 25, 1985 between City of Lewiston and Fuel Technologies, Inc. as amended(2) 10.22 KTI, Inc. 1994 Long-Term Incentive Award Plan(2) 10.23 Employment Agreement between KTI, Inc. and Martin J. Sergi dated May 1, 1994(2) 10.24 Registration Rights Agreement between Davstar Managed Investments Corp. and KTI Environmental Group, Inc. dated March 17, 1993(2) 10.25 Registration Rights Agreement among KTI Environmental Group, Inc., Martin J. Sergi and Midlantic National Bank dated May 10, 1994(2) 10.26 Registration Rights Agreement among KTI Environmental Group, Inc., Nicholas Menonna, Jr. and Midlantic National Bank dated May 10, 1994(2) 10.27 KTI, Inc. Directors Stock Option Plan(5) 10.28 Form of Registration Rights between KTI, Inc. and Mona Kalimian, Mark D. Kalimian, and Linda Berley dated July 27, 1995 and Schedule of Substantially Identical Registration Rights Agreements(4) 10.29 Letter Agreement dated as of November 10, 1995 among Central Maine Power, Maine Energy Recovery Company and Citizens Lehman Power(6) 10.30 Global Agreement dated December 28, 1995 between Environmental Capital Holdings, Inc. and KTI, Inc.(6) 10.31 Agreement of Limited Partnership of American Ash Recycling of Tennessee, Ltd. dated December 28, 1995(6) 10.32 Agreement of Limited Partnership of American Ash Recycling of New England, Ltd. dated December 28, 1995(6) 10.33 First Amendment to Agreement of Limited Partnership of American Ash Recycling of Tennessee, Ltd., dated March 16, 1996(7) 10.34 Agreement dated as of July 19, 1996 by and among KTI, Inc., DataFocus Incorporated and CIBER, Inc.(8) 10.35 Agreement dated July 19, 1996 by and among KTI, Inc., Thomas Bosanko and Patrick B. Higbie(8) 10.36 Operating Agreement of Specialties Environmental Management Company, LLC dated as of October 18, 1996(9) 10.37 Amendment to Employment Agreements between KTI, Inc. and Nicholas Menonna, Jr. and Martin J. Sergi(10) 10.38 Note Purchase Agreement dated as of October 23, 1996 between KTI, Inc. and WEXFORD KTI LLC(11) 10.39 Registration Rights Agreement dated as of October 23, 1996 between KTI, Inc. and WEXFORD KTI LLC(11)
50 10.40 Escrow Agreement dated as of October 23, 1996 between KTI, Inc. and WEXFORD KTI LLC and Key Trust of Ohio, N.A.(11) 10.41 Securities Purchase Agreement by and among KTI Plastic Recycling, Inc., Continental Casualty Company, CNA Realty Corp., CLE, Inc. and Timber Energy Investment, Inc. dated as of November 22, 1996(12) 10.42 Securities Purchase Agreement by and among KTI Plastic Recycling, Inc. and Diane Goodman and Seth Lehner dated as of November 25, 1996(13) 10.43 Loan and Security Agreement between KTI, Inc., KTI Environmental Group, Inc., Kuhr Technologies, Inc., KTI Limited Partners, Inc., KTI Operations, Inc. and PERC, Inc., Borrowers, and Key Bank of New York, Lender, dated October 29, 1996(14) 10.44 Pledge Agreement between each Borrower and Key Bank of New York dated October 29, 1996(14) 10.45 Key Trust Company PRISM(R) Prototype Retirement Plan and Trust adopted as of December 11, 1996(14) 10.46 Option and Consulting Agreement by and among KTI, Inc. and L.T. Lawrence & Co., Inc. dated as of June 1, 1996(14) 10.47 First Amendment to Option and Consulting Agreement by and among KTI, Inc. and L.T. Lawrence & Co., Inc. dated as of December 18, 1996(14) 10.48 Warrant to purchase 200,000 shares of KTI, Inc. common stock at $7.50 per share issued to L.T. Lawrence & Co., Inc. dated as of December 18, 1996(14) 10.49 Warrant to purchase 6,000 shares of KTI, Inc. common stock at $8.50 per share issued to Thomas E. Schulze dated as of January 2, 1997(14) 10.50 Warrant to purchase 3,000 shares of KTI, Inc. common stock at $8.50 per share issued to John E. Turner dated as of January 2, 1997(14) 10.51 Warrant to purchase 6,000 shares of KTI, Inc. common stock at $8.50 per share issued to Robert E. Wetzel dated as of January 2, 1997(14) 10.52 Warrant to purchase 15,000 shares of KTI, Inc. common stock at $6.00 per share issued to The Baldwin & Clarke Companies dated as of January 2, 1997(14) 10.53 Warrant to purchase 15,000 shares of KTI, Inc. common stock at $7.00 per share issued to The Baldwin & Clarke Companies dated as of January 2, 1997(14) 10.54 Third Amendment to Second Amended and Restated Certificate and Agreement of Limited Partnership of FTI Limited Partnership dated as of January 23, 1997(14) 10.55 Warrant to purchase 2,000 shares of KTI, Inc. common stock at $8.50 per share issued to Maine Woodchips Associates dated as of January 23, 1997(14) 10.56 Registration Rights Agreement by and between KTI, Inc. and Maine Woodchips Associates dated as of January 23, 1997(14) 10.57 Securities Purchase Agreement by and among KTI Plastic Recycling, Inc., Continental Casualty Company, CNA Realty Corp., CLE, Inc. and Timber Energy Investment, Inc., dated as of November 22, 1996(15) 10.58 Term sheet (Purchase of assets of Prins Recycling Corp. and subsidiaries)(16) 10.59 Agreement, dated as of April 21, 1997 between KTI Recycling, Inc. and its subsidiaries and PNC Bank(16) 10.60 Operations and Maintenance Agreement, dated as of April 21, 1997, by and between Prins Recycling Corp. and its subsidiaries and KTI Operations, Inc.(16) 10.61 Order of the Bankruptcy Court for the District of New Jersey dated June 19, 1997(16) 10.62 Asset Purchase Agreement, dated as of June 24, 1997, between Prins Recycling Corp. and its subsidiaries and KTI Recycling, Inc. and its subsidiaries(16)
51 10.63 Securities Purchase Agreement by and among I. Zaitlin & Sons, Inc., a Maine corporation, Data Destruction Services, Inc., a Maine corporation, Samuel M. Zaitlin, Steven G. Suher and George G. Deely and KTI Recycling, Inc., a Delaware corporation(17) 10.64 First amendment, dated as of August 14, 1997, to the Loan and Security Agreement between KTI, Inc., KTI Environmental Group, Inc., Kuhr Technologies, Inc., KTI Limited Partners, Inc., KTI Operations, Inc. and PERC, Inc.(18) 10.65 Securities Purchase Agreement, dated as of August 12, 1997, by and among KTI, Inc., and Wenoha Corporation, John G. Mills, L. Don Norton, Glen Wade Stewart, Bruce D. Wentworth and Donald E. Wentworth(18) 10.66 Placement Agreement dated August 7, 1997 between KTI, Inc. and Credit Research & Trading LLC(19) 10.67 Warrant Agreement dated August 7, 1997 between KTI, Inc. and Credit Research & Trading LLC(19) 10.68 Registration Rights Agreement dated August 15, 1997 between KTI, Inc. and the purchases named therein(19) 10.69 Purchase and Option Agreement by and between PERC Management Company Limited Partnership and The Prudential Insurance Company of America dated September 30, 1997(20) 10.70 Second Amendment to the Second Amended and Restated Agreement and Certificate of Limited Partnership of Penobscot Energy Recovery Company, Limited Partnership dated as of September 29, 1997(20) 10.71 Assignment and Assumption Agreement between The Prudential Insurance Company of America and PERC Management Company Limited (20) Partnership dated as of September 29, 1997 re Penobscot Energy Recovery Company, Limited Partnership(20) 10.72 Amendment No. 1 to Reimbursement Agreement and Release of Assignment dated as of September 29, 1997 to the Reimbursement Agreement dated as of May 28, 1991 of Penobscot Energy Recovery Company, Limited Partnership in favor of Morgan Guaranty Trust Company of New York re Penobscot Energy Recovery Company, Limited Partnership(20) 10.73 Assignment and Assumption Agreement between The Prudential Insurance Company of America and PERC Management Company Limited Partnership dated as of September 29, 1997 re Orrington Waste Ltd., Limited Partnership(20) 10.74 Amendment no. 1 to Reimbursement Agreement and Release of Assignment dated as of September 29, 1997 to the Reimbursement Agreement dated as of May 28, 1991 of Penobscot Energy Recovery Company, Limited Partnership in favor of Morgan Guaranty Trust Company of New York re Orrington Waste Ltd.(20) 10.75 Warrant to purchase 7,500 shares of KTI, Inc. Common Stock at $16.25 per share issued to Wilbur L. Ross dated as of January 1, 1998(24) 10.76 Securities Purchase Agreement dated as of January 1, 1998, by and among Vel-A-Tran Recycling, Inc., a Massachusetts corporation, Raymond Vellucci and KTI Recycling of New England, Inc., a Delaware corporation(21) 10.77 Securities Purchase Agreement dated as of January 27, 1998 among Total Waste Management Corporation, Donald A. Littlefield, William Kaylor and KTI Specialty Waste Services, Inc., a Maine corporation(22) 10.78 Commitment Letter from the Finance Authority of Maine dated February 13,1998 regarding willingness to refinance Electric Rate Stabilization Bonds for Penobscot Energy Recovery Company, Limited Partnership(25) 10.79 Letter of Intent dated April 17, 1998 by and between KTI, Inc. and FCR, Inc. describing the intended purchase of FCR, Inc. by KTI, Inc.(26)
52 10.80 Exchange Notice, dated June 5, 1998, notifying shareholders of the Series B Preferred Stock of KTI's intent to convert such stock into Subordinated Convertible Notes ("the Exchange Notes") bearing interest at 8.75%(27) 10.81 Stock Purchase Agreement dated June 16, 1998 by and between KTI, Inc. and the Shareholders of Multitrade Group, Inc.(28) 10.82 Warrant to purchase 17,500 shares of KTI, Inc. Common Stock at $22.25 per share issued to George Mitchell dated as of June 22, 1998(24) 10.83 Amendment No. 2 to Power Purchase Agreement, entered into as of the 26th day of June, 1998 by and between Penobscot Energy Recovery Company, Limited Partnership, a Maine limited partnership, and Bangor-Hydro Electric Company, a Maine corporation.(29) 10.84 Second Amended and Restated Waste Disposal Agreements between Penobscot Energy Recovery Company and the Municipal Review Committee, Inc. dated as of June 26, 1998(29) 10.85 Loan Agreement by and between Finance Authority of Maine and Penobscot Energy Recovery Company, Limited Partnership dated as of June 26, 1998(29) 10.86 KTI, Inc. Limited Guaranty dated as of June 26, 1998 on loan agreement in Exhibit 10.85(29) 10.87 Bangor Hydro-Electric Company Warrant to Purchase Common Stock issued to PERC Management Company Limited Partnership dated as of June 26, 1998(29) 10.88 Third Amended and Restated Agreement of Limited Partnership of Penobscot Energy Recovery Company, Limited Partnership dated as of June 26, 1998(29) 10.89 Surplus Cash Agreement dated as of June 26, 1998 among Penobscot Energy Recovery Company, Limited Partnership, Bangor Hydro-Electric Company and Municipal Review Committee, Inc.(29) 10.90 Revolving Credit Agreement dated July 10, 1998 among KTI, Inc. and the Subsidiary Borrowers, Jointly and Severally as the Borrower, KeyBank National Association and other financial institutions as Lenders and KeyBank National Association, as Agent, regarding $150,000,000 Line of Credit.(30) 10.91 Agreement and Plan of Merger dated as of July 22, 1998 by and between KTI, Inc. and FCR, Inc.(31) 10.92 Fairness opinion letter issued to KTI, Inc. by Donaldson, Lufkin & Jenrette dated as of July 7, 1998.(31) 10.93 Asset Purchase Agreement, dated as of August 5, 1998, by and among First State Recycling, Inc., a Delaware corporation, and KTI Environmental Consulting, Inc., a Delaware corporation.(32) 10.94 Asset Purchase Agreement between KTI New Jersey Fibers, Inc. and Atlantic Coast Fibers, Inc. dated as of August 21, 1998.(33) 10.95 Asset Purchase Agreement between KTI New Jersey Fibers, Inc., PGC Corporation and Gaccione Bros. & Co., Inc. dated as of August 21, 1998.(33) 10.96 Agreement and Plan of Merger, dated July 22, 1998, between KTI, Inc., KTI Acquisition Sub, Inc., FCR, Inc. and certain securityholders of FCR, Inc.(34) 10.97 Employment Agreement, dated August 28, 1998, between KTI, Inc. and Paul A. Garrett.(34) 10.98 Employment Agreement, dated August 28, 1998, between KTI, Inc. and Brian J. Noonan.(34) 10.99 Warrant to purchase 7,500 shares of KTI, Inc. Common Stock at $15.3125 per share issued to Carlos Aguero dated as of August 28, 1998(24) 10.100 Warrant to purchase 7,500 shares of KTI, Inc. Common Stock at $15.3125 per share issued to W. Christopher Hegele dated as of August 28, 1998(24)
53 10.101 Agreement and Plan of Reorganization dated as of October 28, 1998, by and among KTI Specialty Waste Services, Inc., Russell Stull Company, Capitol City Transfer, Inc. and TWTS, Inc., all Maine corporations and Russell G. Stull.(35) 10.102 Purchase and Sale Agreement between KTI Environmental Group, Inc. and CNA Realty Corp, Inc. dated as of December 30, 1998.(36) 10.103 Investment Agreement dated as of December 29, 1998 between and among KTI, Inc., Oakhurst Company, Inc. and Oakhurst Technology, Inc.(37) 10.104 Letter Loan Agreement between KTI, Inc. and CNA Realty Corp, Inc. dated as of December 29, 1998 between and among KTI, Inc., Oakhurst Company, Inc. and Oakhurst Technology, Inc.(37) 10.105 Pledge Agreement dated as of December 29, 1998 between and among KTI, Inc., Oakhurst Company, Inc. and Oakhurst Technology, Inc.(37) 10.106 Intercreditor Agreement between KTI, Inc. and Finova Capital Corporation dated as of December 29, 1998(37) 10.107 Non-Exclusive License to Use Technology between KTI, Inc. and Oakhurst Technology, Inc. dated as of December 29, 1998(37) 10.108 Operating and Maintenance Agreement, dated as of December 29, 1998 by and between New Heights Recovery & Power, LLC and KTI Operations, Inc.(37) 10.109 Agreement and Plan of Merger, dated January 12, 1999, by and among Casella Waste Systems, Inc., Rutland Acquisition Sub, Inc. and KTI, Inc.(38) 10.110 Stock for Stock Reorganization Agreement by and among Anthony A. Peterpaul, Frank Peterpaul, Anthony Peterpaul, The AFA Group, Inc., AFA Pallet Group, Inc., Advanced Enterprises Recycling, Inc., Allied Equipment & Sales Corp., Inc., American Supplies Sales Group, Inc., Artic, Inc., Atlantic Transportation Technologies, Inc., Agro Products, Inc. and KTI Recycling of New Jersey, Inc., dated as of January 27, 1999(39) 21 List of all subsidiaries of Registrant *23 Consent of Ernst & Young LLP
- -------------------- (1) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated September 16, 1997. (2) Filed as an Exhibit to Registrant's Registration Statement on Form S-4 (No. 33-85234) dated January 6, 1995. (3) Filed as an Exhibit to the Company's Current Report on Form 8-K dated August 15, 1997. (4) Filed with the Registration Statement on Form S-1 dated December 6, 1995. (5) Filed as an Exhibit to Registrant's Proxy Statement dated June 5, 1995. (6) Filed with the Amendment No. 1 to the Registration Statement on Form S-1 dated February 2, 1996. (7) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated April 15, 1996. (8) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated July 19, 1996. (9) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated October 18, 1996. (10) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated October 23, 1996. (11) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated October 24, 1996. (12) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated November 22, 1996. (13) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated November 25, 1996. (14) Filed as an Exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1996. (15) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated November 26, 1996. (16) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated June 19, 1997 54 (17) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated July 29, 1997. (18) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated August 12, 1997. (19) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated August 15, 1997. (20) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated September 30, 1997. (21) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated January 15, 1998. (22) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated February 4, 1998. (23) Filed with the Registration Statement on Form S-2 dated February 11, 1998. (24) Filed with the Registration Statement on Form S-3 dated September 30, 1998 (25) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated February 23, 1998 (26) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated May 7, 1998 (27) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated June 17, 1998 (28) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated June 25, 1998 (29) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated July 8, 1998 (30) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated July 15, 1998 (31) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated August 5, 1998 (32) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated August 13, 1998 (33) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated August 31, 1998 (34) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated September 14, 1998 (35) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated November 10, 1998 (36) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated January 6, 1999 (37) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated January 15, 1999 (38) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated January 21, 1999 (39) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated February 10, 1999 * Filed herewith. REPORTS ON FORM 8-K FILED DURING THE FOURTH QUARTER OF 1998. Two Reports on Form 8-K were filed in the fourth quarter of 1998, one of which was amending a Form 8-K filed during the third quarter. The following is a list of the Forms 8-K filed and the dates thereof. (i) A Form 8-K/A was filed on October 7, 1998 reporting that on August 28, 1998, FCR, Inc. was merged with and into KTI Acquisition Sub, Inc. pursuant to an Agreement and Plan of Merger, dated July 22, 1998 and that on July 2, 1998, FCR acquired all of the outstanding shares of stock of Resource Recovery Systems, Inc. (ii) A Form 8-K was filed on November 10, 1998 reporting that in connection with a previous Form 8-K filed on September 14, 1998, reporting that FCR, Inc. was merged with and into KTI Acquisition Sub, Inc. pursuant to an Agreement and Plan of Merger, dated July 22, 1998. As a result of the Merger, FCR became a wholly-owned subsidiary of the Company. 55 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. KTI, INC. (Registrant) By: /s/ Ross Pirasteh ------------------------------------ Ross Pirasteh Chairman of the Board Date: October 29, 1999 Pursuant to the requirements of the Securities 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 date indicated.
Signature Title Date - --------- ----- ---- Chairman of the Board October 29, 1999 - ---------------------- Ross Pirasteh Chief Financial Officer October 29, 1999 - ---------------------- (Principal Executive Financial Brian J. Noonan and Accounting Officer) President and Director October 29, 1999 - ---------------------- Martin J. Sergi Vice Chairman and Director October 29, 1999 - ---------------------- Paul A. Garrett By: * ------------------- Paul Kleinaitis Director October 29, 1999 By: * ------------------- George Mitchell Director October 29, 1999 By: * ------------------- Wilbur Ross Director October 29, 1999 By: * ------------------- Dibo Attar Director October 29, 1999 By: * ------------------- Jack Polak Director October 29, 1999 By: * ------------------- Kenneth Choi Director October 29, 1999
56
Signature Title Date - --------- ----- ---- By: * ------------------- Carlos Aguero Director October 29, 1999 By: * ------------------- H. Christopher Hegele Director October 29, 1999 By: * ------------------- - ------------------------ * /s/ of Martin J. Sergi Attorney-in-Fact
57 KTI, INC. INDEX TO FINANCIAL STATEMENTS
PAGE --------- The following consolidated financial statements and schedules of KTI, Inc.: Consolidated Financial Statements of KTI, Inc.: Report of Independent Auditors........................................................................... F-2 Consolidated Balance Sheets at December 31, 1998 and 1997................................................ F-3 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1998................................................................................................... F-4 Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended December 31, 1998................................................................................ F-5 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1998................................................................................................... F-6 Notes to Consolidated Financial Statements............................................................... F-8 Financial Statements of Penobscot Energy Recovery Company: Report of Independent Auditors........................................................................... F-41 Statement of Income for the year ended December 31, 1996................................................. F-42 Statement of Changes in Partners' Capital for the year ended December 31, 1996........................... F-43 Statement of Cash Flows for the year ended December 31, 1996............................................. F-44 Notes to Financial Statements............................................................................ F-45 The following consolidated financial statement schedules of KTI, Inc.: Report of Independent Auditors on Financial Statement Schedules.......................................... S-1 I Condensed Financial Information of Registrant............................................................ S-2 II Valuation and Qualifying Accounts....................................................................... S-7
All other schedules for which provision is made in the applicable accounting regulations of the Securities Exchange Act of 1934 are not required under the related instructions or are inapplicable, and therefore have been omitted. F-1 REPORT OF INDEPENDENT AUDITORS The Board of Directors KTI, Inc. We have audited the accompanying consolidated balance sheets of KTI, Inc. as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements 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 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 consolidated financial position of KTI, Inc. at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. As discussed in Note 2, the previously issued financial statements for each of the three years in the period ended December 31, 1998 have been restated to reflect the deferral of revenue related to certain proceeds received in connection with the restructuring of a power purchase agreement and the sale of electric generating capacity with two utilities. ERNST & YOUNG LLP Hackensack, New Jersey March 30, 1999, except for the second paragraph of Note 9, as to which the date is August 27, 1999, Note 2 as to which the date is August 30, 1999 and the first paragraph of Note 21 as to which the date is September 23, 1999 F-2 KTI, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, DECEMBER 31, 1998 1997 ------------- ------------- ASSETS Current Assets Cash and cash equivalents.......................................................... $ 9,426 $ 11,181 Restricted funds................................................................... 19,088 13,103 Accounts receivable, net of allowances of $1,313 and $294.......................... 29,272 22,126 Consumables and spare parts........................................................ 4,483 4,041 Inventory.......................................................................... 4,866 1,219 Notes receivable--officers/shareholders and affiliates............................. 1,858 29 Other receivables.................................................................. 4,158 461 Deferred taxes..................................................................... 4,832 2,751 Other current assets............................................................... 3,370 793 ------------- ------------- Total current assets............................................................. 81,353 55,704 Restricted funds..................................................................... 4,350 6,527 Notes receivable--officers/shareholders and affiliates............................... 1,534 81 Other receivables.................................................................... 3,025 271 Other assets......................................................................... 6,167 1,768 Deferred taxes....................................................................... 1,407 Deferred costs, net of accumulated amortization of $1,610 and $676................... 5,268 2,911 Goodwill and other intangibles, net of accumulated amortization of $4,354 and $1,422............................................................................. 119,712 19,535 Deferred project development costs................................................... 937 Property, equipment and leasehold improvements, net of accumulated depreciation of $27,724 and $18,369................................................................ 213,669 164,753 ------------- ------------- Total assets..................................................................... $ 436,485 $ 252,487 ------------- ------------- ------------- ------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable................................................................... $ 14,940 $ 8,779 Accrued expenses................................................................... 9,313 3,990 Debt, current portion.............................................................. 9,775 19,794 Other current liabilities.......................................................... 4,499 1,184 ------------- ------------- Total current liabilities........................................................ 38,527 33,747 Other liabilities.................................................................... 4,227 1,918 Debt, less current portion........................................................... 202,153 74,473 Minority interest.................................................................... 12,437 14,077 Deferred revenue..................................................................... 61,396 68,556 Customer advance..................................................................... 12,788 Convertible subordinated notes....................................................... 6,770 Commitments and contingencies Stockholders' equity Preferred stock; 10,000,000 shares authorized; Series A; non-voting; par value $8 per share; 447,500 shares authorized, issued and outstanding in 1997.............................................................. 3,732 Series B; voting; par value $25 per share; 8.75%, 880,000 shares authorized; 856,000 shares issued and outstanding in 1997.................................... 21,400 Common stock; no par value (stated value $.01 per share); authorized 40,000,000 in 1998 and 20,000,000 in 1997, issued and outstanding 13,266,204 and 8,912,630 shares in 1998 and 1997, respectively................... 133 89 Additional paid-in capital........................................................... 115,026 52,762 Accumulated deficit.................................................................. (16,972) (18,267) ------------- ------------- Total stockholders' equity........................................................... 98,187 59,716 ------------- ------------- Total liabilities and stockholders' equity....................................... $ 436,485 $ 252,487 ------------- ------------- ------------- -------------
SEE ACCOMPANYING NOTES. F-3 KTI , INC. CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, ----------------------------------------- 1998 1997 1996 ------------- ------------ ------------ Revenues.............................................................. $ 179,007 $ 98,587 $ 35,717 Cost of operations.................................................... 156,664 75,864 26,048 ------------- ------------ ------------ Gross Profit........................................................ 22,343 22,723 9,669 Selling, general and administrative................................... 7,947 3,196 2,534 ------------- ------------ ------------ Income from operations.............................................. 14,396 19,527 7,135 Interest expense, net................................................. (10,667) (5,086) (4,464) Other income, net..................................................... 390 37 ------------- ------------ ------------ Income from continuing operations before minority interest, benefit for income taxes and extraordinary item............................. 3,729 14,831 2,708 Minority interest..................................................... 3,702 2,522 1,185 Pre-acquisition earnings.............................................. 4,722 ------------- ------------ ------------ Income from continuing operations before benefit for income taxes and extraordinary item.............................................. 27 7,587 1,523 Benefit for income taxes.............................................. (3,023) (2,586) ------------- ------------ ------------ Income from continuing operations before extraordinary item......... 3,050 10,173 1,523 Discontinued operations Loss from discontinued operations (including a loss on disposal of $549 and provision for income taxes of $200)........................ 714 ------------- ------------ ------------ Income before extraordinary item.................................... 3,050 10,173 809 Extraordinary item--Loss on early extinguishment of debt, net of minority interest and in 1998, taxes................................ 351 2,248 ------------- ------------ ------------ Net income (loss)................................................... 2,699 10,173 (1,439) Accretion and accrued and paid dividends on preferred stock........... (1,133) (1,408) ------------- ------------ ------------ Net income (loss) available to common shareholders.................. $ 1,566 $ 8,765 $ (1,439) ------------- ------------ ------------ ------------- ------------ ------------ Net income (loss) per common share: Basic: Income from continuing operations before extraordinary item.................................................. $ 0.18 $ 1.18 $ 0.25 Loss from discontinued operations................................... (0.12) ------------- ------------ ------------ Income before extraordinary item.................................... 0.18 1.18 0.13 Extraordinary item.................................................. (0.03) (0.37) ------------- ------------ ------------ Net income (loss)................................................... $ 0.15 $ 1.18 $ (0.24) ------------- ------------ ------------ ------------- ------------ ------------ Weighted average number of shares used in computation............... 10,548,570 7,403,681 6,090,956 ------------- ------------ ------------ ------------- ------------ ------------ Diluted: Income from continuing operations before extraordinary item.................................................. $ 0.17 $ 1.08 $ 0.24 Loss from discontinued operations................................... (0.11) ------------- ------------ ------------ Income before extraordinary item.................................... 0.17 1.08 0.13 Extraordinary item.................................................. (0.03) (0.36) ------------- ------------ ------------ Net income (loss)................................................... $ 0.14 $ 1.08 $ (0.23) ------------- ------------ ------------ ------------- ------------ ------------ Weighted average number of shares used in computation............... 11,398,151 8,426,190 6,255,088 ------------- ------------ ------------ ------------- ------------ ------------
See accompanying notes. F-4 KTI, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
SERIES A SERIES B COMMON PREFERRED STOCK PREFERRED STOCK STOCK ---------------------- -------------------- --------- SHARES AMOUNT SHARES AMOUNT SHARES --------- ----------- --------- --------- --------- Balance at December 31, 1995........................................ 5,946,973 Net loss.......................................................... Issuance of common stock for: Exercise of options............................................. 55,346 Exercise of warrants............................................ 41,183 Conversion of debt.............................................. 725,015 Business combinations........................................... 68,249 Issuance of stock purchase warrants............................... --------- ----------- --------- --------- --------- Balance at December 31, 1996........................................ 6,836,766 Net income........................................................ Issuance of preferred stock and common stock purchase warrants.... 487,500 $ 3,376 Accretion of preferred stock...................................... 700 Issuance of preferred stock and common stock purchase warrants.... 856,000 $ 21,400 Issuance of common stock and common stock purchase warrants for: Exercise of options............................................. 85,353 Exercise of warrants............................................ 692,771 Conversion of debt.............................................. 618,609 Conversion of preferred stock................................... (40,000) (344) 40,000 Employee savings plan contribution.............................. 4,117 Business combinations........................................... 635,014 Dividends paid on Series B Preferred Stock........................ --------- ----------- --------- --------- --------- Balance at December 31, 1997........................................ 447,500 3,732 856,000 21,400 8,912,630 Net income........................................................ Accretion of preferred stock...................................... 42 Issuance of common stock and common stock purchase warrants for: Exercise of options............................................. 235,682 Exercise of warrants............................................ 411,894 Non-employee director's compensation............................ Conversion of preferred stock: Series A...................................................... (447,500) (3,774) 447,500 Series B...................................................... (856,000) (21,400) 25,531 Conversion of debt.............................................. 1,283,399 Employee savings plan contribution.............................. 4,215 Business combinations........................................... 1,945,353 Tax benefit realized from stock option transactions............... Dividends paid on Series B Preferred Stock........................ Additional costs related to preferred stock issuance.............. --------- ----------- --------- --------- --------- Balance at December 31, 1998........................................ 13,266,204 --------- ----------- --------- --------- --------- --------- ----------- --------- --------- --------- ADDITIONAL ACCUMULATED AMOUNT PAID-IN DEFICIT TOTAL ----------- ----------- ------------ --------- Balance at December 31, 1995........................................ $ 59 $ 33,427 $ (26,606) $ 6,880 Net loss.......................................................... (1,439) (1,439) Issuance of common stock for: Exercise of options............................................. 1 280 281 Exercise of warrants............................................ 225 225 Conversion of debt.............................................. 7 4,045 4,052 Business combinations........................................... 1 455 456 Issuance of stock purchase warrants............................... 144 144 ----- ----------- ------------ --------- Balance at December 31, 1996........................................ 68 38,576 (28,045) 10,599 Net income........................................................ 10,173 10,173 Issuance of preferred stock and common stock purchase warrants.... 422 3,798 Accretion of preferred stock...................................... (700) Issuance of preferred stock and common stock purchase warrants.... (1,416) 19,984 Issuance of common stock and common stock purchase warrants for: Exercise of options............................................. 1 502 503 Exercise of warrants............................................ 7 3,611 3,618 Conversion of debt.............................................. 6 4,901 4,907 Conversion of preferred stock................................... 1 343 Employee savings plan contribution.............................. 35 35 Business combinations........................................... 6 6,488 6,494 Dividends paid on Series B Preferred Stock........................ (395) (395) ----- ----------- ------------ --------- Balance at December 31, 1997........................................ 89 52,762 $ (18,267) 59,716 Net income........................................................ 2,699 2,699 Accretion of preferred stock...................................... (42) Issuance of common stock and common stock purchase warrants for: Exercise of options............................................. 2 1,894 1,896 Exercise of warrants............................................ 4 1,648 1,652 Non-employee director's compensation............................ 205 205 Conversion of preferred stock: Series A...................................................... 4 3,770 Series B...................................................... 1 300 (21,099) Conversion of debt.............................................. 13 15,686 15,699 Employee savings plan contribution.............................. 41 41 Business combinations........................................... 20 38,122 38,142 Tax benefit realized from stock option transactions............... 738 738 Dividends paid on Series B Preferred Stock........................ (1,404) (1,404) Additional costs related to preferred stock issuance.............. (98) (98) ----- ----------- ------------ --------- Balance at December 31, 1998........................................ $ 133 $ 115,026 $ (16,972) $ 98,187 ----- ----------- ------------ --------- ----- ----------- ------------ ---------
See accompanying notes. F-5 KTI, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) OPERATING ACTIVITIES Net income (loss)............................................................. $ 2,699 $ 10,173 $ (1,439) Adjustments to reconcile net income to net cash provided by operating activities: Loss on disposal of discontinued operations............................... 550 Extraordinary loss........................................................ 351 2,248 Depreciation and amortization............................................. 13,749 6,786 6,694 Minority interest, net of distributions................................... 1,114 2,522 1,185 Deferred revenue and customer advance..................................... (7,807) (7,281) (4,854) Deferred income taxes..................................................... (3,913) (2,751) Provision for losses on accounts receivable............................... 1,289 193 Interest accrued and capitalized on debt.................................. 1,109 906 1,451 Write-off of deferred project development costs........................... 937 Non-cash directors' compensation.......................................... 205 Premium for conversion of convertible debt to common stock................ 1,370 Other non-cash charges.................................................... 187 (83) 262 Equity in net income of subsidiaries, net of distributions................ (198) Loss on sale of debt securities........................................... 296 Changes in operating assets and liabilities: Accounts receivable..................................................... 1,866 (2,458) 4,703 Consumables, spare parts and inventory.................................. (1,104) 71 (842) Other receivables....................................................... 1,206 244 (258) Other assets............................................................ (1,172) (503) (1,410) Accounts payable and accrued expenses................................... (9,038) 1,285 (3,283) Other liabilities....................................................... (1,867) 218 (187) Proceeds from sale of electric generating capacity, net of transaction costs................................................................... 80,691 ---------- ---------- ---------- Net cash provided by operating activities..................................... 1,181 9,322 85,609 INVESTING ACTIVITIES Additions to property, equipment and leasehold improvements................... (8,581) (5,072) (3,412) Proceeds from sale of assets.................................................. 460 203 469 Proceeds from sale of discontinued operation.................................. 5,005 Deferred project development costs............................................ (45) (910) Net change in restricted funds: Cash equivalents.......................................................... (3,251) (2,149) (3) Debt securities available-for-sale........................................ 5,579 Purchase of additional partnership interests.................................. (2,410) (14,532) (792) Cash acquired in purchase of additional partnership interests................. 5,375 Purchase of businesses, net of cash acquired.................................. (55,499) (17,548) (2,958) Investment in unconsolidated affiliate........................................ (865) Notes receivable--officers/shareholders and affiliates........................ (1,400) 340 (9) Proceeds from sale of business................................................ 1,985 ---------- ---------- ---------- Net cash provided by (used in) investing activities........................... (69,561) (33,428) 2,969
F-6 KTI, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- (IN THOUSANDS) FINANCING ACTIVITIES Deferred financing costs...................................................... (3,901) (1,265) (1,188) Net borrowings on lines of credit............................................. 133,573 30,107 8,786 Proceeds from issuance of debt................................................ 44,995 Additional preferred stock issuance costs..................................... (98) 4,121 506 Proceeds from customer advance, net........................................... 5,900 Proceeds from sale of common stock............................................ 3,548 Proceeds from sale of preferred stock......................................... 23,782 Dividends paid................................................................ (1,404) (395) Principal payments on debt.................................................... (115,988) (26,290) (97,909) ---------- ---------- ---------- Net cash provided by (used in) financing activities........................... 66,625 30,060 (89,805) ---------- ---------- ---------- Increase (decrease) in cash and cash equivalents.............................. (1,755) 5,954 (1,227) Cash and cash equivalents at beginning of year................................ 11,181 5,227 6,454 ---------- ---------- ---------- Cash and cash equivalents at end of year...................................... $ 9,426 $ 11,181 $ 5,227 ---------- ---------- ---------- ---------- ---------- ---------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid................................................................. $ 8,864 $ 2,792 $ 6,145 Taxes paid.................................................................... 150 75 NON CASH INVESTING AND FINANCING ACTIVITIES Capital lease obligations entered into for lease of equipment................. 1,725 347 Purchase of businesses and additional partnership interest, net of cash acquired: Working capital surplus (deficit), net of cash acquired................... (1,772) 6,293 1,311 Property, equipment and leasehold improvements............................ 48,277 67,660 8,012 Purchase price in excess of net assets acquired........................... 102,866 14,235 3,256 Other assets.............................................................. 4,466 667 591 Non-current liabilities................................................... 57,786 55,659 8,964 Common stock and common stock purchase warrants issued.................... 38,142 6,494 456
See accompanying notes F-7 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 1. ORGANIZATION KTI, Inc. ("KTI") and subsidiaries (collectively, the "Company"), is an integrated waste handling business providing wood, paper, corrugated, metals, plastic and glass processing and recycling, municipal solid waste processing and disposal capabilities, specialty waste disposal services, recycling of ash combustion residue, the generation of electricity and steam and the manufacture of finished products utilizing recyclable materials. The Company also markets recyclable metals, plastic, paper and corrugated processed at its facilities and by third parties. The Company operates 53 facilities in 21 states and Canada in four operating segments: Waste-to-Energy Processing, Finished Products, Commercial Recycling and Residential Recycling. There are significant restrictions on the ability of certain of the Company's subsidiaries to distribute assets to the Company. These restrictions result from the terms of certain indebtedness and provisions of other agreements with third parties. These subsidiaries include the Company's majority-owned consolidated subsidiaries, Maine Energy Recovery Company ("Maine Energy") and Penobscot Energy Recovery Company ("PERC") and the Company's wholly-owned subsidiary Timber Energy Resources, Inc. ("TERI"). At December 31, 1998, the net assets of these subsidiaries was $51,551. Maine Energy, PERC and TERI are subject to the provisions of various federal, state, local and provincial energy laws and regulations, including the Public Utility Regulatory Policy Act of 1978, as amended. In addition, federal, state and local environmental laws establish standards governing certain aspects of the Company's operations. The Company believes it has all permits, licenses and approvals necessary to operate. 2. RESTATEMENT The Company's balance sheets as of December 31, 1998 and 1997 and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998 have been restated. The restatement is a result of the Securities and Exchange Commission's review of the Company's proxy materials related to the prospective merger with Casella Waste Systems (See note 21). The restatement relates to revenue recognized as a result of the restructuring of a power purchase agreement and the sale of electric generating capacity by two of the Company's majority-owned subsidiaries with its customers, BHE and CMP, which were completed in 1998 and 1996, respectively (See notes 4 and 5). At the time of these transactions, the Company had recognized revenues representing a portion of the cash received in 1996 and the total consideration received in 1998. After discussions with the staff of the Securities and Exchange Commission, the Company agreed to defer these amounts and recognize them over the term of the respective power purchase and capacity purchase agreements to comply with generally accepted accounting principles. In addition, performance credits previously reported as expense have been reclassified as a reduction of F-8 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 2. RESTATEMENT (CONTINUED) revenues. The impact of the restatement on the Company's consolidated financial results as originally reported is summarized as follows:
AS REPORTED RESTATED -------------------------------- -------------------------------- 1998 1997 1996 1998 1997 1996 ---------- --------- --------- ---------- --------- --------- Revenues..................................... $ 192,977 $ 96,157 $ 68,508 $ 179,007 $ 98,587 $ 35,717 Income before extraordinary item............. 7,069 8,092 15,914 3,050 10,173 809 Net income (loss)............................ 6,718 8,092 13,666 2,699 10,173 (1,439) Net income (loss) available to common shareholders............................... 5,585 6,684 13,666 1,566 8,765 (1,439) Net income (loss) per share: Basic...................................... 0.53 0.90 2.25 0.15 1.18 (0.24) Diluted.................................... 0.49 0.83 2.05 0.14 1.08 (0.24)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of KTI and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. As described in Note 6, during 1997 the Company acquired in two transactions certain limited partnership interests in PERC aggregating 64.29%. Prior to these transactions, the Company was a 7.00% owner and the managing general partner of PERC. As a result of the Company's aggregate ownership interest, PERC's financial statements have been included in the Company's consolidated statement of income for the year ended December 31, 1997. The consolidated statement of income includes PERC's operations for the year ended December 31, 1997 as though the acquisition had occurred at the beginning of the year and includes adjustments to eliminate minority interest and the pre-acquisition earnings of PERC attributable to the partnership interests acquired as of the respective dates. Prior to 1997, the Company's investment in PERC was accounted for under the equity method based on the Company's significant influence over its financial and operating policies. The ownership interest of minority owners in the equity and earnings of the Company's less than 100 percent-owned consolidated subsidiaries is recorded as minority interest. CASH EQUIVALENTS The Company considers all highly liquid investments with an original maturity of 90 days or less when purchased to be cash equivalents. RESTRICTED FUNDS Restricted funds consist of cash and cash equivalents held in trust, all of which are available, under certain circumstances, for current operating expenses, debt service, capital improvements and repairs and maintenance in accordance with certain contractual obligations and cash deposited in a bank in connection with certain of the Company's debt and standby letter of credit obligations. Restricted funds available for current operating and debt service purposes are classified as current assets. F-9 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SIGNIFICANT CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK Within the Waste-to-Energy segment, Maine Energy, PERC and TERI each sell electricity to the local electric utility in their respective geographic locations (Central Maine Power Company, ("CMP"), Bangor Hydro Electric Company ("BHE") and Florida Power Company ("FPC"), respectively). Electric power revenue from such utilities during 1998 totaled approximately $19,326, $14,676 and $5,593, respectively, and $18,780, $17,492 and $5,126, respectively, in 1997 and $21,441 in 1996 for CMP. Accounts receivable from CMP, BHE and FPC were $1,393, $3,166 and $472, respectively, at December 31, 1998 and $2,163, $3,212 and $454, respectively, at December 31, 1997. In addition, Maine Energy and PERC earn substantial portions of their waste handling revenues from municipalities in their respective geographic regions in the state of Maine. TERI also earns a significant portion of its revenue from a large national paper manufacturer. Such revenues are earned under the terms of long-term agreements. American Ash Recycling of Tennessee, Ltd. ("AART") earns a substantial portion of its revenues as the result of a contract with the City of Nashville, Tennessee. Although less than 10% of consolidated revenue, a significant portion of sales of recyclables in the Commercial segment is to international (including Pacific Rim countries, South America and Europe) and domestic paper manufacturers. The Company performs periodic credit evaluations of these customers. Although the Company's exposure to credit risk associated with non-payment by paper manufacturers is affected by conditions within the paper industry and the general economic condition of countries within the Pacific Rim, South America and Europe, a significant portion of outstanding receivables are supported through letters of credit either issued, confirmed or discounted by banks located in the United States. No single paper manufacturer or customer exceeded 5% of the Company's total accounts receivable at December 31, 1998. Although less than 10% of consolidated revenue, a significant portion of sales in the Residential Recycling segment is to two customers. The facilities within the Residential Recycling segment operate under long-term contracts with the local municipalities or contract waste haulers. This segment earns a portion of its revenues from these municipalities and waste haulers within the geographic region surrounding the respective facilities. In addition, the Residential Recycling segment enters into long-term contracts to sell recyclable materials at prices based on market price with a contractual floor. These contracts have terms from one to ten years and expire through 2008. No individual municipality or customer under long-term commodity contracts exceeded 5% of the Company's total accounts receivable at December 31, 1998. Although less than 10% of consolidated revenue, a significant portion of sales in the Finished Products segment is to one customer. This customer is under a contract to purchase a specified quantity of product at rates that approximate market value through August, 2000. In addition, a significant portion of this segment's sales are to manufacturers of manufactured homes and insulation contractors throughout the United States and thus the revenues are impacted by sales of new homes, which are cyclical in nature. No individual customer of this segment exceeded 5% of the Company's total accounts receivable at December 31, 1998. Other financial instruments which subject the Company to concentrations of credit risk are cash and cash equivalents including restricted funds. The Company restricts its cash investments to financial institutions with high credit standings and securities backed by the United States Government. F-10 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVENTORIES Inventories, consisting of secondary fibers, recyclables ready for sale and certain finished products, include costs paid to third parties for purchased materials and are stated at the lower of cost (first-in, first-out) or market. Inventories consisted of finished goods of approximately $4,065 and $1,219 at December 31, 1998 and 1997 respectively, and raw material of approximately $801 at December 31, 1998. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. All costs incurred for additions and improvements, including interest during construction, are capitalized. The Company capitalized net interest costs of $285, $20 and $110, in 1998, 1997 and 1996, respectively. Depreciation of property and equipment is provided using the straight-line method over the estimated useful lives ranging principally from three to twenty-five years. Assets under capital leases are amortized using the straight-line method over the estimated useful lives ranging from five to ten years. Amortization of assets under capital leases is included in depreciation expense. Leasehold improvements are amortized on a straight-line basis over the shorter of the term of the lease or the estimated useful life of the improvement. GOODWILL Goodwill represents costs in excess of net assets of businesses acquired in purchase transactions. Goodwill is being amortized on a straight-line basis over periods up to thirty years. DEFERRED FINANCING COSTS Costs incurred in connection with debt and letter of credit financings are deferred and are being amortized over the life of the related debt or letter of credit issues using the interest method. The unamortized portion of such costs related to the previously outstanding PERC bonds in 1998 and the Maine Energy bonds in 1996 were included in the determination of the extraordinary loss. DEFERRED PROJECT DEVELOPMENT COSTS The Company defers certain external costs incurred in the development of new projects including design and costs related to obtaining required permits. Amortization of these costs begins when the project becomes operational. If management concludes that the related project will not be completed, the deferred costs are expensed immediately. REVENUE RECOGNITION Revenues from the sale of electricity to local utilities are recorded at the contract rate specified in each entity's power purchase agreement ("PPA") as it is delivered. Revenue includes the portion of the deferred gain on the sale of electric generating capacity at Maine Energy (see Note 5) which is being amortized on a straight-line basis over the term of the capacity agreement (eleven years). Revenue also F-11 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) includes the amortization of the customer advance at PERC (see note 4) which is being amortized on a straight-line basis over the term of the Power Purchase Agreement (nineteen years). Revenues from waste processing consist principally of fees charged to customers for waste disposal. Substantially all waste processing revenues are earned from customers located in a geographic region proximate to the respective facility. Revenue is generally recorded upon acceptance and in certain cases is based on rates specified in long-term contracts. Certain of these rates are subject to adjustment based on the levels of certain costs and expenses, as defined, of Maine Energy and PERC. The Company periodically reviews the long-term contracts and any anticipated losses are charged to operations in the period the losses are first determinable. The Company's evaluation is based on estimated revenues and direct costs related to the respective contracts. Revenues from the sale of recycled materials ($72,130, and $17,004 in 1998 and 1997, respectively) and finished products are recognized upon shipment. Rebates to certain municipalities based on sales of recyclable materials are recorded upon the sale of such recyclables to third parties and are included in cost of operations. Revenues for processing of recyclable materials are recognized upon delivery of recycled materials to the Company and totaled $7,791 and $690 in 1998 and 1997, respectively. Management fees from affiliates for 1996, related to providing general partner services to PERC, were recognized in accordance with the partnership agreement and were included in waste processing revenues. Such amounts have been eliminated in consolidation for 1998 and 1997. Service and other revenues in connection with transportation and waste management are recognized upon completion of the services. INCOME TAXES Deferred income taxes are determined using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. BUSINESS COMBINATIONS The Company has accounted for all business combinations under the purchase method of accounting. Under this method, the purchase price is allocated to the assets and liabilities of the acquired enterprise as of the acquisition date (to the extent of the Company's ownership interest) based on their estimated respective fair values and are subject to revision for a period not to exceed one year from the date of acquisition. The results of operations of the acquired enterprise are included in the Company's consolidated financial statements for the period subsequent to the acquisition. F-12 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NET INCOME AVAILABLE FOR COMMON SHAREHOLDERS Net income available for common shareholders represents net income adjusted for:
1998 1997 --------- --------- Accretion of preferred stock to redemption value........................... $ 42 $ 700 Preferred stock dividends.................................................. 1,091 395 Dividends earned but not paid or accrued................................... 313 --------- --------- $ 1,133 $ 1,408 --------- --------- --------- ---------
EVALUATION OF LONG-LIVED ASSETS The Company assesses long-lived assets for impairment, including goodwill associated with assets acquired in a business combination when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. The Company performs an evaluation comparing the estimated future undiscounted cash flows associated with the asset to the asset's carrying amount to determine if a write-down to market value or discounted cash flow value is required. No such events or circumstances existed at December 31, 1998. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. RECENT ACCOUNTING DEVELOPMENTS Recent accounting pronouncements which are not required to be adopted at December 31, 1998, include the following Statement of Financial Accounting Standards ("SFAS") and the American Institute of Certified Public Accountants Statements of Position ("SOP"): SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which will be required to be adopted by the Company as of January 1, 2001, establishes standards for derivative instruments, including those embedded in other contracts and for hedging activities. The new standard requires the Company to recognize all derivatives as either assets or liabilities and measure those instruments at fair value. Management believes that the adoption of SFAS No. 133 will not have a material impact on the Company's financial statements. SOP 98-1, ACCOUNTING FOR COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE is required to be adopted by the Company as of January 1, 2000. The Company's current policy falls within the guidelines of SOP 98-1. Also, SOP 98-5, REPORTING ON THE COSTS OF START-UP ACTIVITIES is required to be adopted by the Company as of January 1, 1999. Management believes that the adoption of SOP 98-5 will not have a material impact on the Company's financial statements. F-13 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year presentation. 4. AMENDMENT OF PERC'S POWER PURCHASE AGREEMENT AND WASTE DISPOSAL AGREEMENTS On June 26, 1998, PERC completed an amendment of its PPA with BHE. At closing, PERC received $6,000 in cash and BHE agreed to make 16 quarterly payments of $250 commencing October 1, 1998 (the "BHE Note"). For financial statement purposes, the BHE Note has been discounted using an effective interest rate of 5.45%. The $6,000 cash payment and the present value of the BHE Note ($3,572) are being accounted for as a customer advance. Imputed interest on the BHE Note is being amortized over its term and is included in interest income. In addition, BHE issued the Company warrants to purchase 712,857 shares of BHE common stock at an exercise price of $7.00 per share, exercisable 25% annually with an expiration date of June 26, 2008. The estimated aggregate fair value of these warrants at the date of issuance was approximately $3,814 ($5.35 per share) which was also recorded as a customer advance. The customer advance, net of transaction costs, is being amortized over the life of the PPA with BHE (19 years). As of December 31, 1998 the remaining customer advance in connection with this transaction was approximately $12,788. In connection with the amendment, PERC's waste disposal agreements with certain municipalities (the "Amending Charter Municipalities") were amended to extend the term of such agreements to 2018. In addition, PERC granted the Amending Charter Municipalities the right to purchase up to a 50% limited partnership interest in PERC for an aggregate purchase price of $31,000. Such purchases may only be made to the extent of their respective share of distributable cash from PERC, as defined, and one-half of the quarterly payments to be made under the BHE Note. Any such amounts paid by the Amending Charter Municipalities must be used to prepay PERC's outstanding bonds payable. The Amending Charter Municipalities were also granted the right to purchase the remaining partnership interests in 2018 at the then fair market value, as defined. The waste disposal agreements were further amended to provide that the Amending Charter Municipalities, BHE, and partners in PERC would each receive one-third of PERC's cash flows, as defined. Prior to this amendment, the municipalities received one-half PERC's distributable cash, as defined. Based on PERC's cash flow, as defined, distributable cash of approximately $4,616 and $1,101 was payable for 1998 and 1997, respectively. Of these amounts, approximately $413 and $1,101 remained unpaid as of December 31, 1998 and 1997, respectively, and was included in accrued expenses. Under the PPA, PERC is required to deliver at least 105,000,000 kWh to BHE in any Calendar year. In the event PERC fails to deliver this output, PERC is obligated to pay $4 for each 1,000,000 kWh by which such deliveries fall below 105,000,000 kWh. 5. SALE OF ELECTRIC GENERATION CAPACITY AND RESTRUCTURE OF POWER PURCHASE AGREEMENT On May 3, 1996, Maine Energy completed a restructuring of its PPA with CMP and the sale of the rights to its electrical generating capacity to CL Power Sales One, L.L.C. ("CL One"). At closing, Maine Energy received a payment from CL One of $85,000 ("Capacity Payment") and the PPA was amended to reflect a reduction in CMP's purchase price for electric power. In addition, the term of the F-14 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 5. SALE OF ELECTRIC GENERATION CAPACITY AND RESTRUCTURE OF POWER PURCHASE AGREEMENT (CONTINUED) PPA was extended from 2007 to 2012. The Company also received reimbursement of certain transaction costs, including interest on the Capacity Payment from November 6, 1995 to closing and certain other payments. The Company recorded the payment from CL One, net of transaction costs, of approximately $80,691 as deferred revenue in 1996. This amount is being recognized on a straight-line basis as revenue over the life of the capacity agreement with CL One (eleven years). As of December 31, 1998 and 1997 the remaining deferred revenue was $61,276 and $68,556, respectively. Under the terms of the agreements, Maine Energy will be liable to CMP for liquidated damages of $3,750 for any calendar year through the year 2006 and on a pro rata basis for the period from January 1, to May 31, 2007 in which it does not deliver at least 100,000,000 kilowatt hours ("kWh"). Also, if during the same period, Maine Energy fails to deliver at least 15,000,000 kWh in any calendar year through the year 2006 and on a pro rata basis for the period from January 1, to May 31, 2007 it will be liable to CMP for liquidated damages of $3,750 times the number of years remaining in the term of the agreement. Both the 100,000,000 kWh and the 15,000,000 kWh levels are adjusted in the case of a force majeure event, as defined. Maine Energy produced approximately 166,000,000 and 168,000,000 kWh of electricity in each of 1998 and 1997, respectively. In order to secure CMP's right to liquidated damages, Maine Energy has obtained an irrevocable letter of credit in the initial amount of $45,000 which will be reduced by $3,750 for each completed year in which no event requiring the payment of liquidated damages occurs. Under the terms of the letter of credit agreement, Maine Energy is required to maintain certain restricted funds. The letter of credit is collateralized by liens on substantially all of Maine Energy's assets. Maine Energy used the proceeds from the sale of its capacity to repay the then outstanding Maine Energy Resource Recovery Bonds and to retire the related bank letter of credit. This prepayment resulted in the recognition of an extraordinary loss of $2,248 (net of minority interest of $2,213) in 1996. 6. ACQUISITIONS 1998 ACQUISITIONS The Company acquired ten companies and an additional partnership interest in one company during 1998. Payment of the aggregate purchase price for these acquisitions consisted of (i) 1,945,353 shares of the Company's common stock at a weighted-average value of $19.06 per share (based on the closing prices of the common stock on the date of announcement of each acquisition); (ii) $57,909 in cash (net of cash acquired of $6,198); (iii) a promissory note in the principal amount of $1,086; and (iv) warrants to purchase 130,000 shares of common stock valued at approximately $1,060 as of the date of acquisition. These acquisitions were accounted for as purchases, and accordingly, the assets and liabilities of the acquired entities have been recorded at their estimated fair value at the dates of acquisition. The excess of the purchase price over the fair value of the acquired net assets aggregating $102,866 has been recorded as goodwill and is being amortized on a straight line basis over 30 years. The more significant 1998 acquisitions are described below. In August 1998, the Company acquired FCR, Inc. ("FCR") a diversified recycling company that provides residential and commercial recycling, processing and marketing services and primarily manufactures cellulose insulation and plastics using recycled materials. FCR owns or operates eighteen F-15 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 6. ACQUISITIONS (CONTINUED) material recovery facilities, six cellulose insulation manufacturing facilities and three plastic processing facilities in twelve states. Payment of the purchase price, including all direct costs, of $63,581 consisted of (i) 1,714,285 shares of the Company's common stock valued at $18.96 per share (based on the closing price of the common stock on the date of announcement) and (ii) $31,074 in cash. An additional payment of up to $30,000 may have been required based on the earnings of FCR for the period July 1, 1998 through December 31, 1998 (the "Earnout"). Based on FCR's earnings during the period, no payments are due under the Earnout. The cost of the acquisition exceeded the fair value of the acquired net assets by approximately $70,032. In August 1998, the Company acquired certain assets and assumed certain liabilities of Atlantic Coast Fibers, Inc. ("Atlantic Coast") and Gaccione Bros. & Co., Inc. and PGC Corporation (collectively, "Gaccione"). Atlantic Coast operates a high-grade paper processing facility. Payment of the purchase price, including all direct costs, for Atlantic Coast of $9,655 consisted of (i) 123,532 shares of the Company's common stock valued at $20.29 per share (based on the closing price of the common stock on the date of the announcement), (ii) $6,995 in cash and (iii) warrants to purchase 20,000 shares of common stock valued at approximately $153 as of the date of acquisition. Gaccione operated a high-grade paper processing facility. Payment of the purchase price, including all direct costs, for Gaccione of $6,975 consisted of (i) $5,889 in cash and (ii) a 7% promissory note in the principal amount of $1,086. In September 1998, the Company agreed to a payment of an additional purchase price for Atlantic Coast and Gaccione consisting of 150,000 shares of common stock. The Company recorded this additional purchase price as a liability and an addition to goodwill. Subsequent to year-end, the Board of Directors approved the payment of the additional purchase price and the common stock was issued. The cost of these acquisitions exceeded the fair value of the acquired net assets by approximately $18,104. In June 1998, the Company acquired Multitrade Group, Inc. ("Multitrade"). Multitrade operates three waste-to-energy facilities utilizing biomass and coal to produce steam for sale to major industrial users under long-term contracts. Payment of the purchase price, including all direct costs, for Multitrade was $12,347 in cash. The cost of the acquisition exceeded the fair value of the acquired net assets by approximately $4,537. In December 1998, the Company acquired an additional 9.6% limited partnership interest in Maine Energy from one of the existing limited partners. The cost of the acquisition was $2,410. The transaction has been accounted for under the purchase method of accounting and the cost of the purchase price has been allocated to the assets and liabilities of Maine Energy (to the extent of the Company's additional ownership interest) based on their estimated fair values as of the date of acquisition and resulted in an increase in the carrying value of property and equipment of approximately $1,670. 1997 ACQUISITIONS On September 30, 1997 and November 12, 1997, the Company purchased certain limited partnership interests in PERC aggregating 64.29% from one of the existing limited partners. The aggregate cost of the acquisitions was $14,500. The purchase price has been allocated to the assets and liabilities of PERC (to the extent of the Company's additional ownership interest) based on their estimated fair values as of the date of acquisition and resulted in a reduction in the carrying value of F-16 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 6. ACQUISITIONS (CONTINUED) property and equipment of approximately $8,038. Prior to the acquisition of the additional 64.29% limited partnership interest, the Company accounted for its 7% ownership under the equity method. The excess of the Company's actual capital contributions over its original 7% ownership interest in the partnership's total contributed capital is being amortized over the term of the partnership's energy sales contract. This amount is included in goodwill. In November, 1997, the Company acquired certain assets and assumed certain liabilities of Prins Recycling Corp. and its subsidiaries ("Prins") pursuant to an order of the Bankruptcy Court for the District of New Jersey. Prins was engaged in the operation of three material recycling facilities located in or proximate to Newark, New Jersey, Chicago, Illinois and Charlestown, Massachusetts. The aggregate purchase price including all direct costs was approximately $15,100 and included warrants to purchase 92,250 shares of the Company's common stock at exercise prices ranging from $8.10 to $9.25 per share. The warrants are exercisable at any time and expire on various dates between December 31, 1999 and April 30, 2002. During 1998 and 1997, 40,000 and 17,325 of these warrants were exercised. At December 31, 1998, 34,925 of these warrants remain outstanding. In connection with the transaction, the Company assumed certain administrative claims against Prins. The cost of the acquisition exceeded the fair value of the acquired net assets by approximately $6,374 which has been recorded as goodwill and is being amortized on a straight line basis over 15 years. During 1998, the Company finalized its allocation of the purchase price which resulted in certain changes in estimated liabilities as of the acquisition date, including certain additional administrative claims against Prins and fair values assigned to property, equipment and leasehold improvements. Such adjustments resulted in an increase in goodwill of approximately $1,865. On September 19, 1997, the Company acquired all of the outstanding common stock of K-C Industries, Inc. ("K-C"). K-C is engaged in the marketing of paper and secondary fibers. The aggregate purchase price, including all direct costs, was approximately $6,739 and included 425,014 shares of the Company's common stock. The cost of the acquisition exceeded the fair value of the acquired net assets by approximately $5,035 which has been recorded as goodwill and is being amortized on a straight line basis over 15 years. In August, 1997, the Company acquired all of the outstanding common stock of I. Zaitlin and Sons, Inc. ("Zaitlin"), a company engaged in the recycling business in Maine, and Data Destruction Services, Inc., a company engaged in the destruction of confidential records. The aggregate purchase including all direct costs was approximately $2,245 and included 200,000 shares of the Company's common stock. The cost of the acquisition exceeded the fair value of the acquired net assets by approximately $2,498 which has been recorded as goodwill and is being amortized on a straight line basis over 10 years. During 1998, the Company finalized its allocation of the purchase price which resulted in certain changes in estimated liabilities as of the acquisition date. Such adjustments resulted in an increase in goodwill of approximately $105 during 1998. In June, 1997, the Company acquired the entire general partnership interest in AARNE from the existing general partner. The aggregate cost of the acquisition was $560 which exceeded the carrying value of the minority interest by approximately $328 which was recorded as goodwill and is being amortized on a straight line basis over 15 years. Subsequent to the acquisition, the Company owns 100% of AARNE. F-17 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 6. ACQUISITIONS (CONTINUED) 1996 ACQUISITIONS On May 3, 1996, the Company purchased additional limited partnership interests in Maine Energy aggregating 23.77% from certain other existing limited partners. The aggregate cost of the acquisitions was approximately $485. Subsequent to this acquisition, the Company's ownership in Maine Energy aggregated 74.15%. Prior to September 16, 1994 (the date at which the Company acquired its initial limited partnership interests and became majority owner in Maine Energy), the Company accounted for its 10% ownership interest under the equity method. The difference between the Company's actual capital contributions and its ownership interest in the partnership's total contributed capital is being amortized over the term of the partnership's energy sales contract. This amount is included in goodwill. During the fourth quarter of 1996, the Company acquired all of the outstanding common stock of Timber Energy Investments, Inc. ("TEII"). TEII, through its subsidiaries, is engaged in the generation of electricity and the processing of wood and plastic materials. The purchase price, including all direct costs, was approximately $2,142. The cost of the acquisition exceeded the fair value of TEII's net assets by approximately $2,035 which has been recorded as goodwill and is being amortized on a straight line basis over 10 years. During 1997, the Company finalized its allocation of the purchase price which resulted in certain changes in the fair values assigned to property, equipment and leasehold improvements and the reduction of certain assumed liabilities. Such adjustments resulted in an increase of goodwill of approximately $229. On March 31, 1996, the Company acquired a 60% limited partnership interest in American Ash Recycling Co. of Tennessee, a limited partnership, ("AART"). AART is engaged in the processing of ash residue from a waste-to-energy facility located in Nashville, Tennessee. The purchase price for the limited partnership interest was $2,100. The cost of the acquisition exceeded the fair value of AART's net assets by approximately $800 which has been recorded as goodwill and is being amortized on a straight line basis over 10 years. On November 25, 1996, the Company acquired all of the outstanding common stock of Manner Resins, Inc. ("Manner") a company engaged in the purchase and sale of recyclable plastic materials. The purchase price was approximately $456 and was entirely financed through the issuance of 65,000 shares of the Company's common stock. The cost of the acquisition exceeded the fair value of Manner's net assets by approximately $421 which has been recorded as goodwill and is being amortized on a straight line basis over 5 years. The following unaudited pro forma summary presents selected operating data as if the significant 1998 and 1997 acquisitions described above had occurred as of January 1, 1997, and does not purport F-18 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 6. ACQUISITIONS (CONTINUED) to be indicative of the results that would have occurred had the transactions been completed as of those dates or of results which may occur in the future.
1998 1997 ---------- ---------- Net revenues.............................................................................. $ 239,541 $ 240,354 Income (loss) from continuing operations before extraordinary item........................ (686) 4,603 Net income (loss)......................................................................... (1,037) 4,603 Net income (loss) available for common shareholders....................................... (2,170) 2,031 Net income (loss) per share-basic......................................................... (0.18) 0.21 Net income (loss) per share-diluted....................................................... (0.18) 0.21
7. DISPOSAL OF COMPUTER SERVICES SEGMENT During 1996, the Company disposed of its computer services segment which was comprised entirely of its wholly-owned subsidiary Convergent Solutions, Inc. ("CSI"). The sale was completed in two separate transactions. On July 26, 1996 certain assets and liabilities of CSI were sold to Ciber, Inc. for $5,000. Also, on July 29, 1996, all of the outstanding common stock of CSI was sold to certain members of its management for $5. In addition, the Company had notes receivable from the buyers aggregating $445 at December 31, 1996. The notes receivable were repaid during 1997. The results of operations of CSI for 1996 have been classified as discontinued operations in the accompanying financial statements. CSI's revenues for 1996 were $5,785. 8. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment and leasehold improvements consist of the following at:
DECEMBER 31, ---------------------- 1998 1997 ---------- ---------- Land...................................................................................... $ 3,018 $ 2,171 Buildings and site improvements........................................................... 43,772 40,942 Machinery and equipment................................................................... 184,589 137,184 Automobiles and trucks.................................................................... 3,694 Furniture and fixtures.................................................................... 2,300 2,075 Leasehold improvements.................................................................... 2,917 750 Construction-in-progress.................................................................. 1,103 ---------- ---------- 241,393 183,122 Less accumulated depreciation............................................................. (27,724) (18,369) ---------- ---------- $ 213,669 $ 164,753 ---------- ---------- ---------- ----------
Beginning October 1, 1996 Maine Energy revised the estimated average useful lives used to compute depreciation for substantially all of its plant and equipment. These revisions were made to more properly reflect the remaining useful lives of the assets. The change had the effect of increasing income before extraordinary item and net income by approximately $482 ($.08 per share, basic and $.07 diluted per share) for 1996. F-19 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 9. DEBT The Company's debt consists of the following:
DECEMBER 31, --------------------- 1998 1997 ---------- --------- (A) Revolving credit agreement............................................................ $ 138,628 (A) Revolving and term loan payable....................................................... $ 12,411 (B) Capital lease obligations............................................................. 5,466 357 (C) Revolving credit facility............................................................. 4,000 4,000 (D) Promissory note payable............................................................... 1,086 (E) Bonds Payable......................................................................... 760 (F) Secured term notes payable............................................................ 555 692 (G) Term loan payable..................................................................... 460 489 (H) Secured note payable to bank.......................................................... 50 1,555 (I) Term note payable to bank............................................................. 304 Other................................................................................. 1,210 PERC Bonds Payable.................................................................... 44,995 47,900 Revenue Bonds Payable by TERI......................................................... 11,635 13,400 Convertible Subordinated Notes........................................................ 6,770 Subordinated Notes Payable to Maine Energy Limited Partners........................... 4,293 11,949 ---------- --------- 218,698 94,267 Less current portion.................................................................. 9,775 19,794 ---------- --------- $ 208,923 $ 74,473 ---------- --------- ---------- ---------
- ------------------------ (A) During July 1998, the Company entered into a Revolving Line of Credit Agreement with a bank (the "Credit Agreement") which provides for borrowings of up to $150,000. The Credit Agreement expires in April 2001. The Company may select interest rates on the outstanding borrowings based on the bank's prime rate or LIBOR rates. The interest rates range from the bank's prime rate to the bank's prime rate plus 0.75% or LIBOR rates plus 1.75% to LIBOR rates plus 2.50% depending on the attainment of certain financial covenants, as defined in the Credit Agreement. All borrowings under the Credit Agreement at December 31, 1998 were at LIBOR plus 2.50% (8.05% at December 31, 1998). The Credit Agreement also provides standby letters of credit which reduce the total borrowings available to the Company. At December 31, 1998, approximately $2,275 in standby letters of credit were outstanding and the Company had approximately $9,097 in available borrowings under the Credit Agreement. All borrowings under the Credit Agreement are secured by substantially all of the Company's assets which have not been pledged for other borrowings or certain standby letters of credit. Among other things, the Credit Agreement restricts the Company's ability to incur additional indebtedness and requires it to maintain certain financial ratios. At December 31, 1998, the Company was in default of a debt covenant and received a waiver from the bank for this default. Certain borrowings under this Credit Agreement were utilized to repay the revolving and term loan payable discussed below. F-20 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 9. DEBT (CONTINUED) On May 12, 1999, the Company executed an amendment to the Credit Agreement (the "Amended Agreement") modifying certain financial covenants and requiring bank approval for all acquisitions. The Amended Agreement requires that the Company and certain subsidiaries, as defined, maintain certain specified financial covenants, including, a minimum interest coverage ratio, a maximum funded debt to EBITDA ratio, a minimum fixed charge coverage ratio, and a maximum debt to capitalization ratio, each as defined in the Amended Agreement. The Company's ability to satisfy these covenants is dependent on its ability to substantially achieve its operating plan. As of June 30, 1999, the Company was in default of certain of these covenants and received a waiver from the bank for this default through January 1, 2000. The Company will continue to select interest rates on the outstanding borrowings based on the banks prime rate or LIBOR rates, however, the interest rates range from the bank's prime rate to the bank's prime rate plus 1.50% or LIBOR plus 1.88% to LIBOR plus 3.25% depending on the attainment of a financial covenant, as defined, in the Amended Agreement. During 1997, the Company had entered into an Amended and Restated Revolving and Term Loan and Security Agreement with the same bank which provided an $11,000 revolving credit facility and $7,500 term loan. At December 31, 1997, $5,000 and $7,411 were outstanding under the revolving credit facility and term loan, respectively. The revolving line of credit interest was at the bank's prime rate plus 0.75% (8.75% at December 31, 1997) payable monthly. The term loan bore interest at the bank's prime rate plus 1.25% (9.25% at December 31, 1997), and was due in monthly installments of $89 plus interest. These obligations were repaid in July 1998. (B) The Company leases certain machinery and equipment under capital leases expiring at various times through 2008. These capital lease obligations have a weighted average interest rate of 9.46% at December 31, 1998 and monthly principal and interest payments totaling $129. These obligations are secured by machinery and equipment with a net carrying value of $6,702 at December 31, 1998. (C) A subsidiary of the Company has a $8,000 revolving line of credit (including $1,000 available for letters of credit) with a bank (the "Revolving Credit Agreement") which expires in May 2000. Borrowings under the Revolving Credit Agreement are based on eligible collateral which includes specified percentages of certain cash, accounts receivable and inventory, as defined. Interest on borrowings is at LIBOR rate plus 2.25% (weighted average rate of 7.78% and 9.50% at December 31, 1998 and 1997, respectively). Among other things, the Revolving Credit Agreement restricts the subsidiary's ability to incur additional indebtedness and requires it to maintain certain financial ratios, as defined. (D) Promissory note payable to sellers in a business transaction with interest at 7% and principal due in February 2001. (E) A subsidiary of the Company financed the construction of a facility by issuing bonds with a maturity date of November 1, 1999. Interest is payable monthly at a variable rate, as defined in the bond agreement (3.2% at December 31, 1998). The bonds contain certain restrictive covenants for the subsidiary including maintenance of certain financial ratios and minimum net worth requirements. The bonds are secured by the facility and the related equipment with F-21 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 9. DEBT (CONTINUED) an aggregate net carrying value of $2,138 at December 31, 1998. These bonds were paid in full subsequent to December 31, 1998. (F) The notes payable to various commercial lenders bear interest at rates between 7.90% and 12.5%, with a weighted average interest rate of 8.17% at December 31, 1998, with monthly payments of principal totaling $18. The notes mature at various dates through 2002. The notes are secured by equipment with an aggregate net carrying value of $2,201 at December 31, 1998. (G) A subsidiary has a term loan payable to a private lender. The principal payments are $7 per month plus interest at 12.5% through May 2007. (H) During 1997, a subsidiary of the Company entered into a working capital and term financing agreement (the "Financing Agreement") with a bank. The balance outstanding at December 31, 1998, is under a $500 working capital loan which carries interest at the bank's prime rate plus 0.75% (8.50% at December 31, 1998), is secured by substantially all of the assets of the subsidiary and expires in April 1999. At December 31, 1997 the Financing Agreement included a term loan with an outstanding principal balance of $780, with interest at the bank's prime rate plus 1.25% (9.75%) and was secured by equipment with a carrying value of approximately $1,300; a 5 year mortgage loan with an outstanding principal balance of $670, with interest at the bank's prime rate plus 1.25% (9.75%) and was secured by certain real estate with a carrying value of approximately $715; and $105 outstanding under the working capital loan. The term loan and mortgage loan were repaid in full during 1998. (I) On April 1, 1997, the Company and a bank entered into a Second Amended and Restated Term Note for $607. The bank agreed to forgive $150 of the outstanding balance under the previous Amended and Restated Term Note. This amount is included in other income in 1997. The Second Amended and Restated Term Note was due in monthly installments of $38 plus interest at the bank's prime rate (8.5% at December 31, 1997). The obligation was repaid in full during 1998. PERC BONDS PAYABLE On June 26, 1998, the Finance Authority of Maine ("FAME") issued $44,995 par amount Finance Authority of Maine Electric Rate Stabilization Revenue Refunding Bonds, Series 1998 A and Series B (Penobscot Energy Recovery Company, LP) (the "1998 Bonds"). The proceeds of the 1998 Bonds were used to repay all of the outstanding balance due on PERC's existing Floating Rate Demand Resource Recovery Revenue Bonds (the "1986 Bonds"), which were called for redemption during July 1998. The redemption resulted in the recognition of an extraordinary loss of $351 (net of minority interest of $249 and tax of $267) which included the unamortized portion of the deferred financing costs associated with the original issuance. The 1998 Bonds are fixed rate bonds with yields ranging from 3.75% to 5.20% with a weighted-average yield of approximately 5.06%. The 1998 Bonds are subject to mandatory redemption in annual installments of varying amounts through July 1, 2018. Beginning July 1, 2008, the 1998 Bonds are subject to redemption at the option of PERC at a redemption price equal to 102%, through June 30, 2009, 101% for the period July 1, 2009 to June 30, 2010 and 100% thereafter of the principal amount outstanding plus accrued interest. F-22 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 9. DEBT (CONTINUED) In conjunction with the refinancing, PERC entered into a loan agreement with FAME, which contains various provisions including the maintenance of certain restricted funds and certain restrictive covenants relating to the 1998 Bonds. The covenants restrict PERC's ability to incur additional indebtedness and restrict the ability of the general partners to sell, assign or transfer their general partner interests. The bonds are collateralized by liens on substantially all of PERC's assets In connection with the refinancing, the Company issued a $3,000 limited guaranty of PERC's payment obligation under the Loan Agreement, in the favor of FAME and the 1998 Bond Trustee. In addition, BHE also issued a guaranty to FAME and the 1998 Bond Trustee in the amount equal to the annual payments for principal and interest on the 1998 Bonds. Demands on the above guaranties are to be on a pro-rata basis. If either party shall default under such demand, the other guarantor is liable for the entire demand, up to the limit on such guarantor's guaranty. In addition, the 1998 Bonds are insured by Financial Security Assurance, Inc. At December 31, 1997, two series of the 1986 Bonds totaling $47,900 were outstanding. The interest rates on the Revenue bonds were based on rates for certain tax-exempt obligation, as determined weekly by the remarketing agent for the bonds with a weighted-average interest rate of 4.32% at December 31, 1997. TERI REVENUE BONDS PAYABLE During June 1997, TERI issued two series of 1997 Industrial Development Revenue Bonds: Series A in the amount of $13,400 and Series B in the amount of $308. The Series B bonds carried interest at 10% and were paid in full in December 1997. The Series A bonds bear interest at 7.0%. The Series A bonds have an annual sinking fund payment due each December, ($2,030 due December 1, 1999), with final payment of $4,620 due December 2002. The bond agreements require, among other things, maintenance of various insurance coverages and restrict the borrowers ability to incur additional indebtedness. The bonds are collateralized by liens on TERI's electric generating facility located in Telogia, Florida. The proceeds from these bonds were utilized to repay certain then outstanding indebtedness. CONVERTIBLE SUBORDINATED NOTES During August 1998, the Company issued $21,099 of Convertible Subordinated Notes (the "Convertible Notes") in exchange for substantially all the outstanding shares of the Series B Preferred Stock. This exchange was made in accordance with the original terms of the Series B Preferred Stock. The Convertible Notes carry interest at 8.75% and are due in August 2004. In accordance with the terms of the Convertible Notes established concurrently with the issuance of the Series B Preferred Stock, the holders of Convertible Notes have the option to convert the principal amount of the Convertible Notes into shares of the Company's Common Stock at $11.75 per share. During November 1998, $14,329 of the then outstanding Convertible Notes were converted to common shares (see Note 11). SUBORDINATED NOTES PAYABLE TO MAINE ENERGY LIMITED PARTNERS These notes, as amended, bear interest at 12%. Payments of principal and interest are made solely at the discretion of Maine Energy's general partner. However, all principal and interest must be repaid F-23 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 9. DEBT (CONTINUED) prior to any partner distributions. To the extent interest is not paid, accrued interest is capitalized. As a holder of a portion of the Subordinated Notes Payable, the Company is entitled to receive a proportionate share of such payments. At December 31, 1998 and 1997, Maine Energy had $12,880 and $14,307, respectively, outstanding under the notes of which the Company held $8,587 and $2,358, respectively. Excluding any amounts which may be paid on the subordinated notes payable to the Maine Energy Limited Partners, aggregate maturities as of December 31, 1998 of the Company's debt are as follows: 1999.............................................. $ 9,775 2000.............................................. 5,960 2001.............................................. 143,731 2002.............................................. 6,742 2003.............................................. 2,065 Thereafter........................................ 46,132
10. PREFERRED STOCK SERIES A PREFERRED STOCK In June 1997 the Company sold 487,500 shares of Series A Preferred Stock (the "Original Series A Preferred") for gross proceeds of $3,900 and net proceeds of $3,798, and issued 243,750 common stock purchase warrants with an exercise price of $9.00 per share, subject to adjustment, (the "$9.00 Warrants") and 32,500 common stock purchase warrants with an exercise price of $10.00 per share, subject to adjustment (the "$10.00 Warrants"). Both the $9.00 Warrants and the $10.00 Warrants are exercisable at any time until June 4, 2003. The $9.00 Warrants and the $10.00 Warrants had an aggregate fair value of $524 at the date of issuance which has been accounted for as additional paid-in capital. During 1998, 234,500 of the $9.00 Warrants and 31,267 of the $10.00 Warrants were exercised. At December 31, 1998, 9,250 of the $9.00 Warrants and 1,233 of the $10.00 Warrants remained outstanding. In October 1997, 40,000 shares of the Original Series A Preferred were converted into 40,000 shares of common stock. In December 1997, the remaining outstanding shares of Original Series A Preferred were converted into newly issued Series C Preferred Stock. The Series C Preferred Stock was subsequently renamed Series A Preferred ("Series A Preferred"). During the first quarter of 1998, all of the remaining 447,500 shares of the Series A Preferred were converted into 447,500 shares of common stock. The Company accreted the carrying value of the Series A Preferred by $42 and $228 in 1998 and 1997, respectively, representing periodic accretion to the mandatory redemption value of $12.00 per share and $472 in 1997 which represents the difference between the initial allocated value of the Series A Preferred and the initial conversion rate. F-24 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 10. PREFERRED STOCK (CONTINUED) SERIES B PREFERRED STOCK In August 1997, the Company sold 856,000 shares of Series B Convertible Preferred Stock (the "Series B Preferred") for gross proceeds of $21,400 and net proceeds to the Company of $19,984. Dividends at an annual rate of 8.75% were cumulative and were payable quarterly. Except under certain circumstances, principally resulting from the non-payment of dividends or a change of control of the Company, as defined, the Series B Preferred were non-voting. The Series B Preferred placed certain restrictions on the Company's ability to issue securities in parity with, or senior to, the Series B Preferred. These restrictions principally involved the Company satisfying certain financial ratios, as defined. In June 1998, the Company exercised its option to exchange all of the outstanding shares of the Series B Preferred for the Company's Convertible Subordinated Notes due August 2004. During August 1998, 843,960 shares of Series B Preferred were exchanged for Convertible Subordinated Notes pursuant to their original terms at a conversion price of $25.00 per share totaling $21,099. The remaining 12,040 shares were converted at the holder's option into 25,531 shares of common stock at a conversion price of $11.75 per share and $1 in exchange for fractional shares. 11. STOCKHOLDERS' EQUITY In November 1998, $14,329 of the Convertible Subordinated Notes were exchanged for 1,219,489 shares of common stock at $11.75 per share. The conversion included a premium equal to 3.0% of the face value of the Subordinated Convertible Notes and nine months forward interest at 8.75%, paid to the Convertible Subordinated noteholders in the form of 63,910 shares of common stock valued at $21.44 per share. The premium, aggregating $1,370, was recorded as interest expense. During 1998, the Company issued warrants to purchase 40,000 shares of its common stock at prices ranging from $15.31 to $22.25 per share to certain members of the Board of Directors. These warrants expire ten years from the date of issue with 7,500 of the warrants exercisable immediately and the remaining warrants exercisable beginning one year from the date of issue. These warrants had an aggregate fair value of $205 at the date of issuance which was recorded as compensation expense during 1998. All such warrants remain outstanding at December 31, 1998. The Company issued warrants to purchase 130,000 shares of the Company's common stock at prices ranging from $19.75 to $21.88 per share in connection with certain business acquisitions during 1998. These warrants have a ten year life, and vest ratably over a 60-month period, beginning one month after the date of issue. All such warrants remain outstanding at December 31,1998. During 1997, the Company issued warrants to purchase 149,750 shares of its common stock at prices ranging from $5.71 to $10.00 as consideration for services rendered in connection with certain equity issuances. These warrants are exercisable at any time and expire at various dates ranging from April 30, 2001 to August 15, 2002. During 1998, warrants to purchase 30,592 shares of the Company's common stock were exercised and warrants to purchase 119,158 shares of the Company's common stock remain outstanding at December 31, 1998. F-25 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 11. STOCKHOLDERS' EQUITY (CONTINUED) In February 1997, the Company issued 10,500 shares of its common stock and warrants to purchase an additional 2,100 shares at a price of $8.10 in connection with the purchase of certain minority interests in a subsidiary. These warrants were exercised during 1998. In connection with certain debt obligations issued during 1996, the Company issued warrants to purchase 420,572 shares of common stock at $5.71 per share. The aggregate original issue discount representing the fair value of the warrants was $144. These warrants are exercisable at any time and expire at various dates from March 31, 2001 to June 30, 2001. During 1998 and 1997, warrants to purchase 39,900 and 259,015, respectively, shares of common stock were exercised and at December 31, 1998, warrants to purchase 121,657 shares remain outstanding. During 1996, the Company issued warrants to purchase 210,000 shares of its common stock at a price of $7.10 per share as consideration for consulting services. During 1998 and 1997, warrants to purchase 50,000 and 160,000 shares of common stock, respectively, were exercised. In September of 1996, the Company issued warrants to purchase 26,250 shares of common stock to an officer of the Company, at an exercise price of $8.08. These warrants vested 100% one year from the date of issue and have a 10-year life. All such warrants remain outstanding at December 31, 1998. In addition, warrants issued prior to 1996 to purchase 87,499 shares of common stock at $5.71 per share were exercised during 1998. As of December 31, 1998, the Company has reserved shares of common stock for issuance as follows:
NUMBER OF SHARES ---------- Conversion of Convertible Subordinated Notes Payable............................. 588,774 Exercise of common stock purchase warrants....................................... 482,473 Exercise of common stock options................................................. 2,177,068 Employee savings plan............................................................ 191,668 ---------- 3,439,983 ---------- ----------
Certain of the Company's outstanding warrants contain provisions which allow for the conversion of such warrants into a lesser number of shares without the payment of cash into the Company (so-called "cashless exercise" provisions). Accordingly, there can be no assurance that, even if all such warrants are exercised, the Company will receive all the aggregate gross proceeds. 12. STOCK OPTION PLANS The Company has four stock option plans; the 1986 Stock Option Plan of KTI (the "1986 Plan"), the KTI 1994 Long-Term Incentive Award Plan and the DataFocus Long-Term Incentive Plan (collectively, the "1994 Incentive Plans") and the KTI Directors Stock Option Plan (the "Directors Plan"). All plans are administered by the Compensation Committee of the Board of Directors. The Company has elected to follow Accounting Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25") and related Interpretations in accounting for its employee stock F-26 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 12. STOCK OPTION PLANS (CONTINUED) options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, ("SFAS No. 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Elements of the various plans include the following: THE 1986 PLAN. A maximum of 66,190 shares are subject to the 1986 Plan. Options were granted at prices not less than the fair market value at the date of grant. All options granted had 10 year terms and vested immediately. No new options can be granted under this plan. THE 1994 INCENTIVE PLANS. A maximum of 1,383,333 shares are subject to grant under the 1994 Incentive Plans. Options may be granted at prices not less than the fair market value at the date of grant. All grants prior to January 1, 1998 primarily vest at 20% per year beginning one year from the date of grant. Grants subsequent to January 1, 1998 vest ratably over a 60-month period beginning one month from the date of grant. Vested options may be exercised at any time until their expiration which may be up to ten years from the date of grant. Unvested options are forfeited upon termination of employment. THE DIRECTORS PLAN. A maximum of 200,000 shares are subject to the Directors Plan. Under the Directors Plan, non-employee Directors are automatically granted non-statutory options on August 1 of each year. The number of shares granted is equal to the lesser of (i) 7,500 shares or (ii) a number of shares having a maximum market value of $68. Options granted may not be exercised within one year of grant and have 10 year terms. In addition to the Plans described above, the Company's Board of Directors from time to time has granted key employees non-plan options. During 1998 and 1997, the Board of Directors made non-plan option grants. These non-plan options have a ten-year term, and were granted at the then current fair market value. The 1997 grants vested on the date of grant. The 1998 grants had vesting schedules ranging from immediate vesting to ratably over a 60-month period beginning one month from the date of grant. F-27 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 12. STOCK OPTION PLANS (CONTINUED) Option activities under the plans and for the non-plan options are detailed in the following table:
WEIGHTED 1994 AVERAGE INCENTIVE DIRECTOR EXERCISE 1986 PLAN PLANS PLAN NON-PLAN PRICE PER SHARE ---------- ----------- ------------ ---------- --------------- Outstanding at January 1, 1996............. 15,263 542,566 16,800 52,500 $ 6.28 Granted.................................. 225,475 31,500 7.23 Exercised................................ (55,346) 5.38 Forfeited................................ (238,355) 6.15 ---------- ----------- ------------ ---------- ------ Outstanding at January 1, 1997............. 15,263 474,340 48,300 52,500 6.82 Granted.................................. 169,500 37,500 175,000 10.03 Exercised................................ (85,353) 5.89 Forfeited................................ (46,356) 7.75 ---------- ----------- ------------ ---------- ------ Outstanding at January 1, 1998............. 15,263 512,131 85,800 227,500 8.33 Granted.................................. 884,250 30,000 495,000 16.86 Exercised................................ (15,263) (80,720) (21,324) (118,375) 8.00 Forfeited................................ (129,815) (149,000) 15.54 ---------- ----------- ------------ ---------- ------ Outstanding at December 31, 1998........... 1,185,846 94,476 455,125 $ 14.11 ---------- ----------- ------------ ---------- ------ ---------- ----------- ------------ ---------- ------ Exercisable at December 31, 1998........... 254,383 64,476 218,636 $ 12.11 ---------- ----------- ------------ ---------- ------ ---------- ----------- ------------ ---------- ------
The weighted-average fair value of options granted was $8.60, $4.95 and $5.12 for 1998, 1997 and 1996, respectively. At December 31, 1998, for each of the following classes of options as determined by range of exercise price, information regarding weighted-average exercise prices and weighted-average remaining contractual lives of each class is as follows:
WEIGHTED- WEIGHTED- AVERAGE AVERAGE WEIGHTED-AVERAGE EXERCISE PRICE EXERCISE PRICE REMAINING NUMBER OF OF NUMBER OF OF CONTRACTUAL LIFE OF OPTIONS OPTIONS OPTIONS OUTSTANDING OUTSTANDING OPTIONS CURRENTLY CURRENTLY OPTION CLASS OUTSTANDING OPTIONS (YEARS) EXERCISABLE EXERCISABLE - -------------------------------- ----------- --------------- --------------------- ----------- --------------- Price of $4.70 to $7.05......... 207,094 $ 6.51 6.70 111,121 $ 6.39 Price of $7.051 to $9.40........ 319,400 $ 8.64 8.00 157,524 $ 8.63 Price of $9.401 to $11.75....... 21,620 $ 10.18 8.50 8,737 $ 10.18 Price of $14.01 to $18.80....... 934,833 $ 16.09 9.10 243,955 $ 16.52 Price of $18.801 to $23.50...... 252,500 $ 20.27 9.60 16,158 $ 19.76 ----------- ----------- Total........................... 1,735,447 $ 14.11 8.70 537,495 $ 12.11
Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had been accounting for its employee stock options under the fair value method of that statement. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for 1998, 1997 and 1996, respectively: weighted average risk-free interest rates of 5.5%, 5.9% and 6.5%; no dividends; F-28 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 12. STOCK OPTION PLANS (CONTINUED) volatility factors of the expected market price of the Company's common stock of .517, .494 and .642; and weighted- average expected life of 5 years, 5 years and 8 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options granted subsequent to 1994 is amortized to expense over the options' vesting period. The Company's pro forma information follows:
1998 1997 1996 --------- --------- --------- Pro forma net income (loss) available for common shareholders....................... $ (602) $ 7,973 $ (1,803) Pro forma basic earnings (loss) per share........................................... $ (0.06) $ 1.08 $ (0.30) Pro forma diluted earnings (loss) per share......................................... $ (0.06) $ 0.99 $ (0.30)
The pro forma disclosures presented above reflect compensation expense only for options granted subsequent to 1994. These amounts may not necessarily be indicative of the pro forma effect of SFAS No. 123 for future periods in which options may be granted. F-29 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 13. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
1998 1997 1996 ------------- ------------ ------------ NUMERATOR: Income from continuing operations................................... $ 3,050 $ 10,173 $ 1,523 Preferred stock dividends........................................... (1,091) (708) Accretion of preferred stock........................................ (42) (700) ------------- ------------ ------------ Numerator for basic earnings per share-income from continuing operations available to common stockholders....................... 1,917 8,765 1,523 Effective of dilutive securities: Convertible subordinated notes payable (1)........................ 345 ------------- ------------ ------------ Numerator for diluted earnings per share-income from continuing operations available to common stockholders after assumed conversions....................................................... $ 1,917 $ 9,110 $ 1,523 ------------- ------------ ------------ ------------- ------------ ------------ DENOMINATOR: Denominator for basic earnings per share-weighted average shares.... 10,548,570 7,403,681 6,090,956 Effect of dilutive securities: Employee stock options............................................ 517,426 203,883 55,043 Warrants.......................................................... 332,155 342,382 109,089 Convertible subordinated notes payable (1).......................... 476,244 ------------- ------------ ------------ Dilutive potential common shares.................................... 849,581 1,022,509 164,132 ------------- ------------ ------------ Denominator for diluted earnings per share-adjusted weighted-average shares and assumed conversions.................................... 11,398,151 8,426,190 6,255,088 ------------- ------------ ------------ ------------- ------------ ------------ Income from continuing operations per share-Basic..................... $ 0.18 $ 1.18 $ 0.25 ------------- ------------ ------------ ------------- ------------ ------------ Income from continuing operations per share-Diluted................... $ 0.17 $ 1.08 $ 0.24 ------------- ------------ ------------ ------------- ------------ ------------
- ------------------------ (1) Preferred shares outstanding during 1998 and the convertible subordinated notes payable in 1998 and 1996 are anti-dilutive and the preferred shares were anti-dilutive in 1997. For additional disclosures regarding dilutive securities see Notes 9 through 12. F-30 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 14. INCOME TAXES At December 31, 1998 the Company has net operating loss carryforwards of approximately $52,500 for income tax purposes that expire in years 2002 through 2018 and general business credit carryforwards of approximately $530 which expire in years 1999 through 2006. All of these carryforwards are subject to limitation as described below. In addition, the Company has $906 of minimum tax credit carryovers available that are not subject to limitation. Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31, ---------------------------------- 1998 1997 1996 --------- ------------ --------- Deferred tax assets Current: Alternative minimum tax credit carryforwards.............. $ 906 $ 815 General business credit carryforwards..................... 204 Net operating loss carryforwards.......................... 2,191 1,930 Reserve on notes and accounts receivable.................. 525 65 $ 37 State taxes, net.......................................... 7 14 14 Other liabilities......................................... 999 22 47 --------- ------------ --------- Total current deferred tax assets....................... 4,832 2,846 98 Valuation allowance for current deferred tax assets....... (95) (98) --------- ------------ --------- Net current deferred tax assets........................... 4,832 2,751 --------- ------------ --------- Non-current: Deferred revenues......................................... 20,510 17,074 18,887 Basis difference in partnership interest.................. 14,127 14,555 118 State taxes, net.......................................... 2,182 2,507 3,294 General business credit carryforwards..................... 326 530 530 Alternative minimum tax credit carryforwards.............. 687 Deferred development fees................................. 104 110 117 Net operating loss carryforwards.......................... 16,194 13,098 16,655 --------- ------------ --------- Total non-current deferred tax assets................... 53,443 47,874 40,288 Valuation allowance for non-current deferred tax assets... (12,708) (15,645) (23,467) --------- ------------ --------- Net non-current deferred tax assets....................... 40,735 32,229 16,821 Non-current deferred tax liabilities: Goodwill amortization on asset purchases.................. (107) Deferred development expenses............................. (61) Depreciation.............................................. (39,160) (32,229) (16,821) --------- ------------ --------- Net non-current deferred taxes............................ $ 1,407 $ $ --------- ------------ --------- --------- ------------ ---------
F-31 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 14. INCOME TAXES (CONTINUED) Significant components of the provision (benefit) for income taxes on continuing operations before extraordinary item are as follows:
YEAR ENDED DECEMBER 31, ------------------------------- 1998 1997 1996 --------- --------- --------- Current: Federal..................................................... $ 746 $ 65 State....................................................... 144 100 --------- --------- --------- Total current................................................. 890 165 Deferred: Federal..................................................... (882) 3,095 $ (3,602) State....................................................... 1 362 (44) Valuation allowance......................................... (3,032) (6,208) 3,646 --------- --------- --------- Total deferred................................................ (3,913) (2,751) --------- --------- --------- $ (3,023) $ (2,586) $ --------- --------- --------- --------- --------- ---------
The components of the provision (benefit) from deferred income taxes on continuing operations before extraordinary item for 1998, 1997, and 1996 are as follows:
YEAR ENDED DECEMBER 31, -------------------------------- 1998 1997 1996 --------- --------- ---------- Deferred revenues............................................ $ (3,436) $ 1,813 $ (18,887) Net operating loss carryforwards............................. 1,648 1,627 (635) General business and minimum tax credit carryforwards........ (91) (128) 320 Basis difference in partnership interests.................... 1,103 388 17,875 State taxes, net............................................. 635 510 (1,401) Deferred development fees.................................... (2) 7 3 Goodwill amortization on asset acquisitions.................. 107 Depreciation................................................. (636) (757) (1,110) Change in reserve on receivables............................. (368) (28) 13 Accrued and other expenses................................... 159 25 176 Change in valuation allowance................................ (3,032) (6,208) 3,646 --------- --------- ---------- Provision (benefit) for deferred income taxes................ $ (3,913) $ (2,751) $ --------- --------- ---------- --------- --------- ----------
F-32 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 14. INCOME TAXES (CONTINUED) The reconciliation of income tax computed at the federal statutory tax rates to benefit for income taxes on continuing operations before extraordinary item is:
YEAR ENDED DECEMBER 31, ------------------------------- 1998 1997 1996 --------- --------- --------- Tax at US statutory rates..................................... $ 9 $ 2,655 $ (254) State income taxes, net of federal tax benefit................ 145 455 (44) Amortization of goodwill...................................... 812 250 42 Change in valuation allowance................................. (3,032) (6,208) 3,646 Other......................................................... (957) 262 (3,390) --------- --------- --------- $ (3,023) $ (2,586) $ --------- --------- --------- --------- --------- ---------
The Tax Reform Act of 1986 enacted a complex set of rules limiting the potential utilization of net operating loss and tax credit carryforwards in periods following a corporate "ownership change". In general, for federal income tax purposes, an ownership change is deemed to occur if the percentage of stock of a loss corporation owned (actually, constructively and, in some cases, deemed) by one or more "5% shareholders" has increased by more than 50 percentage points over the lowest percentage of such stock owned during a three-year testing period. During 1994, such a change in ownership occurred. As a result of the change, the Company's ability to utilize certain of its net operating loss carryforwards and general business credits will be limited to approximately $1,200 of taxable income, or approximately $375 of equivalent credit per year. This limitation may be increased if the Company recognizes a gain on the disposition of an asset which had a fair market value greater than its tax basis on the date of the ownership change. The Company recorded net operating loss carryforwards of $25,580, $12,525 and $525 related to the acquisition of TEII, FCR and Total Waste Management, Inc., respectively, which are also subject to a corporate "ownership change". As a result of the change, the Company's ability to utilize the net operating loss carryforwards are limited to approximately $989, $3,219 and $71 per year, respectively. 15. COMMITMENTS The Company has entered into various facility and equipment operating leases. The facility lease agreements generally require the Company to pay certain expenses including maintenance costs and a percentage of real estate taxes. The leases expire at various times ranging through 2007. Rental expense for all operating leases including facilities, amounted to approximately $3,747, $1,192 and $145 for the years ended December 31, 1998, 1997 and 1996, respectively. Included in the Company's operating leases are leases of certain administrative offices from companies whose principals include certain officers and shareholders of the Company. Rent expense under these leases was $708, $96 and $110 for the years ended December 31, 1998, 1997 and 1996, respectively. In addition, the Company leases certain other office and operating facilities from individuals who are shareholders and employees. As of F-33 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 15. COMMITMENTS (CONTINUED) December 31, 1998, future minimum rental commitments on non-cancelable operating leases, are as follows:
THIRD-PARTY RELATED-PARTY LEASES LEASES ----------- ------------- 1999.............................................................. $ 3,920 $ 815 2000.............................................................. 3,252 815 2001.............................................................. 2,685 785 2002.............................................................. 2,127 675 2003.............................................................. 1,565 480 Thereafter........................................................ 3,826 1,280
The Company has entered into employment agreements with certain of its key employees which provide for fixed compensation and bonuses based on operating results, as defined. These agreements generally continue until terminated by the employee or the Company and, under certain circumstances, provide for salary continuation for a specified period. At December 31, 1998 the Company's maximum aggregate liability under the agreements if all the employees were terminated by the Company is $13,129. In connection with their operations, Maine Energy, TERI and PERC have entered into certain contractual agreements with respect to the supply and acceptance of municipal solid waste and the sale of electric power. In 2007, certain of Maine Energy's municipal customers have the right to obtain a 20% interest in Maine Energy's cash flows, as defined in certain agreements, to be applied against the municipalities' future waste disposal costs. FCR Plastics, Inc. ("Plastics"), a subsidiary of FCR, has committed to fund a maximum of $700 towards the construction of certain machinery and equipment on behalf of a customer. The equipment will be located within Plastics facility and the customer will repay the total cost of the equipment up to Plastics maximum contribution of $700. Repayment of the notes will commence as soon as installation of the equipment is complete. On December 31, the Company acquired a 35% interest in the Oakhurst Company, Inc. ("Oakhurst") for approximately $900. Oakhurst is a public holding company which owns two businesses which are distributors in the automotive aftermarket. As part of this transaction, the Company assigned its interest in a joint venture with Grace Brothers, Ltd. and SC Fundamental Investments L.P., the majority bond holders of the Ford Heights, Illinois Waste Tire to Energy Project, to own and operate this facility. Due to amendments to the Illinois Retail Rate Act, which repealed certain incentives to the facility, it was closed during startup testing and the owner sought protection under federal bankruptcy laws. On December 28, the bankruptcy court in Delaware approved the amended Plan of Reorganization which provided for the Company and the bondholders each to own 50% of the reorganized entity which was renamed New Heights Recovery & Power, LLC ("New Heights"). The bondholders converted $80.0 million in bonds and other claims into equity and KTI committed to investing up to $17.0 million in equity for working capital, retrofitting and upgrading of the facility. This commitment to New Heights was transferred to Oakhurst and the Company has agreed to provide financing to Oakhurst. During 1998, the Company advanced $1,500 to Oakhurst. This amount is included in notes receivable-officers/shareholders and affiliates at December 31, 1998. F-34 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 15. COMMITMENTS (CONTINUED) During 1997, FCR acquired a company whereby the former shareholder of the Company may receive up to $2,000 of additional consideration. The amount of the additional consideration will be based on the earnings of the Company for the 12 months ended April 30, 1998 and 1999, as defined in the purchase agreement. Any additional consideration will be recorded as an addition to goodwill. Of the potential additional consideration $924 was advanced at closing and is recorded as a note receivable from the former shareholder. Upon reaching the earnings targets discussed above, this amount will be reclassified to goodwill. 16. EMPLOYEE BENEFIT PLAN The Company has established defined contribution employee savings and investment retirement plans under Section 401(k) of the Internal Revenue Code which cover substantially all employees after satisfying certain eligibility requirements. The Company contributes on behalf of each participating employee an amount as defined in the plans. The Company's contribution was approximately $596, $290 and $164 for the years ended December 31, 1998, 1997 and 1996, respectively. Included in the 1998, 1997 and 1996 Company contributions were 4,215, 4,117 and 4,322 shares, respectively, of the Company's common stock. The 4,322 shares contributed for 1996 were purchased by the Company from third parties. The aggregate fair value of the stock was $41, $35 and $32, respectively. 17. RELATED PARTY TRANSACTIONS The Company receives an annual management fee (adjusted annually for changes in the Consumer Price Index) as co-general partner of PERC. During the year ended December 31, 1996, the Company earned management fees of approximately $418. All such amounts are eliminated in consolidation in 1998 and 1997. During 1998, the Company advanced $1,500 to New Heights with an interest rate at 14%. The advance is due in 2001 and is recorded as a note receivable- affiliate at December 31, 1998. 18. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The carrying amount and estimated fair values of financial instruments at December 31, 1998 and 1997 are summarized as follows: The following methods and assumptions were used to estimate the fair value of financial instruments: CASH, RESTRICTED CASH AND ACCOUNTS RECEIVABLE--the carrying amounts reported in the balance sheet for cash, cash equivalents, restricted funds including debt securities, and accounts receivable approximate their fair value. NOTES AND OTHER RECEIVABLES--the fair value is estimated using discounted cash flow analyses, using appropriate interest rates. F-35 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 18. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) RESOURCE RECOVERY REVENUE BONDS PAYABLE--the fair value of bonds payable is estimated using discounted cash flow analyses, using appropriate interest rates. OTHER DEBT--the fair value is estimated based on discounting the estimated future cash flows using the Company's incremental borrowing rate for similar debt instruments.
DECEMBER 31, 1998 DECEMBER 31, 1997 ---------------------- ---------------------- CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE --------- ----------- --------- ----------- ASSETS Cash and cash equivalents....................... $ 9,426 $ 9,426 $ 11,181 $ 11,181 Restricted cash................................. 23,438 23,438 19,630 19,630 Accounts receivable, net........................ 29,272 29,272 22,126 22,126 Notes receivable, officers/shareholders and affiliates................................ 3,392 3,642 110 90 Other receivables............................... 7,183 6,785 732 618 Stock purchase warrant included in other assets.................................. 3,814 6,459 LIABILITIES Resources Recovery Revenue Bonds Payable......................... 56,630 56,630 61,300 61,300 Other debt...................................... 162,068 162,484 32,967 27,625
19. SEGMENT REPORTING Information as to the operations of the Company in different business segments is set forth below based on the nature of the services and products offered. The Company evaluates performance and allocates resources based on profit or loss from operations before interest and income taxes. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies. Intersegment sales are accounted for at fair value as if the sales were to third parties. During 1998, the Company operated in the business units as indicated below.
COMMERCIAL FINISHED RESIDENTIAL WASTE-TO-ENERGY RECYCLING PRODUCTS RECYCLING --------------- ----------- --------- ----------- Revenues Unaffiliated customers................ $ 76,680 $ 68,139 $ 22,346 $ 11,782 Intersegment revenues................. 273 5,307 427 770 Segment Profit (Loss)................... 17,606 (412) 826 1,349 Depreciation and Amortization........... 8,628 2,303 1,095 1,082 Identifiable Assets..................... 231,767 56,557 54,850 65,662 Capital Expenditures.................... 4,812 1,904 1,786 42
F-36 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 19. SEGMENT REPORTING (CONTINUED) During 1997, the Company operated in the business units indicated below.
COMMERCIAL FINISHED WASTE-TO-ENERGY RECYCLING PRODUCTS --------------- ----------- ----------- Revenues Unaffiliated customers............................. $ 74,232 $ 17,694 $ 6,523 Intersegment revenues.............................. 2,766 1,342 636 Segment Profit....................................... 19,837 490 129 Depreciation and Amortization........................ 8,782 340 90 Identifiable Assets.................................. 207,866 36,791 1,575 Capital Expenditures................................. 4,496 198 63
During 1996, the Company only operated in the waste-to-energy business unit. This segment reporting detailed above reconciles to consolidated revenues and income from continuing operations before provision (benefit) for income taxes and extraordinary item as follows:
YEAR ENDED DECEMBER 31, --------------------- 1998 1997 ---------- --------- REVENUES Total unaffiliated customers revenue for reportable segments........... $ 178,947 $ 98,449 Holding companies revenues............................................. 60 138 Intersegment revenues for reportable segments.......................... 6,777 4,744 Elimination of intersegment revenues................................... (6,777) (4,744) ---------- --------- Total consolidated revenues............................................ $ 179,007 $ 98,587 ---------- --------- PROFIT AND LOSS Total segment profit................................................... $ 19,369 $ 20,456 Holding companies segment loss......................................... (4,973) (929) ---------- --------- Total segment profit................................................... 14,396 19,527 ---------- --------- Unallocated amounts: Interest expense, net................................................ 10,667 5,086 Other income......................................................... (390) Minority interest.................................................... 3,702 2,522 Pre-acquisition earnings............................................. 4,722 ---------- --------- Income from continuing operations before benefit for income taxes and extraordinary item................................................. $ 27 $ 7,587 ---------- --------- ---------- ---------
F-37 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 19. SEGMENT REPORTING (CONTINUED)
DECEMBER 31, ---------------------- 1998 1997 ---------- ---------- ASSETS Total identifiable assets for reportable segments..................... $ 408,836 $ 246,232 Holding companies assets.............................................. 27,649 6,255 ---------- ---------- Total consolidated assets............................................. $ 436,485 $ 252,487 ---------- ---------- ---------- ----------
20. CONTINGENCIES The Company is a defendant in a consolidated purported class action, which alleges violations of certain sections of the federal securities laws. The Company believes the allegations are without merit and intends to defend the litigation vigorously. Two lawsuits have been filed against a subsidiary of the Company and certain of its officers, alleging fraud and tortious interference. The actions are based on two contracts between the plaintiff and the subsidiary, which contracts require all disputes to be resolved by arbitration. Arbitration proceedings have commenced. The Company believes it has meritorious defenses to the allegations. The former majority shareholder of a company acquired by a subsidiary of the Company instigated arbitration proceedings against the Company and two of its subsidiaries, alleging the subsidiaries acted to frustrate the "earn-out" provisions of the acquisition agreement and thereby precluding him from receiving, or alternatively, reducing the sum to which he was entitled to receive. He also alleges his employment agreement was wrongfully terminated. The claim for arbitration alleges direct charges in excess of $5,000 and requests punitive damages, treble damages and attorneys fees. The Company and its subsidiaries have responded to the demand, denying liability and filed a counterclaim for $1,000 for misrepresentations. The Company believes it has meritorious defenses to the claims. The Company is involved in certain litigation arising from the normal course of its business. In the opinion of management, the outcome of these matters individually and in the aggregate will not have a material effect on the Company's financial position, cash flows or results of operations. 21. SUBSEQUENT EVENTS On September 23, 1999, the Company entered into an amended Agreement and Plan of Merger (the "Merger Agreement") with Casella Waste Systems, Inc., ("Casella") a publicly-owned company engaged in the waste services industry. This Merger Agreement was an amendment to the original agreement dated January 12, 1999. The merger will be completed through the exchange of all of shares of the Company's common stock for shares of Casella's Class A common stock based on an exchange ratio specified in the Merger Agreement. In addition, all of the Company's outstanding and unexercised stock options and stock purchase warrants will be converted into similar rights to acquire Casella's Class A common stock under the same terms and conditions and the same exchange ratio. Subsequent to the completion of the merger the current Casella stockholders will own a majority of the combined company. Under the terms of the Merger Agreement, Casella is required to file a registration statement with the Securities and Exchange Commission to register the shares of its Class A common stock to be issued in the Merger. The merger is subject to, among other things, approval of the F-38 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 21. SUBSEQUENT EVENTS (CONTINUED) Company's and Casella's stockholders. No assurances can be given that the remaining conditions of the Merger will be satisfied and that the merger will be consummated. In connection with the merger, Casella has agreed to reimburse the Company for its investment banking fees and other merger related costs and as of December 31, 1998 approximately $1,160 of such costs have been deferred. During January 1999, the Company completed the acquisition of AFA Group, Inc. and subsidiaries, an integrated wood waste processing and hauling business. The purchase price was approximately $9.0 million. During March 1999, the Company signed a definitive agreement to acquire a company which operates a material recovery facility. The acquisition is expected to close on June 30, 1999 upon the resolution of a contingency, as outlined in the purchase agreement. The purchase price is expected to be approximately $5,600 of which $250 was paid at the signing of the definitive agreement. F-39 KTI, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) 22. QUARTERLY DATA (UNAUDITED)
1998 -------------------------------------------- FIRST SECOND THIRD FOURTH --------- ---------- --------- ---------- Revenues............................................................ $ 37,876 $ 34,790 $ 44,987 $ 61,354 Gross Profit........................................................ 7,163 1,810 9,056 4,314 Income (loss) from continuing operations before extraordinary item................................................ 2,038 (1,008) 4,804 (2,784) Net income (loss)................................................... $ 2,038 $ (1,503) $ 4,804 $ (2,640) Earnings per share: Basic: Income (loss) from continuing operations before extraordinary item................................................ $ 0.17 $ (0.16) $ 0.44 (0.21) Net income (loss)................................................... $ 0.17 $ (0.21) $ 0.44 $ (0.20) Diluted: Income (loss) from continuing operations before extraordinary item................................................ $ 0.16 $ (0.16) $ 0.36 $ (0.21) Net income (loss)................................................... $ 0.16 $ (0.21) $ 0.36 $ (0.20)
1997 ------------------------------------------ FIRST SECOND THIRD FOURTH --------- --------- --------- --------- Revenues.............................................................. $ 19,313 $ 20,137 $ 28,020 $ 31,117 Gross Profit.......................................................... 5,461 4,817 7,411 5,034 Income from continuing operations before extraordinary item................................................ 1,879 386 3,131 4,777 Net income.......................................................... $ 1,879 $ 386 $ 3,131 $ 4,777 Earnings per share: Basic: Income from continuing operations before extraordinary item................................................ $ 0.27 $ (0.02) $ 0.39 $ 0.46 Net income.......................................................... $ 0.27 $ (0.02) $ 0.39 $ 0.46 Diluted: Income from continuing operations before extraordinary item................................................ $ 0.25 $ (0.02) $ 0.34 $ 0.40 Net income.......................................................... $ 0.25 $ (0.02) $ 0.34 $ 0.40
F-40 REPORT OF INDEPENDENT AUDITORS Partners Penobscot Energy Recovery Company We have audited the accompanying statements of income, changes in partners' capital and cash flows of Penobscot Energy Recovery Company, Limited Partnership for the year ended December 31, 1996. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Penobscot Energy Recovery Company for the year ended December 31, 1996 in conformity with generally accepted accounting principles. Ernst & Young LLP Hackensack, New Jersey February 7, 1997 F-41 PENOBSCOT ENERGY RECOVERY COMPANY, LIMITED PARTNERSHIP STATEMENT OF INCOME YEAR ENDED DECEMBER 31, 1996 (IN THOUSANDS) REVENUES: Electric power revenues............................................................ $ 17,868 Waste processing revenues.......................................................... 11,807 --------- Total.............................................................................. 29,675 Operating expenses: Supplemental fuels............................................................... 1,026 Electric power purchases......................................................... 124 Disposal costs................................................................... 4,880 Operating and management fees.................................................... 5,353 Equipment and maintenance costs.................................................. 3,196 Depreciation..................................................................... 3,680 Real estate taxes................................................................ 556 Insurance........................................................................ 350 Other............................................................................ 1,230 --------- Total.............................................................................. 20,395 --------- Operating income................................................................... 9,280 Interest and other financing costs, net............................................ (3,170) --------- Net income......................................................................... $ 6,110 --------- ---------
See accompanying notes. F-42 PENOBSCOT ENERGY RECOVERY COMPANY, LIMITED PARTNERSHIP STATEMENT OF CHANGES IN PARTNERS' CAPITAL YEAR ENDED DECEMBER 31, 1996 (IN THOUSANDS)
GENERAL PARTNERS LIMITED PARTNERS TOTAL ------------------------ ------------------------ ------------------------ RETAINED RETAINED RETAINED CONTRIBUTED EARNINGS CONTRIBUTED EARNINGS CONTRIBUTED EARNINGS CAPITAL (DEFICIT) CAPITAL (DEFICIT) CAPITAL (DEFICIT) ----------- ----------- ----------- ----------- ----------- ----------- Balance, January 1, 1996................. $ 2,908 $ 238 $ 23,031 $ 2,139 $ 25,939 $ 2,377 Distributions.......................... (193) (2,141) (2,334) Net income............................. 611 5,499 6,110 ----------- ----- ----------- ----------- ----------- ----------- Balance, December 31, 1996............... $ 2,715 $ 849 $ 20,890 $ 7,638 $ 23,605 $ 8,487 ----------- ----- ----------- ----------- ----------- ----------- ----------- ----- ----------- ----------- ----------- -----------
See accompanying notes. F-43 PENOBSCOT ENERGY RECOVERY COMPANY, LIMITED PARTNERSHIP STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 1996 (IN THOUSANDS) Operating activities Net income......................................................................... $ 6,110 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.................................................... 4,085 Changes in asset and liability accounts: Increasing (decreasing) cash: Accounts receivable............................................................ (729) Prepaid expenses and other assets.............................................. (91) Accounts payable............................................................... 327 Accrued expenses and other liabilities......................................... (1,010) Management and development fees payable........................................ (199) --------- Net cash provided by operating activities.......................................... 8,493 Investing activities Additions to property, plant and equipment......................................... (1,192) Net change in restricted funds..................................................... (117) Proceeds from sale of property, plant and equipment................................ 25 --------- Net cash used in investing activities.............................................. (1,284) Financing activities Payment of bond principal.......................................................... (5,900) Distributions...................................................................... (2,334) --------- Net cash used in financing activities.............................................. (8,234) --------- (Decrease) increase in cash and cash equivalents................................... (1,025) Cash and cash equivalents at beginning of year..................................... 6,465 --------- Cash and cash equivalents at end of year........................................... $ 5,440 --------- --------- Supplemental disclosure of cash flow information Interest paid..................... $ 2,426 --------- ---------
See accompanying notes. F-44 PENOBSCOT ENERGY RECOVERY COMPANY, LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1996 1. ORGANIZATION AND DESCRIPTION OF OPERATIONS Penobscot Energy Recovery Company, Limited Partnership ("PERC") is a limited partnership formed on December 28, 1983 and organized to design, construct, operate, own and manage a facility located in Orrington, Maine for the conversion of solid waste and supplemental fuel to electric power (the "Project"). Certain contractual agreements relating to this facility have been entered into, including agreements with respect to the supply of solid waste, the sale of electric power, and operation and maintenance of the facility. PERC Management Company ("PMC"), which is ultimately owned by KTI, Inc. ("KTI"), and Energy National, Inc. ("ENI") are general partners. As of December 31, 1996, ENI and another entity were limited partners. As of December 31, 1996, the ownership interests of the partners were as follows:
A. OWNERSHIP INTERESTS ----------------------- GENERAL LIMITED PARTNERS PARTNERS ----------- ---------- PMC....................................................................... 7% ENI....................................................................... 3% 25.7% Other limited partner..................................................... 64.3% --- --------- 10% 90.0% --- --------- --- ---------
Profits and losses are to be allocated 10% to the general partners and 90% to the limited partners until such time that the return on equity, as defined in the Partnership Agreement, of the limited partners exceeds their aggregate capital contributions. Commencing on that date and continuing through the remaining term of the Partnership, such allocations, including gains and losses upon net sale or refinancing, shall be 40% to the general partners and 60% to the limited partners. According to the Partnership agreement, the Partnership has a limited life extending to December 31, 2018, unless further extended by a vote of all of the partners. The Project is subject to the provisions of various federal and state energy laws and regulations including the Public Utility Regulatory Policies Act of 1978, as amended. In addition, federal, state and local environmental laws establish standards governing certain aspects of the Project's operations. The Company believes it has all permits, licenses and approvals necessary to operate the facility. 2. SIGNIFICANT ACCOUNTING POLICIES PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost, less accumulated depreciation. All costs incurred for additions and improvements to the facility, including interest during construction, are capitalized. Depreciation is provided on the straight-line method over estimated useful lives. F-45 PENOBSCOT ENERGY RECOVERY COMPANY, LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) DEFERRED COSTS Costs incurred by PERC in connection with permanent financings have been deferred and are being amortized over the life of the related debt issues using the interest method. During 1991, PERC finalized negotiations with municipalities and entered into new long-term waste handling agreements which resulted in higher waste handling fees. Costs associated with the renegotiation were deferred and amortized over 60 months which represented the minimum period covered by the new agreements. REVENUES Electric power revenues are earned from the sale of electricity to Bangor Hydro-Electric Company ("BHE"), a utility serving a portion of the State of Maine, under a Power Purchase Agreement (the "Agreement"). Revenue is recorded at the contract rate specified in the Agreement as the electricity is delivered. Waste processing revenues consist principally of fees charged to customers for waste disposal. Substantially all waste processing revenues are earned from customers located in a geographic region proximate to the facility. Revenue is generally recorded upon delivery based on rates specified in the applicable long-term contracts. Certain of these contract rates are adjusted quarterly based on actual costs incurred in the prior quarter. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. INCOME TAXES There is no provision in the financial statements for income taxes as the income or loss is included in the income tax returns of the partners. STATEMENTS OF CASH FLOWS For purposes of the statements of cash flows, PERC considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. RECLASSIFICATIONS Certain amounts have been reclassified to conform with the 1998 presentation of KTI. F-46 PENOBSCOT ENERGY RECOVERY COMPANY, LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1996 3. INTEREST AND OTHER FINANCING COSTS--NET Interest and other financing costs for the year ended December 31, 1996 consists of: Interest expense.................................................... $ 2,263 Letter of credit fees............................................... 976 Amortization of deferred bond financing costs....................... 351 Remarketing and bank fees........................................... 288 Interest income..................................................... (708) --------- Interest and other financing costs--net............................. $ 3,170 --------- ---------
4. RELATED PARTY TRANSACTIONS PERC incurred management fees payable to the general partners of $595 in 1996, in accordance with the Partnership Agreement. PERC purchases a portion of its supplemental fuel (wood chips) from KTI BioFuels, L.P., an affiliate of PMC. During 1996, these purchases totaled approximately $279. Effective May 1, 1989, PERC entered into an Operation and Maintenance Agreement with ESOCO Orrington, Inc., an affiliate of ENI. For the year ended December 31, 1996, PERC paid operating and maintenance fees to ESOCO of approximately $4,500, plus additional approved pass through operating costs. PERC had waste processing revenue of approximately $615 from Orrington Waste Ltd. (a limited partnership including certain general and limited partners of PERC) (OWL) in 1996. OWL and PERC have a long-term put-pay agreement under which OWL pays waste disposal fees to PERC equivalent to those charged to other municipalities. 5. WASTE HANDLING AGREEMENTS Certain of PERC's long-term, put-pay contracts with municipalities for disposal of solid waste contain provisions which, at the date the bonds are fully paid, allow the municipalities to purchase the facility or terminate or extend the contracts. Certain of the long-term, put-pay contracts with municipalities contain provisions which allow the municipalities to receive a portion of PERC's annual cash flows, as defined. F-47 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in Registration Statements No. 33-80505, 33-89664, 33-89666, 333-34327, 333-56435, 333-56433 and 333-26757 on Forms S-8 and Registration Statements No. 333-30813, 333-28067, 333-80089, 333-64953 and 333-44507 on Form S-3 and Registration Statement No. 333-46057 on Form S-2 of KTI, Inc. and in the related Prospectuses of our reports dated: March 30, 1999 (except for the second paragraph of Note 9 as to which the date is August 27, 1999, Note 2 as to which the date is August 30, 1999 and the first paragraph of Note 21 as to which the date is September 23, 1999) with respect to the consolidated financial statements and schedules of KTI, Inc. and February 7, 1997 with respect to the financial statements of Penobscot Energy Recovery Company, Limited Partnership, each included in the Annual Report (Form 10-K/A) of KTI, Inc. for the year ended December 31, 1998. /s/ Ernst & Young LLP Hackensack, New Jersey October 28, 1999 F-48 REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULES The Board of Directors KTI, Inc. We have audited the consolidated financial statements of KTI, Inc. as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated March 30, 1999, except for the second paragraph of Note 9 as to which the date is August 27, 1999, Note 2 as to which the date is August 30, 1999 and the first paragraph of Note 21 as to which the date is September 23, 1999 (included elsewhere in this Registration Statement). Our audits also included the financial statement schedules listed in Item 21(b) of this Registration Statement. These schedules are the responsibility of KTI's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 2, the previously issued Schedule I--Condensed Financial Information of KTI, Inc. for each of the three years in the period ended December 31, 1998 has been restated to reflect the deferral of revenue related to certain proceeds received in connection with the restructuring of a power purchase agreement and the sale of electric generating capacity with two utilities. ERNST & YOUNG LLP Hackensack, New Jersey March 30, 1999 except for the first paragraph of Note 3 to Schedule I as to which the date is August 27, 1999, Note 2 to Schedule I as to which the date is August 30, 1999 and Note 5 to Schedule I as to which the date is September 23, 1999 S-1 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF KTI, INC. KTI, INC. (PARENT COMPANY) CONDENSED BALANCE SHEETS
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) ASSETS CURRENT ASSETS Cash and cash equivalents.......................................................... $ 397 $ 688 Restricted funds................................................................... 61 Accounts receivable................................................................ 233 53 ------------ ------------ Total current assets........................................................... 630 802 Investments in and amounts due from subsidiaries..................................... 240,463 69,657 Other assets......................................................................... 65 20 Deferred costs, net.................................................................. 2,867 210 Intangible assets, net............................................................... 1,834 2,052 ------------ ------------ Total assets................................................................... $ 245,859 $ 72,741 ------------ ------------ ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities.................................................................. $ 2,274 $ 548 Debt................................................................................. 138,628 12,477 Convertible subordinated debt........................................................ 6,770 Stockholders' equity Preferred stock Series A........................................................................... 3,732 Series B........................................................................... 21,400 Common stock......................................................................... 133 89 Additional paid-in capital........................................................... 115,026 52,762 Accumulated deficit.................................................................. (16,972) (18,267) ------------ ------------ Total stockholders' equity........................................................... 98,187 59,716 ------------ ------------ Total liabilities and stockholders' equity..................................... $ 245,859 $ 72,741 ------------ ------------ ------------ ------------
See accompanying notes to condensed financial statements. S-2 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF KTI, INC.--(CONTINUED) KTI, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------- 1998 1997 1996 --------- --------- --------- (IN THOUSANDS) Revenues.......................................................................... $ 60 $ 138 $ 10 Management fees................................................................... 387 --------- --------- --------- 60 138 397 Selling, general and administrative............................................... 2,397 1,067 370 --------- --------- --------- Income (loss) from operations................................................... (2,337) (929) 27 Interest expense, net............................................................. 6,879 416 425 Other expense, net................................................................ 517 --------- --------- --------- Loss before benefit for income taxes and equity in net income of subsidiaries... (9,216) (1,345) (915) Benefit for income taxes.......................................................... (3,133) (457) --------- --------- --------- Loss before equity in net income of subsidiaries................................ (6,083) (888) (915) Equity (loss) in net income of subsidiaries....................................... 8,782 11,061 (524) --------- --------- --------- Net income (loss)............................................................... $ 2,699 $ 10,173 $ (1,439) --------- --------- --------- --------- --------- ---------
See accompanying notes to condensed financial statements. S-3 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF KTI, INC.--(CONTINUED) KTI, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, --------------------------------- 1998 1997 1996 ---------- ---------- --------- (IN THOUSANDS) NET CASH USED IN OPERATING ACTIVITIES............................................ $ (66,447) $ (13,786) $ (603) INVESTING ACTIVITIES Net change in restricted funds................................................... 61 1,978 (1,858) Investment in unconsolidated affiliate........................................... (865) Notes receivable-officers/shareholders and affiliates............................ (1,500) Purchase of businesses and additional partnership interest, net of cash acquired....................................................................... (57,909) (26,705) (3,749) ---------- ---------- --------- Net cash used in investing activities............................................ (60,213) (24,727) (5,607) FINANCING ACTIVITIES Deferred financing costs......................................................... (1,828) (223) Net borrowings on lines of credit................................................ 133,628 11,667 5,857 Additional preferred stock issuance costs........................................ (98) Proceeds from sale of common stock............................................... 3,548 4,121 506 Proceeds from sale of preferred stock............................................ 23,782 Dividends paid................................................................... (1,404) (395) Principal payments on debt....................................................... (7,477) ---------- ---------- --------- Net cash provided by financing activities........................................ 126,369 39,175 6,140 ---------- ---------- --------- Increase (decrease) in cash and cash equivalents................................. (291) 662 (70) Cash and cash equivalents at beginning of period................................. 688 26 96 ---------- ---------- --------- Cash and cash equivalents at end of period....................................... $ 397 $ 688 $ 26 ---------- ---------- --------- ---------- ---------- ---------
See accompanying notes to condensed financial statements S-4 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF KTI, INC.--(CONTINUED) 1. BASIS OF PRESENTATION In the parent-company-only financial statements, KTI, Inc. (the "Company") investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since date of acquisition. Parent- company-only financial statements should be read in conjunction with the Company's consolidated financial statements 2. RESTATEMENT The Company's balance sheets as of December 31, 1998 and 1997 and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998 have been restated. The restatement is a result of the Securities and Exchange Commission's review of the Company's proxy materials related to the prospective merger with Casella Waste Systems (See Note 5). The restatement relates to revenue recognized as a result of the restructuring of a power purchase agreement and the sale of electric generating capacity by two of the Company's majority-owned subsidiaries with its customers, BHE and CMP, which were completed in 1998 and 1996, respectively (See notes 4 and 5 to the consolidated financial statements). At the time of these transactions, the Company had recognized revenues representing a portion of the cash received in 1996 and the total consideration received in 1998. After discussions with the staff of the Securities and Exchange Commission, the Company agreed to defer these amounts and recognize them over the term of the respective power purchase and capacity purchase agreements to comply with generally accepted accounting principles. The impact of the restatement on the Company's consolidated financial results as originally reported is summarized as follows:
AS REPORTED RESTATED -------------------------------- -------------------------------- 1998 1997 1996 1998 1997 1996 ---------- --------- --------- ---------- --------- --------- Net income (loss)............................ $ 6,718 $ 8,092 $ 13,666 $ 2,699 $ 10,173 $ (1,439)
3. DEBT The Company's debt consists of the following:
DECEMBER 31, --------------------- 1998 1997 ---------- --------- Revolving credit agreement............................................. $ 138,628 Convertible subordinated debt.......................................... 6,770 Revolving and term loan payable........................................ $ 12,411 Other.................................................................. 66 ---------- --------- $ 145,398 $ 12,477 ---------- --------- ---------- ---------
At December 31, 1998, the Company was in default of a debt covenant contained in it's Revolving Credit Agreement and received a waiver from the bank for this default. On May 12, 1999, the Company executed an amendment to the Revolving Credit Agreement (the "Amended Agreement") modifying certain financial covenants and requiring bank approval for all acquisitions. The Amended Agreement requires that the Company and certain subsidiaries, as defined, maintain certain specified financial covenants, including, a minimum interest coverage ratio, a maximum funded debt to EBITDA ratio, a minimum fixed charge coverage ratio, and a maximum debt to capitalization ratio, each as defined in the Amended Agreement. The Company's ability to satisfy these covenants is dependent on its ability to substantially S-5 3. DEBT (CONTINUED) achieve its operating plan. As of June 30, 1999, the Company was in default of certain of these covenants and received a waiver from the bank for this default through January 1, 2000. See Note 9 to the consolidated financial statements for additional discussion. 4. GUARANTEE As a result of a limited partnership interest in Penobscot Energy Recovery Company ("PERC"), a majority-owned consolidated subsidiary, the Company had a contingent obligation to make additional capital contributions to PERC of approximately $3,710. The Company had an irrevocable letter of credit from a bank securing this commitment. This contingent obligation expired during 1998. During 1998, certain bonds payable at the Company's majority-owned consolidated subsidiary, Penobscot Energy Recovery Company ("PERC") were refinanced. In conjunction with this refinancing, the Company issued a $3,000 limited guarantee of PERC's payment obligation under the refinanced bonds payable in favor of the issuer and trustees of the bonds payable. See Note 9 to the consolidated financial statements for additional discussion. 5. SUBSEQUENT EVENT On September 23, 1999, the Company entered into an amended Agreement and Plan of Merger (the "Merger Agreement") with Casella Waste Systems, Inc., ("Casella") a publicly-owned company engaged in the waste services industry. This Merger Agreement was an amendment to the original agreement dated January 12, 1999. The merger will be completed through the exchange of all of shares of the Company's common stock for shares of Casella's Class A common stock based on an exchange ratio specified in the Merger Agreement. In addition, all of the Company's outstanding and unexercised stock options and stock purchase warrants will be converted into similar rights to acquire Casella's Class A common stock under the same terms and conditions and the same exchange ratio. Subsequent to the completion of the merger, the current Casella stockholders will own a majority of the combined company. Under the terms of the Merger Agreement, Casella is required to file a registration statement with the Securities and Exchange Commission to register the shares of its Class A common stock to be issued in the Merger. The merger is subject to, among other things, approval of the Company's and Casella's stockholders. No assurances can be given that the remaining conditions of the Merger will be satisfied and that the merger will be consummated. In connection with the merger, Casella has agreed to reimburse the Company for its investment banking fees and other merger related costs and as of December 31, 1998, approximately $1,160 of such costs have been deferred. S-6 SCHEDULE II KTI, INC. VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - -------------------------------------------------- -------------------------- --------------- ----------- ADDITIONS -------------------------- CHARGED TO BALANCE AT CHARGED TO OTHER BALANCE AT BEGINNING COSTS AND ACCOUNTS-- DEDUCTIONS-- END OF DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD - -------------------------------------------------- ------------- ----------- ------------- --------------- ----------- (IN THOUSANDS) YEAR ENDED DECEMBER 31, 1998 Deducted from asset amounts: Allowance for doubtful accounts................... $ 294 $ 1,289 $ 270(1) $ 1,313 YEAR ENDED DECEMBER 31, 1997 Deducted from asset amounts: Allowance for doubtful accounts................... 242 193 141(1) 294 YEAR ENDED DECEMBER 31, 1996 Deducted from asset amounts: Allowance for doubtful accounts................... 481 24 263(1) 242
- ------------------------ (1) Uncollected accounts written off, net of recoveries. S-7 -----END PRIVACY-ENHANCED MESSAGE-----