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                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                            ------------------------
 
                                   FORM 10-K/A
                              (AMENDMENT NO. 1)
 
              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
 
                          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 (l) 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 [ ]
 
     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:
 
     $159,940,457 at March 27, 1998
 
     Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date:
 
     9,477,953
 
     Documents incorporated by reference: the Company's 1998 Proxy Statement.
 
     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 statments
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]
 
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                                     PART I
 
ITEM 1.  BUSINESS
 
GENERAL
 
BUSINESS OF ISSUER AND BUSINESS DEVELOPMENT
 
     KTI, Inc. (individually and collectively with its subsidiaries, the
"Company") was incorporated in New Jersey in 1985. The Company is a holding
company, and substantially all of its operating assets are owned by corporate
and partnership subsidiaries.
 
     These operations include wholly-owned consolidated subsidiaries and
majority-owned consolidated subsidiaries. The Company's majority-owned
consolidated subsidiaries include Maine Energy Recovery Company ("Maine
Energy"), American Ash Recycling of Tennessee, Ltd., ("AART") and Penobscot
Energy Recovery Company, Limited Partnership ("PERC"). The Company's principal
wholly-owned operating subsidiaries are Timber Energy Resources, Inc. ("TERI"),
K-C International, Ltd. ("K-C"), Manner Resins, Inc. ("Manner") I. Zaitlin and
Sons, Inc. ("Zaitlin") Data Destruction Services ("DDS"), KTI Recycling of New
Jersey ("the Newark Facility"), KTI Recycling of Illinois, ("the Chicago
Facility"), KTI Recycling of New England, ("the Charlestown Facility"), KTI
Specialty Waste Services, Inc. ("KTI Specialty Waste") and KTI Ash Recycling of
New England.
 
     The Company's objectives are focused on the development of 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, facility operations and
recycling of ash combustion residue. The Company's integrated waste handling
business emphasizes the use of low cost processing to add potential value to the
various waste products delivered and in certain cases the generation of electric
power. The Company believes that by adding these processing steps to its system,
it is competitive with traditional landfill alternatives while producing
superior environmental results and meeting social and political mandates. The
Company also markets recyclable metals, plastic, paper and corrugated processed
at its facilities and via third parties.
 
     As part of its integrated waste handling business, the Company operates
eleven processing facilities and seven marketing offices in the United States.
 
     Two of the Company's facilities in Maine are waste-to-energy facilities
which convert ordinary, non-hazardous solid waste from residential, commercial
and industrial sources ("municipal solid waste" or "MSW") into refuse derived
fuel ("RDF"), which in turn is combusted alone or with supplemental fuels (such
as wood chips, tire chips, natural gas and fuel oil) to dispose of the RDF and,
in the process, generate electrical power to be sold to electrical utilities.
These facilities process the MSW prior to combustion to separate for beneficial
reuse, non-combustible materials such as ferrous metals, glass and grit. The
remaining combustible material is further processed to increase the surface
volume and reduce size. Through such processing, the fuel value of the waste is
greatly enhanced, thereby allowing for a more efficient and cleaner combustion
process with substantially lower residues. The Company developed, and currently
owns majority interests in, these two facilities. The first facility is owned by
the Company's 74.15% owned subsidiary, Maine Energy, a Maine limited
partnership, which is located in Biddeford, Maine. Maine Energy commenced
operations in 1987. The other facility, owned by the Company's 71.29% owned
subsidiary PERC, Limited Partnership, a Maine limited partnership, is located in
Orrington, Maine. PERC commenced operations in 1988. Sources of revenues for the
facilities are from fees payable under waste handling agreements with over 280
municipalities and commercial waste sources for the right to dispose of MSW at
the Company's facilities ("tipping fees") and payments from electrical utilities
for electricity sold by the facilities. A third waste-to-energy facility located
in Telogia, Florida, which was acquired in late 1996, utilizes biomass waste as
its source of fuel to be combusted for the production of electricity for sale to
the local electric utility. During May and June of 1997, the Company retrofitted
this facility to increase its processing capabilities prior to combustion and
upgrade its combustion technologies for life extension to be in line with the
Company's other waste-to-energy facilities. This is the first example of the
Company's strategy of acquiring a troubled facility at substantial discounts to
replacement value, retrofitting the facility with increased processing capacity
and improved combustion technology, beneficially utilizing by-products of
processing and combustion and
 
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financially re-engineering the facility's capital structure. (See -- "Waste to
Energy and Waste Processing Facilities -- TEII -- TERI")The Company also
operates two wood processing facilities in Lewiston, Maine and Cairo, Georgia.
The Company's facilities in Maine provide 60% of the long-term MSW disposal
capacity for the State of Maine.
 
     The Company also owns a 60% limited partnership interest in a limited
partnership which operates a permitted municipal waste combustor ("MWC") ash
recycling facility in Nashville, Tennessee (the "Nashville Facility"). This
facility, which commenced operations in 1993, is the first commercially
operational MWC ash recycling facility in the United States.
 
     To solidify its business base in Maine and expand its integrated waste
handling business vertically and geographically, the Company made a number of
strategic acquisitions and financings during 1997.
 
     The Company acquired the exclusive right to own and operate a MWC ash
recycling facility in the State of Maine, similar to the Nashville Facility,
utilizing certain proprietary technology developed by American Ash Recycling
Corp., a Florida corporation ("AAR").
 
     AAR's proprietary MWC ash recycling process, which is being utilized in the
Nashville Facility, recovers substantial quantities of metal contained in MWC
ash residue and, after removing unburned materials, converts the remainder of
the ash into a high grade aggregate which is sold for beneficial reuse in
commercial construction, asphalt, concrete and roadbed material applications.
AAR's process recovers both ferrous and non-ferrous metals, which are cleaned to
enhance their value in the scrap metal markets. AAR's process also removes
unburned combustibles through the utilization of proprietary air separation
processes. The Company is seeking the regulatory approvals required to utilize
the AAR as recycling technology at its waste-to-energy facilities in Maine. All
approvals have not been obtained and such ash residue is not currently being
recycled.
 
     In June 1997, the Company refinanced $13.4 million of tax-exempt debt
issued on behalf of TERI. The transaction resulted in the replacement of
variable rate bonds which bore interest at rates between 3 1/2% and 4 1/2% in
1997 with 7% fixed coupon rates notes with an average maturity of 4 years and
the elimination of the credit enhancement provided by the Bank of Montreal. The
credit enhancement elimination had been a condition in the original acquisition
of Timber Energy Investments, Inc. ("TEII") from Continental Casualty Company
together with its subsidiaries, ("CNA"), which was completed in November 1996.
 
     Also in June 1997, the Company sold its series A convertible preferred
stock, par value $8 ("Series A Convertible Preferred Stock"), to a fund managed
by First Analysis Corporation and certain individuals for $3.9 million.
 
     In August 1997, the Company acquired all of the outstanding common stock of
Zaitlin an environmental recycling company based in Biddeford, Maine. Zaitlin
operates processing, brokering and storage facilities in Maine and
Massachusetts. The acquisition also included the purchase by the Company of all
of the outstanding common stock of DDS, a company engaged in the destruction of
confidential records. The purchase price consisted of $500,000 in cash and
200,000 shares of the common stock of the Company ("Common Stock") and the
assumption of $2.3 million of existing debt. Zaitlin has been in the recycling
industry since 1917 and deals in all grades of waste paper, non-ferrous metals
and some plastics. Sam Zaitlin, the former president of Zaitlin, joined the
Company in an executive capacity. Mr. Zaitlin formerly served as a member and
chairman of Maine's Board of Environmental Protection. He is a recent past chair
of the Maine Chamber and Business Alliance, the state's leading business
organization.
 
     In August 1997, KeyBank, National Association ("KeyBank") increased the
Company's line of credit from $1 million to $6 million. The line with KeyBank
was further increased to $11 million in November 1997 and $22 million in March,
1998.
 
     In August 1997, the Company sold the facility of Timber Energy Plastics
Recycling, Inc. a wholly-owned subsidiary of TEII ("TEPRI"), in Tuscaloosa,
Alabama to a group of investors and employees for $280,000 in cash and notes.
TEPRI's Tuscaloosa facility was acquired in November 1996 as part of the TEII
acquisition transaction. The sale of the Tuscaloosa facility, which is engaged
in plastic film recycling, is consistent with management's strategy of focusing
on the Company's core businesses.
 
     In August, the Company completed a placement of 856,000 shares of its
series B convertible exchangeable preferred stock, par value $25 ("Series B
Preferred Stock") for $21,400,000.
 
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    In September 1997, the Company acquired K-C, an international marketing and
trading company specializing in secondary fiber, pulp and paper worldwide. K-C
was established in 1976 and is headquartered in Portland, Oregon with offices
in Lakewood, New Jersey, Hartford, Connecticut, Los Angeles, California, Rio de
Janeiro, Brazil, Seoul, South Korea and Barcelona, Spain. The purchase price
included $1.85 million in cash and 425,014 shares of Common Stock. K-C's
current sales volume approximates 460,000 tons per year. K-C rounded out the
Company's full service materials handling and processing strategy by
integrating K-C's marketing team with the Company's existing operational and
financial expertise. K-C broadens the Company's marketing and distribution
channels by adding to the capabilities which exist in KTI Specialty, Zaitlin,
the Charlestown Facility, the Chicago Facility, the Newark Facility and Manner.
    
     In September and November 1997, the Company increased its ownership in PERC
to 71.29% by purchasing a 64.29% limited partnership interest from Prudential
Insurance Company of America ("Prudential") in two separate transactions for an
aggregate purchase price of approximately $14.5 million. The completion of these
transactions are part of the Company's ongoing strategy to maximize its
ownership of the waste to energy facilities which it operates.
 
    In October 1997, Wexford KTI LLC of Greenwich, Connecticut converted the
entire principal amount of $5 million of the Company's 8% convertible note
which it held into 618,609 shares of Common Stock.
    
     In November 1997, the Company completed the acquisition of three
state-of-the-art high capacity recycling plants in Boston, Massachusetts,
Chicago, Illinois and Newark, New Jersey which collectively are capable of
processing and marketing approximately 50,000 tons per month of post consumer
and commercial recyclables. Purchased by virtue of an order to sell such plants
from a bankruptcy court, the plants are the former assets of Prins Recycling
Corp. ("Prins"). The purchase price of the acquisition was approximately $15.1
million and was financed in part by a term loan from KeyBank in the amount of
$7.5 million and borrowings under the KeyBank credit line. This acquisition
added municipal and commercial recycling programs to the Company's comprehensive
solid waste disposal services.
 
     On January 15, 1998, the Company acquired Vel-A-Tran Recycling, Inc.
("Vel-A-Tran") for approximately $1.1 million in cash. Vel-A-Tran is
headquartered in Billerica, Massachusetts. Vel-A-Tran is in the business of
recycling high-grade paper and fiber products in the New England area. The
Company expects to consolidate Vel-A-Tran's operations into the Company's
facilities in Charlestown, Massachusetts. Vel-A-Tran had revenues of
approximately $1.0 million in 1997. The management of Vel-A-Tran will be
responsible for managing the high grade paper and fiber recycling operations of
the Company in the New England area.
 
     On January 30, 1998, the partners in PERC, the Municipal Review Committee,
Inc., a Maine not-for-profit corporation (the "MRC"), which represents 130
municipalities served by PERC ("Charter Municipalities"), and Bangor-Hydro
Electric Company ("Bangor Hydro"), executed an agreement, dated as of December
31, 1997 (the "Restructuring Agreement"), outlining the principal terms of a
restructuring of PERC's power purchase agreement with Bangor Hydro (the "Bangor
Hydro PPA") and certain provisions relating to amendments to the waste disposal
agreements between PERC and the 130 municipalities represented by the MRC (the
"Waste Disposal Agreements"). At the same time, the partners in PERC and Bangor
Hydro entered into a commitment with The Finance Authority of Maine ("FAME") to
refinance the existing tax exempt bonds issued to finance the original
construction of the PERC facility. Both documents contain significant conditions
to closing, which are not entirely in the control of the parties to such
documents. Accordingly, no assurance can be given that the Company will be able
to complete the transactions contemplated by such documents.
 
     On February 4, 1998, the Company purchased Total Waste Management
Corporation ("Total Waste Management") for approximately $1.375 million in cash.
Total Waste Management is headquartered in Newington, New Hampshire. Total Waste
Management is in the business of emergency response, site remediation, tank
cleaning, assessment and removal, waste oil and waste water recycling and
hazardous and non-hazardous waste management in the New England area. Total
Waste Management had revenues of approximately $4.2 million in 1997.
 
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     On February 5, 1998, all of the 447,500 issued and outstanding shares of
the Series A Convertible Preferred Stock were converted into 447,500 shares of
Common Stock.
 
     The Company's current business plan for its integrated waste handling
business includes the following elements: to (i) maximize the RDF production and
operating efficiencies at the Company waste-to-energy facilities, (ii) continue
to focus on lowering expenses of its waste-to-energy facilities by identifying
less costly means of disposing or recycling of MSW process and ash combustion
residues produced by its waste-to-energy facilities, (iii) utilize its expanded
specialty waste disposal capabilities (e.g. an increase in the amounts of
specialty waste processed by the Company is planned to offset the effects of the
seasonal nature of the traditional MSW market and the uncertainties of the MSW
spot market, which would increase revenue due to the higher tipping fees that
the Company believes its facilities will be able to charge for processing such
wastes), (iv) enhance the value of its wood waste processing business by
expanding the utilization of available capacity through the acquisition of
additional materials and expanding the menu of materials processed, (v) recycle
ash produced by waste-to-energy facilities, (vi) expand its waste brokerage
service, and (vii) utilize its experience gained in restructuring Maine Energy's
power supply contract, in waste handling and processing, turning around troubled
facilities and operating waste facilities by acquiring an interest in or
assuming operational responsibility for other waste disposal or recycling
facilities in financial or operational distress.
 
     The implementation of parts of the foregoing business plan has only
recently commenced and there can be no assurance that such plan will be
successful.
 
WASTE-TO-ENERGY TECHNOLOGY
 
     The two MSW waste-to-energy facilities developed by the Company utilize RDF
technology, which emphasizes both materials separation prior to the combustion
of MSW and the production of high quality fuel. In the RDF processes utilized by
the Company, non-combustible materials, such as ferrous metals, glass, grit and
fine organic materials, are separated from MSW, which allows for recycling of
non-combustible material and, in addition, yields a more homogeneous and
efficient fuel for electric power generation, more acceptable air emissions and
decreased quantities of ash residue from combustion. The use of supplemental
fuels, such as woodchips, tire chips, natural gas and fuel oil, allows the
Company to compensate for seasonal variations or temporary interruptions in MSW
deliveries or temporary fluctuations in the quality of the RDF used in the power
production process. The combustion of RDF either alone or with supplemental
fuels results in superheated steam that is delivered to a single steam turbine
generator in each facility, each of which generates electricity that is
transmitted through interconnection equipment to Central Maine Power Company
("Central Maine") and Bangor Hydro, respectively, pursuant to power purchase
agreements with Maine Energy and PERC.
 
     Ash residue is the remaining by-product of the Maine Energy and PERC
facilities' energy generation process. The facilities have disposed, and
currently dispose, of their ash residue at landfills located within the State of
Maine that are licensed by the Maine Department of Environmental Protection
("MDEP"). The Company has acquired the exclusive rights to utilize AAR's ash
recycling technology in the State of Maine and is seeking the regulatory
approvals required to recycle its ash residues at its facilities, but such ash
residue is not currently being recycled. There can be no assurance that the
Company will be able to recycle its ash residue. The Company currently utilizes
the AAR technology to recycle ash generated at the Nashville Facility.
 
WASTE-TO-ENERGY AND WASTE PROCESSING FACILITIES
 
  MAINE ENERGY
 
     General
 
     Maine Energy is a limited partnership organized in 1983 for the purpose of
developing and owning a waste-to-energy facility located in Biddeford, Maine.
The Company, through its subsidiaries, owns a 74.15% interest as the sole
general partner and one of three limited partners of Maine Energy. The other two
limited partners are CNA Realty Corp. ("CNA Realty"), a subsidiary of CNA
Financial Corporation, and Energy
 
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National, Inc. ("ENI"), an affiliate of NRG Energy, Inc. ("NRG"), each of which
own a 9.6% and 16.25% interest in Maine Energy, respectively.
 
     Maine Energy Facility
 
     The Maine Energy facility occupies an approximately 9.1 acre site owned by
Maine Energy in the City of Biddeford, Maine. The facility provides waste
disposal services to municipalities in central and southern Maine. The nominal
waste disposal capacity of the facility is 245,000 tons per year. The volume of
waste processed at the Maine Energy facility in 1997 was 254,354 tons.
 
     Financing of Maine Energy Facility
 
     The construction of the Maine Energy facility was financed with the
proceeds from the sale of $85 million original principal amount of variable rate
demand resource recovery bonds issued by the city of Biddeford in two offerings
(the "Biddeford Bonds"), which were issued in 1985 and secured by a letter of
credit from a group of banks, and a $22 million equity investment by Maine
Energy's original limited partners, CNA Realty, ENI and Project Capital 1985
("Project Capital"). The partners subsequently made additional investments in
the aggregate amount of $24.7 million in the form of subordinated loans with an
interest rate of 12% per annum, which are payable solely out of distributable
cash flow of Maine Energy. In May 1996, the Biddeford Bonds and the associated
letter of credit were retired.
 
     During 1997, the Company acquired $2,456,000 principal amount of such
subordinated loans from Project Capital. Maine Energy also retired $2.0 million
of subordinated loans during 1997. The balance of the subordinated loans due to
CNA Realty and ENI at December 31, 1997 was $11,949,000. While the Company
believes that distributable cash flow from the facility's operations will be
adequate to cover future annual interest requirements on the subordinated loans,
there can be no assurance that this will occur.
 
     Management and Fees
 
     An indirect subsidiary of the Company, Kuhr Technologies, Inc. ("Kuhr"), is
the sole general partner and manager and has control of the day to day business
of Maine Energy.
 
     Under the terms and conditions of an operation and maintenance agreement
with Maine Energy, a subsidiary of the Company, KTI Operations, Inc.
("Operations"), also administers, operates and maintains the Maine Energy
facility and is paid an amount equal to the actual operating costs of the Maine
Energy facility plus a monthly fixed fee, currently set at approximately $43,000
and subject to an inflationary adjustment annually. The agreement also provides
for incentive payments to Operations employees at the Maine Energy facility in
the event expected performance standards are exceeded. As a result of such
expected performance standards being exceeded, aggregate incentive payments in
the amount of $127,000, $203,000 and $202,000 have been paid to Operations
employees during 1997, 1996 and 1995, respectively.
 
     Power Purchase Agreement
 
     The electricity produced by the Maine Energy facility is sold to Central
Maine pursuant to the power purchase agreement (the "Central Maine PPA") 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 1997, the Company derived approximately $15,249,000, or
15.9% 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 (the "1996 Agreements") with CL Power Sales
One, L.L.C. ("CL One") and Central Maine, which provided for the purchase of
Maine Energy's available power generation capacity by CL One, and by amending
the Central Maine PPA (together with the 1996 Agreements, the "Agreements"). CL
One 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.
 
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In consideration of its payments to Maine Energy, CL One was assigned all rights
to capacity from the Maine Energy facility through May 31, 2007. In the
restructuring, the term of the Central Maine PPA was extended from May 31, 2007
to December 31, 2012. Pursuant to the 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%. Beginning June
1, 2007 until the expiration date of the Central Maine PPA, 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 million letter of
credit was issued to Central Maine by ING (US) Capital Corporation ("ING"). If,
in any year, Maine Energy fails to produce 100,000,000 kWh of electricity (a
"100,000,000 kWh test") and Maine Energy does not have a force majeure defense
(such as physical damage to the plant and other similar events), Maine Energy
will be obligated to pay $3.75 million to Central Maine as liquidated damages.
Such 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 $3.75 million. If, in any year, Maine Energy fails to produce
15,000,000 kWh of electricity (a "15,000,000 kWh test") and Maine Energy does
not have a force majeure defense, Maine Energy is obligated to pay the then
balance of the ING letter of credit to Central Maine as liquidated damages. In
1997, the 15,000,000 kWh test was met in January and the 100,000,000 kWh test
was met in August, resulting in a reduction of the amount of the ING letter of
credit to $37.5 million. With respect to 1998, the 15,000,000 kWh test was met
in February, although past performance is no indication of future performance.
 
     Management of the Company restructured its relationship with Central Maine
because it believes that the Agreements, which reduced the outstanding
indebtedness of Maine Energy, should allow the Company upon refinancing or
repayment of the reduced subordinated debt, access to Maine Energy's available
cash flow. The restructured Central Maine PPA will allow Maine Energy to be more
competitive when electric utility deregulation legislation passed during 1997 by
the State of Maine becomes effective in the year 2000. The foregoing estimate of
increases in cash flow and competitive advantage, however, are forward-looking
statements that are subject to certain risks and uncertainties that could cause
actual results to differ materially from those set forth herein due to, among
other factors, (i) failure to achieve the levels of power production projected
by the Company or (ii) levels of expenses greater than those projected by the
Company, and, accordingly, there can be no assurance that the Company will
experience such an increase in cash flow and competitive advantage as a result
of such transactions.
 
     Long-Term Waste Handling Agreements
 
     Approximately 30% of the MSW provided to Maine Energy is delivered pursuant
to waste handling agreements with eighteen (18) municipalities with terms
expiring on June 30, 2007 or later. The agreements are substantially similar in
content except that (i) the sixteen (16) "charter" municipalities are entitled
to various concessions as a result of having participated in the financial
restructuring of Maine Energy in 1991, and (ii) the two "host" municipalities of
Biddeford and Saco (both of which are charter municipalities) pay tipping fees
in the amount of one-half of those paid by the other charter municipalities. The
municipalities currently pay tipping fees to Maine Energy for the disposal of
MSW ranging as of December 31, 1997 from $20.75 per ton, in the case of the two
host municipalities of Biddeford and Saco, to $41.50 per ton, which are subject
to adjustment. The annual tipping fees charged to the municipalities are
increased (but not decreased) each year for inflation and any increases in
variable "pass through" costs, such as interest costs and disposal fees for
residues. The municipalities are also responsible for costs associated with
changes in law. Maine Energy was not entitled to an increase in tipping fees in
1997 for variable "pass through" or change in law costs. Approximately 28% of
Maine Energy's total revenue in 1997 was attributable to these long-term waste
handling agreements.
 
     Under the Maine Energy long-term waste handling agreements, each
municipality has agreed 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 which designates the Maine Energy facility as
the
 
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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. The Company does not
believe that currently there is a material risk that the municipalities would
exercise their respective rights to terminate their agreements, as the Company
does not believe that there are currently any less costly alternative long-term
means of MSW disposal available in Maine Energy's market area.
 
     Other Sources of Waste
 
     The Company has short-term MSW disposal contracts with additional
municipalities with terms expiring in 1998 through 2003 that provide Maine
Energy with approximately 64,000 tons per year of MSW, and short-term contracts
principally with one to three year terms with commercial and private waste
haulers that provide approximately 94,000 tons per year of MSW to the Company.
The balance of Maine Energy's capacity is utilized by spot market MSW and
specialty wastes.
 
     Bypass and Residue Disposal
 
     The processing of MSW at the Maine Energy facility generates materials such
as non-combustible material removed from the front-end processing of MSW
("front-end process residue") and ash residue resulting from the RDF combustion
process. These materials are disposed of by licensed third parties under
long-term agreements. Maine Energy is also required, in the event of a shutdown
of the Maine Energy facility, to dispose of MSW received by Maine Energy by
delivering such MSW to PERC or to third party waste disposal facilities.
 
  PERC
 
     General
 
     PERC is a limited partnership organized in 1983 for the purpose of
developing and owning a waste-to-energy facility located in Orrington, Maine. A
subsidiary of the Company, PERC Management Company ("PMC") owns a 71.29% general
and limited partnership interest in PERC. The other partner of PERC is ENI,
which has both a general and limited partnership interest representing an
aggregate 28.71% ownership percentage. During 1997, in two transactions, the
Company acquired its limited partnership interests representing a 64.29%
ownership percentage for an aggregate purchase price of approximately $14.5
million.
 
     Acquisition of Limited Partnership Interests
 
     On September 30, 1997, the Company purchased a 49.5% limited partnership
interest in PERC from Prudential for approximately $11.7 million in cash. In
addition, the Company assumed certain liabilities of Prudential in the amount of
$200,000 and issued letters of credit to Morgan Guaranty Trust Company of New
York for approximately $3.9 million, replacing obligations of Prudential to
Morgan Guaranty Trust Company of New York. At the same time, the Company paid
$300,000 for an option to buy the remaining 14.79% interest of Prudential in
PERC at a price of $2.1 million. On November 12, 1997, the Company exercised its
option and purchased the remaining 14.79% interest held by Prudential.
 
     Following these purchases, the Company's interest in PERC increased to
71.29%. ENI holds the remaining 28.71% interest in PERC, 3% as general partner
and 25.71% as a limited partner.
 
     Prior to the September 30, 1997 limited partnership interest acquisition,
the Company accounted for its 7% ownership interest under the equity method.
 
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     PERC Facility
 
     The PERC facility occupies an approximately 40.3 acre site owned by PERC in
the town of Orrington. The facility provides waste disposal services to 230
municipalities in Penobscot, Hancock, Waldo, Piscataquis, Somerset, Knox,
Kennebec, Lincoln and Aroostook Counties, Maine. The nominal waste disposal
capacity of the facility is 325,000 tons per year. The PERC facility processed
275,406 and 253,523 tons of MSW in 1997 and 1996, respectively.
 
     Management and Fees
 
     ENI and PMC are both general partners of PERC. ENI and PMC each have one
representative on a management committee, which is generally given full
authority and discretion with respect to PERC's business, except as delegated to
PMC the managing general partner. However, certain matters acted upon by the
management committee, such as the addition of new partners or the transfer of
partnership interests and the approval of the terms and conditions of any
contract pursuant to which PERC would expend or receive $100,000 or more in any
year, must be presented to the general partners for approval or rejection.
 
     Primary day-to-day responsibility for operating the PERC facility has been
contracted to ESOCO Orrington, Inc. ("ESOCO"), a subsidiary of ENI, pursuant to
an operating and maintenance agreement. The term of the agreement is for five
years, with renewals for successive five year terms.
 
     PMC also earns an annual management fee from PERC. The base amount of the
fee was set in the PERC partnership agreement subject to annual adjustments on
the basis of the U.S. Consumer Price Index Urban Annual Percentage change as
published by the U.S. Department of Labor Bureau of Labor and Statistics from
year to year (the "Consumer Price Index") and was $431,000 for the year ended
December 31, 1997. The subsidiary of the Company was due $2,151,000 on account
of accrued management fees as of December 31, 1997, which represent the unpaid
portion of management fees earned by the Company through March 31, 1991.
However, this amount is eliminated in preparation of the Company's consolidated
balance sheet at December 31, 1997. Payment of the accrued management fees
currently are restricted by the terms of the PERC partnership agreement to the
extent of 10% of cash flow otherwise distributable to equity owners. The Company
also receives an annual cooperator's fee which was $55,000 for the year ended
December 31, 1997.
 
     In 1997, the Company was entitled to receive $686,000 as a result of PERC's
operations during 1996, $389,000 of which was paid to ENI in repayment of
contributions to PERC made by ENI on behalf of the Company. As of December 31,
1997, the balance due to ENI was $1,072,000.
 
     The Power Purchase Agreement
 
     The electricity produced by the PERC facility is sold to Bangor Hydro
pursuant to a power purchase agreement with Bangor Hydro ("the Bangor Hydro
PPA"). Bangor Hydro serves approximately 97,000 customers in a 4,900 square mile
service area in portions of the counties of Penobscot, Hancock, Washington,
Waldo, Piscataquis and Aroostook, Maine. In 1997, the Company derived
approximately $18,593,000 or 19.3% of its revenues, from the sale of electricity
to Bangor Hydro.
 
     Under the terms of the Bangor Hydro PPA, Bangor Hydro has agreed to
purchase all electricity generated by the PERC facility up to 25 megawatts (the
practical limit of the facility's equipment). The Bangor Hydro PPA rate formula
is currently favorable to PERC, providing a contract rate of 11.7 cents per kWh
for 1997 up to a maximum of approximately 166,000,000 kWh in a calendar year,
net of electricity consumed at the facility. PERC is paid at a lower rate for
electricity generated above this level. A portion of the contract rate is
adjusted annually to reflect changes in inflation. If PERC fails to deliver at
least 105,000,000 kWh to Bangor Hydro in any calendar year, PERC is obligated to
pay Bangor Hydro $4,000 for each 1,000,000 kWh by which such deliveries fall
below 105,000,000 kWh. Although future performance cannot be guaranteed by past
results, PERC has never failed to meet this delivery obligation. The
profitability of PERC is heavily dependent on the Bangor Hydro PPA.
 
                                        8
   10
 
     On January 30, 1998, the partners in PERC, the MRC, which represents
Charter Municipalities and Bangor Hydro, executed Restructuring Agreement,
outlining the principal terms of a restructuring of the Bangor Hydro PPA and
certain provisions relating to amendments to the Waste Disposal Agreements. At
the same time, the partners in PERC and Bangor Hydro entered into a commitment
with FAME to refinance the existing tax exempt bonds issued to finance the
original construction of the PERC facility. Both documents contain significant
conditions to closing, which are not entirely in the control of the parties to
such documents. Accordingly, no assurance can be given that the Company will be
able to complete the transactions contemplated by such documents.
 
     The Restructuring Agreement provides that Bangor Hydro will make a one time
payment of $6 million to PERC at the time of the closing of the refinancing of
the existing tax-exempt debt, and will make additional quarterly payments of
$250,000 per quarter for four years, for an additional total of $4 million, and
issue warrants for two million shares of Bangor Hydro common stock which will be
divided equally between the MRC on behalf of its member municipalities and the
PERC partners. The exercise price of such warrants is $7.00 per share and the
warrants will expire 10 years after issuance. The right to exercise such
warrants will vest over 4 years. In exchange for such consideration, Bangor
Hydro will be entitled, assuming performance of all of its obligations under the
Bangor Hydro PPA, to receive a rebate of a portion of its purchase price of
electric power from PERC, equal to one third of the cash available for
distribution from PERC. This transaction is contingent upon, among other things,
the closing of a reissuance of the tax-exempt bonds of FAME, pursuant to the
FAME commitment.
 
     The FAME commitment provides for a refinancing of the existing tax-exempt
debt which matures in 2004, with an adjustable rate tax-exempt security with an
extended maturity of 20 years, with customary fees. The FAME bonds would be
backed by the moral obligation of the State of Maine. The refinanced bonds will
be secured by substantially all of the assets of the PERC project (including the
$10 million to be received from Bangor Hydro), a guaranty of $3 million from the
Company and a guaranty of annual debt service, subject to a maximum amount of
$4.2 million, by Bangor Hydro. The guaranty by Bangor Hydro is dependent upon
receipt of all necessary orders and consents from the Maine Public Utility
Commission and Bangor Hydro's lenders.
 
     The amendments to the Waste Disposal Agreements will be effective upon
receipt of acceptance of not less than 50% of the Charter Municipalities (as
determined by tonnage delivered to PERC). PERC may terminate the transactions if
25% or more of the Charter Municipalities reject or otherwise object to the
transactions. The amendments permit the Charter Municipalities to: (a) make
equity contributions to PERC, only and to the extent of the MRC's share of
distributable cash from PERC (See -- "PERC -- Long-Term Waste Handling
Agreements") and one-half of the Bangor Hydro quarterly payment, of up to $31
million, which will be used to prepay the FAME bonds outstanding, (if all $31
million are contributed the municipalities will own a 50% partnership interest
in PERC); (b) purchase all of the remaining PERC interests in 2018 at the then
fair market value, in lieu of the existing right to purchase PERC at its then
book value in 2004; (c) extend the term of the Waste Disposal Agreements to
2018; and (d) reduce cash available for distribution to the Charter
Municipalities to one third from one half.
 
     The transactions are expected to close in May, 1998. The term sheet
provides that if the closing is after May 1, 1998, the financial terms of the
transaction are subject to retroactive adjustment. Both documents contain
sugnificant conditions, which are not entirely in the control of the parties to
such documents. No assurance can be given that the transactions contemplated by
such documents can be successfully completed.
 
     Long-Term Waste Handling Agreements.
 
     As of December 31, 1997, PERC had in place 127 long-term waste handling
agreements, of which 90 cover approximately 130 Charter Municipalities with
terms expiring on March 31, 2004, unless sooner terminated, and all of which are
substantially similar in content. The agreements provide PERC with approximately
195,000 tons per year of MSW. In addition, PERC receives approximately 18,000
tons per year of MSW from municipalities with whom PERC has short-term waste
handling agreements, 20,000 tons per year from commercial haulers and 30,000
tons per year from the spot market. As of December 31, 1997, the
 
                                        9
   11
 
municipalities with whom PERC had long-term waste handling agreements pay an
average tipping fee of $49.18 per ton to PERC for the disposal of their waste.
Total waste processing revenues of PERC in 1997 were approximately $12,593,000,
of which approximately 80% was attributable to MSW received from Charter
Municipalities.
 
     The PERC 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.
 
     Each Charter Municipality has the right to receive a pro rata credit
against tipping fees, which credits are known as "Performance Credits" and may
be used to reduce future tipping fee payments at the option of the Charter
Municipalities in lieu of cash payment. Performance Credits for 1996 in the
amount of $619,000 were paid in 1997. The amount due for 1997 which will be paid
during 1998 is approximately $1,101,000.
 
     On one year's notice, a Charter Municipality may terminate its long-term
waste handling agreement as of March 31, 2000 or March 31, 2002. If, as a result
of such termination notices received from Charter Municipalities, the aggregate
Guaranteed Annual Tonnage of non-terminating municipalities would fall below
180,000 tons, PERC may elect to terminate all waste handling agreements with
Charter Municipalities. Currently no Charter Municipality has given any such
notice for March 31, 2000. Effective March 31, 2004, Charter Municipalities,
acting collectively, which have not previously terminated their PERC long-term
waste handling agreements will have three options: (i) to purchase the PERC
facility at its book value (as defined) as of March 31, 2004; (ii) to acquire,
for $1.00, 50% of all "Distributable Cash" (defined as the revenues of PERC less
expenses, amounts credited to reserve accounts and management fees) on or after
April 1, 2004; or (iii) to extend the existing waste handling agreements for a
period of 15 years. If the PERC Charter Municipalities are unable to agree on
the option to select, the option selected by a majority of such municipalities,
based upon Guaranteed Annual Tonnage, shall be the option selected. Upon
consummation of the Restructuring Agreement, all the options of the PERC Charter
Communities described in this paragraph will be terminated. There can be no
assurance, however, that the Restructuring Agreement will be consummated.
 
  TIMBER ENERGY INVESTMENTS, INC.
 
     General
 
    TEII was formed in 1994 as a holding company, which ultimately owned a
majority of common stock of TERI and all of the outstanding stock of Timber
Energy Plastics Recycling, Inc. ("TEPRI") and Timber Energy Trucking, Inc.
("TET").
    
     Acquisition by the Company
 
    On November 22, 1996, the Company acquired TEII from CNA and a group of ten
individual investors. CNA sold its debt obligations of TEII and equity
interests in TEII to the Company for $1.85 million. The remaining ownership
interest in TEII and the minority interest in TERI were purchased from the
group of ten individual investors for an additional approximately $170,000.
    
     The Company acquired TERI subject to $13.4 million of tax exempt bonds. As
part of its purchase agreement with CNA the Company had also agreed to obtain
the release of CNA's reimbursement obligation to the Bank of Montreal, which
provided credit enhancement for the $13.4 million of outstanding bonds. On June
4, 1997, the outstanding bonds, together with accrued interest and associated
closing costs including the funding of a debt service reserve of $1,340,000 were
paid or retired from the proceeds of $13,736,000 of series 1997A and 1997B bonds
issued and from cash on hand. In connection therewith, the Bank of Montreal
credit enhancement was terminated.
 
                                       10
   12
 
     Timber Energy Plastic Recycling, Inc.
 
     TEPRI recycled post consumer low density plastic waste into products sold
to manufacturers of plastic products.
 
     On August 12, 1997, the Company sold TEPRI to the management of TEPRI for
$30,000 in cash and a $250,000 8% promissory note due on November 10, 1997 which
was paid in full when due. From January 1, 1997 to August 12, 1997, TEPRI had
revenue of approximately $1.1 million and a loss of approximately $244,000.
 
     TERI
 
     General
 
     TERI is a Texas corporation organized in July 1984 for the purpose of
constructing and operating biomass waste power plants. TERI owns and operates a
facility located on a 97 acre site in Telogia, Florida, which commended
operations in 1988 (the "Telogia Facility"). The Telogia Facility is fueled with
biomass wastes.
 
     Power Purchase Agreement
 
     Electricity generated by the Telogia Facility is sold to Florida Power
Corporation ("Florida Power") under a power purchase agreement (the "Florida
Power PPA"). Florida Power Corporation serves more than 1.3 million customers in
a 20,000 square mile service area in central and northern Florida. During 1997,
approximately 96.4% of TERI's revenue was derived from the sale of electricity
to Florida Power, with the majority of the remainder in the form of tipping fees
paid by third parties. Under the terms of the Florida Power PPA, Florida Power
has agreed to purchase all of the energy generated by the Telogia Facility, net
of energy consumed by the facility. The contract rate paid by Florida Power is
composed of a monthly capacity fee of $309,000 plus a short-term energy only
rate ("STEO") for each kWh delivered. STEO rates ranged from 1.69 cents to 2.09
cents per kWh during 1997. To earn the monthly capacity charge the Telogia
Facility must produce power at a rolling 12-month capacity factor of 70%. The
Telogia Facility had a 80% capacity factor for 1997. The Telogia Facility has
never failed to meet this delivery obligation, although past performance is no
indication of future results.
 
     Biomass Waste Supply
 
     In 1991, to further improve the supply and lower the cost of fuel for the
Telogia Facility, TERI constructed a waste paper densification line at the
Telogia site. This line produces a densified fuel pellet from incoming
feedstock, which has better burning characteristics than the undensified
material. The Company improved this processing line during the renovation of the
facility in 1997. The Telogia Facility is continually expanding its menu of
biomass waste products that it can process and ultimately dispose of through
combustion. Currently the facility receives waxed corrugated, non-recyclable
paper, construction and demolition wood wastes, residues from the wood
processing industry and waste plastics. The Company is looking to further expand
the menu of biomass waste products processed. When the Company acquired the
biomass facility, the fuel was procured through waste brokers. As a result, when
transportation costs were included, the Telogia Facility paid approximately $1.1
million in 1996 for fuel. The Company's objective is to convert this paid for
fuel into tipping fee based material improving the overall economics of the
facility. In 1997, the Telogia Facility's net cost of fuel including
transportation was reduced to approximately $421,000. The tipping fee material
is principally provided under short term contracts and the spot market. During
1997, the Telogia Facility processed approximately 112,000 tons of wood waste
and 35,000 tons of waste paper, and generated approximately 98,000
megawatt-hours of electricity, which represented 80% of its annual capacity.
 
                                       11
   13
 
  KTI BIO FUELS, INC.
 
     General
 
     The Company's Maine wood waste processing business is operated by the
Company's subsidiary, KTI Bio Fuels, Inc. ("KTI Biofuels"). KTI Bio Fuels owned
a 75% ownership interest in a predecessor partnership, KTI Bio Fuels, L.P. The
sole limited partner of KTI Bio Fuels L.P. was Maine Woodchips Associates, a
Maine partnership ("Woodchips Associates"), which held the remaining 25%
ownership interest in KTI Bio Fuels, L.P. In February 1997, the Company acquired
the 25% interest owned by Woodchips Associates for 10,000 shares of Common Stock
and a five year warrant to purchase 2,000 shares of Common Stock at $8.50 per
share having an aggregate fair market value of approximately $87,200. Upon
acquiring the 25% ownership interest, the Company liquidated the partnership and
moved the operation into its wholly owned subsidiary, KTI Bio Fuels. KTI Bio
Fuels was organized in 1986 for the purpose of developing and operating a plant
in Lewiston (the "Lewiston Facility") to convert treated and untreated wood
waste materials into woodchips used as boiler fuel. This facility also converts
oversized bulky wastes, such as furniture and mattresses into a biomass boiler
fuel.
 
     The principal source of revenue to KTI Bio Fuels is tipping fees from
parties disposing of wood waste at the Lewiston Facility, which is supplemented
by revenues from the sale of woodchips and recovered scrap metals. PERC and to a
lesser extent Maine Energy utilize woodchips produced by the Lewiston Facility
as a supplemental fuel for their RDF combustion processes. In addition to PERC
and Maine Energy, KTI Bio Fuels also sells its woodchips to third party biomass
power plants in Maine.
 
     Lewiston Facility
 
     The Lewiston Facility occupies an approximately 9.7 acre site which is
leased from an affiliate of the city of Lewiston for a term expiring 2015 . The
facility has the capacity to process up to three hundred (300) tons per day of
wood waste materials and consists of a waste processing building, including
equipment for the magnetic separation of ferrous metals, and a large storage
building where processed woodchips are stored. During 1997, KTI Biofuels
processed approximately 45,200 tons of wood waste material at the Lewiston
Facility.
 
  TERI CAIRO FACILITY
 
     TERI owns a 400,000 ton per shift wood chip mill located in Cairo, Georgia
(the "Cairo Facility"). The Cairo Facility was constructed in 1988 to produce
wood chips for Stone Container, Corp. ("Stone Container") and incidentally to
provide an additional source for a continuing, dependable and economical fuel
supply for the Telogia Facility. The Cairo Facility commenced operations in
December 1989. Pulpwood is processed for Stone Container under a "process or
pay" contract. The contract requires Stone Container to pay $3.40 per ton for up
to 240,000 tons per year and $3.00 per ton for all tons processed over 240,000
tons per year. Bark trimmings from the Cairo Facility could provide up to 20% of
the fuel requirement for the Telogia Facility. During 1997, the Cairo Facility
processed approximately 365,000 tons of virgin wood, which represented
approximately 91.3% of its single shift annual capacity, and produced
approximately 317,000 tons of wood chips and approximately 48,000 tons of bark
trimmings. During 1997, the Company began to market the bark produced to mulch
processors. As the Telogia Facility eliminates its need for the Cairo Facility's
bark by replacing its purchased biomass fuel with tipping fee material, the
Company will increase its marketing activities of the bark for alternative uses.
 
  KTI ASH RECYCLING, INC.
 
     Effective March 29, 1996, KTI Ash Recycling, Inc. ("KTI Ash") purchased a
60% interest as a limited partner in American Ash Recycling of Tennessee, a
Florida limited partnership ("AART"). The general partner, American Ash
Recycling Corp. of Tennessee, a Florida corporation, is the previous owner of
the Nashville Facility. AART is carrying on the business of the Nashville
Facility. The Company has a priority on the annual distributions of earnings and
cash flow from the Nashville Facility to the extent of 75% of the earning and
cash flow generated until it receives $315,000 for each year on a cumulative
basis.
 
                                       12
   14
 
     In April, 1996, the Company entered into agreements with American Ash
Recycling Corp., a Florida corporation ("AAR"), an affiliate of the general
partner in AART, pursuant to which the Company acquired a 60% limited
partnership interest in a limited partnership formed to operate a municipal
waste combuster ("MWC") ash recycling facility in the State of Maine (the "Maine
Partnership"). The Company had originally agreed to become a 60% limited
partner, if appropriate, in up to eight (8) more ash recycling facilities that
may be developed by AAR through December, 1999.
 
     The Company believes that its efforts to obtain operating permits for the
Maine Partnership's ash recycling facility were instrumental in Maine Energy's
ability to negotiate a reduced disposal fee with a third-party ash landfill
owner. Under the renegotiated contract, Maine Energy's ash disposal fee was
reduced to $46 per ton from $76 per ton. Maine Energy contractually agreed to
pay 30% of the ash disposal fee savings to the Maine Partnership.
 
     On October 31, 1997, KTI Specialty Waste acquired AAR's 40% general partner
interest in the Maine Partnership for $560,000, and the Maine Partnership has
been renamed KTI Ash Recycling of New England, L.P. Since the Company now owns
all of the interests in such partnership, the Company has received all of the
ash disposal fee savings payable to the Maine Partnership since November 1,
1997. In addition, the Company also obtained the exclusive right to use the AAR
technology in the State of Maine. After the consummation of the acquisition of
AAR's general partner interest, the Company's agreement to become a limited
partner in up to eight additional cash recycling facilities was terminated. In
addition, the Maine Partnership is developing a plan to construct an ash
recycling operation at one of the Company's waste-to-energy facilities. The
Maine Partnership has not yet received regulatory approval for such plan, and
there can be no assurance that such approval will be granted.
 
     AAR's proprietary MWC ash recycling process recovers substantial quantities
of metal contained in MWC ash residue and, after removing unburned materials,
converts the remainder of the ash into a high grade aggregate which is sold for
reuse in commercial construction, asphalt, concrete, and roadbed material
applications. AAR's process recovers both ferrous and non-ferrous metals, which
are cleaned to enhance their value in the scrap metal markets. AAR's process
also removes unburned combustibles through the utilization of proprietary air
separation processes.
 
RECYCLING FACILITIES
 
  KTI Post Consumer and Commercial Recycling Facilities
 
     Acquisition of I. Zaitlin and Sons, Inc.
 
     On August 1, 1997, KTI Recycling, Inc., a subsidiary of the Company ("KTI
Recycling"), acquired Zaitlin and DDS. The purchase of Zaitlin included two
parcels of real estate, used by Zaitlin in its operation.
 
     Zaitlin and DDS are headquartered in Biddeford, Maine. Zaitlin, formed in
1917, has a processing, brokering and storage facility in Biddeford, Maine (the
"Biddeford Facility"). Zaitlin also had a processing, brokerage and storage
facility in Woburn, Massachusetts. The Woburn facility has been closed and the
operations transferred to the Company's facility in Charlestown, Massachusetts.
Zaitlin buys and sells more than 100,000 tons of recycled materials in the
northeastern United States and Canada, handling all grades of waste paper,
non-ferrous metals and some plastics. In addition to the expansion of services
provided in the Maine market through the Biddeford Facility, Zaitlin's expertise
in non-ferrous metal processing and marketing expands the Company's ability to
market and process non-ferrous metals at its waste-to-energy plants and wood
processing facilities. Maine Energy is currently enhancing its frontend
processing to recover non-ferrous metals, such as aluminum. To date, Maine
Energy has recovered only ferrous metals from its waste stream. The Company's
focus is to utilize Zaitlin to increase Maine's recycling percentage which has
been historically low due to Maine's rural population. By utilizing the
Biddeford and Charlestown Facilities for recycling, the state of Maine can enjoy
the economies of scale more typical of large urban recycling units. The Company
also hopes to transfer MSW from the Boston area with the same vehicles used to
transfer recyclables from Maine to Charlestown.
 
                                       13
   15
 
     DDS is in the confidential records destruction business. DDS provides an
additional service for the Company's customers who desire their waste to be
confidentially destructed, including banks and law firms. DDS provides both on
and off-site document destruction. In certain circumstances, DDS's shredded
documents can either be recycled at the Company's paper recycling facilities or
utilized as processed fuel at the Company's waste-to-energy facilities.
 
     The operations of the Woburn, Massachusetts commercial paper recycling
facility have been consolidated into the Company's Charlestown commercial
recycling facility. This consolidation allowed for reductions in duplicative
administrative and operating costs.
 
     Acquisition of Prins Recycling Units
 
     On November 14, 1997, the Company completed the acquisition of three
recycling facilities located in Franklin Park, Illinois, a suburb of Chicago,
Charlestown, Massachusetts, a borough of Boston, and in Newark, New Jersey. The
facilities are operated by wholly owned subsidiaries of the Company. The three
facilities are large capacity facilities, capable of processing an aggregate of
approximately 50,000 tons of post consumer and commercial recyclables per month.
 
     The facilities were purchased as part of an asset purchase from Prins
pursuant to an order of the Bankruptcy Court for the District of New Jersey. In
addition to the facilities, the Company purchased substantially all of the
remaining assets of Prins, including cash, accounts receivable and certain
causes of action.
 
     The purchase price was approximately $15.1 million. The purchase was
financed in part by a term loan of $7.5 million provided by KeyBank bearing
interest at the bank's base rate plus 1.25%, with level monthly principal
payments over 84 months. The term loan is secured by a mortgage on the Franklin
Park, Illinois facilities, all property and equipment at the three facilities
not pledged to third parties and the accounts receivable generated by the three
facilities. The balance of the purchase price was paid by cash on hand and by a
temporary draw of a portion of the company's revolving line of credit, provided
by KeyBank.
 
     Charlestown Facility
 
     The Charlestown Facility consists of two buildings leased from two separate
landlords. One building, the residential building, is used to process
residential or post consumer recyclables and the other building, the commercial
building, is used to process commercial recyclables such as high grade paper
from printers. The residential building receives old newspaper ("ONP"), old
corrugated containers ("OCC") and commingled bottles and cans. These materials
are processed on a series of processing lines which separate various grades of
paper and OCC through the use of mechanical processes and labor at various
picking stations. The process also eliminates waste and non-recyclable paper and
plastics. The waste and non-recyclables are delivered to Maine Energy for
combustion. The resulting processed ONP and OCC is baled and shipped to domestic
and international paper mills.
 
     The commingled bottles and cans are processed on a separate set of
processing lines in the residential building. The material is separated by both
mechanical methods, such as eddy current separators for aluminum and belt
magnets for ferrous metal, and labor, at picking stations, to separate various
grades of plastic and glass by color. The separated products are baled in the
case of plastics, ferrous metal and aluminum or crushed in the case of glass.
These separated products are sold to manufacturers for use as raw material in
the production of intermediate and finished products. Any residual material is
either delivered to Maine Energy for combustion or, in the case of mixed color
glass, disposed of for use as aggregate or landfill cover.
 
     The Company has entered into a series of variable rate tipping contracts
with municipalities in the Boston area pursuant to which, the residential
building of the Charlestown Facility receives ONP, OCC and commingled bottles
and cans from several commercial haulers and local municipalities, including the
City of Boston and numerous surrounding municipalities. The municipalities
currently pay tipping fees for all ONP and OCC delivered to the Charlestown
Facility, which range from $18.00 per ton for Boston as host city to
 
                                       14
   16
 
$25.00 per ton. The municipalities are then entitled to receive rebates if the
selling prices of recycled paper exceed certain benchmark levels. By providing a
budgeting base to municipalities but offering potential revenues should markets
improve, the Company has been able to secure five to thirteen year contracts,
eliminating costly and time consuming annual or biennial bidding cycle. The
Company has structured these variable fee rebate contracts in order to obtain a
processing fee from the communities which will not be subject to the swings in
the commodity market. As a result of the historic volatility in ONP and OCC
prices, communities previously have chosen to bid the services required for
their recycling needs annually. The variable fee rebate structure also allows
the community to commit for longer periods of time. The commingled bottles and
cans delivered under contracts with the communities require a tipping fee per
ton to be paid which ranges from $20.00 per ton for Boston as host city to
$35.00 per ton. There is no rebate structure under this portion of the contract.
 
     The Charlestown commercial building processes high grade paper in order to
separate the incoming material into several grades ranging from direct pulp
substitutes to deinking grades, such as sorted office paper, print shop waste
and sorted white ledger. In addition, the facility handles overissue newsprint
and OCC, both of which are purchased from large commercial generators or from
commercial haulers.
 
     Incoming material is run over a sorting line, where contaminants are
removed and higher value items are extracted for upgrading and separate baling.
Thus, direct grades of secondary fiber are produced to meet the demands of
specific paper mills, and higher values are obtained. The graded paper is baled
and shipped to domestic and international paper mills.
 
     In addition to consolidating Zaitlin's Woburn facility into the Charlestown
commercial building, the Company also acquired Vel-A-Tran of Billerica,
Massachusetts in January 1998. Vel-A-Tran is also in the business of recycling
high grade paper and fiber in the New England area. Vel-A-Tran operations are
being consolidated into the Charlestown commercial building.
 
     Newark Facility
 
     The Newark Facility consists of three processing buildings, a small
separate office building, and a separate scalehouse, all located within an
industrial park. In one building, the Company processes ONP and OCC. In a second
building the Company processes post-consumer office wastes, as well as
pre-consumer papers from printers and document publishing houses. In a third
building, the Company is capable of processing either post-consumer or
pre-consumer paper. This facility also currently serves as a commingled
materials transloading site.
 
     Non-recyclable residuals in Newark are handled by third parties. A
substantial portion of the ONP received at the Newark Facility currently comes
from other recyclers as opposed to directly from municipalities. OCC principally
comes from commercial haulers. Almost all ONP and OCC pricing is determined each
month based on local end-market prices. The marketplace is highly competitive,
due to the presence of several other large operations within a 20 mile radius. A
third source of material is another recycling firm located nearby, which pays a
fixed fee to have its material processed and baled at the Company's facility,
then markets it directly from the Newark Facility. This firm provides up to 25%
of the total material processed in this building.
 
     The second building has two parallel sorting lines which are designed to
handle office waste and other mixed grades coming from commercial
establishments. The first sorting line accepts "dirty" office mixes which may
contain glass, cans, and other non-fiber material. The material is first passed
over a screening device which allows all small particles and objects to fall
through, while all the paper is carried over onto the sort line. Employees then
remove the corrugated and other mixed paper, leaving the higher quality office
papers to collect at the end. The second office paper line is designed for clean
office mixes with no cans, glass, grit or dirt. On this line, employees then
separate high grades such as computer paper and clean white ledger. The
remaining material is collected after processing to be sold as low grade paper.
 
                                       15
   17
 
     A section of the second building is also used both to cut books received
from printers to extract the high quality paper inside, and also to segregate
and store other high quality pre-consumer papers from printers. In some cases,
the Company is principally transloading clean, baled material.
 
     The third building has a sort line and several work areas which can be used
for either low grade or high grade paper as well as a tipping area for
commingled materials. While the facility currently does not process commingled
material, it accepts such materials if accompanied by newspapers. Commingled
materials are sold to a third party for $20.00 per ton. Most commingled
materials are tipped at no cost.
 
     Chicago
 
     The Chicago Facility currently serves the high-grade, pre-consumer market.
It consists of a single one-story building with two adjoining buildings that
enclose rail sidings, one on each side of the central structure. Each siding is
capable of storing six 40-foot boxcars.
 
     A significant portion of the material which arrives at the Chicago Facility
has been baled at the supplier's facility. Suppliers are generally large
printing operations with significant recycling and paper recovery activities.
Material which arrives loose is sorted and baled.
 
     The Company's contracts usually call for a rebate based on a percentage of
the Official Board Markets' (an industry publication) price for that material
for that month. Supplier contracts are for periods ranging from two to five
years. There are fewer suppliers for the Chicago Facility than for the Newark or
Boston commercial operations; this is due to the volume generated by the very
large printers with whom the Company has contracted. Almost all of Chicago's
material is sold to domestic paper mills, as compared to Boston and Newark,
which sell more than half of their materials to overseas customers.
 
MARKETING
 
     The Company's marketing activity was significantly broadened during 1997
with the acquisition of K-C and Zaitlin. The Company's marketing services have
expanded from its historical focus on contract acquisition for biomass,
municipal solid and specialty waste materials supply to the Maine Energy
facility, the Lewiston Facility, the Telogia and Cairo Facilities and the PERC
facility. The Company now markets a wide variety of recycled commodities,
including all grades of secondary fiber and ferrous and non-ferrous metals and
plastics. The Company currently is soliciting waste handling agreements for the
Maine Energy facility from municipalities and commercial waste generators in
Maine and in nearby areas such as northern Massachusetts and southern New
Hampshire. The Company intends to enter into contracts from one to six years in
duration in order to stabilize supply while retaining the ability to take
advantage of any upward movement in regional disposal fees. The Company has
recently assumed additional marketing responsibilities at PERC due to its
increased ownership under which the Company will attempt to fill the
approximately 75,000 tons of annual capacity of PERC currently being utilized by
combusting supplemental fuels. The Company intends to utilize the spot market
for MSW to fill the available capacity at PERC.
 
     Disposal of oil soaked wastes, industrial wastes, out-dated
pharmaceuticals, cosmetics and other commercial wastes, known generally as
"specialty wastes," is another large potential market for the Company. The MDEP
has granted a permit to Maine Energy that allows the Maine Energy facility to
accept a broad variety of specialty wastes for disposal by combustion. The
Company believes that tipping fees on specialty wastes are substantially higher
per ton than MSW delivered on a spot market basis and therefore provides an
opportunity for improved operating margins on Maine Energy's available capacity.
There can be no assurance that improved operating margins will result from
tipping fees on specialty wastes, or if so, to what extent.
 
     The Company markets its specialty waste capacity through retail brokers who
sign contracts with KTI Specialty Waste, a wholly owned subsidiary of the
Company. On October 18, 1996, KTI Specialty executed an Operating Agreement with
Pine Tree Waste, Inc. ("Pine Tree") establishing Specialties Environmental
Management Company, LLC, a Maine Limited Liability Company ("SEMCO"). On
February 4, 1998, the Company acquired Total Waste Management, a company engaged
in waste management in the New England area. SEMCO and Total Waste Management
provide services on a retail basis to municipal, commercial and
 
                                       16
   18
 
industrial customers to dispose of certain solid and liquid wastes in the New
England Region, concentrating on: (a) premium priced unusual or difficult to
dispose of wastes; (b) in and out of jurisdiction municipal solid waste; and (c)
construction and demolition waste, including treated and untreated wood waste.
Both SEMCO and Total Waste Management have entered into contracts with Maine
Energy to dispose of acceptable material at Maine Energy's Biddeford facility
for a term of five years which may be extended for an additional five year
period at set tipping fees, adjusted annually for changes in the consumer price
index.
 
     At the Lewiston Facility, most tipping contracts have durations of one year
or less. Most of the wood waste materials processed by the facility are acquired
as a result of bids on specific demolition or disposal projects concentrated in
Maine or in nearby states such as New Hampshire, Massachusetts and Connecticut.
 
     In order to mitigate the effects of competition in these areas from
companies that operate portable wood chipping equipment, KTI Bio Fuels has
expanded its marketing staff, initiated a waste brokerage business and entered
the oversized bulky waste ("OBW") market. KTI Bio Fuels is processing OBW such
as mattresses, box springs, furniture, wooden pallets and other similar waste
materials, which is shredded and blended with other process materials to be
delivered for ultimate disposal through incineration at the PERC facility.
 
     In marketing the services of the Lewiston Facility, the Company emphasizes
its integrated waste handling capabilities to ensure wood waste producers such
as electric and telephone utilities, railroads and other large scale wood waste
generators that their waste will be processed and completely destroyed through
ultimate incineration at either the Maine Energy or PERC facilities or at other
approved incinerator facilities that currently are doing or may do business with
KTI Bio Fuels. The Company's integrated disposal facilities provide wood waste
or OBW generators with disposal procedures that eliminate many potential future
liabilities associated with the disposal of wood wastes by conventional means
such as landfilling. Management of the Company believes that if landfill
capacity becomes scarcer, the availability of wood waste from within Maine for
use by the Lewiston Facility may increase. Through direct marketing and broker
affiliations, the Company plans to secure new regional accounts.
 
     Manner has a marketing staff of seven commission based recycled plastic
brokers. This staff identifies industrial customers with scrap plastic resins
which can be utilized in value added recycling plants. Manner manages the
movement of all material through internal truck brokers.
 
     The Telogia Facility historically marketed its biomass waste capacity to
brokers of waste materials resulting from the chipping of pulpwood. The Telogia
Facility has been receiving the biomass waste (bark mulch and wood fines) from
the Cairo Facility. Due to the requirement of transporting the material
approximately 60 miles to the Telogia Facility from the Cairo Facility, this
fuel supply actually costs TERI approximately $8.00 per ton. The Company is
currently directly marketing TERI's biomass waste capacity to generators of
residual waste from wood processing industries, clean construction and
demolition wood debris, and non-recyclable paper products. The Company's
objective is to convert the paid for fuel into tipping fee based material
thereby both reducing fuel costs and increasing revenues of the Telogia
Facility. The Company will initially attempt to bring the net costs of fuel
acquisition to zero for the Telogia Facility and ultimately attempt to produce
net revenues from the tipping fee based material. As the Telogia Facility
becomes less dependent on the Cairo Facility for fuel supply, the Cairo Facility
biomass waste, particularly bark mulch, can be marketed for sale to third
parties producing additional revenues for the Company.
 
     K-C markets secondary fiber, pulp and paper worldwide with offices in
Portland, Oregon, Lakewood, New Jersey, Hartford, Connecticut, Los Angeles,
California, Rio de Janeiro, Brazil, Seoul, South Korea and Barcelona, Spain. K-C
is responsible for marketing all of the Company's recycled paper and OCC,
including all domestic and international shipping requirements. K-C has
integrated into its operations marketing personnel from Zaitlin, Prins and
Vel-A-Tran. K-C also actively trades secondary fiber pulp and paper for third
party recyclers and paper producers.
 
COMPETITION
 
     The Company faces significant competition in each of its waste handling
markets. Maine Energy and PERC compete with landfills and several
waste-to-energy facilities and municipal incinerators in Maine and
 
                                       17
   19
 
the New England region. However, the volume of MSW produced in the New England
region has historically increased and the Company believes that it is likely to
continue to increase, while the availability of landfills for waste disposal is
likely to continue to decline. Even though the implementation of recycling
programs to reduce MSW has increased, the Company believes that there are limits
on the percentage of MSW that ultimately can be recycled and that alternatives
for disposal of MSW will continue to be needed. In addition, the Company has
begun to focus on the industrial waste market as an ancillary source of waste
for the Maine Energy and PERC facilities and as a means of reducing its reliance
upon the MSW market. Specifically, KTI Specialty and SEMCO have been formed to
acquire specialty waste products for these facilities.
 
     The Company believes that the RDF technology employed by the Maine Energy
and PERC facilities compares favorably with the mass-burn technology utilized by
many other waste-to-energy facilities. In RDF systems, MSW is preprocessed to
remove various non-combustible items which 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 Lewiston Facility competes with landfills and operators of portable
wood chipping equipment.
 
     The Telogia Facility competes for biomass fuel supply with paper companies
which employ on-site power generation. As the Company moves toward tipping fee
based waste fuels, this facility's dependence on the current fuel supply will be
decreased. The Telogia Facility is permitted to combust 100% of such tipping fee
based fuels. Competition for tipping fee based material will principally come
from landfills whose cost structure is greater than that of the Telogia
Facility. Local landfill costs for biomass waste products range from $15.00 to
$25.00 per ton, while the cost of processing the material ranges from $5.00 to
$8.00 per ton at the Telogia Facility.
 
     Manner competes with several other recycled plastic brokers and direct
marketing from plastic recycling plants for the post industrial plastic scrap
and with materials recovery facilities for post consumer plastics. The Company
believes that Manner will continue to be competitive as a result of its
knowledge of the plastic recycling market and its reputation and relationship
with its customers.
 
     The Company's other recycling subsidiaries which are primarily involved in
the waste paper brokerage business face extensive competition. Such businesses
operate with relatively thin profit margins. In order to be profitable, the
waste paper broker must arrange to simultaneously buy and sell waste paper,
while providing a sufficient margin to cover transportation costs and insurance.
Generally, paper mills purchase paper under long-term contracts which provide
for purchase prices that are adjusted in accordance with a relevant paper price
index. A significant portion of the sales made by K-C are to foreign customers,
and such sales are contingent upon the availability of letters of credit for
such customers.
 
     KTI Recycling, which operates recycling plants in Boston, Chicago and
Newark (formerly owned by Prins), faces significant price competition in each of
its markets. The Newark recycling market is burdened with industry wide
overcapacity and continual price pressure. Combined with high labor costs, the
Newark market currently operates at very low profit margins. In the Chicago
market, the Company's recycling plant has relatively low utilization and price
competition is extensive. The Company does not believe there are any other
facilities in or near the city of Boston which compete directly with the
Charlestown Facility.
 
CUSTOMERS
 
     Maine Energy, TERI and PERC are contractually obliged to sell all of the
electricity generated at their facilities to Central Maine, Florida Power and
Bangor Hydro, respectively. The loss of these electricity customers would have a
material adverse affect on the business and financial condition of the Company.
 
     Maine Energy and PERC, along with approved wood burning energy production
facilities, purchase the majority of the output of woodchips from KTI Bio Fuel's
Lewiston Facility for use as a boiler fuel to supplement their combustion
processes.
 
     The Nashville Facility receives its entire supply of MWC ash from the City
of Nashville as a result of the operation of the city of Nashville's Thermal
Facility. If the city of Nashville reduces the current level of
 
                                       18
   20
 
appropriation or the Nashville Thermal Facility fails to continue to operate,
there would be a material adverse affect on the business and financial condition
of the Nashville Facility.
 
     Prins provides recycling services to municipalities, commercial haulers and
commercial waste generators whithin a geographic proximity of the respective
facilities.
 
     K-C sells its products, including recyclables processed at other Company
facilities, principally to paper manufacturers in the United States, Pacific Rim
Countries, Europe and South America.
 
     Manner sells its products principally to manufacturers in the United
States.
 
     DDS provides on- and off-site document destruction services for banks, law
firms and other commercial establishments who desire confidential destruction.
 
RAW MATERIALS
 
     The raw material demands of the PERC facility currently are met mainly by
PERC's long-term waste handling agreements with approximately 200 municipalities
in Maine. PERC received approximately 75% of its raw materials in 1997 from
these municipalities. Maine Energy received 29% of its raw materials in 1997
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. Maine Energy and PERC are currently
exploring other waste material opportunities in order to lessen their reliance
on the MSW spot market, including pursuing agreements with commercial waste
generators and entering new specialty waste markets. The Company believes that
diversifying its raw materials base could be an important factor in gaining
stability in the Company's waste material requirements if the MSW market
declines due to recycling or other factors. The Company currently has not
experienced a decline in the amounts of MSW raw material that it obtains from
its current market areas. Because of its attractive tipping fees in recent
years, Maine Energy has consistently received and processed waste at its nominal
capacity.
 
     KTI Bio Fuels mainly relies on short-term treated and untreated wood waste
disposal agreements for its raw materials requirements. Most of KTI Bio Fuel's
wood waste disposal agreements have durations of one year or less, with many of
such agreements resulting from bids on specific demolition or disposal projects
concentrated in Maine or in nearby states such as New Hampshire, Massachusetts
and Connecticut. KTI Bio Fuels is exploring additional wood waste markets in
other nearby states such as New York and New Jersey and is also actively seeking
additional sources of chemically treated wood waste and OBW for processing at
the Lewiston Facility, which would not only expand its raw materials base but
also would allow KTI Bio Fuels to charge higher disposal fees for such
materials.
 
     The Telogia Facility utilizes biomass fuels which are a by-product of the
paper pulp woodchip industry as its raw material. The Company plans to
supplement and ultimately replace this raw material with tipping fee based
biomass waste, such as construction and demolition debris and non-recyclable
paper products.
 
     The Charlestown Facility receives a majority of its recyclable material for
processing from local municipalities under long term contracts. These contracts
provide that all recyclables generated in the jurisdiction of each municipality
will be delivered to the Charlestown Facility. The quantity of material
delivered by these communities depends on the level of source separation at the
constituent households.
 
     Zaitlin, Vel-A-Tran and the Charlestown Facility's commercial building
receive high grade paper from printers and publishing houses. The Chicago
Facility's suppliers of high grade, pre-consumer recyclable paper are generally
large printing operations with significant recycling and paper recovery
operations of their own. The Newark Facility receives a majority of its OCC and
ONP from other recyclers and haulers and its pre-consumer paper is received from
printers and publishing houses.
 
     The Nashville Facility relies on the city of Nashville to deliver ash
produced by the city's waste-to-energy facility for its raw materials. If in any
year the city does not provide sufficient ash for the Nashville Facility, the
Nashville Facility may mine ash from the city's landfill.
 
                                       19
   21
 
     K-C obtains its products from other Company facilities, from waste
generators and from third party processors.
 
SEASONALITY
 
     The MSW market in Maine Energy's and PERC's market areas is seasonal, with
one-third more MSW generated in the summer months than is generated during the
rest of the year. Maine Energy and PERC rely on the spot MSW market and waste
from commercial sources as needed to meet their waste material needs over that
delivered pursuant to agreements with municipalities, and charge tipping fees
based on prevailing prices in their respective market areas. The Company
believes that its planned diversification of the waste material used by the
Maine Energy and PERC facilities, such as combusting specialty waste products,
will lessen any seasonality supply problems experienced by the facilities.
 
     KTI Bio Fuels is also affected by seasonal factors, as wood waste materials
from construction and demolition sites in its market areas are significantly
more widely available in the warmer months of the year, when construction and
demolition projects usually occur.
 
     K-C, Zaitlin, the Charlestown Facility and the Newark Facility experience
increased quantities of ONP and OCC in November and December, followed by
reduced quantities in January, due to increased newspaper advertising and retail
activity during the holiday season.
 
GOVERNMENTAL REGULATION
 
     General
 
     The operations of the Company's waste handling businesses are subject to
extensive governmental regulations at the federal, state and local levels. The
Company believes that its operations are in material compliance with existing
laws and regulations material to its business. The laws, rules and regulations
which govern the waste handling businesses are very broad and are subject to
continuing change and interpretation. No assurance can be given that the Company
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 such existing or future laws, rules and regulations or
interpretations thereof could have a material adverse effect on the Company's
operations. The following discussion 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 PERC 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") and regulations promulgated
thereunder, which grants an exemption for such 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
Holding Company Act of 1935 and from certain state laws and regulations
governing electric utility rates and financial organization and, the rates
charged by Maine Energy and PERC for their acceptance of waste at their
respective 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
electric utility of electric energy or capacity or both which, but for the
purchase from the qualifying facility, such utility would generate itself or
purchase from another source.
 
     The Company's waste-to-energy business, which accounted for approximately
66% of the Company's revenue during 1997, is dependent upon electric utilities
that purchase energy produced at the Company's waste-to-energy plants. Pursuant
to the Maine Energy PPA, the Bangor Hydro PPA and the Florida Power PPA, these
utilities have agreed to purchase electricity generated by the respective
waste-to-energy facility at
 
                                       20
   22
 
contractually agreed rates. Sales of electricity to these utilities accounted
for approximately 63%, 59% and 96% of revenues of Maine Energy, PERC and the
Telogia Facility, respectively, in 1997. In the event of the deregulation of
electric utilities, certain electric companies may no longer be financially
viable. To the extent that any of the electric utilities with whom the Company
has contracts is adversely impacted by deregulation, such utilities may not be
able to perform their obligations under such purchase power agreements. The
State of Maine has recently enacted deregulation legislation which will require
the local utilities to transfer their respective contracts with Maine Energy and
PERC to newly formed regulated transmission and distribution companies. The
costs of such contracts will be passed through to rate-payers beginning in the
year 2000 through these transmission and distribution companies.
 
     Further, there are certain risks that the terms of such power purchase
agreements may be altered or changed adversely to Maine Energy, PERC and TERI,
primarily due to a bankruptcy of the contracting utility. These risks are
particularly heightened at the present time because of the existence of excess
energy capacity in the New England area. The rates in the agreements were
established based upon predictions made more than ten years ago as to what each
of Central Maine and Bangor Hydro would spend to provide the same energy and
capacity as Maine Energy or PERC, as applicable, over the terms of the power
purchase agreements. Contrary to the assumptions built into the contract prices,
energy demand did not grow as fast as predicted and oil prices did not increase,
but rather decreased. Central Maine and Bangor Hydro may thus currently purchase
energy and capacity on the open market for significantly less than they are
obligated to pay Maine Energy and PERC, respectively, under the power purchase
agreements.
 
     Bangor Hydro has negotiated buy-outs of long-term power purchase agreements
with certain of its independent producers in order to eliminate or decrease its
purchase requirements at high rates.
 
     Flow Control
 
     One response by state and local governments to the increasing problems
associated with solid waste disposal was the enactment of flow control
ordinances which generally require that all waste generated in the municipality
enacting the ordinance be directed to a specified disposal site. The purpose of
these ordinances was to control the processing of solid waste from the enacting
municipalities as a means of controlling waste tipping fee revenues which were
relied upon as a means to support the financing and operation of solid waste
disposal facilities. The enactment of flow control ordinances was authorized
pursuant to Maine law and most of the municipalities with whom Maine Energy and
PERC executed long-term waste handling agreements enacted such ordinances. From
the municipality's perspective, having such an ordinance in place was a
corollary to its agreement to a "put-or-pay" waste handling agreement which
requires the municipality to pay a guaranteed annual minimum fee to the
waste-to-energy facility regardless of the actual amount of MSW 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. The Company does not believe that loss of flow control
provisions would adversely impact operations at either the Maine Energy facility
or the PERC 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. Therefore, the municipalities have little
financial incentive to pay for the disposal of MSW at alternative sites even at
lower tipping fees. More significantly, however, the Company believes that the
tipping fees charged by both Maine Energy and PERC are less than the long-term
tipping fees currently being charged by landfills and other waste incinerators
in the region. In addition, the closing of landfills and the remoteness of Maine
from urban areas means that there are few disposal alternatives available to
Maine municipalities. Finally, as transportation costs are a significant part of
total disposal costs, it is unlikely that existing disposal facilities located
outside of the Maine Energy or PERC facility waste generation areas would be
able to lower their tipping fees to a point that would justify the incurrence of
the additional transportation expense. The Company believes that comparatively
low tipping fees at the Maine Energy and PERC facilities will make them
attractive alternatives to waste generators who may be free to look elsewhere if
flow control ordinances restricting their disposal opportunities become
unenforceable.
 
                                       21
   23
 
     Environmental Laws
 
     While increasing environmental regulation often presents new business
opportunities to the Company, Maine Energy, PERC and TERI, it likewise often
results in increased operating costs as well. The Company, Maine Energy, PERC
and TERI strive to conduct their operations in compliance with applicable laws
and regulations, including environmental rules and regulations, and have as
their goal 100% compliance with such laws 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, management of the Company
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. At December 31, 1997, there were no pending governmental
environmental enforcement proceedings where the Company, Maine Energy, PERC or
TERI believe potential monetary sanctions will exceed $100,000. The possibility
always exists that substantial expenditures could result from governmental
proceedings, which would have a negative impact on 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 operation of the
plants, equipment, and vehicles of the Company, Maine Energy, PERC or any other
operating subsidiary of the Company 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 have a negative impact on
the Company's business and operations and could have a material adverse impact
on the Company's financial results.
 
     The Company'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 (the "Clean Air
Act"), 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 the Company
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
the Company operates its facilities and could require significant additional
capital expenditures to achieve compliance with such requirements or policies.
In the case of Maine Energy and PERC, however, in most circumstances all or a
portion of these compliance costs may be recovered from the communities with
long-term waste handling agreements as a component of the variable portion of
the tipping fee pursuant to change-in-law provisions of such agreements.
 
     CERCLA, and other environmental remediation laws, may subject the Company
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 the
Company and real property owned by the Company which may be contaminated. The
Company has no information that might indicate that it may be a potentially
responsible party under CERCLA or any other environmental remediation law.
 
                                       22
   24
 
     Timely applications have been made for the air emissions permits for the
Maine Energy, PERC 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. Thereafter, in December 1996, a public hearing was
held by the MDEP on the application and to address the favorable results of an
independently conducted health risk assessment pertaining to Maine Energy. Final
adjudication is expected during mid to late 1998. In the case of PERC, a renewal
application was submitted in advance of the deadline. Final approval is expected
in December 1998. Management of the Company believes that the Maine Energy, PERC
and Telogia facilties are in compliance with the federal Clean Air Act, its
implementing regulations and all other applicable regulations and, therefore,
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.
 
     Management of Maine Energy and PERC believe that relationships with Maine
environmental regulators are good and there are no pending or, to such
management's knowledge, any threatened enforcement actions. The Company, which
is responsible for operating the Maine Energy facility, monitors applicable
environmental standards and evaluates its selection of technology to ensure that
applicable standards are being met.
 
     The United States Supreme Court determined in City of Chicago v.
Environmental Defense Fund, a case interpreting provisions of RCRA, that the
generation of ash residue from waste-to-energy facilities in the incineration
process is not exempt from hazardous waste regulation. The Company believes that
the Supreme Court's decision will have no material adverse effect on operations
at the Maine Energy, PERC and Telogia facilities. The ash produced at the Maine
Energy and PERC facilities is and always has been 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, the Company's ash residue is disposed in landfills
segregated to accept ash residue only, and, to the Company's knowledge, the
landfill facilities at which the ash residue is disposed meet or exceed the
applicable standards for such facilities under RCRA. Further, the Company
receives indemnification from 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 and PERC facilities, which adjustments could
have a material adverse effect on the operation of such facilities and the
financial viability or profitability of the 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, the Company 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. Management believes that the Maine
Energy facility has been in compliance with noise, odor and ash emission
standards.
 
     In order to operate the Lewiston Facility, KTI Bio Fuels is required to
maintain a site location and solid waste permit issued by MDEP and a junkyard
permit issued by the City of Lewiston, Maine. The site location and solid waste
permit has expired, but a timely application for the renewal of same was filed
and the Lewiston Facility continues to operate under the grandfather provisions
of Maine law.
 
     Maine state law and an ordinance of the City of Lewiston forbid the
operation of "junkyards" without obtaining a permit. The nature of the Lewiston
Facility's operation puts it within the definition of a junkyard. The permit is
issued on a yearly basis and local officials have the authority to impose
conditions in the permit consistent with public health and safety. Renewal is
subject to a public hearing. The KTI Bio Fuels permit contains numerous special
conditions, the majority of which were inserted in response to two fires that
occurred at the Lewiston Facility, including, without limitation, restrictions
on the number and size of wood waste piles which may be maintained on the
premises and the requirement that fire hydrants and an additional
 
                                       23
   25
 
access road to the Lewiston Facility from the main road be provided. The permit
was most recently renewed on February 4, 1997. The Company believes that the
Lewiston Facility is in compliance with the provisions of the permit.
 
     Total Waste Management ("TWM") is involved in the transportation of both
liquid and solid waste. TWM is a fully licensed hazardous waste transporter and
operates both a hazardous waste and a special waste transfer facility at its
Newington, New Hampshire site. TWM also operates a 700,000 gallon used oil
processing and marketing facility at the Newington site. TWM's operations staff
is fully trained for emergency response work, industrial service work and tank
cleaning, removal and maintenance services. Its compliance and training
department is fully staffed to deal with all Occupational Safety and Health
Administration, Department of Transportation , US EPA and state rules and
regulations.
 
     TWM is a defendant in a lawsuit filed in the United States District Court
of New Hampshire on October 17, 1991 by Kleen Laundry and Dry Cleaning Corp. in
Lebanon, New Hampshire. The plaintiff alleges that TWM caused subsurface
contamination during the removal operations of several underground petroleum
storage tanks. TWM denies the allegation and has retained counsel to defend the
lawsuit. The former shareholders of TWM have indemnified the Company against any
claims relating to such lawsuit, other than for legal fees.
 
DISCONTINUED OPERATIONS
 
     During 1996, the Company disposed of its computer services segment which
was composed entirely of 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. ("CIBER")for $5,000,000. Also, on
July 29, 1996, after the transfer of certain of CSI's remaining assets and
liabilities to CIBER, all of the outstanding common stock of CSI was sold to
certain members of CIBER's management for $5,000. In addition, the Company
provided cash advances in the form of notes receivable to the buyers of CSI
aggregating $444,643 at December 31, 1996. The notes receivable are due on July
29, 2000, but were prepaid on September 24, 1997.
 
EMPLOYEES
 
     As of December 31, 1997, the Company had a total of 493 full time
employees, comprised of twenty-two (22) full time employees on its corporate
staff, eighty (80) full time employees at the Maine Energy facility, sixteen
(16) full time employees at the Lewiston Facility, thirty-one (31) full time
employees at the Telogia Facility, six (6) full time employees at the Cairo
Facility, fifteen (15) full time employees at the Manner facility in Annapolis,
Maryland, ninety five (95) full time employees at the Charlestown Facility, one
hundred forty seven (147) full time employees at the Newark Facility, twenty
three (23) full time employees at the Chicago Facility, twenty seven (27) full
time employees at the Biddeford Facility, thirteen (13) full time employees at
the DDS Facility and eighteen (18) full time employees at the K-C facilities.
The employees at the PERC Facility and the Nashville Facility are not Company
employees. None of the Company's employees are covered by collective bargaining
agreements and the Company considers its employee relations to be good.
 
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
 
                                       24
   26
 
to the Company's facilities; (iii) restructuring of the Company's power purchase
agreements with Bangor Hydro; (iv) changes in labor, equipment and capital
costs; (v) the ability of the Company to consummate any contemplated joint
ventures and/or restructuring on terms satisfactory to the Company; (vi) changes
in regulations affecting the waste disposal and recycling industries; (vii) the
ability of the Company to comply with the restrictions imposed upon it in
connection with its outstanding indebtedness; (viii) future acquisitions or
strategic partnerships; (ix) general business and economic conditions; and (x)
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.
 











                                       25
   27
 

 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCK HOLDER MATTERS
 
     The Company became a public company on February 8, 1995. From February 8,
1995, until February 14, 1996, the Common Stock was traded in the
over-the-counter market on the NASDAQ SmallCap Market under the symbol KTIE.
Since February 14, 1996, the Company's Common Stock has traded on the NASDAQ
National Market tier of The NASDAQ Stock Market under the symbol KTIE. The
following table sets forth the high and low sale prices for the Common Stock for
the periods indicated, as reported on the NASDAQ Small Cap Market and the NASDAQ
National Market System.
 


                                                              HIGH       LOW
                                                              PRICE     PRICE
                                                              -----     -----
                                                                  
February 8, 1995 through March 31, 1995.....................   $ 6 3/8   $ 5 1/4
April 1, 1995 through June 30, 1995.........................     6 1/8     5 3/8
July 1, 1995 through September 30, 1995.....................     8 7/8     5 3/8
October 1, 1995 through December 31, 1995...................     9         8 1/4
January 1, 1996 through March 31, 1996......................     8 5/8     6
April 1, 1996 through June 30, 1996.........................     7 3/8     6 1/4
July 1, 1996 through September 30, 1996.....................     8 1/2     6 1/4
October 1, 1996 through December 31, 1996...................    11 1/4     7
January 1, 1997 through March 31, 1997......................     9 1/8     7 3/16
April 1, 1997 through June 30, 1997.........................     9 1/2     7 1/2
July 1, 1997 through September 30, 1997.....................    14 7/8     8 5/8
October 1, 1997 through December 31, 1997...................    17 1/2    13 1/2

 
     On March 27, 1998, the last reported sale price of the Common Stock as
reported on the NASDAQ National Market System was $16.875 per share. There were
196 record owners of the Company's 9,477,953 outstanding shares of Common Stock
as of March 27, 1998.
 
     The Company has not paid any cash dividends on its Common Stock or the
Series A Convertible Preferred Stock during the period such Series A Convertible
Preferred Stock was outstanding, and the Company does not anticipate paying any
cash dividends on its Common Stock in the foreseeable future. In February 1998,
all shares of the Company's Series A Convertible Preferred Stock were converted
into shares of Common Stock. The Company is required to pay aggregate annual
dividends of $1,872,500 in the aggregate on the Series B Preferred Stock. In
November 1997, the Company paid aggregate dividends of $395,472 to its
 
                                       27
   28
 
holders of Series B Preferred Stock, representing the dividends earned from the
date of issue through the end of the third quarter of 1997. In February 1998,
the Company paid the full aggregate quarterly dividend of $468,125 to the
holders of Series B Preferred Stock, representing the dividends earned in the
fourth quarter of 1997.
 
     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 and the Series B Preferred Stock contain restrictions on
the payment of cash dividends on the Common Stock. It is anticipated that for
the forseeable future, the Company will use its capital for strategic
opportunities and to reduce debt and not pay cash dividends on its Common Stock.
 







                                       28
   29
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
                                    GENERAL
 
     The Company is a holding company that derives its revenues from its
subsidiaries. During 1997, as part of its integrated waste management strategy,
the Company acquired several businesses and additional partnership interests.
 
     To expand into additional post industrial and post consumer waste handling
and recycling, the Company acquired the assets of Prins, Zaitlin, and DDS. As a
result of these acquisitions, the Company now operates recycling facilities in
Biddeford, Maine, Charlestown, Massachusetts (a borough of Boston), Newark, New
Jersey and Franklin Park, Illinois (a suburb of Chicago).
 
     To strengthen the Company's ability to market these recycled materials, the
Company acquired K-C, a worldwide marketer of secondary fiber and pulp
substitutes. In addition, the acquisition of Zaitlin gave the Company a
marketing presence in ferrous and non-ferrous metals. These operations
complement Manner's plastics marketing operations and Powership Transports'
transportation brokerage, which were acquired in November, 1996.
 
     To forward the Company's strategy of increasing its ownership of
waste-to-energy plants, the Company acquired additional partnership interests in
PERC. On September 29, 1997 and November 12, 1997, the Company acquired,
respectively, 49.5% and 14.8% additional partnership interests in PERC, bringing
its ownership interest to 71.3% at December 31, 1997. Because the Company's
interests in PERC were acquired in two separate transactions, the consolidated
statements of operations for the year ended December 31, 1997 include the
operations of PERC from January 1, 1997 and include adjustments to eliminate
minority interest
 



                                       29
   30
 
and the pre-acquisition earnings of PERC attributable to the partnership
interest acquired on September 29, 1997. Prior to 1997, PERC was accounted for
under the equity method of accounting. For presentation purposes, this section
will discuss and analyze, in addition to the Company's results, the results of
PERC for the periods which it was accounted for under the equity method.
 
WASTE-TO-ENERGY
 
     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 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.
 
     On November 22, 1996, the Company purchased its third waste-to-energy
facility by acquiring TEII from CNA and a group of ten investors. TEII owned
these operating assets through subsidiaries. The waste-to-energy facility is
located in Telogia, Florida. This facility takes in biomass wastes to be
combusted to produce electric power.
 
     Maine Energy, PERC and the Telogia Facility principally derive their
revenues from sale of electric power generated from the combustion of waste
products and sold under long-term contracts with local utilities and, in the
case of Maine Energy and PERC, from tipping fees received under long-term,
short-term and commercial waste disposal contracts with municipalities and spot
market waste received from haulers. During 1997, the Telogia Facility began
taking a portion of its fuel supply under short-term tipping fee contracts with
biomass waste generators and haulers. The Telogia Facility is focused on
increasing the receipt of tipping fee biomass wastes to supplant paid for fuel.
The utilities pay each facility based on the kilowatts delivered to the utility
in accordance with rates agreed to at the inception of the contracts. PERC's and
the Telogia Facility's rates are adjusted annually for expected or actual
increases in inflation.
 
     The disposal fees paid by the municipalities and waste haulers to Maine
Energy, PERC and the Telogia Facility are based on the tons of waste delivered.
The rate charged by each of Maine Energy and PERC under its long-term contracts
for each ton of MSW delivered is based on the contractual tipping fee rate
consisting of a fixed component and a variable component which is adjusted as a
result of inflation, changes in law and changes in operating costs of the
applicable facility. The fixed fee component escalates annually with changes in
the local consumer price index. Maine Energy's and PERC's variable fee is
determined by comparing certain of the then current operating and financing
costs against contractually agreed to base operating and financing costs. In the
case of Maine Energy, the cumulative net increases of all of these cost items is
divided by a total tonnage factor for the facility to determine the per ton
variable component. PERC's variable component is calculated in a similar fashion
but takes into account not only net increases, but also net decreases in these
costs. This can cause the variable component to be a negative amount effectively
reducing PERC's fixed fee component. Based on PERC's long-term contracts, any
decreases or increases in operating or financing costs are passed through to the
affected municipal customers with no benefit or detriment to PERC. The rate
charged by each of Maine Energy, PERC and Telogia for short-term municipal and
commercial contracts (usually one to six years) and spot market contracts are
based on the general market conditions for MSW.
 
ANALYSIS OF TONNAGE RECEIVED
 


                                                                 YEAR ENDED DECEMBER 31,
                                                              -----------------------------
                       MAINE ENERGY:                           1997       1996       1995
                       -------------                          -------    -------    -------
                                                                           
Long-Term Municipal Contracts...............................   72,765     71,203     68,380
Short-Term Municipal Contracts..............................   39,151     45,445     36,214
Spot Market.................................................   56,759     72,634     83,647
Commercial..................................................   85,677     56,352     36,452
                                                              -------    -------    -------
          Total.............................................  254,352    245,634    224,693
                                                              =======    =======    =======

 
                                       30
   31
 
     Growth in Maine Energy's tonnage received was 3.5% and 9.3% in 1997 and
1996, respectively, due to improved processing techniques, resulting in higher
throughput, allowing for increased MSW receipts. Maine Energy is at capacity for
MSW processing and uses supplemental fuels only for flame stabilization.
 


                                                                 YEAR ENDED DECEMBER 31,
                                                              -----------------------------
                           PERC:                               1997       1996       1995
                           -----                              -------    -------    -------
                                                                           
Long-Term Municipal Contracts...............................  205,524    203,875    200,908
Short-Term Municipal Contracts..............................   17,703     18,341     17,614
Spot Market.................................................   32,188     13,163     16,703
Commercial..................................................   19,991     18,144     13,396
                                                              -------    -------    -------
          Total.............................................  275,406    253,523    248,621
                                                              =======    =======    =======

 
     Growth in PERC's tonnage received was 8.6% and 2.0% in 1997 and 1996,
respectively, due primarily to increased activity in the out-of-state market for
MSW. PERC still has capacity for approximately an additional 75,000 tons of MSW.
Obtaining additional MSW is a principal company goal for 1998.
 
     The Company's MSW waste disposal operations are subject to seasonal
fluctuations. Reduced volumes of waste are generated during the winter months.
At Maine Energy, this requires reductions in spot market tipping fees seasonally
and, at PERC, increased reliance on supplemental fuel, principally woodchips.
The Company's Maine facilities are located in summer vacation areas and larger
volumes of waste are generated during that season enabling increases in the spot
market tipping fees charged to the customers of Maine Energy and PERC and
decreases in their reliance on supplemental fuel. General economic conditions of
the surrounding area also have an impact on the availability of waste, with
greater levels of waste usually generated during periods of good economic
conditions. The waste-to-energy plants also have periodic scheduled shutdowns
each year, usually two weeks in April or May, for major maintenance and capital
projects. During 1997, the Telogia Facility was shutdown for an extended period
of 50 days for retrofits and major maintenance to upgrade the facility with
improved combustion technology and expanded waste processing capabilities. As a
result of the retrofit, the expected life of the facility has been extended.
 
     In May 1996, Maine Energy restructured its agreement with Central Maine by
entering into a series of agreements with CL One and Central Maine, which
provided for the purchase of Maine Energy's available power generation capacity
by CL One, and amending the Central Maine PPA (together with the agreement, the
"Agreements"). CL One 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 One was assigned all rights
to capacity from the Maine Energy facility through May 31, 2007. In the
restructuring, the term of the Central Maine PPA was extended from May 31, 2007
to December 31, 2012. Pursuant to the Agreements, Maine Energy has agreed to
sell energy to Central Maine through May 31, 2007 at an initial rate of 7.18
cents per kWh which escalates by 2% per annum. Beginning June 1, 2007 until the
expiration date of the contract, Maine Energy is to be paid market value for
both its energy and capacity by Central Maine. Maine Energy retired the
outstanding principal amount of $64.5 million of the Biddeford Bonds with the
proceeds of the sale of its capacity. Utilizing the balance of the proceeds and
a portion of the reserve funds available, the Company substantially reduced the
outstanding principal amount of Maine Energy's subordinated indebtedness by
paying off $29.5 million of subordinated debt. During 1997, Maine Energy made an
additional $2 million payment of principal and interest on subordinated debt.
Also in October, 1997 the Company acquired approximately $2.4 million of the
subordinated notes from one of the former limited partners. As of December 31,
1997 the net balance of the subordinated debt at Maine Energy was $11,949,000.
 
     Under the terms of the Central Maine restructuring, a $45 million letter of
credit was issued to Central Maine by ING (US) Capital Corporation, ("ING"). If,
in any year, Maine Energy fails to produce 100,000,000 kWh of electricity (a
"100,000,000 kWh test") and Maine Energy does not have a force majeure defense
(physical damage to the plant and other similar events), Maine Energy is
obligated to pay $3.75 million to Central Maine as liquidated damages. Such
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
 
                                       31
   32
 
reduced by $3.75 million. If, in any year, Maine Energy fails to produce
15,000,000 kWh of electricity (a "15,000,000 kWh test") and Maine Energy does
not have a force majeure defense, Maine Energy is obligated to pay the then
balance of the ING letter of credit to Central Maine as liquidated damages. In
1997, the 15,000,000 kWh and the 100,000,000 kWh tests were met, resulting in a
reduction of the amount of the ING letter of credit to $37.5 million.
 
     On January 30, 1998, the partners in PERC, the MRC, which represents 130
municipalities served by PERC, and Bangor Hydro, executed an Restructuring
Agreement, outlining the principal terms of a restructuring of the Power
Purchase Agreement between PERC and Bangor Hydro and certain provisions relating
to amendments to the Waste Disposal Agreements between PERC and the 130
municipalities represented by the MRC. At the same time, the partners in PERC
and Bangor Hydro entered into a commitment with FAME to refinance the existing
tax exempt bonds issued to finance the original construction of the PERC
facility. Both documents contain significant conditions at closing, which are
not entirely in the control of the parties to such documents. Accordingly, no
assurance can be given that the Company will be able to complete the
transactions contemplated by such documents.
 
     The Restructuring Agreement provides that Bangor Hydro will make a one time
payment of $6 million to PERC at the time of the closing of the refinancing of
the existing tax-exempt debt, and will make additional quarterly payments of
$250,000 per quarter for four years, for an additional total of $4 million, and
issue warrants to purchase two million shares of Bangor Hydro common stock which
will be divided equally between the MRC on behalf of its member municipalities
and the PERC partners. The exercise price of such warrants is $7.00 per share
and the warrants will expire 10 years after issuance. The right to exercise such
warrants will vest over 4 years. In exchange for such consideration, Bangor
Hydro will be entitled, assuming performance of all of its obligations under the
Bangor Hydro PPA, to receive a rebate of a portion of its purchase price of
electric power from PERC, equal to one third of the cash available for
distribution from PERC. This transaction is contingent upon, among other things,
the closing of a reissuance of the tax-exempt bonds of FAME, pursuant to the
FAME commitment.
 
     The FAME commitment provides for a refinancing of the existing tax-exempt
debt which matures in 2004, with an adjustable rate tax-exempt security with an
extended maturity of 20 years, with customary fees. The FAME bonds would be
backed by the moral obligation of the State of Maine. The refinanced bonds will
be secured by substantially all of the assets of the PERC project (including the
$10 million to be received from Bangor Hydro), a guaranty of $3 million from the
Company and a guaranty of annual debt service, subject to a maximum amount of
$4.2 million, by Bangor Hydro. The guaranty by Bangor Hydro is dependent upon
receipt of all necessary orders and consents from the Maine Public Utility
Commission and Bangor Hydro's lenders.
 
     The amendments to the Waste Disposal Agreement will be effective upon
receipt of acceptance of not less than 50% of the Charter Municipalities (as
determined by tonnage delivered to PERC). PERC may terminate the transactions if
25% or more of the Charter Municipalities reject or otherwise object to the
transactions. The amendments permit the Charter Municipalities: (a) to make
equity contributions to PERC, only and to the extent of the MRC's share of
distributable cash from PERC and one-half of the Bangor Hydro quarterly payment,
of up to $31 million, which will be used to prepay the FAME bonds outstanding,
(if all $31 million are contributed, the municipalities will own a 50%
partnership interest in PERC); (b) purchase all of the remaining PERC interests
in 2018 at the then fair market value, in lieu of the existing right to purchase
PERC at its then book value in 2004; (c) extend the term of the Waste Disposal
Agreements to 2018, and (d) to reduce cash available for distribution to the
Charter Municipalities to one third from one half.
 
     The transactions are expected to close in May, 1998. The term sheet
provides that if the closing is after May 1, 1998, the financial terms of the
transaction are subject to retroactive adjustment. Both documents contain
significant conditions to closing, which are not entirely in the control of the
parties to such documents. No assurance can be given that the transactions
contemplated by such documents can be successfully completed.
 
                                       32
   33
 
  Wood Processing
 
     The Company owns and operates two wood processing facilities. KTI BioFuels,
located in Lewiston, Maine, accepts hard-to-handle materials such as railroad
ties, telephone poles, bulky wood items, and construction/demolition ("C&D")
debris, processes them into wood chips, and sells the wood chips to PERC, as a
supplemental fuel, or to third parties. The plant processed 40,510 and 48,093
tons of these materials in 1997 and 1996 respectively. The Company will seek to
expand this business in 1998 via acquisition of other C&D processors.
 
     A second plant acquired in the TEII transaction, which is located in Cairo,
Georgia, processes pulpwood logs into woodchips and other wood by-products such
as bark trimmings. Currently, the Cairo Facility processes exclusively for Stone
Container under a long-term tolling agreement, operating on a single shift. The
approximately 100 acre site has the capacity for the storage and staging of
additional raw materials and finished goods; the Company is therefore actively
seeking expansion of its operation. During 1997, the Cairo facility processed
approximately 365,000 tons for Stone Container producing approximately 317,000
tons of wood chips and approximately 48,000 tons of bark trimmings.
 
  Specialty Waste Handling
 
     Effective March 29, 1996, KTI Ash purchased a 60% interest as a limited
partner in American Ash Recycling of Tennessee, Ltd., a Florida limited
partnership ("AART"). The general partner American Ash Recycling Corp. of
Tennessee, a Florida corporationis the previous owner of the Nashville Facility.
The partnership is carrying on the business of the predecessor corporation. The
Company has a priority on the distributions of earnings and cash flow from the
Nashville Facility to the extent of 75% of the earning and cash flow generated
until it receives $315,000 per annum on a cumulative basis. The purchase price
was $2,100,000. AART recycles MWC ash at its Nashville Facility converting the
ash principally into construction aggregate after recovering recyclable metals.
 
    The Company also acquired all of the partnership interests of American Ash
Recycling of New England ("AARNE") in the Maine Partnership, which had been
formed to operate a similar facility in the State of Maine (the "Maine
Partnership"). The Company purchased the Maine Partnership for $1,060,000 in
two separate transactions. As a result of the receipt of permits to operate an
ash recycling facility in Maine, Waste Management of Maine, Inc., the current
provider of ash disposal services for Maine Energy, agreed to lower its
disposal rate to the approximate cost which would have been charged by AARNE to
Maine Energy a portion of which are passed along to AARNE. As a result, Maine
Energy and AARNE benefited from the savings of $1,130,000 and $1,150,000 during
1997 and 1996, respectively. The Company, as a result of this acquisition has
the exclusive right to own and operate a MWC ash recycling facility in the
State of Maine utilizing American Ash Recycling technology. Utilizing the
existing permits, the Company expects to install this technology at Maine
Energy and/or PERC.
    
     KTI Specialty Waste was formed to procure materials for processing and
combustion at Maine Energy and PERC. While spot market MSW at Maine Energy and
PERC is tipped at rates between $25 and $35 per ton, certain specialty
materials, such as off-spec over the counter pharmaceuticals, oily rags and
absorbents, off-spec paints, and other industrial and commercial wastes, command
tipping fees between $65 to $350 per ton. Maine Energy and PERC's RDF processing
lines and environmental permits allow each plant to accept many of these
hard-to-handle wastes. During 1997, KTI Specialty Waste marketed Maine Energy's
and PERC's specialty waste capacity directly to waste generators and to waste
brokers. As a result, Maine Energy processed approximately 12,000 tons of
specialty waste during each of 1997 and 1996.
 
  Recycling
 
  Recycling Facilities
 
     As part of the TEII acquisition, the Company acquired a plastics recycling
facility in Tuscaloosa, Alabama. The Company determined that this facility did
not fit with its operating strategy. The operations were sold to the plant's
managers in July, 1997 for $280,000 in cash. The Company recorded a loss on sale
of
 
                                       33
   34
 
approximately $20,000 from this transaction. In addition, the operations
generated a $244,000 operating loss for the year.
 
     On August 1, 1997, the Company purchased Zaitlin and DDS. Zaitlin operates
a secondary fiber recycling facility in Biddeford, Maine. Sam Zaitlin, the
former president, has joined the executive management team of KTI in a senior
marketing position. DDS accepts, shreds, and bales sensitive documents from
banks, brokerage firms and law firms, and other companies, then sells the baled
materials to paper mills. The Zaitlin facility and DDS facility in Woburn,
Massachusetts were consolidated into the Charlestown Facility.
 
     On November 14, 1997, the Company acquired the assets of Prins, as part of
a plan of reorganization filed with the US Bankruptcy Court for the District of
New Jersey. The acquisition was accounted for as a purchase. The Company paid
approximately $15 million in cash, substantially all of which was provided by
two separate loans from KeyBank. In addition, the Company assumed approximately
$1 million of liabilities. The assets are located in Charlestown, Massachusetts,
Newark, New Jersey and Franklin Park, Illinois.
 
     KTI had operated the assets of Prins under a management agreement with
Prins' principal lender from May 1997 until the acquisition date. Subsequent to
the acquisition, the Company has entered into a series of variable rate tipping
contracts with municipalities in the Boston area. These contracts provide for
the Company to be paid a tipping fee by the municipalities to cover processing
costs and to provide a predictable profit margin. The municipalities are then
entitled to receive rebates if the selling prices of recycled paper exceed
certain benchmark levels. By providing a budgeting base to municipalities but
offering potential revenues should markets improve, the Company has been able to
secure five to thirteen year contracts, eliminating the costly and time
consuming annual or biennial bidding cycle.
 
     At the Newark Facility, the Company installed experienced management, and
is prepared to bid on municipal contracts for post-consumer recyclables in the
30 mile radius around the plant. Management reduced operating costs by
reconfiguring the workforce to match plant capacity and installing tighter
controls on repair and maintenance budgets. The Company made significant
equipment retrofits to allow processing of recyclables not handled by other
firms in the area. In addition, a major capital expenditure is budgeted for
1998, which will increase throughput capacity on all existing processing lines,
streamline material flow through the facility, and expand the menu of
recyclables which can be handled profitably.
 
     In Franklin Park, the Company has installed senior management familiar with
the mid-west marketplace, and is renegotiating its contracts with current
suppliers. In addition, two other major recyclers/haulers in the area have
inquired regarding toll processing of their recyclables at the Chicago Facility;
these negotiations are expected to lead to a significant increase of throughput
by the end of the second quarter of 1998.
 
  Marketing Operations
 
     On September 19, 1997, the Company purchased K-C. K-C operates a worldwide
secondary fiber and pulp brokerage operation from its offices in Portland,
Oregon and Lakewood, New Jersey. In addition, K-C has representatives in major
cities around the world. Over the remainder of 1997, K-C assumed full
responsibility for marketing all materials generated at the Company's recycling
facilities.
 
     Zaitlin has a ferrous and non-ferrous metals brokerage business. Manner
Resins more than doubled the tonnage brokered in 1997 compared to 1996 and
continues to broaden its market outreach. Powership Transport, formed in 1997,
generated $1 million in revenues from transportation brokerage operations. The
company intends to use Powership Transport's resources to lower its shipping
costs.
 
     KTI BioFuels initiated a waste brokerage business, whose function is to
secure additional municipal solid waste for Maine Energy and PERC.
 
     The Company receives a management fee from Maine Energy and PERC. Since
Maine Energy and PERC are still partially owned by third parties, the management
fee permits the Company to derive additional cash flow from operations. During
1997, prior to the acquisition of the Prins facilities the Company earned fees
of $700,000 under a management agreement with Prins' principal secured lender.
As part of its overall
 
                                       34
   35
 
strategy, the Company is seeking to acquire other distressed businesses, and
expects to operate some of those businesses for some time before acquiring them.
 
DISCONTINUED OPERATIONS
 
     On February 8, 1995, the Company acquired Computer Services, Inc.
("Computer Services"). As a result of the acquisition the Company participated
in two business segments, waste handling and computer services.
 
     The Company's operations in the Computer Services segment were carried out
principally by its wholly-owned subsidiary DataFocus. DataFocus is primarily
engaged in client-server systems software engineering and application
development services.
 
     On July 19, 1996, DataFocus executed an agreement with CIBER, Inc.
("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 $5,000,000, 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 $4,250,000.
 
     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. Under the royalty agreement, the Company receives a
monthly base royalty payment of $5,000 and quarterly payments of additional
royalties, equal to 5% of net revenue from the sale of NuTCRACKER software
product in excess of $4,000,000 per year. The Company received $60,000 in
royalties in 1997. DataFocus will have the right to repurchase the Company's
rights under the royalty agreement from the Company for the following payments:
three times the royalty payments due to the Company for the twelve months
immediately prior to the date of notice of repurchase, if given before July 29,
1998; two times the royalty payments due to the Company for the twelve months
immediately prior to the date of notice of repurchase, if given on or after July
29, 1998 but before July 29, 1999; or an amount equal to the royalty payments
due to the Company for the twelve months immediately prior to the date of notice
of repurchase, if given after July 29, 1999.
 
     As part of the sale of DataFocus to its management, the Company agreed to
loan up to $500,000 to certain members of the management of DataFocus, including
Thomas A. Bosanko, who was a director of the Company through August 13, 1996.
The loan carried interest at 8% per annum and provided for level quarterly
principal payments over a four year period. The loan was secured by shares of
the Company's Common Stock owned by such members of management of DataFocus. The
loan was repaid during 1997.
 
     Loss from discontinued operations of $714,000 for the year ended December
31, 1996, resulted from the sale and disposal of the Company's computer service
division.
 
                                       35
   36
 
                             RESULTS OF OPERATIONS
 
  YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
 


                                                                   YEAR ENDED DECEMBER 31,
                                                              ----------------------------------
                                                                   1997               1996
                                                              ---------------    ---------------
                                                                               
Revenue:
  Waste-to-energy:
     Electric power.........................................  $38,968    40.5%   $20,821    30.4%
     Sale of capacity, net..................................                      33,203    48.5%
     Waste processing.......................................   31,545    32.8%    13,975    20.4%
  Recycling.................................................   25,644    26.7%       509     0.7%
                                                              -------   -----    -------   -----
       Total revenues.......................................   96,157   100.0%    68,508   100.0%
Costs and expenses:
  Electric power and waste processing operating costs.......   47,654    49.6%    19,610    28.6%
  Recycling.................................................   20,099    20.9%       508     0.8%
  Selling, general and administrative.......................    2,978     3.1%     2,389     3.5%
  Depreciation and amortization.............................    8,893     9.2%     6,336     9.2%
  Interest expense, net.....................................    5,086     5.3%     4,464     6.5%
  Other income..............................................     (390)   (0.4%)
                                                              -------   -----    -------   -----
       Total costs and expenses.............................   84,320    87.7%    33,307    48.6%
  Equity in net income of PERC..............................                         333     0.5%
  Loss on sale of investments...............................                        (296)   (0.4%)
                                                              -------   -----    -------   -----
  Income from continuing operations before minority
     interest, income taxes and extraordinary item..........   11,837    12.3%    35,238    51.4%
  Minority interest.........................................   (6,331)   (6.6%)  (18,610)  (27.2%)
  Income from continuing operations before income taxes and
     extraordinary item.....................................    5,506     5.7%    16,628    24.3%
  Income tax (benefit)......................................   (2,586)   (2.7%)
                                                              -------   -----    -------   -----
  Income from continuing operations before extraordinary
     item...................................................    8,092     8.4%    16,628    24.3%
  Discontinued operations Loss from discontinued
     operations.............................................       --               (714)   (1.0%)
                                                              -------   -----    -------   -----
  Income before extraordinary item..........................    8,092     8.4%    15,914    23.2%
  Extraordinary item........................................       --             (2,248)   (3.3%)
                                                              -------   -----    -------   -----
       Net income...........................................    8,092     8.4%    13,666    19.9%
  Accretion and paid and accrued dividends on preferred
     stock..................................................   (1,408)   (1.4%)
                                                              -------   -----    -------   -----
       Net income available to common shareholders..........  $ 6,684     7.0%   $13,666    19.9%
                                                              =======   =====    =======   =====

 
  REVENUES
 
     Waste-to-Energy
 
     The Company's electric power revenues increased by $18,147,000, or 87.2%,
for the year ended December 31, 1997 compared to 1996. This increase principally
resulted from the consolidation of PERC in 1997 which accounted for an increase
of $18.6 million and the inclusion of Telogia Facility for the entire year in
1997 compared to only five weeks in 1996 which resulted in an increase of $4.6
million offset by a decrease in Maine Energy's electric power revenues of
approximately $5.0 million for 1997 compared to 1996, substantially all of which
was due to the change in power rates in accordance with the restructuring of the
Central Maine PPA. In 1996, Maine Energy's overall average power rate for the
year was 9.75c/kWh (16.52c/kWh through May 3, and 6.57c/kWh thereafter). In
1997, the average power rate was $6.864/kWh.
 
                                       36
   37
 
     As a result of certain contingencies in connection with the sale of
capacity under the Central Maine PPA, the Company deferred $45 million of
revenue from this transaction which is being amortized through May 31, 2007, of
which $3,750,000 was recognized in each of 1996 and 1997.
 
     Sale of capacity, net was $33,203,000 for the year ended December 31, 1996
arising from the sale of capacity under Central Maine PPA. No such transaction
occurred in 1997.
 
     Revenues from waste processing increased $17,570,000, or 126%, for the year
ended December 31, 1997 compared to 1996. The increase was principally due to
the consolidation of PERC, which accounted for $12.8 million of revenue in 1997,
the inclusion of results from TERI's Cairo, Georgia bio-mass facility for all of
1997 compared to only five weeks in 1996 which resulted in an increase of $1.5
million and the inclusion of results from AART for the entire year of 1997
compared to only eight months in 1996 which resulted in an increase of $480,000
in 1997. Maine Energy waste processing revenues also increased by $340,000 in
1997 compared to 1996 principally due to higher tonnage being processed. In
addition, revenues for KTI BioFuels increased $1.8 million for 1997 compared to
1996 due principally to its brokerage of bio-mass waste in 1997. KTI BioFuels
had no brokerage business in 1996. Also, during 1997, the Company earned
$700,000 in management fees related to its operating agreement with Prins'
principal lender.
 
     Recycling
 
     Sales of recyclables increased to $25,644,000 from approximately $509,000
in 1996 resulting from the acquisitions of Zaitlin, K-C and the Prins facilities
in 1997 and the inclusion of Manner for all of 1997 compared to only one month
in 1996. Recycling included sales of waste paper, ferrous and non-ferrous metals
and plastic materials.
 
COSTS AND EXPENSES
 
     Electric Power and Waste Processing Operating Costs
 
     Electric power waste handling operating costs increased by $28,044,000, or
143% for the year ended December 31, 1997 compared to 1996. The increase
resulted from the consolidation of PERC in 1997, which had costs and expenses of
$17.8 million in 1997, the inclusion of TERI's Telogia Facility and Cairo,
Georgia bio-mass facility for all of 1997 compared to only five weeks in 1996
which resulted in an increase of $5.1 million, the 1997 acquisitions of Zaitlin,
K-C and the Prins facilities which resulted in operating costs of $4.1 million
in 1997. Costs of $1.4 million were incurred in connection with KTI BioFuels'
brokerage business in 1997. Maine Energy's operating costs decreased by
approximately $300,000 in 1997 compared to 1996 resulting principally from lower
supplemental fuel costs and maintenance costs associated with the annual plant
outage.
 
     Recycling
 
     The increase in recycling costs of $19,591,000 principally resulted from
the 1997 acquisitions of K-C, Zaitlin and the Prins facilities, as well as the
inclusion of Manner for the entire year of 1997 compared to only one month in
1996. These costs principally include the costs of acquired recyclables for
resale.
 
     Other Items
 
     Selling, general and administrative expenses increased by approximately
$589,000 or 24.7% for the year ended December 31, 1997 compared to 1996. This
increase was principally due to salaries of additional management personnel and
associated expenses resulting from the acquisitions of K-C, Zaitlin and the
Prins assets in 1997, as well as the inclusion of TERI 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 $2.5 million or 40% compared to 1996. The increase is
the result of the consolidation of PERC in 1997 which resulted in an increase of
$3.5 million and the inclusion of TERI for a full year in 1997 compared to only
five weeks in 1996. These increases where partially offset by a decrease in
depreciation at Maine Energy of $1.5
 
                                       37
   38
 
million due to the full year effect of the change in estimated useful lives of
property, plant and equipment which was effective beginning in the fourth
quarter of 1996.
 
     Interest, net, increased by $622,000, or 13.9% for the year ended December
31, 1997 as compared to the year ended December 31, 1996. This increase resulted
from the consolidation of PERC which had interest expense of $2.5 million, a
full year of interest at TERI in 1997 compared to only five weeks in 1996 which
results in an increase of $560,000 and interest on indebtedness related to the
acquisitions of the Prins facilities and on K-C's and Zaitlin's existing
indebtedness. These increases were partially offset by a decrease in interest
expense of $2.1 million at Maine Energy, as a result of the repayments of $64.5
million in bonds payable and $29.5 million in subordinated debt in the second
quarter of 1996 and a continued reduction in outstanding debt at the Company
level during 1997 compared to 1996.
 
     Equity in net income of PERC was eliminated as a result of the
consolidation of PERC for 1997. Pre-acquisition minority earnings of $4,620,000
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. No such
transactions occurred in 1997.
 
     Minority interest decreased approximately $12.3 million, or 66% for the
year ended December 31, 1997 as compared to the year ended December 31, 1996.
Minority interest in Maine Energy decreased due principally to the non-recurring
minority interest gain on sale of capacity recorded at Maine Energy in 1996 of
$17,709,000. In addition, minority interest was reduced due to the full year
effect of the purchase of additional partnership interest in Maine Energy by the
Company in 1996 to its current 74.15% ownership level. These increases are
offset in 1997 by the inclusion of $4,620,000 of pre-acquisition earnings in
PERC and $685,000 minority interest in earnings after the acquisition of the
additional partnership interest.
 
     The tax benefit of $2,586,000 is the result of reduction in the Company's
valuation allowance on net deferred tax assets. The Company's ability to utilize
its net operating loss carryforwards is limited as discussed below. The tax
benefit recorded in 1997 is based on management's evaluation that the Company
will be able to utilize all net operating loss and alternative minimum credit
carryforwards which are available to offset 1998 and 1999 income.
 
                                       38
   39
 
RESULTS OF CONTINUED OPERATIONS
 
  YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
 


                                                                YEAR ENDED DECEMBER 31,
                                                          ------------------------------------
                                                                1996                1995
                                                          ----------------    ----------------
                                                                     ($ THOUSANDS)
                                                                             
Revenue:
  Waste-to-energy:
  Electric power........................................  $20,821     30.4%   $26,470     69.5%
  Sale of capacity, net.................................   33,203     48.5%
  Waste processing......................................   13,975     20.4%    11,613     30.5%
  Recycling.............................................      509      0.7%
                                                          -------    -----    -------    -----
     Total revenues.....................................   68,508    100.0%    38,083    100.0%
Costs and expenses:
  Electric power and waste processing operating costs...   19,610     28.6%    18,634     48.9%
  Recycling.............................................      508      0.8%
  Selling, general and administrative:..................    2,389      3.5%     2,941      7.7%
  Depreciation and amortization.........................    6,336      9.2%     7,505     19.7%
  Interest expense -- net...............................    4,464      6.5%     9,379     24.7%
                                                          -------    -----    -------    -----
     Total costs and expenses...........................   33,307     48.6%    38,459    101.0%
  Equity in net income of PERC..........................      333      0.5%       335      0.9%
  Loss on sale of investments...........................     (296)    (0.4)%
                                                          -------    -----    -------    -----
  Income (loss) from continuing operations before
     minority interest, income taxes and extraordinary
     item...............................................   35,238     51.4%       (41)    (0.1)%
  Minority interest.....................................  (18,610)   (27.2)%   (1,287)    (3.4)%
                                                          -------    -----    -------    -----
  Income (loss) from continuing operations before income
     taxes and extraordinary item.......................   16,628     24.3%    (1,328)    (3.5)%
  Income taxes..........................................                          (65)    (0.2)%
                                                          -------    -----    -------    -----
  Income (loss) from continuing operations before
     extraordinary item.................................   16,628     24.3%    (1,393)    (3.7)%
  Discontinued operations
     Loss from discontinued operations..................     (714)    (1.0)%      (86)    (0.2)%
                                                          -------    -----    -------    -----
  Income (loss) before extraordinary item...............   15,914     23.2%    (1,479)    (3.9)%
  Extraordinary item -- gain (loss) on early
     extinguishment of debt, net of minority interest...   (2,248)    (3.3)%      148      0.4%
                                                          -------    -----    -------    -----
  Net income (loss).....................................  $13,666     19.9%   $(1,331)    (3.5)%
                                                          =======    =====    =======    =====

 
     Revenues
 
     Electric power revenues decreased by $5,649,000, or 21.3%, for the year
ended December 31, 1996 compared to 1995. The decrease principally resulted from
a reduced contract rate under the amended PPA from 16.52c per kWh to 7.18c per
kWh for all power produced after May 3, 1996. As a result of certain
contingencies required by the sale of capacity under the PPA, the Company has
deferred $45,000,000 of revenue from this transaction which is being amortized
through May 31, 2007, of which $3,750,000 has been amortized into revenues in
1996. As a result of the purchase of TEII on November 22, 1996, $484,000 of
electric power revenue is included for the year ended December 31, 1996.
 
     Net revenues from the sale of capacity, were $33,203,000 for the year ended
December 31, 1996 resulting from the sale of capacity under Maine Energy's PPA.
 
                                       39
   40
 
     Revenues from waste processing increased $2,362,000, or 20.3%, for the year
ended December 31, 1996 compared to 1995. This increase is primarily the result
of the acquisition of the Nashville Facility which had revenues of approximately
$2,529,000 and increased revenues from the Company's specialty waste subsidiary
of approximately $900,000 which is a direct result of the increase of 8,786 tons
in specialty waste processed at Maine Energy. The total tonnage increase at
Maine Energy of 21,000 tons which resulted in increased revenues of $768,000 for
1996 was entirely offset by the permanent tipping fee reduction in charter and
host community tipping fees of $7.27 per ton as required by Maine Energy's
long-term waste supply contracts upon the retirement of the $64.5 million in
bonds at Maine Energy. These increases were offset by decreases in KTI BioFuels
revenues of $749,000 principally resulting from a 22,353 ton, or 29.2% decrease
in woodwaste compared to 1995 and a decrease in lease revenue from
transportation equipment of $239,000 as a result of previous equipment sales.
The decrease in KTI BioFuels revenues was primarily the result of diminished
supply of wastewood due to severe weather conditions during the first quarter of
1996.
 
     Recycling revenues in 1996 represent sales by Manner from the date of
acquisition. No such revenues existed in 1995.
 
     Costs and Expenses
 
     Electric power and waste processing operating costs increased by $976,000,
or 5.2%, for the year ended December 31, 1996 compared to 1995. The principal
cause of the increase in 1996 is the purchase of TEII and AART resulting in
increased costs of $2,401,000 during 1996. These increases were partially offset
by decreased net disposal costs of plant residues of $410,000 primarily as a
result of the renegotiated ash disposal contract; a decrease in the need for
supplemental fuels of $273,000 as a result of an increase in the MSW received at
the facility; and, decreased maintenance and related costs of $346,000 all from
the Maine Energy Facility. Additional decreased costs arose from the
transportation division which during 1995 suspended operations. Also, during
1995, the transportation division recorded a provision of $521,000 to reduce the
carrying value of certain transportation equipment. No such provision was
required during 1996.
 
     Recycling costs in 1996 represent the cost of purchased materials sold by
Manner from the date of acquisition. No such costs were incurred in 1995.
 
     Depreciation decreased by $1,169,000 or 15.6% as a result of a change in
useful lives of plant assets at Maine Energy and a reduction of transportation
related assets in 1996 compared to 1995 offset by additional depreciation of
$954,000 related to TEII and AART in 1996.
 
     Selling, general and administrative expenses decreased by $552,000, or
18.8%, for the year ended December 31, 1996 as compared to the year ended
December 31, 1995. The decrease was principally a result of a decrease in
amortization expense resulting from the write off of deferred costs related to
the PPA restructuring at Maine Energy.
 
     Interest and Other Items
 
     Interest -- net decreased by $4,915,000 or 52.4% for the year ended
December 31, 1996 as compared to 1995. The principal decreases for the year were
$1,728,000 resulting from the retirement of $64,500,000 of bonds at Maine
Energy, $2,010,000 resulting from the payment of $29,500,000 of subordinating
debt at Maine Energy and $1,177,000 resulting from decreased letter of credit
fees at Maine Energy due to the retirement of the bonds.
 
     The increase in minority interest of $17,323,000 for the year ended
December 31, 1996 compared to 1995 principally resulted from the minority
interest of 49.62% in Maine Energy's gain from sale of capacity.
 
     Loss from sale of investments of $296,000 for the year ended December 31,
1996, resulted from the sale of longterm fixed rate municipal bonds pledged by
Maine Energy to the letter of credit banks immediately prior to the sale of
capacity on May 3, 1996.
 
     Extraordinary item of $2,248,000 for the year ended December 31, 1996,
resulted from the early extinguishment of the Biddeford Bonds at Maine Energy,
net of minority interest.
 
                                       40
   41
 
     Equity in the net income of PERC decreased by $2,000, or .6%, for the year
ended December 31, 1996. The Company's ownership interest in PERC was 7%.
 
     PERC
 
     Revenues from electric power for 1996 increased by $210,000 or 1.1% over
1995, as a result of a 2.8% increase in contract rate per kilowatt for 1996,
offset by a decrease in power production of 2,635 mWh or 1.6%. Waste processing
revenues for 1996 increased $625,000, or 5.6%, compared to 1995. This resulted
principally from a $1.68 per ton, or 3.7%, increase in PERC's average tipping
fee arising principally as the result of increases in spot market disposal rates
and a 4,900 ton, or 1.9% increase in MSW received in 1996. PERC's tipping fee
revenues are principally derived under long-term contracts, and increases or
decreases in revenues will principally be a result of inflation adjustments,
increases or decreases in passthrough facility costs and change in law pricing
provisions. Operating expenses for the year ended December 31, 1996 increased
$1,007,000, or 5.0%, as compared with the year ended December 31, 1995,
principally due to increased disposal costs of $626,000, maintenance costs
$669,000 and operating and fuel costs $511,000. These increases were offset by a
decrease of $799,000 in performance credits payable to the Charter
Municipalities. Beginning in 1994, PERC, in accordance with agreement with its
charter municipality customers, paid an amount representing 50% of
"distributable cash," as defined in the agreements, to the charter
municipalities. Expense with respect to these agreements was $619,000 in the
year ended December 31, 1996, compared to $1,418,000 in 1995.
 
     Net interest expense for the year ended December 31, 1996 decreased by
$634,000, or 16.6%, as compared with the year ended December 31, 1995. This
decrease was primarily due to lower interest rates on the variable rate bond
debt as well as a reduction in outstanding principal on such bonds. Interest
expense on the variable rate bond debt is a passthrough cost to municipal
customers. As a result, changes in interest expense did not have a significant
effect on net income.
 
                        LIQUIDITY AND CAPITAL RESOURCES
 
     The Company is a holding company and receives certain of its cash flow 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 $11,949,000 as of December 31, 1997
before partners' cash distributions can begin. 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.
 
THE COMPANY
 
     PERC has significant restrictions on the amount of cash flow that can be
distributed to the Company. Also, PERC management fees are paid annually and
only if PERC meets certain operating results set forth in its loan documents.
Through December 31, 1997, the Company has accumulated management fees
receivable from PERC in the amount of $2.2 million. These fees are payable by
PERC only out of cash flow after all current operating costs and debt service
payments. In addition, the Company has pledged to ENI, the other general partner
of PERC, a portion of the Company's share of PERC management fees as a means of
repaying the remaining outstanding balance of $1,072,000 of an advance ENI made
on the Company's behalf to PERC to cover the Company's additional partnership
capital requirement in 1989. While no assurance can be given, based upon current
conditions, management expects annual management fees to be received on a
current basis and accrued management fees from prior years to be paid from
PERC's distributable cash flow as the project continues its recent trend of
distribution of cash to its partners. The future operating results of PERC will
determine the exact term over which the accrued management fees will be received
by the Company. During 1997, the Company received $686,000 in current and
accrued management fees on account of 1996 operations
 
                                       41
   42
 
of which $389 was paid to ENI. The Company anticipates receipt of cash from PERC
during 1998 on account of 1997 operations of $2,825,000 of which $431,000 will
be paid to ENI.
 
     Since February 28, 1991, the Company has been receiving operating and
management fees from Maine Energy on a current basis. During 1997, the Company
received $501,000 for operating and management fees from Maine Energy on account
of 1997 operations.
 
     On October 24, 1996 the Company executed a Note Purchase Agreement with
WEXFORD KTI LLC, a Delaware limited liability company ("WEXFORD"). Pursuant to
the Note Purchase Agreement, the Company issued an 8%, $5,000,000 convertible
subordinated note (the "Note") to WEXFORD. The Note was due on October 31, 2002
and was convertible by WEXFORD into the Common Stock at a conversion price of
$8.095 per share. On October 9, 1997 Wexford converted the entire balance of the
note into 618,609 shares of the Common Stock.
 
     On June 4, 1997, the Company consummated the private placement of 487,500
shares of Series A Convertible Preferred Stock for gross proceeds of $3,900,000.
The Series A Convertible Preferred Stock was convertible into shares of the
Common Stock, at a price of $8.00 per share, subject to adjustment. Purchasers
of the shares of Series A Convertible Preferred Stock also received, in the
aggregate, warrants to purchase 243,750 shares of Common Stock at $9.00 per
share and warrants to purchase 32,500 shares of Common Stock at $10.00 per
share. During 1997, 40,000 of the shares of Series A Convertible Preferred Stock
were converted to 40,000 shares of Common Stock. The remaining shares of Series
A Convertible Preferred Stock were converted into 447,500 shares of Common Stock
in February 1998.
 
     During August 1997, the Company consummated the offering of 856,000 shares
of its 8.75% Series B Preferred Stock. The gross proceeds of the offering were
$21.4 million and the net proceeds to the Company were $19,984,000.
 
     The Series B Preferred Stock is convertible into Common Stock at $11.75 of
liquidation value per share and is redeemable, at the option of the Company: (a)
on August 15, 1999 for $26.47 per share if the bid price of the Common Stock has
averaged not less than 1.5 times the then conversion price during the preceding
twenty (20) consecutive trading days; and (b) at $26.10 on August 15, 2000 and
declining at approximately $0.37 per share as of August 15 on each subsequent
year until August 15, 2003 when the Series B Preferred Stock may be called at
$25.00 per share. The Series B Preferred Stock is subject to mandatory
redemption at $25.00 per share on August 15, 2004. At the option of the Company,
such mandatory redemption of the Series B Preferred Stock may be made in cash or
in shares of Common Stock, valued at 95% of the average closing price of the
Common Stock during the twenty (20) trading days prior to such redemption date.
 
     So long as any shares of the Series B Preferred Stock are outstanding, the
Company may not issue any new securities in parity with, or senior to, the
Series B Preferred Stock unless (a) the proforma ratios for the latest twelve
months of net income available for preferred dividends is not less than 1:1; and
(b) earnings before interest, taxes, depreciation and amortization, exclusive of
non-recurring items, less capital expenditures, securities amortization and
redemption, cash, taxes and changes in working capital to preferred dividends is
not less than 1.2:1, unless an affirmative vote or consent of the majority of
the outstanding shares of Series B Preferred Stock has been received.
 
     The Company, at its option, may exchange all, but not less than all, or the
then outstanding shares of Series B Preferred Stock into 8.75% convertible
subordinated notes due August 15, 2004 (the "8.75% Convertible Subordinated
Notes") on the first business day of February, May, August or November of any
year. If the 8.75% Convertible Subordinated Notes are issued, the Company is
obligated to qualify the trust indenture for the 8.75% Convertible Subordinated
Notes and the trustee appointed thereby under the Trust Indenture Act of 1939,
as amended.
 
     The Company has financed its operations and capital expenditures primarily
from cash flow from its subsidiaries which are not contractually restricted from
making distributions, collateralized equipment financing, unsecured subordinated
debt and proceeds from the sale of Common Stock.
 
                                       42
   43
 
     The Company and its subsidiaries, other than Maine Energy, PERC and TERI,
at December 31, 1997 had indebtedness maturing in 1998 of $11,829,000, including
borrowings under existing revolving credit facilities.
 
     As of December 31, 1997, the Company had cash on hand without regard to
Maine Energy, PERC and TERI of approximately $2,386,000 and $6,000,000 available
in lines of credit from a bank. On March 23, 1998 the Company received a
commitment from KeyBank to increase its credit line from $11 million to $22
million. This line of credit can be utilized to fund acquisitions, capital
expenditures and for working capital. There can be no assurance such
acquisitions or capital expenditires will take place, or that working capital
will be increased. Management of the Company believes that cash flow from its
subsidiaries and the increased line of credit will meet its current needs for
liquidity. Moreover, management believes that the Company has the ability to
access additional borrowing facilities if needed, although no assurance can be
given in this regard.
 
MAINE ENERGY
 
     Maine Energy has financed its operations and capital expenditures from cash
flows from operations. Cash provided by operations was $3,175,000 in 1997, as
compared to $89,281,000 in 1996. During 1996, Maine Energy sold its generating
capacity to CL One for a period through May 31, 2007. In exchange, CL One agreed
to make a series of quarterly payments to Maine Energy and an initial payment of
$85 million. During May 1996, Maine Energy retired the entire outstanding
principal balance of $64.5 million of its tax exempt variable rate revenue bonds
and $29.5 million of its subordinated loan accrued interest and principal from
the proceeds from the sale of capacity. As of December 31, 1997 Maine Energy had
total indebtedness of $11,949,000
 
     As of December 31, 1997 and December 31, 1996, Maine Energy had operating
cash of $737,000 and $1,648,000, respectively, and as required under the terms
of the credit agreement underlying its letter of credit, Maine Energy has on
account an additional $7,669,000 and $7,433,000, respectively, of reserves to be
used under certain circumstances for capital improvements, debt service,
operating shortfalls and working capital requirements. Maine Energy's capital
expenditures were $2,559,000 and $3,049,000 during 1997 and 1996, respectively.
 
     Management of the Company believes 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 ending December 31, 1998 are expected to be
approximately $2,672,000, which has principally been set aside in the above
mentioned reserve accounts.
 
PERC
 
     PERC has financed its operations and capital expenditures primarily by cash
flow from operations. Cash provided by operations was $11,313,000 in 1997 as
compared to $8,493,000 in 1996. PERC's capital expenditures were $391,000 and
$1,192,000 during 1997 and 1996, respectively.
 
     At December 31, 1997 and December 31, 1996, PERC had outstanding
tax-exempt, variable rate revenue bonds backed by bank letters of credit in the
aggregate amounts of $47,900,000 and $53,500,000, respectively. The variable
interest rate on the bonds at December 31, 1997 and 1996 was 4.40% and 4.25%,
respectively. The bonds are payable pursuant to a schedule through May 2003.
During 1997 and 1996 PERC made principal payments to bondholders in the amounts
of $5,600,000 and $5,900,000, respectively. As of December 31, 1997 PERC had
total indebedness of $47.9 million.
 
     As of December 31, 1997 and 1996, in addition to PERC's operating cash of
$7,125,000 and $5,440,000, respectively, and as required under the terms of the
credit agreement with its letter of credit banks and the trust indenture
governing the bonds, had on account an additional $9,849,000 and $8,482,000,
respectively, of cash reserves to be used for capital improvements, debt
service, operating shortfalls and working capital requirements.
 
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     Company management believes PERC's cash flows from operations and cash
resources available will be sufficient to fund anticipated capital expenditures
and debt service requirements. PERC plans capital expenditures for the year
ending December 31, 1998 of approximately $998,000. PERC intends to finance the
requirements through cash flow from operations.
 
TERI
 
     TERI has financed its operations and capital expenditures primarily by cash
flows from operations. Cash provided by operations was $1,807,000 in 1997.
TERI's capital expenditures were $1,329,000 for additions to property, plant and
equipment during 1997.
 
     During 1997, TERI retired $13.4 million of variable rate revenues bonds and
paid certain debt financing costs with $13,708,000 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 ($1,765,000 due December 1, 1998) with
a final payment of $4,620,000 due December 1, 2002. During 1997, TERI repaid
$308 which represented the entire balance of one of the 1997 Bond issuances. As
of December 31, 1997 TERI had total indebtedness of $13.4 million.
 
     As of December 31, 1997 and December 31, 1996, in addition to TERI's
operating cash of $933,000 and $558,000, respectively, TERI, as required under
the terms of its then existing debt agreements, had on account an additional
$2,051,000 and $499,000, respectively, of reserves to be used under certain
circumstances for capital improvements, debt service, operating shortfalls and
working capital requirements.
 
     Management believes TERI's cash flows from operations and cash resources
available will be sufficient to fund anticipated capital expenditures and debt
service requirements. Capital expenditures for TERI for the year ending December
31, 1998 are expected to be approximately $200,000. TERI intends to finance the
requirements through cash flow from operations.
 
                             TAX LOSS CARRYFORWARDS
 
     At December 31, 1997, the Company had net operating loss carryforwards of
approximately $46.1 million for income tax purposes that expire in years 2002
through 2010 and are subject to the limitations as described below. In addition,
the Company has general business credit carryforwards of approximately $530,000
that expire in the years 1999 through 2006 and alternative minimum tax credits
of approximately $815,000 which do not expire. For financial reporting purposes,
such amounts are treated as deferred tax assets and a valuation allowance has
been recognized to offset these deferred tax assets.
 
     These deferred tax assets can be utilized against future net income of the
Company. When utilized by the Company, net income will not be reduced by income
tax provisions.
 
     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 fifty (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 its net operating loss carryforwards
and general business credits will be limited to approximately $1,200,000 of
taxable income, or approximately $375,000 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.
 
     During 1996, the Company acquired TERI. As a result of this acquisition,
the Company recorded additional net operating loss carryforwards of $25,580,000,
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 of
TERI is limited to approximately $988,000 per year.
 
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                          ENVIRONMENTAL CONTINGENCIES
 
     While increasing environmental regulation often presents new business
opportunities to the Company, Maine Energy, PERC and TERI, it likewise often
results in increased operating costs as well. The Company, Maine Energy, PERC
and TERI strive to conduct their operations in compliance with applicable laws
and regulations, including environmental rules and regulations, and have as
their goal 100% compliance with such laws 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, management of the Company
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. At December 31, 1997, there were no pending governmental
environmental enforcement proceedings where the Company, Maine Energy, PERC or
TERI believe potential monetary sanctions will exceed $100,000. The possibility
always exists that substantial expenditures could result from governmental
proceedings, which would have a negative impact on 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 operation of the
plants, equipment, and vehicles of the Company, Maine Energy, PERC or any other
operating subsidiary of the Company 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 have a negative impact on
the Company's business and operations and could have a material adverse impact
on the Company's financial results.
 
                                   INFLATION
 
     The effect of inflation on operating costs has been minimal in over the
past three (3) years. Most of the Company's 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 the
Company's project's overall operating costs is not expected to be greater for
such project than for its respective competitors. In addition, each of Maine
Energy and PERC can contractually increase its waste processing fees to
municipal customers annually based on inflation.
 
                                YEAR 2000 ISSUE
 
     Until recently computer programs were written to store only two digits of
date-related information in order to more efficiently handle and store data.
Thus the programs were unable to properly distinguish between the year 1900 and
the year 2000. This is frequently referred to as the "Year 2000 Problem". During
1997, the Company initiated a Year 2000 Project to begin to address this issue.
Utilizing both internal and external resources, the Company is in the process of
defining, assessing and converting, or replacing, various programs, hardware and
instrumentation systems including those at its subsidiaries and its facilities
to make them Year 2000 compatible. The Company's Year 2000 project is comprised
of several components including, business applications, computer hardware and
facilities equipment. The business applications component consists of the
Company's business computer systems, as well as the computer systems of
customers whose Year 2000 problems could potentially impact the Company.
Equipment exposures consist of the micro-processors with the power of small
computers that are embedded within operating, control and safety equipment
utilized within the Company's facilities. Should the Company not be able to
convert or replace all such programs, hardware and instrumentation systems it
could have a material adverse effect on the Company's results of operations and
financial position. No assurance can be given that the Company will be able to
successfully convert or replace all such programs, hardware and instrumentation
systems. The cost of the Year 2000 initiatives is not expected to be material to
the Company's results of operations or financial position.
 
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       RECENT PRONOUNCEMENTS OF THE FINANCIAL ACCOUNTING STANDARDS BOARD
 
     Recent pronouncements of the Financial Accounting Standards Board ("FASB")
which are not required to be adopted at December 31, 1997, include the following
Statements of Financial Accounting Standards ("SFAS"):
 
     SFAS No. 130, "Reporting Comprehensive Income," establishes standards for
reporting and display of comprehensive income (all changes in equity during a
period except those resulting from investments by and distributions to owners)
and its components in the financial statements. This new standard which will be
effective for the Company for the year ending December 31, 1998, is not
currently anticipated to have a significant impact on the Company's financial
statements based on the current financial structure and operations of the
Company.
 
     SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," which will be effective for the Company for the year ending
December 31, 1998, establishes standards for reporting information about
operating segments in the annual financial statements, selected information
about operating segments in interim financial reports and disclosures about
products and services, geographic areas and major customers. This new standard
may require the Company to report financial information on the basis that is
used internally for evaluating segment performance and deciding how to allocate
resources to segments, which may result in more detailed information in the
notes to the Company's financial statements than is currently required and
provided. The Company has not yet determined the effects, if any, of
implementing SFAS No. 131 on its reporting of financial information.
 












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     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this amended 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: April 13, 1998
 
     







 
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