UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1998. [_] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ________ to ________. COMMISSION FILE NUMBER 0-20819 THERMATRIX INC. (Exact name of registrant as specified in its charter) DELAWARE 94-2958515 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) 2025 GATEWAY PLACE, SUITE 132 SAN JOSE, CALIFORNIA 95110 (Address of principal executive offices) (408) 453-0490 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days: Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class Outstanding at September 30, 1998 ----- --------------------------------- Common stock, $.001 par value 7,695,872 THERMATRIX INC. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Certain Business Considerations" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in, or incorporated by reference into, this report. TABLE OF CONTENTS PART I. FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements........................................... 3 Condensed Consolidated Balance Sheets.......................... 3 Condensed Consolidated Statements of Operations................ 4 Condensed Consolidated Statements of Cash Flows................ 5 Notes to Condensed Consolidated Financial Statements........... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 8 PART II. OTHER INFORMATION Item 1. Legal Proceedings.............................................. 15 Item 2. Changes in Securities.......................................... 15 Item 3. Defaults Upon Senior Securities................................ 15 Item 4. Submission of Matters to a Vote of Security Holders............ 15 Item 5. Other Information.............................................. 15 Item 6. Exhibits and Reports on Form 8-K............................... 15 SIGNATURE...................................................... 16 2 THERMATRIX INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------ ------------ (Unaudited) ASSETS CURRENT ASSETS Cash & cash equivalents $ 2,658 $ 3,990 Short-term investments 1,647 3,587 Accounts receivable, net 5,570 3,520 Costs of uncompleted contracts, net 273 547 Prepaid expenses and other current assets 296 250 -------- -------- Total current assets 10,444 11,894 PROPERTY AND EQUIPMENT Machinery and equipment 833 857 Demonstration equipment 558 506 Furniture and fixtures 441 322 -------- -------- 1,832 1,685 Less - Accumulated depreciation and amortization (1,152) (749) -------- -------- Net property and equipment 680 936 -------- -------- PATENTS AND OTHER ASSETS, net 1,354 1,157 -------- -------- $ 12,478 $ 13,987 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 3,556 $ 1,055 Accrued liabilities 848 802 Billings on uncompleted contracts in excess of costs 46 181 -------- -------- Total current liabilities 4,450 2,038 STOCKHOLDERS' EQUITY: Common stock, $0.001 par value 8 8 Additional paid-in capital 48,756 48,644 Accumulated other comprehensive income 50 - Accumulated deficit (40,786) (36,703) -------- -------- Total stockholders' equity 8,028 11,949 -------- -------- $ 12,478 $ 13,987 ======== ======== See notes to condensed consolidated financial statements. 3 THERMATRIX INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------------ ------------------------ 1998 1997 1998 1997 ------- ------- ------- ------- REVENUES $ 3,964 $ 2,304 $ 9,642 $ 5,638 COST OF REVENUES 3,705 2,311 8,850 6,200 ------- ------- ------- ------- Gross margin 259 (7) 792 (562) ------- ------- ------- ------- OPERATING EXPENSES: Research and development 390 302 1,053 922 Selling, general and administrative 1,247 1,877 4,113 5,309 ------- ------- ------- ------- Total operating expenses 1,637 2,179 5,166 6,231 ------- ------- ------- ------- Loss from operations (1,378) (2,186) (4,374) (6,793) OTHER INCOME: Interest income (net) 82 152 292 546 Other income 7 1 49 4 ------- ------- ------- ------- Total other income 89 153 341 550 ------- ------- ------- ------- Net loss before income taxes (1,289) (2,033) (4,033) (6,243) PROVISION FOR INCOME TAXES (17) (17) (50) (50) ------- ------- ------- ------- Net loss $(1,306) $(2,050) $(4,083) $(6,293) ======= ======= ======= ======= BASIC NET LOSS PER SHARE $ (0.17) $ (0.27) $ (0.53) $ (0.84) ======= ======= ======= ======= BASIC WEIGHTED AVERAGE COMMON SHARES 7,696 7,573 7,668 7,526 ======= ======= ======= ======= See notes to condensed consolidated financial statements. 4 THERMATRIX INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) NINE MONTHS ENDED --------------------------------- SEPTEMBER 30, SEPTEMBER 30, 1998 1997 ------------- ------------- (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(4,083) $(6,293) Adjustments to reconcile net loss to net cash used in operating activities - Depreciation and amortization 531 308 Provision for doubtful accounts 190 175 Changes in assets and liabilities - Accounts receivable (2,240) (632) Costs of uncompleted contracts 279 (332) Prepaid expenses and other (45) 42 Accounts payable 2,500 (319) Accrued liabilities 44 (83) Billings on uncompleted contracts in excess of costs (136) (8) ------- ------- Net cash used in operating activities (2,960) (7,142) ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Sale of short-term investments 1,940 6,291 Purchases of property and equipment (147) (429) Increase in patents and other assets (324) (256) ------- ------- Net cash provided by investing activities 1,469 5,606 ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from sale of common stock 112 118 ------- ------- INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS (1,379) (1,418) CUMULATIVE EFFECT OF FOREIGN EXCHANGE RATES ON CASH 47 - ------- ------- CASH & CASH EQUIVALENTS BEGINNING OF PERIOD 3,990 4,781 ------- ------- CASH & CASH EQUIVALENTS END OF PERIOD $ 2,658 $ 3,363 ======= ======= SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest 10 24 Cash paid for income taxes 54 99 See notes to condensed consolidated financial statements. 5 THERMATRIX INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. The condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the three months and nine months ended September 30, 1998 and 1997. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results for the nine months ended September 30, 1998 are not necessarily indicative of the results expected for the full fiscal year. 2. BASIC NET LOSS PER SHARE Basic net loss per share is computed using the weighted average number of shares of common stock outstanding. No diluted loss per share information has been presented in the accompanying statements of operations since potential common shares from conversion of stock options and warrants are antidilutive. 3. SHORT-TERM INVESTMENTS In accordance with the Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified all marketable debt securities as held-to-maturity and has accounted for these investments at amortized cost. Short-term investments are marketable securities with original maturities greater than three months and less than one year. As of September 30, 1998, short-term investments consist of certificates of deposit. 4. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued SFAS No. 130 (SFAS 130), "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial 6 statements. The following table reconciles comprehensive income under the provisions of SFAS 130 for the three months and nine months ended September 30, 1998 and 1997. For the Three Months Ended September 30 1998 1997 --------- -------- Net Loss $(1,306) $(2,050) Other Comprehensive Income, net of tax Unrealized Currency Gain $ 37 $ - ------- ------- Comprehensive Loss $(1,269) $(2,050) ======= ======= For the Nine Months Ended September 30 1998 1997 --------- -------- Net Loss $(4,083) $(6,293) Other Comprehensive Income, net of tax Unrealized Currency Gain $ 50 $ - ------- ------- Comprehensive Loss $(4,033) $(6,293) ======= ======= 5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The Statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheets as either an asset or liability measured at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Statement 133 is effective for fiscal years beginning after June 15, 1999. The Company does not expect the adoption of Statement 133 to have a material effect on the financial statements. 7 THERMATRIX INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains forward-looking information that involves known and unknown risks and uncertainties which may cause the Company's actual results in future periods to differ materially from those indicated herein as a result of certain factors, including those set forth under "Certain Business Considerations." The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 1997, contained in the Company's Annual Report on Form 10-K. GENERAL - ------- Thermatrix Inc. is a global industrial technology company engaged in the development, manufacture and sale of industrial process equipment for the destruction of volatile organic compounds and hazardous air pollutants (collectively "VOCs"). The core component of the Company's technology is its proprietary flameless thermal oxidizer ("FTO"). The Company's products also include PADRE(R), a proprietary technology used to capture and recover very low concentration VOCs from low-to-medium flow vapor streams. In addition to its primary focus on the industrial VOC emissions control market, the Company is currently focusing its development activities on the application of its FTO technology to treat emissions from both mobile and stationary diesel engines. The Company derives its revenues primarily from contracts to design, develop, manufacture and install systems for the treatment of VOCs. The Company uses the percentage-of-completion method of accounting to recognize contract revenues. Losses on contracts are charged to cost of revenues as soon as such losses become known. The Company experienced a shift in market demand for its products during the last two fiscal years. In 1997, the United States VOC market declined, reflecting, the Company believes, low capital expenditures in new process facilities. However, the Company experienced an increase in demand for its products overseas, primarily due to the continued globalization of the chemical and pharmaceutical industries, increased adoption of ISO 14000 standards, and capital expenditures by overseas companies. The Company responded to this shift by reducing its United States sales and operating staff and increasing its presence overseas. In 1998, the Company experienced positive momentum in its global VOC business, particularly in Europe. The geographic split of the orders received during the first nine months of fiscal 1998 is approximately 62% in Europe and 38s% in the United States and includes orders from the pharmaceutical, specialty chemical, refining and remediation industries. In addition to its primary focus on the industrial VOC emissions control market, the Company is currently evaluating the feasibility of applying the Company's technology to treat emissions from diesel engines. During the second quarter of fiscal 1998, the Company announced the successful conclusion of an eighteen- month testing and technology evaluation program and the completion of a joint development project with Lucas Diesel Systems, a division of LucasVarity plc. The testing and evaluation program provided for the development and testing of a prototype system utilizing the Company's patented FTO technology for the treatment of diesel engine emissions from mobile sources. In the course of conducting this test program, the Company developed a new configuration that would allow the technology to be downsized to enhance its suitability for mobile applications while confirming 8 the ability to inject diesel fuel into the matrix core to maintain operating temperature. The results of the testing show a level of control equal to or superior to any other technology commercially available and significantly better than the U.S. Environmental Protection Agency's proposed regulations for mobile sources including trucks, off-road vehicles, locomotives and marine vessels. During the third quarter of fiscal 1998, the Company entered into a Demonstration Project Partnership Agreement with the Massachusetts Executive Office of Environmental Affairs working with the Massachusetts Executive Office of Transportation and Construction whose jurisdiction includes the Massachusetts Bay Transportation Authority ("MBTA"). The goal of the project is to demonstrate the application of the FTO to treat the exhaust of a diesel locomotive owned by the MBTA, to validate the performance of the technology on a locomotive, and to evaluate the cost-effectiveness of this particular application. The program also includes demonstrating the integration of various oxides of nitrogen ("NOx") reduction technologies to achieve as complete destruction as possible of all the undesirable components contained in this diesel engine emission exhaust. Subsequent to September 30, 1998, the Company received a contract award from the Advanced Technology Program ("ATP") of the National Institute of Standards and Technology, an agency of the U.S. Department of Commerce, for the development of a four-way diesel emissions treatment device. Pursuant to the contract the Company will develop and test a device capable of reducing or eliminating all four key pollutants in diesel engine exhaust by combining the Company's FTO technology for the reduction of particulate matter, carbon monoxide, and hydrocarbons with a proprietary Lean NOx Catalyst developed by Southwest Research Institute of San Antonio, Texas. ATP grants funding to industry for research and development projects that have the potential to provide direct, broad-based economic benefits to the United States. Expenses incurred by the Company in connection with these development programs, primarily labor and equipment operation costs, are generally recorded as research and development expenses. The Company may also provide an evaluation system as part of a joint development program, and if it does, the capital cost of the evaluation system is amortized over the estimated useful life of the system. Such expenses incurred by the Company for these evaluation programs have not been material. However, due to the positive test results in the diesel engine emissions program, the Company anticipates that more extensive development and engineering will be needed in order to commercialize its technology for such use. There can be no assurance as to the outcome of such evaluation programs or, if initiated, the outcome of any such applications development and engineering effort. RESULTS OF OPERATIONS - --------------------- Revenues were $4.0 million and $9.6 million for the three months and nine months ended September 30, 1998, up from $2.3 million and $5.6 million for the three months and nine months ended September 30, 1997. The increase in revenues was primarily attributable to sales of large FTO systems to customers overseas, primarily in the United Kingdom, and an increase in domestic activity. Two significant customers accounted for 62% and 11%, respectively, of revenues in the three months ended September 30, 1998, and 48% and 15%, respectively, of revenues in the nine months ended September 30, 1998. Revenues from international customers for the three months and nine months ended September 30, 1998 were 67% and 60%, respectively, compared to 33% and 38%, respectively, of revenues for the three months and nine months ended September 30, 1997. The Company had a gross margin contribution of $259,000 and $792,000, respectively, in the three months and nine months ended September 30, 1998 compared to gross margin losses of $7,000 and $562,000, respectively, in the comparable periods in 1997. The increase in gross margin was primarily attributable to higher revenues, which were sufficient to absorb the fixed and semi-fixed costs of 9 engineering and operations in the United States and Europe, and to a lesser extent, reductions in costs from repeat sales of systems for established applications. Research and development expenses were $390,000 and $1,053,000, respectively, in the three months and nine months ended September 30, 1998, compared to $302,000 and $922,000, respectively, for the comparable periods in 1997. Research and development expenses were largely attributable to expenditures for the development and testing of a prototype system utilizing the Company's patented FTO technology for the treatment of diesel engine emissions from mobile sources, the development of a prototype of a new FTO configuration, and PADRE(R) product development. Selling, general and administrative expenses decreased to $1.2 million and $4.1 million, respectively, for the three months and nine months ended September 30, 1998, compared to $1.9 million and $5.3 million, respectively, in the comparable periods in 1997. The decrease in selling, general and administrative expenses reflects reduced staffing and related costs, lower sales commissions and marketing expenses, and a decrease in travel expenses, partially offset by higher consulting and legal fees. Net interest income of $82,000 and $292,000 for the three months and nine months ended September 30, 1998 primarily results from the investment of cash at hand. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Total cash and short-term investments were $4.3 million at September 30, 1998, down from $7.6 million at December 31, 1997. This decrease was primarily due to cash used in operations. Net cash used in operating activities was $3.0 million in the nine months ended September 30, 1998, compared to $7.1 million used in operating activities during the nine months ended September 30, 1997. The reduction in cash used in operating activities is primarily a result of reduced operating losses and an increase in accounts payable, partially offset by an increase in accounts receivable. The increases in accounts payable and accounts receivable are primarily attributable to the increase in revenue. The Company has a $4.0 million accounts receivable line of credit with a $2,000,000 letter of credit sub-limit. The committed line will bear interest at the prime interest rate plus 0.50% and is subject to certain financial and non- financial covenants. There are no interest-bearing borrowings outstanding under the line of credit as of September 30, 1998. The Company has a stand-by letter of credit issued under the sub-facility in the amount of $354,000. The Company anticipates satisfying its cash requirements from, among other things, (i) its cash and short-term investments, (ii) increased revenues and positive gross margin, (iii) the timely collection of accounts receivable, and (iv) the line of credit facility. These strategies are dependent on the Company's ability to continue to meet its forecasts, including developing increased sales and generating positive gross margins therefrom, the timely collection of amounts due to the Company and compliance with the line of credit agreement covenants. The Company believes that its existing cash and short-term investments and line of credit facility will provide sufficient liquidity for it to meet its obligations for the twelve-month period ending September 30, 1999. YEAR 2000 COMPLIANCE - -------------------- The Year 2000 issue arises from computer programs that use two digits rather than four to define the applicable year. Such computer programs may cause computer systems to recognize a date using "00" as the calendar year 1900 rather than the calendar year 2000. Systems that do not properly recognize such information could generate erroneous dates or cause a system to fail. The Company has conducted a preliminary review of its products and internal computer systems to identify the systems that could be affected by the Year 2000 issue. A more comprehensive review will be completed by the end of 1998. The Company believes its products and most of its management 10 information systems are already Year 2000 compliant. However, its existing accounting system is not. The Company plans to upgrade to a Year 2000 compliant version of its accounting system by the end of 1998 and does not anticipate that the cost of such a conversion will be material. While the Company currently expects the Year 2000 issue will not pose significant operational problems, failure to fully identify all Year 2000 dependencies in the Company's systems could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, the Company cannot be sure that systems of other companies on which the Company relies will be converted in a timely manner. The failure of other companies to convert systems on which the Company relies may have a material adverse effect on the Company's business, results of operations or financial condition. CERTAIN BUSINESS CONSIDERATIONS - ------------------------------- The Company's business is subject to the following risks and uncertainties, in addition to those described elsewhere. Operating Losses and Accumulated Deficit; Uncertainty of Future Profitability. The Company had a net loss of approximately $9.6 million in 1997 and $4.1 million for the nine months ended September 30, 1998, and had an accumulated deficit of approximately $40.8 million at September 30, 1998. The Company does not expect to be profitable unless and until sales of its systems generate sufficient revenues with an appropriate gross margin to fund its operations. In the event the Company does not achieve such revenues or margins, the Company may require additional financing to fund its operations in the future. There can be no assurance that such financing will be available or, if available, that it will be on favorable terms. Ability to Compete Against Lower Cost Technologies. To date, FTO systems have been installed in a small segment of a number of industries. There can be no assurance that the Company's FTO technology will receive broad market acceptance as an economically and environmentally acceptable means of destroying VOCs. The Company's ability to compete will depend upon the Company's ability to persuade potential customers to adopt its FTO technology in place of certain, more established, competing technologies, including flame-based destruction and carbon adsorption systems. The failure of the Company to persuade a significant number of potential customers to adopt its FTO technology would have a material adverse effect on the growth of the Company's business, results of operations and financial condition. Sensitivity to Major Projects. For the nine months ended September 30, 1998, two projects accounted for 63% of the Company's revenues. In 1997, two projects accounted for 38% of the Company's revenues and in 1996, three projects accounted for 38% of the Company's revenues. Although the Company is expanding the number of its customers and installations, the average size and dollar volume of each installation has been increasing. The Company anticipates the size of turnkey projects in 1998 will range from $1 million to $4 million, up from an average of $850,000 in 1996. As a result, the Company's results of operations are likely to continue to be dependent on major projects. Such a reliance on major orders is likely to lead to fluctuations in quarterly results. Larger projects also pose other challenges. The sales cycle for larger projects tends to be longer than for smaller projects, and, when orders are received, projects may be delayed by factors outside the Company's control, including customer budget decisions, design changes and delays in obtaining permits. Orders for large systems are often issued in stages and it is not uncommon for there to be delays between the completion of the engineering design phase and the receipt of the equipment order due to complex permitting and/or other requirements. In addition, orders for large systems often have tight delivery schedules and the customer will often attempt to negotiate penalties for late delivery and/or the 11 ability to assess liquidated damages for lost production if the delivery schedule is not met. Also, because the dollar volumes are larger, the costs of providing warranty services could increase. The Company's business, results of operations and financial condition could be materially adversely affected if the Company were to fail to obtain major project orders, if such orders were delayed, if installations of such systems were delayed, or if such installations encountered operating, warranty or other problems. Management of Growth. Although it relies on subcontractors to fabricate subassemblies and to assemble and install completed systems, the Company uses its own employees to design, test and commission systems. The Company seeks to maintain engineering and design staffing levels adequate for current and near- term demand. During periods of rapid growth, such as that experienced by the Company during 1996 and 1998, the Company's engineering and design personnel generally operate at full capacity. As a result, future growth, if any, is limited by the Company's ability to recruit and train additional engineering, design and project management personnel and by the ability and performance of the individual employees in managing more and larger projects. Furthermore, any failure to maintain quality or to meet customer installation schedules could damage relationships with important customers, damage the Company's reputation generally and result in contractual liabilities. There can be no assurance that the Company will be able to effectively manage an expansion of its operations or that the Company's systems or controls will be adequate to support the Company's operations if expansion occurs. In such event, any failure to manage growth effectively could have a material adverse effect on the Company's business, results of operations and financial condition. Risks Associated with International Operations and Sales. In 1997, sales to international customers in Europe and Asia increased to 35%, up from 14% in 1996. For the nine months ended September 30, 1998, sales to international customers in Europe increased to 58%. The Company plans to increase its revenues, in part, through an expansion of its overseas operations. Expansion internationally encompasses the need to provide an infrastructure for operations, sales and administration. The Company's overseas growth has placed, and could continue to place, a significant strain on its managerial, operational and financial resources. There can be no assurance that the Company will be able to attract, hire and train personnel or to continue to develop the infrastructure needed on a timely basis which may have an adverse impact on the Company's business, results of operations and financial condition. Additionally, the Company's business, results of operations and financial condition may be materially adversely affected by fluctuations in currency exchange rates and duty rates, and therefore its ability to maintain or increase prices due to competition. The Company denominates international sales in either United States dollars or local currencies. Sales in Europe have been primarily denominated in pounds sterling. Since some expenses in connection with international contracts are often incurred in foreign currency, there can be a short-term exchange risk created. If the Company has significant international sales or purchases in the future denominated in foreign currencies, the Company may purchase hedging instruments to mitigate the exchange risk on these contracts. Risks Associated with Fixed Price Contracts. A majority of the Company's contracts are performed using "fixed-price" rather than "cost-plus" terms. Under fixed-price terms, the Company quotes firm prices to its customers and bears the full risk of cost overruns caused by estimates that differ from actual costs incurred or manufacturing delays during the course of the contract. Some costs, including component costs, are beyond the Company's control and may be difficult to predict. If manufacturing or installation costs for a particular project exceed anticipated levels, gross margins would be materially adversely affected, and the Company could experience losses. In addition, the manufacturing process may be subject to significant change orders. However, in some cases the cost of these change orders may not be negotiated until after the system is installed. The failure of the Company to recover the full cost of these change orders could materially adversely affect gross margins and also cause the Company to experience losses. 12 Dependence on Key Personnel. The Company's success depends to a significant extent upon its executive officers and key engineering, sales, marketing, financial and technical personnel, both in the United States and overseas. Employees may voluntarily terminate their employment with the Company at any time, and none of the Company's employees is subject to any term employment contract with the Company. The Company has limited personnel resources available to address the different activities in its business. The loss of the services of one or more of the Company's key employees could have a material adverse effect on the Company's business, results of operations and financial condition. The Company also believes that its future success will depend in large part upon its ability to attract and retain additional highly skilled personnel, particularly design and process engineers. Because of the technical sophistication of the Company's systems and the sophisticated engineering software utilized by the Company, design and process engineers who join the Company generally are required to have advanced technical knowledge and significant training to perform efficiently and productively. The availability of such personnel is limited, and the Company has at times experienced difficulty in locating new employees with the requisite level of expertise and experience. In addition, the Company believes its ability to manage the anticipated increase in customer orders for the Company's products in Europe will depend in a large part on its success in attracting and retaining skilled project managers and engineers in Europe. There can be no assurance that the Company will be successful in retaining its existing key personnel or in attracting and retaining the personnel it requires in the future. The Company maintains key employee life insurance on the life of its Chairman, President and Chief Executive Officer, John T. Schofield, in the amount of $2,000,000. There can be no assurance that such amount will be sufficient to compensate the Company for the loss of the services of such individual. Fluctuations in Quarterly Operating Results. The Company's quarterly revenues and operating results have varied significantly in the past and may fluctuate significantly in the future as a result of a variety of factors, many of which are outside the Company's control. Such factors include the size and timing of individual orders, the timing and amount of project change orders, customer delays, order cancellations, general economic and industry conditions, the amount of first-time engineering needed, the introduction of new products or services by the Company or its competitors or the introduction of the Company's products to new markets, changes in the levels of operating expenses, including development costs, and the amount and timing of other costs relating to the expansion of the Company's operations. Furthermore, the purchase of the Company's products, particularly for major projects, may involve a significant commitment of capital, with the attendant delays frequently associated with large capital expenditures and authorization procedures within its customers' organization. For these and other reasons, the sales cycle for the Company's products can be lengthy (up to two years) and subject to a number of significant risks over which the Company has little or no control, including customer budgetary constraints. The Company historically has operated with little backlog because most customer orders are placed with relatively short lead times, usually from four to thirty weeks. Variations in the timing of recognition of specific revenues due to changes in project scope and timing may adversely and disproportionately affect the Company's operating results for a quarter because the Company establishes its expenditure levels on the basis of expected future revenues, and a significant portion of the Company's expenses do not vary with current revenues. Risks Associated With the Diesel Engine Emission Control Development Program. The engineering challenges involved in treating diesel emissions are different in a number of respects from the conditions in which the Thermatrix technology has been used in the past, and there can be no assurance that it will prove successful in this development area. Moreover, the Company's extensive database of test results that it uses to design systems for industrial installations may not be relevant to diesel engine emission control. Although the results of its recently completed technology evaluation program were positive, the 13 Company anticipates that more extensive development and engineering will be needed in order to commercialize the technology for such use. The level of expenditure by the Company in this area will depend on the degree of support it receives from strategic partners. Although pilot test results to date have been positive, there can be no assurance as to the success of any such effort. 14 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time, the Company has been, or may become, involved in litigation proceedings incidental to the conduct of its business. The Company does not believe that any such proceedings presently pending will have a material adverse effect on the Company's financial position or its results of operations. ITEM 2. CHANGES IN SECURITIES Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.3 Restated Certificate of Incorporation of Registrant.(**) 3.4 Amended and Restated Bylaws of Registrant.(*) 4.2 Amended and Restated Investor Rights Agreement.(*) 10.1 Form of Indemnification Agreement between the Registrant and each of its directors and executive officers.(*) 10.2 1987 Incentive Stock Plan, as amended and related agreements.(*) 10.3 1996 Stock Plan and form of Stock Option Agreement thereunder.(*) 10.4 Employee Stock Purchase Plan and forms of agreement thereunder.(*) 10.5 1996 Director Option Plan and form of Director Stock Option Agreement thereunder.(*) 10.6 Asset Purchase Agreement between the Registrant and Purus, Inc. dated January 4, 1996.(*) 10.8 Lease dated June 24, 1995 between the Registrant and American General Life Insurance Company.(*) 10.11 Amended and Restated Loan and Security Agreement between the Registrant and Venture Banking Group, a Division of Cupertino National Bank, dated January 21, 1998.(***) 10.12 1996 Stock Plan: UK Rules for Employees.(***) 10.13 First Amendment to the Amended and Restated Loan and Security Agreement between Registrant and Venture Banking Group, a Division of Cupertino National Bank.(***) 10.14 Sublease dated May 7, 1998 between Registrant and Clinimetrics Research Associates, Inc. 27.1 Financial Data Schedule. 15 -------------------- (*) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1 (No. 333-4370) which became effective June 19, 1996. (**) Incorporated by reference to exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (***) Incorporated by reference to exhibits field with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997. (b) Reports on Form 8-K None TRADEMARK ACKNOWLEDGMENTS . Thermatrix and PADRE are registered trademarks of the Company. SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THERMATRIX INC. Date: November 13, 1998 By: /s/ Daniel S. Tedone -------------------- Daniel S. Tedone Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 16 SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THERMATRIX INC. Date: November 13, 1998 By: /s/ Daniel S. Tedone -------------------- Daniel S. Tedone Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 17