================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------

FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
COMMISSION FILE NO. 0-25490

KTI, INC.

NEW JERSEY 22-2665282
(STATE OF OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

7000 BOULEVARD EAST
GUTTENBERG, NEW JERSEY 07093
(201) 854-7777
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

------------------------

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common stock, no par value

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X].

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:

$36,345,118 at March 27, 1997

Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date:

6,862,032

================================================================================
2

TABLE OF CONTENTS

PAGE
ITEM NUMBER AND CAPTION NUMBER
- ------------------------------------------------------------------------------------ ------

PART I
Item 1. Business................................................................. 1
Item 2. Properties............................................................... 18
Item 3. Legal Proceedings........................................................ 19
Item 4. Submission of Matters to a Vote of Security Holders...................... 20
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.... 20
Item 6. Selected Financial Data.................................................. 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................ 22
Item 8. Financial Statements and Supplementary Data.............................. 34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure............................................................... 34
PART III
Item 10. Directors and Executive Officers of the Registrant....................... 34
Item 11. Executive Compensation................................................... 34
Item 12. Security Ownership of Certain Beneficial Owners and Management........... 34
Item 13. Certain Relationships and Related Transactions........................... 34
PART IV
Item 14. Exhibits, Financial Statement Schedules.................................. 35

i
3

PART I

ITEM 1. BUSINESS

GENERAL

KTI, Inc. (individually and collectively with its subsidiaries, "KTI" or
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 and affiliates.

The Company's objectives are focused on the development of an integrated
waste handling business, providing waste recycling, processing and disposal
capabilities, specialty waste disposal services, facility operations and
recycling of ash combustion residue.

As part of its integrated waste handling business, the Company owns
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 to dispose of the RDF and, in the process, to generate
electrical power to be sold to electrical utilities. The Company has developed
and currently owns interests in two such facilities. The first facility is owned
by KTI's 74.15% owned subsidiary, Maine Energy Recovery Company, Limited
Partnership, a Maine limited partnership ("Maine Energy"), which is located in
Biddeford, Maine. Maine Energy commenced operations in 1987. The other facility,
owned by KTI's 7% owned affiliate Penobscot Energy Recovery Company, a Maine
limited partnership ("PERC"), is located in Orrington, Maine. PERC commenced
operations in 1988. Sources of revenues are from fees payable under waste
handling agreements with over 250 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. The
Company also developed and operates a wood waste processing facility in
Lewiston, Maine through its subsidiary KTI Bio Fuels, Inc. ("KTI Bio Fuels").
This facility commenced operations in 1986 and processes woodwaste, producing
woodchips which are used by Maine Energy and PERC, as well as third parties, as
supplemental fuel. These three facilities provide 60% of the long-term disposal
capacity for the State of Maine.

To solidify its business base in Maine and expand its integrated waste
handling business vertically and geographically, KTI made a number of strategic
acquisitions and entered into contract restructurings and joint ventures during
1996.

In April 1996, the Company entered into a series of agreements with
Environmental Capital Holdings, Inc., a Florida corporation ("ECH"), and its
subsidiary American Ash Recycling Corp., a Florida corporation ("AAR"), under
which the Company made the following acquisitions and commitments.

(i) The Company acquired a 60% limited partnership interest in a limited
partnership which operates a permitted municipal waste combustor ("MWC") ash
recycling facility in Nashville, Tennessee. This facility, which commenced
operations in 1993, is the first commercially operational MWC ash recycling
facility in the United States.

(ii) The Company acquired a 60% limited partnership interest in a limited
partnership formed to operate a similar facility in the State of Maine (the
"Maine Partnership"). The Maine Partnership is in the process of obtaining its
federal, state and local permits.

(iii) The Company 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.

AAR's MWC proprietary 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.

1
4

With respect to the Maine Partnership and the other proposed partnerships,
there can be no assurance that the intended projects would be economically
feasible and, if feasible, that necessary financing and regulatory approvals
would be obtained in order to construct and operate the proposed facilities.

Also in April 1996, Maine Energy negotiated a reduced disposal fee
retroactive to January 1, 1996 with the third party ash landfill owner that
disposes of all ash residue produced at the Biddeford facility. The cost per ton
was reduced from $70 per ton to $46 per ton. This reduced fee will stay constant
through 1997 and then be increased by inflation. Maine Energy disposed of 55,826
tons of ash in 1996 which produced a total savings of $1,339,824. KTI's share of
this savings through its ownership of Maine Energy and the Maine Partnership was
$936,604 for 1996. The Company believes that the Company's effort to obtain
permits for the ash recycling facility in Maine resulted in the third party ash
landfill owner reducing the ash residue disposal cost, yielding such savings.

In May 1996, KTI completed a restructuring of the long-term power supply
contract between its waste-to-energy subsidiary, Maine Energy and Central Maine
Power Company ("Central Maine"), a major utility in the State of Maine. As part
of the restructuring, Maine Energy sold its generating capacity through May 31,
2007 to CL Power Sales One, L.L.C., an affiliate of Citizens Lehman Power ("CL
One"). Maine Energy recorded a gain on the transaction of $33.2 million and an
additional amount of $45 million was deferred which will be recognized as
certain contingencies are eliminated. At closing, Maine Energy received
approximately $90 million in cash and an extension of the contract for five and
one-half years to December 31, 2012 in exchange for reducing the price of its
above-market rate of electricity to Central Maine from 16 cents per kilowatt
hour (kWh) to 7.18 cents per kWh. The new rate will escalate by 2% per year
through May 31, 2007 and then convert to a market based rate for the remaining
term of the contract. The proceeds, together with cash released from reserves,
were used by the Company to: 1) repay the entire $64.5 million of Maine Energy's
outstanding bonds and terminate the bank letter of credit supporting them and 2)
reduce the subordinated debt of this subsidiary by $29.5 million. Also as a
result of the transaction, the Company was able to increase its ownership in the
subsidiary to 74.15% from 50.38%.

In June 1996, Maine Energy received the Environmental Protection Agency
("EPA") Environmental Leadership Award. Maine Energy received the award in
recognition of its performance in operating at a plateau above compliance. The
Company was the only waste-to-energy company so recognized by the EPA. As a
function of the program, Maine Energy will benefit via decreased reporting
procedures and will spearhead a move toward facility self-certification. Maine
Energy will also be a mentor to two facilities selected by the EPA who can
benefit from the Biddeford facilities pollution prevention techniques and
successes.

In September 1996, the Company entered into a joint venture with Pinetree
Waste, Inc. of Portland, Maine. The joint venture with experienced Maine waste
management professionals will concentrate on the sourcing of MSW and specialty
waste for Maine Energy and PERC.

In November and December 1996, the Company acquired Timber Energy
Investments, Inc. ("TEII"), a Florida-based company. TEII and its subsidiaries
own the following facilities:

- A 14-megawatt power plant in Telogia, Florida which processes biomass
waste and sells electricity to Florida Power Company under a long-term
contract. The power plant is subject to $13.4 million of tax exempt debt.

- A 400,000-ton per year wood chip mill in Cairo, Georgia which processes
pulp wood under a long-term service contract with Stone Container, Inc.
("Stone"), and

- A 15-million pound plastic recycling plant in Tuscaloosa, Alabama

In exchange for a purchase price of $1.85 million the Company received 49%
of the common stock of TEII, preferred stock with a $50 million liquidation
preference and $11.8 million in notes previously owned by Continental Casualty
Company and its affiliates ("CNA"). KTI has agreed to release CNA from its
current reimbursement obligations on the $13.4 million outstanding municipal
bonds. The net result of this purchase and restructuring will be a retirement of
approximately $61.8 million in TEII's obligations. In a series of

2
5

subsequent transactions, KTI acquired the remaining 51% of common stock of TEII
for approximately $290,000. KTI currently owns 100% of the TEII preferred and
common stock outstanding.

Also in November 1996, the Company acquired Manner, Inc. ("Manner"), a
Maryland-based company doing business as a broker of recycling plastics
nationwide. Manner is expected to play a key role in the Company's participation
in the plastic recycling market including the anticipated enhancement of the
profitability of the acquired TEII plastic recycling plant located in
Tuscaloosa, Alabama. KTI acquired Manner for 65,000 shares of KTI stock and
granted incentive stock options to Manner's key personnel.

The Company's current business plan for its integrated waste handling
business includes the following elements: (i) to maximize the RDF production and
operating efficiencies of the Maine Energy and PERC facilities, (ii) to continue
to focus on lowering expenses of its waste-to-energy facilities, including
identifying less costly means of disposal or by utilizing recycling
opportunities for MSW process and ash combustion residues, (iii) to utilize its
expanded specialty waste disposal capabilities (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) to 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) to
recycle ash produced by waste-to-energy facilities, (vi) to expand its waste
brokerage service, and (vii) to utilize its experience gained in restructuring
Maine Energy's power supply contract, in waste handling and processing, in
turning around troubled facilities and in 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 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 a high quality fuel. In the RDF process utilized by
the Company, non-combustible materials, such as ferrous metals, glass, grit and
fine organic materials, are separated from MSW, which promotes 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 and Bangor
Hydro-Electric Company ("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 of, 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 is seeking the regulatory approvals required to recycle
its ash residues, 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.

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%

3
6

interest as the sole general partner and one of three limited partners of Maine
Energy. Accordingly, the Company holds a majority ownership interest in Maine
Energy. The other two limited partners are CNA Realty Corp. ("CNA Realty"), a
subsidiary of CNA Financial Corporation, and Energy National, Inc., an affiliate
of Pacific Generation Company ("PacifiCorp"), which own 9.6% and 16.25%
interests in the partnership, 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 1996 was 245,634 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 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.
Payments on these loans were restricted by the terms of the documents governing
the Biddeford Bonds and the letter of credit.

In May 1996, in connection with the restructuring of the Central Maine PPA
(as defined below) the Biddeford Bonds and the associated Letter of Credit were
retired with a $64.5 million prepayment and a payment of $29.5 million was made
for principal and accrued interest on the subordinated loans. The balance of the
subordinated loans at December 31, 1996 was $14,575,985. 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

A 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 $40,500
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 standard being exceeded, aggregate incentive payments in
the amount of $212,601, $202,016 and $203,200 have been paid to Operations
employees during 1994, 1995 and 1996, respectively.

Power Purchase Agreement

The electricity produced by the Maine Energy facility is sold to Central
Maine pursuant to a power purchase agreement dated January 12, 1984 with a term
through December 31, 2012 (as amended, the "Central Maine PPA"). 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 1996, Maine Energy derived approximately $20,337,000, or 31.6% of its
revenues, from the sale of electricity to Central Maine.

4
7

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 also make additional quarterly payments through May 31,
2007 to Maine Energy as a portion of its purchase price and for reimbursement to
Maine Energy of certain expenses. In consideration of its payments to Maine
Energy, CL One would be 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. Maine Energy will
sell energy to Central Maine through May 31, 2007 at an initial rate of 7.18
cents per kWh which would escalate annually by 2% per annum. Beginning June 1,
2007 until the expiration date of the contract, Maine Energy will 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. As of December 31, 1996 the
balance of the subordinated debt at Maine Energy was $14,575,985.

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 default") 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 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 default") 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 1996, 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 $41.25 million.

Management of the Company restructured its relationship with Central Maine
because it believes that the cash proceeds from the restructuring which enabled
the Company to reduce the outstanding indebtedness of Maine Energy, should allow
the Company upon refinancing or repayment of the reduced subordinated debt to
access Maine Energy's available cash flow. In addition, the newly restructured
Central Maine PPA will allow Maine Energy to be more competitive as electric
utility deregulation become a reality. 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 one-third 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, 1996 from $20.42, in the case
of the two host municipalities of Biddeford and Saco, to $40.83 per ton, which
are subject to adjustment. During 1996, Maine Energy reduced the tipping fees as
required by the Waste Handling Agreements by $7.27 and $3.64 for charter and
host communities, respectively, as a result of the retirement of the Biddeford
Bonds. 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 disposal fees for residues. The municipalities are also
responsible for costs associated with changes in law. Maine Energy was not

5
8

entitled to an increase in tipping fees in 1996 for variable "pass through" or
change in law costs. Approximately 35% of Maine Energy's total waste handling
revenues in 1996 was attributable to these long-term waste handling agreements.

Under the Maine Energy long-term waste handling agreements, each
municipality agrees to deliver to the Maine Energy facility acceptable waste in
an amount equal to its "Guaranteed Annual Tonnage." Maine Energy is required to
accept 110% of each municipality's Guaranteed Annual Tonnage. The total tonnage
processed under long-term agreements in 1996 was only 30.4% of the total waste
processed by the facility. 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 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 -- Waste Handling -- 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 there are
currently no less costly alternative longterm 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 1997 through 2000 that provide Maine
Energy with approximately 38,800 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 87,900 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 owns a 7% general partnership interest in PERC. The
other partners of PERC are ENI, which has both a general and limited partnership
interest representing an aggregate 28.71% ownership percentage, and The
Prudential Insurance Company of America, which has a limited partnership
interest representing a 64.29% ownership percentage.

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
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
253,523 tons of MSW in 1996. The Company intends to increase the annual
processed total to approximately 325,000 tons over the next ten years.

6
9

Management and Fees

A subsidiary of the Company and ENI are both general partners of PERC. The
subsidiary of the Company and ENI 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 the managing general partner, which
is the subsidiary of the Company. 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 the partnership 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.

The subsidiary of the Company also earns an annual management fee from
PERC. The base amount was set in the PERC partnership agreement subject to
annual adjustments on the basis of the Consumer Price Index and was $334,338 for
the year ended December 31, 1996. The subsidiary of the Company was due
$2,279,105 on account of accrued management fees as of December 31, 1996, which
represent the unpaid portion of management fees earned by the Company through
March 31, 1991. 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
co-operator's fee which was $53,109 for the year ended December 31, 1996.

In 1996, the Company was entitled to receive $691,442 as a result of PERC's
operations during 1995, $398,311 of which was paid to ENI for principal and
interest due on its note from the Company.

The Power Purchase Agreement

The electricity produced by the PERC facility is sold to Bangor Hydro
pursuant to a power purchase agreement dated June 21, 1984 with a term through
February 14, 2018 (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
1996, PERC derived approximately 61% 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) and up to a maximum of
approximately 166,000,000 kWh in a calendar year, net of electricity consumed at
the facility. The Bangor Hydro PPA rate formula is currently favorable to PERC,
providing a contract rate of 11.402 cents per kWh for 1996. 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.

The Company is currently working with Bangor Hydro in an attempt to
restructure the Bangor Hydro PPA utilizing the Central Maine PPA restructuring
as a model. The Company's objectives in a restructuring would be the same as it
believes were accomplished in the Central Maine PPA restructuring. The
discussions with Bangor Hydro have only recently commenced and no assurances can
be given that such restructuring will be successful.

Long-Term Waste Handling Agreements.

As of December 31, 1996, PERC had in place 124 long-term waste handling
agreements, of which 82 cover approximately 100 so-called charter municipalities
("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 200,000 tons per year of MSW. PERC
receives approximately 20,000 tons per year of MSW from municipalities with whom
PERC has short-term waste handling

7
10

agreements, 20,000 tons per year from commercial haulers and 10,000 tons per
year from the spot market. As of December 31, 1996, the municipalities under the
PERC long-term waste handling agreements pay an average tipping fee of $47.02
per ton to PERC for the disposal of their waste. Total waste processing revenues
of PERC in 1996 were approximately $11,792,000 of which approximately 81.3% is
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 PERC 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 1995 in the
amount of $1,417,567 were paid in 1996. The amount due for 1996 which will be
paid during 1997 is approximately $619,000.

On one year's notice, a PERC Charter Municipality may terminate its
long-term waste handling agreement as of March 31, 1998, 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, 1998. 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.

KTI BIO FUELS -- WOOD WASTE PROCESSING

General

The Company's Maine wood waste processing business is operated by the
Company's subsidiary, KTI Bio Fuels, Inc. ("KTI Bio Fuels"). KTI Bio Fuels was
organized in 1986 for the purpose of developing and operating a wood waste
processing facility on a leased site in Lewiston, Maine (the "Lewiston
Facility") to convert treated and untreated wood waste materials into woodchips
used for disposal through use 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. Maine Energy
and PERC utilize woodchips produced by the Lewiston Facility as a supplemental
fuel for their RDF combustion processes. In addition to Maine Energy and PERC,
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.

8
11

Ownership

A subsidiary of the Company owned a 75% ownership interest in the
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 Maine
Woodchips for 10,000 shares of its common stock and a five year warrant for
2,000 shares at $8.50 per share. Upon acquiring the ownership, KTI liquidated
the partnership and moved the operation into its wholly owned subsidiary, KTI
Bio Fuels

KTI ASH RECYCLING, INC.

On December 28, 1995 the Company, through its wholly owned subsidiary KTI
Ash Recycling, Inc. ("KTI Ash"), entered into a series of agreements with
Environmental Capital Holdings, Inc. ("ECH") and its subsidiary, American Ash
Recycling Corp. ("AAR"). These agreements were subject to due diligence which
was completed in the first quarter of 1996.

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 is the previous owner of the Facility,
American Ash Recycling Corp. of Tennessee, a Florida corporation, an affiliate
of AAR. The partnership will carry on the business of the predecessor
corporation. The Company has a priority on the annual distributions of earnings
and cash flow from the 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.
The purchase price consisted of $500,000 in cash and a short-term promissory
note for $1,600,000 which was paid during 1996.

The partnership owns an incinerator ash recycling plant in Nashville,
Tennessee, which commenced operations in 1993. The plant recycles ash from a
landfill owned by the city of Nashville and Davidson County.

The Company also agreed to become a 60% limited partner of a partnership,
American Ash Recycling of New England ("AARNE") to operate a similar facility in
the State of Maine (the "Maine Partnership"). The Company's initial contribution
to this partnership was $500,000.

The Company has agreed to become a 60% limited partner in up to an
additional eight facilities. The purchase price for each of these partnership
interests is $2 million. ECH and AAR have a four year period to develop these
eight facilities which ends December 31, 1999.

Maine Energy executed an Ash Recycling Agreement with AARNE. In April 1996,
Maine Energy negotiated a reduced disposal fee retroactive to January 1, 1996
with the third party ash landfill owner that disposes of all ash residue
produced at the Biddeford facility. The cost per ton was reduced from $70 per
ton to $46 per ton. This reduced fee will stay constant through 1997 and then be
increased by inflation. Maine Energy disposed of 55,826 tons of ash in 1996
which produced a total savings of $1,339,824. KTI's share of this savings
through its ownership of Maine Energy and AARNE was $936,604 for 1996.

PERC also executed an Ash Recycling Agreement with AARNE. The Ash Recycling
Agreement guarantees the delivery by PERC of a minimum of 35,000 tons of ash to
AARNE. The processing fee is $43.50 per ton, including a trucking fee of $11.00
per ton. Under PERC's current ash recycling contract, the other party may retain
PERC's ash disposal if its reduces its current price of $56.56 to match the
$43.50 price contained in the AARNE Ash Recycling Agreement. The current ash
recycling contract requires a one year notice period for termination, such
notice will be given when AARNE receives such notice of its required federal,
state and local approvals and permits. AARNE expects to complete construction of
its facility within six months of receiving the necessary permits and approvals,
at which time PERC will begin delivery of ash residue to AARNE.

9
12

value in the scrap metal markets. AAR's process also removes unburned
combustibles through the utilization of proprietary air separation processes.

With respect to the Maine Partnership and the other proposed partnerships,
there can be no assurance that the intended projects would be economically
feasible and, if feasible, that necessary financings and regulatory approvals
would be obtained in order to construct and operate the proposed facilities.

TIMBER ENERGY INVESTMENTS, INC.

General

TEII was formed in 1994 as a holding company, which ultimately owned a
majority of common stock of Timber Energy Resources, Inc. ("TERI") and all of
the outstanding stock of Timber Energy Plastics Recycling, Inc. ("TEPRI") and
Timber Energy Trucking, Inc. ("TET").

Acquisition by KTI, Inc.

On November 22, 1996, the Company acquired TEII from Continental Casualty
Company (together with its subsidiaries, "CNA") and a group of ten individual
investors. CNA sold its debt obligations of TEII (approximately $11.8 million at
par plus accrued interest) and equity interests in TEII (73,500 shares, or 49%,
of common stock and $50 million in preferred stock) to KTI for $1.85 million.
The remaining 51% ownership interest was purchased from the group of ten
individual investors for an additional approximately $290,000.

As part of its purchase agreement with CNA, the Company has also agreed to
obtain the release of CNA's reimbursement obligation to the letter of credit
bank, Bank of Montreal ("BOM") which credit enhances the $13,400,000 of
outstanding bonds. If the Company is unable to obtain the release of CNA of its
obligation by August 21, 1997, then CNA has the option of reimbursing the
Company $1.75 million of its purchase price and reversing the transaction. The
Company has retained an investment banking firm to place the bonds and is
confident it will be able to obtain the release of CNA of its obligation by the
August 21, 1997 deadline. While the company believes that it will be able to
release CNA of its obligation and that cash flow from the facility's operations
will be adequate to cover future principal and interest payments on the bonds,
there can be no assurance that these results will occur.

Timber Energy Resources, Inc.

General

TERI is a Texas corporation organized in July 1984 for the purpose of
constructing and operating bio-mass waste power plants. TERI owns and operates a
14 megawatt ("MW") steam generating, bio-mass waste-fired power plant (the
"Telogia Facility") located on a 97 acre site in Telogia, Florida, which
commended operations in 1988. The Telogia Facility is fueled with biomass
wastes, such as residual waste from wood processing industries, clean
construction and demolition wood debris, and non-recyclable paper products.
Electricity generated by the Facility is sold to Florida Power Corporation under
a long term power purchase agreement that expires on March 31, 2002 ("Florida
Power PPA").

To assure a continuing, dependable and economical fuel supply, TERI
constructed a chip mill in 1988 in Cairo, Georgia (the "Cairo Facility"), which
commenced operations in December 1989. Pulpwood is processed for Stone under a
"process or pay" contract. Bark trimmings from the Cairo Facility can provide up
to 20% of fuel requirement for the Telogia Facility.

In 1991, to further improve the supply and 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.

During 1996, approximately 80% of TERI's revenue was derived from the sale
of electricity to Florida Power, with the majority of the remainder in the form
of tolling fees paid by Stone and from waste bark sales to third parties.

10
13

During 1996, the Telogia Facility processed approximately 150,000 tons of
wood waste and 40,000 tons of waste paper, and generated approximately 120,000
megawatt-hours of electricity, which represented 95% and 97%, respectively, of
its annual capacity. The Cairo Facility processed approximately 310,000 tons of
virgin wood, which represented 77% of its single shift annual capacity, and
produced approximately 276,000 tons of wood chips and approximately 35,000 tons
of bark trimmings.

Timber Energy Plastic Recycling, Inc.

TEPRI recycles post consumer low density plastic waste into products that
are sold to manufacturers of plastic products at its facility which is located
in Tuscaloosa, Alabama (the "Tuscaloosa Facility").

Timber Energy Trucking, Inc.

At the date of acquisition, TET was inactive. In December 1996, KTI renamed
TET "Power Ship Transport, Inc." and it commenced handling of Manner's transport
requirements.

MARKETING

Most of the Company's current marketing activity is focused on contract
acquisition for biomass, municipal solid and specialty waste materials supply to
the Maine Energy facility, the Lewiston Facility, the Timber Facilities and the
PERC facility. 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 of from one (1) to six
(6) years duration in order to stabilize supply while retaining the ability to
take advantage of any upward swings in regional disposal fees. The Company has
recently taken additional marketing responsibilities at PERC under which the
Company will attempt to fill the approximately 75,000 ton annual capacity of
PERC currently being utilized by combusting supplemental fuels. The Company
intends on utilizing 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 enables 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
improved operating margins on Maine Energy's available capacity.

The Company markets its specialty waste capacity through retail brokers of
such materials who sign contracts with a wholly owned subsidiary, KTI Specialty
Waste, Inc. ("KTI Specialty"). On October 18, 1996 KTI Specialty Waste executed
an Operating Agreement with Pine Tree Waste, Inc. ("Pine Tree"). Under the
Agreement, the Company and Pine Tree established Specialties Environmental
Management Company, LLC, a Maine Limited Liability Company ("SEMCO"). SEMCO will
provide services on a retail basis to municipal, commercial and 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.
SEMCO has entered into a contract 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. The Company is a 55% owner of
the joint venture and currently utilizes SEMCO as it's retail broker to handle
all of the supply of specialty waste into Maine Energy which is delivered
directly by the waste generators.

The Company also intends to pursue either the acquisition of or operational
responsibility for existing, financially-troubled waste-to-energy or waste
processing and recycling facilities with the goal of improving the operational
efficiencies of such facilities utilizing its successful experiences with the
Maine Energy and PERC facilities. The Company's acquisition of TEII is the first
example of this strategy. The Company currently is working with several
additional institutions and companies which own or have financed such facilities
in an attempt to structure transactions regarding their respective facilities.

11
14

At the Lewiston Facility, most contracts have durations of one (1) 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 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 shred 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, then 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. Manner is complementing
the marketing personnel at TEPRI to increase the throughput of raw materials and
market the recycling plastic pellets produced by TEPRI. Manner management is
working closely with the Company's senior management to develop an overall
marketing strategy for the Company in the plastics recycling industry.

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 per ton. TERI during 1996, paid
to third parties between $5 and $10 per ton for its fuel supply when the cost of
transporting the material is taken into account. The Company is currently
directly marketing this capacity to generators of residual waste from wood
processing industries, clean construction and demolition wood debris, and
non-recyclable paper products. The Company believes its marketing efforts will
produce biomass wastes for the Telogia Facility which will be received on a
tipping fee basis as a result of its direct marketing program. The Company will
initially attempt to bring the net costs of fuel acquisition to zero for the
Telogia Facility and ultimately look 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.

COMPETITION

The Company experiences 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 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.

12
15

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. KTI Bio Fuels is, however, with Maine Energy and PERC,
part of an integrated waste handling company which both processes wood waste
into wood chips and also destroys it through combustion. The Company believes
that this integrated process will become increasingly attractive to wood waste
generators such as electric and telephone utilities who are seeking a means of
eliminating many potential environmental liabilities associated with traditional
means of landfill disposal.

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 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 to $25 per ton,
while the cost of processing the material ranges from $5 to $8 per ton at the
Telogia Facility.

Competition for the Company's ash recycling subsidiaries is primarily from
ash landfills. The Company believes its ash recycling facilities will be able to
compete favorably based on historical prices charged by these landfill
operators.

Manner competes with several other recycled plastic brokers and direct
marketing from plastic recycling plans 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 and will
be able to increase revenues and maintain its operating margin as a result of
its knowledge of the plastic recycling market and its reputation and
relationship with its customer base.

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 other approved incinerator facilities,
purchase the majority of the output of woodchips from KTI Bio Fuel's Lewiston
Facility for use as a boiler fuel supplement to their combustion processes. The
Company does not believe that there will be a substantial decline in the amount
of woodchips required by the Maine Energy and PERC facilities in the foreseeable
future.

The Nashville Facility receives its entire supply of MWC ash from the City
of Nashville as a result of the operation of the Nashville Thermal Facility. If
the City of Nashville reduces the current level of 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.

Manner markets the materials acquired from its venders to plastic recycling
plants throughout the United States, including TEPRI.

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. Maine Energy received 30.4% of its raw materials in 1996 from 18 Maine
municipalities under long-term waste handling agreements and the majority

13
16

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 (1) 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.

Manner acquires recyclable post industrial and post consumer material from
plastic manufacturers and materials recycling facilities.

AART receives ash produced as a by-product of the combustion process at the
Thermo Facility, from the City of Nashville.

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 also much more
widely available in the warmer months of the year, when construction and
demolition projects usually occur.

None of the Company's other facilities is affected by seasonal factors.

GOVERNMENTAL REGULATION

Waste Handling

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

14
17

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 ("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, PERC
and TERI 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.

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, as to Maine Energy and PERC, at the present time because of the
existence of excess energy capacity in the New England area. The rates in the
Maine Energy and PERC 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.

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 an ordinance.
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 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

15
18

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.

Environmental Laws

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 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 ("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 ("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.

Timely applications have been made for air emissions permits for the Maine
Energy and PERC facilities. Under Maine regulatory law, a permit continues in
effect provided that a timely application for renewal is made. Due to protracted
delays in processing the application at the state level, MDEP has elected to
defer its decision until such time as the new Title V Clean Air Act Standards
are promulgated. In Maine Energy's case, the Title V application was submitted
in compliance with state mandate during August, 1996. Thereafter, in December,
1996 a public meeting was convened by MDEP to delineate the Title V 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. Management of the Company believes that Maine Energy is in
compliance with the federal Clean Air Act, its implementing regulations and all
other applicable regulations and, therefore, anticipates that the permit will be
renewed following the hearing. There can be no assurance, however, that new
conditions will not be imposed in the permit or that the permit will be renewed.
PERC is not yet required to file a new application in conformity with the new
Clean Air Act requirements.

16
19

Management of Maine Energy, PERC and TERI believe that relationships with
Maine and Florida environmental regulators is 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 and TERI facilities,
monitors applicable environmental standards and evaluates its selection of
technology to ensure that applicable standards are being met.

The United States Supreme Court recently 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 and PERC 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 nonhazardous material according to the
regulations implementing RCRA promulgated by the EPA 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.
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 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.

TERI's biomass-to-energy facility applied for renewal of its federal NPDES
and state of Florida Industrial Wastewater permits during March, 1996 in
conformance with both policy and schedule. Likewise, TERI submitted its Title V
Air Permit application to the Florida Department of Environmental Protection
("FDEP") in June, 1996. At this juncture, a backlog of other applications at
FDEP has prevented the regulatory authorities from acting on either application.
Accordingly, the current permits and conditions remain in effect until further
notice. TERI is considered to be in substantial compliance with its existing
Air/Operating, NPDES and Industrial Wastewater Permits.

The Company's ash recycling subsidiary, AART, is required to maintain
permits issued by the State of Tennessee Department of Environmental and
Conservation. These permits allow for the recovery of ferrous

17
20

and non-ferrous metals from the ash residue, as well as processing the ash
residue for reuse as an asphalt aggregate. These permits were issued on October
9, 1992 and January 23, 1993, respectively and are "Permits-by-Rule", which are
valid from the time of issuance and continue to be in effect as long as the
facility is in compliance with these permits. The facility also maintains a
Metropolitan Health Department Pollution Control Division Air Pollutant Service
Operating Permit which was renewed on December 31, 1996 and is subject to an
annual renewal.

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. for $5,000,000. Also, on July 29,
1996, after the transfer of certain of CSI's remaining assets and liabilities to
the Company, all of the outstanding common stock of CSI was sold to certain
members of its management for $5,000. In addition, the Company has notes
receivable from the buyers aggregating $444,643 at December 31, 1996. The notes
receivable are due on July 29, 2000.

EMPLOYEES

As of December 31, 1996, the Company had eighteen (18) full time employees
on its corporate staff, eighty-one (81) full time employees at the Maine Energy
facility, fourteen (14) full time employees at the Lewiston Facility,
sixty-seven (67) full time employees at the TEII facilities and eight (8) at
Manner. The employees at the PERC and Nashville facilities 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 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. Actual results may differ materially. Among
the factors that could cause actual results to differ materially are the
following: (i) the availability of sufficient capital to finance the Company's
business plan and its other capital needs on terms satisfactory to the Company;
(ii) competitive factors such as availability of less expensive waste disposal
outlets or expanded recycling programs that may significantly reduce the amount
of waste products available to the Company's facilities; (iii) 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.

ITEM 2. PROPERTIES

MAINE ENERGY FACILITY

The Maine Energy facility occupies an approximately 9.1 acre site owned by
Maine Energy in the City of Biddeford, Maine and borders the west bank of the
Saco River.

18
21

PERC FACILITY

The PERC facility occupies an approximately 40.3 acre site owned by PERC in
the Town of Orrington, Maine.

LEWISTON FACILITY

The Lewiston Facility occupies an approximately 9.7 acre site which is
leased from South Park Company, an affiliate of the City of Lewiston, Maine,
under a long-term ground lease for a term expiring in 2015. Current annual
rental charges are approximately $16,000.

TERI FACILITY

The TERI Facility occupies an approximately 97 acre site under long term
lease from St. Joseph Land and Development Company in Telogia, Florida for a
term expiring November 30, 2009 and owns a 60 acre site in Cairo, Georgia. The
current annual rent charges for the Telogia Facility are approximately $58,000.

TEPRI FACILITY

The TEPRI Facility occupies a site under a long-term lease from Wenoha
Corporation in Tuscaloosa, Alabama for a term expiring May 31, 1998, with annual
options to renew for unlimited number of annual extension periods. If the lease
is extended, the annual rent would increase by 4% for each option period.
Current annual rent charges are approximately $73,800.

NASHVILLE FACILITY

The Nashville Facility occupies a site provided by the City of Nashville
adjacent to the City's ash landfill as part of its contractual relationship with
AART.

CORPORATE OFFICES

The Company's executive offices are located in Guttenberg, New Jersey. The
aggregate floor area of these facilities is approximately 4,500 square feet. The
lease provides for a base annual rent of approximately $96,000, plus a
proportionate share of the increase of expenses such as real property taxes,
utilities and maintenance costs. The lease on these offices expires on September
30, 2001 and is renewable for an additional five year term. The lease is from an
affiliated party. See "Certain Relationships and Related
Transactions -- Transactions with Nicholas Menonna, Jr. and Martin J. Sergi."

The Company also maintains offices in Saco, Maine consisting of
approximately 3,000 square feet of leased office space. The lease provides for
an annual rental of approximately $26,300 which increases 5% annually during the
term of the lease. The lease expires on March 31, 1999 and is renewable through
2003.

ITEM 3. LEGAL PROCEEDINGS

Anthony Buonaguro, a former officer of the Company, has instituted
arbitration proceedings in New York, New York against the Company for alleged
breaches of an employment agreement between Mr. Buonaguro and the Company more
than five years prior to the filing of the arbitration proceedings. The amount
of damages requested is approximately $220,000. The Company believes that it has
meritorious defenses against this claim and will defend the matter.

A fatality of an employee of PERC's operator, ESOCO, occurred when he was
working under a conveyor belt in the plant. His widow has instituted a lawsuit
against various parties. Her lawyer recently has moved to join the Company to
the suit as additional defendants on the basis that the Company is an owner of
PERC. PERC's insurance carrier has accepted the defense of this lawsuit. All
actual owners of record are additional insureds. Under the operations and
maintenance agreement with the operator, ESOCO, such operator is obligated to
defend the Company.

19
22

The Company is a defendant in certain other law suits alleging various
claims incurred in the ordinary course of business, none of which, either
individually or in the aggregate, the Company believes will have a material
adverse effect on the Company.

Management of the Company does not believe that the outcome of the
foregoing matters, individually or in the aggregate, will have a materially
adverse effect on the Company's financial condition, cash flows or results of
operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

PART II

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 1/2
October 1, 1996 through December 31, 1996........................... 11 1/4 7

On March 27, 1997, the last reported sale price of the Common Stock as
reported on the NASDAQ National Market System was $8.625 per share. There were
180 record owners of the Company's 6,862,032 outstanding shares of Common Stock
as of March 27, 1997.

The Company has not paid cash dividends on the Common Stock and has no
plans to begin paying cash dividends in the immediate future. Furthermore,
provisions of certain of the Company's debt instruments restrict the payment of
cash dividends. A 5% stock dividend was declared, payable on March 28, 1997 to
stockholders of record on March 14, 1997. Free cash flow, if any, will be used
for strategic opportunities and to reduce debt.

20
23

ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION

YEAR ENDED DECEMBER 31,
--------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

STATEMENT OF OPERATIONS DATA
Revenues:
Operating revenues............................ $ 35,305 $ 38,083 $ 37,783 $11,290 $ 6,287
Sale of capacity, net......................... 33,203
-------- -------- -------- ------- -------
Total revenues...................... 68,508 38,083 37,783 11,290 6,287
Total costs and expenses...................... 33,603 38,459 37,615 10,740 7,691
Equity in net income (loss) of partnerships... 333 335 324 133 (661)
-------- -------- -------- ------- -------
Income (loss) from continuing operations
before minority interest, income taxes and
extraordinary item.......................... 35,238 (41) 492 683 (2,065)
Minority interest(1).......................... (18,610) (1,287) (1,920)
-------- -------- -------- ------- -------
Income (loss) from continuing operations
before income taxes and extraordinary
item........................................ 16,628 (1,328) (1,428) 683 (2,065)
Income taxes.................................. -- 65
-------- -------- -------- ------- -------
Income (loss) from continuing operations
before extraordinary item................... 16,628 (1,393) (1,428) 683 (2,065)
Loss from discontinued operations............. (714) (86)
Extraordinary item -- net..................... (2,247) 148
-------- -------- -------- ------- -------
Net income (loss)............................. $ 13,667 $ (1,331) $ (1,428) $ 683 $(2,065)
======== ======== ======== ======= =======
Per share data:
Primary:
Income (loss) from continuing operations.... $ 2.61 $ (0.26) $ (0.42) $ 0.19 $ (0.60)
Loss from discontinued operations........... (0.11) (0.02)
-------- -------- -------- ------- -------
Income (loss) before extraordinary item..... 2.50 (0.28) (0.42) 0.19 (0.60)
Extraordinary item.......................... (0.35) 0.03
-------- -------- -------- ------- -------
Net income (loss)........................... $ 2.15 $ (0.25) $ (0.42) $ 0.19 $ (0.60)
======== ======== ======== ======= =======
Weighted average number of shares used in
calculating earnings per share(2)(3)........ 6,360 5,264 3,409 3,630 3,435
======== ======== ======== ======= =======
Fully-diluted:
Income (loss) from continuing operations.... $ 2.46 $ (0.26) $ (0.42) $ 0.19 $ (0.60)
Loss from discontinued operations........... (0.10) (0.02)
-------- -------- -------- ------- -------
Income (loss) before extraordinary item..... 2.36 (0.28) (0.42) 0.19 (0.60)
Extraordinary item.......................... (0.32) 0.03
-------- -------- -------- ------- -------
Net income (loss)........................... $ 2.03 $ (0.25) $ (0.42) $ 0.19 $ (0.60)
======== ======== ======== ======= =======
Weighted average number of shares used in
calculating earnings per share(2)(3)........ 6,926 5,264 3,409 3,630 3,435
======== ======== ======== ======= =======
BALANCE SHEET DATA
Total assets.................................. $123,075 $132,906 $131,383 $21,171 $11,938
Debt.......................................... 39,073 115,376 127,348 15,348 6,148
Minority interest............................. 10,872 1,840 553
Deferred revenue.............................. 41,250
Shareholders' equity (deficit)................ 25,705 6,881 (3,911) (1,905) (3,594)

- ---------------

(1) Minority interest for the year ended December 31, 1994 includes $1,367,000
of preacquisition earnings of Maine Energy.

(2) Earnings (loss) per share have been determined based on the weighted average
number of shares outstanding as well as the dilutive effect of outstanding
options and warrants to purchase common stock, In addition, an adjustment
for shares issued during the twelve month period prior to the Merger has
been made for all periods presented whether dilutive or antidilutive.

(3) All periods reflect the effect of a 5% common stock dividend declared by the
Board of Directors on February 28, 1997 and payable March 28, 1997.

21
24

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

The Company is a holding company deriving its revenues from its
subsidiaries and PERC, an affiliate, of which it owns less than 50% and which is
accounted for under the equity method of accounting. Prior to 1994, Maine Energy
also was accounted for under the equity method of accounting. On September 16,
1994 and May 3, 1996, the Company acquired an additional 40.38% and 23.77%,
respectively, partnership interest in Maine Energy bringing its ownership
interest to 74.15% at December 31, 1996. Because the Company's controlling
interest in Maine Energy was acquired in two separate transactions, the
consolidated statements of operations for the year ended December 31, 1994
include the operations of Maine Energy from January 1, 1994 and include
adjustments to eliminate minority interest and the pre-acquisition earnings of
Maine Energy attributable to the partnership interest acquired on September 16,
1994. For presentation purposes, this section will discuss and analyze, in
addition to the Company's results, the results of PERC.

The Company, since its inception, has developed and managed waste
facilities. The Company's subsidiary, Maine Energy, and its affiliate, PERC,
both take in municipal solid waste and convert it to a 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. KTI BioFuels processes treated and untreated waste wood materials into
woodchips which are then used as a supplemental fuel by Maine Energy and PERC or
sold to other parties.

On November 22, 1996, the Company acquired TEII from CNA and a group of ten
investors. CNA sold its debt obligations (approximately $11.8 million at par
plus accrued interest) and equity interest (73,500 shares, or 49%, of common
stock and $50 million in preferred stock) to KTI for $1.85 million. The
remaining 51% ownership interest was purchased from a group of ten investors for
an additional approximately $290,000.

As part of its purchase agreement with CNA, the Company has also agreed to
obtain the release of CNA's reimbursement obligation to the letter of credit
bank, BOM which credit enhances $13,400,000 of outstanding bonds. If the Company
is unable to obtain the release of CNA from its obligation by August 21, 1997,
then CNA has the option of reimbursing the Company $1.75 million of its purchase
price and reversing the transaction. The Company has retained an investment
banking firm in connection with the bonds and is confident it will be able to
obtain the release of CNA of its obligation by the August 21, 1997 deadline.
While the Company believes that cash flow from the facility's operations will be
adequate to cover future principal and interest payments on the bonds, there can
be no assurance that this will occur.

TEII's Telogia Facility takes in biomass fuels to be combusted to produce
electric power. TEII's Cairo Facility processes pulpwood under a tolling
agreement to produce woodchips for use in the paper industry. TEII's Tuscaloosa
Facility takes in post consumer low density recyclable plastics and processes
the material through a washing, grinding and extruding process to produce a high
quality, low density plastic resin pellets.

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 is the previous owner of the Facility,
American Ash Recycling Corp. of Tennessee, a Florida corporation, an affiliate
of AAR. The partnership will carry on the business of the predecessor
corporation. The Company has a priority on the distributions of earnings and
cash flow from the 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 consisted of $500,000 in cash and a short-term promissory note
for $1,600,000 which was paid during 1996. AART recycles MWC ash at its
Nashville Facility converting the ash principally into construction aggregate
after recovering recyclable metals.

22
25

Maine Energy, PERC and the Telogia Facility principally derive their
revenues from sale of electric power generated as a by-product of 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. 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.

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 also
make additional quarterly payments through May 31, 2007 to Maine Energy as a
portion of its purchase price and for reimbursement to Maine Energy of certain
expenses. In consideration of its payments to Maine Energy, CL One would be
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. Maine Energy will sell energy to Central
Maine through May 31, 2007 at an initial rate of 7.18 cents per kWh which would
escalate annually by 2% per annum. Beginning June 1, 2007 until the expiration
date of the contract, Maine Energy will 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. As of December 31, 1996 the balance of the subordinated
debt at Maine Energy was $14,575,985.

The disposal fees paid by the municipalities and waste haulers to Maine
Energy and PERC are based on the tons of MSW delivered. The rate charged by each
of Maine Energy and PERC under its long-term contracts for each ton 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 current 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

23
26

of Maine Energy and PERC 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,
-------------------------------
1996 1995 1994
------- ------- -------

MAINE ENERGY:
Long-Term Municipal Contracts................................. 71,203 68,380 70,339
Short-Term Municipal Contracts................................ 45,445 36,214 22,211
Spot Market................................................... 72,634 83,647 120,678
Commercial.................................................... 56,352 36,452 16,125
------- ------- -------
Total............................................... 245,634 224,693 229,353
======= ======= =======
PERC:
Long-Term Municipal Contracts................................. 203,875 200,908 200,464
Short-Term Municipal Contracts................................ 18,341 17,614 25,477
Spot Market................................................... 13,163 16,703 17,218
Commercial.................................................... 18,144 13,396 4,879
------- ------- -------
Total............................................... 253,523 248,621 248,038
======= ======= =======

The Company's MSW waste disposal operations are subject to seasonal
fluctuations. Reduced volumes of waste are generated during the winter months.
This requires reductions in spot market tipping fees and increases 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.

DISCONTINUED OPERATIONS

On February 8, 1995, the Company acquired CSI. As a result of the
acquisition the Company participated in two business segments, waste handling
and computer services. The original business of the Company prior to the Merger
are included in waste handling and the CSI businesses are included in computer
services segment.

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. During the past three years, DataFocus has developed and
brought to market a new software product, NuTCRACKER(TM), which assists
customers in porting from the UNIX to the Microsoft Windows NT operating
environment.

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, on July
26, 1996. 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, are 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.

24
27

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. DataFocus will have the right to repurchase the royalty agreement from the
Company for the following payments: $400,000 prior to July 29, 1997; three 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, 1997 but
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 bears interest of 8% per annum and provides for level quarterly
principal payments to repay the loan over a four year period. The loan is
secured by Company common stock owned by such members of management of
DataFocus. The royalty agreement provides that royalty payments to the Company
terminate three years after the repayment of the loans.

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.

25
28

RESULTS OF OPERATIONS

Year Ended December 31, 1996 Compared with Year Ended December 31, 1995

YEAR ENDED DECEMBER 31,
------------------------------------------
1996 1995
------------------ -----------------
($ THOUSANDS)

Revenue:
Electric power revenues............................ $ 20,821 30.4 % $26,470 69.5 %
Sale of capacity, net.............................. 33,203 48.5 %
Waste processing revenues.......................... 11,024 16.1 % 8,314 21.8 %
Other waste handling revenues...................... 3,459 5.0 % 3,299 8.7 %
------- ----- ------- ---- -
Total revenues............................. 68,507 100.0 % 38,083 100.0 %
Costs and expenses:
Electric power and waste processing operating
costs........................................... 26,453 38.6 % 26,139 68.6 %
Selling, general and administrative................ 2,389 3.5 % 2,941 7.7 %
Interest expense -- net............................ 4,464 6.5 % 9,379 24.6 %
------- ----- ------- ---- -
Total costs and expenses............................. 33,306 48.6 % 38,459 101.0 %
Equity in net income of PERC......................... 332 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............................................... 35,237 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................ 16,627 24.3 % (1,328) (3.5)%
Income taxes......................................... (65) (0.2)%
------- ----- ------- ---- -
Income (loss) from continuing operations before
extraordinary item................................. 16,627 24.3 % (1,393) (3.7)%
Discontinued operations
Loss from discontinued operations.................. (714) (1.0)% (86) (0.2)%
------- ----- ------- ---- -
Income (loss) before extraordinary item.............. 15,913 23.2 % (1,479) (3.9)%
Extraordinary item -- gain (loss) on early
extinguishment of debt, net of minority interest... (2,247) (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 decreased revenue 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.

Sale of capacity, net was $33,203,000 for the year ended December 31, 1996
arising from the sale of capacity under Maine Energy's PPA.

Revenues from waste processing increased $2,711,000, or 32.6%, for the year
ended December 31, 1996 compared to the same period in 1995. This increase is
primarily the result of the acquisition of the Nashville Facility which produced
revenues of approximately $1,827,000 from the date of acquisition and increased

26
29

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 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.

Other waste handling revenues for the year ended December 31, 1996
increased by $161,000, or 4.9%, as compared to the year ended December 31, 1995.
This increase is primarily the result of the acquisitions of Manner and the
Nashville Facility which recorded sales of recycled plastic and recovered metals
of $398,000 and $702,000, respectively, from the date of acquisition to December
31, 1996. This was partially offset by decreases in KTI BioFuels revenues of
$749,000 principally resulting from a 22,353 ton, or 29.2% decrease in woodwaste
revenues compared to 1995. This decrease was primarily as the result of
diminished supply of wastewood due to severe weather conditions during the first
quarter of 1996. Lease revenue from transportation equipment decreased by
$239,000 as a result of previous equipment sales.

Costs and Expenses

Waste handling operating costs increased by $314,000, or 1.2%, for the year
ended December 31, 1996, compared to the corresponding period in 1995. The
principal cause of the increase in 1996 is the purchase of TEII, Manner and AART
resulting in increased costs of $2,909,000 during 1996. These increases were
partially offset by decreased depreciation and amortization expenses of
$787,000, primarily as a result of a change in the estimated useful lives of the
plant assets; 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 ($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.

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.

Interest and Other Items

Interest -- net decreased by $4,915,000 or 52.4% during the year ended
December 31, 1996 as compared to the year ended December 31, 1995. The primary
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 principally resulted from the minority interest of 49.62%
share of 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 long-term 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 $2,247,000 for the year ended December 31, 1996,
resulted from the early extinguishment of the Biddeford Bonds at Maine Energy,
net of minority interest.

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 is 7%.

27
30

PERC

Revenues from electric power for 1996 increased by $210,000 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 pass-through 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 agreements 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
$633,000, 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 pass-through cost to municipal
customers. As a result, changes in interest expense do not have a significant
effect on net income.

28
31

Year Ended December 31, 1995 Compared with Year Ended December 31, 1994

YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1994
----------------- ----------------
($ THOUSANDS)

Revenue:
Electric power revenues............................... $26,470 69.5% $26,837 70.5%
Waste processing revenues............................. 8,314 21.8% 7,718 20.3%
Other waste handling revenues......................... 3,299 8.7% 3,230 8.5%
------- ------ ------- ----
-
Total revenues................................ 38,083 100.0% 37,785 99.2%
Costs and expenses:
Electric power and waste processing operating costs... 26,139 68.6% 25,501 67.0%
Selling, general and administrative................... 2,941 7.7% 2,401 6.3%
Interest expense -- net............................... 9,379 24.6% 9,714 25.5%
------- ------ ------- ----
-
Total costs and expenses...................... 38,459 101.0% 37,616 98.8%
Equity in net income of PERC.......................... 335 0.9% 324 0.9%
------- ------ ------- ----
-
Income (loss) from continuing operations before (41) (0.1)% 493 1.3%
minority interest, income taxes and extraordinary
item...............................................
Minority interest..................................... (1,287) (3.4)% (553) (1.5)%
Pre-acquisition earnings minority interest............ (1,367) (3.6)%
------- ------ ------- ----
-
Loss from continuing operations before income taxes (1,328) (3.5)% (1,427) (3.7)%
and extraordinary item.............................
Income taxes.......................................... (65) (0.2)%
------- ------ ------- ----
-
Loss from continuing operations before (1,393) (3.7)% (1,427) (3.7)%
extraordinary item.................................
Discontinued operations
Loss from discontinued operations.................. (86) (0.2)%
------- ------ ------- ----
-
Loss before extraordinary item........................ (1,479) (3.9)% (1,427) (3.7)%
Extraordinary item -- gain on early extinguishment 148 0.4%
of debt............................................
------- ------ ------- ----
-
Net loss.............................................. $(1,331) (3.5)% $(1,427) (3.7)%
======= ====== ======= =====

Revenues

Electric power revenues decreased by $367,000, or 1.4%, for the year ended
December 31, 1995 compared to 1994. The decrease resulted from a decrease in
electric power generated by Maine Energy of 1.8% for 1995, which was partially
offset by a 0.2% increase in the contract rate per kilowatt hour in 1995.

Revenues from waste processing increased $596,000, or 7.7%, for the year
ended December 31, 1995 compared to the same period in 1994. The increase
resulted from an increase at Maine Energy in the average tipping fee of $4.97,
per ton or 16.1%, principally in spot market and commercial tonnage, and from a
shift in mix in waste received in 1995 to higher priced municipal and commercial
tonnage. The volume of MSW received in 1995 decreased by 4,660 tons, or 2.0%, in
1995. The average tipping fee increase resulted in an increase in revenues of
$1,117,000, and the decrease in volume resulted in a decrease of $145,000. This
amount was partially offset by the absence in 1995 of the recovery from the
State of Maine of waste import fees of $640,000 recorded in the year ended
December 31, 1994.

Other waste handling revenues for the year ended December 31, 1995
increased by $69,000, or 2.1%, as compared to the year ended December 31, 1994.
This increase is primarily a result of increases in KTI BioFuels tipping fee
revenues of $621,000 and woodchip sales of $154,000, both principally resulting
from

29
32

increases in tonnage in 1995 compared to the prior year. These increases were
offset in part by the absence in 1995 of revenues from transportation services.
Transportation revenues in 1994, the final year of the Company's active
participation in the transportation business, were $510,000. Also included in
other waste handling revenues is rental income, principally of transportation
equipment, of $298,000 and $292,000 for the years ended December 31, 1995 and
1994, respectively.

Costs and Expenses

Electric power and waste handling operating costs increased by $638,000, or
2.5%, for the year ended December 31, 1995, compared to the corresponding period
in 1994. Principal causes of the increase in 1995 include costs resulting from
the settlement of claims of $389,000 relating to businesses sold in prior years,
and a provision of $521,000 to reduce the carrying value of certain
transportation equipment and additional equipment and maintenance expense of
$502,000 and depreciation expense of $413,000 both at Maine Energy. These
increases were partially offset by a $543,000 decrease in costs of the
transportation business which reduced operations in the fourth quarter of 1994
and a decrease of $375,000 in amortization as a result of deferred renegotiation
costs being fully amortized at Maine Energy.

Selling, general and administrative expenses increased by $540,000, or
22.4%, for the year ended December 31, 1995 as compared to the year ended
December 31, 1994. The increase principally resulted from $380,000 of payroll
and related costs principally attributed to the corporate staff and increases in
consulting expenses of $132,000.

Interest and Other Items

Interest expense -- net decreased by $336,000 during the year ended
December 31, 1995 as compared to the year ended December 31, 1994. The primary
decreases for the year were $272,000 resulting from decreases in obligations
related to transportation equipment and $152,000 resulting from the
extinguishment of the debt owed to CSI prior to the Merger. These decreases were
offset in part by a net increase of $116,000 at Maine Energy. The increase at
Maine Energy is the result of a $636,000 increase in interest on its variable
rate bond debt partially offset by a $242,000 increase in interest income, a
$160,000 decrease in subordinated note interest resulting from a repayment of
principal and a $118,000 reduction in letter of credit fees resulting from a
decrease in the principal amount of bonds outstanding.

Minority interest of $1,287,000 for the year ended December 31, 1995
resulted from the elimination of 49.62% of Maine Energy's net income, net of
amortization of the step up in basis of certain assets. In 1994, 90% of the net
income of Maine Energy was eliminated as "Pre-acquisition Earnings" for income
prior to September 16, 1994.

Equity in the net income of PERC increased by $11,000, or 3.4%, for the
year ended December 31, 1995. The increase resulted from an increase in PERC's
net income of $151,000. The Company's ownership interest in PERC is 7%.

PERC

Revenues from electric power for 1995 increased by $389,000 over 1994, as a
result of a 2.4% increase in contract rate per kilowatt for 1995. Waste
processing revenues for 1995 increased $597,000, or 5.6%, compared to 1994. This
resulted principally from a $4.37 per ton, or 10.6%, increase in PERC's average
tipping fee arising principally as the result of the pass-through of increases
in the interest paid on PERC's variable rate bonds. 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 pass-through facility costs and change in law pricing provisions.
Waste processing revenue in 1994 included a $306,000 retroactive adjustment for
1993 pass-through costs and the refund of $174,000 of fees for imported MSW paid
in prior years. No such adjustments occurred in 1995. Operating expenses for the
year ended December 31, 1995 increased $687,000, or 3.6%, as compared with the
year ended December 31, 1994, principally due to an increase of $978,000 in
performance credits payable to the Charter Municipalities partially offset by
reductions in disposal costs.

30
33

Net interest expense for the year ended December 31, 1995 increased by
$148,000, or 4.0%, as compared with the year ended December 31, 1994. This
increase was primarily due to the increase in interest rates on the variable
rate bond debt offset by a reduction in outstanding principal on such bonds.
Interest expense on the variable rate bond debt is a pass through cost to
municipal customers. As a result, changes in interest expense do not have a
significant effect on net income.

LIQUIDITY AND CAPITAL RESOURCES

The Company is a holding company and receives cash flow from its
subsidiaries. Receipt of cash flow from its affiliate PERC is currently
restricted by covenants under loan agreements, distribution restrictions under
partnership agreements with its equity investors, and put-or-pay agreements with
municipalities. Maine Energy's cash flow is required to retire the remaining
outstanding balance of $14,575,985 as of December 31, 1996 before partners cash
distributions can begin. As a result, the following discussion is organized to
present liquidity and capital resources of the Company separate from Maine
Energy and PERC and liquidity and capital resources of each of Maine Energy and
PERC independently.

The Company

Through December 31, 1996, the Company has accumulated management fees
receivable from PERC in the amount of $2,279,000. These fees are payable by PERC
only out of cash flow after all current operating costs and debt service
payments of the project. PERC has significant restrictions on the amount of cash
flow that can be distributed to the Company. Also, management fees are only paid
annually and only if the partnership meets certain operating results set forth
in its loan documents.

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 a
$1,693,000 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 of the Company 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. As of December 31, 1996
the Company owed ENI $1,353,479. During 1996, the Company received $691,442 in
current and accrued management fees on account of 1995 operations of which
$298,311 was paid to ENI.

The Company anticipates receipt of cash from PERC during 1997 on account of
1996 operations of $686,363 of which $389,381 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 1996 the Company
received $548,080 for operating and management fees from Maine Energy on account
of 1996 operations. The Company also received $857,534 for accrued management
fees through February 28, 1990.

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 is due on October 31, 2002
and is convertible into the Company's common stock at a conversion price of
$8.50 per share. The Notes are subordinated to bank debt. The Note Purchase
Agreement has customary and usual covenants, including limitations in incurring
additional indebtedness and on incurring liens on assets. The $8.50 per share
conversion price may be adjusted in certain circumstances under antidilution
provisions. Of the proceeds, $2,300,000 was used to fund certain designated
acquisition costs of TEII. The balance was used for transaction costs of
approximately $200,000 and working capital.

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

31
34

financing, unsecured subordinated debt, borrowings from CSI prior to the Merger
and proceeds from the sale of the Company's common stock.

The Company and its subsidiaries, other than Maine Energy and PERC, at
December 31, 1996 had indebtedness maturing in 1997 of $4,124,000. During 1996,
the Company, other than Maine Energy and PERC, incurred additional debt of
approximately $23,664,000, primarily as a result of the acquisition of TEII and
the issuance of 8%, convertible subordinated debt and retired approximately
$7,400,000 of debt.

As of December 31, 1996, the Company had cash on hand without regard to
Maine Energy and PERC of approximately $3,579,000 and $490,000 available in
lines of credit from a bank. Management of the Company believes that cash flow
from its subsidiaries and affiliates and unused lines 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. There are no pending agreements or
commitments relating to either new debt or equity financing by the Company.

Maine Energy

During the last three years Maine Energy has financed its operations and
capital expenditures from cash flows from operations. Cash provided by
operations was $89,259,000 in 1996, as compared to $8,987,000 in 1995. During
1996 Maine Energy sold its generating capacity to CL One for a period through
May 31, 2007. In exchange CL One has agreed to make a series of quarterly
payments to Maine Energy including an initial payment of $85 million. Maine
Energy capital expenditures were $2,939,000 and $2,121,000 for additions to
property, plant and equipment during 1996 and 1995, respectively.

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, 1996 and December 31, 1995, in addition to Maine
Energy's operating cash of $1,648,000 and $5,507,000, respectively, Maine
Energy, as required under the terms of the credit agreement with the issuer of
its letter of credit, has on account an additional $7,433,000 and $13,363,000,
respectively, of reserves to be used for capital improvements, debt service,
operating shortfalls and working capital requirements.

Management of the Company believes Maine Energy has adequate cash resources
available to fund its future operations and anticipated capital expenditures.
Capital expenditures for Maine Energy for the year ending December 31, 1997 are
expected to be approximately $2,581,000, which has principally been set aside in
the above mentioned reserves accounts.

PERC

PERC has financed its recent operations and capital expenditures primarily
by cash flow from operations. Cash provided by operations was $8,493,000 in 1996
as compared to $10,328,000 in 1995. PERC's capital expenditures were $1,192,000
and $1,172,000 for additions to property, plant and equipment during 1996 and
1995, respectively.

At December 31, 1996 and December 31, 1995, PERC had outstanding
tax-exempt, variable rate revenue bonds backed by bank letters of credit in the
aggregate amounts of $53,500,000 and $59,400,000, respectively. The variable
interest rate on the Orrington Bonds at December 31, 1996 and 1995 was 4.25% and
6.125%, respectively. The bonds are payable pursuant to a schedule through May
2003. During 1996 and 1995 PERC made principal payments to bondholders in the
amounts of $5,900,000 and $4,900,000, respectively.

As of December 31, 1996 and 1995, in addition to PERC's operating cash of
$5,440,000 and $6,465,000, respectively, PERC, as required under the terms of
the credit agreement with its letter of credit banks and the trust indenture
governing the Orrington Bonds, had on account an additional $8,482,000 and
$8,364,000, respectively, of cash reserves to be used for capital improvements,
debt service, operating shortfalls and working capital requirements.

32
35

Company management believes PERC has adequate cash resources available to
fund its current project operations and currently anticipated capital
expenditures. PERC plans capital expenditures for the year ending December 31,
1997 of approximately $782,000. PERC intends to finance the requirements through
cash flow from operations.

TAX LOSS CARRYFORWARDS

At December 31, 1996, the Company had net operating loss carryforwards of
approximately $47,587,000 for income tax purposes that expire in years 2002
through 2010 and are subject to the limitations described below. In addition,
the Company has general business credits carryforwards of approximately $530,000
that expire in the years 1999 through 2006 and alternative minimum tax credits
of approximately $687,000 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 at the Company. 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
$1,100,000 of taxable income, or approximately $375,000 of equivalent credit per
year.

As a result of the Company's acquisition of TEII, the Company's ability to
utilize TEII's net operating loss carryforwards will be limited to approximately
$874,000 per year. These limitations may be increased if the Company recognizes
a gain on the disposition of the respective assets which had a fair market value
greater than its tax basis on the date of the ownership change.

ENVIRONMENTAL CONTINGENCIES

While increasing environmental regulation often presents new business
opportunities to the Company and PERC, it likewise often results in increased
operating costs as the Company and PERC 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. There were no pending
governmental environmental enforcement proceedings where the Company or PERC
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 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.

33
36

INFLATION

The effect of inflation on operating costs has been minimal in recent
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.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of the Company and those of its
unconsolidated equity basis investees, Penobscot Energy Recovery Company,
together with the reports of independent auditors thereon and related schedules
appear on pages F-27 to F-37.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

Incorporated by reference to the Company's definitive proxy statement for
the 1997 Annual Meeting of Shareholders which will be filed with the Securities
and Exchange Commission on or before April 30, 1997.

ITEM 11. EXECUTIVE COMPENSATION

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

34
37

PART IV

ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) The following financial statements are filed as a part of this report:

CONSOLIDATED FINANCIAL STATEMENTS OF KTI, INC.:
Report of Independent Auditors..................................................
Consolidated Balance Sheets at December 31, 1996 and 1995.......................
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 1996.......................................................
Consolidated Statements of Stockholders Equity (Deficit) for each of the three
years in the period ended December 31, 1996...................................
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 1996.......................................................
Notes to Consolidated Financial Statements......................................
FINANCIAL STATEMENTS OF PENOBSCOT ENERGY RECOVERY COMPANY:
Report of Independent Auditors..................................................
Balance Sheets at December 31, 1996 and 1995....................................
Statements of Income for each of the three years in the period ended
December 31, 1996.............................................................
Statements of Changes in Partners' Capital for each of the three years in the
period ended December 31, 1996................................................
Statements of Cash Flows for each of the three years in the period ended
December 31, 1996.............................................................
Notes to Financial Statements...................................................

(b) The following exhibits which are furnished with this report or
incorporated herein by reference, are filed as part of this report.

EXHIBIT INDEX

*2. Agreement and Plan of Merger (filed as Annex I to the Joint Proxy Statement
Prospectus part of the Registrant's Registration Statement on Form S-4 (No.
33-85234) effective January 6, 1995).
(1)3.1 Restated Certificate of Incorporation of Registrant filed with the Secretary of
State of the State of New Jersey on July 12, 1994, as amended through March 13,
1995.
(12)3.2 By-Laws of Registrant, as amended.
*4.1 Specimen Form of Common Stock Certificate.
(3)4.2 Form of Warrant.
(3)4.3 Loan Agreement dated as of June 1, 1985 between City of Biddeford, Maine and
Maine Energy Recovery Company, as amended.
(3)4.4 Subordinated Note of Maine Energy Recovery Company dated as of December 1, 1990
in the original principal amount of $14,252,338.39 payable to CNA Realty Corp.
(3)4.5 Subordinated Note of Maine Energy Recovery Company dated as of December 1, 1990
in the original principal amount of $9,495,327.45 payable to Energy National,
Inc.
(3)4.6 Subordinated Note of Maine Energy Recovery Company dated as of December 1, 1990
in the original principal amount of $4,737,517.54 payable to Project Capital
1985.

35
38

(3)4.7 Loan Agreement dated as of April 1, 1986 between Town of Orrington, Maine and
Penobscot Energy Recovery Company, as amended.
(3)4.8 Credit Agreement dated as of May 15, 1986 by and among Penobscot Energy Recovery
Company, PERC Management Company and Energy National, Inc. and The Banking
Institutions Signatory Hereto and Bankers Trust Company, as Agent, as amended.
*10.1 Second Amended and Restated Agreement and Certificate of Limited Partnership of
Penobscot Energy Recovery Company dated May 15, 1986, as amended.
*10.2 Agreement between Penobscot Energy Recovery Company and Bangor Hydro-Electric
Company dated June 21, 1984, as amended.
*10.3 Form of Penobscot Energy Recovery Company Waste Disposal Agreement (City of
Bangor) dated April 1, 1991 and Schedule of Substantially Identical Waste
Disposal Agreements.
*10.4 Operation and Maintenance Agreement Between Esoco Orrington, Inc. and Penobscot
Energy Recovery Company dated June 30, 1989.
*10.5 Residue Disposal Agreement between Penobscot Energy Recovery Company and Sawyer
Environmental Recovery Facilities, Inc. dated September 19, 1985, as amended.
*10.6 Amended and Restated Bypass Agreement between Sawyer Environmental Recovery
Facilities, Inc. and Penobscot Energy Recovery Company dated April 4, 1994.
*10.7 Second Amended and Restated Agreement and Certificate of Limited Partnership of
Maine Energy Recovery Company dated June 30, 1986, as amended.
*10.8 Power Purchase Agreement Between Maine Energy Recovery Company and Central Maine
Power Company dated January 12, 1984, as amended.
*10.9 Operation and Maintenance Agreement Between Maine Energy Recovery Company and KTI
Operations, Inc. dated December 1, 1990.
*10.10 Host Municipalities' Waste Handling Agreement among Biddeford-Saco Solid Waste
Committee, City of Biddeford, City of Saco and Maine Energy Recovery Company
dated June 7, 1991.
*10.11 Form of Maine Energy Recovery Company Waste Handling Agreement (Town of North
Berwick) dated June 7, 1991 and Schedule of Substantially Identical Waste
Disposal Agreements.
*10.12 Material Disposal and Transportation Agreement among Consolidated Waste Service,
Inc., Waste Management of New Hampshire and Maine Energy Recovery Company dated
October 21, 1991.
*10.13 Front-End Process Residue Agreement between Arthur Schofield, Inc. and Maine
Energy Recovery Company dated May 27, 1994.
*10.14 Second Amended and Restated Agreement and Certificate of Limited Partnership of
FTI Limited Partnership dated December 11, 1986, as amended.
*10.15 Land Lease dated November 25, 1985 between City of Lewiston and Fuel
Technologies, Inc. as amended.
*10.16 KTI, Inc. 1994 Long-Term Incentive Award Plan.
*10.17 Employment Agreement between KTI, Inc. and Nicholas Menonna, Jr. dated May 1,
1994.
*10.18 Employment Agreement between KTI, Inc. and Martin J. Sergi dated May 1, 1994.
*10.19 Registration Rights Agreement between Davstar Managed Investments Corp. and KTI
Environmental Group, Inc. dated March 17, 1993.
*10.20 Registration Rights Agreement among KTI Environmental Group, Inc., Martin J.
Sergi and Midlantic National Bank dated May 10, 1994.
*10.21 Registration Rights Agreement among KTI Environmental Group, Inc., Nicholas
Menonna, Jr. and Midlantic National Bank dated May 10, 1994.

36
39

(2)10.22 KTI, Inc. Directors Stock Option Plan.
(3)10.23 Form of Registration Rights between KTI, Inc. and Mona Kalimian, Mark D.
Kalimian, and Linda Berley dated July 27, 1995 and Schedule of Substantially
Identical Registration Rights Agreements.
(4)10.24 Letter Agreement dated as of November 10, 1995 among Central Maine Power, Maine
Energy Recovery Company and Citizens Lehman Power.
(4)10.25 Global Agreement dated December 28, 1995 between Environmental Capital Holdings,
Inc. and KTI, Inc.
(4)10.26 Agreement of Limited Partnership of American Ash Recycling of Tennessee, Ltd.
dated December 28, 1995.
(4)10.27 Agreement of Limited Partnership of American Ash Recycling of New England, Ltd.
dated December 28, 1995.
(5)10.28 First Amendment to Agreement of Limited Partnership of American Ash Recycling of
Tennessee, Ltd., dated March 16, 1996.
(6)10.29 Agreement dated as of July 19, 1996 by and among KTI, Inc., DataFocus
Incorporated and CIBER, Inc.
(6)10.30 Agreement dated July 19, 1996 by and among KTI, Inc., Thomas Bosanko and
Patrick B. Higbie.
(7)10.31 Operating Agreement of Specialties Environmental Management Company, LLC dated as
of October 18, 1996.
(8)10.32 Amendment to Employment Agreements between KTI, Inc. and Nicholas Menonna, Jr.
and Martin J. Sergi.
(9)10.33 Note Purchase Agreement dated as of October 23, 1996 between KTI, Inc. and
WEXFORD KTI LLC.
(9)10.34 Registration Rights Agreement dated as of October 23, 1996 between KTI, Inc. and
WEXFORD KTI LLC.
(9)10.35 Escrow Agreement dated as of October 23, 1996 between KTI, Inc. and WEXFORD KTI
LLC and Key Trust of Ohio, N.A.
(10)10.36 Securities Purchase Agreement by and among KTI Plastic Recycling, Inc.,
Continental Casualty Company, CNA Realty Corp., CLE, Inc. and Timber Energy
Investment, Inc. dated as of November 22, 1996.
(11)10.37 Securities Purchase Agreement by and among KTI Plastic Recycling, Inc. and Diane
Goodman and Seth Lehner dated as of November 25, 1996.
(12)10.38 Loan and Security Agreement between KTI, Inc., KTI Environmental Group, Inc.,
Kuhr Technologies, Inc., KTI Limited Partners, Inc., KTI Operations, Inc. and
PERC, Inc., Borrowers, and Key Bank of New York, Lender, dated October 29, 1996.
(12)10.39 Pledge Agreement between each Borrower and Key Bank of New York dated October 29,
1996 (6 Agreements).
(12)10.40 Key Trust Company PRISM Prototype Retirement Plan and Trust adopted as of
December 11, 1996.
(12)10.41 Option and Consulting Agreement by and among KTI, Inc. and L.T. Lawrence & Co.,
Inc. dated as of June 1, 1996.
(12)10.42 First Amendment to Option and Consulting Agreement by and among KTI, Inc. and
L.T. Lawrence & Co., Inc. dated as of December 18, 1996.
(12)10.43 Warrant to purchase 200,000 shares of KTI, Inc. common stock at $7.50 per share
issued to L.T. Lawrence & Co., Inc. dated as of December 18, 1996.

37
40

(12)10.44 Warrant to purchase 6,000 shares of KTI, Inc. common stock at $8.50 per share
issued to Thomas E. Schulze dated as of January 2, 1997.
(12)10.45 Warrant to purchase 3,000 shares of KTI, Inc. common stock at $8.50 per share
issued to John E. Turner dated as of January 2, 1997.
(12)10.46 Warrant to purchase 6,000 shares of KTI, Inc. common stock at $8.50 per share
issued to Robert E. Wetzel dated as of January 2, 1997.
(12)10.47 Warrant to purchase 15,000 shares of KTI, Inc. common stock at $6.00 per share
issued to The Baldwin & Clarke Companies dated as of January 2, 1997.
(12)10.48 Warrant to purchase 15,000 shares of KTI, Inc. common stock at $7.00 per share
issued to The Baldwin & Clarke Companies dated as of January 2, 1997.
(12)10.49 Third Amendment to Second Amended and Restated Certificate and Agreement of
Limited Partnership of FTI Limited Partnership dated as of January 23, 1997.
(12)10.50 Warrant to purchase 2,000 shares of KTI, Inc. common stock at $8.50 per share
issued to Maine Woodchips Associates dated as of January 23, 1997.
(12)10.51 Registration Rights Agreement by and between KTI, Inc. and Maine Woodchips
Associates dated as of January 23, 1997.
(12)21 List of all subsidiaries of Registrant.
(12)23.1 Consent of Ernst & Young LLP

- ---------------

* Filed as an Exhibit to Registrant's Registration Statement on Form S-4 (No. 33-85234)
effective January 6, 1995.
(1) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated March 13, 1995.
(2) Filed as an Exhibit to Registrant's Proxy Statement dated June 5, 1995.
(3) Filed with the Registration Statement on Form S-1 dated December 6, 1995.
(4) Filed with the Amendment No. 1 to the Registration Statement on Form S-1 dated February
2, 1996.
(5) Filed as an Exhibit to Registrant's Current Report on Form 8-K dated April 15, 1996.
(6) Filed with Form 8-K dated July, 1996.
(7) Filed with Form 8-K dated October 18, 1996.
(8) Filed with Form 8-K dated October 23, 1996.
(9) Filed with Form 8-K dated October 24, 1996.
(10) Filed with Form 8-K dated November 22, 1996.
(11) Filed with Form 8-K dated November 25, 1996.
(12) Filed herewith.

REPORTS ON FORM 8-K FILED DURING THE FOURTH QUARTER OF 1996

Four Reports on Form 8-K were filed in the fourth quarter of 1996. No
financial statements were included with such Forms 8-K. The following is a list
of the Forms 8-K filed and the dates thereof.

(i) A Form 8-K was filed on October 28, 1996 reporting that Nicholas
Menonna, Jr., Chairman of the Board of Directors and Chief Executive
Officer and Martin J. Sergi, President, Chief Operating Officer and Chief
Financial Officer propose to modify certain provisions of their employment
contract with respect to their 1996 bonuses, resulting in a significant
reduction in their expected compensation.

38
41

(ii) A Form 8-K was filed on October 31, 1996 reporting the execution
of a Note Purchase Agreement with Wexford KTI LLC, a Delaware limited
liability company. Pursuant to the Note Purchase Agreement, the Company
issued an 8%, $5,000,000 convertible subordinated note to Wexford KTI LLC.

(iii) A Form 8-K was filed on December 3, 1996 to report the execution
of an agreement to purchase certain investments in Timber Energy
Investments, Inc.

(iv) A Form 8-K was filed on December, 1996 to report the execution of
an agreement to purchase all of the common stock of Manner, Inc., a
Maryland corporation.

39
42

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

KTI, INC. (Registrant)

By: /s/ NICHOLAS MENONNA, JR. Date: March 28, 1997
--------------------------------
Nicholas Menonna, Jr.
Chairman of the Board,
and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.

SIGNATURE TITLE DATE
- ------------------------------------------ --------------------------------- ---------------

/s/ NICHOLAS MENONNA, JR. Chairman of the Board, Chief March 28, 1997
- ------------------------------------------ Executive Officer and Director
Nicholas Menonna, Jr. (Principal Executive Officer)

/s/ MARTIN J. SERGI Vice Chairman, President, Chief March 28, 1997
- ------------------------------------------ Operating Officer, Chief
Martin J. Sergi Financial Officer and Director
(Principal Financial and
Accounting Officer)
- ------------------------------------------ Director March 28, 1997
Robert M. Davies

/s/ JEFFREY R. POWER Director March 28, 1997
- ------------------------------------------
Jeffrey R. Power

/s/ ROSS PIRASTEH Director March 28, 1997
- ------------------------------------------
Ross Pirasteh

/s/ DIBO ATTAR Director March 28, 1997
- ------------------------------------------
Dibo Attar

Director March 28, 1997
- ------------------------------------------
Jack Polak

40
43

KTI, INC.

INDEX TO FINANCIAL STATEMENTS

PAGE
----

The following consolidated financial statements and schedules of KTI, Inc. are
included in Item 3:

CONSOLIDATED FINANCIAL STATEMENTS OF KTI, INC.:
Report of Independent Auditors...................................................... F-2
Consolidated Balance Sheets at December 31, 1996 and 1995........................... F-3
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 1996........................................................... F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit) for each
of the three years in the period ended December 31, 1996.......................... F-5
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 1996........................................................... F-6
Notes to Consolidated Financial Statements.......................................... F-7
FINANCIAL STATEMENTS OF PENOBSCOT ENERGY RECOVERY COMPANY:
Report of Independent Auditors...................................................... F-25
Balance Sheets at December 31, 1996 and 1995........................................ F-26
Statements of Income for each of the three years in the period ended December 31,
1996.............................................................................. F-27
Statements of Changes in Partners' Capital for each of the three years in the period
ended December 31, 1996........................................................... F-28
Statements of Cash Flows for each of the three years in the period ended December
31, 1996.......................................................................... F-29
Notes to Financial Statements....................................................... F-30
The following consolidated financial statement schedule of KTI, Inc. is included in
Item 14(d):
II Valuation and Qualifying Accounts.......................................... F-34

All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore have
been omitted.

F-1
44

REPORT OF INDEPENDENT AUDITORS

The Board of Directors
KTI, Inc.

We have audited the accompanying consolidated balance sheets of KTI, Inc.
as of December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1996. Our audits also included the
financial statement schedule listed in the Index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of KTI, Inc. at
December 31, 1996 and 1995, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31, 1996
in conformity with generally accepted accounting principles. Also, in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.

ERNST & YOUNG LLP

Hackensack, New Jersey
February 28, 1997

F-2
45

KTI, INC.

CONSOLIDATED BALANCE SHEET

DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------

ASSETS
Current Assets
Cash and cash equivalents..................................... $ 5,227,381 $ 6,454,558
Restricted funds -- current portion........................... 5,163,965 7,042,404
Accounts receivable, net of allowances of $291,939 and
$480,662................................................... 4,080,503 8,983,699
Management fees receivable -- current portion................. 566,634 556,578
Consumables and spare parts................................... 2,100,311 1,258,397
Notes receivable -- officers/shareholders and
affiliates -- current...................................... 57,629 96,225
Other receivables............................................. 398,320 295,723
Other current assets.......................................... 480,034 742,638
------------ ------------
Total current assets.................................. 18,074,777 25,430,222
Restricted funds................................................ 2,903,761 6,502,227
Management fees receivable -- affiliates........................ 2,175,203 2,376,696
Notes receivable -- officers/shareholders and affiliates........ 212,835 224,438
Other receivables............................................... 711,783 495,901
Investment in PERC.............................................. 3,792,429 3,594,638
Deferred costs, net of accumulated amortization of $208,096 and
$524,236...................................................... 1,020,120 3,818,732
Goodwill and other intangibles, net of accumulated amortization
of $297,941 and $539,483...................................... 2,179,466 3,613,621
Deferred project development costs.............................. 909,998
Other assets.................................................... 238,893 486,778
Property, equipment and leasehold improvements, net of
accumulated depreciation of $12,671,949 and $10,108,341....... 90,855,366 86,363,180
------------ ------------
Total assets.......................................... $123,074,631 $132,906,433
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.............................................. $ 2,371,430 $ 2,512,109
Accrued expenses.............................................. 1,829,959 5,322,013
Current portion of long-term debt............................. 4,123,840 7,977,899
Income taxes payable.......................................... 200,000 290,000
Other current liabilities..................................... 465,585 614,837
------------ ------------
Total current liabilities............................. 8,990,814 16,716,858
Other liabilities............................................... 1,308,199 70,368
Long-term debt, less current portion............................ 34,949,148 107,398,263
Minority interest............................................... 10,871,852 1,840,377
Deferred revenue................................................ 41,250,000
Commitments and contingencies
Stockholders' equity
Preferred stock; 10,000,000 shares authorized,
no shares issued or outstanding
Common stock, no par value (stated value $.01 per share);
authorized 13,333,333; issued and outstanding 6,836,766
in 1996 and 5,946,973 in 1995.............................. 68,368 59,470
Additional paid-in capital...................................... 38,575,892 33,427,091
Accumulated (deficit)........................................... (12,939,642) (26,605,994)
------------ ------------
Total stockholders' equity...................................... 25,704,618 6,880,567
------------ ------------
Total liabilities and stockholders' equity............ $123,074,631 $132,906,433
============ ============

See accompanying notes.

F-3
46

KTI, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
----------- ----------- -----------

Revenues:
Electric power revenues............................... $20,820,860 $26,470,093 $26,836,890
Sale of capacity, net................................. 33,203,252
Waste processing revenues............................. 11,024,265 8,313,434 7,718,172
Other waste handling revenues......................... 3,459,546 3,298,984 3,229,640
----------- ----------- -----------
Total revenues................................ 68,507,923 38,082,511 37,784,702
Costs and expenses:
Electric power and waste processing operating costs... 26,453,290 26,139,179 25,500,606
Selling, general and administrative:.................. 2,389,008 2,940,941 2,401,059
Interest -- net....................................... 4,463,873 9,378,605 9,714,599
----------- ----------- -----------
Total costs and expenses...................... 33,306,171 38,458,725 37,616,264
Equity in net income of PERC............................ 332,655 334,844 324,283
Loss on sale of investments............................. (296,459)
----------- ----------- -----------
Income (loss) from continuing operations before minority
interest, income taxes and extraordinary item......... 35,237,948 (41,370) 492,721
Minority interest....................................... 18,609,797 1,287,005 553,372
Pre-acquisition earnings minority interest -- Maine
Energy................................................ 1,366,968
----------- ----------- -----------
Income (loss) from continuing operations before income
taxes and extraordinary item.......................... 16,628,151 (1,328,375) (1,427,619)
Income taxes............................................ -- 65,000 --
----------- ----------- -----------
Income (loss) from continuing operations before
extraordinary item.................................... 16,628,151 (1,393,375) (1,427,619)
Discontinued operations Loss from discontinued
operations (including a loss on disposal of $549,788
and income taxes of $200,000 in 1996)................. (714,422) (85,897) --
----------- ----------- -----------
Income before extraordinary item........................ 15,913,729 (1,479,272) (1,427,619)
Extraordinary item -- gain (loss) on early
extinguishment of debt, net of minority interest... (2,247,377) 147,778
----------- ----------- -----------
Net income (loss)....................................... $13,666,352 $(1,331,494) $(1,427,619)
=========== =========== ===========
Earnings (loss) per common share and common share
equivalent:
Primary:
Income (loss) from continuing operations.............. $ 2.61 $ (0.26) $ (0.42)
Loss from discontinued operations..................... (0.11) (0.02) --
----------- ----------- -----------
Income (loss) before extraordinary item............... 2.50 (0.28) (0.42)
Extraordinary item.................................... (0.35) 0.03 --
----------- ----------- -----------
Net income (loss)..................................... $ 2.15 $ (0.25) $ (0.42)
=========== =========== ===========
Weighted average number of shares used in
computation........................................ 6,359,593 5,263,797 3,409,081
=========== =========== ===========
Fully-diluted:
Income (loss) from continuing operations.............. $ 2.46 $ (0.26) (0.42)
Loss from discontinued operations..................... (0.10) (0.02) --
----------- ----------- -----------
Income (loss) before extraordinary item............... 2.36 (0.28) (0.42)
Extraordinary item.................................... (0.32) 0.03 --
----------- ----------- -----------
Net income (loss)..................................... $ 2.03 $ (0.25) $ (0.42)
=========== =========== ===========
Weighted average number of shares used in
computation........................................ 6,925,976 5,263,797 3,409,081
=========== =========== ===========

See accompanying notes.

F-4
47

KTI, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

COMMON STOCK ADDITIONAL
------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------- ----------- ------------ -----------

Balance at December 31, 1993........ 3,463,110 $34,631 $21,459,154 $(23,398,705) $(1,904,920)
Net loss.......................... (1,427,619) (1,427,619)
Repurchase and cancellation of
common stock................... (86,493) (865) (129,083) (448,176) (578,124)
--------- ------- ----------- ------------ -----------
Balance at December 31,1994......... 3,376,617 33,766 21,330,071 (25,274,500) (3,910,663)
Net loss.......................... (1,331,494) (1,331,494)
Issuance of common stock from
exercise of stock options...... 73,980 740 256,077 256,817
Issuance of common stock in
connection with business
combination.................... 1,801,044 18,010 8,983,708 9,001,718
Issuance of common stock.......... 695,332 6,954 2,857,235 2,864,189
--------- ------- ----------- ------------ -----------
Balance at December 31, 1995........ 5,946,973 59,470 33,427,091 (26,605,994) 6,880,567
Net income........................ 13,666,352 13,666,352
Issuance of common stock under
exercise of stock options...... 55,346 553 280,107 280,660
Issuance of common stock from
exercise of warrants........... 41,183 412 225,114 225,526
Issuance of common stock upon
conversion of debt............. 725,015 7,250 4,044,697 4,051,947
Issuance of stock purchase
warrants....................... 143,738 143,738
Issuance of common stock in
connection with business
combination.................... 68,249 683 455,145 455,828
--------- ------- ----------- ------------ -----------
Balance at December 31, 1996........ 6,836,766 $68,368 $38,575,892 $(12,939,642) $25,704,618
========= ======= =========== ============ ===========

See accompanying notes.

F-5
48

KTI, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31,
----------------------------------------------
1996 1995 1994
------------ ----------- -------------

OPERATING ACTIVITIES
Net income (loss)................................................................ $ 13,666,352 $(1,331,494) $ (1,427,619)
Adjustments to reconcile net income (loss) to net cash (used in) provided by
operating activities:
Loss on disposal of discontinued operations.................................... 549,788
Extraordinary loss (gain)...................................................... 2,247,377 (147,778)
Depreciation and amortization.................................................. 6,336,252 7,505,364 2,842,655
Minority interest.............................................................. 18,609,797 1,287,005 553,372
Deferred revenue............................................................... 41,250,000 --
Provision for losses on accounts receivable.................................... 323,750 51,335
Provision for asset valuation.................................................. 23,892 520,500
Interest accrued and capitalized on debt....................................... 1,451,005 2,237,816 298,034
Non-cash employee compensation from stock purchase............................. -- 51,962
Non-cash interest expense from issuance of warrants............................ 143,738
Equity in net income of PERC, net of distributions............................. (197,791) (258,467) (324,283)
Loss on sale of assets......................................................... 93,612 83,744 47,000
Loss on sale of debt securities................................................ 296,459
Changes in operating assets and liabilities
Increasing (decreasing) cash:
Accounts receivable.......................................................... 4,702,570 (2,342,539) 1,132,173
Management fees receivable................................................... 191,437 98,930 551,758
Consumables and spare parts.................................................. (841,914) (23,376) (35,440)
Other receivables............................................................ 201,451 513,103 404,192
Other assets................................................................. 814,277 (92,788) 532,722
Notes receivable............................................................. (459,930) 90,000
Accounts payable............................................................. (3,282,978) (318,483) 886,311
Income taxes................................................................. (90,000)
Other liabilities............................................................ (96,130) 157,563 (1,060,164)
------------ ----------- -----------
Net cash provided by operating activities........................................ 85,609,264 8,354,812 4,452,046
INVESTING ACTIVITIES
Additions to property, equipment and leasehold improvements...................... (3,412,428) (2,916,071) (475,888)
Proceeds from sale of assets..................................................... 469,300 468,426 2,892,798
Proceeds from sale of discontinued operation..................................... 5,005,000 --
Deferred project development costs............................................... (909,998) --
Net change in restricted funds:
Cash equivalents............................................................... (2,858) 5,143,775 4,383,808
Debt securities available-for-sale............................................. 5,579,480 (5,875,939)
Costs incurred in connection with merger......................................... -- (449,761) (787,342)
Cash acquired in merger with Convergent Solutions, Inc........................... -- 2,838,188
Purchase of additional partnership interest in Maine Energy...................... (792,340) -- (1,456,059)
Cash acquired in purchase of additional partnership interest in Maine Energy..... -- 1,723,819
Acquisition of businesses, net of cash acquired.................................. (2,956,828)
Notes receivable -- officers/shareholders and affiliates......................... (9,801) 28,053 145,456
------------ ----------- -----------
Net cash provided by (used in) investing activities.............................. 2,969,527 (763,329) 6,426,592
FINANCING ACTIVITIES
Deferred financing costs......................................................... (1,188,463) (2,091,488) (66,482)
Proceeds from issuance of debt................................................... 8,785,955 400,034 4,974,155
Proceeds from sale of common stock............................................... 506,201 2,973,065 --
Principal payments on debt and costs related to early extinguishment............. (97,909,661) (9,804,750) (8,830,096)
------------ ----------- -----------
Net cash used in financing activities............................................ (89,805,968) (8,523,139) (3,922,423)
------------ ----------- -----------
Decrease in cash and cash equivalents............................................ (1,227,177) (931,656) 6,956,215
Cash and cash equivalents at beginning of period................................. 6,454,558 7,386,214 429,999
------------ ----------- -----------
Cash and cash equivalents at end of period....................................... $ 5,227,381 $ 6,454,558 $ 7,386,214
============ =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid.................................................................... $ 6,144,505 $ 6,619,869 $ 1,880,890
============ =========== ===========
NON CASH INVESTING AND FINANCING ACTIVITIES
Fixed assets disposed of under capital leases.................................... $ 1,427,282
Fixed assets received from AJR in settlement of receivable....................... 707,333
Fixed assets purchased under capital lease....................................... 569,469
Debt issued in connection with:
Purchase of additional partnership interest in Maine Energy.................... $ 164,000 1,572,345
Retirement of common stock for notes receivable -- officer/shareholder........... 578,124
Common Stock issued in connection with the merger with Convergent Solutions,
Inc............................................................................ $ 9,001,718
Liquidation of dent payable to Convergent Solutions, Inc......................... (4,666,127)
Conversion of debt to equity..................................................... 4,051,947
Common Stock issued in connection with the purchase of Manner, Inc............... 455,813

See accompanying notes.

F-6
49

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994

1. ORGANIZATION

KTI, Inc. ("KTI") and subsidiaries (collectively, the "Company"), are
engaged in the development of an integrated waste handling business for
municipal solid and specialty wastes through the development, ownership and
operation of facilities which provide recycling, processing and disposal
services to communities, utilities and commercial waste generators. The
Company's operations are located in the eastern United States. These operations
include its wholly-owned consolidated subsidiaries, its majority-owned
consolidated subsidiaries, including Maine Energy Recovery Company ("Maine
Energy"), American Ash Recycling of Tennessee, Ltd. ("AART"), American Ash
Recycling of New England, Ltd. ("AARNE") and its unconsolidated equity basis
investee, Penobscot Energy Recovery Company ("PERC").

Maine Energy and PERC earn a significant portion of their revenue from
municipalities and the local electric utility in their respective geographic
locations within Maine. In addition, the Company's wholly-owned subsidiary,
Timber Energy Investments, Inc. ("TEII"), earns a substantial portion of its
revenue from an electric utility in the State of Florida and AART earns
substantially all of its revenues as a result of a contract with the City of
Nashville.

Maine Energy, PERC and TEII are subject to the provisions of various
federal and state energy laws and regulations, including the Public Utility
Regulatory Policy Act of 1978, as amended. In addition, federal, state and local
environmental laws establish standards governing certain aspects of the
Company's operations. The Company believes it has all permits, licenses and
approvals necessary to operate.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of KTI and its
wholly-owned and majority-owned subsidiaries. All significant intercompany
accounts and transactions are eliminated in consolidation. As described in Note
7, on September 16, 1994 the Company acquired certain limited partnership
interests in Maine Energy aggregating 40.38%. Prior to this transaction, the
Company was a 10% owner and the sole general partner of Maine Energy. As a
result of the Company's aggregate ownership interest at that date, Maine
Energy's financial statements have been included in the Company's consolidated
statement of operations for the year ended December 31, 1994. In accordance with
Accounting Research Bulletin No. 51, the consolidated statement of operations
includes Maine Energy's operations for the year ended December 31, 1994 as
though the acquisition had occurred at the beginning of the year and includes
adjustments to eliminate minority interest and the pre-acquisition earnings of
Maine Energy attributable to the partnership interests acquired on September 16,
1994.

The Company's investment in PERC is accounted for under the equity method
based on the Company's significant influence over its financial and operating
policies (see Note 8).

The ownership interest of minority owners in the equity and earnings of the
Company's less than 100 percent-owned consolidated subsidiaries is recorded as
minority interest. The Company accounts for 100 percent of the losses of those
consolidated subsidiaries in which the minority owners' are limited partners and
their cumulative share of losses has exceeded their capital basis in the
subsidiary. The Company has accounted for losses totaling approximately
$2,471,000 and $2,358,000 attributable to such minority ownership at December
31, 1996 and 1995, respectively. The Company will account for 100 percent of any
income of such less than 100 percent-owned subsidiaries until this balance is
restored.

F-7
50

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Cash Equivalents

The Company considers all highly liquid investments with a maturity of 90
days or less when purchased to be cash equivalents.

Restricted Funds

Restricted funds consist of cash, cash equivalents held in trust and, at
December 31, 1995, investments in tax-exempt debt securities ($5,875,939), all
of which are available, under certain circumstances, for current operating
expenses, debt service, capital improvements and repairs and maintenance in
accordance with certain contractual obligations and amounts deposited in a bank
in connection with one of the Company's debt obligations. Restricted funds
available for current operating and debt service purposes are classified as
current assets.

Management determines the appropriate classification of debt securities at
the time of purchase and reevaluates such designation as of each balance sheet
date. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses reported as a separate component of stockholders'
equity (deficit). The amortized cost of debt securities classified as
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization is included in interest income.

Property, Equipment and Leasehold Improvements

Property, equipment and leasehold improvements are stated at cost, less
accumulated depreciation and amortization. All costs incurred for additions and
improvements, including interest during construction, are capitalized. The
Company capitalized net interest costs of $110,000 in 1996. Capitalizable
interest costs were not material in 1995 and 1994. Depreciation of property and
equipment is provided using the straight-line method over the estimated useful
lives ranging from three to forty five years. Assets under capital leases are
amortized using the straight-line method over the estimated useful lives ranging
from five to seven years. Leasehold improvements are amortized on a
straight-line basis over the shorter of the term of the lease or the estimated
useful life of the improvement.

Goodwill and Intangibles

Goodwill represents costs in excess of net assets of businesses acquired in
purchase transactions. Goodwill is being amortized on a straight-line basis
principally over periods of five to ten years.

Intangible assets included the value assigned to a power purchase agreement
owned by Maine Energy. The unamortized portion of this asset was included in the
determination of the gain on sale of capacity in 1996.

Deferred Financing and Other Deferred Costs

Costs incurred in connection with debt and letter of credit financings have
been deferred and are being amortized over the life of the related debt or
letter of credit issues using the interest method. The unamortized portion of
these costs related to the Maine Energy bonds was included in the determination
of the extraordinary loss in 1996.

Costs incurred in connection with renegotiation of certain municipal waste
contracts were deferred and were amortized over 60 months, which represented the
minimum period covered by the new agreements. These costs were fully amortized
during 1995.

During 1995, the Company deferred approximately $741,000 of costs incurred
in connection with negotiating an amendment to its Power Purchase Agreement (the
"PPA") with Central Maine Power Company ("CMP"). This amount was included in the
determination of the gain on sale of capacity.

F-8
51

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred Project Development Costs

The Company defers certain external direct costs incurred in the
development of new projects. Amortization of these costs begins when the project
becomes operational. If management concludes that the related project will not
be completed, the deferred costs are expensed immediately.

Revenue Recognition

Electric power revenues are earned from the sale of electricity to local
utilities under the specific agreements with the utilities. Revenue is recorded
at the contract rate specified in each agreement as it is delivered. Electric
power revenue also includes the portion of the deferred gain on sale of electric
generating capacity recognized during the respective period. (See Note 3.)

Waste processing revenues consist principally of fees charged to customers
for waste disposal. Substantially all waste processing revenues are earned from
customers located in a geographic region proximate to the facility. Revenue is
generally recorded upon acceptance based on rates specified in the applicable
long-term contracts. Certain of these rates are subject to adjustment based on
the levels of certain operating expenses and net operating income, as defined,
of Maine Energy.

Management fees from affiliates included in other waste handling revenues,
related to providing general partner services to PERC, are recognized in
accordance with the partnership agreement. Service and other revenues in
connection with transportation and waste management are recognized upon
completion of the services.

Income Taxes

Deferred income taxes are determined using the liability method. Under this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.

Business Combinations

The Company has accounted for all business combinations under the purchase
method of accounting. Under this method, the purchase price is allocated to the
assets and liabilities of the acquired enterprise as of the acquisition date (to
the extent of the Company's ownership interest) based on their estimated
respective fair values and are subject to revision for a period not to exceed
one year from the date of acquisition. The results of operations of the acquired
enterprise are included in the Company's consolidated financial statements for
the period subsequent to the acquisition.

Earnings (Loss) Per Share

Earnings (loss) per share have been computed based on the weighted average
number of shares outstanding as well as the dilutive effect of outstanding
options and warrants during the periods presented computed in accordance with a
Staff Accounting Bulletin ("SAB") of the Securities and Exchange Commission. The
SAB requires that all stock issued within a twelve month period prior to the
Company's initial public offering of common stock in February, 1995 must be
treated as outstanding for all periods prior to the offering whether dilutive or
anti-dilutive. For purposes of the computation, the number of shares treated as
outstanding is reduced based on the number of shares that could be repurchased
based on the initial public price of the Company's common stock. Fully diluted
earnings per share is computed by adjusting both net income and shares
outstanding as if the conversions of certain debt instruments occurred on the
first day of the year. Primary earnings per share for 1996 would have been $2.32
per share had these conversions occurred on the first day of the year.

F-9
52

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Evaluation of Long-Lived Assets

The Company assesses long-lived assets for impairment as prescribed by FASB
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. Under those rules, goodwill associated with
assets acquired in a purchase business combination is included in impairment
evaluations when events or circumstances exist that indicate the carrying amount
of those assets may not be recoverable. The Company's evaluation at December 31,
1996 has been based on projected operating results of the businesses giving rise
to the goodwill. Management believes that these projections are reasonable,
however actual future operating results may differ.

Stock Dividend

On February 28, 1997, a 5% stock dividend was declared by the Board of
Directors for shareholders of record on March 14, 1997. The stock dividend is
payable March 28, 1997. All stock related data in the consolidated financial
statements reflect the stock dividend for all periods presented.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Reclassifications

Certain prior year amounts have been reclassified to conform with the
current year presentation.

3. SALE OF ELECTRIC GENERATION CAPACITY AND RESTRUCTURE OF POWER PURCHASE
AGREEMENT

On May 3, 1996, Maine Energy completed a restructuring of its Power
Purchase Agreement ("PPA") with Central Maine Power ("CMP") and the sale of the
rights to its electrical generating capacity to CL Power Sales One, L.L.C. ("CL
One"). At closing, Maine Energy received a payment from CL One of $85,000,000
("Capacity Payment") and the PPA was amended to reflect a reduction in CMP's
purchase price for electric power. In addition, the term of the PPA was extended
from 2007 to 2012. The Company also received reimbursement of certain
transaction costs, including interest on the Capacity Payment from November 6,
1995 to closing and certain other payments.

Under the terms of the agreements, Maine Energy will be liable to CMP for
liquidated damages of $3,750,000 for any calendar year through the year 2006 and
on a pro rata basis for the period from January 1, to May 31, 2007 in which it
does not deliver at least 100,000,000 kWh. Also, if during the same period,
Maine Energy fails to deliver at least 15,000,000 kWh in any calendar year
through the year 2006 and on a pro rata basis for the period from January 1 to
May 31, 2007 it will be liable to CMP for liquidated damages of $45,000,000 less
the product of $3,750,000 times the number of completed calendar years from and
including 1996 to the year of default. Both the 100,000,000 kWh and the
15,000,000 kWh levels are adjusted in the case of a force majeure event, as
defined. Maine Energy produced approximately 170,000,000 kWh of electricity in
1996. In order to secure CMP's right to liquidated damages, Maine Energy has
obtained an irrevocable letter of credit in the initial amount of $45,000,000
which will be reduced by $3,750,000 for each completed year in which no event
requiring the payment of liquidated damages occurs. Under the terms of the
letter of credit agreement, Maine Energy is required to maintain certain
restricted funds. The letter of credit is collateralized by liens on
substantially all of Maine Energy's assets. Based on these contingencies, Maine
Energy deferred an amount totaling $45,000,000 on the date of the transaction.
This amount is being recognized as revenue as the contingencies are eliminated.
As of December 31, 1996, the letter of credit and remaining deferred amount
equaled $41,250,000.

F-10
53

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Maine Energy used the proceeds from the sale of its capacity to repay
$64,500,000 Resource Recovery Bonds and to retire the related bank letter of
credit. This prepayment resulted in the recognition of an extraordinary loss of
$2,247,377 (net of minority interest of $2,213,475). The remaining proceeds were
used together with certain unrestricted cash balances on hand to repay
$29,500,000 of outstanding subordinated notes payable to Maine Energy limited
partners.

4. ACQUISITION AND DISPOSAL OF CONVERGENT SOLUTIONS, INC.

On February 8, 1995, the Company acquired by way of merger (the "Merger")
Convergent Solutions, Inc. ("CSI"), a publicly-owned company engaged in the
development and marketing of computer software products and related services.
The acquisition was completed through the exchange of one share of the Company's
common stock for each share of outstanding CSI common stock. On that date,
1,801,044 shares of the Company's common stock valued at $5.00 per share were
exchanged in the Merger. The purchase price including the stock exchanged and
transaction costs of approximately $2,000,000 was approximately $11,100,000. The
transaction has been accounted for as a purchase. The purchase price exceeded
the fair value of the net assets acquired by approximately $2,655,000 which was
recorded as goodwill and was being amortized over a five year period. In
connection with the acquisition, the Company filed a registration statement with
the Securities and Exchange Commission to register the shares of its common
stock which were issued to complete the Merger.

During 1996, the Company disposed of its computer services segment which
was comprised entirely of CSI. The sale was completed in two separate
transactions. On July 26,1996 certain assets and liabilities of CSI were sold to
Ciber, Inc. for $5,000,000. Also, on July 29, 1996, all of the outstanding
common stock of CSI was sold to certain members of its management for $5,000. In
addition, the Company has notes receivable from the buyers aggregating $444,643
at December 31, 1996. The notes receivable are due on July 29, 2000. The results
of operations of CSI have been classified as discontinued operations in the
accompanying financial statements. CSI's revenues for 1996 and 1995 were
$5,785,050 and $10,198,851, respectively.

5. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Property, equipment and leasehold improvements consist of the following:

1996 1995
------------ -----------

Land............................................. $ 907,839 $ 746,563
Buildings and site improvements.................. 15,397,462 15,729,403
Machinery and equipment.......................... 85,419,005 76,415,325
Transportation equipment......................... 34,929 1,115,796
Furniture and fixtures........................... 1,337,879 1,373,650
Computer equipment............................... 507,195
Leasehold improvements........................... 430,201 583,589
------------ -----------
103,527,315 96,471,521
Less allowances for depreciation and 12,671,949 10,108,341
amortization...................................
------------ -----------
$ 90,855,366 $86,363,180
============ ===========

Beginning October 1, 1996, Maine Energy revised the estimated average
useful lives used to compute depreciation for substantially all of its plant and
equipment. These revisions were made to more properly reflect the remaining
useful lives of the assets. The change had the effect of increasing income
before extraordinary item and net income by approximately $432,000 ($.07 per
share).

F-11
54

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. OTHER RECEIVABLES

The Company has entered into several sales-type leases related to the sale
of transportation equipment. These leases have original terms of up to 5 years
and provide for fixed monthly payments. Future minimum lease payments, excluding
interest, to be received related to these leases are as follows:

1997.............................................. $192,026
1998.............................................. 398,147

7. ACQUISITIONS

On May 3, 1996, the Company purchased additional limited partnership
interests in Maine Energy aggregating 23.77% from certain other existing limited
partners. The aggregate cost of the acquisitions was approximately $485,000. The
acquisition resulted in a reduction in the carrying value of property and
equipment of approximately $7,800,000. Subsequent to this purchase, the
Company's ownership in Maine Energy aggregated 74.15%.

During the fourth quarter of 1996, the Company acquired all of the
outstanding common stock of TEII. TEII, through its subsidiaries, is engaged in
the generation of electricity and the processing of wood and plastic materials.
The purchase price, including all direct costs, was approximately $2,142,000 in
cash. The cost of the acquisition exceeded the fair value of TEII's net assets
by approximately $2,035,000 which has been recorded as goodwill. In connection
with this acquisition, the Company has an obligation to obtain a letter of
credit to support TEII's outstanding Resource Recovery Revenue Bonds payable in
an amount sufficient to allow the release of a similar letter of credit
guaranteed by a party affiliated with the seller.

On March 31, 1996, the Company acquired a 60% limited partnership interest
in American Ash Recycling Co. of Tennessee, a limited partnership, ("AART").
AART is engaged in the processing of ash residue from a waste-to-energy facility
located in Nashville, Tennessee. The purchase price for the limited partnership
interest was $2,100,000. The cost of the acquisition exceeded the fair value of
AART's net assets by approximately $800,000 which has been recorded as goodwill.

On November 25, 1996, the Company acquired all of the outstanding common
stock of Manner, Inc. ("Manner") a company engaged in the purchase and sale of
recyclable plastic materials. The purchase price was approximately $456,000 and
was entirely financed through the issuance of 65,000 shares of the Company's
common stock. The cost of the acquisition exceeded the fair value of Manner's
net assets by approximately $421,000 which has been recorded as goodwill.

On September 16, 1994, the Company purchased certain limited partnership
interests in Maine Energy aggregating 40.38% from certain of the existing
limited partners. The aggregate cost of the acquisition was approximately $3.1
million and was partially financed through the issuance of notes payable
aggregating $1,572,346 to the sellers. Prior to this transaction, the Company
was a 10% owner and the sole general partner of Maine Energy.

Prior to the September 16, 1994 limited partnership interest acquisition,
the Company accounted for its 10% ownership interest under the equity method.
The difference between the Company's actual capital contributions and its
ownership interest in the partnership's total contributed capital is being
amortized over the term of the partnership's energy sales contract. This amount
is included in goodwill.

In 2007, certain of Maine Energy's municipal customers have the right to
obtain a 20% interest in Maine Energy's cash flows, as defined in certain
agreements, to be applied against the municipalities' future waste disposal
costs. Maine Energy's ability to distribute assets to its partners is restricted
by the provisions of certain agreements among Maine Energy, the partners and
certain third parties.

The following unaudited pro forma summary presents selected operating data
as if the acquisitions described above had occurred as of the beginning of the
respective periods and does not purport to be

F-12
55

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

indicative of the results that would have occurred had the merger been completed
as of those dates or of results which may occur in the future.

1996 1995
------- -------
(IN THOUSANDS
EXCEPT PER SHARE
AMOUNTS)

Net revenues............................................. $79,321 $50,153
Net income (loss) before extraordinary item.............. 22,369 (1,347)
Net income (loss)........................................ 20,122 (1,200)
Net income (loss) per share before extraordinary item.... 3.52 (.26)
Net income (loss) per share.............................. 3.16 (.23)

The pro forma amounts presented for 1996 include approximately $7,211,000
of income from Maine Energy resulting from the gain on sale of electric
generating capacity attributable to the additional limited partnership interest
acquired in 1996.

8. INVESTMENT IN PERC

PERC is a 25 megawatt waste-to-energy project which began operations in
1988. The Company is a co-general partner and 7% owner of PERC until such time
that the return on equity, as defined, of the limited partners exceeds their
aggregate capital contributions. Commencing on that date and continuing through
the remaining term of the partnership, the Company's ownership interest
increases to 28 percent. Investment in PERC represents the Company's net
investment in the partnership. The PERC partnership agreement provided for the
respective partners to make capital contributions in amounts disproportionate to
their ownership interest in the partnership. Differences between the Company's
capital contributions and its ownership interest in the partnership's total
contributed capital are being amortized over the term of the partnership's power
purchase agreement. Amortization is included in the determination of the
Company's equity in the partnership's net income.

In 2004, certain of PERC's municipal customers have the right to purchase
the waste-to-energy facility for an amount equal to its book value at the
purchase date, as defined, or to receive 50% of the partnerships' cash flows, as
defined, to be applied against the municipalities' future waste disposal costs.
PERC's ability to distribute assets to its partners is restricted by the
provisions of certain agreements among PERC, the partners and certain third
parties.

The Company's ownership interest in PERC is summarized as follows:

DECEMBER 31,
-------------------------
1996 1995
---------- ----------

Credited capital contributions...................... $2,112,587 $2,112,587
Distributions....................................... (211,239) (76,375)
Excess of actual capital contributions over
ownership interest (net of accumulated
amortization of $384,338 and $289,285 at December
31, 1996 and December 31, 1995 respectively)...... 1,331,398 1,392,043
Cumulative interest in partnership income........... 594,090 166,383
---------- ----------
$3,792,429 $3,594,638
========== ==========

F-13
56

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Summarized financial information for PERC is as follows:

DECEMBER 31,
---------------------------
1996 1995
----------- -----------

BALANCE SHEET DATA:
Total assets...................................... $91,760,278 $94,766,638
Bonds payable (non-recourse)...................... 53,500,000 59,400,000
Total liabilities................................. 59,667,838 66,450,262
Partners' capital................................. 32,092,440 28,316,376

STATEMENTS OF OPERATIONS DATA:
Revenues.......................................... 30,294,859 29,458,979
Operating expenses................................ 21,013,967 20,007,226
Net income........................................ 6,110,107 5,647,488

9. DEBT

The Company's debt consists of the following:

DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------

(A) 8% convertible subordinated note payable............ $ 5,000,000 $ --
(B) 12% term note payable to bank....................... 1,657,448 2,607,448
(C) 10% note payable to Energy National, Inc............ 1,353,479 1,455,430
(D) $1,000,000 bank line of credit at bank prime rate 589,904
plus .25%...........................................
(E) $300,000 bank line of credit at bank prime rate plus 220,000
1.5%................................................
(F) 9.94% secured term notes payable.................... 780,357
(G) Notes payable to limited partners of Maine Energy... 490,063 326,063
(H) 8.63% secured term note payable..................... 400,000
(I) 9.9% secured term notes payable to GE Capital....... 190,368 382,699
(J) 10.13% secured term notes payable................... 179,997 428,193
(K) Note payable to former shareholder.................. 127,137 183,494
(L) Subordinated convertible notes payable.............. -- 3,721,182
Other............................................... 108,250 1,455,558
----------- ------------
11,097,003 10,560,067
Resource Recovery Revenue Bonds Payable.................. 13,400,000 64,500,000
12% Subordinated Notes Payable to Maine Energy Limited
Partners............................................... 14,575,985 40,316,095
----------- ------------
39,072,988 115,376,162
Less current portion................................ 4,123,840 7,977,899
----------- ------------
$ 34,949,148 $107,398,263
=========== ============

- ---------------
(A) During 1996, the Company issued an 8% convertible subordinated note to a
private lender to fund certain designated acquisitions. The note is due
October 31, 2002 and is convertible into the Company's common stock at a
conversion price of $8.50 per share. Interest on the note is payable
quarterly.

(B) During 1989, a subsidiary of the Company entered into a $4.0 million 5-year
Term Loan Agreement, as amended, with a bank. On September 16, 1994, the
Company and the bank entered into a Purchase and Sales Agreement under which
the Company purchased the subsidiary's debt obligation to the bank.

F-14
57

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Payment of the purchase price included cash of $1.5 million and a $2,607,448
term note payable to the bank bearing interest at the bank's prime rate. On
August 15, 1996, the Company and the bank entered into an Amended and
Restated Term Note for $1,857,448. The term of the note is through July 31,
1998, with principal payments in the amount of $50,000 per month plus
interest at the bank's prime rate (8.25% at December 31, 1996) and a payment
at maturity in the amount of $707,447. During 1995, interest was also
payable monthly at the bank's prime rate (8.5% at December 31, 1995).

(C) This debt arose when Energy National Inc., a co-general partner in PERC,
made an advance on behalf of the Company to meet a capital call by PERC.
Interest and principal are payable annually on the date PERC distributes its
annual and any accrued general partner fees. Annual principal payments are
due in amounts equal to 60 percent of the Company's current and accrued
general partner fees paid from PERC after payment of interest on the
outstanding balance of this obligation. The unpaid balance is secured by all
future general partner fee payments to be made to the Company by PERC.

(D) In October 1996, the Company obtained a line of credit with a bank in the
amount of $1,000,000 bearing interest at the bank's prime rate plus .25%
(8.50% at December 31, 1996). The line of credit is secured by the Company's
investment in certain of its subsidiaries and is subject to renewal on June
30, 1997.

(E) During 1996, certain subsidiaries of the Company obtained a line of credit
with a bank in the amount of $300,000 bearing interest at the bank's prime
rate plus 1.5% (9.75% at December 31, 1996) of which $220,000 is outstanding
at December 31, 1996. The line of credit is secured by accounts receivables
of the Company's subsidiaries and is subject to renewal on April 30, 1997.

(F) AART note payable to a commercial lender bearing interest at 9.94%, with
monthly payments of principal and interest in the amount of $42,500. The
note matures on August 20, 1998. The balance is secured by equipment with an
aggregate net carrying value of $2,776,486 at December 31, 1996.

(G) Aggregate balance due to limited partners of Maine Energy in connection with
the purchase of certain limited partnership interests (see Note 7). The
balance bears interest at one percent over a published prime interest rate
(9.25% and 9.5% at December 31, 1996 and 1995, respectively). These balances
are secured by the limited partnership interests in Maine Energy. The
outstanding balance is due in 1997.

(H) In December 1996, a subsidiary of the Company entered into a secured term
note with a commercial lender. The note bears interest at 8.63% with monthly
principal and interest payments of $8,231. The note matures on December 31,
2001. The balance is secured by equipment with an aggregate net carrying
value of $886,385 at December 31, 1996.

(I) Secured term note payable in monthly installments of principal and interest
of approximately $18,400 through August 1998. Secured by equipment with an
aggregate net carrying value of $361,551 at December 31,1996.

(J) Secured term note payable to a commercial lender with original terms of 48
months. Payable in monthly installments of principal and interest
aggregating approximately $10,900. Secured by equipment with an aggregate
net carrying value of $224,656 at December 31, 1996.

(K) Non-interest bearing note payable to former shareholder in connection with
the repurchase and retirement of certain shares of the Company's common
stock. The note is payable in equal monthly installments of $5,750. The note
has been discounted using an effective interest rate of 8%. The note is
secured by cash deposited in an escrow account with a balance of $117,201
and $181,612 at December 31, 1996 and 1995, respectively.

(L) In March 1993, the Company issued Davstar Managed Investments Corporation a
$1,500,000 subordinated term note payable, 252,248 shares of the Company's
common stock and a warrant to purchase an additional 297,430 shares of the
Company's common stock at a stated purchase price of $5.64. The aggregate
original issue discount representing the fair value of the common stock and
the warrant was $258,989. The note carried interest at a stated rate of 8%
and had an effective interest rate, including the amortization of the
original issue discount of 18%. Various additional subordinated unsecured
12% term

F-15
58

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

notes payable in an aggregate amount of $2,295,000 were issued to foreign
lenders during 1993 and 1994. These lenders were associated with Davstar
Managed Investments Corporation through affiliation of their respective
management. The Company paid all interest on these obligations through
December 31, 1994 by the issuance of additional shares of its common stock.
On January 1, 1996, the terms of these notes were amended. Under this
amended agreement, $500,000 of principal was converted to 74,866 shares of
the Company's common stock at $7.0125 per share and accrued interest of
$50,301 was capitalized. Interest was payable quarterly and principal was
payable in full on April 1, 1997. The amended notes were convertible into
common stock at the option of the holder subsequent to September 30, 1996 at
75% of the market price, as defined, at the time of conversion within the
limits of not less than $5.00 and not more than $13.50 per share, subject to
adjustments. In December 1996, the notes were converted into 650,148 shares
of the Company's common stock.

Resource Recovery Revenue Bonds Payable

The City of Biddeford, on behalf of Maine Energy, issued $81,000,000 of
Resource Recovery Revenue Bonds in June 1985 to partially finance the
construction of the Maine Energy waste-to-energy facility. The bonds carried
interest at variable rates (3.90% at December 31, 1995), which was determined
monthly by the remarketing agent for the bonds. In May 1996, the bonds were
retired.

In connection with the acquisition of TEII, the Company assumed $15,685,000
of Liberty County, Florida Resource Recovery Revenue Bonds. The bonds bear
interest at variable rates (4.20% at December 31, 1996), which are determined
weekly by the remarketing agent for the bonds. The bonds have an annual sinking
fund payment due each October ($1,000,000 due October 1997), with final payment
due January 2003. The bonds are fully secured by an irrevocable letter of credit
issued by a bank. The letter of credit and related agreements require, among
other things, maintenance of various insurance coverages and restricts the
borrowers ability to incur additional indebtedness. The bonds and letter of
credit are collateralized by liens on TEII's electric generating facility
located in Liberty County, Florida.

Subordinated Notes Payable to Maine Energy Limited Partners

These notes, as amended, bear interest at 12%. Payments of principal and
interest are made solely at the discretion of Maine Energy's general partner.
However, all principal and interest must be repaid prior to any partner
distributions. To the extent interest is not paid, accrued interest is
capitalized.

Excluding any amounts which may be paid on the subordinated notes payable
to the Maine Energy Limited Partners, aggregate maturities as of December 31,
1996 of the Company's debt for each of the next five years are as follows:

1997............................................. $4,123,840
1998............................................. 3,076,230
1999............................................. 1,755,209
2000............................................. 2,022,411
2001............................................. 1,834,314

10. STOCKHOLDERS' EQUITY

In connection with certain debt obligations issued during 1996, the Company
issued warrants to purchase 420,572 shares of common stock at $5.71 per share.
The aggregate original issue discount representing the fair value of the
warrants was $143,738.

During July and August of 1995, in a private transaction the Company sold
650,412 shares of its common stock and warrants to purchase an additional
382,031 common shares exercisable during the period

F-16
59

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

commencing from the date of grant of the warrants and terminating not more than
five years from the date of grant at an exercise price of $5.48. The proceeds of
this transaction were $2,512,227, net of expenses of approximately $225,000.

In December 1995, in a private transaction, the Company sold 44,920 shares
of its common stock to an officer of the Company. The cash proceeds of this
transaction were $300,000 and the Company recognized compensation expense of
$51,962.

11. STOCK OPTION PLANS

The Company has four stock option plans; the 1986 Stock Option Plan of KTI,
Inc. (the "1986 Plan"), the KTI, Inc. 1994 Long-Term Incentive Award Plan and
the DataFocus Long-Term Incentive Plan (collectively, the "1994 Incentive
Plans") and the KTI, Inc. Directors Stock Option Plan (the "Directors Plan").
All plans are administered by the Compensation Committee of the Board of
Directors. In addition to options granted under these plans, the Company also
issued statutory non-plan options to purchase 41,503 shares of common stock at
$3.63 per share to certain officers of the Company in 1986. All of these
statutory options were exercised during 1995.

The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," ("SFAS No. 123")
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.

Elements of the various plans include the following:

THE 1986 PLAN. A maximum of 66,190 shares are subject to the 1986 Plan.
Options were granted at prices not less than the fair market value at the date
of grant. All options granted had 10 year terms and vested immediately. No new
options can be granted under this plan.

THE 1994 INCENTIVE PLAN. The 1994 Incentive Plans were adopted by the
Board of Directors during 1994 and approved by the Company's shareholders during
1995. A maximum of 466,666 shares are subject to the 1994 Incentive Plans.
Options may be granted at prices not less than the fair market value at the date
of grant and normally vest at 20% per year beginning one year from the date of
grant. Vested options may be exercised at any time until their expiration which
may be up to ten years from the date of grant. Unvested options are forfeited
upon termination of the employee. As a result of the merger with CSI, options
issued under CSI's previously existing plans were replaced by options to
purchase the Company's common stock having essentially the same terms and
conditions. The sale of CSI's operations during 1996 resulted in the forfeiture
of certain outstanding options.

THE DIRECTORS PLAN. The Directors Plan was adopted by the Board of
Directors and approved by the Company's shareholders during 1995. A maximum of
100,000 shares are subject to the Directors Plan. Under the Directors Plan,
non-employee Directors are automatically granted non-statutory options on August
1 of each year, commencing on August 1, 1995 for the lesser of (i) 4,000 shares
or (ii) a number of shares having a maximum market value of $36,000. Options
granted may not be exercised within one year of grant and have 10 year terms.

In addition to the Plans described above, the Company's Board of Directors
from time to time has granted key employees non-plan options. During 1995, the
Board of Directors made a non-plan option grant. These non-plan options have a
ten year term, were granted at the then current fair market value and vested 20%
per year commencing on the first anniversary of the grant date.

F-17
60

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Option activities under the plans and for the non-plan options are detailed
in the following table:

1994 WEIGHTED
INCENTIVE AVERAGE EXERCISE
1986 PLAN PLANS DIRECTOR PLAN NON PLAN PRICE PER SHARE
--------- --------- ------------- -------- ------------------

Outstanding at January 1, 1994........ 69,500 -- -- 28,350 $ 3.46
Granted............................. 15,263 -- -- -- $ 3.46
Exercised........................... -- -- -- -- $ --
Forfeited........................... (69,500) -- -- -- $ 3.46
------- -------- ------ ------- -----
Outstanding at January 1, 1995........ 15,263 -- -- 28,350 $ 3.46
Granted............................. -- 162,745 16,800 105,000 $ 6.91
Assumed............................. -- 445,507 -- -- $ 5.66
Exercised........................... -- (1,603) -- (28,350) $ 3.49
Forfeited........................... -- (63,204) -- -- $ 4.63
------- -------- ------ ------- -----
Outstanding at January 1, 1996........ 15,263 543,444 16,800 105,000 $ 6.09
Granted............................. -- 226,574 31,500 -- $ 7.23
Exercised........................... -- (55,346) -- -- $ 5.38
Forfeited........................... -- (292,333) -- -- $ 6.15
------- -------- ------ ------- -----
Outstanding at December 31, 1996...... 15,263 422,340 48,300 105,000 $ 6.62
======= ======== ====== ======= =====
Exercisable at December 31, 1996...... 15,263 122,101 16,800 21,000 $ 5.84
======= ======== ====== ======= =====
Exercisable at December 31, 1995...... 15,263 381,955 -- -- $ 5.75
======= ======== ====== ======= =====

The weighted-average fair value of options granted was $5.38 and $5.37 for
1996 and 1995, respectively.

At December 31, 1996, for each of the following classes of options as
determined by range of exercise price, the following information regarding
weighted-average exercise prices and weighted-average remaining contractual
lives of each class is as follows:

WEIGHTED-AVERAGE
EXERCISE PRICE WEIGHTED-AVERAGE NUMBER OF WEIGHTED-AVERAGE
NUMBER OF OF REMAINING OPTIONS EXERCISE PRICE OF
OPTIONS OUTSTANDING CONTRACTUAL LIFE OF CURRENTLY OPTIONS CURRENTLY
OPTION CLASS OUTSTANDING OPTIONS OUTSTANDING OPTIONS EXERCISABLE EXERCISABLE
- ------------------------ ----------- ---------------- -------------------- ----------- -----------------

Prices ranging from
$3.63 - $5.45......... 15,263 $ 3.46 7 15,263 $3.46
Prices ranging from
$6.00 - $8.75......... 575,643 $ 7.25 7.79 159,901 $6.07

Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had been
accounting for its employee stock options under the fair value method of that
statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions for
1996 and 1995, respectively: weighted average risk-free interest rates of 6.5%
and 6.4%; no dividends; volatility factors of the expected market price of the
Company's common stock of .642 and .642; and for both periods a weighted-average
expected life of the options of 8 years.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in

F-18
61

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the
options granted in 1996 and 1995 is amortized to expense over the options'
vesting period. The Company's pro forma information follows:

1996 1995
----------- -----------

Pro forma net income (loss)....................... $13,478,958 $(1,379,776)
Pro forma primary earnings (loss) per share....... $ 2.12 $ (.26)
Pro forma fully diluted earnings (loss) per $ 2.00 $ (.26)
share...........................................

The pro forma disclosures presented above for 1995 reflect compensation
expense only for options granted in 1995 and for 1996 only for options granted
in 1995 and 1996. These amounts may not necessarily be indicative of the pro
forma effect of SFAS No. 123 for future periods in which options may be granted.

F-19
62

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. INCOME TAXES

At December 31, 1996 the Company has net operating loss carryforwards of
approximately $47,587,000 for income tax purposes that expire in years 2002
through 2010, general business credit carryovers of approximately $530,000 which
expire in years 1999 through 2006 and alternative minimum tax credits of
approximately $687,000, which do not expire. All of these carryforwards are
subject to limitation as described below.

Significant components of the Company's deferred tax liabilities and assets
are as follows:

DECEMBER 31,
---------------------------------------------
1996 1995 1994
------------ ------------ -----------

Deferred tax assets
Current:
Reserve on notes and accounts receivable.......... $ 37,000 $ 50,000 $ 53,000
State taxes, net.................................. 14,000 27,000 5,000
Other liabilities................................. 47,000 223,000 --
------------- ------------- -----------
Total current deferred tax assets....... 98,000 300,000 58,000
Valuation allowance for current deferred tax (98,000) (300,000) (58,000)
assets..........................................
------------- ------------- -----------
-- -- --
------------- ------------- -----------
Non-current:
Depreciation...................................... 440,000 255,000 104,000
State taxes, net.................................. 2,083,000 923,000 817,000
General business credit carryforwards............. 530,000 850,000 530,000
Alternative minimum tax credit carryforwards...... 687,000 687,000 --
Deferred development fees......................... 117,000 120,000 126,000
Net operating loss carryforwards.................. 16,655,000 7,702,000 9,066,000
------------- ------------- -----------
Total non-current deferred tax assets... 20,512,000 10,537,000 10,643,000
Valuation allowance for non-current (15,449,000) (10,344,000) (8,981,000)
deferred tax assets.............................
------------- ------------- -----------
Net non-current deferred tax assets..... 5,063,000 193,000 1,662,000
------------- ------------- -----------
Non-current deferred tax liabilities
Equity investments................................ 5,063,000 193,000 1,662,000
------------- ------------- -----------
Net non-current deferred taxes.................... $ -- $ -- $ --
============= ============= ===========

F-20
63

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of the provision for income taxes are as follows:

YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
----------- --------- ---------

Current:
Federal.............................. $ -- $ -- $ --
State................................ -- 65,000 --
----------- --------- ---------
Total Current.......................... -- 65,000 --
Deferred:
Federal.............................. $ 5,075,000 $(274,000) $(448,000)
State................................ 863,000 (128,000) (57,000)
Valuation allowance.................. (5,938,000) 402,000 505,000
----------- --------- ---------
Total deferred......................... -- -- --
----------- --------- ---------
$ -- $ 65,000 $ --
=========== ========= =========

The components of the provision for deferred income taxes from continuing
operations for the years ended December 31, 1996, 1995 and 1994 are as follows:

YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
----------- ----------- -----------

Net operating loss carryforwards.... $ 951,000 $ 1,364,000 $(1,579,000)
Equity investments.................. 4,870,000 (1,470,000) 686,000
State taxes, net.................... 110,000 (128,000) (57,000)
Deferred development fees........... 3,000 6,000 6,000
Depreciation........................ (185,000) (142,000) (70,000)
Change in reserve on receivables.... 13,000 25,000 509,000
Accrued and other expenses.......... 176,000 (57,000) --
Change in valuation allowance....... (5,938,000) 402,000 505,000
----------- ----------- -----------
Provision for deferred income
taxes............................. $ -- $ -- $ --
=========== =========== ===========

The reconciliation of income tax computed at the federal statutory tax
rates to income tax expense is:

YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
----------- --------- ---------

Tax (benefit) at US statutory rates.... $ 5,033,000 $(452,000) $(486,000)
State income taxes, net of federal tax
benefit.............................. 863,000 (85,000) (57,000)
Amortization of goodwill............... 42,000 191,000 38,000
Change in valuation allowance from
continuing operations................ (5,938,000) 402,000 505,000
Other.................................. -- 9,000 --
----------- --------- ---------
$ -- $ 65,000 $ --
=========== ========= =========

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"

F-21
64

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

has increased by more than 50 percentage points over the lowest percentage of
such stock owned during a three-year testing period. During 1994, such a change
in ownership occurred. As a result of the change, the Company's ability to
utilize certain of its net operating loss carryforwards and general business
credits will be limited to approximately $1,100,000 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 1995, the Company acquired Convergent Solutions, Inc. As a result of
this combination, the Company recorded deferred tax assets of $1,203,000 and a
related valuation allowance for the same amount.

During 1996, the Company acquired Timber Energy Investments, Inc. ("TEII").
As a result of this acquisition, the Company recorded a deferred tax asset
related to 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 TEII is
limited to approximately $874,000 per year.

13. COMMITMENTS

The Company has entered into various facility and equipment operating
leases. The facility lease agreements generally require the Company to pay
certain expenses including maintenance costs and a percentage of real estate
taxes. The lease expires in 2001. The Company entered into a sublease agreement
for certain of its office facilities. Rental expense, net of sublease income,
for all operating leases amounted to $145,000, $133,000, and $100,000 for the
years ended December 31, 1996, 1995 and 1994, respectively. As of December 31,
1996, future minimum rental commitments on noncancelable operating leases, net
of sublease income are as follows:

1997.............................................. $279,000
1998.............................................. 237,000
1999.............................................. 186,000
2000.............................................. 189,000
2001.............................................. 165,000

The Company has entered into employment agreements with certain of its key
employees which provide for fixed compensation and bonuses based on operating
results, as defined. These agreements generally continue until terminated by the
employee or the Company and, under certain circumstances, provide for salary
continuation for a specified period. At December 31, 1996 the Company's maximum
aggregate liability under the agreements if all the employees were terminated by
the Company is $1,490,000.

In connection with their operations, Maine Energy, TEII and PERC have
entered into certain contractual agreements with respect to the supply and
acceptance of municipal solid waste and the sale of electric power.

14. EMPLOYEE BENEFIT PLAN

The Company has established a defined contribution employee savings and
investment retirement plan under Section 401(k) of the Internal Revenue Code.
All employees are eligible to participate in the plan after satisfying certain
eligibility requirements. The Company contributes on behalf of each
participating employee an amount equal to 4% of the employees eligible salary.
The Company's contribution was approximately $164,000 $146,000, and $156,000 for
the years ended December 31, 1996, 1995 and 1994, respectively.

F-22
65

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. RELATED PARTY TRANSACTIONS

The Company receives an annual management fee (adjusted annually for
changes in the Consumer Price Index) as co-general partner of PERC. During the
years ended December 31, 1996, 1995 and 1994, the Company earned management fees
of approximately $417,800, $406,500, and $395,700 respectively. As described in
Note 9 above, a portion of these fees are required to be applied to outstanding
interest and principal due to Energy National, Inc. The receivable from PERC was
approximately $2,279,000 and $2,419,000 at December 31, 1996 and December 31,
1995, respectively. Payment of this obligation by PERC is limited by the
provisions of certain agreements to which the Company and PERC are parties. The
Company expects the remaining balance to be realized over a 10-year period.

The Company leases its administrative offices from a company whose
principals include certain officers and shareholders of KTI. Rents for the years
ended December 31, 1996, 1995 and 1994 were $109,500 $101,000, and $97,000,
respectively.

During the years 1988 to 1991, the Company made loans evidenced by
promissory notes, including those related to the sale of the Company's real
estate business (KTI Realty, Inc.), and made certain other advances to a then
officer/shareholder of the Company. The individual's employment as an officer of
the Company was terminated during 1992. During 1992, the Company began legal
action against the former officer for collection of the notes, among other
matters. In February 1994, the former shareholder transferred title to all of
his shares of the Company's common stock to a third party. Based on the former
officer's aggregate obligations to the Company ($1,069,544 at December 31,
1993), management challenged his right to transfer these shares and threatened
additional legal action. In April 1994, the Company and the third party entered
into an agreement under which 82,374 of these shares were transferred to the
Company to settle the former officer's obligations to the Company. The cost of
these shares was $578,124. In addition, the Company entered into an agreement
with the former officer/shareholder under which all of his debts to the Company
were discharged and the related litigation was dismissed. Provision for loss on
the remaining balance due from the former officer had been provided in prior
years.

During 1991, the Company formed EWM Holdings, LP (a limited partnership)
("Eastern") as the sole general partner and a 50% owner and accounted for the
investment using the equity method. EWM Holdings, LP acquired 95% of the
outstanding common stock of Eastern Waste Management Corp. and Rilco Group, Inc.
which were engaged in the ownership and operation of a solid waste transfer
station. In August 1993, Eastern sold its operations. In connection with the
sale of Eastern's operations, N&M Consulting, Inc., a company under the control
of relatives of a Company shareholder and officer, entered into a consulting
agreement under which it receives certain fees from the buyer. N&M Consulting,
Inc. has entered into an agreement with the Company under which it pays the
Company fees equal to the fees it receives from the buyer. The Company received
approximately $25,000 $54,000, and $128,000 under this arrangement in 1996, 1995
and 1994, respectively.

16. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair values of financial instruments have been determined by
the Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required in interpreting market
data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The carrying amount and estimated fair
values of financial instruments at December 31, 1996 and 1995 are summarized as
follows:

The following methods and assumptions were used to estimate the fair value
of financial instruments;

Cash, restricted cash and accounts receivable -- the carrying amounts
reported in the balance sheet for cash, cash equivalents, and restricted
funds including debt securities approximate their fair value.

F-23
66

KTI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Management fees receivable -- the fair value is estimated using
discounted cash flow analyses, using estimates of current market interest
rates and periods in which the receivables will be realized.

Notes and other receivables -- the fair value is estimated using
discounted cash flow analyses, using appropriate interest rates.

Resource Recovery Revenue Bonds Payable -- carrying amount of bonds
payable approximates fair value.

Debt -- the fair value is estimated based on discounting the estimated
future cash flows using the Company's incremental borrowing rate for
similar debt instruments.

DECEMBER 31, 1996 DECEMBER 31, 1995
------------------------- -------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
----------- ----------- ----------- -----------

ASSETS
Cash................................ $ 3,315,705 $ 3,315,705 $ 6,454,558 $ 6,454,558
Restricted cash..................... 9,979,402 9,979,402 13,544,631 13,544,631
Accounts receivable (net)........... 4,080,503 4,080,503 8,983,699 8,983,699
Management fee receivable........... 2,741,837 2,097,532 2,933,274 2,250,752
Notes receivable (net).............. 270,464 250,071 380,663 309,938
Other receivables................... 1,110,103 912,862 791,624 738,885

LIABILITIES
Resources Recovery
Revenue Bonds Payable.......... 13,400,000 13,400,000 64,500,000 64,500,000
Other debt.......................... 25,672,988 24,792,930 50,876,162 50,106,923

17. CONTINGENCIES

The Port Authority of New York and New Jersey ("Port Authority") sued
certain wholly-owned subsidiaries of KTI, in the Supreme Court of the State of
New York, New York County on April 11, 1995. Port Authority sought damages in
the amount of $439,819 for the cost of the storage and removal of wood
recyclables that were delivered to the Howland Hook Marine terminal located on
Staten Island and leased by Port Authority from the City of New York. The
Company and the Port Authority have settled this litigation. Pursuant to the
settlement agreement, the Company has paid $100,000 to the Port Authority. An
additional payment of $32,000 is due in April 1997. The Company had fully
provided for the settlement amount in 1995.

The Company is involved in additional outstanding litigation, but the
Company expects to settle all such litigation within the limits of its insurance
policies. In the opinion of Management, the outcome of these matters
individually and in the aggregate will not have a material effect on the
Company's financial position, cash flows or results of operations.

F-24
67

REPORT OF INDEPENDENT AUDITORS

Partners
Penobscot Energy Recovery Company

We have audited the accompanying balance sheets of Penobscot Energy
Recovery Company (a limited partnership) as of December 31, 1996 and 1995, and
the related statements of income, changes in partners' capital and cash flows
for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Penobscot Energy Recovery
Company at December 31, 1996 and 1995, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.

ERNST & YOUNG LLP

February 7, 1997

F-25
68

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

BALANCE SHEETS

DECEMBER 31,
---------------------------
1996 1995
----------- -----------

ASSETS
Cash and cash equivalents......................................... $ 5,439,833 $ 6,465,266
Accounts receivable............................................... 4,695,790 3,967,028
Restricted funds.................................................. 8,481,761 8,363,958
Prepaid expenses and other assets................................. 480,561 389,533
Property, plant and equipment, net (Note 3)....................... 71,321,295 73,853,243
Deferred costs, less accumulated amortization of
$4,518,768 in 1996 and $4,838,526 in 1995....................... 1,341,038 1,727,610
----------- -----------
Total................................................... $91,760,278 $94,766,638
=========== ===========
LIABILITIES AND PARTNERS' CAPITAL
Accounts payable (Note 6)......................................... $ 1,640,871 $ 1,313,602
Accrued expenses and other liabilities............................ 1,271,103 2,281,092
Management and development fees payable to general partners (Note
6).............................................................. 3,255,864 3,455,568
Bonds payable (Note 4)............................................ 53,500,000 59,400,000
----------- -----------
Total liabilities....................................... 59,667,838 66,450,262
Partners' capital:
Contributed capital............................................. 23,605,435 25,939,478
Retained earnings............................................... 8,487,005 2,376,898
----------- -----------
Total partners' capital................................. 32,092,440 28,316,376
----------- -----------
Total................................................... $91,760,278 $94,766,638
=========== ===========

See accompanying notes.

F-26
69

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

STATEMENTS OF INCOME

YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
----------- ----------- -----------

Revenues (Note 2):
Electric power revenues........................... $18,487,405 $18,276,914 $17,888,227
Waste processing revenues......................... 11,807,454 11,182,065 10,585,266
----------- ----------- -----------
Total..................................... 30,294,859 29,458,979 28,473,493
Operating expenses:
Supplemental fuels (Note 6)....................... 1,026,128 872,581 892,517
Electric power purchases.......................... 124,215 110,303 92,967
Disposal costs.................................... 4,879,689 4,253,355 4,436,119
Operating and management fees (Note 6)............ 5,353,385 5,165,224 5,130,913
Equipment and maintenance costs................... 3,196,370 2,527,208 2,347,437
Depreciation...................................... 3,679,624 3,689,987 3,672,193
Real estate taxes................................. 555,690 521,350 486,312
Insurance......................................... 349,820 379,675 368,962
Other............................................. 1,849,046 2,487,543 1,893,177
----------- ----------- -----------
Total..................................... 21,013,967 20,007,226 19,320,597
----------- ----------- -----------
Operating income.................................... 9,280,892 9,451,753 9,152,896
Interest and other financing costs, net (Note 5).... (3,170,785) (3,804,265) (3,656,271)
----------- ----------- -----------
Net income.......................................... $ 6,110,107 $ 5,647,488 $ 5,496,625
=========== =========== ===========

See accompanying notes.

F-27
70

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

GENERAL PARTNERS LIMITED PARTNERS TOTAL
----------------------- ------------------------- -------------------------
RETAINED RETAINED RETAINED
CONTRIBUTED EARNINGS CONTRIBUTED EARNINGS CONTRIBUTED EARNINGS
CAPITAL (DEFICIT) CAPITAL (DEFICIT) CAPITAL (DEFICIT)
----------- --------- ----------- ----------- ----------- -----------

Balance, January 1, 1994........ $ 3,016,552 $(876,721) $27,148,974 $(7,890,494) $30,165,526 $(8,767,215)
Capital distributions......... (58,481) (58,481) --
Net income.................... 549,663 4,946,962 -- 5,496,625
---------- --------- ----------- ----------- ----------- -----------
Balance, December 31, 1994...... 3,016,552 (327,058) 27,090,493 (2,943,532) 30,107,045 (3,270,590)
Capital distributions......... (109,107) (4,058,460) (4,167,567) --
Net income.................... 564,749 5,082,739 -- 5,647,488
---------- --------- ----------- ----------- ----------- -----------
Balance, December 31, 1995...... 2,907,445 237,691 23,032,033 2,139,207 25,939,478 2,376,898
Distributions................. (192,663) (2,141,380) (2,334,043)
Net income.................... 611,011 5,499,096 6,110,107
---------- --------- ----------- ----------- ----------- -----------
Balance, December 31, 1996...... $ 2,714,782 $ 848,702 $20,890,653 $ 7,638,303 $23,605,435 $ 8,487,005
========== ========= =========== =========== =========== ===========

See accompanying notes.

F-28
71

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
----------- ----------- -----------

OPERATING ACTIVITIES
Net income.......................................... $ 6,110,107 $ 5,647,488 $ 5,496,625
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization..................... 4,085,410 4,208,161 4,212,193
Changes in asset and liability accounts:
Increasing (decreasing) cash:
Accounts receivable............................ (728,762) 52,943 (62,621)
Prepaid expenses and other assets.............. (91,028) (141,673) 61,376
Accounts payable............................... 327,269 (50,312) (263,237)
Accrued expenses and other liabilities......... (1,009,989) 716,787 853,632
Management and development fees payable........ (199,704) (105,726) (1,609,391)
------------ ----------- ------------
Net cash provided by operating activities........... 8,493,303 10,327,668 8,688,577

INVESTING ACTIVITIES
Additions to property, plant and equipment.......... (1,191,890) (1,171,925) (1,799,623)
Net change in restricted funds...................... (117,803) (384,211) 526,827
Proceeds from sale of property, plant and
equipment......................................... 25,000
------------ ----------- ------------
Net cash used in investing activities............... (1,284,693) (1,556,136) (1,272,796)

FINANCING ACTIVITIES
Payment of bond principal........................... (5,900,000) (4,900,000) (3,800,000)
Distributions....................................... (2,334,043) (4,167,567) (58,481)
------------ ----------- ------------
Net cash used in financing activities............... (8,234,043) (9,067,567) (3,858,481)
------------ ----------- ------------
(Decrease) increase in cash and cash equivalents.... (1,025,433) (296,035) 3,557,300
Cash and cash equivalents at beginning of year...... 6,465,266 6,761,301 3,204,001
------------ ----------- ------------
Cash and cash equivalents at end of year............ $ 5,439,833 $ 6,465,266 $ 6,761,301
============ =========== ============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid....................................... $ 2,425,761 $ 2,980,420 $ 2,224,872
============ =========== ============

See accompanying notes.

F-29
72

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995

1. ORGANIZATION AND DESCRIPTION OF OPERATIONS

Penobscot Energy Recovery Company ("PERC") is a limited partnership formed
on December 28, 1983 and organized to design, construct, operate, own and manage
a facility located in Orrington, Maine for the conversion of solid waste and
supplemental fuel to electric power (the "Project"). Certain contractual
agreements relating to this facility have been entered into, including
agreements with respect to the supply of solid waste, the sale of electric
power, and operation and maintenance of the facility.

PERC Management Company ("PMC"), which is ultimately owned by KTI, Inc.
("KTI"), and Energy National, Inc. ("ENI") are general partners. ENI and another
entity are limited partners. The ownership interests of the partners are as
follows:

OWNERSHIP INTERESTS
---------------------
GENERAL LIMITED
PARTNERS PARTNERS
-------- --------

PMC....................................................... 7%
ENI....................................................... 3 25.7%
Other limited partner..................................... 64.3
--- ---- -
10% 90.0%
=== =====

Profits and losses are to be allocated 10% to the general partners and 90%
to the limited partners until such time that the return on equity, as defined in
the Partnership Agreement, of the limited partners exceeds their aggregate
capital contributions. Commencing on that date and continuing through the
remaining term of the Partnership, such allocations, including gains and losses
upon net sale or refinancing, shall be 40% to the general partners and 60% to
the limited partners.

According to the Partnership agreement, the Partnership has a limited life
extending to December 31, 2018, unless further extended by a vote of all of the
partners.

The Project is subject to the provisions of various federal and state
energy laws and regulations including the Public Utility Regulatory Policies Act
of 1978, as amended. In addition, federal, state and local environmental laws
establish standards governing certain aspects of the Project's operations. The
Company believes it has all permits, licenses and approvals necessary to operate
the facility.

2. SIGNIFICANT ACCOUNTING POLICIES

Property, Plant and Equipment

Property, plant and equipment are stated at cost, less accumulated
depreciation. All costs incurred for additions and improvements to the facility,
including interest during construction, are capitalized.

Depreciation is provided on the straight-line method over estimated useful
lives.

Deferred Costs

Costs incurred by PERC in connection with permanent financings have been
deferred and are being amortized over the life of the related debt issues using
the interest method.

During 1991, PERC finalized negotiations with municipalities and entered
into new long-term waste handling agreements which resulted in higher waste
handling fees. Costs associated with the renegotiation were deferred and
amortized over 60 months which represented the minimum period covered by the new
agreements.

F-30
73

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Restricted Funds

Restricted funds consist of cash and cash equivalents held in trust which
are available for debt service, certain capital improvements and repairs and
maintenance.

Revenues

Electric power revenues are earned from the sale of electricity to Bangor
Hydro-Electric Company ("BHE"), a utility serving a portion of the State of
Maine, under a Power Purchase Agreement (the "Agreement"). Revenue is recorded
at the contract rate specified in the Agreement as the electricity is delivered.

Waste processing revenues consist principally of fees charged to customers
for waste disposal. Substantially all waste processing revenues are earned from
customers located in a geographic region proximate to the facility. Revenue is
generally recorded upon delivery based on rates specified in the applicable
long-term contracts. Certain of these contract rates are adjusted quarterly
based on actual costs incurred in the prior quarter.

Use of Estimates

Income Taxes

There is no provision in the financial statements for income taxes as the
income or loss is included in the income tax returns of the partners.

Statements of Cash Flows

For purposes of the statements of cash flows, PERC considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.

Fair Values of Financial Instruments

The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:

Cash, cash equivalents and restricted funds

The carrying amounts reported in the balance sheet for cash, cash
equivalents and restricted funds approximate their fair value.

Bonds payable

The carrying amount of the Company's borrowings under its bonds
payable approximates their fair value.

F-31
74

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

3. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consists of the following:

1996 1995
------------ ------------

Machinery and equipment......................... $ 66,727,285 $ 66,191,892
Buildings and site improvements................. 30,426,327 30,098,486
Furniture and fixtures.......................... 799,576 787,609
Parts and supplies.............................. 2,041,659 1,783,380
Land............................................ 322,783 322,783
------------ ------------
Total........................................... 100,317,630 99,184,150
Less accumulated depreciation................... (28,996,335) (25,330,907)
------------ ------------
Property, plant and equipment, net.............. $ 71,321,295 $ 73,853,243
============ ============

4. FINANCING TRANSACTIONS

On May 22, 1986, the Town of Orrington, on behalf of PERC, issued
$50,400,000 of Floating Rate Demand Resource Recovery Revenue Bonds to finance
the Project. Commencing May 1, 1988, the bonds became variable rate obligations
based on rates for certain tax-exempt obligations, as determined weekly by the
remarketing agent for the bonds (4.125% and 5.875% at December 31, 1996 and
1995, respectively).

Additionally, on December 3, 1986, the Town of Orrington, on behalf of
PERC, issued $30,600,000 of Floating Rate Demand Resource Recovery Revenue Bonds
to supplement the previous financing of the Project. These bonds also bear
interest based on rates for certain tax-exempt obligations, as determined weekly
by the remarketing agent for the bonds (4.25% and 6.125% at December 31, 1996
and 1995, respectively).

The bonds are subject to mandatory redemption in quarterly installments of
varying amounts through November 2003 and are subject to redemption at the
option of PERC at the redemption price of 100% of the principal amount thereof
plus accrued interest.

Aggregate principal maturities for the next five years and thereafter are
as follows:

1997............................................................ $ 4,800,000
1998............................................................ 6,200,000
1999............................................................ 7,000,000
2000............................................................ 7,800,000
2001............................................................ 8,800,000
Thereafter...................................................... 18,900,000
-----------
Total........................................................... $53,500,000
===========

The bonds are fully secured by irrevocable letters of credit from a group
of banks. The bonds and letter of credit are collateralized by liens on
substantially all of PERC's assets and contain certain restrictive covenants
which require, among other things, maintenance of working capital, as defined,
and restrict PERC's ability to incur additional indebtedness, make loans and
acquire investments. If necessary, the limited partners are obligated to fund up
to $5,000,000 to reimburse any shortfalls in principal and interest payments
under the bond and related letter of credit agreements.

F-32
75

PENOBSCOT ENERGY RECOVERY COMPANY
(A LIMITED PARTNERSHIP)

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

5. INTEREST AND OTHER FINANCING COSTS -- NET

Interest and other financing costs for the years ended December 31, 1996,
1995 and 1994 consist of:

1996 1995 1994
---------- ---------- ----------

Interest expense........................... $2,262,680 $2,963,143 $2,433,048
Letter of credit fees...................... 976,982 1,075,143 1,148,917
Amortization of deferred bond financing
costs.................................... 351,252 376,894 398,720
Remarketing and bank fees.................. 288,436 153,904 180,528
Interest income............................ (708,565) (764,819) (504,942)
---------- ---------- ----------
Interest and other financing
costs -- net............................. $3,170,785 $3,804,265 $3,656,271
========== ========== ==========

6. RELATED PARTY TRANSACTIONS

PERC incurred management fees payable to the general partners of $595,408,
$580,668, and $565,165 in 1996, 1995 and 1994, respectively, in accordance with
the Partnership Agreement. PERC purchases a portion of its supplemental fuel
(wood chips) from KTI BioFuels, L.P., an affiliate of PMC. During 1996, 1995 and
1994, these purchases totalled approximately $279,700, $153,600 and $148,546,
respectively. Accounts payable includes $21,070 and $8,748 due to KTI BioFuels,
L.P. at December 31, 1996 and 1995, respectively.

Effective May 1, 1989, PERC entered into an Operation and Maintenance
Agreement with ESOCO Orrington, Inc., an affiliate of ENI. For the years ended
December 31, 1996, 1995 and 1994, PERC paid operating and maintenance fees to
ESOCO of approximately $4,500,000, $4,400,000 and $4,200,000, respectively, plus
additional approved pass through operating costs. The amounts payable as of
December 31, 1996 and 1995 were $346,359 and $349,031, respectively.

PERC had waste processing revenue of approximately $615,546, $603,820 and
$564,942 from Orrington Waste Ltd. (a limited partnership including certain
general and limited partners of PERC) (OWL) in 1996, 1995 and 1994,
respectively. OWL and PERC have a long-term put-pay agreement under which OWL
pays waste disposal fees to PERC equivalent to those charged to other
municipalities. Included in accounts receivable at December 31, 1996 and 1995 is
approximately $60,160 and $87,296, respectively, related to the waste processing
revenue recognized.

7. WASTE HANDLING AGREEMENTS

Certain of PERC's long-term, put-pay contracts with municipalities for
disposal of solid waste contain provisions which, at the date the bonds are
fully paid, allow the municipalities to purchase the facility or terminate or
extend the contracts.

Certain of the long-term, put-pay contracts with municipalities contain
provisions which allow the municipalities to receive a portion of PERC's annual
cash flows, as defined. Based on PERC's cash flows, as defined, approximately
$619,000, $1,418,000 and $440,000 was payable to these municipalities for 1996,
1995 and 1994, respectively. These amounts are included in other expenses.

F-33
76

SCHEDULE II

KTI, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS

COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ---------------------------------- --------- ------------------------- ------------ ----------
ADDITIONS
-------------------------
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS -- DEDUCTIONS -- END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
- ---------------------------------- ---------- ---------- ----------- ------------- ----------

YEAR ENDED DECEMBER 31, 1996
Deducted from assets accounts:
Allowance for doubtful accounts... $ 480,662 23,632 $ 212,355(1) $ 291,939

YEAR ENDED DECEMBER 31, 1995
Deducted from asset accounts:
Allowance for doubtful accounts... 156,912 323,750 480,662

YEAR ENDED DECEMBER 31, 1994
Deducted from asset accounts:
Allowance for doubtful accounts... 105,577 51,335 156,912
Allowance for notes receivable --
officers/shareholders and
affiliates...................... 1,097,065 618,941(1) 0
478,124(1)

- ---------------
(1) Uncollectible accounts written off, net of recoveries.

F-34