<PAGE>
Filed Pursuant to Rule 424(b)(1)
Registration No. 333-39748
PROSPECTUS
7,000,000 Shares
[LOGO OF PROTON ENERGY SYSTEMS]
COMMON STOCK
---------------
PROTON ENERGY SYSTEMS, INC. IS OFFERING 7,000,000 SHARES OF ITS COMMON STOCK.
THIS IS OUR INITIAL PUBLIC OFFERING AND NO PUBLIC MARKET CURRENTLY EXISTS FOR
OUR SHARES.
---------------
OUR COMMON STOCK HAS BEEN APPROVED FOR QUOTATION ON THE NASDAQ NATIONAL MARKET
UNDER THE SYMBOL "PRTN."
---------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 6.
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PRICE $17 A SHARE
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<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS PROTON
-------- ------------- -----------
<S> <C> <C> <C>
Per Share.................... $17.00 $1.19 $15.81
Total........................ $119,000,000 $8,330,000 $110,670,000
</TABLE>
Proton has granted the underwriters the right to purchase up to an additional
1,050,000 shares to cover over-allotments.
The Securities and Exchange Commission and state securities regulators have
not approved or disapproved these securities, or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal
offense.
Morgan Stanley & Co. Incorporated expects to deliver the shares to purchasers
on October 4, 2000.
---------------
MORGAN STANLEY DEAN WITTER
CREDIT SUISSE FIRST BOSTON
SALOMON SMITH BARNEY
September 28, 2000
<PAGE>
[Gatefold graphics]
[The Proton logo appears at the top left corner of this page.
The first section on this page is captioned "Proton's Two Product Families."
The photograph in the left column is labeled "HOGEN(R) Hydrogen Generators."
The photograph in the right column is labeled "UNIGEN(R) Regenerative Fuel
Cell Systems."
The second section on this page is captioned "Potential Applications." The
following appears in the left column of the second section.
Hydrogen gas for industrial applications
. Manufacturing processes
. Microelectronics
. Laboratories
Hydrogen generation for fuel cell vehicles
. Fleet application
. At the "gas" station
The following appears in the right column of the second section.
Power quality and reliability
. Telecommunications
. Computer networks
Renewable power applications
. Off-grid power
. Electricity available as needed independent of natural conditions]
[inside front cover graphics]
[The Proton logo appears at the top left and lower right corners of this page.
The left side of the page contains four photographs. The photograph at the top
of this area depicts a UNIGEN system and is captioned "Proton UNIGEN prototype
built under contract for Electric Power Research Institute." The photograph at
the left center of this area depicts HOGEN 380 equipment and is captioned
"HOGEN 380 prototype in place at electronics manufacturer." The photograph at
the right center of this area depicts HOGEN 40 equipment and is captioned
"HOGEN 40 late stage development units being prepared for shipment." The
photograph at the bottom of this space depicts an individual working on Proton
equipment and is captioned "Late stage development model of Matheson Chrysalis
laboratory hydrogen generator manufactured by Proton Energy Systems."
The top half of the right side of the page contains two photographs: the top
photograph depicts an outdoor solar collector, and the lower photograph
depicts HOGEN equipment. The photographs are captioned "HOGEN prototype unit
connected to solar power device in regenerative energy demonstration at
Arizona Power Star Facility."
Below the large photograph and to the left is a cutaway diagram labeled "HOGEN
380 Hydrogen Generator." The diagram contains the captions "Power and control
system," "Cooling System," "Hydrogen drier," "Cell stack," and "Hydrogen and
oxygen water separator vessels," each with a line pointing to the appropriate
place in the diagram.
Below the large photograph and to the right is a cutaway diagram labeled
"Proposed layout of UNIGEN 1 kw Regenerative fuel cell system." The diagram
contains the captions "Control Panel," "Fuel cell stack," "Electrolysis
stack," and "Water management system," each with a line pointing to the
appropriate place in the diagram. The caption "Power interface and control
electronics (not shown)" also appears.]
<PAGE>
TABLE OF CONTENTS
<TABLE>
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Page
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Prospectus Summary.................. 1
Risk Factors........................ 6
Special Note Regarding Forward-
Looking Statements................. 16
Use of Proceeds..................... 17
Dividend Policy..................... 17
Capitalization...................... 18
Dilution............................ 20
Selected Financial Data............. 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 22
</TABLE>
<TABLE>
<CAPTION>
Page
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<S> <C>
Business......................... 26
Management....................... 39
Certain Transactions............. 45
Principal Stockholders........... 47
Description of Capital Stock..... 50
Shares Eligible For Future Sale.. 53
Underwriters..................... 55
Legal Matters.................... 57
Experts.......................... 57
Where You Can Find More
Information..................... 57
Index to Financial Statements.... F-1
</TABLE>
----------------
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell shares of common stock
and seeking offers to buy shares of common stock, only in jurisdictions where
offers and sales are permitted. The information contained in this prospectus
is accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of the common stock.
Until October 23, 2000 (25 days after the date of this prospectus), all
dealers that buy, sell or trade shares of the common stock, whether or not
participating in this offering, may be required to deliver a prospectus. This
delivery requirement is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
i
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock being sold in this
offering and our financial statements and the related notes appearing elsewhere
in this prospectus.
PROTON ENERGY SYSTEMS, INC.
Our Business
We design, develop and manufacture proton exchange membrane, or PEM,
electrochemical products that we employ in hydrogen generating devices and in
regenerative fuel cell systems that function as power generating and energy
storage devices. Our hydrogen generators produce hydrogen from electricity and
water in a clean and efficient process using our proprietary PEM technology. We
are currently manufacturing and delivering late stage development models of our
hydrogen generators to customers for use in commercial applications. Our
regenerative fuel cell systems, which we are currently developing, will combine
our hydrogen generation technology with a fuel cell power generator to create
an energy device that is able to produce and store the hydrogen fuel it can
later use to generate electricity.
Our Market Opportunities and Our Solutions
We believe a number of trends favor the deployment of fuel cell systems and
other products incorporating PEM technology. These include:
. increased demand for high quality electric power, driven by rapid growth
in the use of computers, computer networks and communications networks
in the Internet economy;
. continuing deregulation of utilities, which we believe will accelerate
the adoption of innovative power technology products; and
. intensifying world interest in developing alternatives to combustion-
based power generation and in harnessing renewable sources of energy to
produce clean power.
Since our inception we have focused on developing commercial applications
for our PEM technology to serve the needs of several distinct markets. We
believe these markets will provide us with significant opportunities for growth
both in the near term and in the longer term.
Hydrogen Gas Generation for Industrial Applications. Our hydrogen generators
have been designed to address the existing demand by small- and medium-volume
users for on-site hydrogen gas generation in a variety of manufacturing and
laboratory applications which we believe will provide a lower-cost, safer and
more convenient alternative to conventionally delivered hydrogen. We believe
that our hydrogen generators may also be well suited for servicing the needs of
small to mid-sized manufacturing and food processing facilities located in
markets with inadequate or nonexistent hydrogen distribution infrastructures.
Hydrogen Fuel Generation for Fuel Cells. In the longer term, as fuel cell
markets develop, we believe our hydrogen generators will provide an attractive
and environmentally friendly solution to the challenge of providing fuel for
fuel cell vehicles and other fuel cell applications. We believe that our
hydrogen generators can be a key component of a broad-based refueling
infrastructure in which they are installed at gas stations and connected to the
stations' existing water and electrical supplies. Our process of generating
hydrogen presents an alternative to the hydrocarbon reforming process in which
hydrocarbons, such as natural gas, methanol, diesel fuel
1
<PAGE>
and propane, are converted into hydrogen gas. While initial commercial sales of
fuel cell automobiles are not expected to occur until between 2003 and 2005, we
believe the eventual refueling market for these vehicles will represent a
significant market opportunity.
Power Quality and Reliability. We are developing our regenerative fuel cell
systems to address the demand for highly reliable backup power systems. The
increased use of computers, computer networks and communications networks in
the Internet economy, as well as the increased use of sensitive electronics in
manufacturing, are all creating an increase in the demand for highly reliable
backup power to avoid the costs and lost revenue associated with power
disruptions. According to the Electric Power Research Institute, the cost of
power disruptions in the United States is approximately $30 billion per year.
We believe our regenerative fuel cell systems will offer a reliable, efficient
and low-cost alternative to current backup power technologies.
Renewable Power Applications. In the longer term, we believe our
regenerative fuel cell systems may enable renewable energy solutions by
facilitating the storage of energy produced by non-depleting and non-polluting,
but inherently intermittent, energy sources, such as solar, wind and
hydroelectric power. Our regenerative fuel cell systems are designed to be
connected to a renewable power source to generate and store hydrogen fuel when
excess power is available and then convert it to electricity when power is
needed but the renewable power source cannot produce power because of
unfavorable natural conditions. We believe our regenerative fuel cell systems
could enable more widespread use of renewable energy technologies.
We believe we are among the first companies to manufacture and deliver
systems incorporating PEM technology for use in commercial applications. We
have begun shipping late stage development models of our hydrogen generators to
customers for use in industrial applications and are working to finalize the
commercial design and deliver additional units to our customers. We also have
an agreement with a leading supplier of laboratory gases under which it plans
to distribute our line of smaller scale hydrogen generators for laboratory use.
We also intend to develop commercial applications for our regenerative fuel
cell technology. We manufactured and delivered two demonstration regenerative
fuel cell systems in 1999 and recently entered into an agreement with NASA to
develop a larger, second-generation regenerative fuel cell system to be
delivered in 2001. This next-generation system is being designed to have the
scale and technical attributes necessary to serve a broad range of commercial
applications. Our goal is to deliver our first commercially configured
regenerative fuel cell system for field testing in 2002.
Our History
We were incorporated in Delaware in August 1996. We sustained net losses of
$2.7 million in 1998, $3.3 million in 1999 and $2.0 million for the six months
ended June 30, 2000. We anticipate we will incur substantial losses in the
future, primarily as a result of research and development activities and
expansion of manufacturing facilities. We face significant technical challenges
and intense competition. Prior to this offering, we have raised over $60
million of private equity. Our stockholder base includes investors with
extensive contacts and experience in the power technology industry. Our
management team has significant power industry and PEM technology experience.
Our Strategy
Our objective is to be a leader in harnessing PEM technology for a number of
commercial applications. Our strategy for achieving this objective includes the
following elements:
. leverage our technological position to develop innovative products that
address attractive markets and that can benefit from further
developments by other fuel cell developers and increases in demand for
their fuel cell products;
2
<PAGE>
. focus on near-term market opportunities such as the industrial gas and
backup power markets;
. continue to reduce our manufacturing costs;
. develop key strategic relationships with companies seeking to gain
access to fuel cell-related technology; and
. position our technology for longer-term opportunities in automotive
refueling and renewable power technologies.
3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered.................... 7,000,000 shares
Common stock to be outstanding after
this offering.......................... 32,014,816 shares
Use of proceeds......................... For general corporate purposes,
including working capital and capital
expenditures.
Nasdaq National Market symbol........... PRTN
</TABLE>
The number of shares to be outstanding after this offering is based on
shares outstanding at August 31, 2000 and excludes:
. 1,558,604 shares of common stock issuable upon the exercise of
outstanding options as of August 31, 2000 at a weighted average exercise
price of $1.83 per share;
. 860,000 shares of common stock issuable upon the exercise of options to
be granted upon the closing of this offering with an exercise price
equal to the initial public offering price per share shown on the cover
of this prospectus;
. 50,000 shares of common stock issuable upon the exercise of a warrant
outstanding as of August 31, 2000 at an exercise price of $1.10 per
share; and
. an additional 5,517,632 shares of common stock reserved for future
issuance under our stock plans.
----------------
Except as otherwise indicated, the information in this prospectus:
. assumes the exercise upon the completion of this offering of warrants
held by some of our stockholders to purchase 441,959 shares of
convertible preferred stock at an exercise price of $2.00 per share. In
lieu of exercising these warrants by paying cash to Proton, the
warrantholders could elect to convert the warrants into a smaller number
of shares determined based upon the initial public offering price of the
shares being sold in this offering; to the extent warrantholders elect
this method of exercise, the number of shares of common stock
outstanding will be lower;
. gives effect to the conversion of all outstanding convertible preferred
stock, including the shares of convertible preferred stock issued upon
the assumed exercise of the warrants, into an aggregate of 23,101,052
shares of common stock, which will occur automatically upon the
completion of this offering; and
. assumes the underwriters do not exercise their over-allotment option to
purchase additional shares in this offering.
----------------
Our principal executive offices are located at 50 Inwood Road, Rocky Hill,
Connecticut 06067 and our telephone number is (860) 571-6533. Our web site
address is www.protonenergy.com. The information on our web site is not
incorporated by reference into this document and should not be considered to be
a part of this document. Our web site address is included in this document as
an inactive textual reference only.
HOGEN(R), PROTON(R) and UNIGEN(R) are trademarks or service marks of Proton.
Chrysalis(TM) is a trademark of Matheson Tri-Gas, Inc. Other trademarks or
service marks appearing in this prospectus are the property of their respective
holders.
4
<PAGE>
SUMMARY FINANCIAL DATA
The following table summarizes the financial data for our business. You
should read this information in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our financial
statements and related notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
Six Months Ended
Year Ended December 31, June 30,
------------------------- -----------------
1997 1998 1999 1999 2000
------- ------- ------- ------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Contract revenue................. $ -- $ -- $ 934 $ 47 $ 187
Costs and expenses:
Costs of contract revenue...... -- 377 355 263 88
Costs of production............ -- -- 154 -- 116
Research and development....... 963 1,323 2,182 421 1,187
General and administrative..... 735 950 1,705 837 1,432
------- ------- ------- ------- --------
Loss from operations............. (1,698) (2,650) (3,462) (1,474) (2,636)
Interest income (expense), net... 28 (31) 172 77 682
------- ------- ------- ------- --------
Net loss......................... (1,670) (2,681) (3,290) (1,397) (1,954)
------- ------- ------- ------- --------
Deemed preferred dividends and
accretion....................... (160) (441) (899) (404) (51,430)
------- ------- ------- ------- --------
Net loss attributable to common
stockholders.................... $(1,830) $(3,122) $(4,189) $(1,801) $(53,384)
======= ======= ======= ======= ========
Basic and diluted net loss per
share attributable to common
stockholders.................... $ (0.96) $ (1.64) $ (2.20) $ (0.95) $ (28.07)
======= ======= ======= ======= ========
Shares used in computing basic
and diluted net loss per share
attributable to common
stockholders.................... 1,900 1,900 1,900 1,900 1,902
======= ======= ======= ======= ========
</TABLE>
<TABLE>
<CAPTION>
As of June 30, 2000
-------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and marketable
securities................................... $ 50,523 $51,407 $160,577
Working capital............................... 51,597 52,481 161,651
Total assets.................................. 53,799 54,683 163,853
Mandatorily redeemable convertible preferred
stock........................................ 64,828 -- --
Total stockholders' equity (deficit).......... (12,143) 53,569 162,739
</TABLE>
The pro forma balance sheet data gives effect to:
. the assumed issuance upon the completion of this offering of 441,959
shares of series B convertible preferred stock at a price of $2.00 per
share upon the exercise of warrants that would otherwise expire upon the
completion of this offering; and
. the conversion of all outstanding shares of our convertible preferred
stock, including the series B shares issued as a result of the exercise
of warrants, into an aggregate of 23,101,052 shares of common stock,
which will occur automatically upon the completion of this offering.
The pro forma as adjusted balance sheet data also reflects our sale of
7,000,000 shares of common stock in this offering, after deducting underwriting
discounts and commissions and estimated offering expenses payable by us.
5
<PAGE>
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks described below are not the only ones facing
our company. Additional risks not presently known to us or that we currently
deem immaterial may also impair our business operations. Our business,
financial condition, results of operations or cash flows could be materially
adversely affected by any of these risks. The trading price of our common
stock could also decline due to any of these risks, and you may lose all or
part of your investment. This prospectus also contains forward-looking
statements that involve risks and uncertainties. Our actual results could
differ materially from those anticipated in these forward-looking statements
as a result of several factors, including the risks faced by us described
below and elsewhere in this prospectus.
Our future success is uncertain because we have a limited operating history.
As a development stage company, we face many risks and uncertainties. If we
are unsuccessful in addressing these risks and uncertainties, we may be unable
to generate revenue and grow our company. We were formed in 1996 to research
and develop PEM electrochemical products. We began shipping late stage
development models of our hydrogen generators in the first quarter of 2000 and
have not yet manufactured commercial regenerative fuel cell systems.
Accordingly, there is only a limited basis upon which you can evaluate our
business and prospects and our future success is uncertain. In addition, until
we have adequate information to estimate warranty obligations relating to our
product sales, we are deferring recognition of revenue on product sales. You
should consider the challenges, expenses, delays and other difficulties
typically involved in the establishment of a new business, including the
continued development of our products, development of fully functioning
manufacturing operations, refinement of processes and components for our
commercial products, recruitment of qualified personnel, and achievement of
market acceptance for our products.
We have incurred, and expect to continue to incur, substantial losses, and we
may never become profitable.
We have incurred substantial losses since we were founded and we anticipate
we will continue to incur substantial losses in the future. As of June 30,
2000, we had an accumulated deficit of $60.5 million. We cannot predict when
we will operate profitably, if ever. We expect to continue to incur increased
expenses related to research and development activities, expansion of our
manufacturing facilities and general administrative functions. As a result, we
anticipate that we will continue to incur losses until we can cost-effectively
produce and sell our hydrogen generators and regenerative fuel cell systems in
substantial quantities. Even if we do achieve profitability, we may be unable
to sustain or increase our profitability in the future.
If we fail to retain our key personnel and attract and retain additional
qualified personnel, we may be unable to develop our products and generate
revenue.
Our success depends upon the continued service of our executive officers
and other key employees such as manufacturing and research and development
personnel. The loss of any of our executive officers or key employees,
especially Walter W. Schroeder, president and chief executive officer, Trent
M. Molter, vice president of engineering and technology, and Lawrence C.
Moulthrop, Jr., vice president of product engineering, could impair our
ability to pursue our growth strategy and slow our product development
processes. We do not have employment agreements with any of our key
executives. Furthermore, we must continue to hire large numbers of highly
qualified individuals, including researchers, engineers and manufacturing
professionals. Competition for these individuals is intense, and we may not be
able to attract, assimilate or retain additional highly qualified personnel in
the future.
We may not be able to generate revenue in the future if we do not complete the
development of our hydrogen generators and regenerative fuel cell systems.
Our hydrogen generators and regenerative fuel cell systems are still in the
development stage. We do not know when or whether we will successfully
complete research and development of commercial hydrogen
6
<PAGE>
generators or regenerative fuel cell systems. If we are unable to develop
commercial hydrogen generators or commercial regenerative fuel cell systems,
we may not be able to generate future revenue and we may not recover the
losses we have incurred in attempting to develop these products. If we
experience delays in meeting our development milestones or if our hydrogen
generators and regenerative fuel cell systems exhibit technical defects or
cannot meet cost or performance goals, including output, useful life and
reliability goals, potential purchasers of our products may decline to
purchase them or choose alternative technologies. We may be unable to make the
substantial technological advances necessary to produce commercial hydrogen
generators and regenerative fuel cell systems that provide the features and
performance specifications required by customers at a competitive price. For
example, we must identify improved hydrogen storage technologies and fuel cell
module structures. In addition, in order to commercially market our smaller
scale hydrogen generators, we need to develop an effective method of removing
water vapor from the hydrogen produced. If we are unable to successfully
complete these development activities, we may be unable to commercially market
our products. In some cases, we are attempting to expedite our development
efforts by utilizing third parties for important engineering work. These third
parties include vendors of hydrogen storage, purification systems, power
supply and control components. If these third parties are unable to
successfully complete their development activities on our behalf, we may be
unable to commercially market our products.
We will not be able to grow our business if we do not achieve widespread
commercial acceptance of our hydrogen generators in the market for delivered
hydrogen.
We intend to market our hydrogen generators to small- and medium-volume
users of delivered hydrogen. Our business depends on the widespread commercial
acceptance of our hydrogen generators and we may be unable to grow our
business if our targeted customers do not purchase substantial numbers of our
hydrogen generators. Our targeted customers, or the distributors who we intend
to use to market to these customers, may not purchase our hydrogen generators
at all or in sufficient quantities to support the growth of our business. Our
hydrogen generators will require our target customers to make a substantial
initial investment, currently ranging from approximately $50,000 to $200,000
per unit for our HOGEN models. Our method of supplying hydrogen by producing
it on-site using PEM electrolysis represents a significant departure from
conventional means of supplying hydrogen to end users. PEM electrolysis is a
new and unproven technology in the markets we are targeting, and we do not
know if our targeted customers will accept our product. In addition, we have
not demonstrated that we can supply hydrogen to our targeted customers at a
lower cost than conventionally delivered hydrogen.
The success of our hydrogen generators as a fuel source for PEM fuel cells
depends upon the development of a mass market for PEM fuel cells, and we may
not be able to generate revenue in the future if this market does not develop.
We also intend to market our hydrogen generators for use as fuel generators
for PEM fuel cells in a variety of applications, in particular fuel cell
vehicles. If a mass market for PEM fuel cells fails to develop or develops
more slowly than we anticipate, we may be unable to generate revenue in the
future and recover the losses we will have incurred in the development of our
hydrogen generators. PEM fuel cells represent an emerging commercial market,
and we do not know whether end-users will want to use them. The development of
a mass market for PEM fuel cells may be affected by many factors outside of
our control, including:
. the emergence of newer, more competitive technologies;
. the cost competitiveness of PEM fuel cells compared to existing and new
technologies;
. the future cost of hydrogen;
. regulatory requirements;
. consumer perceptions of the safety, reliability and functionality of PEM
fuel cells; and
. consumer willingness to try a new product.
7
<PAGE>
In addition, the sole market for vehicular PEM fuel cells is and will
continue to be car, bus and other vehicle manufacturers. Automobile
manufacturers' interest in vehicular PEM fuel cells has been driven in large
part by environmental laws and regulations concerning vehicle emission
requirements that have been enacted in California and some northeastern
states. If these laws and regulations are not kept in force or do not become
widely adopted, the demand for vehicular PEM fuel cells may be limited.
Further, automobile manufacturers may be able to use other technologies to
meet their regulatory requirements, such as batteries, low emission internal
combustion engines and hybrid internal combustion/battery engines. Even if
automobile manufacturers decide to develop vehicles powered by PEM fuel cells,
it may be many years before substantial numbers of vehicles powered by PEM
fuel cell systems are manufactured. Further, there are several other
technologies that may be used to generate hydrogen, such as hydrocarbon
reforming, and there remains a strong possibility that our means of generating
hydrogen will not be used to supply fuel to fuel cells.
We may be unable to increase our revenue in the future if the use of renewable
energy does not increase.
We anticipate that one of the primary uses of our regenerative fuel cell
systems will be for storing energy produced by renewable power sources, such
as solar, wind and hydroelectric power. If the demand for renewable energy
develops more slowly than we anticipate, our ability to sell our regenerative
fuel cell systems could be impaired and we may be unable to grow our business.
The market for renewable energy is still in an early stage of development and
the demand for renewable energy will remain limited until the cost of
producing energy from renewable sources is substantially reduced. Power from
renewable energy sources currently costs significantly more than power derived
from nonrenewable sources, such as coal and oil. The growth of the renewable
energy market will be dependent on many factors that are outside of our
control, such as the emergence of new, more cost-effective power technologies
and products, and domestic and international regulatory requirements.
We expect to incur significant expenses in expanding our manufacturing
facilities and production and we may not be successful in these efforts.
We will be expanding our manufacturing facilities in anticipation of
increased demand for our products. If this demand does not materialize, we
will not generate sufficient revenue to offset the costs of developing and
operating these facilities, which could increase our losses and prevent us
from growing our business. We currently anticipate we will spend approximately
$10 million over the next two years to purchase equipment and make leasehold
improvements for our planned manufacturing facility. We have not yet finalized
plans or executed contracts for this expansion, and actual costs may be
significantly in excess of our estimates. In addition, we expect to expand our
production and may experience delays or problems in our expected expansion
that could compromise our ability to increase our sales and grow our business.
Factors that could delay or prevent our expected production expansion include:
. the inability to purchase parts or components in adequate quantities or
sufficient quality;
. the cost of raw materials;
. the failure to increase our assembly and test operations;
. the failure to hire and train additional manufacturing personnel;
. the failure to develop and implement manufacturing processes and
equipment; and
. the inability to acquire new space for additional production capacity.
If we fail to successfully manufacture our products in commercial quantities,
we may not be able to increase our revenue.
To be financially successful, we will have to manufacture our products in
commercial quantities at acceptable costs while also preserving the quality
levels achieved in manufacturing these products in limited quantities. This
presents a number of technological and engineering challenges for us. We may
not be successful
8
<PAGE>
in developing product designs and manufacturing processes that permit us to
manufacture our hydrogen generators and regenerative fuel cell systems in
commercial quantities at commercially acceptable costs while preserving
quality. Currently, we sell some of our products for less than it costs us to
produce them. In addition, we will incur significant start-up costs and may
experience unforeseen delays and expenses in our product design and
manufacturing efforts. If the commercialization of our products is delayed,
potential purchasers may also decline to purchase them or choose alternative
technologies, both of which could impair our ability to generate revenue in
the future.
If our suppliers do not supply us with a sufficient amount and quality of
components at acceptable prices, we may not be able to manufacture our
products commercially.
Although we generally attempt to use standard components for our products,
the proton exchange membrane material and hydrogen purification system used in
our products are currently available only from limited sources. Also, we may
be unable to purchase components of adequate quality or that meet our cost
requirements. In addition, to the extent these components are proprietary
products of our suppliers, or the processes used by our suppliers to
manufacture these components are proprietary, we may be unable to obtain
comparable components from alternative suppliers. We may experience delays in
production of our products and our business and financial results would suffer
if we fail to identify alternate suppliers, or if our supply is interrupted or
reduced or there is a significant increase in cost.
In addition, platinum is a key component of our PEM fuel cells. Platinum is
a scarce natural resource and we are dependent upon a sufficient supply of
this commodity. We may not be able to produce commercial products, or the cost
of producing our products may significantly increase, if there are any
shortages in the supply of platinum.
We may be unable to sell our products and generate revenue if we fail to
establish distribution relationships.
Because we intend to sell our products primarily through third-party
distributors, the financial benefits to us of commercializing our products
will be dependent on the efforts of others. We intend to enter into additional
distribution agreements or other collaborative relationships to market and
sell our products. If we are unable to enter into additional distribution
agreements, or if our third-party distributors do not successfully market and
sell our products, we may be unable to generate revenue and grow our business.
We may seek to establish relationships with third-party distributors who also
indirectly compete with us. For example, we have targeted industrial gas
suppliers as potential distributors of our hydrogen generators. Because
industrial gas suppliers currently sell hydrogen in delivered form, adoption
by their customers of our hydrogen generation products could cause them to
experience declining demand for delivered hydrogen. For this reason,
industrial gas suppliers may be reluctant to become distributors of our
hydrogen generators. In addition, our third-party distributors may require us
to provide volume price discounts and other allowances, or customize our
products, either of which could reduce the potential profitability of these
relationships.
We have historically focused on research and development activities and have
limited experience in marketing, selling and servicing our products.
We have primarily focused on the research and development of our hydrogen
generators and regenerative fuel cell systems. Consequently, our management
team has limited experience directing the commercialization efforts that are
essential to our future success. To date, we only have limited experience
marketing, selling and servicing our hydrogen generators, and no experience
marketing, selling or servicing our regenerative fuel cell systems.
Furthermore, there are very few people anywhere who have significant
experience marketing, selling or servicing PEM electrochemical products. We
will have to expand our marketing and sales organization and will have to
create a maintenance and support capability. We may not be successful in our
efforts to market and service our products, which would compromise our ability
to increase our revenue.
9
<PAGE>
Our plans to market, distribute and service our products internationally
subject our business to additional risks, which could prevent us from growing
our business.
We intend to market, distribute and service our products internationally
and we may derive a significant portion of our revenue from international
sales. If we fail to successfully sell our products internationally, our
ability to increase our future revenue and grow our business would be
impaired. We have limited experience developing, and no experience
manufacturing, our products to comply with the commercial and legal
requirements of international markets. Our success in those markets will
depend on our ability to secure relationships with foreign resellers and our
ability to manufacture products that meet foreign regulatory and commercial
requirements. In addition, our planned international operations may be subject
to a variety of additional risks, including:
. difficulties in collecting international accounts receivable;
. increased costs associated with maintaining international marketing
efforts;
. compliance with U.S. Department of Commerce export controls;
. increases in duty rates;
. the introduction of non-tariff trade barriers;
. fluctuations in currency exchange rates;
. political and economic instability; and
. difficulties in enforcing intellectual property rights.
We currently face and will continue to face significant competition, which
could cause us to lose sales or render our products uncompetitive or obsolete.
The markets for delivered hydrogen and reliable backup power are highly
competitive. There are a number of companies located in the United States,
Canada and abroad that deliver hydrogen, sell hydrogen generation equipment or
are developing PEM fuel cell technology. Many of these companies have
substantially greater resources than we do. Each of these companies has the
potential to capture market share in the markets we intend to address, which
could cause us to lose sales and prevent us from growing our business. New
developments in technology may also delay or prevent the development or sale
of some or all of our products or make our products uncompetitive or obsolete.
If this were to occur, we would not be able to generate sufficient revenue to
offset the cost of developing our hydrogen generators and regenerative fuel
cell systems.
Our regenerative fuel cell systems are one of a number of power technology
products being developed today to provide high quality, highly reliable backup
power to the existing electric transmission system, or grid. These products
include advanced batteries, ultracapacitors, microturbines, flywheels,
internal combustion generator sets, superconducting magnetic energy storage
devices and other fuel cells using alternative hydrogen supply applications.
Improvements are also being made to the existing electric grid. Technological
advances in power technology products and improvements in the electric grid
may reduce the attractiveness of our regenerative fuel cell systems.
As the markets for PEM fuel-cell related products, on-site hydrogen
generation and backup power develop, other large industrial companies may
enter these fields and compete with us. These large industrial companies may
have the research and development, manufacturing, marketing and sales
resources necessary to commercialize hydrogen generators and regenerative fuel
cell systems more quickly and effectively than we do.
We depend on our intellectual property and our failure to protect it could
enable competitors to market products with similar features that may reduce
demand for our products.
If we are unable to protect our intellectual property, our competitors
could use our intellectual property to market products similar to our
products, which could reduce demand for our products. Our success depends
10
<PAGE>
substantially upon the internally developed technology that is incorporated in
our products. We may be unable to prevent unauthorized parties from attempting
to copy or otherwise obtain and use our products or technology. Policing
unauthorized use of our technology is difficult, and we may not be able to
prevent misappropriation of our technology, particularly in foreign countries
where the laws may not protect our intellectual property as fully as those in
the United States. Others may circumvent the trade secrets, trademarks and
copyrights that we own and any of the U.S. patents or foreign patents owned by
us or subsequently issued to us may be invalidated, circumvented, challenged
or rendered unenforceable. In addition, we may not be issued any patents as a
result of our pending and future patent applications and any patents we are
issued may not have the breadth of claim coverage sought by us.
Most of our intellectual property is not covered by any patent or patent
application. We seek to protect this proprietary intellectual property, which
includes intellectual property that may not be patented or patentable, in part
by confidentiality agreements with our distributors and employees. These
agreements afford only limited protection and may not provide us with adequate
remedies for any breach or prevent other persons or institutions from
asserting rights to intellectual property arising out of these relationships.
We could incur substantial costs defending our intellectual property from
infringement by others.
Unauthorized parties may attempt to copy aspects of our products or to
obtain and use our proprietary information. Litigation may be necessary to
enforce our intellectual property rights, to protect our trade secrets and to
determine the validity and scope of the proprietary rights of others. Any
litigation could result in substantial costs and diversion of resources with
no assurance of success.
We could incur substantial costs defending against claims that our products
infringe on the proprietary rights of others.
The patent situation in the field of PEM fuel cell technology is complex. A
large number of patents, including overlapping patents, relating to this
technology have been granted worldwide. We are aware of patents in the fuel
cell architecture field held by potential competitors and other third parties,
including Ballard Power Systems, General Motors, Giner, H-Power, Oronzio
deNora Impianti Electrochemical, Packard Instrument, Plug Power, Shinko
Pantec, Siemens, Toyota, United Technologies and Whatman. Third parties could
claim infringement by us with respect to these patents or other patents or
proprietary rights, and we cannot assure you that we would prevail in any such
proceeding.
In addition, some of our employees are parties to assignment of invention
and nondisclosure agreements with their former employers. These agreements
generally grant the former employer rights to technology developed by the
employee while employed by the former employer and prohibit disclosure of that
technology or other employer information to third parties. We cannot assure
you that such employers will not assert claims against us or our employees
alleging a breach of those agreements or other violations of their proprietary
rights or alleging rights to inventions by our employees, or that we would
prevail in any such proceeding.
Any infringement claim against us, whether meritorious or not, could:
. be time-consuming;
. result in costly litigation or arbitration and diversion of technical
and management personnel; or
. require us to develop non-infringing technology or to enter into royalty
or licensing agreements.
We might not be successful in developing non-infringing technologies. Royalty
or licensing agreements, if required, may not be available on terms acceptable
to us, or at all, and could significantly harm our business and operating
results. A successful claim of infringement against us or our failure or
inability to license the infringed or similar technology could require us to
pay substantial damages and could harm our business because we would
11
<PAGE>
not be able to sell the affected product without redeveloping it or incurring
significant additional expense. In addition, to the extent we agree to
indemnify customers or other third parties against infringement of the
intellectual property rights of others, a claim of infringement could require
us to incur substantial time, effort and expense to indemnify these customers
and third parties and could disrupt or terminate their ability to use, market
or sell our products.
We may not be able to control our warranty exposure, which could increase our
expenses.
Any significant incurrence of warranty expense could increase our costs. To
date, we have not had adequate information to estimate warranty obligations
and therefore we may be unable to reasonably predict our warranty expenses. In
addition, any warranty disclaimers we use may not effectively limit our
liability.
We may be exposed to lawsuits and other claims if our products malfunction,
which could increase our expenses, harm our reputation and prevent us from
growing our business.
Any liability for damages resulting from malfunctions of our products could
be substantial and could increase our expenses and prevent us from growing our
business. In particular, hydrogen is a flammable gas and can pose safety risks
if not handled properly. In addition, our products may require modifications
to operate properly under extreme temperatures. Potential customers will also
rely upon our products for critical needs, such as backup power. A malfunction
of our products could result in tort or warranty claims. In addition, a well-
publicized actual or perceived problem could adversely affect the market's
perception of our products. This could result in a decline in demand for our
products, which would reduce our revenue and harm our business.
Future government regulation may impair our ability to market and sell our
products.
Our products are potentially subject to federal, local and foreign laws and
regulations governing, among other things, emissions to air as well as laws
relating to occupational health and safety. We may incur substantial costs or
liabilities in complying with governmental regulations. Our potential
customers must also comply with numerous laws and regulations, which could
affect their interest in our products. We could incur potentially significant
expenditures in complying with environmental and health and safety laws,
regulations and requirements that may be adopted or imposed in the future.
We anticipate undergoing a period of rapid growth and our failure to manage
this growth could harm our business.
We anticipate undergoing a period of rapid growth in the number of our
employees and the scope of our operations. We intend to introduce new
products, increase our production capacity and develop additional distributor
relationships. Rapid expansion would likely place a significant strain on our
senior management team and other resources. In addition, we may be required to
hire additional senior management personnel. Our ability to manage growth will
depend in part on our ability to continue to enhance our operating, financial
and management information systems. Our personnel, systems and controls may be
unable to support our growth.
We may not be able to obtain sufficient funds to grow our business.
We have regularly needed to raise funds in order to operate our business
and believe we may need to raise additional funds to achieve full
commercialization of some or all of our products. If we are unable to raise
additional funds when needed, our ability to operate and grow our business
could be impaired. We do not currently have a line of credit. We do not know
whether we will be able to secure additional funding or funding on terms
acceptable to us. Our ability to obtain additional funding will be subject to
a number of factors, including market conditions, our operating performance
and investor sentiment. These factors may make the timing, amount, terms and
conditions of additional funding unattractive to us. If we issue additional
equity securities, existing stockholders may experience dilution or be
subordinated to any rights, preferences or privileges granted to the new
equity holders.
12
<PAGE>
Our revenue and operating results may fluctuate significantly as a result of
factors outside of our control, which could cause the market price of our
common stock to decline.
We expect our revenue and operating results to vary significantly from
quarter to quarter. As a result, quarterly comparisons of our financial
results are not necessarily meaningful and you should not rely on them as an
indication of our future performance. In addition, due to our stage of
development, we cannot predict our future revenue or results of operations
accurately. As a consequence, our operating results may fall below the
expectations of securities analysts and investors, which could cause the price
of our common stock to decline. Factors that may affect our operating results
include:
. the status of development of our technology, products and manufacturing
capabilities;
. the cost of our raw materials and key components;
. the introduction, timing and market acceptance of new products
introduced by us or our competitors;
. the development of our strategic relationships and distribution
channels;
. general economic conditions, which can affect our customers' capital
investments and the length of our sales cycle;
. the development of vehicular PEM fuel cells and renewable energy
markets; and
. government regulation.
We expect to make significant investments in all areas of our business,
particularly in research and product development and in expanding our
manufacturing capability. Because the investments associated with these
activities are relatively fixed in the short-term, we may be unable to adjust
our spending quickly enough to offset any unexpected shortfall in our revenue
growth. In addition, because we are in the very early stages of selling our
products and have a limited number of customers, we expect our order flow to
be uneven from period to period.
Our stock price is likely to be highly volatile and may result in substantial
losses for investors purchasing shares in the offering.
The market price of our common stock is likely to be highly volatile. The
stock market in general, and the market for technology-related stocks in
particular, has been highly volatile. As a result, investors in our common
stock may experience a decrease in the value of their common stock regardless
of our operating performance or prospects. Our common stock may not trade at
the same levels as other technology-related stocks and technology-related
stocks in general may not sustain their current market prices. In addition,
the initial public offering price may bear no relationship to the price at
which the common stock will trade upon completion of this offering. An active
public market for our securities may not develop or be sustained after
completion of this offering.
In addition, the trading price of our common stock could be subject to wide
fluctuations in response to:
. our perceived prospects;
. variations in our operating results and achievement of key business
targets;
. changes in securities analysts' recommendations or earnings estimates;
. differences between our reported results and those expected by investors
and securities analysts;
. announcements of new products by us or our competitors;
. market reaction to any acquisition, joint venture or strategic
investments announced by us or our competitors; and
. general economic or stock market conditions unrelated to our operating
performance.
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<PAGE>
In the past, securities class action litigation has often been instituted
against companies following periods of volatility in their stock price. This
type of litigation could result in substantial costs and divert our
management's attention and resources.
Our executive officers, directors and their affiliates hold a large percentage
of our stock and their interests may differ from other stockholders.
We anticipate that our directors, executive officers and individuals or
entities affiliated with our directors as a group will beneficially own
approximately 31.0% of our outstanding common stock after the completion of
this offering. If these stockholders choose to act or vote together, they will
have the power to significantly influence the election of our directors, and
the approval of any other action requiring the approval of our stockholders,
including any amendments to our certificate of incorporation and mergers or
sales of substantially all of our assets. In addition, without the consent of
these stockholders, we could be prevented from entering into transactions that
could be beneficial to us or our other stockholders. Also, third parties could
be discouraged from making a tender offer or bid to acquire us at a price per
share that is above the then-current market price.
Our management will have broad discretion over the use of the net proceeds
from this offering and you may not agree with how we use them.
Our management will have broad discretion as to the use of the net proceeds
from this offering. While we currently anticipate that we will use the net
proceeds of this offering for general corporate purposes, including working
capital and capital expenditures related to the expansion of our operations,
as described under "Use of Proceeds," our management may allocate the net
proceeds as it determines is necessary. In addition, market factors may
require our management to allocate all or portions of the net proceeds for
other purposes. Accordingly, you will be relying on the judgment of our
management with regard to the use of the net proceeds from this offering.
The provisions of our charter documents and Delaware law could inhibit a
takeover that stockholders may consider favorable and diminish the voting
rights of the holders of our common stock.
There are provisions in our certificate of incorporation and by-laws that
make it more difficult for a third party to acquire, or attempt to acquire,
control of Proton, even if a change in control was considered favorable by our
stockholders. For example, our board of directors has the authority to issue
up to 5,000,000 shares of preferred stock. The board of directors can fix the
price, rights, preferences, privileges and restrictions of the preferred stock
without any further vote or action by our stockholders. The issuance of shares
of preferred stock may delay or prevent a change in control transaction. As a
result, the market price of our common stock and the voting and other rights
of our stockholders may be adversely affected. The issuance of shares of
preferred stock may result in the loss of voting control to other
stockholders.
Our charter documents contain other provisions that could have an anti-
takeover effect, including:
. only one of the three classes of directors is elected each year;
. stockholders have limited ability to remove directors;
. stockholders cannot take actions by written consent;
. stockholders cannot call a special meeting of stockholders; and
. stockholders must give advance notice to nominate directors or submit
proposals for consideration at stockholder meetings.
In addition, we are subject to the anti-takeover provisions of Section 203
of the Delaware General Corporation Law, which regulates corporate
acquisitions. These provisions could discourage potential acquisition
proposals and could delay or prevent a change in control transaction. They
could also have the effect of
14
<PAGE>
discouraging others from making tender offers for our common stock. These
provisions may also prevent changes in our management.
The substantial number of shares that will be eligible for sale in the near
future could cause our common stock price to decline.
Sales by our stockholders of a substantial number of shares of our common
stock in the public market following this offering, or the perception that
these sales could occur, could cause the market price of our common stock to
decline. These sales also might make it more difficult for us to sell equity
or equity-related securities in the future at a time and price that we deem
appropriate. Upon completion of this offering, we will have outstanding
32,014,816 shares of common stock, assuming no exercise of outstanding
options. Of these shares, the 7,000,000 shares sold in this offering will be
freely tradable, 10,151,029 additional shares of common stock will be
available for sale in the public market 180 days after the date of this
prospectus following the expiration of lock-up agreements between our
stockholders and the underwriters, and 14,863,787 more shares will become
available for sale in the public market on subsequent dates. Morgan Stanley &
Co. Incorporated, on behalf of the underwriters, may release stockholders from
their lock-up agreements with the underwriters at any time and without notice,
which would allow for the earlier sale of shares in the public market.
If you invest in this offering, you will experience immediate and substantial
dilution.
The initial public offering price of our common stock is substantially
higher than the pro forma net tangible book value per share of the outstanding
common stock. As a result, investors purchasing common stock in this offering
will incur immediate and substantial dilution of $11.92 per share in the pro
forma net tangible book value of the common stock. In addition, we have a
significant number of stock options and warrants outstanding. To the extent
these outstanding options or warrants are ultimately exercised, there will be
further dilution to investors in this offering.
15
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve
substantial risks and uncertainties. You can identify these statements by
forward-looking words such as "anticipate," "believe," "could," "estimate,"
"expect," "intend," "may," "plan," "potential," "should," "will," and "would"
or similar words. You should read statements that contain these words
carefully because they discuss our future expectations, contain projections of
our future results of operations or of our financial position or state other
forward-looking information. We believe that it is important to communicate
our future expectations to our investors. However, there may be events in the
future that we are not able to predict accurately or control. The factors
listed above in the section captioned "Risk Factors," as well as any
cautionary language in this prospectus, provide examples of risks,
uncertainties, and events that may cause our actual results to differ
materially from the expectations we describe in our forward-looking
statements. Before you invest in our common stock, you should be aware that
the occurrence of the events described in these risk factors and elsewhere in
this prospectus could have a material adverse effect on our business, results
of operations and financial position.
16
<PAGE>
USE OF PROCEEDS
We estimate that the net proceeds from our sale of 7,000,000 shares of
common stock in this offering will be $109.2 million, after deducting
underwriting discounts and commissions and estimated offering expenses payable
by us. If the underwriters exercise their over-allotment option in full, we
estimate that our net proceeds from this offering will be $125.8 million.
The primary purposes of this offering are to obtain additional equity
capital, create a public market for our common stock and facilitate future
access to public markets. As of the date of this prospectus, we have not made
any specific expenditure plans with respect to the net proceeds of this
offering. We expect to use the net proceeds of this offering for general
corporate purposes and capital expenditures. We currently anticipate we will
spend approximately $1 million in 2000 and $9 million in 2001 to purchase
equipment for and make leasehold improvements to our planned manufacturing
facility. We may also use a portion of the net proceeds to acquire businesses,
products, or technologies that are complementary to our business. However, we
currently have no specific acquisitions planned. Pending their use, we plan to
invest the net proceeds in short-term investment grade, interest-bearing
securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain all future earnings, if any, for use in the
operation and expansion of our business. As a result, we do not anticipate
paying cash dividends in the foreseeable future.
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<PAGE>
CAPITALIZATION
The following table presents our capitalization as of June 30, 2000:
. on an actual basis;
. on a pro forma basis to reflect the assumed issuance upon the completion
of this offering of 441,959 shares of series B convertible preferred
stock at a price of $2.00 per share upon the exercise of warrants that
would otherwise expire upon the completion of this offering, and the
automatic conversion of all outstanding shares of our convertible
preferred stock, including the series B shares issued as a result of the
exercise of warrants, into 23,101,052 shares of common stock upon the
completion of this offering; and
. on a pro forma as adjusted basis to adjust the pro forma balances to
reflect the sale of 7,000,000 shares of common stock in this offering,
after deducting underwriting discounts and commissions and estimated
offering expenses payable by us.
You should read this table along with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our financial statements
and related notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
As of June 30, 2000
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands)
<S> <C> <C> <C>
Mandatorily redeemable convertible preferred
stock:
Series A convertible preferred stock, $.01 par
value per share; 2,908,511 shares authorized,
issued and outstanding, actual; no shares
authorized, issued or outstanding, pro forma
and pro forma as adjusted.................... $ 3,693 $ -- $ --
Series A-1 convertible preferred stock, $.01
par value per share; 2,500,000 shares
authorized, 2,398,530 shares issued and
outstanding, actual; no shares authorized,
issued or outstanding, pro forma and pro
forma as adjusted............................ 3,381 -- --
Series B convertible preferred stock, $.01 par
value per share; 2,200,000 shares authorized,
1,545,151 shares issued and outstanding,
actual; no shares authorized, issued or
outstanding, pro forma and pro forma as
adjusted..................................... 3,604 -- --
Series B-1 convertible preferred stock, $.01
par value per share; 1,500,000 shares
authorized, issued and outstanding, actual;
no shares authorized, issued or outstanding,
pro forma and pro forma as adjusted.......... 3,276 -- --
Series C convertible preferred stock, $.01 par
value per share; 15,000,000 shares
authorized, 14,306,901 issued and
outstanding, actual; no shares authorized,
issued or outstanding, pro forma and pro
forma as adjusted............................ 50,874 -- --
-------- -------- --------
Total mandatorily redeemable convertible
preferred stock............................. 64,828 -- --
-------- -------- --------
Stockholders' equity (deficit):
Preferred stock, undesignated, $.01 par value
per share; 5,000,000 shares authorized; no
shares issued or outstanding, actual, pro
forma and pro forma as adjusted.............. -- -- --
Common stock, $.01 par value per share;
100,000,000 shares authorized; 1,911,764
shares issued and outstanding, actual;
25,012,816 shares issued and outstanding, pro
forma; 32,012,816 shares issued and
outstanding, pro forma as adjusted........... 19 250 320
Additional paid-in capital.................... 50,606 116,087 225,187
Unearned compensation......................... (2,273) (2,273) (2,273)
Deficit accumulated during the development
stage........................................ (60,495) (60,495) (60,495)
-------- -------- --------
Total stockholders' equity (deficit)......... (12,143) 53,569 162,739
-------- -------- --------
Total capitalization........................ $ 52,685 $ 53,569 $162,739
======== ======== ========
</TABLE>
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<PAGE>
The outstanding share information excludes:
. 1,472,895 shares of common stock issuable upon the exercise of
outstanding options as of June 30, 2000, at a weighted average exercise
price of $1.56 per share;
. 860,000 shares of common stock issuable upon the exercise of options to
be granted upon the closing of this offering at the initial public
offering price shown on the cover of this prospectus;
. 50,000 shares of common stock issuable upon the exercise of a warrant
outstanding at June 30, 2000 at an exercise price of $1.10 per share;
and
. an additional 5,605,341 shares of common stock reserved for future
issuance under our stock plans.
Between June 30, 2000 and August 31, 2000, we issued additional options to
purchase up to 92,000 shares of common stock at an exercise price of $6.00 per
share. In addition, we issued 2,000 shares of common stock upon the exercise
of options and options to purchase 4,291 shares of common stock were
cancelled.
In lieu of exercising their warrants to purchase shares of series B
convertible preferred stock by paying cash to Proton, the warrantholders could
choose to convert the warrants into a smaller number of shares of our stock
determined based upon the initial public offering price of the shares being
sold in this offering. To the extent warrantholders elect this method of
exercise, the number of shares of common stock outstanding will be lower and
stockholders' equity will be reduced.
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<PAGE>
DILUTION
Our pro forma net tangible book value as of June 30, 2000 was approximately
$53.6 million, or $2.14 per share of common stock. Pro forma net tangible book
value per share is determined by dividing our total tangible assets less total
liabilities by the number of shares of common stock outstanding, after giving
effect to:
. the assumed issuance upon the completion of this offering of 441,959
shares of convertible preferred stock upon the exercise of warrants held
by some of our stockholders and our receipt of the proceeds of that
exercise at a price of $2.00 per share; and
. the conversion of all outstanding convertible preferred stock, including
the shares issued upon exercise of the warrants, into shares of our
common stock, which will occur automatically upon the completion of this
offering.
After giving effect to our sale of 7,000,000 shares of common stock in this
offering, after deducting underwriting discounts and commissions and estimated
offering expenses payable by us, our pro forma net tangible book value as of
June 30, 2000 would have been $162.7 million, or $5.08 per share. This
represents an immediate increase in pro forma net tangible book value of $2.94
per share to existing stockholders and an immediate dilution of $11.92 per
share to new investors purchasing shares of common stock in this offering. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share....................... $17.00
Pro forma net tangible book value per share before this
offering................................................... $2.14
Increase in pro forma net tangible book value per share
attributable to new investors.............................. 2.94
-----
Pro forma net tangible book value per share after this
offering..................................................... 5.08
------
Dilution per share to new investors........................... $11.92
======
</TABLE>
The following table summarizes on the pro forma basis described above, as
of June 30, 2000, the difference between the number of shares of common stock
purchased from us, the total consideration paid to us, and the average price
per share paid by our existing stockholders and to be paid by new investors in
this offering, before deducting underwriting discounts and commissions and
estimated offering expenses payable by us:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ -------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders... 25,012,816 78% $ 62,480,721 34% $ 2.50
New investors........... 7,000,000 22 119,000,000 66 $17.00
---------- --- ------------ ---
Total................. 32,012,816 100% $181,480,721 100%
========== === ============ ===
</TABLE>
The table assumes no exercise of stock options or other warrants
outstanding at June 30, 2000. As of June 30, 2000, there were options
outstanding to purchase 1,472,895 shares of common stock at a weighted average
exercise price of $1.56 per share and a warrant, in addition to the warrants
the exercise of which is being assumed, outstanding to purchase 50,000 shares
of common stock at an exercise price of $1.10 per share. To the extent any of
these options or this warrant are exercised, there will be further dilution to
new investors.
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<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
our financial statements and the related notes, and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
included elsewhere in this prospectus. The statement of operations data for
the years ended December 31, 1997, 1998 and 1999, and the balance sheet data
as of December 31, 1998 and 1999, are derived from our audited financial
statements that have been audited by PricewaterhouseCoopers LLP, independent
accountants, and that are included in this prospectus. The balance sheet data
as of December 31, 1997 are derived from our audited financial statements that
have been audited by PricewaterhouseCoopers LLP, independent accountants, and
that are not included in this prospectus. The statement of operations data for
the period from our inception on August 16, 1996 through December 31, 1996 are
derived from our audited financial statements that are not included in this
prospectus. The balance sheet data as of December 31, 1996 are derived from
unaudited financial statements that are not included in the prospectus. The
statement of operations data for the six-month periods ended June 30, 1999 and
2000, and the balance sheet data as of June 30, 2000, are derived from the
unaudited financial statements included in this prospectus. The unaudited
financial statements have been prepared on the same basis as the audited
financial statements and, in our opinion, include all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
information set forth therein. Historical results are not necessarily
indicative of results that may be expected for any future period.
<TABLE>
<CAPTION>
Period from Inception Six Months Ended
(August 16, 1996) Year Ended December 31, June 30,
through ------------------------- -----------------
December 31, 1996 1997 1998 1999 1999 2000
--------------------- ------- ------- ------- ------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Contract revenue........ $ -- $ -- $ -- $ 934 $ 47 $ 187
Costs and expenses:
Costs of contract
revenue............... -- -- 377 355 263 88
Costs of production.... -- -- -- 154 -- 116
Research and
development........... 51 963 1,323 2,182 421 1,187
General and
administrative........ 164 735 950 1,705 837 1,432
------ ------- ------- ------- ------- --------
Loss from operations.... (215) (1,698) (2,650) (3,462) (1,474) (2,636)
Interest income
(expense), net......... (10) 28 (31) 172 77 682
------ ------- ------- ------- ------- --------
Net loss................ (225) (1,670) (2,681) (3,290) (1,397) (1,954)
------ ------- ------- ------- ------- --------
Deemed preferred
dividends and
accretion.............. -- (160) (441) (899) (404) (51,430)
------ ------- ------- ------- ------- --------
Net loss attributable to
common stockholders.... $ (225) $(1,830) $(3,122) $(4,189) $(1,801) $(53,384)
====== ======= ======= ======= ======= ========
Basic and diluted net
loss per share
attributable to common
stockholders........... $(0.12) $ (0.96) $ (1.64) $ (2.20) $ (0.95) $ (28.07)
====== ======= ======= ======= ======= ========
Shares used in computing
basic and diluted net
loss per share
attributable to common
stockholders........... 1,900 1,900 1,900 1,900 1,900 1,902
====== ======= ======= ======= ======= ========
</TABLE>
<TABLE>
<CAPTION>
As of
As of December 31, June
-------------------------------- 30,
1996 1997 1998 1999 2000
----- ------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and
marketable securities............. $ 293 $ 2,990 $ 3,228 $ 3,131 $50,523
Working capital.................... 272 2,925 3,274 3,225 51,597
Total assets....................... 323 3,664 4,870 5,000 53,799
Long-term liabilities.............. 500 -- -- -- --
Mandatorily redeemable convertible
preferred stock................... -- 5,571 9,237 13,136 64,828
Total stockholders' equity
(deficit)......................... (206) (2,036) (5,159) (9,057) (12,143)
</TABLE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
our financial statements and the related notes included elsewhere in this
prospectus. This discussion and analysis contains forward-looking statements
that involve risks and uncertainties. Our actual results may differ materially
from those anticipated in these forward-looking statements as a result of
several factors, including, but not limited to, those set forth under "Risk
Factors" and elsewhere in this prospectus.
Overview
We were founded in 1996 to design, develop and manufacture PEM
electrochemical products for commercial applications. Our proprietary PEM
technology is incorporated in two families of products: hydrogen generators,
late stage development models of which we are currently manufacturing and
delivering to customers, and regenerative fuel cell systems, which we are
currently developing. Since our inception, we have funded our operations
through private financings that raised approximately $61.6 million, including
$50.1 million raised in a private financing in April 2000.
We began delivering late stage development models of our hydrogen
generators to customers in 1999. However, we have deferred revenue on these
units and will continue to defer revenue on product deliveries until we have
adequate information to estimate our warranty obligations. Product revenue
will be recognized when we can estimate such obligations. As of June 30, 2000,
we have deferred revenue of approximately $814,000 related to the units we
have delivered. In the future, we expect to derive the majority of our revenue
from the sale of the hydrogen generator and regenerative fuel cell systems
products we may develop.
We derive contract revenue from customer-sponsored research and development
contracts related to our PEM technology. For those contracts which do not
require us to meet specific obligations, we recognize contract revenue
utilizing the percentage-of-completion method, which is based on the
relationship of costs incurred to total estimated contract costs. For those
research and development contracts which require us to meet specified
obligations, including delivery and acceptance obligations, amounts advanced
to us pursuant to the contracts are recognized as contract liabilities until
such obligations are met. Once the obligations are met, the amounts are
recognized as contract revenue. Through June 30, 2000, we have recognized
approximately $1.1 million in contract revenue from research and development
funding under arrangements with both government and private sources. Under
these contracts, we have delivered HOGEN hydrogen generators and demonstration
regenerative fuel cell systems. We currently have ongoing research and
development projects with both NASA and the United States Department of
Energy, or DOE. Our NASA contract extends to October 2001 and provides for
total payments to us of approximately $600,000, of which we had recognized
approximately $216,000 in revenue through June 30, 2000. The DOE contract
extends to September 2002 and provides for payments to us of approximately
$1.3 million, none of which we have yet recognized in revenue.
Our costs of contract revenue reflect costs incurred under specific
customer-sponsored research and development contracts. These costs consist
primarily of salaries and benefits for our research and development personnel,
materials to build prototype units, materials for testing, facility-related
costs, operating supplies and other costs associated with our research and
development activities. We expect our costs of contract revenue to increase as
we complete work under existing contracts and receive additional research and
development contracts.
Our costs of production reflect costs incurred in the manufacture of our
products. These costs consist primarily of product materials, fees paid to
outside suppliers for subcontracted components and services, salaries and
benefits for our manufacturing personnel, facility-related costs, operating
supplies and other costs associated with our manufacturing activities. Through
June 30, 2000, costs of production reflected costs incurred in excess of the
corresponding sales price.
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Our research and development expenses reflect costs incurred for internal
research and development projects conducted without specific customer-
sponsored contracts. These costs consist primarily of salaries and benefits
for our research and development personnel, materials to build prototype
units, materials for testing, facility- related costs, operating supplies and
other costs associated with our internal research and development activities.
We expect our research and development expenses to increase as we increase our
internal research and product development activities.
Our general and administrative expenses consist primarily of salaries and
benefits for sales and administrative personnel, professional fees for
recruiting, legal and accounting services, training expenses, travel costs,
rent, utilities and other general office expenses. We expect our general and
administrative expenses to increase as we continue to invest in our employees,
increase our recruiting efforts, expand our infrastructure and incur
additional costs related to the growth of our business and operations as a
public company.
We have generated cumulative losses since our inception, and as of June 30,
2000 our accumulated deficit was $60.5 million, of which $50.7 million is
attributable to deemed preferred dividends and accretion and $9.8 million is
attributable to net losses since inception. We expect to continue to make
significant investments in new product design and development for the
foreseeable future. We expect to incur operating losses in 2000 and for the
next several years and cannot predict when we will become profitable, if ever.
Results of Operations
Comparison of Six-Month Periods Ended June 30, 1999 and June 30, 2000
Contract revenue. Contract revenue increased from $47,000 for the six
months ended June 30, 1999 to $187,000 for the corresponding period in 2000.
This increase was due to increased research and development activity related
to regenerative fuel cell systems under the NASA contract in 2000. In the
future, we expect contract revenue from government sponsored research and
development contracts to decrease as a percentage of total revenues once we
begin to recognize revenue from product sales.
Costs of contract revenue. Costs of contract revenue decreased from
$262,000 for the six months ended June 30, 1999 to $88,000 for the
corresponding period in 2000. The amount in 1999 reflects costs incurred on
the first phase of our DOE contract and on our Electric Power Research
Institute, or EPRI, contract, for which contract revenue was deferred until
specified obligations were met in the fourth quarter of 1999.
Costs of production. Costs of production increased from $0 for the six
months ended June 30, 1999 to $116,000 for the corresponding period in 2000.
The amount in 2000 reflects costs associated with manufacturing and delivering
our hydrogen generators in excess of the corresponding sales price. We expect
to continue to incur costs in excess of our sales price under our contract
with Matheson Tri-Gas, Inc. as we refine our production process. Under this
contract, Matheson has the exclusive right to sell our Chrysalis hydrogen
generators if it meets minimum purchase requirements specified in the
contract. Because we have not yet completed development of commercial models
of these units, no minimum purchase requirements are applicable to Matheson
prior to December 31, 2001. For periods after December 31, 2001, the contract
currently provides that Matheson must purchase 1,000 units per year if it
wishes to maintain exclusivity. Under the contract, we have the right to
increase prices on the units once annually by providing six months notice,
subject to either party's right to terminate the contract if agreement on
price increases is not reached. Any future recognition of losses by us under
this contract will depend on the number of orders placed by Matheson and the
extent to which our cost per unit exceeds the sale price per unit.
Research and development expenses. Research and development expenses
increased from $421,000 for the six months ended June 30, 1999 to $1.2 million
for the corresponding period in 2000. This increase was due to an increase in
our research and development activities related to our PEM technology in our
regenerative fuel cell systems and our hydrogen generators. We expect our
research and development expenses to continue to increase in the future.
23
<PAGE>
General and administrative expenses. General and administrative expenses
increased from $837,000 for the six months ended June 30, 1999 to $1.4 million
for the corresponding period in 2000. This increase reflects an increase in
legal expenses of $268,000, an increase in salaries and benefits of $68,000,
an increase in recruiting and relocation expenses of $82,000 and an increase
of $54,000 of non-cash compensation expense associated with stock option
grants.
Interest income (expense), net. Interest income increased from $77,000 for
the six months ended June 30, 1999 to $682,000 for the corresponding period in
2000. The increase resulted from increased cash and marketable securities
balances as a result of investing the proceeds from the issuance of our series
C preferred stock.
Comparison of Years 1997, 1998 and 1999
Contract revenue. Contract revenue increased from $0 in 1997 and 1998 to
$934,000 in 1999. The amount in 1999 includes revenue related to our DOE
contract for approximately $400,000 and of our EPRI contract for approximately
$350,000.
Costs of contract revenue. Costs of contract revenue increased from $0 in
1997 to $378,000 in 1998. The amounts in 1998 reflects costs incurred on the
first phase of our DOE contract and on our EPRI contract for which revenue
recognition was deferred until specific obligations were met. Costs of
contract revenue decreased to $355,000 in 1999. This decrease was due to
slightly lower activity on the first phase of our DOE contract and on our EPRI
contract. Our obligations under both these contracts were met in the fourth
quarter of 1999.
Costs of production. Costs of production increased from $0 in 1997 and 1998
to $154,000 in 1999. The amount in 1999 reflects costs associated with
manufacturing and delivering our hydrogen generators in excess of the
corresponding sales price.
Research and development expenses. Research and development expenses
increased from $963,000 in 1997 to $1.3 million in 1998 and to $2.2 million in
1999. These increases were due to increases in our research and development
activities related to our PEM technology in our regenerative fuel cell systems
and our hydrogen generators.
General and administrative expenses. General and administrative expenses
increased from $735,000 in 1997 to $950,000 in 1998. This increase reflects an
increase in legal expenses of $73,000 and an increase in salaries and benefits
of $70,000 as a result of an increase in our number of employees. General and
administrative expenses increased to $1.7 million in 1999 reflecting an
increase in salaries and benefits of $138,000 as a result of an increase in
our number of employees and an increase in legal expenses of $136,000. The
amount in 1999 also includes $290,000 of non-cash compensation expense
associated with stock option grants.
Interest income (expense), net. Interest income was $28,000 in 1997
compared to net interest expense of $31,000 in 1998. The change was due to
interest incurred on convertible debt which was outstanding for a portion of
1998 until its conversion into preferred stock in the fourth quarter of 1998.
Interest income in 1999 was $172,000, primarily the result of interest earned
on higher cash balances from the funds raised by us through private
financings.
Liquidity and Capital Resources
Since our inception in August 1996 through June 2000, we have financed our
operations through the series A, A-1, B, B-1 and C preferred stock issuances
that raised approximately $61.6 million. As of June 30, 2000, we had $50.5
million in cash, cash equivalents and marketable securities.
Cash used in operating activities was $3.0 million for the six months ended
June 30, 2000 and was primarily attributable to our net loss and increases in
inventory and other current assets, offset by a decrease in deferred revenue.
Cash used in operating activities was $2.9 million in 1999 and was primarily
attributable to our net loss, an increase in inventory and a decrease in
contract advances, offset by increases in accounts payable, accrued expenses
and deferred revenue.
24
<PAGE>
Cash used in investing activities was $46.8 million for the six months
ended June 30, 2000 and was primarily attributable to purchases of marketable
securities. Cash used in investing activities was $14,000 in 1999 and was
primarily attributable to purchases of equipment, offset by maturities of
marketable securities exceeding reinvestments of marketable securities.
Cash provided by financing activities was $50.0 million for the six months
ended June 30, 2000 and was attributable to the receipt of proceeds from the
sale of our series C convertible preferred stock. Cash provided by financing
activities was $3.0 million in 1999 and was attributable to the receipt of
proceeds from the sale of our series B-1 convertible preferred stock.
We anticipate that our cash and marketable securities on hand as of June
30, 2000 will be adequate to fund our operations, working capital and capital
expenditure requirements for at least the next 12 months. We currently
anticipate we will spend approximately $1 million in 2000 and $9 million in
2001 to purchase equipment for and to make leasehold improvements to our
planned manufacturing facility. The planned manufacturing facility may be
within or outside Connecticut. We also expect over the next 12 months to
continue to fund the production of our hydrogen generators and to continue our
research and development activities on our regenerative fuel cell systems. We
cannot assure you that we will not require additional financing to fund our
operations or that, if required, any further financing will be available to us
on acceptable terms, or at all. If sufficient funds are not available, we may
be required to delay, reduce or eliminate some of our research and development
or manufacturing programs. The terms of any additional financing may require
us to relinquish rights to our technologies or potential products or other
assets.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues
clarifies the following: the definition of an employee for purposes of
applying APB Opinion No. 25; the criteria for determining whether a plan
qualifies as a non-compensatory plan; the accounting consequence of various
modifications to the terms of previously fixed stock options or awards; and
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 is effective July 1, 2000, but certain conclusions in FIN
44 cover specific events that occurred after either December 15, 1998 or
January 12, 2000. The Company does not expect the application of FIN 44 to
have a material impact on the Company's financial position or results of
operations.
In November 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 100, "Restructuring and Impairment Charges." In
December 1999, the commission issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." Staff Accounting Bulletin No.
100 expresses the views of the commission staff regarding the accounting for
and disclosure of certain expenses not commonly reported in connection with
exit activities and business combinations. Staff Accounting Bulletin No. 101,
as amended by Staff Accounting Bulletins No. 101A issued in March 2000 and No.
101B issued in June 2000, provides guidance on the measurement and timing of
revenue recognition in financial statements of public companies. Changes in
accounting policies to apply the guidance in Staff Accounting Bulletin No. 101
must be recorded as a cumulative effect of a change in accounting principle no
later than the fiscal quarter ending December 31, 2000. We do not expect the
provisions of Staff Accounting Bulletin No. 100 or No. 101 to have a material
impact on our financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which establishes accounting and reporting standards
for derivative instruments and for hedging activities. This statement requires
recognition of all derivatives at fair value in the financial statements.
Statement of Financial Accounting Standards No. 137 defers implementation of
Statement of Financial Accounting Standards No. 133 until fiscal years
beginning after June 15, 2000. We have reviewed Statement of Financial
Accounting Standards No. 133 and believe that, upon implementation, the
standard will not have a material impact on our financial statements.
25
<PAGE>
BUSINESS
Overview
We design, develop and manufacture proton exchange membrane, or PEM,
electrochemical products that we employ in both hydrogen generating devices
and power generating and energy storage devices for use in a variety of
commercial applications. Our proprietary PEM technology is embodied in two
families of products: hydrogen generators and regenerative fuel cell systems.
Our hydrogen generators produce hydrogen from electricity and water in a clean
and efficient process. We are currently manufacturing and delivering late
stage development models of our hydrogen generators to customers for use in
commercial applications. Our regenerative fuel cell systems, which we are
currently developing, will combine our hydrogen generation technology with a
fuel cell power generator to create an energy device that is able to produce
and store the hydrogen fuel it can later use to generate electricity. By
providing the hydrogen fuel used by fuel cells, our core technology can enable
fuel cells to function not only as power generating devices, but also as
energy storage devices.
We are designing our products to meet the needs of attractive near-term and
longer-term markets. Our hydrogen generators have been designed to address the
existing demand for on-site hydrogen gas generation in a variety of
manufacturing and laboratory applications which we believe will provide a
lower-cost, safer and more convenient alternative to conventionally delivered
hydrogen. In the longer term, as fuel cell markets develop, we believe our
hydrogen generators can be a key component of the hydrogen supply
infrastructure which will be needed to provide the hydrogen used by fuel cells
in transportation, stationary power generation and portable power generation
applications. We are developing our regenerative fuel cell systems to address
the demand for highly reliable backup power systems. In particular, the
increased use of computers, computer networks and communications networks in
the Internet economy, as well as the increased use of sensitive electronics in
manufacturing, are all creating an increase in the demand for highly reliable
backup power to avoid the costs and lost revenue associated with power
disruptions. In addition, we believe that in the longer term our regenerative
fuel cell systems may enable renewable energy solutions by facilitating the
storage of energy produced by non-depleting, non-polluting energy sources,
such as solar, wind and hydroelectric power.
We believe we are among the first companies to manufacture and deliver
systems incorporating PEM technology for use in commercial applications. In
the first quarter of 2000, we began shipping late stage development models of
our hydrogen generators to customers for use in industrial applications. The
goal of our development program over the next twelve months is to finalize the
commercial design of our hydrogen generators and deliver additional units to
customers seeking alternatives to conventionally delivered hydrogen. We also
have an agreement with a leading supplier of laboratory gases under which it
plans to distribute our line of smaller scale hydrogen generators for
laboratory use. In the longer term, we also intend to develop commercial
applications for our regenerative fuel cell technology. We manufactured and
delivered two demonstration regenerative fuel cell systems in 1999 and
recently entered into an agreement with NASA to develop a larger, second-
generation regenerative fuel cell system to be delivered in 2001. This next-
generation system is being designed to have the scale and technical attributes
necessary to serve a broad range of commercial applications. Our goal is to
deliver our first commercially configured regenerative fuel cell system for
field testing in 2002.
Products
Hydrogen Generators
Our HOGEN hydrogen generators convert water and electricity into high
purity, pressurized hydrogen gas, using PEM electrolysis. PEM electrolysis is
a process in which water is divided into its component elements to produce
pure hydrogen gas, with oxygen and heat as the only by-products. Users can
connect our hydrogen generators directly to existing water and electrical
sources, allowing them to be installed and used in a wide range of locations.
The following diagram illustrates our PEM electrolysis hydrogen generation
technology.
26
<PAGE>
[The caption Hydrogen Generator (Electrolysis) is centered over a graphic
depiction of Proton's PEM electrolysis hydrogen generation technology. Two
arrows, labeled Water and Electricity, point to the right, to a square labeled
PEM Cell Stack. Three arrows point to the right from this square. One arrow,
labeled Oxygen, points to the upper right; the second arrow, labeled Hydrogen,
points directly to the right; the third arrow, labeled Heat, points to the lower
right.]
We have shipped late stage development models of our HOGEN hydrogen
generators with 20 and 40 cubic feet per hour hydrogen production capacities,
and are testing a 380 cubic feet per hour capacity unit. Our HOGEN 20 and
HOGEN 40 units are freestanding, roughly the size of a household washing
machine, and are intended for indoor use. Our HOGEN 380 is a larger
freestanding unit with a weatherized design for outdoor use. We are continuing
testing of and preparing to manufacture hydrogen generators to be marketed
under the Chrysalis brand name by Matheson Tri-Gas, Inc. under a long-term
agreement for use in laboratory applications. These units are compact and
designed to sit on a laboratory countertop.
Regenerative Fuel Cell Systems
The UNIGEN regenerative fuel cell systems we are developing will integrate
PEM hydrogen generation technology with PEM fuel cell technology to create a
power generation device that produces hydrogen from water and electricity,
stores the hydrogen and later uses the hydrogen as fuel for the production of
electricity. The diagram below illustrates our regenerative fuel cell system
technology. In the hydrogen generation mode, the regenerative fuel cell works
exactly like a hydrogen generator, producing hydrogen at pressures suitable
for storage without compressors. In the power generation mode, the process is
reversed and the stored hydrogen is combined with air to produce electricity
as needed instantaneously, efficiently and without any harmful by-products. We
believe that our regenerative fuel cell architecture can also be used by other
fuel cell manufacturers to enable their fuel cells to become energy storage
devices.
[The caption Regenerative Fuel Cell Systems is centered over two graphics.
The graphic on the left side of this space is titled Hydrogen Generation Mode
(Electrolysis). Two arrows, labeled Water and Electricity, point to the right,
to a square labeled PEM Cell Stack. Three arrows point to the right from this
square. One arrow, labeled Oxygen, points to the upper right; the second arrow,
labeled Hydrogen, points directly to the right, to a square labeled Storage; the
third arrow, labeled Heat, points to the lower right.
The graphic on the right side of this space is titled Power Generation Mode
(Fuel Cell). A square labeled Storage appears at the right, with an arrow
labeled Hydrogen pointing to the left, to a square labeled PEM Cell Stack. Three
arrows point to the left from this square. One arrow, labeled Water, points to
the upper left; the second arrow, labeled Electricity, points directly to the
left; the third arrow, labeled Heat, points to the lower left. An additional
arrow, labeled Air, points from the bottom of this space to the box labeled PEM
Cell Stack.]
27
<PAGE>
We currently have ongoing research programs related to our regenerative
fuel cell systems with both the United States Department of Energy, or DOE,
and NASA for use in ongoing research programs. The DOE program is focused on
hydrogen generation and storage from renewable energy sources. The NASA
program is concentrated on advanced fuel cell and system integration hardware
for a second-generation regenerative fuel cell system. We believe that as a
result of our involvement in these programs, we will be well positioned to
develop regenerative fuel cell systems that address the 0.5 to 25 kilowatt
commercial backup power market.
Our Market Opportunities and Our Solutions
Since our inception, we have focused on developing commercial applications
for our PEM technology to serve the needs of several distinct markets. We
believe these markets will provide us with significant opportunities for
growth in both the near term and longer term.
Hydrogen Gas Generation for Industrial Applications
Hydrogen is a critical input in many manufacturing processes. According to
SRI Consulting, an industrial consulting firm, annual consumption of hydrogen
gas worldwide is approximately 15 trillion standard cubic feet of hydrogen.
Large volume users of hydrogen include oil refiners, ammonia manufacturers and
food processors, who use hydrogen as a chemical reactant in their production
processes. Smaller-volume users include microelectronics manufacturers and
specialty metals manufacturers, who use hydrogen to remove oxygen from their
processing environments. Hydrogen is also used in scientific laboratories and
as a lifting gas in meteorological applications.
Larger users usually produce their own hydrogen on-site using large-scale
steam methane reformers. This process generally results in lower hydrogen
costs due to economies of scale and the absence of delivery charges. Small-
and medium-volume users, whose requirements do not support the cost of steam
methane reformers, have traditionally had their hydrogen delivered by truck.
These users purchase their hydrogen from industrial gas suppliers and
distributors who deliver and store the hydrogen in tanks, tubes or cylinders
at the user's site. In a study commissioned by us, Campbell Associates
estimated the worldwide market for hydrogen delivered by truck at $908 million
in 1997. SRI Consulting estimates that the demand for hydrogen delivered by
truck will grow at an average annual rate of approximately 10% through 2001.
While delivery of hydrogen to small- and medium-volume users in cylinder
form is widespread, delivered hydrogen is also the most expensive way to
purchase hydrogen. The higher cost is largely attributable to the high cost of
packaging and delivery, especially since a compressed hydrogen gas cylinder
weighs approximately 125 pounds but only contains about 250 cubic feet of
hydrogen gas weighing just over one pound. Industrial gas suppliers have
recently raised prices for delivered cylinder hydrogen, attributing such
increases to increased transportation costs. In addition to the high cost
associated with cylinder hydrogen, there are numerous safety concerns
resulting from the need to store inventories of flammable hydrogen gas.
These cost and safety concerns are not unique to hydrogen. The industrial
gas industry has already implemented on-site gas generation technologies for
nitrogen and oxygen as a way of reducing cost and safety concerns for these
gases for small- and medium-volume users. To date, however, an economical on-
site hydrogen production solution has generally not been available. We believe
our hydrogen generators will offer an on-site hydrogen generation solution for
small- and medium-volume users by providing:
. cost advantages in an estimated 50% of the delivered hydrogen market due
to eliminating transport and delivery expenses;
. increased safety by reducing the amount of potentially hazardous
hydrogen inventory stored at an end-user location;
. more consistent hydrogen purity due to eliminating the need to connect
and disconnect cylinders with varying levels of quality;
28
<PAGE>
. hydrogen at process pressure (150 pounds per square inch) without a
compressor and at a high purity level (99.999% purity); and
. a simple, compact and single-box design that is easily installed.
In addition to the benefits to small- and medium-volume users, we believe
that our hydrogen generators will also offer additional benefits to hydrogen
gas suppliers and distributors with whom we may partner to sell our products.
These benefits include:
. lower delivery costs and simpler delivery logistics;
. the opportunity to supply on-site equipment on a more stable, long-term
lease basis rather than through annual purchase contracts;
. the opportunity to combine on-site generation with other complementary
products and services in a single package; and
. the ability to extend geographic markets by reducing delivery
requirements.
We believe that our hydrogen generators may also be well suited for
servicing the needs of small to mid-sized manufacturing and food processing
facilities located in markets with inadequate or nonexistent hydrogen
distribution infrastructures.
Hydrogen Fuel Generation for Fuel Cells
In recent years, fuel cell systems, which use hydrogen as a fuel to produce
electricity, have come to be viewed as a potential alternative to
conventional, combustion-based power generation systems. These systems have
several advantages over combustion-based power generation systems, including
higher quality electrical power output, low or no pollution, much higher fuel
efficiency, greater flexibility in installation and operation, quiet
operation, low vibration and potentially lower maintenance and capital costs.
Currently, several companies are focused on developing fuel cell systems
primarily for use in automobiles and buses, as well as other applications such
as stationary and portable power generation. These development efforts have
been fostered by government authorities in North America, Europe and Japan who
have imposed stringent environmental standards on the automobile industry and
other industries and seek cleaner power generation technologies, such as fuel
cells, as alternatives to existing combustion-based power generation
technologies.
While fuel cell-powered vehicles are expected to generate the largest
demand for hydrogen fuel, the best means of providing hydrogen for these
vehicles continues to be debated among fuel cell developers, automobile
manufacturers and energy companies. The hydrogen fuel required by all fuel
cells can be produced either through water electrolysis or high temperature
reforming of hydrocarbons, such as natural gas, methanol, diesel fuel and
propane. In the hydrocarbon reforming process, hydrocarbons are converted into
hydrogen gas through a combustion or catalytic process. This alternative,
however, faces significant technical challenges in smaller scale applications
due to the need to optimize and balance performance of various subsystems,
including fuel vaporization, oxidation, catalytic reaction and sulfur removal
subsystems. This alternative also emits carbon dioxide and other by-products.
We believe our hydrogen generators will provide an attractive solution to
the challenge of providing fuel for fuel cell vehicles as well as other
applications because our products are less complex and more environmentally
friendly than alternative small-scale hydrocarbon-based generators of
hydrogen. Our products generate hydrogen in a room temperature process using
fewer steps and fewer parts than alternative technologies. They emit no carbon
dioxide, contain no toxic chemicals and can generate fuel from renewable
sources. We believe that our hydrogen generators can be a key component of a
broad-based refueling infrastructure in which they are installed at existing
gas stations and connected to the stations' existing water and electrical
supply. In a report prepared for DOE and Ford in 1997, Directed Technologies,
Inc. indicated that an electrolysis-based refueling infrastructure, utilizing
water and electricity sources already available at existing gas stations,
initially would provide the most flexibility at a lower upfront capital cost
than an on-site hydrocarbon-based infrastructure. In the longer term, the
price competitiveness of an electrolysis-based refueling infrastructure will
depend on a variety of factors, including the cost of electricity, the cost of
fossil fuels for reforming, advances in hydrocarbon reforming technologies,
applicable environmental restrictions and the number of fuel cell vehicles
29
<PAGE>
in service. In particular, if the price of natural gas used to fuel
hydrocarbon based reformers remains low, our electrolysis-based systems could
be at a competitive disadvantage.
Based on public statements by automobile manufacturers, initial commercial
sales of fuel cell automobiles are not expected to occur until between 2003
and 2005. In the nearer term, we believe we may be able to supply fuel for the
buses that are being developed to operate on routes that have been proposed
for hydrogen-fueled bus service by some local transit authorities.
Ultimately, the issue of consumer acceptance of fuel cell vehicles and the
preferred source of hydrogen fuel for those vehicles is likely to be resolved
largely by cost considerations. We believe that our hydrogen generators may
produce hydrogen fuel at a favorable cost when compared to gasoline.
Power Quality and Reliability
The increased use of computers and computer and communications networks in
the Internet economy, as well as the increased use of sensitive electronics in
manufacturing, are all creating an increase in the demand for highly reliable
and stable sources of electricity. For example, industry sources have
estimated that the share of all U.S. electricity consumed by computer-based
microprocessors is 13% and that within two decades 30% to 50% of the nation's
electricity supply may be required to meet the direct and indirect needs of
the Internet. However, the traditional method of delivering power through the
power transmission and distribution system owned by utilities, known as the
grid, has proven to be inadequate to meet the high power quality and
reliability needs of technology-oriented applications. Power interruptions and
voltage fluctuations can disable or damage critical systems, resulting in
large potential costs. According to EPRI, the cost of power disruptions in the
United States is approximately $30 billion per year.
In order to mitigate the effect of power disruptions, companies have
maintained backup power systems to ensure a continuous supply of power for
their critical operations. As the use of high technology applications
increases and the avoidance of downtime related to power disruptions becomes
even more critical, the quality and reliability requirements of these backup
power systems will also increase. The market for backup power has
traditionally been served by battery-based uninterruptible power supply, or
UPS, products, often coupled with fossil fueled power generators. Batteries
provide backup power for short-term, intermittent power outages and
fluctuations, but cannot provide extended power generation beyond short time
periods. A fossil fueled power generator, which can generate power for longer
periods of time, can be coupled with a battery to provide longer-term backup
power. According to Frost & Sullivan, a market research firm, global UPS sales
were $4.9 billion in 1999 and are anticipated to grow to $11.6 billion by
2006, representing an estimated compound annual growth rate of 13%.
Existing battery technology possesses a number of serious weaknesses that
limit the effectiveness of this technology as a power quality and reliability
solution. Batteries have high maintenance costs and a limited and
unpredictable useful life and face significant environmental issues related to
their disposal. Similarly, fossil fueled power generators also possess a
number of disadvantages, including a high noise level when operating,
environmentally hazardous exhaust emissions, high maintenance costs and
dependence on an on-site fuel source that must be replenished and monitored to
prevent spills.
We believe our regenerative fuel cell systems will offer a viable low-cost
alternative to meet the backup power requirements of high-technology
applications at levels below 25 kilowatts, such as computer networks,
transmitter sites, communications switching units and small to medium-sized
central office telecommunications systems. We are designing our regenerative
fuel cell systems to possess the following advantages:
. Rapid response to power outages and fluctuations. Our regenerative fuel
cell systems, supplied with stored hydrogen, are designed to generate
power rapidly, with no motors to start or reactors to warm up. The
pressure of the hydrogen in the system's storage tank may be
continuously monitored by a pressure sensor to assure power
availability.
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<PAGE>
. High reliability of power delivery. PEM fuel cells have no moving parts
and thus have the potential to demonstrate high reliability and
durability.
. Efficient energy storage technology. In our regenerative fuel cell
systems, energy can be stored without loss indefinitely in the form of
hydrogen gas, unlike batteries, which lose their energy over time and
must continually use electricity to retain their energy level.
. Ability to withstand extended outages. Our regenerative fuel cell
systems are being designed to withstand extended power outages by using
their stored supply of hydrogen fuel to generate power over lengthy
periods. Existing power quality products, including batteries,
ultracapacitors and flywheels, are generally designed to deliver power
for durations ranging from several seconds to several hours. These
products must rely on fossil fuel engine generators for extended power
outages. Our product may also be particularly useful in remote locations
where it is difficult to obtain fuel for fossil fuel generators.
We could encounter obstacles in marketing our fuel cell systems as power
quality products due to the novelty and unproven nature of this technology.
Because a fuel cell system contains water, it must also be maintained at
temperatures above freezing when not in operation. This can be accomplished by
locating the unit in a heated space or providing a small amount of electric
current to heat the unit when not in operation. In addition, because our
product requires the storage of hydrogen at or near the electrical load, some
customers may require specialized configuration of the systems to satisfy
permit requirements.
Renewable Power Applications
Concern about the increasing level of greenhouse gases, such as carbon
dioxide produced as a result of fossil fuel combustion, is intensifying global
interest in seeking better ways to harness renewable sources of energy,
including solar, wind and hydroelectric power. This intensifying world
interest in environmental sustainability is evidenced by a large and growing
body of opinion that there is a likely connection between greenhouse gas
emissions and global warming and by recent announcements by major energy
companies and automobile manufacturers withdrawing their membership in a group
that opposes the Kyoto Accords, a landmark agreement among nations to curtail
the generation of greenhouse gases. Renewable power applications have
experienced significant growth as a result of this interest and technological
advancements have been made to reduce the costs and increase the efficiency of
these power sources. In addition, in the United States, continued utility
privatization and deregulation have opened the market for innovative power
technologies, with many consumers having elected to use renewable power
applications even where they are more costly than traditional sources.
Despite these factors, the inherent intermittency of renewable power
sources continues to be a major disadvantage. Renewable power sources do not
always have the ability to generate power on demand because these sources are
dependent upon favorable natural conditions, such as the presence of sunlight
or wind, to produce power. We believe that use of these power sources could
grow more rapidly if the inherent intermittent output limitation of these
sources could be overcome.
We believe our regenerative fuel cell systems could enable more widespread
use of renewable energy technologies. Our regenerative fuel cell systems can
be connected to a renewable power source and, when excess renewable power is
available, these systems would store the energy in the form of hydrogen fuel.
When the end user requires power and the renewable power source cannot produce
power because of unfavorable natural conditions, our regenerative fuel cell
systems could then draw on their supply of hydrogen fuel and convert it into
electricity. In this way, we believe our regenerative fuel cell systems can
provide a crucial linkage between clean, renewable power and the broader
energy market.
While we believe our regenerative fuel cell systems could have a
significant impact on the broader energy markets, we believe there are
potential nearer term opportunities as well. For example, a renewable power
source tied to a regenerative fuel cell system could provide a source of power
in a number of applications where other power sources are prohibitively costly
to install, such as in remote cellular stations and remote lighting. Further,
in developing regions of the world that lack the infrastructure required for
centralized power generation, renewable power sources coupled with
regenerative fuel cell systems could meet the needs of those currently without
power.
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Product Milestones
The following are major milestones we have achieved in developing and
commercializing our technology:
<TABLE>
<CAPTION>
Date Milestone
---- ---------
<S> <C>
September 1996....... Built proof-of-concept demonstration models of our
hydrogen generator and regenerative fuel cell system
technology.
May 1998............. Delivered prototype HOGEN hydrogen generator to NASA.
April 1999........... Commenced field testing of our HOGEN 380 hydrogen
generator.
June 1999............ Delivered prototype 50 watt UNIGEN regenerative fuel cell
system to NASA.
September 1999....... Delivered prototype 250 watt UNIGEN regenerative fuel
cell system to EPRI.
October 1999......... Demonstrated our renewable energy storage concept using
our HOGEN hydrogen generator in a DOE sponsored program.
November 1999........ Delivered late stage development model of our HOGEN 20
hydrogen generator to a customer for commercial
application.
Signed our agreement with Matheson Tri-Gas, Inc. for
distribution of our laboratory hydrogen generators under
the Chrysalis brand name.
January 2000......... Delivered late stage development model of our HOGEN 40
hydrogen generator to a customer for commercial
application.
January-August 2000.. Delivered additional late stage development models of our
HOGEN 40 hydrogen generators to four customers for
commercial applications.
</TABLE>
To help describe our progress, we use the terms "proof-of-concept
demonstration model," "prototype" and "late stage development model". A proof-
of-concept demonstration model represents the first demonstration of one or
more new technology items, usually in a laboratory environment using a small-
scale test device. These models do not feature complete component integration
and are intended only to demonstrate technology feasibility. A prototype is a
test device or demonstration system that contains all required technology
elements integrated into a single unit. Prototype units are often used to
demonstrate new technology concepts that have been demonstrated previously in
the laboratory. Prototypes are typically operated under controlled conditions
to evaluate and demonstrate the interplay between various system elements. A
late stage development model is a unit that demonstrates a product
configuration but has not yet undergone all of the rigors of full field
testing for a given product application. It contains individual hardware
elements that have specifications comparable to those that would be included
in the final product design.
Our Strategy
Our objective is to be a leader in harnessing PEM technology for a number
of commercial applications. Our strategy for achieving this objective includes
the following elements:
Leverage Technological Position
In developing PEM technology, we have focused on two key areas: the
development of PEM hydrogen generators and the development of regenerative
fuel cell systems. We believe these technologies provide us with the
opportunity to develop innovative products that address attractive markets. In
addition, our technology is complementary to other fuel cell technologies and
could enable the commercial use of other fuel cell products, such as vehicular
fuel cells, by providing a hydrogen delivery infrastructure. For example, our
hydrogen generators could be deployed at refueling sites to provide hydrogen
for fuel cell vehicle fleets. As a result, we
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<PAGE>
believe we are also well positioned to benefit from further developments by
other fuel cell developers and from increases in demand for their fuel cell
products. We intend to maintain our technology leadership in PEM-based
hydrogen generation and regenerative fuel cell system technology by continuing
to develop our core technology, develop our commercial manufacturing processes
and improve the design and features of our products.
Focus on Near-Term Market Opportunities
We believe we are among the first companies to manufacture and deliver
systems incorporating PEM technology for use in commercial applications. We
intend to focus on designing and marketing our products in the near term for
two primary markets: hydrogen generation for industrial applications and
backup power for communications network-related applications. We believe the
industrial gas market is an attractive market for us because it is well
developed and our hydrogen generator products will offer cost and safety
advantages to users that currently rely on conventionally delivered hydrogen.
We believe the backup power market for the communications industry is also
attractive given its large size and the advantages our regenerative fuel cell
systems are being designed to offer over existing products. Our focus on near-
term market opportunities will continue to reinforce our emphasis on the
commercial application of PEM technology.
Continue Focus on Cost Reduction
Given our focus on commercial applications for PEM technology,
manufacturing improvements are a critical element of our product development
and design efforts. We intend to continue to focus on reducing the cost of
manufacturing our products. We will seek to reduce costs in part through the
simplification of our product designs, identification and use of lower cost
materials and components, development of long-term relationships with third-
party component and raw material suppliers and construction of larger-scale
manufacturing facilities that will use higher volume, automated processes.
Develop Key Strategic Relationships
We intend to establish strategic relationships with leading companies in
our target markets. The strategic relationships we develop may include joint
development efforts and sales and marketing agreements. At present, we are in
various stages of discussions with potential partners, including industrial
gas suppliers and distributors, energy producers, backup power providers and
renewable energy companies. We do not have definitive, binding agreements with
any of these parties. In seeking to develop strategic relationships, we will
focus on partners that can provide us with distribution channels for our
products and assist us in the design, development and manufacture of new
products. We believe that our demonstrated capabilities in PEM technology and
our focus on creating commercial applications make us an attractive potential
partner for many established companies seeking to gain access to fuel cell-
related technology.
Position Our Technology for Longer-Term Opportunities
We believe we are well positioned to take advantage of growth in the
markets for fuel cell applications and renewable power technologies. If fuel
cell applications achieve commercial acceptance, our hydrogen generators can
be a key component of the hydrogen supply infrastructure that will be
required. We intend to work with leading energy and power companies to
position our hydrogen generators for automotive refueling applications. With
respect to renewable power, as developers of renewable technologies,
especially wind and solar power, achieve cost and performance improvements,
the need to overcome the inherent intermittence of renewable power will become
even more important. Accordingly, we plan to work with renewable energy
companies to explore and develop energy storage applications using our
regenerative fuel cell architecture.
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<PAGE>
Our Technology
PEM-Based Hydrogen Generators
Our hydrogen generators are electrochemical devices that convert water and
electricity into hydrogen gas using a process known as PEM electrolysis. As
illustrated below, the core of a hydrogen generator is an electrolysis cell
consisting of a solid electrolyte proton exchange membrane. Catalyst material
is bonded to both sides of the membrane, forming two electrodes. To generate
hydrogen, water is introduced to one side of the membrane and voltage is
applied to the electrodes. This process divides the water into protons,
electrons and oxygen. The protons are drawn through the proton exchange
membrane and recombined with the electrons at the opposite side of the
membrane to form hydrogen. The oxygen is removed from the cells with the
excess water flow. This process produces hydrogen with a high level of purity
and at significant pressures.
[A graphic depiction of the PEM Electrolysis process appears here. In the center
is a rectangle labeled Proton Exchange Membrane, containing spheres with plus
signs (which represent Protons). Along the left and right sides of the rectangle
are two white strips representing an Electrode (+) on the left and an Electrode
(-) on the right. To the left of this rectangle appear two arrows pointing to
the upper left, surrounding spheres representing Oxygen. Below these arrows
appear two arrows pointing to the right containing four objects representing
Water. The objects each contain two small half-spheres representing Hydrogen
attached to one larger sphere representing Oxygen.
To the right of the rectangle appear two arrows pointing to the right,
surrounding spheres representing Hydrogen.
Below the rectangle are several dots (representing Electrons) and an arrow
pointing to the right (representing Electricity)]
A single electrolysis cell is typically integrated into a complete cell
assembly that includes flowfield structures that provide mechanical support,
conduct current and provide a means to introduce water and remove gases. These
cell assemblies are stacked and compressed between two end plates along with
other support components to form a complete cell stack. The hydrogen
production capability of a cell stack is approximately proportional to the
area of each cell, the number of cells in the stack and the electric current
supplied.
We have delivered several late stage development units of our HOGEN 20 and
40 and Chrysalis hydrogen generators. In some cases, these units have not met
product specifications for applications requiring very low water vapor levels
in the product gas. In addition, some of our HOGEN 20 and 40 units have not
achieved satisfactory hydrogen sealing performance when operated at full
output over extended trials. We currently are evaluating and testing technical
solutions to these issues.
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Our HOGEN 380 model has successfully completed prototype testing and is
currently undergoing field testing. To date, these field tests have
demonstrated successful integration of system fluids, electrical and control
elements as well as effective electrochemical performance. We are currently
working to improve long-term sealing of the individual cell stack components,
system thermal regulation and product gas dryer control.
PEM-Based Fuel Cell Power Generators
In our PEM fuel cell, which is very similar to our PEM electrolysis cell,
the opposite reaction occurs. To generate electricity, hydrogen and air, or
oxygen, are introduced to opposite sides of the cell. The hydrogen passes over
an electrode structure adjacent to the proton exchange membrane, where it is
divided into its component protons and electrons. When the electrons are
separated from the protons, the electrons are conducted in the form of a
usable electric current. The protons travel through the proton exchange
membrane and recombine with the electrons and oxygen to produce water.
[A graphic depiction of PEM Fuel Cell Power Generation appears here. In the
center is a rectangle labeled Proton Exchange Membrane, containing spheres with
plus signs which represent Protons. Along the left and right sides of the
rectangle are two white strips representing an Electrode (+) on the left and an
Electrode (-) on the right. To the left of the rectangle appear two arrows
pointing to the right, surrounding spheres which represent Hydrogen. To the
right of the rectangle appear two arrows pointing to the upper right,
surrounding spheres representing Water; below these arrows appear two arrows
pointing to the left, surrounding spheres representing Oxygen.
Above the rectangle is a drawing of a lightbulb penetrated by an arced
rightward-
pointing arrow containing dots which represent Electrons. The caption
Electrical Current appears to the left of and above the lightbulb.]
To form a complete fuel cell stack, individual PEM fuel cells are stacked
and compressed between two end plates. The electrical power production of a
cell stack is approximately proportional to the area of each cell and the
number of cells in the stack.
Our regenerative fuel cell systems incorporate the ability to support both
an electrolysis reaction and a fuel cell reaction. Our proprietary design
allows a single cell to operate as an electrolysis cell using water and
electricity to generate hydrogen and oxygen at elevated pressure and then
reverse the process and consume the hydrogen to generate electricity. The
resulting product functions like a rechargeable battery in which hydrogen is
produced through electrolysis, stored and then used for power generation.
Unlike one-way fuel cells, because our regenerative fuel cell systems use
hydrogen produced through electrolysis rather than extracted from hydrocarbon
fuels, electricity can be produced at room temperature, without lengthy start-
up times or carbon-based emissions and in areas where fossil fuels such as
natural gas, propane or gasoline are not available.
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<PAGE>
Through our internal research and development activity and efforts under
our NASA contract, we have successfully demonstrated our regenerative fuel
cell technology at levels ranging from 50 to 250 watts in various proof-of-
concept hardware configurations. As part of this effort, we have developed
proprietary reversible electrode materials and structures, developed high
performance flow field technology, incorporated high pressure sealing features
into the cell architecture and performed comprehensive systems integration. We
have also demonstrated automated reversible systems in the laboratory.
We are working to define and develop prototype units having a power
capacity of approximately one kilowatt. We believe these units will serve as a
building block for scale-up to multikilowatt products for backup power
applications. We must do additional work to verify the impact of large numbers
of reversible cycles on cell and system architecture, to simplify the system
design to provide higher reliability and lower product costs and to develop
and implement low cost cell materials.
Proprietary Technology
We have developed proprietary technology relating to various aspects of our
electrolysis cells, regenerative fuel cell systems and related systems. These
include:
. membrane processing technology;
. electrolysis catalytic electrode formulation;
. reversible fuel cells;
. high pressure cell structures that simplify overall system
implementation; and
. integrated system designs for both hydrogen generators and regenerative
fuel cell systems.
Distribution and Marketing
We plan to sell our hydrogen generators both through distribution
arrangements with third parties and through a limited direct sales force.
Because small- and medium-volume hydrogen users generally buy hydrogen from
industrial gas suppliers and distributors, we intend to focus our marketing
efforts on sales to these companies for resale to end users. By focusing on
industrial gas suppliers and distributors, we intend to maximize our sales by
leveraging their established marketing, distribution and service channels. We
currently have a development, marketing and distribution agreement with
Matheson Tri-Gas, Inc. under which Matheson has exclusive distribution rights
for hydrogen generators for the laboratory market bearing Matheson's Chrysalis
trademark or other designated commercial names. In addition, we have a
distribution agreement with Diamond Lite S.A. for distribution of our hydrogen
generators in France, Germany, Italy and 16 other countries in Western and
Central Europe. We intend to establish additional sales and distribution
arrangements with industrial gas suppliers and distributors, as well as
meteorology equipment providers and original equipment manufacturers.
As the market to supply hydrogen fuel for fuel cell vehicles develops, we
also plan, where possible, to focus on existing distribution channels. We
believe that existing energy suppliers are likely to begin supplying new forms
of automotive fuel as they come to market. Accordingly, we intend to establish
relationships with major oil companies to explore ways of supplying our
hydrogen generators for installation at local service stations. In addition,
we believe that automobile manufacturers providing introductory and fleet fuel
cell vehicles will be interested in our refueling technology and therefore we
will seek to establish relationships with these manufacturers.
Currently, backup power equipment is sold by a few large manufacturers to
commercial end users through diverse reseller networks, including integrators
and qualified resellers. We plan to sell our backup power products to these
existing manufacturers, integrators and qualified resellers.
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<PAGE>
Manufacturing
We are currently manufacturing hydrogen generators at our facility in Rocky
Hill, Connecticut. Key aspects of this process include formulation of our
proprietary catalysts, deposition of the catalyst on the proton exchange
membrane and fabrication of cells into cell stacks. The balance of the
manufacturing process consists of integrating cell stacks into systems that
perform fluids and electrical management of the electrochemical process.
Approximately 35% of the cost of our hydrogen generation systems is
associated with our cell stack, with the balance of costs associated with
system components and assembly. We purchase raw proton exchange membrane
material from Dupont, although we have identified other companies we believe
capable of providing suitable membrane material. We purchase the other
components used in our systems from third-party suppliers. We regularly
consult with our suppliers to evaluate ways to lower the cost of other
components or subassemblies while meeting the performance needs of our
products. In this regard, we have considered and will continue to evaluate the
option of having subassemblies that we currently produce in-house produced to
our specifications by others if lower costs can be achieved. We anticipate
continuing to integrate and assemble our products at our Rocky Hill facility
through at least 2001.
Intellectual Property
We rely on patent, trade secret, trademark and copyright law to protect our
intellectual property. We have two issued U.S. patents, covering a hydrogen
electrochemical system that eliminates the need for explosion-proof equipment
and an electrochemical cell frame design, one allowed U.S. patent application
covering a fluids management system for PEM electrolysis, and several U.S. and
international patent applications on file. We also seek to protect our
proprietary intellectual property, including intellectual property that may
not be patented or patentable, in part by confidentiality agreements with our
strategic partners and employees. We cannot assure you that these agreements
will not be breached, that we will have adequate remedies for any breach or
that such persons or institutions will not assert rights to intellectual
property arising out of these relationships.
Competition
Our hydrogen generators will compete with delivered hydrogen, and with
older alternative equipment used to manufacture hydrogen-rich gas. Competitors
in the delivered hydrogen market include Air Liquide, Air Products and
Chemicals, Linde and Praxair. Our hydrogen generators will also compete with
older generations of electrolysis-based hydrogen generation equipment sold by
Electrolyser, Norsk Hydro, Teledyne-Brown and other companies. These systems
are generally much larger in size, require manual operation and supervision,
contain hazardous liquid electrolyte and require the assistance of mechanical
compressors to produce hydrogen at pressure.
In backup power applications, our products may compete against:
. battery-based, uninterruptible power supply systems, which are widely
manufactured and used around the world;
. ultracapacitors, which store energy as an electrostatic charge;
. internal combustion engine generator sets;
. microturbines;
. superconducting energy storage systems, which store energy within a
superconducting magnet kept at extremely low temperatures;
. flywheels, which store energy in the form of a continuously spinning
wheel, the kinetic energy of which can be converted into electrical
energy; and
. other fuel cells using alternative hydrogen supply applications.
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There are a number of companies located in the United States, Canada and
abroad that are developing PEM fuel cell technology. These companies include
Avista Labs, Ballard Power Systems, General Motors, Giner, H-Power, Idacorp,
Nuvera, Plug Power, Toyota and United Technologies. Although we believe these
companies are currently primarily targeting vehicular and residential
applications, they could decide to enter the hydrogen generation and backup
power markets we intend to address. We may also encounter competition from
companies that have developed or are developing fuel cells based on non-PEM
technology, as well as other distributed generation technologies.
Many of our competitors have substantially greater financial, research and
development and marketing capabilities than we do. In addition, as the backup
power and hydrogen fuel markets develop, other large industrial companies may
enter these fields and compete with us.
Facilities
Our principal executive offices are located in Rocky Hill, Connecticut. We
currently lease a 20,000 square foot facility that houses all of our research,
manufacturing and office activities and staff. We believe that this facility
will be sufficient to accommodate our anticipated growth through 2001. After
that time, we believe that we will need an additional 50,000 to 100,000 square
feet of space for our manufacturing activities. We have begun to examine
alternatives both within and outside Connecticut to satisfy this expected
need.
Employees
As of August 31, 2000, we had a total staff of 44 persons, of which 24 were
engineers, scientists or other degreed professionals. None of our employees
are represented by a labor union. We consider our relations with our employees
to be excellent.
Legal Proceedings
We are not currently involved in any pending legal proceedings.
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MANAGEMENT
Executive Officers and Directors
Our executive officers and directors, and their ages as of August 31, 2000,
are as follows:
<TABLE>
<CAPTION>
Name Age Title
---- --- -----
<S> <C> <C>
Walter W. Schroeder..... 52 President, chief executive officer and director
Robert J. Friedland..... 34 Vice president of operations
Trent M. Molter......... 37 Vice president of engineering and technology and director
Lawrence C.
Moulthrop, Jr.......... 44 Vice president of product engineering
William F. Smith........ 49 Vice president of business development
David E. Wolff.......... 43 Vice president of sales and marketing
John A. Glidden......... 37 Vice president and controller
Robert W. Shaw, Jr...... 59 Chairman of the board of directors
Richard A. Aube......... 31 Director
Gerald B. Ostroski...... 59 Director
Philip R. Sharp......... 58 Director
</TABLE>
Walter W. Schroeder, one of our founders, has served as our president and
chief executive officer, and as a director, since our founding in August 1996.
From 1991 to August 1996, Mr. Schroeder served as an officer of AES Corp., an
independent power company. From 1986 to 1991, Mr. Schroeder was a vice
president in the investment banking division of Goldman Sachs & Co. Mr.
Schroeder holds BS and MS degrees from Massachusetts Institute of Technology.
Robert J. Friedland, one of our founders, has served as our vice president
of operations since our founding in August 1996. From 1995 to August 1996, Mr.
Friedland served as a program operations manager for United Technologies
Corporation, a diversified aerospace and building systems company. Mr.
Friedland holds a BS in mechanical engineering from Syracuse University and an
MBA from Rennselaer Polytechnic Institute.
Trent M. Molter, one of our founders, has served as our vice president of
engineering and technology since our founding in August 1996, and as a
director since 1997. From 1984 to August 1996, Mr. Molter served as an
advanced technology engineer and a project manager in PEM products for United
Technologies. Mr. Molter holds a BS in chemical engineering from Clarkson
University and an MS in metallurgy from Rennselaer Polytechnic Institute.
Lawrence C. Moulthrop, Jr., one of our founders, has served as our vice
president of product engineering since our founding in August 1996. From 1994
to August 1996, Mr. Moulthrop served as the PEM technology engineering manager
for United Technologies. From 1984 to 1994, Mr. Moulthrop served in various
other PEM engineering positions for United Technologies. Mr. Moulthrop holds a
BS in chemical engineering from the University of New Hampshire.
William F. Smith, one of our founders, has served as our vice president of
business development since our founding in August 1996. From 1986 to August
1996, Mr. Smith served as a business development program manager for United
Technologies. Mr. Smith holds a BA in physics from the University of
Connecticut and an MBA from the University of Massachusetts.
David E. Wolff has served as our vice president of sales and marketing
since March 1999. From 1992 to March 1999, Mr. Wolff served in various
capacities for MG Industries, a subsidiary of the Messer Group, a supplier of
industrial gas. From 1979 to 1992 Mr. Wolff served in various sales positions
for Air Products and Chemicals. Mr. Wolff holds an AB in engineering science
from Dartmouth College.
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<PAGE>
John A. Glidden has served as our vice president and controller since
November 1997. From July 1996 to November 1997, Mr. Glidden served as a
financial manager for United Technologies. From 1987 to July 1996, Mr. Glidden
served as a senior financial planning analyst for United Technologies. Mr.
Glidden holds a BS in business administration from Central Connecticut State
University and an MS in international management from Rensselaer Polytechnic
Institute.
Robert W. Shaw, Jr. has served as our chairman of the board of directors
since our founding in August 1996. Dr. Shaw has served as president of Arete
Corporation, a private investment firm, since March 1997. From 1983 to 1997,
Dr. Shaw served as president of Arete Ventures, Inc., a private investment
firm he founded to invest in the fields of modular/dispersed power generation,
renewable power generation and specialty materials. Prior to that time, Dr.
Shaw was a senior vice president and director of Booz Allen & Hamilton, a
consulting firm, where he founded the firm's energy division. Dr. Shaw holds
BEP and MS degrees from Cornell University, an MPA from American University
and a PhD in applied physics from Stanford University. He serves as a director
of CellTech Power, Inc., Evergreen Solar, Inc. and Northern Power Systems,
Inc., each a private power technology company.
Richard A. Aube has served as a director since April 2000. Mr. Aube is
currently a managing director of The Beacon Group LLC, a private investment
and strategic advisory firm, where he has focused on investments in the energy
sector since 1993. Prior to that time, Mr. Aube was an investment banker in
the natural resources group at Morgan Stanley & Co. Incorporated. Mr. Aube
holds a BA from Dartmouth College. He serves as a director of Capstone Turbine
Corporation, a maker of microturbines, and Generac Portable Products, a
private power technology company.
Gerald B. Ostroski has served as a director since February 1999. Mr.
Ostroski has served as vice president of Minnesota Power, Inc. since January
1982. Since 1991, Mr. Ostroski has also served as president of Minnesota
Power's Synertec subsidiary and currently serves as a director or officer of
several other Minnesota Power subsidiaries. Mr. Ostroski is a registered
professional engineer, licensed in Minnesota and North Dakota. Mr. Ostroski
holds a BSEE from the University of Wisconsin.
Philip R. Sharp has served as a director since March 1999. Dr. Sharp has
served as a lecturer at the John F. Kennedy School of Government of Harvard
University since February 1995. From July 1995 to February 1998, Dr. Sharp
also served as director of Harvard University's Institute of Politics, and is
currently a member of the Institute's senior advisory board. From 1975 to
1995, Dr. Sharp served as a member of the United States House of
Representatives, representing the second district of Indiana. He was a member
of the House Energy and Commerce Committee and the Interior Committee. Dr.
Sharp also chaired the Subcommittee on Fossil and Synthetic Fuels and the
Energy and Power Subcommittee. Dr. Sharp holds a BSFS in foreign service and a
PhD in government from Georgetown University. He serves as a director of
Cinergy Corp. and New England Power Co.
Each executive officer serves at the discretion of the board of directors
and holds office until his successor is elected and qualified or until his
earlier resignation or removal. There are no family relationships among any of
our directors or executive officers.
Compensation of Directors
We reimburse directors for reasonable out-of-pocket expenses incurred in
attending meetings of the board of directors. In addition, we have agreed to
grant each non-employee director (other than Dr. Sharp) options to purchase
10,000 shares of common stock upon the closing of this offering and options to
purchase an additional 5,000 shares of common stock on each anniversary of the
closing of this offering while the director continues to serve on the board of
directors. These options will have an exercise price equal to the fair market
value of our common stock at the date of grant and will vest one year after
grant. In connection with his election to the board of directors, we granted
Dr. Sharp options to purchase 10,000 shares of common stock at an exercise
price of $.35 per share and have agreed to grant him options to purchase an
additional 5,000 shares of common stock on
40
<PAGE>
each anniversary of his election to the board of directors while he continues
to serve on the board of directors. These options have or will have an
exercise price equal to the fair market value of our common stock at the date
of grant and will vest one year after grant.
Board Committees
The board of directors has established a compensation committee and an
audit committee. The compensation committee, which consists of Dr. Sharp and
Dr. Shaw, reviews executive salaries, administers our bonus, incentive
compensation and stock plans and approves the salaries and other benefits of
our executive officers. In addition, the compensation committee consults with
our management regarding our pension and other benefit plans and compensation
policies and practices.
The audit committee, which consists of Messrs. Aube and Ostroski and Dr.
Shaw, reviews the professional services provided by our independent
accountants, the independence of our accountants from our management, our
annual financial statements and our system of internal accounting controls.
The audit committee also reviews other matters with respect to our accounting,
auditing and financial reporting practices and procedures as it may find
appropriate or that may be brought to its attention.
Election of Directors
Following this offering, the board of directors will be divided into three
classes, each of whose members will serve for a staggered three-year term. Mr.
Ostroski and Dr. Sharp will serve in the class whose term expires in 2001;
Messrs. Aube and Molter will serve in the class of directors whose term
expires in 2002; and Mr. Schroeder and Dr. Shaw will serve in the class of
directors whose term expires in 2003. Upon the expiration of the term of a
class of directors, directors in that class will be eligible to be elected for
a new three-year term at the annual meeting of stockholders in the year in
which that term expires.
Our current directors were elected to the board under rights held by
holders of our common stock and preferred stock. These rights, which will
terminate upon completion of this offering, are as follows:
. holders of shares of common stock were entitled prior to the offering to
elect two directors to the board of directors, one of whom was to be our
chief executive officer; Mr. Molter and Mr. Schroeder were elected by
the holders of common stock;
. holders of shares of preferred stock were entitled prior to the offering
to elect four directors to the board of directors; of these directors,
Dr. Shaw was elected by entities affiliated with Arete Corporation, Mr.
Ostroski was elected by MP Investments, Inc., and Mr. Aube was elected
by The Beacon Group Energy Investment Fund II, LP. In addition, entities
affiliated with Arete Corporation were also entitled to designate Dr.
Shaw as our chairman of the board of directors; and
. holders of shares of preferred stock and common stock, voting as
separate classes, were entitled prior to the offering to elect two
directors to the board of directors; Dr. Sharp was elected by the
holders of preferred stock and common stock, voting as separate classes.
Compensation Committee Interlocks and Insider Participation
No member of our compensation committee during the last fiscal year was at
that time, or formerly, an officer or employee of Proton. No interlocking
relationships exist between any member of our board of directors or
compensation committee and the board of directors or compensation committee of
any other company, nor has any interlocking relationship existed in the past.
Executive Compensation
The table below sets forth, for the year ended December 31, 1999, the cash
compensation earned and shares underlying options granted to Mr. Schroeder. We
did not pay any other officer over $100,000 in 1999.
41
<PAGE>
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Long-term
Compensation Compensation Awards
--------------- -------------------
Shares
Underlying All Other
Name and Principal Position Salary Bonus Options Compensation
--------------------------- -------- ------ ------------------- ------------
<S> <C> <C> <C> <C>
Walter W. Schroeder(1)........ $164,000 $4,944 105,525 $3,218(2)
President and chief executive
officer
</TABLE>
--------
(1) As of December 31, 1999, Mr. Schroeder held 56,000 restricted shares of
common stock having an aggregate value of $166,320, based on the fair
market value of our common stock on December 31, 1999 less the
consideration paid.
(2) Represents disability insurance premiums paid on behalf of Mr. Schroeder.
Stock Options
The table below contains information concerning the grant of options to
purchase shares of our common stock to Mr. Schroeder during the year ended
December 31, 1999. The percentage of total options granted to employees set
forth below is based on an aggregate of 667,040 shares subject to options
granted to our employees in 1999.
Option Grants In Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants
-------------------------------------------------------------
Potential
Realizable
Value at
Assumed Annual
Rates of Stock
Price
Percent of Appreciation
Total Options for Option
Number of Granted To Term(1)
Securities Underlying Employees Exercise Price Expiration ---------------
Name Options Granted in 1999 Per Share Date 5% 10%
---- --------------------- ------------- -------------- ---------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Walter W. Schroeder..... 50,000 7.5% $0.15 1/15/2009 $ 4,717 $11,953
55,525 8.3 0.35 2/10/2009 12,222 30,972
</TABLE>
--------
(1) Does not include options to purchase 1,236 shares of common stock granted
to Mr. Schroeder in March 2000 at an exercise price of $0.50 per share,
options to purchase 75,000 shares of common stock granted to Mr. Schroeder
in June 2000 at an exercise price of $6.00 per share or options to
purchase 300,000 shares of common stock which we have agreed to grant to
Mr. Schroeder upon the closing of this offering at an exercise price equal
to the initial public offering price per share shown on the cover of this
prospectus.
(2) The potential realizable value is calculated based on the term of the
option at the time of grant. Stock price appreciation of 5% and 10% is
assumed pursuant to rules promulgated by the Securities and Exchange
Commission and does not represent our prediction of our stock price
performance. The potential realizable values at 5% and 10% appreciation
are calculated by assuming that the exercise price on the date of grant
appreciates at the indicated rate for the entire term of the option and
that the option is exercised at the exercise price and sold on the last
day of its term at the appreciated price.
Fiscal Year-End Option Values
The table below sets forth information for Mr. Schroeder with respect to
the value of his options outstanding as of December 31, 1999. Mr. Schroeder
did not exercise any options to purchase shares of common stock during the
year ended December 31, 1999.
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised In-
Options at Fiscal Year- The-Money Options at
End Fiscal Year-End
------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Walter W. Schroeder........ 44,934 127,427 $127,710 $349,146
</TABLE>
42
<PAGE>
There was no public trading market for our common stock as of December 31,
1999. Accordingly, as permitted by the rules of the Securities and Exchange
Commission, we have calculated the value of unexercised in-the-money options
at fiscal year-end on the basis of the fair market value of our common stock
as of December 31, 1999 of $2.98 per share, less the aggregate exercise price.
Benefit Plans
A total of 7,686,236 shares of common stock, subject to adjustment in the
event of stock splits and other similar events, are reserved for issuance in
the aggregate under our 2000 Stock Incentive Plan and 1996 Stock Option Plan
described below.
2000 Stock Incentive Plan
Our 2000 Stock Incentive Plan was adopted by our board of directors and
approved by our stockholders in June 2000. The 2000 plan provides for the
grant of incentive stock options intended to qualify under Section 422 of the
Internal Revenue Code, nonstatutory stock options, restricted stock awards and
other stock-based awards. As of August 31, 2000, options to purchase 92,000
shares of common stock were outstanding under the 2000 plan.
Our officers, employees, directors, consultants and advisors are eligible
to receive awards under the 2000 plan. Under present law, however, incentive
stock options may only be granted to employees.
Optionees receive the right to purchase a specified number of shares of our
common stock at a specified option price, subject to the terms and conditions
of the option grant. We may grant options at an exercise price less than,
equal to or greater than the fair market value of our common stock on the date
of grant. Under present law, incentive stock options and options intended to
qualify as performance-based compensation under Section 162(m) of the Internal
Revenue Code may not be granted at an exercise price less than the fair market
value of the common stock on the date of grant, or less than 110% of the fair
market value in the case of incentive stock options granted to optionees
holding more than 10% of our voting power. The 2000 plan permits our board of
directors to determine how optionees may pay the exercise price of their
options, including by cash, check or in a "cashless exercise" through a
broker, by surrender to us of shares of common stock, by delivery to us of a
promissory note, or by any combination of the permitted forms of payment.
Our board of directors administers the 2000 plan. Our board of directors
has the authority to adopt, amend and repeal the administrative rules,
guidelines and practices relating to the 2000 plan and to interpret its
provisions. It may delegate authority under the 2000 plan to one or more
committees of the board of directors. Our board of directors has authorized
the compensation committee to administer the 2000 plan, including the granting
of options to our executive officers. Subject to any applicable limitations
contained in the 2000 plan, our board of directors or our compensation
committee, as the case may be, selects the recipients of awards and
determines:
. the number of shares of common stock covered by options and the dates
upon which such options become exercisable;
. the exercise price of options;
. the duration of options; and
. the number of shares of common stock subject to any restricted stock or
other stock-based awards and the terms and conditions of such awards,
including the conditions for repurchase, issue price and repurchase
price.
In the event of a merger or other acquisition event, our board of directors
must provide that all outstanding options or other stock-based awards under
the 2000 plan be assumed or substituted for by the acquiror. If any of these
events constitutes a change in control, and if within one year of the change
in control, the optionee's employment is terminated without cause or the
optionee leaves for good reason, then the assumed or substituted or other
stock-based awards will be immediately exercisable in full or free from
restrictions, as the case may be. In the event of a liquidation or
dissolution, all options will become immediately exercisable ten days prior to
such event and will terminate upon the occurrence of such event.
43
<PAGE>
No award may be granted under the 2000 plan after June 2010, but the
vesting and effectiveness of awards granted before those dates may extend
beyond those dates. Our board of directors may at any time amend, suspend or
terminate the 2000 plan.
1996 Stock Option Plan
Our original stock option plan provided for the grant of incentive stock
options intended to qualify under Section 422 of the Internal Revenue Code and
nonstatutory stock options. As of August 31, 2000, options to purchase
1,466,604 shares of common stock were outstanding under the 1996 plan. The
1996 plan includes change in control provisions similar to those under our
2000 Stock Incentive Plan. Following this offering, our board of directors has
provided that no additional grants will be made under the 1996 plan.
2000 Employee Stock Purchase Plan
Our 2000 Employee Stock Purchase Plan was adopted by our board of directors
and approved by our stockholders in June 2000. The purchase plan authorizes
the issuance of up to a total of 250,000 shares of our common stock to
participating employees.
All of our employees, including our directors who are employees, whose
customary employment is more than 20 hours per week and for more than five
months in any calendar year and have been employed by us for at least six
months, are eligible to participate in the purchase plan. Employees who would
immediately after the grant own 5% or more of the total combined voting power
or value of our stock are not eligible to participate.
On the first day of a designated payroll deduction period, or offering
period, we will grant to each eligible employee who has elected to participate
in the purchase plan an option to purchase shares of our common stock as
follows: the employee may authorize up to 10% of his or her base pay to be
deducted by us from his or her base pay during the offering period. On the
last day of this offering period, the employee is deemed to have exercised the
option, at the option exercise price, to the extent of accumulated payroll
deductions. Under the terms of the purchase plan, the option price is an
amount equal to 85% of the closing price, as defined in the purchase plan, per
share of our common stock on either the first day or the last day of the
offering period, whichever is lower. The first offering period under the
purchase plan will commence on the first day of the fiscal quarter beginning
after the completion of this offering. In no event may an employee purchase in
any one offering period a number of shares that exceeds the number of shares
determined by dividing $25,000 by the average market price of a share of our
common stock on the commencement date of the offering period. Our compensation
committee may, in its discretion, choose an offering period of 12 months or
less for each offering and choose a different offering period for each
offering.
An employee who is not a participant on the last day of the offering period
is not entitled to exercise any option, and the employee's accumulated payroll
deductions will be refunded. An employee's rights under the purchase plan
terminate upon voluntary withdrawal from the purchase plan at any time, or
when the employee ceases employment for any reason, except that upon
termination of employment because of death, the employee's beneficiary has a
right to elect to exercise the option to purchase the shares which the
accumulated payroll deductions in the participant's account would purchase at
the date of death.
Because participation in the purchase plan is voluntary, we cannot now
determine the number of shares of our common stock to be purchased by any of
our current executive officers, by all of our current executive officers as a
group or by our non-executive employees as a group.
44
<PAGE>
CERTAIN TRANSACTIONS
Issuances of Preferred Stock and Warrants
Since our inception in August 1996, we have issued and sold five series of
preferred stock, and warrants to purchase series B convertible preferred stock
at an exercise price of $2.00 per share, to the following persons and entities
who are our executive officers, directors or 5% or greater stockholders. Each
share of our outstanding preferred stock will be converted into a share of
common stock upon the closing of this offering. For more detail on shares of
stock held by these purchasers, see "Principal Stockholders."
<TABLE>
<CAPTION>
Warrants to
Purchase the
Series A Series A-1 Principal Series B Following Shares Series B-1 Series C
Convertible Convertible Amount of Convertible of Series B Convertible Convertible Aggregate
Preferred Preferred Promissory Preferred Convertible Preferred Preferred Purchase
Name Stock Stock Notes (2) Stock Preferred Stock Stock Stock Price
---- ----------- ----------- ---------- ----------- ---------------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Entities Affiliated
with Arete
Corporation......... 1,094,040 1,045,460 $960,000 492,412 164,139 450,000 1,642,859 $9,878,877
Ballentine Capital
Partners Fund,
L.P................. -- -- -- -- -- -- 1,428,572 5,000,002
The Beacon Group
Energy Investment
Fund II, LP......... -- -- -- -- -- -- 2,857,143 10,000,001
Connecticut
Innovations,
Inc.(1)............. 500,000 363,636 500,000 256,465 85,489 365,011 1,428,571 7,142,950
Robert J. Friedland.. 1,000 3,636 1,000 512 171 -- -- 6,024
John A. Glidden...... -- 2,500 400 205 69 -- 286 4,161
MP Investments,
Inc................. -- -- -- 500,000 100,000 73,616 571,429 3,147,234
Trent M. Molter...... 1,005 909 1,000 512 171 -- -- 3,029
Lawrence C.
Moulthrop, Jr....... 1,000 1,818 1,100 564 188 -- -- 4,128
Walter W. Schroeder.. 50,274 4,545 -- -- -- -- -- 55,274
William F. Smith..... 1,000 1,000 400 205 69 125 -- 2,760
David E. Wolff....... -- -- -- -- -- 1,000 5,000 19,500
</TABLE>
--------
(1) Includes 285,715 shares of series C convertible preferred stock held by
Connecticut Innovations/Webster LLC.
(2) The principal and accrued interest on these promissory notes converted
into series B convertible preferred stock as described below under "Series
B Financing" and is included in the aggregate purchase price of the shares
set forth in this table.
Series A Financing. On May 9, 1997 and July 10, 1997, we issued an
aggregate of 2,908,511 shares of series A convertible preferred stock to 32
investors, including affiliates of Arete Corporation, Robert J. Friedland,
Trent M. Molter, Lawrence C. Moulthrop, Jr., Walter W. Schroeder and William
F. Smith. The per share purchase price for our series A convertible preferred
stock was $1.00.
Series A-1 Financing. In 1997, we issued an aggregate of 2,275,367 shares
of series A-1 convertible preferred stock to 33 investors, including
affiliates of Arete Corporation, Connecticut Innovations, Inc., Robert J.
Friedland, John A. Glidden, Trent M. Molter, Lawrence C. Moulthrop, Jr.,
Walter W. Schroeder and William F. Smith. The per share purchase price for our
series A-1 convertible preferred stock paid by these purchasers was $1.10.
Series B Financing. On December 22, 1998, we issued an aggregate of
1,545,151 shares of series B convertible preferred stock to 28 investors,
including affiliates of Arete Corporation, Connecticut Innovations, Inc.,
Minnesota Power, Inc. (which subsequently transferred these shares to MP
Investments, Inc., a wholly-owned subsidiary of Minnesota Power), Robert J.
Friedland, Trent M. Molter, Lawrence C. Moulthrop, Jr. and William F. Smith.
The per share purchase price for our series B convertible preferred stock was
$2.00.
45
<PAGE>
Of the aggregate purchase price for our series B convertible preferred
stock, $1,038,600 was paid in cash at closing and the balance was accounted
for through the conversion of principal and interest on notes payable in the
total principal amount of $2.0 million and bearing 8% yearly interest that we
had issued to some of our preferred stockholders in August 1998. In connection
with the series B financing, we issued warrants to purchase an aggregate of
441,959 shares of series B convertible preferred stock at an exercise price of
$2.00 per share to 20 investors, including affiliates of Arete Corporation,
Connecticut Innovations, Inc., Minnesota Power, Inc. (which subsequently
transferred these shares to MP Investments, Inc.), Robert J. Friedland, John
A. Glidden, Trent M. Molter, Lawrence C. Moulthrop, Jr. and William F. Smith.
Series B-1 Financing. On May 12, 1999, we issued an aggregate of 1,500,000
shares of series B-1 convertible preferred stock to 28 investors, including
affiliates of Arete Corporation, Connecticut Innovations, Inc., Minnesota
Power, Inc. (which subsequently transferred these shares to MP Investments,
Inc.), William F. Smith and David E. Wolff. The per share purchase price for
our series B-1 convertible preferred stock was $2.00.
Series C Financing. On April 12, 2000, we issued an aggregate of 14,306,901
shares of series C convertible preferred stock to 66 investors, including
affiliates of Arete Corporation, Connecticut Innovations, Inc., LLC, MP
Investments, Inc., Connecticut Innovations/Webster LLC, Ballentine Capital
Partners Fund, L.P., The Beacon Group Energy Investment Fund II, LP, John A.
Glidden and David E. Wolff. The per share purchase price for our series C
convertible preferred stock was $3.50.
Issuances of Common Stock
In connection with Proton's formation, on August 22, 1996, we issued
280,000 shares of our common stock to each of Messrs. Friedland, Molter,
Moulthrop, Schroeder and Smith and 250,000 shares of our common stock to each
of Utech Climate Challenge Fund, L.P. and UVCC Fund II. The per share purchase
price for this common stock was $.01.
Indemnification Agreements
We have entered into indemnification agreements with each of our directors
and executive officers. Such indemnification agreements will require us to
indemnify our directors and executive officers to the fullest extent permitted
by Delaware law.
Policy on Transactions with Affiliates
For all future transactions, we have adopted a conflict of interest policy
whereby all material transactions between Proton and our officers, directors
and other affiliates must (i) be approved by a majority of the disinterested
members and (ii) be on terms no less favorable to us than could be obtained
from unaffiliated third parties. In addition, any loans to our officers,
directors and other affiliates must be for bona fide business purposes only.
46
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding beneficial ownership
of our common stock as of August 31, 2000 by:
. each person who beneficially owns more than 5% of the outstanding shares
of our common stock;
. each of our directors;
. the executive officer named in the Summary Compensation Table;
. all of our directors and executive officers as a group; and
. certain other significant stockholders of Proton.
The percentages shown are based on 25,014,816 shares of common stock
outstanding as of August 31, 2000 and 32,014,816 shares of common stock
outstanding after this offering, including the 7,000,000 shares that are being
offered for sale by us in this offering. Beneficial ownership is determined in
accordance with the rules of the Securities and Exchange Commission, and
includes voting and investment power with respect to shares. The number of
shares beneficially owned by a person includes shares of common stock subject
to options held by that person that are currently exercisable or exercisable
within 60 days of August 31, 2000. The shares issuable under those options are
treated as if they were outstanding for computing the percentage ownership of
the person holding those options but are not treated as if they were
outstanding for the purposes of computing the percentage ownership of any
other person. Unless otherwise indicated below, to our knowledge, all persons
named in the table have sole voting and investment power with respect to their
shares of common stock, except to the extent authority is shared by spouses
under applicable law. Unless otherwise indicated, the address of each person
owning more than 5% of the outstanding shares of common stock is c/o Proton
Energy Systems, Inc., 50 Inwood Road, Rocky Hill, Connecticut 06067.
<TABLE>
<CAPTION>
Percentage of Common Stock
Beneficially Owned
Shares --------------------------------
Beneficial Owner Beneficially Owned Prior to Offering After Offering
---------------- ------------------ ----------------- --------------
<S> <C> <C> <C>
Entities Affiliated with 5,388,910 21.5% 16.8%
Arete Corporation(1)......
P.O. Box 1299
Center Harbor, NH 03226
Connecticut Innovations, 2,999,172 12.0 9.4
Inc.(2)...................
999 West Street
Rocky Hill, CT 06067
The Beacon Group Energy In- 2,857,143 11.4 8.9
vestment Fund II, L.P. ...
399 Park Avenue
New York, NY 10022
Ballentine Capital Partners 1,428,572 5.7 4.5
Fund, L.P.(3) ............
10 Avon Meadow Lane
Avon, CT 06001
MP Investments, Inc.(4).... 1,245,045 5.0 3.9
30 W. Superior Street
Duluth, MN 55802
Entities Affiliated with 1,142,858 4.6 3.6
CIBC World Markets(5).....
161 Bay Street, 6th Floor
Toronto, Ontario M5J 2S8
Entities Affiliated with 1,071,429 4.3 3.3
Nth Power Technolo-
gies(6)...................
100 Spear Street, Suite
1450
San Francisco, CA 94105
</TABLE>
47
<PAGE>
<TABLE>
<CAPTION>
Percentage of Common Stock
Beneficially Owned
Shares --------------------------------
Beneficial Owner Beneficially Owned Prior to Offering After Offering
---------------- ------------------ ----------------- --------------
<S> <C> <C> <C>
Entities and Individuals 857,143 3.4% 2.7%
Affiliated with Chase Cap-
ital Partners(7)..........
1221 Avenue of the Ameri-
cas, 40th Floor
New York, NY 10020
Lehman Brothers VC Partners 857,143 3.4 2.7
L.P. .....................
3 World Financial Center
New York, NY 10285
Solstice Capital Limited 790,787 3.2 2.5
Partnership...............
15 Broad Street, 3rd Floor
Boston, MA 02109
Perseus 2000, L.L.C. ...... 714,286 2.9 2.2
1627 I Street, N.W., Suite
600
Washington, DC 20006
Stephens--Proton Energy 714,286 2.9 2.2
LLC.......................
111 Center Street, Suite
2800
Little Rock, AR 72201
Walter W. Schroeder(8)..... 410,343 1.6 1.3
Trent M. Molter(9)......... 333,854 1.3 1.0
Richard A. Aube(10)........ 2,857,143 11.4 8.9
Gerald B. Ostroski(11)..... -- -- --
Philip R. Sharp(12)........ 2,500 * *
Robert W. Shaw, Jr.(13).... 5,388,910 21.5 16.8
All executive officers and
directors as a group (11
persons)(14).............. 10,018,397 39.6 31.0
</TABLE>
-------
* Less than 1%.
(1) Represents 1,534,620 shares of common stock held of record by Utech
Climate Challenge Fund, L.P., 1,891,763 shares of common stock held of
record by UVCC Fund II, 285,715 shares of common stock held of record by
UVCC II Parallel Fund, L.P. and 1,676,812 shares of common stock held of
record by Micro-Generation Technology Fund, LLC.
(2) Includes 285,715 shares of common stock held of record by Connecticut
Innovations/Webster LLC. Voting control of Connecticut Innovations, Inc.
is exercised by its board of directors, which is appointed by the
governor of Connecticut and members of the Connecticut legislature.
(3) Ballentine Capital Partners, LLC exercises voting control of this fund in
its capacity as general partner. Steven W. Ballentine exercises voting
control of this fund in his capacity as managing member of its general
partner. Mr. Ballentine disclaims beneficial ownership of these shares.
(4) Minnesota Power, Inc. owns all of the outstanding stock and has voting
control of MP Investments, Inc. Does not include any shares held of
record by Utech Climate Challenge Fund, L.P., UVCC Fund II and Micro-
Generation Technology Fund, LLC. Minnesota Power is an investor in each
such fund, and MP Investments, Inc. disclaims beneficial ownership of the
shares held by these funds.
(5) Represents 857,143 shares of common stock held of record by CIBC WMC Inc.
and 285,715 shares of common stock held of record by CIBC Employee
Private Equity Fund.
(6) Represents 928,572 shares of common stock held of record by Nth Power
Technologies Fund I, L.P. and 142,857 shares of common stock held of
record by Nth Power Technologies Fund II, L.P.
48
<PAGE>
(7) Represents 357,143 shares of common stock held of record by CB Capital
Investors, LLC, 278,293 shares of common stock held of record by
Haddington/Chase Energy Partners (Proton) LP, 150,278 shares of common
stock held of record by Haddington Energy Partners, L.P. and an
aggregate of 71,429 shares of common stock held of record by entities
and individuals affiliated with Hambrecht & Quist, an affiliate of Chase
Capital Partners.
(8) Includes 75,524 shares subject to options exercisable within 60 days
after August 31, 2000.
(9) Includes 51,257 shares subject to options exercisable within 60 days
after August 31, 2000.
(10) Represents 2,857,143 shares of common stock held of record by The Beacon
Group Energy Investment Fund II, LP. Mr. Aube serves in a managerial
capacity at Beacon Energy Investors II, LP, which controls The Beacon
Group Energy Investment Fund II, LP. Mr. Aube disclaims beneficial
ownership of these shares.
(11) Does not include 1,245,045 shares of common stock beneficially owned by
MP Investments, Inc., a wholly owned subsidiary of Minnesota Power, Inc.
Mr. Ostroski serves as a vice president of Minnesota Power, but does not
have or share investment or voting control over these shares.
(12) Represents 2,500 shares subject to options exercisable within 60 days
after August 31, 2000.
(13) Consists of the shares listed in footnote 1 above. Dr. Shaw is the
president of Arete Corporation, which is the manager of Micro-Generation
Technology Fund, LLC. Dr. Shaw is the general partner of the general
partner of UVCC Fund II and UVCC II Parallel Fund, L.P. and the managing
member of the general partner of Utech Climate Challenge Fund, L.P. Dr.
Shaw disclaims beneficial ownership of these shares.
(14) See notes 8 through 13 above. Also includes 167,799 shares of common
stock subject to options exercisable within 60 days after August 31,
2000.
49
<PAGE>
DESCRIPTION OF CAPITAL STOCK
After completion of this offering, our authorized capital stock will
consist of 100,000,000 shares of common stock, $.01 par value per share, and
5,000,000 shares of preferred stock, $.01 par value per share. The following
is a summary of the material features of our capital stock. For more detail,
please see our amended and restated certificate of incorporation and amended
and restated by-laws to be effective after the completion of this offering,
filed as exhibits to the registration statement of which this prospectus is a
part.
Common Stock
As of August 31, 2000, there were 25,014,816 shares of common stock
outstanding held by 121 stockholders of record. Based upon the number of
shares outstanding as of that date, and the issuance of the shares of common
stock offered by us in this offering, there will be 32,014,816 shares of
common stock outstanding upon the completion of this offering.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Directors are elected by a plurality of the votes of the shares
present in person or by proxy at the meeting and entitled to vote in such
election. Subject to preferences that may be applicable to any outstanding
preferred stock, holders of common stock are entitled to receive ratably such
dividends, if any, as may be declared by the board of directors out of funds
legally available to pay dividends. Upon our liquidation, dissolution or
winding up, the holders of common stock are entitled to receive ratably all
assets after the payment of our liabilities, subject to the prior rights of
any outstanding preferred stock. Holders of the common stock have no
preemptive, subscription, redemption or conversion rights. They are not
entitled to the benefit of any sinking fund. The outstanding shares of common
stock are, and the shares offered by us in this offering will be, when issued
and paid for, validly issued, fully paid and nonassessable. The rights,
powers, preferences and privileges of holders of common stock are subject to
the rights of the holders of shares of any series of preferred stock which we
may designate and issue in the future.
At present, there is no established trading market for the common stock.
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "PRTN."
Preferred Stock
On the completion of this offering, the board of directors will be
authorized, subject to any limitations prescribed by law, without further
stockholder approval, to issue up to an aggregate of 5,000,000 shares of
preferred stock. The preferred stock may be issued in one or more series and
on one or more occasions. Each series of preferred stock will have the number
of shares, designations, preferences, voting powers, qualifications and
special or relative rights or privileges as the board of directors may
determine. These rights and privileges may include, among others, dividend
rights, voting rights, redemption provisions, liquidation preferences,
conversion rights and preemptive rights.
The issuance of preferred stock, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could
adversely affect the voting power or other rights of the holders of common
stock. In addition, the issuance of preferred stock could make it more
difficult for a third party to acquire us, or discourage a third party from
attempting to acquire us.
Warrants
In February 1998, we issued EPRI a warrant to purchase 50,000 shares of our
common stock at an exercise price of $1.10 per share. This warrant expires ten
years after issuance. In August and December 1998, we issued some of our
investors warrants to purchase an aggregate of 441,959 shares of our series B
convertible preferred stock at an exercise price of $2.00 per share. These
warrants may be exercised either through payment of the exercise price in cash
or through application of a formula under which the warrantholder could choose
to convert the warrant into a number of shares of our stock determined based
upon the public offering price of the shares being sold in this offering.
These warrants will expire upon completion of this offering.
50
<PAGE>
Delaware Law and Charter and By-Law Provisions; Anti-Takeover Effects
We are subject to the provisions of Section 203 of the General Corporation
Law of Delaware. Section 203 prohibits a publicly held Delaware corporation
from engaging in a business combination with an interested stockholder for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved
in a prescribed manner. A business combination includes mergers,
consolidations, asset sales and other transactions involving Proton and an
interested stockholder. In general, an interested stockholder is a person who,
together with affiliates and associates, owns, or within three years did own,
15% or more of the corporation's voting stock.
Our amended and restated certificate of incorporation and amended and
restated by-laws to be effective upon the completion of this offering provide:
. that the board of directors be divided into three classes, as nearly
equal in size as possible, with staggered three-year terms;
. that directors may be removed only for cause by the affirmative vote of
the holders of at least 75% of the shares of our capital stock entitled
to vote; and
. that any vacancy on the board of directors, however occurring, including
a vacancy resulting from an enlargement of the board, may only be filled
by vote of a majority of the directors then in office.
The classification of the board of directors and the limitations on the
removal of directors and filling of vacancies could have the effect of making
it more difficult for a third party to acquire us, which could have the effect
of discouraging a third party from attempting to do so.
Our amended and restated certificate of incorporation and amended and
restated by-laws will also provide that:
. any action required or permitted to be taken by the stockholders at an
annual meeting or special meeting of stockholders may only be taken if
it is properly brought before such meeting and may not be taken by
written action in lieu of a meeting;
. special meetings of the stockholders may only be called by the chairman
of the board of directors, the president, or by the board of directors;
and
. in order for any matter to be considered properly brought before a
meeting, a stockholder must comply with requirements regarding advance
notice to us.
These provisions could delay until the next stockholders' meeting
stockholder actions which are favored by the holders of a majority of our
outstanding voting securities. These provisions may also discourage another
person or entity from making a tender offer for our common stock, because such
person or entity, even if it acquired a majority of our outstanding voting
securities, would be able to take action as a stockholder, such as electing
new directors or approving a merger, only at a duly called stockholders
meeting, and not by written consent.
Delaware's corporation law provides generally that the affirmative vote of
a majority of the shares entitled to vote on any matter is required to amend a
corporation's certificate of incorporation or by-laws, unless a corporation's
certificate of incorporation or by-laws, as the case may be, requires a
greater percentage. Our amended and restated certificate of incorporation
requires the affirmative vote of the holders of at least 75% of the shares of
our capital stock entitled to vote to amend or repeal any of the foregoing
provisions of our amended and restated certificate of incorporation.
Generally, our amended and restated by-laws may be amended or repealed by a
majority vote of the board of directors or the holders of a majority of the
shares of our capital stock issued and outstanding and entitled to vote. To
amend our amended and restated by-laws regarding special meetings of
stockholders, written actions of stockholders in lieu of a meeting, and the
election, removal and classification of members of the board of directors
requires the affirmative vote of the holders of at least 75% of
51
<PAGE>
the shares of our capital stock entitled to vote. The stockholder vote would
be in addition to any separate class vote that might in the future be required
pursuant to the terms of any series preferred stock that might be outstanding
at the time any such amendments are submitted to stockholders.
Limitation of Liability and Indemnification
Our amended and restated certificate of incorporation provides that our
directors and officers will be indemnified by us to the fullest extent
authorized by Delaware law. This indemnification would cover all expenses and
liabilities reasonably incurred in connection with their services for or on
behalf of us. In addition, our amended and restated certificate of
incorporation provides that our directors will not be personally liable for
monetary damages to us for breaches of their fiduciary duty as directors,
unless they violated their duty of loyalty to us or our stockholders, acted in
bad faith, knowingly or intentionally violated the law, authorized illegal
dividends or redemptions or derived an improper personal benefit from their
action as directors.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is American Stock
Transfer & Trust Company.
52
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have 32,014,816 shares of common
stock outstanding assuming no exercise of outstanding options and warrants. Of
these shares, the 7,000,000 shares to be sold in this offering will be freely
tradable without restriction or further registration under the Securities Act
of 1933, as amended, except that any shares purchased by our affiliates, as
that term is defined in Rule 144 under the Securities Act, may generally only
be sold in compliance with the limitations of Rule 144 described below.
Sales of Restricted Shares
<TABLE>
<CAPTION>
Days After Date
of Approximate Shares
This Prospectus Eligible for Future Sale Comment
--------------- ------------------------ -------
<S> <C> <C>
On effectiveness.. 7,000,000 Sold in offering and freely tradable
180 days.......... 10,151,029 Lock-up released; shares saleable under Rule
144, 144(k) or 701
Restricted securities held for one year or
Thereafter........ 14,863,787 less
</TABLE>
In general, under Rule 144, a person, including an affiliate, who has
beneficially owned shares for at least one year is entitled to sell, within
any three-month period, a number of such shares that does not exceed the
greater of (1) one percent of the then outstanding shares of common stock, or
approximately 320,148 shares immediately after this offering, or (2) the
average weekly trading volume in the common stock in the over-the-counter
market during the four calendar weeks preceding the date on which notice of
such sale is filed, provided specified requirements concerning availability of
public information, manner of sale and notice of sale have been satisfied. In
addition, our affiliates must comply with the restrictions and requirements of
Rule 144, other than the one-year holding period requirement, in order to sell
shares of common stock which are not restricted securities.
Under Rule 144(k), a person who is not an affiliate and has not been an
affiliate for at least three months prior to the sale and who has beneficially
owned shares for at least two years may resell these shares without compliance
with the foregoing requirements. In meeting the one- and two-year holding
periods described above, a holder of shares can include the holding periods of
a prior owner who was not an affiliate. The one- and two-year holding periods
described above do not begin to run until the full purchase price or other
consideration is paid by the person acquiring the shares from the issuer or an
affiliate. Rule 701 provides that currently outstanding shares of common stock
acquired under our employee compensation plans may be resold beginning 90 days
after the date of this prospectus (1) by persons, other than affiliates,
subject only to the manner of sale provisions of Rule 144, and (2) by
affiliates under Rule 144 without compliance with its one-year minimum holding
period, subject to certain limitations.
Stock Options
As of August 31, 2000, approximately 409,211 shares of common stock were
issuable pursuant to vested options granted under our 1996 Stock Option Plan.
We intend to file a registration statement on Form S-8 under the Securities
Act following the date of this prospectus, to register up to 7,936,236 shares
of common stock issuable under our stock plans, including the 1,558,604 shares
of common stock subject to outstanding options as of August 31, 2000. This
registration statement is expected to become effective upon filing.
Warrants
As of August 31, 2000, 50,000 shares of common stock were issuable pursuant
to outstanding warrants.
53
<PAGE>
Lock-Up Agreements
Proton, its executive officers and directors, and substantially all of our
stockholders have agreed not to sell or transfer their shares of common stock,
or to engage in hedging transactions with respect to the common stock, without
the prior written consent of Morgan Stanley & Co. Incorporated for a period of
180 days from the date of this prospectus. In addition, for a period of 180
days from the date of this prospectus, Proton has agreed that its Board of
Directors will not consent to any offer for sale, sale or other disposition,
or any transaction which is designed or could be expected to result in the
disposition by any person, directly or indirectly, of any shares of common
stock without the prior written consent of Morgan Stanley & Co. Incorporated.
Morgan Stanley & Co. Incorporated in its sole discretion may release for sale
in the public market all or any portion of the shares subject to the lock-up
agreements. Please turn to the section titled "Underwriters" for more
information on the lock-up agreements.
Morgan Stanley & Co. Incorporated intends to enter into similar lock-up
agreements for up to 180 days with those individuals and entities who purchase
shares under our reserved share program.
Registration Rights
After this offering, the holders of approximately 23,101,052 shares of
common stock will be entitled to certain rights with respect to the
registration of such shares under the Securities Act. Under the terms of the
agreement between us and the holders of these registrable securities if we
propose to register any of our securities under the Securities Act, either for
our own account or for the account of other security holders exercising
registration rights, these holders are entitled to notice of the registration
and are entitled to include shares of their common stock in the registration.
Additionally, the holders holding in the aggregate at least 50% of the
registrable securities are entitled to demand registration rights pursuant to
which they may require us on up to three occasions to file a registration
statement under the Securities Act at our expense with respect to their shares
of common stock. Holders holding in the aggregate at least 25% of the
registrable securities may also require us to file up to four additional
registration statements on Form S-3 at our expense. All of these registration
rights are subject to typical conditions and limitations, among them the right
of the underwriters of an offering to limit the number of shares included in
the registration and our right not to effect a requested registration, other
than a registration on Form S-3, within six months following this offering or
any subsequent offering of our securities pursuant to a registration statement
filed with the Securities and Exchange Commission. We also have agreed to
indemnify shareholders whose shares are included in a registration statement
from losses arising from violations by us of applicable securities laws in
connection with the registration statement.
In addition, after this offering, the holder of a warrant to purchase
50,000 shares of common stock is entitled to notice of any registration
statement filed by us and to include shares of common stock acquired upon
exercise of the warrant in the registration. This registration right is
subject to typical conditions and limitations, including the right of the
underwriters of an offering to limit the number of shares included in the
registration. We have also agreed to indemnify the warrant holder from losses
arising from violations by us of applicable securities laws in connection with
any registration statement that includes the warrant holder's shares of common
stock.
54
<PAGE>
UNDERWRITERS
Under the terms and subject to the conditions contained in an underwriting
agreement dated the date of this prospectus, the underwriters named below, for
whom Morgan Stanley & Co. Incorporated, Credit Suisse First Boston Corporation
and Salomon Smith Barney Inc. are acting as representatives, have severally
agreed to purchase, and we have agreed to sell to them, severally, the number
of shares of common stock indicated below:
<TABLE>
<CAPTION>
Number of
Name Shares
---- ---------
<S> <C>
Morgan Stanley & Co. Incorporated............................... 2,120,000
Credit Suisse First Boston Corporation.......................... 2,120,000
Salomon Smith Barney Inc........................................ 2,120,000
Adams, Harkness & Hill, Inc..................................... 80,000
Coburn & Meredith, Inc.......................................... 80,000
Deutsche Bank Securities, Inc................................... 80,000
A.G. Edwards & Sons, Inc........................................ 80,000
First Union Securities, Inc..................................... 80,000
Jefferies & Company, Inc........................................ 80,000
Edward D. Jones & Co., L.P...................................... 80,000
C.L. King & Associates, Inc..................................... 80,000
---------
Total......................................................... 7,000,000
=========
</TABLE>
The underwriters are offering the shares of common stock subject to their
acceptance of the shares from us and subject to prior sale. The underwriting
agreement provides that the obligations of the several underwriters to pay for
and accept delivery of the shares of common stock offered by this prospectus
are subject to the approval of specified legal matters by their counsel and to
other conditions. The underwriters are obligated to take and pay for all of
the shares of common stock offered by this prospectus, other than those shares
covered by the over-allotment option described below, if any shares are taken.
The underwriters initially propose to offer part of the shares of common
stock directly to the public at the initial public offering price set forth on
the cover page of this prospectus and part to dealers at a price that
represents a concession not in excess of $.77 a share under the initial public
offering price. After the initial offering of the shares of common stock, the
offering price and other selling terms may from time to time be varied by the
representatives. Morgan Stanley Dean Witter Online Inc., an affiliate of
Morgan Stanley & Co. Incorporated, may act as a selected dealer in the
offering to facilitate the distribution of shares of common stock over the
Internet to its eligible account holders.
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to an aggregate of 1,050,000
additional shares of common stock at the initial public offering price listed
on the cover page of this prospectus, less underwriting discounts and
commissions. The underwriters may exercise this option solely for the purpose
of covering over-allotments, if any, made in connection with the offering of
the shares of common stock offered by this prospectus. To the extent this
option is exercised, each underwriter will become obligated, subject to
specified conditions, to purchase approximately the same percentage of the
additional shares of common stock as the number listed next to the
underwriter's name in the preceding table bears to the total number of shares
of common stock listed next to the names of all underwriters in the preceding
table. If the underwriters' option is exercised in full, the total price to
public would be $136,850,000, the total underwriters' discounts and
commissions would be $9,579,500, and the total proceeds to Proton would be
$127,270,500.
We estimate expenses payable by us in connection with this offering, other
than the underwriting discounts and commissions referred to above, will be
approximately $1.5 million.
55
<PAGE>
The underwriters have informed us that they do not intend sales to
discretionary accounts to exceed five percent of the total number of shares of
common stock offered by them.
Proton, our directors and executive officers and all of our other
stockholders and option holders have each agreed that, without the prior
written consent of Morgan Stanley & Co. Incorporated on behalf of the
underwriters, it will not, during the period ending 180 days after the date of
this prospectus, subject to limited exceptions:
. offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock,
whether such shares or any such securities are then owned by such person
or are thereafter acquired directly from us; or
. enter into any swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the
common stock,
whether any such transaction described above is to be settled by delivery of
shares of common stock or such other securities, in cash or otherwise.
The restrictions described in the paragraph above do not apply to:
. the sale of shares of common stock to the underwriters;
. the issuance by us of shares of common stock upon the exercise of an
option or a warrant or the conversion of a security outstanding on the
date of this prospectus of which the underwriters have been advised in
writing;
. the grant of options under our existing stock plans provided that either
the options do not become exercisable during the 180-day lock-up period
or the option holders enter into agreements containing the restrictions
described above; or
. transactions by any person other than us relating to shares of common
stock or other securities acquired in open market transactions after the
completion of this offering.
In order to facilitate the offering of the common stock, the underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
price of the common stock. Specifically, the underwriters may sell more shares
than they are obligated to purchase under the underwriting agreement, creating
a short position. A short sale is covered if the short position is no greater
than the number of shares available for purchase by the underwriters under the
over-allotment option. The underwriters can close out a covered short sale by
exercising the over-allotment option or purchasing shares in the open market.
In determining the source of shares to close out a covered short sale, the
underwriters will consider, among other things, the open market price of
shares compared to the price available under the over-allotment option. The
underwriters may also sell shares in excess of the over-allotment option,
creating a naked short position. The underwriters must close out any naked
short position by purchasing shares in the open market. A naked short position
is more likely to be created if the underwriters are concerned that there may
be downward pressure on the price of the common stock in the open market after
pricing that could adversely affect investors who purchase in the offering. As
an additional means of facilitating the offering, the underwriters may bid
for, and purchase, shares of common stock in the open market to stabilize the
price of the common stock. The underwriting syndicate may also reclaim selling
concessions allowed to an underwriter or a dealer for distributing the common
stock in the offering, if the syndicate repurchases previously distributed
common stock to cover syndicate short positions or to stabilize the price of
the common stock. These activities may raise or maintain the market price of
the common stock above independent market levels or prevent or retard a
decline in the market price of the common stock. The underwriters are not
required to engage in these activities, and may end any of these activities at
any time.
We and the underwriters have agreed to indemnify each other against certain
liabilities, including liabilities under the Securities Act.
56
<PAGE>
At our request, the underwriters have reserved for sale up to 600,000
shares of common stock offered by this prospectus for sale at the initial
public offering price for our directors, officers, employees and business
associates and related persons of Proton. The number of shares of common stock
available for sale to the general public will be reduced to the extent that
these persons purchase the reserved shares. Any reserved shares which are not
so purchased will be offered by the underwriters to the general public on the
same basis as the other shares offered by this prospectus. Each participant in
the reserved share program will be required to enter into lock-up agreements
with the underwriters in connection with their purchase of reserved shares.
Pricing of the Offering
Prior to this offering, there has been no public market for the shares of
common stock. Consequently, the initial public offering price for the shares
of common stock was determined by negotiations between Proton and the
representatives of the underwriters. Among the factors considered in
determining the initial public offering price were:
. our future prospects and the future prospects of our industry in
general;
. the experience of our management;
. our revenue, earnings and other financial and operating information in
recent periods; and
. the price-revenue ratios, market prices of securities and financial and
operating information of companies engaged in activities similar to
ours.
LEGAL MATTERS
The validity of the shares of common stock we are offering will be passed
upon for us by Hale and Dorr LLP, Washington, D.C. Certain legal matters in
connection with this offering will be passed upon for the underwriters by
Shearman & Sterling, Toronto, Ontario.
EXPERTS
The financial statements of Proton Energy Systems, Inc., a development
stage company, as of December 31, 1998 and 1999 and for each of the three
years in the period ended December 31, 1999 included in this prospectus have
been so included in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act with respect to the common
stock we propose to sell in this offering. This prospectus, which constitutes
part of the registration statement, does not contain all of the information
set forth in the registration statement. For further information about us and
the common stock we propose to sell in this offering, we refer you to the
registration statement and the exhibits and schedules filed as a part of the
registration statement. Statements contained in this prospectus as to the
contents of any contract or other document filed as an exhibit to the
registration statement are not necessarily complete. If a contract or document
has been filed as an exhibit to the registration statement, we refer you to
the copy of the contract or document that has been filed. The registration
statement may be inspected without charge at the principal office of the
Commission in Washington, D.C. and copies of all or any part of which may be
inspected and copied at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Judiciary Plaza, Room 1024, Washington,
D.C. 20549, and at the Commission's regional offices located at Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511 and
7 World Trade Center, Suite 1300, New York, New York 10048. Copies of such
material can also be obtained at prescribed rates by mail from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549. The Commission's toll-free number is 1-800-SEC-0330. In addition,
the Commission maintains a website (http://www.sec.gov) that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission.
57
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants........................................ F-2
Balance Sheets at December 31, 1998 and 1999, and June 30, 2000
(unaudited)............................................................. F-3
Statements of Operations for each of the three years in the period ended
December 31, 1999, for the period from inception (August 16, 1996)
through December 31, 1999, for the six-month periods ended June 30, 1999
(unaudited) and 2000 (unaudited), and for the period from inception
(August 16, 1996) through June 30, 2000 (unaudited)..................... F-4
Statements of Changes in Stockholders' Equity (Deficit) for the period
from inception (August 16, 1996) through December 31, 1999, and for the
six-month period ended June 30, 2000 (unaudited)........................ F-5
Statements of Cash Flows for each of the three years in the period ended
December 31, 1999, for the period from inception (August 16, 1996)
through December 31, 1999, for the six-month periods ended June 30, 1999
(unaudited) and 2000 (unaudited), and for the period from inception
(August 16, 1996) through June 30, 2000 (unaudited)..................... F-6
Notes to Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Proton Energy Systems, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, changes in stockholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of Proton
Energy Systems, Inc. (the "Company"), a development stage company, at December
31, 1998 and 1999 and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1999, and for the
period from inception (August 16, 1996) through December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States, which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Hartford, Connecticut
April 14, 2000
F-2
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 2000
Pro Forma
Mandatorily Redeemable
December 31, Convertible Preferred Stock
------------------------ June 30, and Stockholders' Equity
1998 1999 2000 (Note 2)
----------- ----------- ------------ ---------------------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash
equivalents........... $ 478,322 $ 580,709 $ 1,483,029
Marketable securities
(Note 2).............. 2,750,000 2,550,000 49,040,344
Inventory (Note 3)..... 752,719 942,227 1,377,679
Other current assets... 84,653 73,665 810,316
----------- ----------- ------------
Total current assets... 4,065,694 4,146,601 52,711,368
----------- ----------- ------------
Fixed assets, net (Note
4)..................... 797,516 847,374 1,081,510
Other assets............ 6,299 6,299 6,299
----------- ----------- ------------
Total assets......... $ 4,869,509 $ 5,000,274 $ 53,799,177
=========== =========== ============
LIABILITIES, MANDATORILY
REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND
STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable....... $ 104,567 $ 113,072 $ 108,792
Accrued expenses....... 50,689 319,687 190,911
Deferred revenue (Note
2).................... -- 488,482 814,373
Contract advances (Note
2).................... 635,970 -- --
----------- ----------- ------------
Total current
liabilities........... 791,226 921,241 1,114,076
----------- ----------- ------------
Commitments and
contingencies (Note 8)
Mandatorily redeemable
convertible preferred
stock (Note 5), $.01
par value; 7,608,511,
9,108,511, 24,108,511
and 0 shares
authorized,
respectively;
6,749,029, 8,249,029,
22,659,093 and 0 shares
issued and outstanding,
respectively; stated at
redemption value....... 9,236,917 13,135,917 64,828,187 $ --
----------- ----------- ------------ ============
Stockholders' equity
(deficit) (Notes 5, 6
and 7):
Preferred stock,
undesignated, $.01 par
value per share;
5,000,000 shares
authorized, no shares
issued or
outstanding........... -- -- -- --
Common stock, $.01 par
value; 100,000,000
shares authorized;
1,900,000, 1,900,000,
1,911,764 and
24,570,857 shares
issued and
outstanding,
respectively.......... 19,000 19,000 19,118 $ 245,709
Additional paid-in
capital............... -- 200,281 50,605,667 115,207,263
Unearned compensation.. -- (808,821) (2,272,569) (2,272,569)
Deficit accumulated
during the development
stage................. (5,177,634) (8,467,344) (60,495,302) (60,495,302)
----------- ----------- ------------ ------------
Total stockholders'
equity (deficit)...... (5,158,634) (9,056,884) (12,143,086) $ 52,685,101
----------- ----------- ------------ ============
Total liabilities,
mandatorily
redeemable
convertible
preferred stock and
stockholders' equity
(deficit)........... $ 4,869,509 $ 5,000,274 $ 53,799,177
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the period
For the period from
from inception inception
(August 16, 1996) Six Months (August 16,
Year Ended December 31, through Ended June 30, 1996) through
------------------------------------- December 31, ------------------------- June 30,
1997 1998 1999 1999 1999 2000 2000
----------- ----------- ----------- ----------------- ----------- ------------ --------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Contract revenue (Note 2).. $ -- $ -- $ 933,512 $ 933,512 $ 46,625 $ 187,131 $ 1,120,643
Costs and expenses:
Costs of contract
revenue............. -- 377,705 354,532 732,237 262,442 88,098 820,335
Costs of production.. -- -- 154,000 154,000 -- 115,936 269,936
Research and
development......... 963,425 1,322,945 2,181,548 4,519,435 421,299 1,186,466 5,705,901
General and
administrative...... 734,618 949,824 1,705,369 3,553,802 836,878 1,432,291 4,986,093
----------- ----------- ----------- ----------- ----------- ------------ ------------
Total costs and
expenses............ 1,698,043 2,650,474 4,395,449 8,959,474 1,520,619 2,822,791 11,782,265
----------- ----------- ----------- ----------- ----------- ------------ ------------
Loss from operations.. (1,698,043) (2,650,474) (3,461,937) (8,025,962) (1,473,994) (2,635,660) (10,661,622)
Interest income
(expense), net....... 28,280 (30,931) 172,227 159,618 77,409 681,856 841,474
----------- ----------- ----------- ----------- ----------- ------------ ------------
Net loss.............. (1,669,763) (2,681,405) (3,289,710) (7,866,344) (1,396,585) (1,953,804) (9,820,148)
Deemed preferred
dividends and
accretion (Note 5)... (160,000) (441,000) (899,000) (1,500,000) (404,500) (51,430,154) (52,930,154)
----------- ----------- ----------- ----------- ----------- ------------ ------------
Net loss attributable
to common
stockholders......... $(1,829,763) $(3,122,405) $(4,188,710) $(9,366,344) $(1,801,085) $(53,383,958) $(62,750,302)
=========== =========== =========== =========== =========== ============ ============
Basic and diluted net
loss per share
attributable to
common stockholders.. $ (0.96) $ (1.64) $ (2.20) $ (4.93) $ (0.95) $ (28.07) $ (33.02)
=========== =========== =========== =========== =========== ============ ============
Shares used in
computing basic and
diluted net loss per
share attributable to
common stockholders.. 1,900,000 1,900,000 1,900,000 1,900,000 1,900,000 1,902,396 1,900,303
=========== =========== =========== =========== =========== ============ ============
Pro forma basic and
diluted net loss per
common share (Note
2)................... $ (0.34) $ (0.12)
=========== ============
Shares used in
computing pro forma
basic and diluted net
loss per common share
(Note 2)............. 9,599,029 16,129,828
=========== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Deficit
Accumulated Total
Common Stock Additional During the Stockholders'
----------------- Paid-In Unearned Development Equity
Shares Amount Capital Compensation Stage (Deficit)
--------- ------- ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Initial capitalization,
(Note 6)............... 1,900,000 $19,000 $ -- $ -- $ -- $ 19,000
Net loss................ -- -- -- -- (225,466) (225,466)
--------- ------- ----------- ----------- ------------ ------------
Balance at December 31,
1996................... 1,900,000 19,000 -- -- (225,466) (206,466)
Accretion............... -- -- -- -- (160,000) (160,000)
Net loss................ -- -- -- -- (1,669,763) (1,669,763)
--------- ------- ----------- ----------- ------------ ------------
Balance at December 31,
1997................... 1,900,000 19,000 -- -- (2,055,229) (2,036,229)
Accretion............... -- -- -- -- (441,000) (441,000)
Net loss................ -- -- -- -- (2,681,405) (2,681,405)
--------- ------- ----------- ----------- ------------ ------------
Balance at December 31,
1998................... 1,900,000 19,000 -- -- (5,177,634) (5,158,634)
Unearned compensation
related to stock option
grants................. -- -- 1,099,281 (1,099,281) -- --
Amortization of unearned
compensation........... -- -- -- 290,460 -- 290,460
Accretion............... -- -- (899,000) -- -- (899,000)
Net loss................ -- -- -- -- (3,289,710) (3,289,710)
--------- ------- ----------- ----------- ------------ ------------
Balance at December 31,
1999................... 1,900,000 19,000 200,281 (808,821) (8,467,344) (9,056,884)
Exercise of stock
options (unaudited).... 11,764 118 1,815 -- -- 1,933
Unearned compensation
related to stock option
grants (unaudited)..... -- -- 1,666,492 (1,666,492) -- --
Amortization of unearned
compensation
(unaudited)............ -- -- -- 202,744 -- 202,744
Deemed preferred
dividends and accretion
(unaudited)............ -- -- 48,718,154 -- (50,074,154) (1,356,000)
Other (unaudited)....... -- -- 18,925 -- -- 18,925
Net loss (unaudited).... -- -- -- -- (1,953,804) (1,953,804)
--------- ------- ----------- ----------- ------------ ------------
Balance at June 30, 2000
(unaudited)............ 1,911,764 $19,118 $50,605,667 $(2,272,569) $(60,495,302) $(12,143,086)
========= ======= =========== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the period from For the period from
inception Six Months inception
Year Ended December 31, (August 16, 1996) Ended June 30, (August 16, 1996)
------------------------------------- through ------------------------- through June 30,
1997 1998 1999 December 31, 1999 1999 2000 2000
----------- ----------- ----------- ------------------- ----------- ------------ -------------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Cash flows from
operating
activities:
Net loss......... $(1,669,763) $(2,681,405) $(3,289,710) $(7,866,344) $(1,396,585) $ (1,953,804) $(9,820,148)
Adjustments to
reconcile net
loss to net cash
used in
operations:
Depreciation and
amortization.... 50,385 231,261 164,588 446,941 77,534 101,419 548,360
Non-cash stock-
based expense... 10,000 59,000 395,460 464,460 227,216 369,780 834,240
Changes in
operating assets
and liabilities:
Inventory....... (51,138) (699,351) (189,508) (942,227) (692,392) (435,452) (1,377,679)
Other current
assets......... (4,209) (74,587) 10,988 (73,665) 50,270 (736,651) (810,316)
Other assets.... (7,737) 1,638 -- (6,299) -- -- (6,299)
Accounts payable
and accrued
expenses....... 89,519 43,187 172,503 334,461 116,455 16,944 351,405
Deferred
revenue........ -- -- 488,482 488,482 434,484 325,891 814,373
Contract
advances....... -- 635,970 (635,970) -- -- -- --
----------- ----------- ----------- ----------- ----------- ------------ -----------
Net cash used
in operating
activities.... (1,582,943) (2,484,287) (2,883,167) (7,154,191) (1,183,018) (2,311,873) (9,466,064)
----------- ----------- ----------- ----------- ----------- ------------ -----------
Cash flows from
investing
activities:
Purchases of
fixed assets.... (631,262) (315,942) (214,446) (1,184,115) (77,760) (335,555) (1,519,670)
Purchases of
marketable
securities...... (2,100,000) (2,750,000) (2,550,000) (7,400,000) (3,900,000) (50,590,806) (57,990,806)
Proceeds from
maturities of
marketable
securities...... -- 2,100,000 2,750,000 4,850,000 2,150,000 4,100,462 8,950,462
----------- ----------- ----------- ----------- ----------- ------------ -----------
Net cash used
in investing
activities.... (2,731,262) (965,942) (14,446) (3,734,115) (1,827,760) (46,825,899) (50,560,014)
----------- ----------- ----------- ----------- ----------- ------------ -----------
Cash flows from
financing
activities:
Repayment of
debt............ (500,000) -- -- -- -- -- --
Proceeds from
issuance of
common stock.... -- -- -- 19,000 -- -- 19,000
Proceeds from
exercise of
stock options... -- -- -- -- -- 1,933 1,933
Proceeds from
issuance of
notes payable
and warrants.... -- 2,000,000 -- 2,000,000 -- -- 2,000,000
Proceeds from
issuance of
mandatorily
redeemable
convertible
preferred stock
and warrants.... 5,411,415 1,038,600 3,000,000 9,450,015 3,000,000 50,038,159 59,488,174
----------- ----------- ----------- ----------- ----------- ------------ -----------
Net cash
provided by
financing
activities.... 4,911,415 3,038,600 3,000,000 11,469,015 3,000,000 50,040,092 61,509,107
----------- ----------- ----------- ----------- ----------- ------------ -----------
Net increase
(decrease) in
cash............. 597,210 (411,629) 102,387 580,709 (10,778) 902,320 1,483,029
Cash at beginning
of period........ 292,741 889,951 478,322 -- 478,322 580,709 --
----------- ----------- ----------- ----------- ----------- ------------ -----------
Cash at end of
period........... $ 889,951 $ 478,322 $ 580,709 $ 580,709 $ 467,544 $ 1,483,029 $ 1,483,029
=========== =========== =========== =========== =========== ============ ===========
Supplemental
disclosure of
cash flow
information:
Cash paid during
the year for:
Interest......... $ 16,837 $ 1,680 $ -- $ 32,873 $ -- $ -- $ 32,873
</TABLE>
Non-cash transactions disclosed in Note 5.
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. Formation and Operations of the Company
Proton Energy Systems, Inc. (the "Company") was incorporated in Delaware on
August 16, 1996 to design, develop and manufacture proton exchange membrane
("PEM") electrochemical products. The Company employs PEM electrochemical
products in hydrogen generation and power generating and storage devices for
use in a variety of commercial applications. The Company manufactures products
for the international industrial gas market and operates in a single segment.
The Company is considered a development stage company, as defined in Statement
of Financial Accounting Standards ("SFAS") No. 7, "Accounting and Reporting by
Development Stage Enterprises," because its principal operations have not yet
commenced.
The Company has funded its operating losses since inception through the
sale of equity securities. Management believes that the existing cash on hand,
including the proceeds from the April 2000 financing (see Note 5), will be
adequate to fund the Company's operations through at least the end of 2000.
2. Summary of Significant Accounting Policies
Unaudited Interim Financial Data
The financial information as of June 30, 2000, for the six-month periods
ended June 30, 1999 and 2000, and for the period from inception (August 16,
1996) through June 30, 2000 is unaudited. In the opinion of management, the
interim financial information includes all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of the results for
the interim periods. The results of operations for the six months ended June
30, 2000 are not necessarily indicative of the results to be expected for any
future period.
Pro Forma Data (unaudited)
If the offering contemplated in this prospectus is consummated, all of the
mandatorily redeemable convertible preferred stock shares outstanding as of
June 30, 2000 will automatically convert into 22,659,093 shares of common
stock (the "Common Stock"). The unaudited pro forma presentation of the June
30, 2000 mandatorily redeemable convertible preferred stock and stockholders'
equity (deficit) has been prepared assuming such conversion. Pro forma basic
and diluted net loss per common share have been computed assuming the
conversion of all outstanding shares of mandatorily redeemable preferred stock
into common stock as of the beginning of the periods presented or as of the
date of issuance, if later.
Net Loss Per Share
Net loss per share has been computed by dividing the net loss attributable
to common stockholders by the weighted average common shares outstanding. No
effect has been given to the exercise of common stock options, stock warrants,
convertible notes and redeemable convertible preferred stock, since the effect
would be antidilutive for all reporting periods. All deemed preferred stock
dividends accrued during the respective periods were added back in computing
pro forma basic and diluted net loss attributable per common share.
The following table sets forth the computation of the unaudited pro forma
basic and diluted loss attributable per common share for the year ended
December 31, 1999 and for the six-month period ended June 30, 2000 assuming
the automatic conversion of all shares of mandatorily redeemable convertible
preferred stock
F-7
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
outstanding at December 31, 1999 and June 30, 2000 into 7,699,029 and
22,659,093 (unaudited) shares, respectively, of the Company's Common Stock
effective upon the closing of a Qualified Offering (see Note 5) as if the
conversion had occurred at the beginning of the period or at date of issuance
(if later):
<TABLE>
<CAPTION>
Year Ended Six Months
December Ended
31, June 30,
1999 2000
----------- ------------
(unaudited) (unaudited)
<S> <C> <C>
Numerator:
Net loss attributable to common stockholders.... $(4,188,710) $(53,383,958)
Plus: deemed preferred dividends and accretion.. 899,000 51,430,154
----------- ------------
Pro forma net loss.............................. $(3,289,710) $ (1,953,804)
=========== ============
Denominator:
Weighted average common stock outstanding....... 1,900,000 1,902,396
Pro forma adjustment to reflect weighted average
effect of assumed conversion of outstanding
mandatorily redeemable preferred stock into
common stock................................... 7,699,029 14,227,432
----------- ------------
Weighted average shares used to compute pro
forma basic and diluted net loss per common
share.......................................... 9,599,029 16,129,828
=========== ============
Pro forma basic and diluted net loss per common
share.......................................... $ (0.34) $ (0.12)
=========== ============
</TABLE>
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturity dates of three months or less as of the purchase date to be cash
equivalents. The Company invests excess cash primarily in a money market
account at a major banking institution, which is subject to credit and market
risk.
Marketable Securities
The Company classifies its entire investment portfolio as available for
sale as defined in SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities." As of December 31, 1998 and December 31, 1999, the
Company's investment portfolio consisted of repurchase agreements
collateralized by U.S. government securities and held by a major banking
institution. The outstanding repurchase agreements had weighted average
maturities of 191 and 210 days, respectively. As of June 30, 2000, the
Company's investment portfolio consisted of U.S. government securities held by
two major banking institutions, as follows (unaudited):
<TABLE>
<CAPTION>
Investments in marketable securities that mature in: Costs
---------------------------------------------------- -----------
<S> <C>
Less than one year................................................ $19,175,000
One to five years................................................. 29,865,344
-----------
Total........................................................... $49,040,344
===========
</TABLE>
The cost basis, using the specific identification method, approximates fair
value and no unrealized gain or loss has been recognized.
F-8
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
Inventory
Inventory is recorded at the lower of cost or market value. Cost is
determined by the first-in, first-out method.
Fixed Assets
Fixed assets are stated at cost and are depreciated using the straight-line
method over the following estimated useful lives by asset category.
<TABLE>
<CAPTION>
Asset Category Estimated Useful Life
------------------------------ -----------------------------------
<S> <C>
Machinery and equipment 7 years
Leasehold improvements Shorter of life of lease or 7 years
Office furniture, fixtures and
equipment 3-5 years
</TABLE>
When assets are sold or retired, the related cost and accumulated
depreciation are removed from their respective accounts and any resulting gain
or loss is include in income. The Company periodically reviews the carrying
value of its fixed assets to assess recoverability based upon the expectation
of non-discounted future cash flows.
Revenue Recognition
During 1999 and the six months ended June 30, 2000, the Company began
delivering equipment units under commercial agreements. As of December 31, 1999
and June 30, 2000, the Company has deferred product revenue of $488,482 and
$814,373 (unaudited), respectively, on delivered units until such time that the
Company has adequate information to estimate warranty obligations. Product
revenue will be recognized once such estimates of warranty obligations can be
made.
The Company receives payments under customer sponsored research and
development contracts. For those research and development contracts which
require the Company to meet specific obligations as defined in the agreements
(including delivery and acceptance of units), amounts advanced pursuant to the
contracts are recognized as liabilities until such obligations are met. Once
the obligations are met, the amounts are recognized as contract revenue. For
those research and development contracts which do not require the Company to
meet specific obligations, the Company recognizes customer funding as contract
revenue utilizing the percentage of completion method by the relationship of
costs incurred to total estimated contract costs. As of December 31, 1999 and
June 30, 2000 (unaudited), the Company had one research and development
contract in place. The research and development contract in place was for
partial funding for regenerative fuel cell systems development and is scheduled
to be completed by the fourth quarter of 2001.
Research and Development
Research and development costs are expensed as incurred.
Stock Compensation
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for its stock-based
compensation plans. Under APB Opinion No. 25, compensation expense is
recognized to the extent that the fair market value of the underlying stock on
the date of grant exceeds the exercise price of the employee stock option or
stock award. The Company has adopted the disclosure only provisions of SFAS No.
123, "Accounting for Stock-Based Compensation". The Company will continue to
account for its stock option plans in accordance with the provisions of APB
Opinion No. 25.
Warranty Costs
The Company's warranty policy is limited to replacement parts and services
and generally expires one year from date of shipment. Estimated future warranty
obligations will be provided for as costs of production in the period in which
the related revenue is recognized.
F-9
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
Income Taxes
The Company uses the liability method of accounting for income taxes. Under
this method, deferred tax assets and liabilities are recognized for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax basis of assets and liabilities. A valuation allowance is
established against net deferred tax assets if, based on the weight of
available evidence, it is more likely than not that some or all of the net
deferred tax assets will not be realized.
Concentration of Risk
Concentrations of credit risk exist with respect to cash and cash
equivalents, investments and vendors. The Company maintains its cash and cash
equivalents and investments with high-quality financial institutions. In
addition, certain critical product components are only available from one
source for which the source maintains proprietary rights.
For the year ended December 31, 1999, 60% of contract revenue was from
government-sponsored agencies. For the six-month periods ended June 30, 1999
(unaudited) and 2000 (unaudited), 100% of contract revenue was from
government-sponsored agencies.
Comprehensive Income (Loss)
Comprehensive income is defined as changes in equity other than
transactions resulting from investments by owners and distributions to owners.
The Company's comprehensive loss for the years ended December 31, 1997, 1998
and 1999, and for the six-month periods ended June 30, 1999 (unaudited) and
2000 (unaudited) was the same as its reported net loss.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues
clarifies the following: the definition of an employee for purposes of
applying APB Opinion No. 25; the criteria for determining whether a plan
qualifies as a non-compensatory plan; the accounting consequence of various
modifications to the terms of previously fixed stock options or awards; and
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 is effective July 1, 2000, but certain conclusions in FIN
44 cover specific events that occurred after either December 15, 1998 or
January 12, 2000. The Company does not expect the application of FIN 44 to
have a material impact on the Company's financial position or results of
operations.
In November 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 100, Restructuring and Impairment
Charges ("SAB 100"). SAB 100 expresses the views of the SEC staff regarding
the accounting for and disclosure of certain expenses not commonly reported in
connection with exit activities and business combinations. In December 1999,
the SEC issued SAB No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). SAB 101, as amended by SAB No. 101A and SAB No. 101B, provides
guidance on the measurement and timing of revenue recognition in financial
statements of public companies. The Company does not expect the provisions of
SAB 100 or 101 to have a material impact on its financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which
establishes accounting and reporting standards for derivative instruments and
for hedging activities. This statement requires recognition of all derivatives
at fair value in the financial statements. SFAS No. 137 defers implementation
of SFAS No. 133 until fiscal years beginning after June 15, 2000. The Company
has reviewed SFAS No. 133 and believes that upon implementation the standard
will not have a material impact on its financial statements.
F-10
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. Inventory
The inventory balance consists of the following components:
<TABLE>
<CAPTION>
December 31,
----------------- June 30,
1998 1999 2000
-------- -------- -----------
(unaudited)
<S> <C> <C> <C>
Raw materials and components................... $167,878 $345,071 $ 392,507
Work-in-progress............................... 584,841 98,852 162,633
Finished goods................................. -- 498,304 822,539
-------- -------- ----------
$752,719 $942,227 $1,377,679
======== ======== ==========
</TABLE>
4. Fixed Assets
<TABLE>
<CAPTION>
December 31,
--------------------- June 30,
1998 1999 2000
--------- ---------- -----------
(unaudited)
<S> <C> <C> <C>
Machinery and equipment................. $ 530,595 $ 657,619 $ 744,632
Leasehold improvements.................. 249,492 267,443 280,705
Office, furniture, fixtures and
equipment.............................. 189,582 258,277 493,557
--------- ---------- ----------
969,669 1,183,339 1,518,894
Less accumulated depreciation........... (172,153) (335,965) (437,384)
--------- ---------- ----------
$ 797,516 $ 847,374 $1,081,510
========= ========== ==========
</TABLE>
Depreciation expense was $50,385, $121,061, $164,588, $77,534 (unaudited)
and $101,419 (unaudited) for the years ended December 31, 1997, 1998 and 1999
and the six-month periods ended June 30, 1999 and 2000, respectively.
5. Notes Payable and Mandatorily Redeemable Convertible Preferred Stock
Since inception, the Company has issued Series A, A-1, B, B-1 and C
Convertible Preferred Stock ("Preferred Stock").
In May and July 1997, the Company issued an aggregate of 2,908,511 shares
of Series A Preferred Stock at $1.00 per share for $2,908,511. In December
1997, the Company issued 2,275,367 shares of Series A-1 Preferred Stock at
$1.10 per share for $2,502,904. In July 1998, the Company issued 20,000 shares
of Series A-1 Preferred Stock, valued at $24,000, to service providers.
In August 1998, the Company issued notes payable, accruing interest at 8%,
to existing preferred stockholders of the Company totaling $2,000,000. The
notes and any accrued but unpaid interest were convertible into Series B
Preferred Stock shares at a price of $2.00 per share upon a subsequent closing
of Series B Preferred Stock financing by the Company. The maturity date of the
notes was August 31, 1999. The notes payable were issued with detachable
warrants to acquire 341,959 shares of Series B Preferred Stock at $2.00 per
share with an expiration date of August 2003 or earlier upon occurrence of
certain liquidity events, including a public offering resulting in gross
proceeds of at least $15 million and with an offering price per share of at
least $10 (a "Qualified Offering"), or sale or liquidation of the Company. In
connection with a liquidity event, and in lieu of cash payment, a warrant
holder may convert all but not less than all warrants into a number of shares
of preferred stock calculated pursuant to a formula defined in the agreement.
The warrants were valued at $331,058 and netted against the carrying value of
the notes payable.
F-11
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
In December 1998, the Company issued 1,545,151 shares of Series B Preferred
Stock. Of these shares, 1,025,851 shares were issued upon conversion of the
notes payable and accrued interest of $1,830,844. Of the remaining 519,300
shares, which were issued at $2.00 per share, 500,000 shares were issued with
100,000 warrants to acquire Series B Preferred Stock with the same
characteristics and expiration date as the warrants issued in August 1998.
In May 1999, the Company issued 1,500,000 shares of Series B-1 Preferred
Stock at $2.00 per share for $3,000,000.
In April 2000, the Company issued 14,306,901 shares of Series C Preferred
Stock for $3.50 per share for gross proceeds of approximately $50 million
(unaudited). Concurrent with the issuance of the Series C Preferred Stock, the
Company recorded a beneficial conversion charge. The beneficial conversion
charge was calculated in accordance with EITF 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios," and was the difference between the Series C
Preferred Stock price and the deemed fair market value of the Company's common
stock into which the Series C Preferred Stock was immediately convertible,
limited to the total Series C Preferred Stock proceeds. Accordingly, a deemed
preferred dividend of approximately $50 million (unaudited) as of the issuance
date has been recognized as a charge to accumulated deficit and net loss
attributable to common stockholders, and as an increase to additional paid-in
capital.
All of the series of Preferred Stock have similar conversion rights, voting
rights, dividend rights, liquidation preferences and redemption rights. At the
option of the Preferred Stockholders, shares are convertible one for one into
Common Stock, subject to adjustment for dilutive events and issues. The
Preferred Stock shall automatically convert into shares of Common Stock upon
the closing of a Qualified Offering or upon the approval of the holders of at
least two-thirds of the outstanding Preferred Stock. The Preferred Stock
contains voting rights equivalent to the number of whole shares of common
stock into which it is convertible. In addition, the Preferred Stock has
liquidation preferences over the common stockholders. The liquidation
preferences for the Series A, A-1, B and B-1 are $1.00, $1.10, $2.00 and
$2.00, respectively.
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, or a change in control which is deemed to be
a liquidation, the holders of Preferred Stock shall be entitled to receive,
prior and in preference to any distribution of any assets of the Company to
the holders of common stock or any other class or series of stock ranking in
liquidation junior to the Preferred Stock, an amount per share equal to the
greater of (i) the holder's liquidation preference (as adjusted for any stock
dividends, splits, combinations or other similar recapitalization affecting
such shares) or (ii) the amount that would have otherwise been payable upon
the conversion of the shares of Preferred Stock into shares of common stock at
the then effective conversion rate, as defined.
The holders of shares of Preferred Stock are entitled to receive, prior to
any cash dividend on any other shares of capital stock of the Company, non-
cumulative dividends at the rate of 8% of the liquidation preference per
annum. The right to dividends on Preferred Stock is non-cumulative such that
the holders are not entitled to receive annual dividends for any year in which
the net income of the Company is not at least equal to the aggregate amount
required to pay the dividends. Holders of Preferred Stock have the right, on
December 31, 2002, December 31, 2003 and December 31, 2004 and at any time
after such dates, to compel the Company to redeem 33 1/3%, 50% and 100%,
respectively, of the shares of Preferred Stock. The price of redemption will
be equal to the original purchase price plus 8% per annum (compounded
annually) for each year in which dividends are not declared and paid. Such
dividends are being accreted annually to the carrying value of the Preferred
Stock from additional paid-in capital or accumulated deficit if additional
paid-in capital is not available.
Included in the Preferred Stock outstanding at December 31, 1999 and June
30, 2000 are 2,913,683 shares of Preferred Stock issued to Connecticut
Innovations, Inc. ("CII") and Connecticut Innovations/Webster LLC for
$7,142,951. As a requirement of the funding, the Company must maintain its
principal place of business, base a majority of its employees and conduct the
majority of its operations in Connecticut. If the Company fails to maintain
its Connecticut presence, CII has the right to redeem its shares at the
greater of the original purchase
F-12
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
price plus a 25% annual compounded rate of return or the fair market value of
the shares. The CII redemption right terminates upon the earliest to occur of
(i) the closing of a public offering, (ii) the time at which CII's shares are
eligible to be sold under Rule 144(k) under the Securities Act of 1933, as
amended, or (iii) the closing of certain private financings of at least
$5,000,000 in which CII does not participate. CII's redemption rights are also
available to other Preferred Stockholders under certain circumstances.
The redemption value of the convertible Preferred Stock is as follows:
<TABLE>
<CAPTION>
December 31,
---------------------- June 30,
1998 1999 2000
---------- ----------- -----------
(unaudited)
<S> <C> <C> <C>
Series A, $0.01 par value, 2,908,511
shares authorized, issued and
outstanding............................. $3,280,511 $ 3,550,511 $ 3,692,511
Series A-1, $0.01 par value, 2,500,000
shares authorized; 2,398,530 shares
issued and outstanding.................. 2,746,904 2,964,904 3,381,015
Series B, $0.01 par value, 2,200,000
shares authorized; 1,545,151 shares
issued and outstanding.................. 3,209,502 3,470,502 3,604,502
Series B-1, $0.01 par value, 1,500,000
shares authorized, issued and
outstanding............................. -- 3,150,000 3,276,000
Series C, $0.01 par value, 15,000,000
shares authorized; 14,306,901 issued and
outstanding............................. -- -- 50,874,159
---------- ----------- -----------
$9,236,917 $13,135,917 $64,828,187
========== =========== ===========
</TABLE>
In May 2000, the Company issued 103,163 shares of Series A-1 Preferred
Stock to a service provider. Total shares reserved under this obligation as of
December 31, 1998 and 1999 and March 31, 2000, of which none had been issued,
were 37,792, 71,322 and 103,163, respectively. The Company had accrued
expenses related to this obligation based on the fair value of the Preferred
Stock at the time the obligation was incurred. At December 31, 1998 and 1999
and March 31, 2000, the total accrued expense was approximately $45,000,
$150,000 and $298,000, respectively.
In June 2000, the Company created a class of 5,000,000 authorized but
undesignated shares of preferred stock, par value $.01.
6. Common Stock and Common Stock Warrants
The Company has authorized 100,000,000 shares of common stock, par value
$.01. The Company issued 1,900,000 shares of common stock upon incorporation.
Of the 1,900,000 issued shares, 1,400,000 shares were issued to the Company's
founders, subject to a vesting schedule. At December 31, 1999, 1,120,000
shares were vested.
In connection with a February 1998 customer sponsored research and
development contract, the Company issued a warrant to purchase 50,000 shares
of the Company's common stock at a purchase price of $1.10 per share. At
December 31, 1999, the warrant was fully exercisable and expires in February
2008.
7. Stock Option Plan
Under the 1996 Stock Option Plan (the "1996 Plan"), the Company has
reserved 5,700,000 shares of common stock for issuance of non-qualified and
incentive stock options to its employees, officers, directors, consultants and
advisors. Options are generally granted at the fair market value of the common
stock at the time of grant, as determined by the Board of Directors. Options
granted under the 1996 Plan have a vesting period as determined by the Board
of Directors, generally vesting ratably over four years. The stock options are
exercisable over a period of ten years from the date of grant.
In June 2000, the Company adopted the 2000 Stock Incentive Plan, which
provides for grants of non-qualified and incentive stock options, restricted
stock awards and other stock-based awards to its employees, officers,
directors, consultants and advisors. The Company has reserved a total of
7,700,000 shares of common stock for issuance under this plan and the
Company's 1996 Stock Option Plan. The 2000 Stock Incentive Plan provides that
in the event of a merger or other acquisition event, the Board of Directors
must provide that all outstanding options
F-13
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
or other stock-based awards under the plan be assumed or substituted for by
the acquiror. If any of these events constitutes a change of control, and if,
within one year of the change of control, the optionee's employment is
terminated without cause or the optionee leaves for good reason, then the
assumed or substituted options will be immediately exercisable in full. In the
event of a liquidation or dissolution, all options will become immediately
exercisable ten days prior to such event and will terminate upon the
occurrence of such event.
In June 2000, the Company adopted the 2000 Employee Stock Purchase Plan,
which permits eligible employees of the Company to purchase shares of common
stock pursuant to payroll deductions at a price equal to 85% of the fair
market value of the common stock. The Company has reserved an aggregate of
250,000 shares of Common Stock for issuance under this plan.
Also in June 2000, the Company approved a resolution inserting change of
control provisions in the Company's 1996 Plan similar to those contained in
the 2000 Stock Incentive Plan.
A summary of stock option activity for the years ended December 31, 1997,
1998 and 1999 and for the six months ended June 30, 2000 (unaudited) under the
Plan is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price
--------- --------
<S> <C> <C>
Outstanding at January 1, 1997......................... 55,000 $0.10
Granted................................................ 273,000 0.13
---------
Outstanding at December 31, 1997 (18,000 shares
exercisable).......................................... 328,000 0.13
Granted................................................ 46,201 0.15
---------
Outstanding at December 31, 1998 (107,050 shares
exercisable).......................................... 374,201 0.13
Granted................................................ 667,040 0.28
Cancelled or forfeited................................. (5,000) 0.35
---------
Outstanding at December 31, 1999 (246,225 shares
exercisable).......................................... 1,036,241 0.23
Granted (unaudited).................................... 451,918 4.50
Exercised (unaudited).................................. (11,764) 0.16
Cancelled or forfeited (unaudited)..................... (3,500) 0.39
---------
Outstanding at June 30, 2000 (381,075 shares
exercisable) (unaudited).............................. 1,472,895 1.56
=========
</TABLE>
All options granted during 1999 and during the six-month period ended June
30, 2000, were granted with exercise prices below fair market value. As a
result, the Company recorded unearned compensation of $1,099,281 and
$1,666,492 (unaudited), respectively. The Company recognizes this cost over
the vesting period and has recognized amortization expense of $290,460,
$167,216 (unaudited) and $202,744 (unaudited) during the year ended December
31, 1999 and the six-month periods ended June 30, 1999 and 2000, respectively.
The following table summarizes additional information about stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------ ------------------------
Weighted
Average
Number Remaining Weighted Number Weighted
Outstanding Contractual Average Exercisable Average
at December 31, Life Exercise at December 31, Exercise
Range of Exercise Prices 1999 (years) Price 1999 Price
------------------------ --------------- ----------- -------- --------------- --------
<S> <C> <C> <C> <C> <C>
$.10-$.15............... 604,901 7.98 $0.14 246,225 $0.13
.16- .35............... 420,340 9.26 0.35 -- --
.36- .50............... 11,000 10.00 0.50 -- --
--------- -------
1,036,241 8.59 $0.23 246,225 $0.13
========= =======
</TABLE>
F-14
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
The fair value of each option grant is estimated on the date of grant using
the minimum value option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Risk free interest rate.................. 5.73%-6.45% 5.38%-5.55% 4.82%-6.48%
Expected dividend yield.................. None None None
Expected life of option.................. 7 years 7 years 6 years
Expected volatility...................... 0% 0% 0%
</TABLE>
The weighted average fair value of options granted during 1997, 1998 and
1999 was $0.13, $0.15 and $1.81, respectively.
If compensation expense had been recognized based on the fair value of
options at their grant date, in accordance with SFAS No. 123, "Accounting for
Stock-Based Compensation," the net loss for the years ended December 31, 1997,
1998 and 1999 would have been as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Net loss attributable to common
stockholders:
As reported....................... $(1,829,763) $(3,122,405) $(4,188,710)
Pro forma under SFAS 123.......... (1,832,467) (3,126,505) (4,439,118)
Basic and diluted net loss per share
attributable to common stockholders
As reported....................... $ (0.96) $ (1.64) $ (2.20)
Pro forma under SFAS 123.......... (0.96) (1.65) (2.34)
</TABLE>
The above pro forma results are not necessarily indicative of future
results.
8. Commitments and Contingencies
Development, Marketing and Distribution Agreement
In November 1999, the Company entered into an agreement with a distributor
to develop, market and distribute hydrogen generators to be used solely in
laboratory applications. This agreement grants the distributor worldwide
exclusivity to the commercial sale of this product during the fifteen-year
term of the contract as long as the distributor meets minimum purchases, as
defined in the agreement. The Company retains the right to modify the contract
once annually by providing six months notice. In the six-month period ended
June 30, 2000, the Company recorded a loss of approximately $55,000
(unaudited) for orders received under this contract. Any future loss
recognition is contingent on the distributor placing additional orders and the
Company's cost per unit exceeding the related sale price per unit.
Operating Leases
At December 31, 1999, the Company was committed under an operating lease
for its facilities extending through June 2001. The Company also rents certain
office equipment under operating leases.
Rent expense under the non-cancelable operating leases was approximately
$57,000, $114,000 and $118,000 for the years ended December 31, 1997, 1998 and
1999, respectively, and was $61,298 (unaudited) and $92,647 (unaudited) for
the six months ended June 30, 1999 and 2000, respectively.
Minimum lease payments under the noncancelable leases at December 31, 1999
are as follows:
<TABLE>
<S> <C>
2000............................................................... $137,668
2001............................................................... 67,834
--------
Total minimum obligations........................................ $205,502
========
</TABLE>
F-15
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS--(Continued)
9. Income Taxes
The Company's gross deferred tax assets and liabilities were as follows:
<TABLE>
<CAPTION>
December 31,
------------------------
1998 1999
----------- -----------
<S> <C> <C>
Gross deferred tax assets:
Net operating loss carryforwards............... $ 1,841,000 $ 2,885,000
Nondeductible expenses......................... -- 136,000
Research and development tax credits........... 6,000 15,000
----------- -----------
1,847,000 3,036,000
----------- -----------
Gross deferred tax liabilities:
Depreciation..................................... 60,000 86,000
----------- -----------
Net deferred tax asset........................... 1,787,000 2,950,000
Less: valuation allowance.......................... (1,787,000) (2,950,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
At December 31, 1999, the Company had approximately $7.3 million of federal
net operating loss carryforwards that expire beginning in the year 2011
through 2019, approximately $7.3 million of state net operating loss
carryforwards that expire beginning in the year 2001 through 2019 and state
research and development tax credit carryforwards of approximately $15,000
that expire beginning in the year 2001 through 2019.
The amount of the net operating loss and research and development tax
credit carryforwards that may be utilized annually to offset future taxable
income and tax liability will be limited as a result of certain ownership
changes pursuant to Section 382 of the Internal Revenue Code.
10. 401(k) Plan
In 1997, the Company established a 401(k) plan covering substantially all
of its employees, subject to certain eligibility requirements. Participants
have the option of contributing up to 15% of their annual compensation.
F-16
<PAGE>
[LOGO OF PROTON ENERGY SYSTEMS]
