<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
________ TO _________
Commission File Number: 000-31533
PROTON ENERGY SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
50 INWOOD ROAD, ROCKY HILL, CT 06067
(Address of registrant's principal executive office)
(860) 571-6533
(Registrant's telephone number, including area code)
DELAWARE 06-1461988
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [ X ]
--- ---
The number of shares of common stock outstanding as of November 13, 2000 was
33,082,093 with a par value of $.01 per share.
<PAGE>
PROTON ENERGY SYSTEMS, INC.
INDEX to FORM 10-Q
<TABLE>
<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1 - Financial Statements
Condensed Balance Sheets - December 31, 1999, September 30, 2000 (unaudited)
and Pro Forma September 30, 2000 (unaudited) 1
Condensed Statements of Operations - Three Month and Nine Month Periods
ended September 30, 1999 (unaudited) and September 30, 2000 (unaudited)
and Cumulative Amounts from Inception through September 30, 2000 (unaudited) 2
Statement of Changes in Stockholders' Equity (Deficit)
from Inception through September 30, 2000 (unaudited). 3
Condensed Statements of Cash Flows - Nine Month Periods ended September 30,
1999 (unaudited) and September 30, 2000 (unaudited) and Cumulative Amounts
from Inception through September 30, 2000 (unaudited). 4
Notes to Condensed Financial Statements 5-7
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 7-19
PART II. OTHER INFORMATION
Item 1 - Legal Proceedings 19
Item 2 - Changes in Securities and Use of Proceeds 19
Item 3 - Defaults upon Senior Securities 19
Item 4 - Submission of Matters to a Vote of Security Holders 19
Item 5 - Other Information 20
Item 6 - Exhibits and Reports on Form 8-K 20
Signature 21
</TABLE>
<PAGE>
Part I - FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 2000
December 31, September 30, Pro Forma Balance Sheet
1999 2000 (Note 2)
------------------ ------------------ -------------------------
ASSETS (Unaudited) (Unaudited)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 580,709 $ 1,471,925 $ 112,732,283
Marketable securities 2,550,000 47,717,208 47,717,208
Inventories and deferred costs (Note 3) 942,227 1,654,191 1,654,191
Other current assets 73,665 2,219,558 873,832
------------------ ------------------ -------------------------
Total current assets 4,146,601 53,062,882 162,977,514
------------------ ------------------ -------------------------
Fixed assets, net 847,374 1,112,460 1,112,460
Other assets 6,299 6,299 6,299
------------------ ------------------ -------------------------
Total assets $ 5,000,274 $ 54,181,641 $ 164,096,273
================== ================== =========================
LIABILITIES, MANDATORILY REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 113,072 $ 207,602 $ 207,602
Accrued expenses 319,687 352,960 352,960
Deferred revenue/customer advances 488,482 979,883 979,883
Deferred offering costs - 975,000 975,000
------------------ ------------------ -------------------------
Total current liabilities 921,241 2,515,445 2,515,445
------------------ ------------------ -------------------------
Commitments and contingencies (Note 7)
Mandatorily redeemable convertible preferred stock
(Note 5), $.01 par value ; 9,108,511, 22,659,093
and 0 shares authorized, respectively; 8,249,029,
22,659,093 and 0 shares issued and outstanding,
respectively; stated at redemption value 13,135,917 66,089,187 -
------------------ ------------------ -------------------------
Stockholders' equity (deficit) (Note 5):
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, 1,948,311 and 32,032,093
shares issued and outstanding, respectively 19,000 19,483 320,321
Additional paid-in capital 200,281 50,079,341 225,782,322
Unearned compensation (808,821) (2,817,265) (2,817,265)
Accumulated other comprehensive loss - (194,974) (194,974)
Deficit accumulated during the development stage (8,467,344) (61,509,576) (61,509,576)
------------------ ------------------ -------------------------
Total stockholders' equity (deficit) (9,056,884) (14,422,991) 161,580,828
------------------ ------------------ -------------------------
Total liabilities, mandatorily redeemable
convertible preferred stock and stockholders' ------------------ ------------------ -------------------------
equity (deficit) $ 5,000,274 $ 54,181,641 $ 164,096,273
================== ================== =========================
</TABLE>
The accompanying notes are an integral part of the financial statements.
1
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
For the period
from
inception
(August 16,
Three Months Ended September 30, Nine Months Ended September 30, 1996) through
----------------------------------- --------------------------------- September 30,
1999 2000 1999 2000 2000
----------------------------------- --------------------------------- ------------------
<S> <C> <C> <C> <C> <C>
Contract revenue $ 33,312 $ 350,125 $ 79,937 $ 537,256 $ 1,470,768
Costs and expenses:
Costs of contract revenue 56,270 236,502 318,713 324,600 1,056,837
Costs of production - 14,917 - 130,853 284,853
Research and development 415,021 891,229 836,318 2,077,692 6,597,130
General and administrative 462,120 949,477 1,299,000 2,381,771 5,935,570
----------------------------------- --------------------------------- ------------------
Total costs and expenses 933,411 2,092,125 2,454,031 4,914,916 13,874,390
----------------------------------- --------------------------------- ------------------
Loss from operations (900,099) (1,742,000) (2,374,094) (4,377,660) (12,403,622)
Interest income 51,247 727,726 128,657 1,409,582 1,569,200
----------------------------------- --------------------------------- ------------------
Net loss (848,852) (1,014,274) (2,245,437) (2,968,078) (10,834,422)
Deemed preferred dividends and
accretion (247,250) (1,261,000) (651,750) (52,691,154) (54,191,154)
----------------------------------- --------------------------------- ------------------
Net loss attributable to common
stockholders (1,096,102) (2,275,274) (2,897,187) (55,659,232) (65,025,576)
=================================== ================================= ==================
Basic and diluted net loss per
share attributable to common
stockholders $ (0.58) $ (1.18) $ (1.52) $ (29.16) $ (34.20)
=================================== ================================= ==================
Shares used in computing basic
and diluted net loss per share
attributable to common
stockholders 1,900,000 1,920,772 1,900,000 1,908,566 1,901,589
=================================== ================================= ==================
</TABLE>
The accompanying notes are an integral part of the financial statements.
2
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Common Stock Additional
-------------------------- Paid-In Unearned
Shares Amount Capital Compensation
---------------------------------------------------------
<S> <C> <C> <C> <C>
Inititial capitalization 1,900,000 $ 19,000 $ - $ -
Net loss
------------ ----------- -------------- ------------
Balance at December 31, 1996 1,900,000 19,000 - -
Accretion - - - -
Net loss - - - -
------------ ----------- -------------- ------------
Balance at December 31, 1997 1,900,000 19,000 - -
Accretion - - - -
Net loss - - - -
------------ ----------- -------------- ------------
Balance at December 31, 1998 1,900,000 19,000 - -
Unearned compensation related to
stock option grants - - 1,099,281 (1,099,281)
Amortization of unearned
compensation - - - 290,460
Accretion - - (899,000) -
Net loss - - - -
------------ ----------- -------------- ------------
Balance at December 31, 1999 1,900,000 19,000 200,281 (808,821)
Exercises of stock
options (unaudited) 48,311 483 7,923 -
Unearned compensation related to
stock option grants (unaudited) - - 2,395,057 (2,395,057)
Amortization of unearned
compensation (unaudited) - - - 386,613
Deemed preferred dividends and
accretion (unaudited) - - 47,457,155 -
Other (unaudited) 18,925
Change in unrealized gain (loss)
on marketable Securities (unaudited)
(Note 2)
Net loss (unaudited)
------------ ----------- -------------- ------------
Balance at September 30, 2000 1,948,311 $ 19,483 $ 50,079,341 $ (2,817,265)
============ =========== ============== ============
<CAPTION>
Deficit
Accumulated Accumulated Total
Other During the Stockholders'
Comprehensive Development Equity
Income (loss) Stage (Deficit)
----------------------------------------------
<S> <C> <C> <C>
Inititial capitalization $ - $ - $ 19,000
Net loss (225,466) (225,466)
------------- -------------- --------------
Balance at December 31, 1996 - (225,466) (206,466)
Accretion - (160,000) (160,000)
Net loss - (1,669,763) (1,669,763)
------------- -------------- --------------
Balance at December 31, 1997 - (2,055,229) (2,036,229)
Accretion - (441,000) (441,000)
Net loss - (2,681,405) (2,681,405)
------------- -------------- --------------
Balance at December 31, 1998 - (5,177,634) (5,158,634)
Unearned compensation related to -
stock option grants - - -
Amortization of unearned -
compensation - - 290,460
Accretion - - (899,000)
Net loss - (3,289,710) (3,289,710)
------------- -------------- --------------
Balance at December 31, 1999 - (8,467,344) (9,056,884)
Exercises of stock options (unaudited) - - 8,406
Unearned compensation related to
stock option grants (unaudited) - - -
Amortization of unearned
compensation (unaudited) - - 386,613
Deemed preferred dividends and
accretion (unaudited) - (50,074,154) (2,616,999)
Other (unaudited) 18,925
Change in unrealized gain (loss)
on marketable Securities (Note 2)
(unaudited) (194,974) (194,974)
Net loss (unaudited) (2,968,078) (2,968,078)
------------- -------------- --------------
Balance at September 30, 2000 $ (194,974) $ (61,509,576) $ (14,422,991)
(unaudited) ============= ============== ==============
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
PROTON ENERGY SYSTEMS, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the period
from
inception
(August 16,
Nine Months Ended September 30, 1996) through
-------------------------------- September 30,
1999 2000 2000
--------------- -------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (2,245,437) $ (2,968,078) $ (10,834,422)
Adjustments to reconcile net loss to net
cash used in operations:
Depreciation and amortization 118,949 210,907 657,848
Non-cash stock-based expense 314,418 553,650 1,018,110
Changes in operating assets and
liabilities:
Inventory (820,357) (711,964) (1,654,191)
Other current assets 39,494 (800,167) (873,832)
Other assets (970) - (6,299)
Accounts payable and accrued
expenses 58,584 277,803 612,264
Deferred revenue and contract advances 496,185 491,401 979,883
-------------------------------- ---------------
Net cash used in operating
activities (2,039,134) (2,946,448) (10,100,639)
-------------------------------- ---------------
Cash flows from investing activities:
Purchases of fixed assets (161,020) (475,993) (1,660,108)
Purchases of marketable securities (1,900,000) (51,048,812) (58,448,812)
Proceeds from maturities of marketable
securities 1,050,000 5,686,630 10,536,630
-------------------------------- ---------------
Net cash used in investing
activities (1,011,020) (45,838,175) (49,572,290)
-------------------------------- ---------------
Cash flows from financing activities
Proceeds from issuance of common
stock - - 19,000
Proceeds from exercise of stock
options - 8,406 8,406
Proceeds from issuance of notes payable
and warrants - - 2,000,000
Proceeds from issuance of mandatorily
redeemable convertible preferred stock
and warrants 3,000,000 50,038,159 59,488,174
Payment of initial public offering costs - (370,726) (370,726)
-------------------------------- ---------------
Net cash provided by financing
activities 3,000,000 49,675,839 61,144,854
-------------------------------- ---------------
Net (decrease) increase in cash (50,154) 891,216 1,471,925
Cash at beginning of period 478,322 580,709 0
-------------------------------- ---------------
Cash at end of period $ 428,168 $1,471,925 $ 1,471,925
================================ ===============
Supplemental disclosure of cash flow
information:
Cash paid during the period for:
Interest - - $ 32,873
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
PROTON ENERGY SYSTEMS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
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.
2. BASIS OF PRESENTATION
The financial information as of September 30, 2000, for the three and nine
month periods ended September 30, 1999 and 2000, and for the period from
inception (August 16, 1996) through September 30, 2000 is unaudited. In the
opinion of management, all adjustments, which consist solely of normal recurring
adjustments, necessary to present fairly in accordance with generally accepted
accounting principles, the financial position, results of operations and cash
flows for all periods presented, have been made. The results of operations for
the interim periods presented are not necessarily indicative of the results that
may be expected for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These condensed financial statements should be
read in conjunction with the Company's audited financial statements and notes
thereto included in the Company's Registration Statement on Form S-1/A filed on
September 28, 2000.
Pro Forma Data
The unaudited pro forma presentation of the September 30, 2000 balance
sheet has been prepared to reflect the issuance of 7.0 million shares of common
stock through the initial public offering at a price of $17.00 per share,
conversion of 424,689 warrants, receipt of the net proceeds from the sale of
stock and exercise of warrants and the conversion of all 22.7 million shares
outstanding of preferred stock.
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 September 30, 2000, the Company's investment
portfolio consisted of U.S. government securities held by two major banking
institutions. As of September 30, 2000, the maturities of marketable
securities are as follows:
Less than one year $23,470,519
One to five years 24,246,689
-----------
$47,717,208
===========
Securities are carried at fair value with the unrealized gains/losses
reported as a separate component of stockholders equity. The unrealized loss
from marketable securities was $0 and $194,974 at December 31, 1999 and
September 30, 2000, respectively.
Comprehensive Income (Loss)
Comprehensive income (Loss) 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 three and nine month periods ended
September 30, 1999 was the same as its reported net loss. The Company's
comprehensive loss, for the three and nine month periods ended September 30,
2000, consisted of the reported net loss and unrealized losses on marketable
securities and totaled $2,470,248 and $55,854,206, respectively.
5
<PAGE>
3. INVENTORIES
Inventories are stated at the lower of cost or market value. Cost is
determined by the first-in, first-out method.
December 31, September 30,
1999 2000
--------------- --------------
Raw materials $ 345,071 $ 740,459
Work in process 98,852 60,880
Finished goods 498,304 852,852
--------------- --------------
$ 942,227 $1,654,191
=============== ==============
4. LOSS PER SHARE
Net loss per share has been computed by dividing the net loss attributable
to common shareholders 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.
5. CAPITAL STRUCTURE
Series C Preferred Stock Offering
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.
6
<PAGE>
6. STOCK OPTION GRANTS
During 1999 and the nine months ended September 30, 2000, the Company
issued common stock options at less than the fair value of its common stock.
Accordingly, the Company recorded stock-based compensation expense of $60,000
and $184,000 for the three-month periods ended September 30, 1999 and September
30, 2000, and $227,000 and $405,000 for the nine month periods ended September
30, 1999 and September 30, 2000, respectively.
7. COMMITMENTS AND CONTINGENCIES
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 nine-month period ended
September 30, 2000, the Company recorded a loss of approximately $55,000 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.
8. SUBSEQUENT EVENT
Initial Public Offering
On October 4, 2000, the Company closed an agreement to sell 7.0 million
shares of common stock through an initial public offering at an offering price
of $17.00 per share resulting in net proceeds of $109.3 million. In addition the
Company received approximately $600,000 in proceeds from the conversion of
warrants. Total offering costs, excluding underwriting discounts and
commissions, approximated $1.3 million of which $975,000 were accrued at
September 30, 2000. Upon the closing of the offering, all of the Company's then
outstanding preferred stock automatically converted into common stock on a one-
for-one basis.
In October 2000, the Company's underwriters exercised the option to
purchase an additional 1,050,000 shares to cover over-allotments. The net
offering proceeds to the Company from the sale of the additional shares was
$16.6 million after deducting the underwriter's fees. The over-allotment option
was granted to the underwriters in connection with the Company's initial public
offering.
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Financial
Statements and Notes thereto appearing elsewhere in this Form 10-Q and with the
Company's Registration Statement (Registration No. 333-39748) on Form S-1.
This Form 10-Q 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 and contain projections of our future results of
operation or of our financial position or state other forward-looking
information. We believe that it is important to communicate our future
expectation to our investors. However, there may be events in the future that we
are unable to predict accurately or control. The factors in the section
captioned "Certain Factors That May Affect Future Results" 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.
Overview
7
<PAGE>
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 through September 2000, 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. In
October 2000, we completed our initial public offering and exercise of the
underwriters' over-allotment of common stock resulting in net proceeds to us of
$125.9 million.
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 September 30, 2000,
we have deferred revenue and customer advances of approximately $980,000 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
September 30, 2000, we have recognized approximately $1.5 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 $405,000 as of September 30, 2000. The DOE
contract extends to September 2002 and provides for payments to us of
approximately $1.3 million, of which we had recognized approximately $161,000 as
of September 30, 2000.
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.
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
September 30, 2000, costs of production reflected costs incurred in excess of
the corresponding sales price and warranty costs incurred on units shipped.
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
September 30, 2000 our accumulated deficit was $61.5 million, of which $50.7
million is attributable to deemed preferred dividends and accretion, primarily
in the form of a beneficial conversion charge, and $10.8 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.
8
<PAGE>
Results of Operations
Comparison of Three Month Periods Ended September 30, 1999 and September 30,
2000
Contract revenue. Contract revenue increased from $33,000 for the three
months ended September 30, 1999 to $350,000 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 and DOE contracts 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 increased from $56,000
for the three months ended September 30, 1999 to $237,000 for the corresponding
period in 2000. The amount in 1999 reflects costs incurred on the NASA contract.
The amount in 2000 reflects costs incurred under the NASA contract and the
second phase of our DOE contract.
Costs of production. Costs of production increased from $0 for the three
months ended September 30, 1999 to $15,000 in the corresponding period of 2000.
The amount in 2000 reflects costs associated with the repair and maintenance of
our hydrogen generators in the field.
Research and development expenses. Research and development expenses
increased from $415,000 for the three months ended September 30, 1999 to
$891,000 for the corresponding period in 2000. The 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.
General and administrative expenses. General and administrative expenses
increased from $462,000 for the three months ended September 30, 1999 to
$949,000 for the corresponding period in 2000. This increase reflects an
increase in legal expenses of $72,000, an increase in salaries and benefits of
$122,000, an increase in office-related expenses of $36,000, an increase in
marketing expenses of $29,000 and an increase of $124,000 of non-cash
compensation expense associated with stock option grants.
Interest income (expense), net. Interest income increased from $51,000 for
the three months ended September 30, 1999 to $728,000 for the corresponding
period in 2000. The increase resulted from increased cash and marketable
securities as a result of investing the proceeds from the issuance of our Series
C preferred stock.
Comparison of Nine Month Periods Ended September 30, 1999 and September 30, 2000
Contract revenue. Contract revenue increased from $80,000 for the nine months
ended September 30, 1999 to $537,000 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 and DOE contracts 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 increased from $319,000
for the nine months ended September 30, 1999 to $325,000 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 specific obligations
were met in the fourth quarter of 1999. The amount in 2000 reflects costs
incurred under the NASA contract and the second phase of our DOE contract.
Costs of production. Costs of production increased from $0 for the nine
months ended September 30, 1999 to $131,000 in the corresponding period of 2000.
The amount in 2000 reflects costs associated with manufacturing and delivering
our hydrogen generators in excess of the corresponding sales price as well as
warranty costs on units in the field. 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
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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 $836,000 for the nine months ended September 30, 1999 to
$2,078,000 for the corresponding period in 2000. The 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.
General and administrative expenses. General and administrative expenses
increased from $1,299,000 for the nine months ended September 30, 1999 to
$2,382,000 for the corresponding period in 2000. This increase reflects an
increase in legal expenses of $340,000, an increase in salaries and benefits of
$187,000, an increase in marketing expenses of $50,000, an increase in
recruiting and relocation of $94,000 and an increase of $178,000 of non-cash
compensation expense associated with stock option grants.
Interest income (expense), net. Interest income increased from $129,000 for
the nine months ended September 30, 1999 to $1,410,000 for the corresponding
period in 2000. The increase resulted from increased cash and marketable
securities as a result of investing the proceeds from the issuance of our Series
C preferred stock.
Liquidity and Capital Resources
Since our inception in August 1996 through September 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 September 30, 2000, we had $49.2
million in cash, cash equivalents and marketable securities. In October 2000, we
completed our initial public offering and exercise of the underwriters' over-
allotment of common stock resulting in net proceeds to us of $125.9 million.
Cash used in operating activities was $2.9 million for the nine months ended
September 30, 2000 and was primarily attributable to our net loss and increases
in inventory and other current assets, offset by an increase in deferred revenue
and accounts payable and accrued expenses. Cash used in operating activities was
$2.0 million in 1999 and was primarily attributable to our net loss and an
increase in inventory, offset by an increase in deferred revenue.
Cash used in investing activities was $45.8 million for the nine months ended
September 30, 2000 and was primarily attributable to purchases of marketable
securities, offset by maturities of marketable securities. Cash used in
investing activities was $1.0 million in 1999 and was primarily attributable to
purchases of marketable securities, offset by maturities of marketable
securities.
Cash provided by financing activities was $49.7 million for the nine months
ended September 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 September
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. We also expect over the next 12 months to continue to
fund operating efforts related to 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.
Inflation
We do not believe that inflation has had a material effect on our financial
position or results of operations during the past three years. However, we
cannot predict the future effects of inflation, including interest rate
fluctuations and market fluctuations.
Certain Factors That May Affect Future Results
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by management from
time to time.
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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 September 30,
2000, we had an accumulated deficit of $61.5 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 professional. 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 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.
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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.
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.
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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 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.
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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.
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.
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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 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.
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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 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.
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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.
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, an active
public market for our securities may not be sustained.
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;
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. 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.
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.
Our directors, executive officers and individuals or entities affiliated
with our directors as a group beneficially own approximately one-third of our
outstanding common stock. 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.
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 discouraging others from making tender offers for our common stock.
These provisions may also prevent changes in our management.
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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, 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. As of November 13, 2000, we
have outstanding approximately 33.1 million shares of common stock, assuming no
exercise of outstanding options. Of these shares, the 8,050,000 shares sold in
our initial public offering are freely tradable. Approximately 10.1 million
shares will be available for sale in the public market 180 days after the date
of the offering following the expiration of lock up agreements, and
approximately 14.9 million share will become available for sale 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.
ITEM 3-QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly increasing risk.
Our investment portfolio consists of U.S. government securities held by two
major banking institutions. We do not utilize any derivative financial
instruments, derivative commodity instruments or other market risk sensitive
instruments, positions or transactions in any material fashion. We believe that
the investment-grade securities we hold are not subject to any material risks
arising from changes in interest rates.
PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 29, 2000, the Commission declared effective the Company's
Registration Statement (Registration No. 333-39748) on Form S-1, as filed with
the Commission in connection with the Company's initial public offering of
common stock (the "IPO"), which was managed by Morgan Stanley & Co.
Incorporated, Credit Suisse First Boston Corporation and Salomon Smith Barney
Inc. Pursuant to this Registration Statement, the Company consummated the
issuance and sale of an aggregate of 7,000,000 shares of common stock on October
4, 2000 and an additional 1,050,000 shares of common stock on October 6, 2000,
pursuant to the underwriters' exercise of their over-allotment option. The gross
aggregate offering price of the securities registered and sold in the IPO was
$136.9 million. The Company incurred underwriting discounts and commissions of
approximately $9.6 million and additional expenses aggregating approximately
$1.3 million in connection with the IPO.
Upon the closing of the IPO, outstanding warrants to purchase 295,179
shares of Series B Preferred Stock of the Company were exercised for cash in the
aggregate exercise price of $590,358 and outstanding warrants to purchase
146,780 shares of Series B Preferred Stock of the Company were converted to
129,510 shares of such stock. The purchasers of these shares represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends were affixed to the stock
certificates issued in such transactions. All recipients had access, through
employment or other relationships, to information about the Company to make an
informed investment decision. No underwriters were involved in the foregoing
sales of securities. Upon the closing of the IPO, all shares of preferred stock
outstanding including those issued upon exercise or conversion of the warrants
described above, were converted one-for-one into 22.7 million shares of common
stock.
None of the proceeds of the IPO were paid directly or indirectly to any
director, officer, general partners of the Company or their associates, persons
owning 10% or more of any class of equity securities of the Company, or any
affiliate of the Company. After deducting the underwriting discounts and the
estimated offering expenses, the net proceeds to the Company from the IPO,
including the over-allotment, were approximately $125.9 million. We except to
use the net proceeds of the IPO 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. As of the date of this Form
10-Q we have not made any specific expenditure plans with respect to the
remainder of the net proceeds of the IPO offering. We may 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, the net proceeds are invested in short-
term investment grade, interest-bearing securities.
During the three months ended September 30, 2000, the Company issued
options to purchase 92,000 shares of common stock at an exercise price of $6.00
per share to employees and a director pursuant to the Company's 2000 Stock
Incentive Plan ("the Plan"). During the three months ended September 30, 2000,
the Company issued options to purchase 23,400 shares of common stock at an
exercise price of $10.00 per share to employees and a consultant pursuant to
the Plan. During the three months ended September 30, 2000, the Company issued
options to purchase 800,000 shares of common stock at an exercise price equal to
the IPO price of $17.00 per share to employees and officers pursuant to the
Plan. The Company relied on an exemption provided by Rule 701 under the
Securities Act for the issuance of these options.
In July, the Company issued 2,000 shares of common stock on the exercise
of stock options generating proceeds of $300. This issuance was made pursuant to
Rule 701 of the Securities Act of 1933, as amended (the "Act").
In September, the Company issued 34,547 shares of common stock on the
exercise of stock options generating proceeds of $6,173. The issuance was made
pursuant to Rule 701 of the Securities Act of the Act.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
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ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report.
Exhibit
No. Description
------- -----------
3.1 Third Amended and Restated Certificate of Incorporation of the
Company, (incorporated herein by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1, SEC File 333-39748)
3.2 Amended and Restated By-Laws of the Company (incorporated herein
by reference to Exhibit 3.4 to the Company's Registration
Statement on Form S-1, SEC File No. 333-39748)
4.1* Specimen common stock certificate
4.2* See Exhibits 3.1 and 3.2 for provisions of the Certificate of
Incorporation and By-Laws of the Registrant defining the rights of
holders of common stock of the Company
10.1* 1996 Stock Option Plan
10.2* 2000 Stock Incentive Plan
10.3* 2000 Employee Stock Purchase Plan
10.4* Development, Marketing and Distribution Agreement, dated November
10, 1999, between the Company and Matheson Tri-Gas, Inc.
10.5* Distribution Agreement, dated November 24, 1999, between the
Company and Diamond Lite Limited
10.6* Lease, dated as of May 27, 1997, between the Company and 50 Inwood
Road Limited Partnership, as amended on January 29, 1998, March 1,
1999 and April 9, 1999
10.7* Series C Preferred Stock Purchase Agreement, dated April 12, 2000,
among the Company and certain stockholders
10.9* Common Stock Purchase Warrant, dated February 1998, issued to the
Electric Power Research Institute
10.10* NASA SBIR Contract, dated October 25, 1999
10.11* Contract with the U.S. Department of Energy, dated May 21, 1998
10.12* Form of Indemnification Agreement between the Company and its
directors and executive officers
27.1 Financial Data Schedule
--------
* Incorporated herein by reference to the identically-numbered Exhibit to
the Company's Registration Statement on Form S-1, SEC File No. 333-39748.
(b) Reports on Form 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PROTON ENERGY SYSTEMS, INC.
(Registrant)
Date: November 13, 2000 By: /s/ Walter W. Schroeder
_____________________________
Walter W. Schroeder
President and Chief
Executive Officer
By: /s/ John A. Glidden
_____________________________
John A. Glidden
Vice President and Controller
(Principal Financial and
Accounting Officer)
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