UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: October 31, 1998
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: 0-24852
ENERGY RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)
----------------------
New York 06-0853042
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3 Great Pasture Road
Danbury, Connecticut 06813
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (203) 825-6000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0001 par value per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of 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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of voting stock held by non-affiliates of the
registrant was approximately $34,967,600, which is based on the closing price of
$12.50 on January 26, 1999. On January 26, 1999 there were 4,135,873 shares of
Common Stock of the registrant issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE Certain information contained in the
registrant's definitive proxy statement relating to its forthcoming 1999 Annual
Meeting of Stockholders to be filed not later than 120 days after the end of
registrant's fiscal year ended October 31, 1998 is incorporated by reference in
Part III of this Report on Form 10-K.FORM 10-K ANNUAL REPORT
<PAGE>
<TABLE>
<CAPTION>
ENERGY RESEARCH CORPORATION
INDEX
-----
Description Page Number
----------- -----------
<S> <C> <C>
Part I
------
Item 1 Business 3
Item 2 Properties 19
Item 3 Legal Proceedings 20
Item 4 Submission of Matters to a Vote of Security Holders 20
Part II
-------
Item 5 Market for the Registrant's Common Equity and Related Stockholder Matters 20
Item 6 Selected Financial Data 21
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations 22
Item 8 Financial Statements and Supplementary Data 27
Item 9 Changes In and Disagreements with Accountants on Accounting and Financial
Disclosure 27
Part III
--------
Item 10 Directors and Executive Officers of the Registrant 27
Item 11 Executive Compensation 27
Item 12 Security Ownership of Certain Beneficial Owners and Management 27
Item 13 Certain Relationships and Related Transactions 27
Part IV
-------
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 28
Signatures
32
</TABLE>
2
<PAGE>
Forward-looking Statement Disclaimer
When used in this Report, the words "expects", "anticipates", "estimates",
"should", "will", "could", "would", "may", and similar expressions are intended
to identify forward-looking statements. Such statements include statements
relating to the Company's planned spin-off of its battery business, the
development and commercialization schedule for its fuel cell technology, future
funding under government contracts, the expected cost competitiveness of its
technology, and the timing and availability of products under development. These
and other forward looking statements contained in this Report are subject to
risks and uncertainties, known and unknown, that could cause actual results to
differ materially from those forward-looking statements, including, without
limitation, general risks associated with product development and introduction,
changes in the utility regulatory environment, potential volatility of energy
prices, government appropriations, the ability of the government to terminate
its development contracts at any time, rapid technological change, and
competition, as well as other risks. The Company cannot assure that the spin-off
will occur as planned, that the Company will be able to meet any of its
development or commercialization schedules, that the government will appropriate
the funds anticipated by the Company under its government contracts, that the
government will not exercise its right to terminate any or all of the Company's
government contracts, that any of the Company's products or technology, once
developed, will be commercially successful, or that the Company will be able to
achieve any other result anticipated in any other forward-looking statement
contained herein. The forward-looking statements contained herein speak only as
of the date of this Report. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any such statement
to reflect any change in the Company's expectations or any change in events,
conditions or circumstances on which any such statement is based.
PART I
Item 1. Business
Introduction
Energy Research Corporation (the "Company") is a leading developer of
electrochemical technologies for electric power generation and storage. The
Company is principally engaged in the development of a carbonate fuel cell power
plant for distributed electric power generation. A fuel cell is a device which
electrochemically converts the chemical energy of a fossil fuel into electricity
without any combustion of fuel. The Company's fuel cell system feeds a fuel,
such as natural gas, into the fuel cell where the fuel and air undergo an
electrochemical reaction to produce electricity. The Company has also developed
a nickel-zinc battery which can be used in a range of rechargeable battery
applications. See "Recent Developments".
From its founding in 1969 until approximately 1983, the Company focused on
developing fuel cells and specialized batteries for the United States military.
These efforts resulted in the Company obtaining various patents and expertise in
these electrochemical technologies. For the last fifteen years the Company has
concentrated on developing products using its technologies for mostly
non-military markets, availing itself of substantial funding from the United
States Department of Energy ("DOE") and other outside sources such as the MTU
division of Daimler Chrysler Corporation.
The Company has developed a patented fuel cell technology which allows efficient
and environmentally benign generation of electricity without requiring any
combustion or mechanical equipment. This technology is known as Direct Fuel Cell
because it introduces most of the hydrocarbon fuel such as pipeline natural gas
directly into the fuel cell without requiring external reforming for producing
hydrogen. This "one-step" operation results in a significantly more efficient,
simpler and more cost-effective energy system compared with other
external-reforming type fuel cells.
The Company currently conducts its operations through two principal operating
groups: the Fuel Cell Group and the Battery Group. The Fuel Cell Group
concentrates its efforts on the development, demonstration and,
commercialization, of the Company's carbonate fuel cell, the Direct Fuel Cell.
The Battery Group is engaged in the
3
<PAGE>
development and commercialization of an innovative, patented nickel-zinc
rechargeable battery, as well as the research and design of other advanced
battery technologies.
The Company has licensed its fuel cell technology internationally to several
major corporations, including MTU-Friedrichshafen GmbH ("MTU"), a subsidiary of
DaimlerChrysler and Mitsubishi Electric Corporation. In addition, the Company
has licensed its Ni-Zn battery technology to a joint venture between Nan Ya
Plastics Corporation of Taiwan, a Formosa Plastics Group company and Xiamen
Three Circles Co., Ltd. ("Xiamen") of Xiamen, China and a joint venture formed
between the Company and Xiamen.
Recent Developments -- Proposed Spin-off of Battery Group
On October 1, 1998, the Company announced that its Board of Directors had
approved a plan to effect a spin-off to its stockholders of 100% of the shares
of Evercel, Inc. ("Evercel"), a newly formed, wholly-owned subsidiary of the
Company. In connection with this transaction, which is expected to occur in
early 1999, the Company plans to transfer to Evercel the principal assets and
liabilities related to the Battery Group. Following the transfer, the Company
plans to distribute to its stockholders in a tax-free distribution one share of
Evercel Common Stock for every three shares of Common Stock of the Company held.
Immediately after the distribution of Evercel's shares to the Company's
stockholders, in order to fund its commercialization efforts, Evercel plans to
conduct a rights offering to its stockholders. As described more fully in a
Registration Statement filed by Evercel with the Securities and Exchange
Commission on September 30, 1998, as amended on December 15, 1998, Evercel
expects to grant at no cost to holders of its Common Stock, transferable
subscription rights ("Rights") to subscribe for and purchase an additional share
of Evercel's Common Stock. Each holder of Evercel's Common Stock is expected to
receive one Right for each share of Evercel Common Stock held on the record date
(which has not yet been determined). Each Right will be exercisable, for a
period of approximately 30 days, to purchase one share of Common Stock of
Evercel at a purchase price of $6.00 per share. The rights offering will be made
only by means of a Prospectus which will be delivered to stockholders
concurrently with the distribution. The transaction remains subject to the
satisfaction of certain conditions. See "Introductory Statement -
Forward-looking Information Disclaimer."
The Fuel Cell Group
Industry Background
According to the U.S. Department of Energy's ("DOE"), "Energy Information
Administration Energy Outlook 1999" report, a projected 363 gigawatts of new
capacity generation will be needed by 2020 to meet the growing demand for
electricity and to offset retirements. Approximately 81% of this new capacity is
projected to be fueled by natural gas. The Company believes that most of this
$363 billion market, will develop in the 2002 to 2020 time period.
At present capacity reserve margins (the difference between installed generating
capacity and demand for electricity) in the U.S. as a whole average only 15%. In
addition they are shrinking and vary greatly from region to region. The Company
believes the prospects of wholesale and retail wheeling of electric power (the
sharing of electricity from multiple sources) together with overall uncertainty
as to the future will discourage utilities from adding substantial new
generation during the next several years. These factors, together with tougher
environmental laws already in existence, the need to relicense nuclear plants,
which may not be economically feasible in some cases, and the aging of U.S.
plants, could result in market opportunities at about the time the Company plans
to bring its product to market. Even the wheeling of power over long distances
will result in additional energy losses over the transmission lines, thus
offsetting some of the gains achieved by balancing power usage and keeping
pressure on capacity margins.
The U.S. electric utility industry has been edging toward change for several
years triggered in part by the Energy Policy Act of 1992, which called for open
access for consumers. In 1994, a major upheaval in the industry began as a
result of significant moves toward direct access and deregulation of the
electric utility industry in various states. As a result, a heightened
atmosphere of competition, as well as uncertainty, exists in the industry.
Furthermore, some electric utilities have already decided to phase out of the
power generation aspect of the business, leaving it to independent power
producers and non-utility generators. Others have merged with either other
electric utilities or gas supply companies. A number of significant mergers of
this type have taken place
4
<PAGE>
and further major reorganizations are anticipated. Regardless of the
reorganization of the electric utility industry, substantial generation
equipment will be required.
In their 1997 report on North American Distributed Generation System Markets,
Frost and Sullivan predicted that by 2003, up to 20 percent of new installed
capacity may be served by distributed generation and that fuel cells will
capture an increasing share of this emerging market. In the second phase of
Clean Air Act regulations, set to take effect January 1, 2000, emissions
reductions will be mandatory. Installation permits for internal combustion
engine generators, as anything other than emergency power generation may be
severely limited. Furthermore, in a deregulated market, power producers and
power marketers are likely to take advantage of "green marketing" to
differentiate their electricity to end-users. This general market trend strongly
supports a market for emissions-free fuel cell technologies.
The Company believes that the restructuring of the utility industry and the
growth of the distributed generation market discussed above, greatly enhance its
market opportunities. Newly formed entities are working to find the best market
solution for the customer. Increasing demands are being put on efficiency, power
quality, lifetime, low maintenance and environmental compatibility and cost. The
use of highly efficient and flexible heat and power generating systems is being
investigated by every potential energy company in the world. Fuel cells with the
capability to meet these demands in a wide variety of settings offer an
excellent enabling technology to energy services companies.
The Company's Fuel Cell
The Company's Fuel Cell Group concentrates its efforts on the development,
demonstration, and, commercialization of the Company's carbonate fuel cell for
generating electricity. Fuel cells are devices for converting the chemical
energy of a fossil fuel into electricity electrochemically, that is, without
burning fuel or needing any mechanical equipment. Different types of fuel cells
are distinguished generally by the electrolyte medium they use. ERC's Direct
Fuel Cell system employs metal carbonates as the electrolyte, hence the term
"carbonate fuel cell". The Company's fuel cell system feeds a fuel, such as
natural gas, into the fuel cell where the fuel and air undergo an
electrochemical reaction to produce electricity. A fuel cell power plant can be
thought of as having two basic segments: the fuel cell stack module, which is
the part that actually produces the electricity, and the "balance of plant",
which includes various fuel handling and processing equipment, including
requisite pipes and blowers, computer controls, inverters to convert the DC
output of the fuel cell to AC, and other related equipment.
Conventional non-nuclear power plants burn a hydrocarbon such as coal, oil or
natural gas, to create heat. The heat boils water, converting it to steam which
rotates a turbine which produces the electricity. Some power plants use a
combined cycle approach where the heat is sent to gas turbines, and then to
raise steam, which produces additional power in steam turbines. Each step in
these processes consumes some of the potential energy in the fuel, and the
combustion process typically creates emissions of sulfur and nitrogen oxides,
carbon monoxide, soot and other air pollutants. Because of the non-combustion,
non-mechanical power generation process, the Company's fuel cell is much more
efficient than the conventional power plants. Emissions of sulfur and nitrogen
oxides are nearly zero, and other pollutants are minimal or non-existent. With
the only moving parts being the air blower, in contrast to large rotating
turbines, fuel cells are extremely quiet. In addition, fuel cells achieve high
efficiency at extremely small sizes allowing fuel cells to satisfy market needs
for distributed generation, such as providing electrical power to a hospital or
a retail store.
The Company's patented Direct Fuel Cell uses hydrocarbon fuel without the
intermediate step (reforming) of creating hydrogen fuel, which is more
efficient, simpler and less costly as compared with other external-reforming
type fuel cells. The Direct Fuel Cell, is capable of using a variety of fuels,
including natural gas, methanol, ethanol, bio-gas and any other hydrocarbon
fuels. The Direct Fuel Cell operates at much higher temperatures than most other
fuel cells. As a result, less expensive electrocatalysts can be used and high
quality heat energy is available for cogeneration. Even though fuel cells are
believed to be superior to conventional generators in terms of efficiency,
environmental characteristics, and flexibility of size, commercial sales of fuel
cells have been minimal to date. The Company, as well as most potential
competitors in the field, have not yet completed development and commercial
release of their products. In addition, at such an early stage of the
technology's development, the selling price of a fuel cell is expected to be
high, reflecting the initial low production volume. The Company
5
<PAGE>
recognizes that achieving a significant share of the power generation
equipment market will require that the Company offer its products at very
competitive prices, which can only be accomplished when production costs are cut
substantially from current levels.
Accomplishing these cost reductions requires a number of interrelated
developments and achievements. Some of them include:
- Production volume is a significant factor in unit cost. There are
numerous fixed costs, such as factory overhead, that would have a lower
contribution to unit cost if spread over more units. Likewise, there
are numerous components whose costs could decline with volume
purchases.
- Many components are being purchased from outside vendors at high
prices because current volume doesn't yet justify investing in the
specialized equipment needed to produce these parts in-house at lower
cost.
- The Company continues to explore alternative materials, processes, and
vendors that it believes could result in savings. For example, by
making certain components thinner, material costs could be reduced.
- Various processes are being performed manually that the Company
believes could be converted to automated operation, producing
considerable savings and tightening manufacturing tolerance. Equipment
operating at low speeds could be replaced by faster, more efficient
equipment.
- To the extent that the Company can make improvements in manufacturing
and produce its stack components to tighter tolerances, that increased
uniformity would increase the electrical output of the stack, in turn
lowering its cost per kW.
The Company regularly reviews and revises its cost reduction plans. In addition,
the DOE has on several occasions assigned an independent outside auditor to
examine the Company's present and projected cost figures to determine if the
DOE's continued support of the Company through development contracts will
achieve its intent of creating commercially viable fuel cell power generation
technology in the U.S. The most recent such audit, completed in 1998, projected
that the Company's commercial design fuel cell is capable of being manufactured,
delivered and installed at a cost per kW of $1140 in 1995, assuming production
of 400 MW per year. The Company believes that this cost would be low enough to
be competitive in the marketplace. However, achieving these costs savings and
the ability of the Company to compete based upon these cost savings, if
achieved, are subject to risks and uncertainties. "See Introductory Statement -
Forward-looking Information Disclaimer."
The Company is transitioning from a development company to a manufacturer of
fuel cell power plants. The Company believes there is substantial work to be
done before it can commercially produce and sell its fuel cell systems. In
addition to achieving cost reductions, the Company will need to demonstrate the
endurance and reliability of its fuel cells. The Company believes its
commercialization program is dependent upon one or more additional field trials
of its power plants.
Fuel Cell Development Program
During 1996 and 1997, the Company operated its "proof-of-concept" fuel cell
plant (the "Santa Clara Plant") at a site in Santa Clara, California. The
demonstration involved the largest carbonate fuel cell power plant in the world
and the largest fuel cell of any type operated in the United States. The Santa
Clara Plant was initially designed to provide 1.8 megawatts. Following its start
up, the Santa Clara Plant achieved a peak power output of 1.93 megawatts.
Adjusting for supplemental fuel, it achieved an electrical efficiency level of
50%, a record for a single cycle fossil fuel cell power plant, as well as record
low emissions of sulfur and nitrogen oxides.
The Santa Clara Plant operated at various electrical outputs for almost one
year, half of such time being connected to the utility grid. Despite
encountering equipment problems unrelated to the basic fuel cell technology, the
Santa Clara Plant achieved most of the goals set by the Company for the project
and established new milestones. After the end of the operation of the Santa
Clara Plant in March 1997, all of the fuel cell stacks were returned to the
Company for a comprehensive analysis. The Company used the results of this
analysis, along with the results of
6
<PAGE>
ongoing development activities, to develop a commercial fuel cell design
significantly more compact, reliable and cost-effective than the Santa Clara
Plant design.
In March 1998, the Company commenced operation of a single stack Direct Fuel
Cell power plant demonstration in Danbury, Connecticut (the "Danbury Power
Plant"). The single stack power plant produced in excess of 250 kilowatts. The
Danbury Power Plant operated for 3000 hours and represented various improvements
over the Santa Clara Power Plant. The cells contained 40% less material and
produced 50% more power per individual cell. The cells were constructed using an
automated process resulting in closer tolerances. The Danbury Power Plant
converted pipeline natural gas to DC electricity equivalent to an estimated 50%
efficiency in commercial operation.
The Company's current fuel cell power plant design is projected to be capable of
producing the same output as the Santa Clara Plant with a footprint one ninth as
large. This reduction in size and increase in power per stack results in
substantial manufacturing cost savings. In the second quarter of 1999, the
Company expects to demonstrate its final commercial fuel cell stack design, a
250 kW unit, at its Danbury Power Plant. The Company will provide electrical
power for its facility from the fuel cell, and provide excess power to the local
utility grid. The Company anticipates a demonstration of a commercial 1 MW fuel
cell stack design in 2000, followed by a complete power plant demonstration as
well as initiation of commercial sales in 2001. Achieving these time tables are
subject to risks and uncertainties. See "Introductory Statement -
Forward-looking Information Disclaimer" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."
Recent market research has indicated that the demand for fuel cell power plants
from early commercial adopters of the technology may be greater in the sub-MW
size than the larger sizes. To meet that demand, the Company plans to take
advantage of its license rights to the "Hot Module" fuel cell developed by MTU.
See "Fuel Cell Licenses". This nominal 250kW design, which incorporates the
Company's fuel cell stacks, uses an innovative integration of some of the
elements of the balance-of-plant into the fuel cell stack module itself, with
the expectation of reducing costs to the power plant as a whole. The design is
very compact and specially suited for cogeneration applications. During 1999,
the Company expects to deliver fuel cell assemblies to MTU for a field
demonstration of the Hot Module design at a municipal utility in Germany. In
calendar 2000, the Company expects to demonstrate a Hot Module unit in the
United States.
Principal Development Contracts
The Company's revenues have been principally derived from U.S. government and
industry research and development contracts and license fee income. Government
funding provided approximately 75%, 92% and 97% of revenues in fiscal 1996, 1997
and 1998, respectively, principally by the DOE. Because the Company receives a
significant portion of its revenues from contracts and subcontracts with the DOE
and other government agencies, future revenues and income of the Company could
be materially affected by changes in procurement or appropriation policies, a
reduction in expenditures for the services provided by the Company, and other
risks generally associated with government contracts and cooperative agreements.
The Company performs its services under contracts or agreements that usually
require performance over a period of one to five years. However congressional
budget limits could prolong the contracts. In general, the Company's contracts
or agreements may be terminated, in whole or in part, at the convenience of the
Government. Virtually all government contracts are funded annually based on
administrative recommendations and annual congressional appropriations.
Regardless of the terms of the Company's government contracts, the Company can
only receive up to the appropriated funds made available to the Company.
The Company has been working on the development of its Direct Fuel Cell
technology under contracts since 1977, with various government agencies in
addition to the DOE, including the Department of Defense, the Defense Advanced
Research Projects Agency ("DARPA"), and the National Aeronautics and Space
Administration ("NASA").
7
<PAGE>
The Company currently receives its government funding primarily under a
long-term Cooperative Agreement with the DOE. The original agreement covered a
5-year project which commenced in the first fiscal quarter of 1995 and had an
estimated value of $78 million, excluding cost-share funding by the Company and
other private sector sources. The DOE Cooperative Agreement covers the design,
scale up, construction and testing of direct carbonate fuel cells operating on
natural gas. Major development emphasis under this agreement focuses on fuel
cell and total power plant cost reduction and improved endurance.
The present estimated value of the DOE Cooperative Agreement is $86 million,
excluding cost share funding, with $20.2 million of work remaining to be
performed as of October 31, 1998. The term of this contract has been extended to
December 2000. The Company's expected 1999 funding allocation from DOE is $15.7
million subject to government appropriations "See Introductory Statement -
Forward-looking Information Disclaimer." The Company has requested additional
funds from DOE and an extension of the term of the contract in order to complete
the development and conduct planned field trials of its commercial fuel cell
stack design products. The Company and its partners have been providing
significant cost-share funding for the project covered by this contract. The
Company is also seeking additional funding from potential customers and other
private sector organizations which will be necessary to complete the project as
planned, even if additional funds from DOE are obtained.
In addition to the activities listed above, the Company has been active in
soliciting other business from industry and government organizations. The
Company has been working on Direct Fuel Cell power plants for marine
applications under contracts with the U.S. Navy and U.S. Coast Guard. These
power plants are required to operate on liquid fuels such as diesel. Initial
feasibility of using diesel in Direct Fuel Cell has already been demonstrated.
In 1998, the Navy added $3 million to its original $1.6 million contract. Under
this contract, the Company has already produced clean fuel-cell compatible fuel
from marine diesel in a compact fuel processing system. In 1999, subscale fuel
cell stacks will be tested on this clean fuel under conditions simulating marine
requirements.
The Company also has received several Small Business Innovative Research grants
and research contracts from various organizations to explore advanced concepts
or new applications of fuel cells.
Fuel Cell Licenses
The Company has entered into international licensing agreements with several
major corporations. Generally, the Company has reserved for itself the exclusive
rights to manufacture and sell carbonate fuel cells in North America. The
licensees pay annual license fees to the Company and royalties on equipment
sales.
The Company has benefited from its licenses and has received and generally
expects to continue to receive valuable technical and manufacturing information
from its licensees. By coordinating its own development program with the
extensive effort of its partners, it has leveraged its own efforts
substantially.
DaimlerChrysler subsidiary MTU-Friedrichshafen GmbH ("MTU"). In 1989, the
Company entered into a license agreement (the "MTU Agreement") with DASA, a
German aerospace and aircraft equipment manufacturer and a subsidiary of Daimler
Benz Corporation, one of the largest industrial companies in Europe. That
agreement was transferred to a subsidiary of DASA, MTU Friedrichshafen in 1993,
and, in 1994, MTU became a subsidiary of AEG Daimler Benz Industries, now
DaimlerChrysler. Pursuant to the terms of the MTU Agreement, the Company has
granted to MTU an exclusive license to use, develop and sell carbonate fuel
cells in Europe, subject to certain rights of others, and a non-exclusive
license in South America, the Middle East and Africa, subject to certain rights
of the Company and others. MTU has agreed to conduct research, development,
manufacturing and marketing programs in the area of carbonate fuel cell
technology and to make the results available to the Company on a royalty-free
basis. In addition, MTU has agreed to pay to the Company an annual license fee
through at least 1999, with an option for MTU to extend, and a royalty based on
kilowatts of electrical generating capacity using carbonate fuel cells made or
sold by MTU or its permitted licensees.
In July 1992, MTU, formed a European consortium (ARGE) including RWE AG, the
largest electric utility in Germany, Ruhrgas AG, the largest natural gas
supplier in Germany, Elkraft Power Co. Ltd. (Elkraft), a large Danish utility,
and Haldor Topsoe A/S, a Danish industrial company. The intent of the consortium
is to spend approximately 130 million Deutsche Marks ($90 million), over a nine
year period on further development,
8
<PAGE>
demonstration and commercialization of the Company's carbonate fuel cell
technology. Certain individual members of the consortium, including MTU, Elkraft
and Haldor Topsoe A/S, have conducted carbonate fuel cell activities on their
own utilizing the Company's technology. The activities of this group complement
the Company's efforts to design and manufacture natural gas and coal gas fueled
carbonate fuel cell systems based on the Company's designs.
During 1998, MTU designed and built a 250 kW cogeneration fuel cell unit (the
"Hot Module"), which incorporates the Company's fuel cell stacks, uses an
innovative integration of some of the elements of the balance-of-plant into the
fuel cell stack module itself, with the expectation of reducing costs to the
power plant as a whole. The design is very compact and especially suitable for
cogeneration applications. In July 1998, the Company entered into a
Cross-Licensing and Cross-Selling Agreement with MTU pursuant to which MTU and
the Company have granted to each other the right to manufacture and sell each
other's stationary power fuel cell products in their respective regions. The
Company therefore has the right to manufacture and sell fuel cell power plants
based on MTU's Hot Module in North America; MTU has the right to sell fuel cell
power plants based on the Company's larger 1.25 MW base module in Europe. Each
company will pay the other royalties based upon sales.
During 1999, the Company expects to deliver a fuel cell stack to MTU for a field
demonstration of the Hot Module design at a municipal utility in Bielefeld,
Germany. In calendar 2000, the Company expects to demonstrate a Hot Module unit,
using a Company-manufactured fuel cell stack, in the United States at a site to
be determined in 1999. MTU buys its fuel cell assemblies from the Company and
has ordered fuel cell assemblies from the Company for three other power plants
to be delivered in 1999 and 2000. The Company anticipates that MTU will continue
to purchase fuel cell assemblies from it for the foreseeable future.
Mitsubishi Electric Corporation ("MELCO"). In November 1981, the Company and
MELCO, a Japanese electronics and electric equipment manufacturer entered into a
license agreement relating to carbonate fuel cell technology. This agreement is
automatically extended yearly unless canceled by either party in advance. Under
this agreement, the Company has granted to MELCO an exclusive license to utilize
the Company's patents and know-how for carbonate fuel cells in Japan, South
Korea, and certain other Asian countries. The Company has also granted to MELCO
a non-exclusive license in the other countries of the world, except for certain
countries including the United States. MELCO has granted to the Company a
royalty-free license to use the improvements developed by MELCO for carbonate
fuel cells in the United States, Canada and Mexico. The Company receives an
annual license fee from MELCO and is to be paid a royalty based on kilowatts of
electric generating capacity using carbonate fuel cells made or sold by MELCO.
MELCO is designing and constructing a 200 kW power plant at a Japanese utility
site incorporating Direct Fuel Cell technology, which is planned to be
operational in 1999.
Electric Power Research Institute ("EPRI"). In 1988, the Company entered into a
license agreement with EPRI, granting the Company the right to use carbonate
fuel cell proprietary data developed under certain EPRI contracts with the
Company. The Company has agreed to pay EPRI a one-time fee of approximately
$50,000 upon the Company's first commercial sale of a carbonate fuel cell stack
of one megawatt or larger in size, and a royalty of 0.5% to 1% upon commercial
sales of carbonate fuel cell stacks.
Santa Clara. In 1993, the Company obtained an exclusive license with rights to
sublicense through the year 2005 to use the balance of plant design for the
Santa Clara Plant. The license becomes non-exclusive after 2005 or earlier, at
the option of Santa Clara, if the Company does not meet certain
commercialization milestones. In addition, beginning three years after
commencement of production of fuel cells at a commercial scale manufacturing
plant, the Company is required to make royalty payments of up to $15 per
kilowatt subject to consumer price index and other adjustments on sales of fuel
cell power plant stacks of capacities of 100 kilowatts or more.
U.S. Department of Energy ("DOE"). In connection with certain contracts and
grants from DOE, the Company has agreed to pay DOE 10% of the annual license
income received from MTU, up to $500,000.
9
<PAGE>
Fuel Cell Markets
The Company expects to sell its direct fuel cell power plants for distributed
generation applications to four principal customer groups. These include: (i)
small municipal electric utilities and rural electrical utilities, (ii) large
electric utilities, (iii) end users and (iv) retail companies.
There are approximately 2000 municipally or cooperatively owned public utilities
in the United States representing 90,000 megawatts or more than 10% of the
United States Electric Utility market. The Company believes that due to
efficiencies, which can be achieved at fuel cell power plants as small as one or
two megawatts, its plants could provide a cost-effective means for small
municipal utilities to generate their own power. Large utilities are interested
in fuel cell power plant technology primarily as an efficient, low pollution and
cost-effective dispersed generator. Since fuel cells can be located at, or in
place of, distribution and transformer stations, they may provide greater
flexibility in the transmission and distribution of electricity. The modular
aspects of fuel cells may also allow larger utilities to introduce phased
capacity construction into their generation system. In this approach, the
utilities could expand electricity generation capacity to keep pace with demand
by adding blocks of fuel cells on a periodic basis as required, thereby
improving cash flow as compared with building a single large plant.
End users such as hospitals, military bases, schools, shopping centers and
office buildings have already emerged as early adopters of distributed
generation mainly in the form of cogeneration, the combined utilization of heat
and electricity generated by the power plant. The high operating temperature of
the Company's direct fuel cell provides an advantage in these applications. The
Company believes as much as 70% of the early market for distributed generation
may come from end users. The Company, using a consultant (ERI Services, of
Hartford, Connecticut), has identified cogeneration markets where credits for
waste heat could be used to reduce the cost of electricity produced. Markets in
11 states were characterized as a function of selling price from $1,000 to
$3,000/kW for units for applications of between 1 and 5 MW. The study indicated
a potential market in these states of $15 billion at $1,500/kW and $7 billion at
$3,000/kW.
Retail companies selling energy services to end-users are expected to emerge as
the result of deregulation of the electric utility industry. As markets open and
customer's expectations increase, retail companies will offer a comprehensive
slate of services. Distributed generation technologies offer a flexible tool for
this purpose and industry experts expect that within 10 years energy retailers
will purchase up to 60% of all new distributed generation equipment.
In 1998, the Company engaged Fletcher Spaght to further define the market for
distributed generation. The Company believes, as a result, that the combined
available U.S. and European market for distributed generation will reach 8000 MW
per year by 2001 and 10,000 MW by 2006. This study also verified the need to
broaden the Company's product line to include a submegawatt (250-300kW) power
plant.
The Company has been working since 1990 with a group of utilities, called the
Fuel Cell Commercialization Group (the "FCCG"). The purpose of the FCCG is to
form a collaborative effort between the Company and a group of prospective
buyers to advance the commercialization of the Direct Fuel Cell power plants.
The Company has been working with this group to define power plants
requirements, develop system planning models, construct a model contract for
power plant purchases and to review power plant designs and other activities.
Most of the group's work in these areas, as originally anticipated and planned
in 1990, has essentially been completed. The group remained active in 1998 but
with reduced participation. The FCCG is modifying its structure in response to
the changing utility market by inviting newly emerging prospective buyers such
as retail companies, end users and equipment manufacturers to participate. In
addition to FCCG, the Company has been active in various trade associations to
increase fuel cell awareness among the public, potential customers and
legislators.
The Company is targeting its initial commercialization efforts for niche
stationary power applications. This is because the Company will not yet have
gained the cost advantages of mass production. Therefore, the Company expects
initial adopters to include those in regions where air pollution requirements
are particularly strict, industrial and commercial users who can make use of the
high quality waste heat for cogeneration purposes, customers with opportunity
fuels such as landfill or digester gas, customers with a requirement for premium
power quality, those seeking grid independence or those trying to solve grid
transmission shortages and especially those customers who combine several of the
above characteristics. The Company also expects to have early purchases
10
<PAGE>
from utility and non-utility power producers who will purchase fuel cells
to improve their knowledge of the technology with the intention of purchasing or
leasing and servicing the equipment in the future. The Company is in active
discussions with various utilities, other power producers and equipment
suppliers regarding the purchase of its fuel cell products for applications such
as those described above, although the Company can give no assurance that any of
these discussions will result in equipment sales.
Fuel Cell Competition
Several companies in the United States are involved in fuel cell development.
One of these companies, M-C Power Corporation, competes directly with the
Company in the development of carbonate fuel cells but uses a different
technical approach, which involves auxiliary equipment to convert fuel to
hydrogen. In Japan, at least six manufacturers have demonstrated interest in
developing and marketing carbonate fuel cells. One of these, Mitsubishi Electric
Company, is a licensee of the Company (see licenses). Some have larger marketing
and sales departments than the Company and a history of producing and selling
electric generation equipment. Two Japanese companies have demonstrated extended
operation of 100kW carbonate fuel cells and are planning to test a 1MW plant in
1999.
In Europe, companies in Germany, Holland, Spain and Italy are actively engaged
in carbonate fuel cell development and are potential competitors, although these
efforts are not as well advanced as the progress of the United States and
Japanese companies. The German activity through the Company's licensee MTU and
its partners is by far the largest effort. Almost all of these companies are
also significantly larger than the Company, possess greater financial resources
and have established product lines in electric generation equipment and in other
fields.
In addition to the carbonate fuel cell, other types of fuel cells are also being
developed by different companies worldwide. These fuel cells, generally referred
to by the electrolyte medium they use, include phosphoric acid, polymer
electrolyte and solid oxide systems. These fuel cells are in various stages of
development and aim at different applications including stationary power,
transportation and portable power. Only the phosphoric acid fuel cell system,
developed by United Technology's ONSI Corporation is in advanced stages of
development and has limited commercial sales. This system is significantly less
efficient and is expected to be more expensive compared to the Company's Direct
Fuel Cell.
The Company must also compete with companies manufacturing more established
combustion equipment, including various engines and turbines, which are
currently in use and have established operating and cost features. The greatest
competition comes from the gas turbine industry which recently has made good
progress in improving fuel efficiency and reducing pollution in large size
combined cycle natural gas fueled generators. Efforts are underway to extend
these advantages to small size machines. The Company believes that in the small
size units, under 5 MW, gas turbines will not be able to match its fuel cell
efficiency or environmental characteristics. However, the Company can give no
assurance that the Company will be able to compete with small gas turbines even
if these machines have less desirable operating characteristics. See
"Introductory Statement - Forward-looking Information Disclaimer."
Nuclear power is expected to experience a decline in its share of the
electricity market. Social and political hurdles make it virtually impossible to
site new nuclear power plants in the U.S. at this time. Further, some of the
nuclear plants operating today will not be economical in a competitive market
due to high operating and maintenance costs. There are currently 110 nuclear
units licensed, providing about 20% of electricity in the United States. DOE
projects that, by 2020, 45 nuclear units will remain in service supplying about
8% of electricity in the United States.
While hydroelectric power is not forecast to shrink as dramatically as nuclear
power as a share of the market, it faces limited growth. The best domestic hydro
opportunities have been exploited, and there is growing pressure from
conservationists to remove some existing dams that obstruct the up-river journey
of spawning salmon. The DOE's forecast projects slightly under 3% growth in
hydroelectric capability by 2020.
The Company is competing primarily on the basis of fuel cell efficiency,
environmental considerations and cost. The Company believes that the carbonate
fuel cell enjoys competitive advantages over other fuel cells including
11
<PAGE>
higher efficiency, ease of operation, environmental quality and expected
low cost. The Company believes it is more advanced in the development of
carbonate fuel cells than other manufacturers. The Company can give no assurance
that such advantages will continue or that the carbonate fuel cells being
developed by the Company will be commercially successful. See "Introductory
Statement - Forward-looking Information Disclaimer."
Fuel Cell Manufacturing
The Company manufactures fuel cells at its facility located in Torrington, CT.
At present, the capacity of the plant is approximately 5 MW per year on a single
shift basis. The Company is planning to increase the capacity of this plant by,
purchasing equipment for certain elements of the manufacturing process which
currently restrict the overall output of the facility. The Company will need to
raise funds for this purpose. The first stage in this process is to raise the
output capability to 50 MW per year. The Company estimates that the cost of this
expansion will be approximately $16 million. Meanwhile, the Company is using
existing funds to expand production capacity incrementally and to implement cost
reduction and process improvement projects. See "Introductory Statement -
Forward-looking Information Disclaimer" and Management's Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources."
The Company believes that virtually all of the raw materials used in its
products are readily available from a variety of vendors in the United States
and Canada. However, certain manufacturing processes which are necessary to
transform the raw materials into component parts for fuel cells are presently
available only through a small number of foreign manufacturers. The Company
believes that these manufactured products eventually will be obtainable from the
United States suppliers as demand for these items increases.
The Battery Group
Industry Background
A battery is an electrochemical apparatus used to store energy and release it in
the form of electricity. There are two types of batteries, primary and
rechargeable batteries, also known as secondary batteries. A primary, or
disposable, battery is used until discharged and then discarded. A rechargeable,
or secondary, battery can, after discharge, be recharged and used again.
The Company's Ni-Zn batteries are designed to be rechargeable.
No one battery system is ideal for all rechargeable applications. There are
numerous performance variables which vary in importance by application. Each
commercially available battery system is stronger in certain areas and weaker in
others. Important variables include: voltage; energy capacity per unit weight
(energy density); energy capacity per unit of volume (volumetric energy
density); power or discharge rate capability (how rapidly energy can be drawn
from the battery or specific power); cycle life and how this varies with
discharge rate and depth of discharge; response to ambient temperatures; rate of
self-discharge; shelf life in charged and discharged states; size, shape and
design flexibility; time and other constraints on recharging; safety,
environmental and disposal considerations; and various application-specific
considerations. The needs of various battery applications place a different
priority on these characteristics, and, thus, require different solutions. In
addition, for each anode/cathode combination there are many alternative ways to
design a battery, involving choices of electrolyte and electrode materials and
how components are shaped and manufactured. Design choices involve trade-offs,
and as a result improvement in one element of a battery's performance often
comes at a sacrifice of another characteristic. A battery optimized for just one
characteristic may not be competitive if its performance in other areas is
inferior.
The world battery industry totals approximately $33 billion of manufacturers'
shipments, growing at 6-8% per year. This total includes primary batteries ($9.8
billion), motive power batteries ($2.1 billion), high performance rechargeable
batteries ($6.1 billion) and starting, lighting and ignition batteries ($15
billion). These four major types of batteries are sold into a wide array of
different markets, some of which the Company does not intend to enter. These
different markets frequently require different battery systems and have
different competitors.
EVs and Motive: The Company estimates that the total worldwide market for
electric vehicles ("Evs") and hybrid electric vehicles ("HEVs") and other motive
power that could use the Company's batteries was $700 million in 1997; however,
precise statistics are not available. The market for electric vehicles is now in
the early stages of development and many of the vehicles on the road are
prototypes. The market for EV's is predicted to grow rapidly
12
<PAGE>
after the year 2000, and projections for annual growth rates for EV's and
motive batteries are expected to accelerate from 7% annually from 1997-2002 to
approximately 22% annually, reaching $8 billion of sales in 2007.
Successful battery development has been a barrier to the emergence of a large EV
market. Lead-acid batteries, while potentially cost effective, are too heavy to
give adequate vehicle range. Other higher energy density battery systems
including nickel metal-hybrid ("Ni-MH"), nickel cadmium ("Ni-Cd"), lithium-ion
("Li-ion") as well as Ni-Zn are being tested in vehicles. The Company believes
that its Ni-Zn battery has adequate energy density to permit acceptable vehicle
range and has the potential to be produced at lower cost than the most likely
other contenders for the EV market.
Recently, HEVs have also received more interest and development efforts. An HEV
combines a battery/electric motor drive, which is typically used for
acceleration to a predetermined speed, with an alternative drive system, such as
a small internal combustion engine, which takes over when the power requirements
are lower at steady highway speed. Toyota has reported mileages of greater than
60 mpg for its Prius HEV. HEVs are likely to use similar battery systems to EVs,
albeit in smaller capacity battery packs.
The other motive power applications for rechargeable batteries include scooters
and bicycles; industrial trucks; neighborhood vehicles; golf carts; electric
wheelchairs, and marine batteries. These markets are primarily supplied by
lead-acid (and some Ni-Cd) batteries today. These markets have been grouped with
EV's rather than automotive batteries because of their need for the deeper
discharge (deep cycle) capability which is required in the EV/HEV markets.
The motive power markets differ in their requirements, however. Target markets
for the Company's battery include the electric bicycle market, particularly in
China and the electric wheelchair market. The deep-cycle marine market values
the benefit Ni-Zn offers in providing a multi-year life; the industrial truck
market, in contrast, sees little benefit to weight savings as lead-acid
batteries are used as counterweights. The Company believes its Ni-Zn technology
is particularly well suited to motive power applications due to its combination
of lower weight, higher specific power and acceptable cost compared to presently
used batteries.
High Performance and Other Rechargeable Batteries: The worldwide market for
rechargeable batteries, excluding automotive, motive power and specialty battery
systems, including applications such as power tools, emergency power and light,
telephones and communications and computers and electronics, among others, is
approximately $6.1 billion, growing at 7% to 8% per year. The growth rate of
individual application markets varies widely, with the small cell, portable
rechargeable markets generally representing the faster-growing sectors,
resulting primarily from the continued development and proliferation of new
portable electronic products.
The market for portable rechargeable batteries consists of three major
technologies and is measured on a per unit basis as follows: 1) Ni-Cd, presently
approximately 62% of the market, 2) Ni-MH, approximately 31% of the market and
3) lithium-ion ("Li-ion"), approximately 7% of the market. Approximately 75% of
all cells are assembled into battery packs for use in a variety of portable
devices. Increasingly, these packs contain sophisticated electronics for power
management and safety.
Ni-Cd is the oldest commercialized rechargeable system in the market. Ni-Cd
cells can be employed in battery packs without high-cost electronics and safety
devices and enjoy a substantial price advantage over Ni-MH and Li-ion cells. In
the last decade, Ni-Cd has increasingly been the subject of tightening
environmental and workplace regulations and related pressures for recycling and
mandatory collection due to the toxicity of cadmium as a principal component.
However, pressures to enforce mandatory collection schemes or even to ban Ni-Cd
have partially abated due to industry-wide recycling efforts. Although Ni-Cd
will remain attractive in certain applications which do not experience a
significant performance benefit from other technologies and are sensitive to
their higher cost, industry analysts believe growth in this segment will remain
relatively flat.
Ni-MH technology, which typically offers a 25% to 40% advantage in energy
density relative to Ni-Cd, was commercialized in the early 1990's. Because it
employs a metal hydride electrode rather than a cadmium electrode, Ni-MH is
considered an environmentally preferred technology and has increased its market
penetration in several applications and geographic regions as a result of this
attribute. However, Ni-MH cells and batteries typically carry a substantial cost
premium relative to Ni-Cd.
13
<PAGE>
Li-ion battery technology was also commercialized in the early 1990's.
Production of Li-ion cells has increased from 15 million cells in 1994 to an
estimated 200 million cells in 1997. Li-ion technology offers the highest energy
density of all commercial rechargeable technologies on the market today. On a
weight basis, the technology offers 2 to 3 times the energy content of Ni-Cd and
offers higher voltage (3.6 volts per cells) than Ni-MH or Ni-Cd (1.2 volt)
technologies. Lithium-based technologies are expected to experience high growth
rates. Li-ion cells and batteries are expected to continue to be more expensive
than the Company's Ni-Zn cells.
Ni-Zn technology is in the early stages of commercialization by the Company.
Ni-Zn cells can be employed in battery packs without high-cost electronics and
safety devices. Ni-Zn cells are considered the safest and most environmentally
benign of the rechargeable technologies available today. The Company expects
Ni-Zn to enjoy a substantial price advantage over Ni-Cd, Ni-MH and Li-ion
battery systems, assuming high volume production levels. Ni-Zn cells offer a 30%
volts per cell advantage over Ni-MH and Ni-Cd. The Company believes that Ni-Zn's
greatest benefits will be in rechargeable battery markets that require a high
specific power (i.e., a high wattage capability per unit of weight), high
specific energy (i.e., a high capacity per unit) and a favorable cost, such as
EV/HEV, power tools, bicycles and neighborhood transportation.
Ni-Zn also offers a weight advantage over current starting, lighting and
ignition batteries, due to its higher specific energy, as well as other
performance advantages which the Company believes may be of only minor benefit
to automotive OEMs. The Company's Ni-Zn batteries are being tested by a European
automotive OEM for use in higher voltage electrical systems for vehicles. These
benefits may offset the moderately higher cost of Ni-Zn. The success of the
Company in capturing a market share in the starting, lighting and ignition
market will depend on, among other factors, the timing and degree to which
automotive manufacturers adopt these higher voltage electrical systems.
The Company's Ni-Zn Batteries
The Company's Battery Group is engaged in the development and commercialization
of an innovative, patented, nickel-zinc ("Ni-Zn") rechargeable battery. The
Company believes that its Ni-Zn battery technology offers high energy density
and low material costs, resulting in a low weight, high power battery with a
substantial price advantage over other comparable technologies. The Company's
Ni-Zn battery has been used on a limited test basis in a range of rechargeable
battery applications, including bicycles, scooters, electric vehicles, trolling
motors for boats, and lawn mowers. The Company also believes that its Ni-Zn
battery may be used in other rechargeable battery applications, including
electric wheelchairs, golf carts, power tools, and consumer and electronic
products. Use of the Company's proprietary process in the construction of Ni-Zn
batteries has the additional advantage of having very low environmental impact
compared to lead-acid or Ni-Cd batteries. The Company intends to commercialize
its Ni-Zn technology through a combination of direct sales, licensing agreements
and joint venture relationships.
The Company's Ni-Zn battery combines a low-cost, light-weight nickel electrode
with the high-energy of environmentally benign zinc to produce a rechargeable
battery having a voltage 30% higher and an energy density per unit weight
approximately 30% greater than that of conventional Ni-Cd batteries. In tests
conducted by the Company, the Company's batteries have approximately 600 deep
discharge cycles and approximately 11,000 shallow discharge cycles.
The rechargeable Ni-Zn battery was first patented in 1923. During the early
1980's extensive research and development efforts were made by others to develop
a Ni-Zn battery with a satisfactory cycle life; these efforts were not
successful. More recently, the Company has solved many of the problems which had
been associated with the short cycle life. Patents have been granted to the
Company in which the zinc electrode solubility (shape change) has been greatly
reduced and construction features provide for a sealed maintenance-free
construction. In tests conducted by the Company, the Company's batteries have
achieved over 600 charge-discharge cycles with only a 20% loss in capacity.
The Ni-Zn cell developed by the Company consists of layers of positive (nickel)
electrodes and negative (zinc) electrodes separated by both electrolyte
absorptive layers and microporous separator layers. The Company plans to
manufacture a range of cells in various energy capacities. These cells can then
be arranged in series and packaged
14
<PAGE>
to produce convenient voltages, such as typical 12 volt blocks. The Company
is supplying demonstration batteries to various potential customers for
evaluation and is conducting in-house testing of its batteries for electric
vehicles, electric bicycles and scooters. The EV batteries are being evaluated
in a European vehicle produced in Germany and are also being supplied for
evaluation to another European vehicle produced in Norway. The batteries being
evaluated in these vehicles have both recently undergone successful preliminary
testing, achieving ranges for these vehicles approximately 2.5 times greater
than that produced by lead acid batteries of approximately equivalent weight.
Also, batteries are being supplied to an Italian company for electric scooters
and to several start-up electric bicycle companies in the United States. The
Company is also working with bicycle companies in China through the Company's
joint venture partnership in Xiamen, China (Xiamen Three Circles-ERC Battery
Corp., Ltd.) to begin manufacture of the Company's batteries which is currently
anticipated to begin on a small scale in late fiscal 1999.
The Company operates an extensive test facility for evaluation of all the
various size cells and modules being manufactured. At any given time there are
usually over 300 cells and batteries being life-tested by the Company.
To further commercialize its Ni-Zn technology, the Company intends to pursue a
range of battery markets, each of which has performance requirements aligned
with the benefits Ni-Zn offers. However, since these markets range from
moderately-sized, current battery applications to large future markets, such as
electric vehicles, the Company intends to pursue a range of business strategies.
To capitalize on these opportunities, the Company plans to manufacture and sell
directly to OEMs, as well as continue to enter into joint venture agreements,
and license its technology to larger organizations with established
manufacturing or distribution capabilities in specific markets.
Electric vehicles and hybrid electric vehicles and a range of motive power
applications are significant potential markets for the Company's Ni-Zn battery.
The Company believes that markets for the Ni-Zn battery include the existing
markets for Ni-MH and Ni-Cd, such as power tools, high-end portable lighting,
and consumer and electronic products. In addition, the Ni-Zn battery has the
potential to compete in the upper cost segment of the lead acid battery markets
where it would enjoy a substantial weight advantage.
Partnerships, Joint Ventures and Licenses
Corning, Inc. In January 1997 the Company entered into a license agreement with
Corning, Inc. to continue the development of the Ni-Zn battery and to
manufacture and market batteries worldwide. This license was exclusive for all
applications with the exception of EV/HEVs for which the Company retained all
rights. After approximately one and one-half years and having successfully
validated the performance of the Company's technology, Corning decided for
strategic business reasons to discontinue its development of certain energy
related products, including the Company's batteries, and as a result
discontinued the license agreement with the Company. This has allowed the
Company to seek business opportunities which had previously been reserved
exclusively for Corning.
Nan Ya Plastics Corporation of Taiwan/ Xiamen Three Circles Co., Ltd.. In
February 1998, the Company entered into a license agreement (the "NanYa License
Agreement") with a joint venture between NanYa Plastics Corporation of Taiwan, a
Formosa Plastics Group company, and Xiamen Three Circles Co., Ltd. of Xiamen,
China for the use of the Company's Ni-Zn batteries in EV /HEVs in China, Taiwan,
Hong Kong and Macao on an exclusive basis and for certain other Southeast Asian
countries on a non-exclusive basis. The license agreement calls for the payment
of $5 million in three stages and a royalty for the exclusive and non-exclusive
territories. The payments include $1.5 million received by the Company in 1998,
a further $2 million to be paid to the Company upon completion of certain
conditions which the Company expects will occur in the second fiscal quarter of
1999, and a final payment of $1.5 million to be paid to the Company upon
completion of duplication of the battery at its facilities in China. The NanYa
License Agreement provides that the Company has the right to invest the final
payment in equity in the joint venture manufacturing and sales organization
formed between NanYa Plastics and Xiamen Three Circles Co., Ltd.
Xiamen Three Circles-ERC Battery Corp., Ltd. In July 1998, the Company also
entered into a Technology Transfer and License Contract (the "Three Circles
License Agreement") with Xiamen Three Circles-ERC Battery Corp., Ltd. for the
use of the Company's Ni-Zn batteries in electric bicycles, scooters, three-wheel
vehicles, off-road vehicles, and miner's safety lamps in China on an exclusive
basis and in Southeast Asia on a non-exclusive basis. The license included an
initial payment to the Company of $3 million. Pursuant to the Three Circles
License
15
<PAGE>
Agreement, the Joint Venture must also pay the Company certain royalties
based upon the net sales of Ni-Zn batteries sold, leased or transferred in the
applicable territories. In addition the Joint Venture may sub-license the
Company's technology to third parties in China, Hong Kong, Taiwan and Macao on a
non-exclusive basis. In connection with the Three Circles License Agreement, the
Company entered into a joint venture agreement with Xiamen Three Circles Co.,
Ltd., used this $3 million as its initial investment in the joint venture, and
received a 50.5% share of the joint venture called Xiamen Three Circles-ERC
Battery Corp. (the "Joint Venture"). The Company reserves exclusive rights for
exporting batteries from the Joint Venture to other territories outside of the
exclusive and non-exclusive field territories. The Company expects to use the
production capability of this Joint Venture to produce batteries to sell to OEMs
and distributors.
Battery Sales and Marketing
The Company intends to build a sales and marketing organization to focus on the
following;
- To generate direct sales to OEMs and distributors in selected
applications and geographical territories.
- To develop joint venture partnerships for manufacturing and
distribution in applications and geographical territories for
which the Company believes strategic partners can improve its
chances of success.
- To license its technology and know-how to strategic partners in
applications and geographical territories for which the above two
business models are not appropriate.
The Company will focus its direct marketing efforts on those applications which
represent specialty niches where the Ni-Zn battery technology has significant
competitive advantages and where the channels of distribution are relatively
narrow. An example of such an application is the electric wheelchair market. For
those areas where broad distribution is required, the Company believes a joint
venture manufacturing and/or sales partnership with companies who have a
position in the distribution channels will be a more effective way to exploit
the technology in a shorter amount of time. An example of such an application
and a geographical area is the Company's license agreement and joint venture
with Xiamen Three Circles Co., Ltd. for China and Southeast Asia. The Company
intends to license its technology for those applications which require very
large capital investment in manufacturing and very broad distribution channels,
such as consumer electronics and power tools.
Upon establishment of the core joint venture manufacturing and sales agreements,
the Company expects to use the manufacturing capability of the joint ventures to
sell directly to OEMs in other geographical territories. An example may be to
use the China joint venture production capability for batteries for bicycles to
satisfy the North American and/or European markets for these products.
Battery Competition
Competition in the battery industry is, and is expected to remain, intense.
Competitors range from development stage companies to major domestic and
international companies, most of which have financial, technical, manufacturing,
marketing, sales and other resources significantly greater than those of the
Company. There are at least two, and possibly more, other battery manufacturers
in the world who have demonstrated interest in developing and marketing Ni-Zn
rechargeable batteries. The Company does not perceive these competitors, who are
significant battery producers, to be its prime competition as their technology
development is believed to be less advanced than that of the Company. The
Company expects to be competing against suppliers of lead-acid, Ni-Cd, Ni-MH,
and lithium rechargeables, as well as other rechargeables and potentially
primary battery technologies. The Company is competing on the basis of battery
performance, the price and economics of its batteries, as well as usage
considerations (stability, safety, environmental).
16
<PAGE>
Battery Manufacturing
The Company has leased approximately 26,000 square feet of space in Danbury,
Connecticut, to be used as a small-scale manufacturing plant for Ni-Zn battery
production and for office space. The small-scale Ni-Zn manufacturing plant will
be designed to be flexible enough to produce batteries for the different markets
which will be pursued. Different size batteries will be produced by combining
different numbers of a common cell design into varying combinations of cells in
series and parallel arrangements. The intended flexibility precludes investment
in a completely automated facility which would have the potential for the lowest
direct labor cost per unit. As the markets for higher volume batteries are
proven, the Company intends to progressively automate production to reduce
production costs.
All the materials required to manufacture the Company's Ni-Zn battery are
readily available from multiple sources in North America. The Company's
principal raw materials for the production of its battery products are nickel
and zinc. Prices for both nickel and zinc, as commodities, are subject to market
forces beyond the control of the Company.
Research and Development
Most of the Company's research and development has been funded by the Company's
government contracts, therefore, research and development expense has been
included in the Company's "cost of revenues" and not in its "research and
development expense". In addition, the Company has incurred discretionary
research and development expense under its government contracts for both fuel
cell and battery development which has been included in "research and
development expense" although it, too, has been reimbursed fully under the
government contracts. During fiscal 1996, 1997 and 1998, 100% of the Company's
research and development was funded by customers, including approximately $1.26
million, $1.27 million and $2.26 million, respectively, of discretionary
independent research and development expense.
During 1998 the Company also formed a joint venture with the City of Xiamen,
China called Xiamen-ERC Technology Company, Limited. This Joint Venture has been
formed to fund other entities, such as Xiamen University, to conduct research in
advanced electrochemical technologies, which will benefit the Company and
Xiamen. The Company has invested $400,000 of capital into this Joint Venture
which is two-thirds owned by the Company.
Proprietary Rights
The Company relies primarily on a combination of copyright and trademark laws,
trade secrets, patents, confidentiality procedures (including, in some
instances, the encryption of certain technical information) and contractual
provisions to protect its proprietary rights. The Company has obtained patents
and will continue to make efforts to obtain patents, when available, in
connection with its technologies. The Company can give no assurance that any
patent obtained will provide protection or be of commercial benefit to the
Company, or that its validity will not be challenged. The Company also seeks to
protect its software, documentation and other written materials under trade
secret and copyright laws, which may afford only limited protection. The Company
presently has 73 United States patents (expiring between 1999 and 2017),
including 4 obtained in 1998, and 6 pending United States patent applications,
including 3 filed in 1998, as well as 117 patents in certain foreign
jurisdictions, including 2 obtained in 1998, and 19 pending patent applications,
including 1 filed in 1998, in certain other jurisdictions, principally in
Europe, South America, and Japan. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy aspects of the
Company's technology or to obtain and use information that the Company regards
as proprietary. The laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States
and, because of the Company's significant international presence, the Company
can give no assurance that the Company will be able to protect its proprietary
rights in the jurisdictions in which it conducts business or into which it
licenses its technology or in which products incorporating its technology are
manufactured and sold. The Company can give no assurance that the Company's
means of protecting its proprietary rights will be adequate or that the
Company's competitors will not independently develop similar technology.
17
<PAGE>
In addition, the Company can give no assurance that the Company's pending patent
applications or any future applications will be approved, that any patents will
provide it with competitive advantages or will not be challenged by third
parties. Others may have filed and in the future may file patent applications
that are similar or identical to those of the Company. The Company can give no
assurance that any such patent application will not have priority over patent
applications filed by the Company. Further, any determination that the Company's
products or manufacturing processes have infringed on the product or process
rights held by others could have a material adverse effect on the Company's
business and results of operation. The Company has not filed for patent
protection for most of its patents in certain potential major markets such as
India, China and Southeast Asia. Agreements reached with partners in these areas
would have to be based on trade secrets and know-how. In the future, the Company
may seek patent protection in those areas.
Many of the Company's United States patents were the result of government-funded
research programs. The Government does not impose significant restrictions on
the Company's use of government-sponsored patents, except that military and
national security applications of technology remain the property of the United
States Government. Patents of the Company that were the result of
government-funded research prior to January 1988 (the date the Company qualified
as a small business under applicable government regulations) belong to the
Government unless the Government waives its rights to these patents. In most
cases, what the Company has obtained is owned by the United States Government.
The Company has received a license to use these patents, which is revocable only
in the limited circumstances where it has been demonstrated that the Company is
not making an effort to commercialize the invention. Patents resulting from
government-funded research after January 1988 automatically belong to the
Company because of its small business status. In both instances, however, the
Government retains a royalty free right to use the patents for government
purposes. In addition, the Government may take title to the patents and may
license the patented technology to others if the Government believes that the
Company is not utilizing the patents. A number of the Company's patents are
subject to such rights. The Company believes, however, that the likelihood of
the Government exercising these rights is very small and would only occur if the
Company ceased its commercialization efforts.
Government Regulation
The Company presently is, and its fuel cell power plants will be, subject to
various federal, state and local laws and regulations relating to, among other
things, land use, safe working conditions, handling and disposal of hazardous
and potentially hazardous substances and emissions of pollutants into the
atmosphere. To date, the Company believes that it has obtained all necessary
government permits and has been in substantial compliance with all of these
applicable laws and regulations.
Pursuant to the National Environmental Protection Act (NEPA), since 1991, each
local Department of Energy procurement office must file and have approved by the
Department of Energy in Washington, DC, appropriate documentation for
environmental, safety and health impacts with respect to procurement contracts
entered into by that local office. The costs associated with compliance with
environmental regulations are generally recoverable under the Company's cost
reimbursable contracts. In certain cases, contract work may be delayed until the
approval is received.
Employees
As of December 31, 1998, the Company had 165 full-time employees, of which
approximately 83 were engineers, scientists, and other degreed professionals and
82 were professional, technical, administrative and manufacturing support
personnel. The Company considers relations with its employees to be good. The
loss of key employees could cause delays in completing contracted work and
development and commercialization activities.
18
<PAGE>
<TABLE>
<CAPTION>
Executive Officers of the Registrant
The executive officers of the Company and their ages are as follows:
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<S> <C> <C>
Jerry D. Leitman 56 President and Chief Executive Officer
Dr. Hansraj C. Maru 54 Executive Vice President and Director
Christopher R. Bentley 56 Executive Vice President and Director
Joseph G. Mahler 46 Vice President, Chief Financial Officer, Treasurer &
Corporate Secretary
</TABLE>
Jerry D. Leitman has been President, Chief Executive Officer and a Director of
the Company since August 1997. Mr. Leitman was previously President of ABB Asea
Brown Boveri's global air pollution control businesses from 1992 to 1995. Prior
to joining ABB Mr. Leitman was Group Executive Vice President of FLAKT AB, a
Swedish multinational, responsible for FLAKT`s worldwide industrial businesses
from 1989 to 1992. Mr.Leitman is also a Director and a member of the Audit
Committee of Esterline Technologies Inc. Mr. Leitman obtained both a BS and MS
in Mechanical Engineering from Georgia Institute of Technology in 1965 and 1967
respectively.
Dr. Hansraj C. Maru has been Executive Vice President and a director of the
Company since December 1992. Dr. Maru was Chief Operating Officer of the Company
from December 1992 to December 1997. Prior to that he was Senior Vice
President-Research and Development of the Company. Dr. Maru joined the Company
in 1977. Prior to joining the Company, Dr. Maru was involved in fuel cell
development at the Institute of Gas Technology. Dr. Maru received a Ph.D. in
Chemical Engineering from the Illinois Institute of Technology in 1975.
Christopher R. Bentley has been a director of the Company since June 1993 and
Executive Vice President of the Company since September 1990. Mr. Bentley was
President of Fuel Cell Manufacturing Corporation, a subsidiary of the Company,
from September 1990 to December 1997. From 1985 through 1989 he was Director of
Manufacturing (1985), Vice President and General Manager (1985-1988) and
President (1988-1989) of the Turbine Airfoils Division of Chromalloy Gas Turbine
Corporation, a major manufacturer of gas turbine hardware. Mr. Bentley received
a BSME from Tufts University in 1966.
Joseph G. Mahler joined the Company in October 1998 as Vice President,
Chief Financial Officer, Corporate Secretary and Treasurer. Prior to joining the
Company, Mr. Mahler was Vice President-Chief Financial Officer at Earthgro, Inc.
from 1993 to 1998 and prior to that, he was a partner at Ernst & Young. Mr.
Mahler received a B.S. in Accounting from Boston College in 1974.
Significant Employee
Allen Charkey has been Executive Vice President and Chief Operating Officer of
Evercel, Inc., the subsidiary of the Company formed to operate the Company's
battery group, since October 1988 and a director of Evercel, Inc. since its
formation in June 1998. He joined the Company in 1970 and has held various
positions of increasing responsibility at the Company since then. Prior to
joining the Company, Mr. Charkey was employed by Yardney Electric Corporation
from 1963 to 1970 as a battery scientist.
Item 2. PROPERTIES
The Company currently owns and occupies approximately 72,000 square feet in two
interconnected single story buildings on 10.8 acres, of which approximately 5.4
acres are currently used, in Danbury, Connecticut. For specific information with
respect to the mortgage on the Danbury, CT facility, see Note 6 to consolidated
financial statements. Additionally, ERC has leased a 63,000 square foot facility
in Torrington, Connecticut for its manufacturing operations. The lease expires
February 1, 2001, however, the Company is currently negotiating to extend the
term of this lease. The annual lease cost of the Torrington facility is
approximately $325,000. The
19
<PAGE>
Company is leasing approximately 28,500 square feet of space in Danbury,
Connecticut, to be used as a small-scale manufacturing plant for Ni-Zn battery
production and for office space. The annual lease cost in Danbury, Connecticut
is approximately $171,000. The Company believes that its facilities are adequate
for its current operations.
Item 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceeding.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of securities holders during the fourth
quarter of the fiscal year covered in this report.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock (Common Stock), par value $.0001, has been publicly
traded since June 25, 1992. From September 21, 1994 through February 25, 1997
the Common Stock traded on the Nasdaq National Market ("NASDAQ") and since
February 26, 1997 the Common Stock has traded on the American Stock Exchange
("AMEX") under the symbol "ERC". On January 26, 1999 there were approximately
1,833 common stockholders of record.
<TABLE>
<CAPTION>
The following table sets forth the range of high and low prices of the Common
Stock on the AMEX and NASDAQ for the fiscal quarters indicated, as reported by
AMEX and the NASDAQ.
Year Ended 10/31/98 High Low
- ------------------- ---- ---
<S> <C> <C>
First Quarter $17.438 $12.750
Second Quarter 29.000 14.875
Third Quarter 24.500 17.250
Fourth Quarter 18.250 9.500
Year Ended 10/31/97 High Low
- ------------------- ---- ---
First Quarter $15.625 $9.750
Second Quarter 13.000 9.375
Third Quarter 10.750 8.500
Fourth Quarter 20.500 9.375
</TABLE>
The Company has never paid any dividends on its Common Stock and does not
anticipate paying any cash dividends in the foreseeable future. The Company
currently anticipates retaining all of its earnings to finance future growth.
Under the terms of the Company's Loan Agreement with First Union Bank of
Connecticut, the Company may not, without the written consent of First Union
Bank, declare or pay any dividend.
20
<PAGE>
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data presented below as of the end
of each of the years in the five-year period ended October 31, 1998 have been
derived from the audited consolidated financial statements of the Company
together with the notes thereto included elsewhere in this Report (the
"Consolidated Financial Statements"). The data set forth below is qualified by
reference to, and should be read in conjunction with, the Consolidated Financial
Statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Report.
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS DATA
(in thousands, except share and per share data)
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net Sales $ 24,318 $ 24,830 $ 29,446 $ 33,955 $ 30,084
Gross Profit 9,728 9,188 8,551 7,696 8,020
Operating Expenses:
Administrative & Selling 6,986 6,081 4,858 4,513 4,730
Depreciation 1,529 1,768 1,919 1,801 1,663
Research & Development 2,258 1,270 1,260 944 1,348
Operating income (loss) (1,045) 69 514 438 279
Interest & other income,
net 267 307 442 317 148
Interest expense (269) (354) (503) (459) (435)
License fee income net 678 650 357 357 364
Income (loss) before income taxes (369) 672 810 653 356
Income tax expense 13 247 301 211 136
Net income (loss) ($ 382) $ 425 $ 509 $ 442 $ 220
--------- --------- --------- --------- ---------
Basic earnings (loss) per share $ (0.09) $ 0.11 $ 0.13 $ 0.12 $ 0.06
Basic shares outstanding 4,081,018 3,954,507 3,796,320 3,714,490 3,692,705
Diluted earnings (loss) per share $ (0.09) $ 0.10 $ 0.13 $ 0.11 $ 0.06
Diluted shares outstanding 4,081,018 4,191,830 4,063,061 3,972,281 3,923,925
BALANCE SHEET DATA
Working capital $ 10,234 $ 6,366 $ 8,087 $ 8,216 $ 7,619
Total assets 26,843 21,433 23,540 23,847 22,515
Long-term debt 1,944 2,699 4,363 6,487 5,839
Total shareholders' equity 15,870 14,769 14,062 12,238 11,685
</TABLE>
21
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company obtains its revenues primarily from government, industry funded
research and development contracts and license fees. These contracts are
generally multi-year, cost reimbursement type contracts The majority of these
are United States Government contracts which are dependent upon the government's
continued allocation of funds.
Under a cost-reimbursement contract, the Company is reimbursed for reasonable
and allocable costs of the materials, subcontracts, direct labor, overhead,
general and administrative expenses, independent research and development costs,
and bid and proposal preparation costs, provided the total of such costs do not
exceed the reimbursement limits set by the contract. In addition, some of these
contracts bear a fixed fee or profit. The profitability of these contracts to
the Company depends upon charging direct costs to contracts, maintaining
adequate control of overhead costs and general and administrative expenses so
they do not exceed the approved billing rates, and limiting the aggregate
reimbursable costs to the allowable amounts set by the contract.
In addition to cost reimbursement contracts, the Company enters into firm
fixed-price contracts and cost-sharing type contracts. In performance of a firm
fixed price contract, the Company is paid the price that is set in advance
without regard to the costs actually incurred in performance, subject to certain
excess profit limitations. In a cost sharing type contract, the Company agrees
in advance to contribute or cause to be contributed an agreed upon amount of
funds, third party services or in-kind services toward fulfilling the objective
of the contract. Except for the Company's cost contributions, the contract
operates in substantially the same manner as a cost reimbursement type contract.
At present, most of the Company's contracts are cost shared and no fee or profit
is allowed. The government contracts and agreements provide for a cost-of-money
recovery based upon capital investment in facilities employed in contract
performance.
Since 1983, when the Company began to shift its emphasis from fuel cells for
military use to commercial applications, the Company's primary focus has been
researching and developing carbonate fuel cells. The funding received for this
research has represented a substantial portion of the Company's revenues.
The Company will continue to seek research and development contracts for all its
product lines. To obtain contracts, the Company must continue to prove the
benefits of its technologies and be successful in its competitive bidding.
Failure to obtain these contracts could have an adverse effect upon the Company.
Because the Company receives a significant portion of its revenues from
contracts with the Department of Energy and other government agencies, future
revenues and income of the Company could be materially affected by changes in
government agency procurement policies, a reduction in expenditures for the
services provided by the Company, and other risks generally associated with
government contracts. In general, the Company's government contracts may be
terminated, in whole or in part, at the convenience of the government. A
reduction or delay in the Company's government funding could have a material
adverse effect on the Company's ability to commercialize its fuel cell
technology.
In 1998, the DOE allocated approximately $12,900,000 increasing the total DOE
funding to $65,800,000 since inception. For the 1999 budget, $15,700,000 is
expected to be allocated to the Company's DOE direct fuel cell cooperative
agreement of which $3,500,000 was awarded in November 1998. Separately the
Company received approximately $3,000,000 in additional funding on its Navy
program for the development of a shipboard direct fuel cell.
During 1998, the funding received for its major cooperative agreement was less
than the amount anticipated due to a DOE budget shortfall. The Company adjusted
its expenditures to the lower funding rates as it had done in prior years. The
Company is currently reviewing 1999 expenditure levels based upon expected
funding from DOE. The result of adjusting expenditure levels may cause delays on
the work being performed under existing contracts, which inevitably cause delays
in the Company's activities and commercialization schedule.
22
<PAGE>
In 1998, the Company decided to accelerate the commercialization of its
proprietary nickel-zinc (Ni-Zi) battery technology. On October 1, 1998, the
Company announced that its Board of Directors had approved a plan to effect a
spin-off to its stockholders of 100% of the shares of Evercel, Inc. In
connection with this transaction, which is expected to occur in early 1999, the
Company plans to transfer to Evercel the principal assets and liabilities
related to the Battery Group.
RESULTS OF OPERATIONS
1998 compared to 1997. Revenues decreased 2% to $24,318,000 in the 1998 period
from $24,830,000 in the 1997 period. The decrease in revenues was primarily due
to the final completion of all activities related to the Direct Fuel Cell power
plant project in Santa Clara, California. The decline was partially offset by an
increase in billings, as compared to fiscal year 1997, on the DOE Agreement and
the contract with the U.S. Navy for the development of ship service fuel cells.
Cost of revenues decreased 7% to $14,590,000 in the 1998 period from $15,642,000
in the 1997 period due to decreased revenues and partially offset by increased
spending levels on research and development.
Administrative and selling expenses increased 15% to $6,986,000 in the 1998
period from $6,081,000 in the 1997 period. The 1998 period reflects an increase
in costs related primarily to the acceleration of the commercialization of the
Ni-Zi battery technology. These included salary and fringe benefits, and legal
and professional costs related to the creation of joint venture and licensing
agreements with the Company's Chinese partner, the unconsummated acquisition of
a battery manufacturing company, and the costs associated with the distribution
and Rights offering in connection with the spin off of the Battery Group. These
costs amounted to $400,000, $280,000, and $240,000, respectively. Depreciation
expense decreased 14% to $1,529,000 in the 1998 period from $1,768,000 in the
1997 period. The decrease was substantially due to completion of the
depreciation period for assets capitalized in 1992 related to the manufacturing
facility in Torrington, which ended February 1, 1998. Research and Development
expenses increased 78% to $2,258,000 in the 1998 period from $1,270,000 in the
1997 period. This was a result of increased costs as compared to fiscal 1997
relating to the commercialization of the battery technology amounting to
$886,000 and to the development of fuel cell technology of $102,000.
License fee income, net, increased 4% to $678,000 in the 1998 period from
$650,000 in the 1997 period. Decreased income resulting from the termination of
the Company's battery license with Corning in May 1998 was more than offset by
increased license fee income from the Nan Ya license.
Interest expense decreased 24% to $269,000 in the 1998 period from $354,000
in the 1997 period due to a decrease in the prime rate and the reduction of
notes payable to MTU.
Interest and other income, net, decreased 13% to $267,000 in the 1998
period from $307,000 in the period. The decrease resulted from lower interest
rates on invested funds.
The effective tax rate decreased to 3.6% in the 1998 period from 36.7% in the
1997 period. The primary reason for the difference in the rate is attributable
to non-deductible expenses for tax purposes relating to the spin off of the
Battery Group.
1997 compared to 1996. Revenues decreased 16% to $24,830,000 in the 1997 period
from $29,446,000 in the 1996 period. The expected decrease in revenues was due
primarily to the completion of the Santa Clara Plant. The decrease was partially
offset by an increase in billings under the Company's other contracts.
Cost of revenues decreased 25% to $15,642,000 in the 1997 period from
$20,895,000 in the 1996 period. The decrease was due primarily to the completion
of the Santa Clara Plant.
Administrative and selling expense increased 25% to $6,081,000 in the 1997
period from $4,858,000 in the 1996 period. The 1997 period reflects an increase
in various expenses including bid and proposal activity, employment costs,
amortization and legal and professional fees. Depreciation decreased 8% to
$1,768,000 in the 1997 period from $1,919,000 in the 1996 period. The decrease
was due substantially to completion of the amortization of costs
23
<PAGE>
associated with the Company's manufacturing facility. Research and
development expense was relatively unchanged at $1,270,000 in the 1997 period
and $1,260,000 in the 1996 period.
Income from operations decreased 87% to $69,000 in the 1997 period from $514,000
in the 1996 period. The decrease was due primarily to the recovery of
non-recurring costs associated with certain Company contracts in the 1996 period
and the incurrence of certain non-recoverable employment related costs due to
the hiring of a new chief executive officer in the 1997 period. The remainder of
the decrease was due to the decrease in the revenues related to the completion
of the Santa Clara Plant.
License fee income, net, increased 82% to $650,000 in the 1997 period from
$357,000 in the 1996 period. The increase was primarily due to the recognition
of license income under the Company's battery license with Corning, Inc.
Interest expense decreased 30% to $354,000 in the 1997 period from $503,000 in
the 1996 period. The decrease was due primarily to the reduction of debt to MTU
as a result of conversion of $666,000 of principal at $9 per share into common
stock of the Company in fiscal 1996 and the repayment of $684,000 of principal
during the first quarter of fiscal 1997. The decrease was also due to the
Company refinancing its bank debt at more favorable terms during the third
quarter of fiscal 1996.
Interest and other income, net, decreased 31% to $307,000 in the 1997 period
from $442,000 in the 1996 period. The decrease was primarily due to the use of
cash for debt repayment during the first quarter of fiscal 1997.
Liquidity and Capital Resources
The Company has funded its operations primarily through cash generated from
operations including government contracts and cooperative agreements,
borrowings, and sales of equity. In 1998, the Company also received License
FeeIncome of $1,500,000 from the Xiamen-Three Circles Co. (formerly Xiamen
Daily-Used Chemicals Co.) and Nan Ya Plastics Corp. license agreement and
$3,000,000 from the Xiamen-Three Circles Co. (formerly Xiamen Daily-Used
Chemicals Co.) Agreement. The $3,000,000 was subsequently invested in the Joint
Venture to obtain a 50.5% ownership position in the Joint Venture.
At October 31, 1998, the Company had working capital of $10,234,000 including
$10,304,000 of cash and cash equivalents, compared to working capital of
$6,366,000 including $6,802,000 of cash and cash equivalents at October 31,
1997. The primary increase in cash is the result of investing the license fee of
$3,000,000 received as part of the Three Circles License Agreement into the
Joint Venture, and the exercise of stock options and purchase of stock under
benefit plans of $858,000.
During 1998, cash of $2,516,000 was provided from operations primarily from
increased deferred income related to the license fees received from the Nan Ya
License Agreement of $1,300,000 and depreciation and amortization of $1,942,000.
Offsetting these increases was a $2,203,000 increase in current assets
(excluding cash) primarily related to increased accounts receivable from the
government, legal and professional expenses related to the spin off and Rights
offering for Evercel, and an increase in deferred taxes related to the deferred
license fee income and accrued incentive costs. Current liabilities increased
$1,837,000 which includes deferred income of $1,300,000 from the Nan Ya License
Agreement, expenses connected to the commercialization of the battery business,
and increased incentive costs. These funds were used to acquire $1,650,000 in
property, plant and equipment and retire $1,701,000 in debt.
The Company's capital expenditures are incurred primarily to support ongoing
contracts and to replace existing equipment. A portion of these expenditures was
financed from the recovery of depreciation expense under cost-reimbursement
contracts and cooperative agreements.
During the 1995 period, the Company entered into a $2,500,000 credit facility
with MetLife Capital Corporation, an affiliate of Metropolitan Life Insurance
Company. The credit facility bears interest at the 30-day commercial paper rate
plus 2.5 percent. The Company used the credit facility during 1995 and 1996 to
acquire machinery and equipment for the Company's manufacturing facility in
Torrington, Connecticut. Repayment of the credit facility commenced during the
1996 period and provides for repayment over 36-50 months.
24
<PAGE>
During the 1996 period, the Company entered lending arrangements with First
Union Bank of Connecticut, a subsidiary of First Union Corporation, which
provide for (i) a $2,250,000 five-year term loan facility, which bears interest
at a floating rate equal to 1.75 percent above London Interbank Offered Rates
(LIBOR), and (ii) a $600,000 term loan facility to the Company's fuel cell
manufacturing subsidiary, which bears interest at a floating rate equal to 1.75
percent above LIBOR. The term loan facility was fully repaid in 1998.
In fiscal year 1990, the Company borrowed $1,980,000 from MTU at a rate of 6%
per annum. The pledge of ERC stock and certain machinery, equipment and
leasehold improvements at the Torrington, CT, facility, secured this loan.
During fiscal 1996, $877,000 of this loan was converted into 97,397 shares of
common stock of the Company. MTU extended the maturity of $630,000 of the loan
to November 30, 1997 with the right to convert to common stock at $9 per share.
During December 1997 the Company paid the entire balance of principal and
interest due in the amount of $673,000.
In December 1994, the Company entered into a Cooperative Agreement with the U.S.
Department of Energy (DOE) pursuant to which the DOE agreed to provide funding
to the Company over the next five years to support the continued development and
improvement of the Company's commercial product. The current aggregate dollar
amount of that contract is $144,000,000 with the DOE providing $86,000,000 in
funding. The balance of the funding is expected to be provided by the Company,
the Company's partners or licensees, other private agencies and utilities.
Approximately 90% of the non-DOE portion has been committed or credited to the
project in the form of in-kind or direct cost share from non-U.S. government
sources. Failure of the Company to obtain the required final 10% of the funding
from non-U.S. government sources on a timely basis, could result in delay or
reduction of DOE funding.
The Company will need to raise additional funds to expand its Direct Fuel Cell
manufacturing capability. The first stage in this process is to raise the output
capability of the Company's manufacturing facility to 50 MW per year.
Approximately $16 million has been estimated for this step. The Company cannot
assure that this funding will be available on favorable terms, if at all, or
that such funding if obtained would enable the Company to achieve the desired
output level. In the interim, the Company is using existing funds to expand
production capacity incrementally. See "Introductory Statement - Forward-looking
Information Disclaimer."
The Company anticipates that its existing capital resources together with
anticipated revenues will be adequate to satisfy its existing financial
requirements and agreements through 1999. However, the Company may require
additional capital beginning in 1999 if the aforementioned plan to expand
manufacturing capability in its Torrington, CT facility is implemented.
Proposed Evercel Spin-off
On October 1, 1998, the Company announced that its Board of Directors had
approved a plan to effect a spin-off to its stockholders of 100% of the shares
of Evercel, Inc. ("Evercel"), a newly formed, wholly-owned subsidiary of the
Company. In connection with this transaction, which is expected to occur in
early 1999, the Company plans to transfer to Evercel the principal assets and
liabilities related to the Battery Group. Following the transfer, the Company
plans to distribute to its stockholders in a tax-free distribution one share of
Evercel Common Stock for every three shares of Common Stock of the Company held.
As of October 31, 1998, the Company had $1,175,000 of assets and $753,000 of
liabilities attributable to the battery business that it intends to transfer to
Evercel. In addition, in fiscal 1998, the Company's revenues and net loss
attributable to the battery business were $438,000 and ($2,201,000),
respectively. In connection with the proposed spin-off, the Company anticipates
that it will also transfer its interest in the Joint Venture and the related
Three Circles License Agreement to Evercel.
Year 2000 Readiness Disclosure
The year 2000 ("Y2K") issue is the potential for system and processing failure
of date-related data and the result of computer-controlled systems using two
digits rather than four to define the applicable year. For example, computer
programs that have date sensitive software may recognize a date using "00" as
the year 1900 rather than
25
<PAGE>
the year 2000. Systems that do not properly recognize date-sensitive
information when the year changes to 2000 could generate system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar ordinary business activities.
The Company is evaluating the Y2K issue with respect to its financial and
management information systems, its products and its suppliers. At this point in
its assessment, the Company is not currently aware of any Y2K problems that are
reasonably likely to have a material effect on the Company's business, results
of operations or financial condition, without taking into account the Company's
efforts to avoid such problems.
The Company believes that its accounting and information systems will be
compliant as a result of installing new software. The Company anticipates that
it will be able to complete, test and implement all upgrades of this software
that may be material to its business on a timely basis. The implementation of
this software is part of an on-going project to upgrade the information systems
at ERC. If this software is not implemented on a timely basis, the cost to
upgrade the existing software would be $18,000. There is a risk that
notwithstanding is internal review, if the Company has not properly identified
all year 2000 compliance issues with respect to its management and information
systems, the Company may not be able to implement all necessary changes to these
systems on a timely basis and within budget. Such a failure could result in a
material disruption to the Company's business, which could have a material
adverse effect on its business, results of operations and financial condition.
The Company is also exposed to the risk that it could experience material
payment or sales delays from its major customers, including the U.S. Government,
due to year 2000 issues relating either to their management information or
production systems. The Company has inquired of these third parties in an
attempt to ascertain their year 2000 readiness. At this time, the Company is
unable to estimate the nature or extent of any potential adverse impact
resulting from the failure of third parties, such as its suppliers and
customers, to achieve year 2000 compliance. Moreover, such third parties, even
if year 2000 compliant, could experience difficulties resulting from year 2000
issues that may affect their suppliers, service providers and customers. As a
result, although the Company does not currently anticipate that it will
experience any material shipment delays from their major product suppliers or
any material payment or sales delays from its major customers due to year 2000
issues, these third parties could experience year 2000 problems that could have
a material adverse effect on the Company's business, results of operations and
financial condition.
Apart from its activities described herein, the Company plans to develop a
contingency plan to address Y2K issues. As the Company is primarily involved in
the research and development of fuel cell technology, it is not subject to major
supply issues at this time. The Company believes that alternate sources of
material are available to supply Company requirements and the Company will
prepare its plans to identify these. To the extent that the Company does not
identify any material non-compliant year 2000 issues affecting the Company or
third parties, such as the Company's suppliers, service providers and customers,
the most reasonably likely worst case year 2000 scenario is a systemic failure
beyond the control of the Company, such as a prolonged telecommunications or
electrical failure, or a general disruption in United States or global business
activities that could result in a significant economic downturn. The Company
believes that the primary business risk will be limited to, loss of customers or
orders, increased operating costs, inability to obtain materials on a timely
basis or other business interruptions of a material nature, as well as claims of
mismanagement, misrepresentation, or breach of contract, any of which could have
a material adverse effect on the Company's business, results of operations and
financial condition.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest
Rate Exposure
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investment portfolio and long term debt obligations.
The investment portfolio includes short term United States Treasury instruments
with maturities of three months or less. Cash is invested overnight with high
credit quality financial institutions. The Company's notes payable expire in
2000 and 2001. Based on the Company's overall interest exposure at October 31,
1998, including all interest rate sensitive instruments, a near-term change in
interest rate movements would not materially affect the consolidated results of
operations or financial position of the Company.
26
<PAGE>
Currency Rate Exposure
The Company's functional currency is the U.S. dollar. During 1998, the Company
invested $3,000,000 in a joint venture. This investment is currently being
maintained in U.S. dollars. Since the cash deposit with the joint venture is in
U.S. dollars, the company's foreign currency risk is limited to the investment
in the joint venture. To the extent that the Company expands its international
operations, the Company will be exposed to increased risk of currency
fluctuation.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated Financial Statements and Supplementary Data of the Company are
listed under Part IV, Item 14, in this report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is contained in part under the caption
"Executive Officers of the Company" contained in Part I hereof and the remainder
is incorporated herein by reference to "Election of Directors" in the Company's
Proxy Statement for the Company's Annual Meeting of Shareholders to be held on
March 30, 1999 (the "1999 Proxy Statement") to be filed with the SEC within 120
days from the fiscal year end.
Item 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the
Section captioned "Executive Compensation " to be contained in the 1999 Proxy
Statement to be filed with the SEC within 120 days from fiscal year end.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to the
Section captioned "Security Ownership of Certain Beneficial Owners and
Management" to be contained in the 1999 Proxy Statement to be filed with the SEC
within 120 days from fiscal year end.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the
Section captioned "Certain Relationships and Related Transactions" to be
contained in the 1999 Proxy Statement to be filed with the SEC within 120 days
from fiscal year end.
27
<PAGE>
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) (1) FINANCIAL STATEMENTS
1) Independent Auditors' Report
KPMG LLP (See page F-2, hereof.)
2) Consolidated Balance Sheets as of October 31, 1998 and 1997 (See page F-3
hereof.)
3) Consolidated Statements of Income (Loss) for Years Ended October 31, 1998,
1997 and 1996 (See page F-4, hereof.)
4) Consolidated Statements of Changes in Common Shareholders' Equity for the
Years Ended October 31, 1998, 1997 and 1996 (See page F-5, hereof.)
5) Consolidated Statements of Cash Flows for the Years Ended October 31, 1998,
1997 and 1996 (See page F-6, hereof.)
6) Notes to Consolidated Financial Statements (See pages F-7 thru F-22,
hereof.)
(A) (2) FINANCIAL STATEMENT SCHEDULES
Supplement schedules are not provided because of the absence of conditions under
which they are required or because the required information is given in the
financial statements or notes thereto.
28
<PAGE>
<TABLE>
<CAPTION>
(A) (3) EXHIBITS
- ----------------
(A) (3) EXHIBITS TO THE 10-K
----------------------------
Method of
Exhibit No. Description Filing
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
3.1 Certificate of Incorporation of the Company, as amended, March 3, 1994
(incorporated by reference to exhibit of the same number contained in the
Company's 10-KSB for fiscal year ended October 31, 1994 dated January 18, 1995)
3.2 Restated By-Laws of the Company, dated December, 1992 (incorporated by reference
to exhibit of the same number contained in the Company's 10-KSB for fiscal year
ended October 31, 1992 dated January 20, 1993)
4 Specimen of Common Share Certificate (incorporated by reference
to exhibit of the same number contained in the Company's Form
8-A, dated September 20, 1994)
10.4 **License Agreement, dated November 24, 1981, between Mitsubishi
Electric and the Company, as amended by Agreements dated
December 4, 1981, June 3, 1983, January 11, 1984, November 20,
1986, November 23, 1988 and November 23, 1991 (confidential
treatment requested) (incorporated by reference to exhibit of
the same number contained in the Company's Amendment No. 1 to
its Registration Statement on Form S-1 (File No. 33-47233) dated
June 1, 1992)
10.6 **License Agreement, dated February 11, 1988, between EPRI and
the Company (confidential treatment requested) (incorporated by
reference to exhibit of the same number contained in the
Company's Registration Statement on Form S-1 (File No. 33-47233)
dated April 14, 1992)
10.9 **License Agreement, dated November 30, 1989, between
Messerschmitt-Daimler Benz and the Company (confidential
treatment requested) (incorporated by reference to exhibit of
the same number contained in the Company's Registration
Statement on Form S-1 (File No. 33-47233) dated April 14, 1992)
10.21 *Energy Research Corporation 1988 Stock Option Plan (incorporated by reference to
exhibit of the same number contained in the Company's Amendment No. 1 to its
Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992)
10.26 Addendum to License Agreement, dated as of September 29, 1989,
between Messerschmitt-Daimler Benz and the Company (incorporated
by reference to exhibit of the same number contained in the
Company's Amendment No. 3 to its Registration Statement on Form
S-1 (File No. 33-47233) dated June 24, 1992)
10.27 Cross-Licensing and Cross-Selling Agreement, dated as of July 16, 1998, between
the Company and MTU Friedrichshafen GmbH.
10.31 License Agreement For The Santa Clara Demonstration Project between the Company
and the Participants in the Santa Clara Demonstration Project, dated September
16, 1993 (incorporated by reference to exhibit of the same number contained in
the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 18,
1994)
10.32 Security Agreement for the Santa Clara Demonstration Project,
dated September 16, 1993 (incorporated by reference to exhibit
of the same number contained in the Company's 10-KSB for fiscal
year ended October 31, 1993, dated January 18, 1994)
29
<PAGE>
10.33 Guaranty By Energy Research Corporation, dated September 16,
1993 for the Santa Clara Demonstration Project (incorporated by
reference to exhibit of the same number contained in the
Company's 10-KSB for fiscal year ended October 31, 1993, dated
January 18, 1994)
10.34 Guaranty by Fuel Cell Manufacturing Corporation, dated September 16, 1993 for the
Santa Clara Demonstration Project (incorporated by reference to exhibit of the
same number contained in the Company's 10-KSB for fiscal year ended October 31,
1993, dated January 18, 1994)
10.36 *The Energy Research Corporation Section 423 Stock Purchase Plan
(incorporated by reference to exhibit of the same number
contained in the Company's 10-KSB for fiscal year ended October
31, 1994 dated January 18, 1995)
10.39 **Cooperative Agreement, dated December 20, 1994, between the
Company and the United States Department of Energy, Cooperative
Agreement #DE-FC21-95MC31184 (confidential treatment requested)
(incorporated by reference to exhibit of the same number
contained in the Company's 10-KSB for fiscal year ended October
31, 1994 dated January 18, 1995)
10.40 Loan and Security Agreement between the Company and MetLife
Capital Corporation. (incorporated by reference to exhibit of
the same number contained in the Company's 10-KSB for fiscal
year ended October 31, 1995 dated January 17, 1996)
10.41 *Amendment No. 2 to the Energy Research Corporation Section 423
Stock Purchase Plan (incorporated by reference to exhibit of the
same number contained in the Company's 10-Q for the period ended
April 30, 1996 dated June 13, 1996
10.42 *Amendments to the Energy Research Corporation 1988 Stock Option Plan
(incorporated by reference to exhibit of the same number contained in the
Company's 10-Q for the period ended April 30, 1996 dated June 13, 1996)
10.43 Loan Agreements with First Union Bank of Connecticut, dated June 28, 1996
(incorporated by reference to exhibit of the same number contained in the
Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996)
10.44 Notes in favor of First Union Bank of Connecticut, dated June 28, 1996
(incorporated by reference to exhibit of the same number contained in the
Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996)
10.45 Security Agreements with First Union Bank of Connecticut, dated June 28, 1996
(incorporated by reference to exhibit of the same number contained in the
Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996)
10.47 Amendment of Cooperative Agreement dated September 5, 1996
between the Company and the United States Department of Energy,
Cooperative Agreement #DE-FC21-95MC31184 (incorporated by
reference to exhibit of the same number contained in the
Company's 10-K for the fiscal year ended October 31, 1998)
10.48 *Employment Agreement between Energy Research Corporation and
the Chief Financial Officer, Treasurer and Secretary, dated
October 5, 1998.
10.49 *Employment Agreement between Energy Research Corporation and
the President and Chief Executive Officer, dated August 1, 1997
(incorporated by reference to exhibit of the same number
contained in the Company's 10-K for the fiscal year ended
October 31, 1997)
30
<PAGE>
10.50 Technology Transfer and License Agreement between the Company
and the Joint Venture owned jointly by the Xiamen Daily-Used
Chemicals Co., Ltd. of China and Nan Ya Plastics Corporation of
Taiwan, dated February 21, 1998 (incorporated by reference to
exhibit of the same number contained in the Company's 10-Q for
the period ended April 30, 1998)**
10.51 Technology Transfer and License Contract, dated May 29, 1998 for
Ni-Zn Battery Technology among Xiamen ERC Battery Corp., Ltd.,
and Xiamen Daily-Used Chemicals Co., Ltd. and the Company
(incorporated by reference to exhibit of the same number
contained in the Company's 10-Q for the period ended July 31,
1998)**.
10.52 Cooperative Joint Venture Contract, dated as of July 7, 1998,
between Xiamen Three Circles Co., Ltd. and the Company for the
establishment of Xiamen Three Circles-ERC Battery Corp., Ltd., a
Sino Foreign Manufacturing Joint Venture (incorporated by
reference to exhibit of the same number contained in the
Company's 10-Q for the period ended July 31, 1998)**.
10.53 Amendment to the Energy Research Corporation 1988 Stock Option Plan, as amended
(incorporated by reference to exhibit of the same number contained in the
Company's 10-Q for the period ended July 31, 1998).
10.54 The Energy Research Corporation 1998 Equity Incentive Plan (incorporated by
reference to exhibit of the same number contained in the Company's 10-Q for the
period ended July 31, 1998).
21 Subsidiaries of the Company (incorporated by reference to
exhibit of the same number contained in the Company's
Registration Statement on Form S-1, (File No.33-47233) dated April 14, 1992)
23.1 Consent of KPMG LLP
27 Financial data schedule
* Management Contract or Compensatory Plan or Arrangement **Confidential
Treatment has been granted for portions of this document.
(b) REPORTS ON FORM 8-K.
None
</TABLE>
31
<PAGE>
Table of Contents
Page
Independent Auditors' Report F-2
Consolidated Balance Sheets - October 31, 1998 and 1997 F-3
Consolidated Statements of Income (Loss) for Years ended
October 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Changes in Common
Shareholders' Equity for the Years ended October 31,
1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows for the Years
ended October 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
F-1
<PAGE>
Independent Auditors' Report
The Board of Directors
Energy Research Corporation:
We have audited the accompanying consolidated balance sheets of Energy Research
Corporation (the "Company") as of October 31, 1998 and 1997, and the related
consolidated statements of income (loss), changes in common shareholders' equity
and cash flows for each of the years in the three-year period ended October 31,
1998. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Energy Research
Corporation as of October 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
October 31, 1998, in conformity with generally accepted accounting principles.
KPMG LLP
January 22, 1999
Stamford, CT
F-2
<PAGE>
ENERGY RESEARCH CORPORATION
Consolidated Balance Sheets
October 31, 1998 and 1997
(Dollars in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,304 6,802
Accounts receivable 3,813 2,828
Inventories 30 47
Deferred income taxes 1,073 205
Other current assets 646 279
------------- -------------
Total current assets 15,866 10,161
Property, plant and equipment, net 8,347 8,254
Other assets, net 2,630 3,018
------------- -------------
Total assets $ 26,843 21,433
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 755 1,702
Accounts payable 620 865
Accrued liabilities 2,928 1,182
Current portion of deferred license fee income 1,329 46
------------- -------------
Total current liabilities 5,632 3,795
Long-term liabilities:
Long-term debt 1,944 2,699
Deferred income taxes 177 170
------------- -------------
Total liabilities 7,753 6,664
------------- -------------
Minority interest 3,220 --
------------- -------------
Shareholders' equity:
Convertible preferred stock, Series C ($.01 par
value); 30,000 shares outstanding in 1998
and 1997 600 600
------------- -------------
Common shareholders' equity:
Common stock, ($.0001 par value);
8,000,000 shares authorized: 4,129,273 and 4,000,650 shares issued
and outstanding in 1998 and 1997, respectively
Additional paid-in capital 12,943 11,460
Retained earnings 2,327 2,709
------------- -------------
Total common shareholders' equity 15,270 14,169
------------- -------------
Total shareholders' equity 15,870 14,769
------------- -------------
Total liabilities and shareholders' equity $ 26,843 21,433
============= =============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-3
<PAGE>
ENERGY RESEARCH CORPORATION
Consolidated Statements of Income (Loss)
Years ended October 31, 1998, 1997 and 1996
(Dollars in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues $ 24,318 24,830 29,446
Costs and expenses:
Cost of revenues 14,590 15,642 20,895
Administrative and selling 6,986 6,081 4,858
Depreciation 1,529 1,768 1,919
Research and development 2,258 1,270 1,260
--------- --------- ---------
Total costs and expenses 25,363 24,761 28,932
--------- --------- ---------
Income (loss) from operations (1,045) 69 514
License fee income, net 678 650 357
Interest expense (269) (354) (503)
Interest and other income, net 267 307 442
--------- --------- ---------
Income (loss) before provision for
income taxes (369) 672 810
Provision for income taxes 13 247 301
--------- --------- ---------
Net income (loss) $ (382) 425 509
========= ========= =========
Basic earnings (loss) per share $ (0.09) 0.11 0.13
========= ========= =========
Basic shares outstanding 4,081,018 3,954,507 3,796,320
========= ========= =========
Diluted earnings (loss) per share $ (0.09) 0.10 0.13
========= ========= =========
Diluted shares outstanding 4,081,018 4,191,830 4,063,061
========= ========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-4
<PAGE>
ENERGY RESEARCH CORPORATION
Statements of Changes in Common Shareholders' Equity Years ended October
31, 1998, 1997 and 1996 (Dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
Shares Total
of Additional common
common paid-in Retained shareholders'
stock capital earnings equity
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Balance at October 31, 1995 3,728,914 $ 9,263 1,775 11,038
Issuance of common stock
under benefit plans 32,809 193 -- 193
Conversion of preferred stock
to common stock 30,000 600 -- 600
Conversion of notes payable
to common stock 97,397 877 -- 877
Warrants exercised 22,667 245 -- 245
Net income -- -- 509 509
--------- --------- --------- --------
Balance at October 31, 1996 3,911,787 11,178 2,284 13,462
Issuance of common stock
under benefit plans 96,621 188 -- 188
Common stock retired (8,119) -- -- --
Conversion of notes payable
to common stock 361 3 -- 3
Tax effect of disposition
of stock options -- 91 -- 91
Net income -- -- 425 425
--------- --------- --------- --------
Balance at October 31, 1997 4,000,650 11,460 2,709 14,169
Compensation for options granted -- 239 -- 239
Issuance of common stock under
benefit plans 15,226 172 -- 172
Common stock retired (2,022) (31) -- (31)
Stock options exercised 115,419 718 -- 718
Tax effect of disposition
of stock options -- 385 -- 385
Net loss -- -- (382) (382)
--------- --------- --------- --------
Balance at October 31, 1998 4,129,273 $ 12,943 2,327 15,270
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-5
<PAGE>
ENERGY RESEARCH CORPORATION
Consolidated Statements of Cash Flows
Years ended October 31, 1998, 1997 and 1996
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (382) 425 509
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Compensation for options granted 239 -- --
Depreciation and amortization 1,942 2,162 2,156
Deferred income taxes (738) (90) 46
Conversion of accrued interest to
principal on long-term debt -- 38 109
(Gain) loss on disposal of property 6 (1) 3
(Increase) decrease in operating assets:
Accounts receivable (985) 20 355
Inventories 17 25 107
Other current assets (367) (48) (144)
Increase (decrease) in operating liabilities:
Accounts payable (245) (367) (1,151)
Accrued liabilities 1,746 63 (476)
Deferred license fee income 1,283 (66) (66)
--------- --------- ----------
Net cash provided by operating activities 2,516 2,161 1,448
--------- --------- ----------
Cash flows from investing activities:
Capital expenditures (1,650) (2,801) (1,904)
Proceeds-sale of marketable securities -- 2,025 2,000
Payments on other assets (3) (77) (97)
--------- --------- ----------
Net cash used in investing activities (1,653) (853) (1)
--------- --------- ----------
Cash flows from financing activities:
Repayment on long-term debt (1,701) (2,382) (3,823)
Sale of minority interest in joint venture 3,220 -- --
Proceeds from long-term financing -- -- 4,113
Common stock issued 858 188 438
Tax effect of stock options exercised 262 91 --
--------- --------- ----------
Net cash provided by (used) in financing activities 2,639 (2,103) 728
--------- --------- ----------
Net increase (decrease) in cash and cash equivalents 3,502 (795) 2,175
Cash and cash equivalents-beginning of year 6,802 7,597 5,422
--------- --------- ----------
Cash and cash equivalents-end of year $ 10,304 6,802 7,597
========= ========= =========
Cash paid during the period for:
Interest $ 269 344 404
Income taxes 620 446 508
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-6
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
(1) Summary of Significant Accounting Policies
Nature of Business
Energy Research Corporation (the Company or ERC) is engaged in the
development of electrochemical technologies for electric power generation
and storage. The Company manufactures fuel cell and battery products,
generally on a contract basis.
The Company's revenues are generated from customers located throughout
the United States, Europe and Asia. The Company generally does not
require collateral in providing credit except for international sales
where a deposit may be required with the purchase orders.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company
and its three subsidiaries: Xiamen Three Circles - ERC Battery Corp., a
50.5% owned joint venture formed between the Company and Xiamen Three
Circle Co., Ltd.; Xiamen-ERC High Technology Joint Venture, Inc. a
66-2/3% owned joint venture formed between the Company and the City of
Xiamen, PRC; and Evercel, Inc. a wholly-owned subsidiary.
Cash and Cash Equivalents
Cash equivalents consist primarily of United States Treasury instruments
issued directly by the agency with original maturities of three months or
less at date of acquisition. The Company places its temporary cash
investments with high credit quality financial institutions.
Inventories
Inventories consist principally of raw materials and are stated at the
lower of cost or market.
Property, Plant and Equipment
Property, plant and equipment are stated at cost, less accumulated
depreciation provided on the straight-line method over the estimated
useful lives of the respective assets. Leasehold improvements are
amortized on the straight-line method over the shorter of the estimated
useful lives of the assets or the term of the lease.
When property is sold or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts and any resulting
gain or loss is reflected in operations for the period.
Intellectual Property
Intellectual property including patents and know-how is carried at no
value.
F-7
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
Revenue Recognition
Revenues and fees on long-term contracts, including government and
commercial cost reimbursement contracts, are recognized on the
percentage-of-completion method. Percentage-of-completion is measured by
costs (including applicable general and administrative) incurred and
accrued to date as compared with the estimated total costs for each
contract. Contracts typically extend over a period of one or more years.
In accordance with industry practice, receivables include amounts
relating to contracts and programs having production cycles longer than
one year and a portion thereof will not be realized within one year.
Provisions for estimated losses, if any, are made in the period in which
such losses are determined. The Company recognized approximately $74, $42
and $1,131 of long-term contract revenues from corporate shareholders of
the Company during fiscal years ended October 31, 1998, 1997 and 1996,
respectively.
License fee income arises from license agreements whereby the Company
grants the right to use Company patents and know-how. Amounts are
deferred and recognized ratably over the respective terms of the
agreements. The Company recognized approximately $266, $316 and $316 of
license fee income during each of the fiscal years ended October 31,
1998, 1997 and 1996, under license agreements with corporate shareholders
of the Company.
Revenues from the U.S. Government and its agencies directly and through
primary contractors were $24,221, $23,377 and $22,410, for the years
ended October 31, 1998, 1997 and 1996, respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date.
Stock Option Plan
Prior to November 1, 1996, the Company accounted for its stock option
plan in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees, and
related interpretations." As such, compensation expense would be recorded
on the date of grant only if the current market price of the underlying
stock exceeded the exercise price.
On November 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which permits entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the
date of grant. Alternatively, SFAS No. 123 also allows entities to
continue to apply the provisions of APB Opinion No. 25 and provide pro
forma net income and pro forma earnings per share disclosures for
employee stock option grants made in fiscal years beginning after
December 15, 1994 as if the fair-value-based method defined in SFAS No.
123 had been applied. The Company has elected to continue to apply the
recognition provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
F-8
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
Earnings Per Share (EPS)
Basic earnings per share are based upon the weighted average common
shares outstanding during the period. Diluted earnings per share assume
exercise of in-the-money stock options outstanding and full conversion of
convertible preferred stock into common stock at the beginning of the
year or the date of issuance, unless they are antidilutive.
Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements
in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
Impairment of Long-Lived Assets
The Company adopted the provisions of SFAS No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
of," in fiscal year 1997. This Statement requires that long-lived assets
and certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset to
future undiscounted net cash flows expected to be generated by the asset.
If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs to
sell. Adoption of this Statement did not have a material impact on the
Companys financial position, results of operations, or liquidity.
Accounting Changes
FASB Statement No. 128 - Effective the first quarter ending January 31,
1998 the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 128 - "Earnings per Share." SFAS No. 128 simplifies the
calculation of earnings per share (EPS), replaces primary EPS with basic
EPS and replaces fully diluted EPS with diluted EPS.
Basic EPS is computed by dividing income available to common stockholders
by the weighted average number of common shares outstanding during the
period. The computation of diluted EPS is similar to the computation of
basic EPS except that it gives effect to all potentially dilutive
instruments that were outstanding during the period. In 1998, the Company
has computed EPS without consideration to potentially dilutive
instruments due to the loss incurred by the Company.
FASB Statement No. 129 - Effective October 1998, the Company adopted
No.129, "Disclosure of Information about Capital Structure". The
statement lists required disclosures about capital structure. SFAS No.
129 did not require any revisions to the Company's existing disclosures.
FASB Statement No. 130 - Effective November 1, 1998, the Company
adopted SFAS No. 130, "Reporting Comprehensive Income". The
statement establishes standards for reporting and display of
comprehensive income and its components in a full set of general
purpose financial statements. For the Company, comprehensive income
is the same as net income (loss).
F-9
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
FASB Statement No. 131 - In June 1997, SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information" , was issued by the
FASB. This Statement establishes standards for the way that public
business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial
reports issued to shareholders. This standard is effective for fiscal
years beginning after December 15, 1997. It also establishes standards
for related disclosures about products and services, geographic areas,
and major customers. The statement address presentation and disclosure
matters and will have no impact on the Company's financial position or
results of operations.
FASB Statement No. 133 - In June 1998, the Financial Accounting Standard
Board issued SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities". It requires that an entity recognize all derivative
instruments as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. This statement is
effective for all fiscal quarters of fiscal years beginning after June
15, 1999. The Company does not expect the adoption of this statement to
have a material impact on its financial position or results of
operations.
During 1998, the American Institute of Certified Public Accountants
("AICPA") released its Statement of Position No. 98-1 ("SOP 98-1")
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" and Statement of Position No. 98-5 ("SOP 98-5") "Reporting
on the Costs of Start-Up Activities," both of which are effective for
fiscal years beginning after December 15, 1998. SOP 98-1 requires that
certain costs related to the development or purchase of internal-use
software be capitalized and amortized over the estimated useful life of
the software. SOP 98-1 also requires that the costs related to the
preliminary project stage and the post-implementation stage of an
internal-use computer software development project be expensed as
incurred. SOP 98-5 requires that the costs of start-up activities be
expensed as incurred. SOP 98-5 requires companies to report the initial
application of the standard as a cumulative effect of an accounting
change. The Company is not required to adopt these standards until fiscal
2000. Management believes that the adoption of these standards will not
have a material effect on the Company's results.
(2) Joint Ventures and License Agreements
In February 1998, The Company entered into a license agreement (the
"NanYa License Agreement") with a joint venture between Nan Ya Plastics
Corporation of Taiwan, a Formosa Plastics Group company, and Xiamen Three
Circles Co., Ltd. of Xiamen, China for the use of the Company's Ni-Zn
batteries in EV/HEVs in China, Taiwan, Hong Kong and Macao on an
exclusive basis and for certain other Southeast Asian countries on a
non-exclusive basis. The license agreement calls for the payment of $5
million in three stages and a royalty for the exclusive and non-exclusive
territories. The payments include $1.5 million received by the Company in
1998, of which amount $1.3 million is recorded as deferred income pending
achievement of certain test results, a further $2 million to be paid to
the Company upon completion of certain conditions which the Company
expects will occur in the second fiscal quarter of 1999, and a final
payment of $1.5 million to be paid to the Company upon completion of
duplication of the battery at its facilities in China. The NanYa License
Agreement provides that the Company has the right to invest the final
payment in equity in the joint venture manufacturing and sales
organization formed between NanYa Plastics and Xiamen Three Circles Co.,
Ltd.
In July 1998, the Company also entered into a Technology Transfer and
License Contract (the "Three Circles License Agreement") with Xiamen
Three Circles-ERC Battery Corp., Ltd. for the use of the Company's Ni-Zn
batteries in electric bicycles, scooters, three-wheel vehicles, off-road
vehicles, and miner's safety lamps in China on an exclusive basis and in
Southeast Asia on a non-exclusive basis. The license included an initial
payment to the Company of $3 million. Pursuant to the Three Circles
License Agreement, the Joint Venture must also pay the Company certain
royalties based upon the net sales of Ni-Zn
F-10
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
batteries sold, leased or transferred in the applicable territories. In
addition the Joint Venture may sub-license the Company's technology to
third parties in China, Hong-Kong, Taiwan and Macao on a non-exclusive
basis. In connection with the Three Circles License Agreement, the
Company entered into a joint venture agreement with Xiamen Three Circles
Co., Ltd., used this $3 million as its initial investment in the joint
venture, and received a 50.5% share of the joint venture called Xiamen
Three Circles-ERC Battery Corp. (the "Joint Venture"). Through October
31, 1998, the results of operations of the Joint Venture are immaterial.
During 1998 the Company also formed a joint venture with the City of
Xiamen, China, called Xiamen-ERC High Technology Joint Venture, Inc. This
joint venture has been formed to fund other entities, such as Xiamen
University, to conduct research in advanced electrochemical technologies,
which will benefit the Company and Xiamen. The Company has invested $400
of capital into this joint venture.
(3) Accounts Receivable
Accounts receivable at October 31, 1998 and 1997 consisted of the
following:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
U.S. Government:
Amount billed $ 382 102
Unbilled recoverable costs 2,361 2,156
Retainage 724 420
---------- ----------
3,467 2,678
---------- ----------
Commercial Customers:
Amount billed 56 88
Unbilled recoverable costs 283 32
Retainage 7 7
Other -- 23
---------- ----------
346 150
---------- ----------
$ 3,813 2,828
---------- ----------
</TABLE>
Unbilled receivables represent amounts of revenue recognized on costs
incurred on contracts in progress which will be billed within the next 30
days. The balances billed but not paid by customers pursuant to retainage
provisions in the contracts will be due upon completion of the contracts
and acceptance by the customer.
F-11
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
(4) Property, Plant and Equipment
Property, plant and equipment at October 31, 1998 and 1997 consisted of
the following:
<TABLE>
<CAPTION>
Estimated
1998 1997 Useful Life
------------ ------------ -----------
<S> <C> <C> <C>
Land $ 524 524 --
Building and improvements 4,508 4,362 30 years
Machinery and equipment 15,121 13,983 3-8 years
Furniture and fixtures 1,409 1,369 6-10 years
Construction in progress 1,938 1,738
---------- ----------
23,500 21,976
Less, accumulated
depreciation and
amortization (15,153) (13,722)
---------- ----------
$ 8,347 8,254
---------- ----------
</TABLE>
(5) Other Assets
Other assets at October 31, 1998 and 1997 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Power Plant License $ 2,221 2,504
Other 409 514
---------- ----------
Total $ 2,630 3,018
---------- ----------
</TABLE>
The Power Plant License is being amortized over 10 years. Accumulated
amortization was $1,374, $1,091, and $767 at October 31, 1998, 1997 and
1996, respectively.
F-12
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
(6) Long-Term Debt
Long-term debt at October 31, 1998 and 1997 consisted of the following:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Note payable (a) -- 668
Note payable (b) 774 1,408
Note payable (c) -- 250
Note payable (d) 1,925 2,075
---------- ----------
2,699 4,401
Less - current portion (755) (1,702)
---------- ----------
Long-term debt, less
current portion $ 1,944 2,699
---------- ----------
</TABLE>
(a) On November 30, 1989, Daimler Benz affiliate MTU-Friedrichshafen
GmbH (MTU) loaned $500 and $1,480 to ERC, evidenced by two 6%
promissory notes. The notes are collateralized by a pledge of
stock and a first priority lien on all current and future assets,
acquired with the proceeds of this loan, until the notes are
satisfied in full. During 1996, $877 of principal and deferred
interest was converted into 97,397 shares of common stock of the
Company. In 1998, the Company repaid in full $673 of principal and
accrued interest.
(b) During 1995, the Company entered into a $2,500 credit facility
with GE Capital (formerly MetLife Capital Corporation, an
affiliate of Metropolitan Life Insurance Company). Repayment of
this note commenced during 1996 and expires February 2000. The
note is payable in monthly installments of $53 plus interest. The
interest on this note is payable at the thirty-day commercial
paper rate plus 2-1/2%. At October 31, 1998, the commercial paper
rate was 5.09%. All borrowings under this credit facility are
collateralized by certain assets acquired with the proceeds of
this loan.
(c) The note is payable to First Union Bank in monthly installments of
$25 plus interest. Interest on this note is payable at the London
Interbank Offered Rate (LIBOR) plus 1.75%. During 1998, this loan
was paid in full.
(d) The note is payable to First Union Bank in monthly installments of
$13 plus interest. Interest on this note is payable at LIBOR plus
1.75% or 7.19% at October 31, 1998.
The borrowings under the First Union Bank agreement are
collateralized by a substantial portion of the Company's equipment
and other assets, and a mortgage note in (d) above is
collateralized by a first mortgage on the Company's Danbury,
Connecticut location. The credit agreement associated with the
Notes above require the Company to maintain certain financial
covenants, including tangible net worth, debt service coverage and
liabilities to tangible net worth.
As of October 31, 1998, the above notes payable mature as follows:
fiscal 1999, $755; fiscal 2000, $319; fiscal 2001, $1,625.
F-13
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
(7) Commitments and Contingencies
The Company has been notified by the United States Environmental
Protection Agency (EPA) that it is a potentially responsible party
associated with Gallup's Quarry in Plainfield, Connecticut, which is a
National Priorities List site under the Superfund. The alleged disposal
at this site took place in 1977. An agreement between the potentially
responsible parties (PRP's) and the EPA has been achieved. The PRP's have
agreed among themselves as to how to distribute the cost. The Company has
been assessed $87 and has paid $83 as its share. The Company does not
believe its share of the remediation costs will have a significant impact
on the Company's results of operations or financial position.
The Company leases certain EDP and office equipment and the Torrington,
Connecticut manufacturing facility, and office space in Washington, D.C.
under operating leases expiring on various dates through 2003. Rent
expense was $472, $463 and $460 for the fiscal years ended October 31,
1998, 1997 and 1996, respectively. Aggregate minimum annual payments
under the lease agreements for the five years subsequent to October 31,
1998 are: 1999, $375; 2000, $375; 2001, $115; 2002, $14; and 2003, $9.
The Company has an agreement with Electric Power Research Institute
(EPRI) pursuant to which ERC has agreed to pay EPRI royalties based upon
commercial sales of carbonate fuel cells.
In connection with certain contracts and grants from the United States
Department of Energy (DOE), ERC has agreed to pay DOE 10% of the annual
license income received from MTU, up to $500. Through 1998, ERC has paid
to DOE a total of $225.
(8) Shareholders' Equity
The Company's common shares are currently traded on the American Stock
Exchange. In connection with the Company's public offering of its common
stock in 1992, the Company sold to the underwriters, at a nominal price,
warrants to purchase from the Company 80,000 shares of common stock at
$10.80 per share which were exercisable for a period of four years
commencing June 25, 1993. During 1996, 22,667 warrants were exercised.
The remaining warrants expired June 25,1997.
The Company is authorized to issue a total of 250,000 shares of preferred
stock, the character of which is determined by the Board of Directors
(the Board). During the year ended October 31, 1994, the Company agreed
to exchange 120,000 shares of redeemable, nonconvertible Preferred "B"
Shares for 60,000 shares of convertible, nonredeemable Preferred "C". The
redemption value of the Preferred "B" was $1,200. The Preferred "C"
Shares originally had a liquidation preference of $1,200 and are
convertible into shares of common stock on a one-for-one basis. During
1996, 30,000 shares of Preferred "C" were converted to 30,000 shares of
the Company's common stock.
At October 31, 1998, 858,157 shares of common stock have been reserved
for issuance pursuant to the Company's stock option plans, the
convertible Preferred "C" Stocks and the Company's Section 423 Stock
Purchase Plan.
(9) Stock Option Plan
The Board has adopted 1988 and 1998 Stock Option Plans (collectively the
Plans). Under the terms of the Plans, options to purchase up to 1,201,000
shares of common stock may be granted to officers, key employees and
directors of the Company. Pursuant to the Plans, the Board is authorized
to grant incentive stock options or nonqualified options and stock
appreciation rights to officers and key employees of the Company and may
grant nonqualified options and stock appreciation rights to directors of
the Company.
F-14
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
Stock options and stock appreciation rights have restrictions as to
transferability. The option exercise price shall be fixed by the Board
but, in the case of incentive stock options, shall not be granted at an
exercise price less than 100% of the fair market value of the shares
subject to the option on the date the option is granted. Stock
appreciation rights may be granted in conjunction with options granted
under the Plans. Stock appreciation rights shall be exercisable during
the period and to the extent related stock options are exercisable. Upon
exercise, the holder of a stock appreciation right is entitled to receive
in cash or stock, the excess fair market value of one share of common
stock over the related option price per share multiplied by the number of
shares subject to the right. Stock options that have been granted are
exercisable commencing one year after grant at the rate of 25% of such
shares in each succeeding year. There are no stock appreciation rights
outstanding at October 31, 1998.
In 1997, in connection with the hiring of the Company's Chief Executive
Officer, options were granted to purchase 149,000 shares of the Company's
common stock at the Purchase price of $9.875 per share (the market value
at the date of the grant). The Company also granted options to purchase
an additional 101,000 shares at $9.875 per share based upon the approval
of the shareholders at the 1998 annual meeting of the shareholders.
The per share weighted-average fair value of stock options granted in
1998, 1997 and 1996 was $7.99, $7.15 and $8.06, respectively, on the date
of grant using the Black Scholes option-pricing model with the following
weighted-average assumptions:
<TABLE>
<CAPTION>
Risk free
Dividend interest rate Expected Volatility
Year rate range life factor
---- -------- ------------- -------- ----------
<S> <C> <C> <C> <C>
1998 0% 4.31-4.43% 10 years .5495
1997 0% 6.07-6.66% 10 years .5044
1996 0% 5.63-5.71% 10 years .5044
</TABLE>
The Company applies APB Opinion No.25 in accounting for its Plan and,
accordingly, no compensation cost has been recognized for its stock
options in the financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options under SFAS No.123, the Company's net income would have been
reduced to the pro forma amounts indicated below.
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net income: As reported $ (382) 425 509
Pro forma $ (569) 39 476
Earnings per share: As reported - Basic $ (0.09) 0.11 0.13
Pro forma - Basic $ (0.14) 0.01 0.13
As reported - Diluted $ (0.09) 0.10 0.13
Pro forma - Diluted $ (0.14) 0.01 0.12
</TABLE>
F-15
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
Pro forma net income reflects only options granted in 1998, 1997 and
1996. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No.123 is not reflected in the pro forma net
income amounts presented above because compensation cost is reflected
over the options' vesting period, generally 4 years, and compensation
cost for options granted prior to November 1,1995 is not considered.
The following table summarizes the plan activity for the years ended
October 31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
Number Weighted average
of shares option price
--------- ----------------
<S> <C> <C>
Outstanding at October 31, 1995 281,200 $ 4.26
Granted 30,000 $ 12.25
Exercised (21,300) $ 4.33
Outstanding at October 31, 1996 289,900 $ 5.08
Granted 219,000 $ 10.60
Exercised (91,232) $ 1.85
Outstanding at October 31, 1997 417,668 $ 8.68
Granted 151,000 $ 10.91
Exercised (115,269) $ 6.28
Cancelled (3,000) $ 12.25
Outstanding at October 31, 1998 450,399 $ 9.70
</TABLE>
The following table summarize information about stock options outstanding
and exercisable at October 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options exercisable
----------------------------------- ---------------------------
Weighted
average Weighted Weighted
remaining average average
Range of exercise Number contractual exercise Number exercise
price outstanding life price exercisable price
----------- ----------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 4.50 37,399 1.9 years $ 4.50 37,399 $ 4.50
$ 9.75 - $ 13.00 413,000 7.7 years $ 10.17 192,000 $ 10.39
</TABLE>
F-16
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
The shareholders of the Company adopted a Section 423 Stock Purchase Plan
at the April 30, 1993 Annual Meeting. The total shares allocated to the
Plan are 150,000. The shares are offered to employees over an eight-year
period commencing January 1, 1993. It allows an employee with one year of
service to purchase up to 300 shares per year at 85% of the lower of the
average price on the day of grant or issue. An employee may not sell the
stock for six months after the date of issue.
Plan activity for the years ended October 31, 1998, 1997 and 1996, was as
follows:
Number of Shares
----------------
Balance at October 31, 1995 136,882
Issued @ $8.50 (1,659)
Issued @ $8.82 (9,850)
--------
Balance at October 31, 1996 125,373
Issued @ $10.31 (1,076)
Issued @ $8.55 (4,313)
--------
Balance at October 31, 1997 119,984
Issued @ $8.55 (6,997)
Issued @ $13.65 (8,229)
--------
Balance at October 31, 1998 104,758
--------
(10) Employee Benefits
The Capital Accumulation Plan for employees of Energy Research
Corporation was established by the Company on January 19, 1987 and was
last amended on June 1, 1997. The Plan is administered by a three-member
pension committee. The plan is a 401(k) plan covering full-time employees
of the Company who have completed one year of service. The Company
contributes an amount equal to 5% of each participant's W-2 compensation
to the plan on a monthly basis. Participants are required to contribute
3% and may make voluntary contributions up to an additional 7% of W-2
compensation out of pretax earnings. Effective June 1, 1997, participants
may make voluntary contributions up to an additional 6% of W-2
compensation out of after-tax earnings. The Company charged $435, $412
and $395 to expense during the years ended October 31, 1998, 1997 and
1996, respectively.
The Energy Research Corporation Pension Plan, a defined contribution plan
was established by the Company on May 10, 1976 and was last amended on
June 1, 1997. The Plan covers full-time employees of the Company who have
completed one year of service. The Company contributes an amount equal to
4% effective April 1, 1993 (previously 5%) of each participant's W-2
compensation to the plan on a monthly basis. Participants are not
required to contribute to the plan but may make voluntary contributions
up to an additional 6% of W-2 compensation out of after-tax earnings
through May 31, 1997. After May 31, 1997, participants are not permitted
to make contributions to the Plan. The Company charged $343, $346 and
$320, to expense during the years ended October 31, 1998, 1997 and 1996,
respectively.
F-17
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
(11) Income Taxes
The Company's deferred tax assets and liabilities consisted of the
following at October 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
Deferred tax assets:
Deferred revenue $ 573 --
Compensation recognized on options 121 26
Incentive bonuses 150 --
Capital loss carryforward 24 55
Vacation accrual 34 113
Self-insurance 53 49
Royalty income -- 19
Tax credit carryforwards 140 --
Other 26 11
--------- ---------
Gross deferred tax assets 1,121 273
Valuation allowance 24 55
--------- ---------
Deferred tax assets after
valuation allowance 1,097 218
--------- ---------
Deferred liability -
Accumulated depreciation (201) (183)
--------- ---------
Gross deferred tax
liability (201) (183)
--------- ---------
Net deferred tax assets/(liability) $ 896 35
--------- ---------
</TABLE>
Management believes that the result of future operations will generate
sufficient taxable income to realize deferred tax assets.
The components of Federal income tax expense (benefit) were as follows
for the years ended October 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal $ 122 327 236
Foreign 460 10 10
-------- ------- -------
582 337 246
-------- ------- -------
Deferred:
Federal (569) (90) 55
Foreign -- -- --
-------- ------- -------
(569) (90) 55
Total income tax expense $ 13 247 301
-------- ------- -------
</TABLE>
F-18
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
The components of state income tax expense which are included in
administrative and selling expenses were as follows for the years ended
October 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Current $ 227 148 91
Deferred (169) (9) (7)
------ ------ ------
Total state income tax expense $ 58 139 84
</TABLE>
The reconciliation of the federal statutory income tax rate to the
Company's effective income tax rate for the years ended October 31, 1998,
1997 and 1996 was as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Statutory Federal
income tax rate (34.0%) 34.0% 34.0%
Nondeductible expenditures 34.8 -- --
Other, net 2.8 2.7 3.2
------ ------ ------
Effective income tax rate 3.6% 36.7% 37.2%
------ ------ ------
</TABLE>
(12) Earnings Per Share
Basic and diluted earnings per share are calculated based upon the
provisions of SFAS No. 128, using the following data:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Weighted average basic
Common shares 4,081,018 3,954,507 3,796,320
Effect of dilutive securities
Stock options -- 137,323 236,741
Preferred "C" Convertible -- 30,000 30,000
Convertible debt -- 70,000 --
--------- --------- ---------
Weighted average basic
Common shares adjusted
for diluted calculations 4,081,018 4,191,830 4,063,061
--------- --------- ---------
</TABLE>
F-19
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
The computation of diluted loss per share for fiscal year 1998 follows
the basic calculation since common stock equivalents were antidilutive.
The weighted average shares of dilutive securities that would have been
used to calculate diluted EPS had their effect not been antidilutive are
as follows:
Stock options 522,720
Preferred "C" Convertible 30,000
-------
Total 552,720
-------
(13) Proposed Spin Off Of Battery Group
On October 1, 1998, the Company announced that its Board of Directors had
approved a plan to effect a spin-off to its stockholders of 100% of the
shares of Evercel, Inc. ("Evercel"), a newly formed, wholly-owned
subsidiary of the Company. In connection with this transaction, which is
expected to occur in early 1999, the Company plans to transfer to Evercel
the principal assets and liabilities related to its Battery Group.
Following the transfer, the Company plans to distribute to its
stockholders in a tax-free distribution one share of Evercel Common Stock
for every three shares of Common Stock of the Company. Immediately after
the distribution of Evercel's shares to the Company's stockholders, in
order to fund its commercialization efforts, Evercel plans to conduct a
rights offering to its stockholders. Evercel expects to grant at no cost
to holders of its Common Stock, transferable subscription rights
("Rights") to subscribe for and purchase an additional share of Evercel's
Common Stock. Each holder of Evercel's Common Stock is expected to
receive one Right for each share of Evercel Common Stock held on the
record date (which has not yet been determined). Each Right will be
exercisable, for a period of approximately 30 days, to purchase one share
of Common Stock of Evercel at a purchase price of $6.00 per share. The
Rights offering will be made only by means of a Prospectus which will be
delivered to stockholders concurrently with the distribution. The
transaction remains subject to the satisfaction of certain conditions.
As part of the separation of Evercel's business from the Company, Evercel
will enter into various agreements with the Company including a
Distribution Agreement, Tax Sharing Agreement, Service Agreement and
License Assistance Agreement.
The Distribution Agreement will provide for, among other things, the
principal corporate transactions required to effect the Distribution, the
transfer to Evercel of the assets of the battery business, the division
between the Company and Evercel of certain liabilities and obligations,
the distribution by the Company of all outstanding shares of the Evercel
Common Stock to the Company stockholders and certain other agreements
governing the relationship between the Company and Evercel after the
Distribution. Subject to certain exceptions, the Distribution provides
for assumptions of obligations and liabilities and cross-indemnities
designed to allocate financial responsibility for the obligations and
liabilities arising out of or in connection with the battery business to
Evercel and financial responsibility for the obligations and liabilities
arising out of or in connection with the fuel cell business to the
Company.
The Tax Sharing Agreement defines the parties' rights and obligations
with respect to the filing of returns, payments, etc. relating to the
Company business for periods prior to and including the Distribution and
with respect to certain tax attributes of the Company after the
distribution.
F-20
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
The Services Agreement provides that the Company will provide to Evercel
certain management and administrative services, as well as the use of
certain office, research and development, manufacturing and support
facilities and services of the Company. The Services Agreement shall
continue until terminated by either party upon 120 days' notice. In
addition, Evercel may terminate the Services Agreement as to one or more
of the Services upon 60 days' notice to the Company.
The types of services to be provided pursuant to the Services Agreement
by the Company, through its employees, include financial reporting,
accounting, auditing, tax, office services, payroll, human resources,
analytical lab, microscopic analysis, machine shop and drafting, as well
as the part time management services of the Company Chief Executive
Officer and Chief Financial Officer. The Company will also provide
office, research and development and manufacturing space for Evercel.
The method of calculating the applicable charges to be paid by Evercel
for each type of service are set forth in the Services Agreement; such
charges are payable quarterly.
The Company estimates that the net fees to be paid to the Company for
services performed will initially be approximately $208 per quarter,
excluding certain services billed on the basis of usage, such as
purchasing, analytical lab, microscope analysis, machine shop and
drafting, which amount takes into account the Company's additional costs
related to providing such services, and will decline as the services
performed decrease. Evercel presently expects that most of such services
will be provided by the Company for approximately one year.
In connection with the proposed spin-off, the Company and Evercel will
enter into a License Assistance Agreement pursuant to which Evercel will
provide all services and assistance necessary for Evercel to effectively
fulfill, on behalf of the Company, all of ERC's obligations under the
Joint Venture Contract and the License Contract, until such time as the
Company obtains the approval for the assignment of the agreements to
Evercel. In return for such assistance, the Company will pay Evercel an
amount equal to the sum of all money, dividends, profits, reimbursements,
distributions and payments actually paid to the Company in cash or in
kind or otherwise accruing to the Company pursuant to the Joint Venture
Contract and the License Contract. All expenses and costs incurred by
Evercel in meeting the obligations under the License Assistance Agreement
shall be solely those of Evercel, and the Company shall not be liable for
their payment. Evercel will account for its involvement in the Joint
Venture under the License Assistance Agreement in a manner similar to the
equity method of accounting. Upon execution of the License Assistance
Agreement the Company will relinquish its rights under the Joint Venture
Contract and License Contract and, accordingly, will deconsolidate its
interest therein.
(14) Subsequent Events
On December 4, 1998, the Company gave notice, pursuant to Section 2.2 of
the Exchange Agreement dated as of April 30, 1994 between Sanyo Electric
Co., Ltd a Japanese Corporation and the Company, requiring the exchange
of ERC's 30,000 shares of Series C Preferred Stock held by Sanyo into the
equivalent number of shares of ERC's Common Stock, $.001 par value. This
transaction is expected to complete in February, 1999.
F-21
<PAGE>
ENERGY RESEARCH CORPORATION
Notes to Consolidated Financial Statements
October 31, 1998 and 1997
(dollars in thousands except share and per share amounts)
On December 22, 1998, Evercel entered into a commitment to borrow up to
$1,000 for the purpose of acquiring machinery and equipment. As of
January 22, 1999, Evercel had borrowed $500 against this commitment. The
notes are due on June 30, 1999. ERC has unconditionally guaranteed the
commitment and has pledged $1,000 of cash. The Note is payable from the
proceeds of the planned Evercel Rights Offering.
On January 15, 1999, Evercel entered into a lease for manufacturing and
office space in Danbury, CT. The lease term is five years with a five
year option to extend. The annual rent is $171 for the first three years
and increases to $178 in year four and $185 in year five. ERC has
guaranteed the performance of the lease. In the event of a default by
Evercel, ERC's liability is limited to $500 reduced each anniversary date
of the lease by $100. Notwithstanding the foregoing, the guaranty
terminates after the first anniversary of the lease upon Evercel's Net
Worth exceeding $3,000.
F-22
<PAGE>
PART IV
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
ENERGY RESEARCH CORPORATION
/s/ Jerry D. Leitman
- --------------------
Jerry D. Leitman, President
Dated: January 28, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons, on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Capacity Date
- --------- -------- ----
/s/ Jerry D. Leitman
- ------------------------- Chief Executive Officer, President,
Jerry D. Leitman Director (Principal Executive
Officer) January 28, 1999
/s/ Joseph G. Mahler
- ------------------------ Chief Financial Officer, January 28, 1999
Joseph G. Mahler Vice President,Corporate Secretary,
Treasurer(Principal Accounting and
Financial Officer)
/s/ Warren D. Bagatelle
- ------------------------- Director January 28, 1999
Warren D. Bagatelle
/s/ Christopher R. Bentley
- -------------------------- Director January 28, 1999
Christopher R. Bentley
/s/ Michael Bode
- -------------------------- Director January 28, 1999
Michael Bode
/s/ James D. Gerson
- -------------------------- Director January 28, 1999
James D. Gerson
/s/ Thomas L. Kempner
- -------------------------- Director January 28, 1999
Thomas L. Kempner
/s/ William A. Lawson
- -------------------------- Director January 28, 1999
William A. Lawson
31
<PAGE>
/s/ Hansraj C. Maru
- -------------------------- Director January 28, 1999
Hansraj C. Maru
/s/ Richard M.H. Thompson
- -------------------------- Director January 28, 1999
Richard M.H. Thompson
/s/ Bernard S. Baker
- -------------------------- Director January 28, 1999
Bernard S. Baker
32
<PAGE>
Confidential Treatment has been
Requested for Portions of this
document, Deleted portions are
marked with an asterisk
AGREEMENT
by and between
ENERGY RESEARCH CORPORATION (ERC)
and
MTU MOTOREN-UND TURBINEN-UNION FRIEDRICHSHAFEN GmbH (MTU)
This Agreement is made and entered into this 16th day of July, 1998 (the
Effective Date) by and between ERC and MTU.
WHEREAS
ERC and MTU presently are parties to the License Agreement of September 29, 1989
(the CELL LICENSE AGREEMENT), which remains in full force and effect, and
ERC has developed "Balance of Plant" ("BOP") technologies for its compact Direct
Fuel Cell power plant design including 4 (four) vertical stacks in a container,
and
MTU has developed BOP technologies for its compact fuel cell power plant design
including 1 (one) horizontal stack(s) in a container, and
ERC and MTU both wish to obtain the mutual benefits and technological advantages
of a cross-license between the Parties by sharing their respective BOP
technologies, including technical efforts, designs, patents and know how
developed or to be developed by each, and
ERC and MTU both wish to obtain the mutual benefits and technical advantages, of
a cross-selling of BASE MODULES, and
ERC and MTU both understand and agree that the BOP technologies which are the
subject matter of this BOP license are not included in the existing CELL LICENSE
AGREEMENT, and
ERC warrants, represents and agrees that it has the capacity and authority to
grant the BOP license hereunder and to be bound by the terms of this agreement,
and
MTU warrants, represents and agrees that it has the capacity and authority to
grant the BOP license hereunder and to be bound by the terms of this agreement.
1
<PAGE>
THEREFORE
In consideration of the mutual covenants contained herein, ERC and MTU agree as
follows:
Article I - Definitions
1 . The term "BALANCE OF PLANT" or "BOP" shall mean all subsystems necessary
for operation and generation of electrical power by Molten Carbonate Fuel
Cells (but excluding fuel cell technology included in the CELL LICENSE
AGREEMENT) in one or more stacks and including, but not limited to base
modules, fuel pre-treatment, boilers, water recovery, fuel exhaust burner,
inverter, control system, utility interface and start-up and stand-by
equipment,
2. The term "BOP KNOW HOW" shall mean any and all information, whether or not
patented or patentable, of ERC and MTU in respect of BOP which presently
and/or during the life of this Agreement are or may be useful in the
design, development, manufacture and/or use of the BOP and are known to,
possessed or acquired by ERC and/or MTU during the life of this Agreement,
subject to any third party confidentiality agreements.
3. The term "ERC BASE MODULE" shall mean 4 (four) vertical stacks in a
container.
4. The term "MTU BASE MODULE" shall mean 1 (one) horizontal stack(s) in a
container, known as the "Hot Module".
Article II - BOP Cross License
1. ERC and MTU each grant to the other a non-exclusive BOP license to sell,
use, make or have made, use and/or practice their respective BOP KNOW HOW
(the "BOP LICENSES")
2. Sub-licenses of ERC's or MTU's BOP KNOW HOW may only be granted upon prior
written approval by MTU or ERC respectively.
3. The BOP LICENSE granted herein by MTU to ERC is a non-exclusive license for
end use in the territories of USA, Canada and Mexico.
4. The BOP LICENSE granted herein by ERC to MTU is a non-exclusive license for
end use in the territories of Western Europe, Eastern Europe, the Middle
East, South America and Africa.
5. The BOP LICENSE territories as defined herein are subject to
reconsideration upon request of ERC or MTU after the initial term of this
agreement.
6. The BOP LICENSES granted herein may not be assigned by either party without
prior written approval of the other party.
2
<PAGE>
Article III - BOP Cross Selling
1. It is understood by the Parties that the BOP LICENSES are based on and
include the cross- selling of ERC's and MTU's BASE MODULES.
2. For the first 10 (ten) units (approximately 2.5 megawatt installed
capacity), under the BOP LICENSE, ERC commits to purchase and MTU commits
to sell its MTU BASE MODULE at a { *** } basis.
3. For the first unit (approximately 1 megawatt installed capacity) under the
BOP LICENSE, MTU commits to purchase and ERC commits to sell its ERC BASE
MODULE at { *** } basis.
4. Once the installed capacity defined in Article III, paragraphs 2 and 3
above has been reached or exceeded, both Parties will continue to purchase
the other Party's BASE MODULE and retain the obligation to sell their BASE
MODULE to the other Party provided the offers will be competitive
especially regarding key parameters, including but not limited to price,
terms of payment, quality, lead time and overall reliability of the
supplier.
5. The Parties always intend to reach cost efficiency to the extent possible
and grant each other preferential treatment as licensees. The parties will
continuously inform each other regarding the parameters of competitiveness
in order to reach the target of cross selling / cross purchasing.
6. In the event either party believes the other Party's base module is not as
competitive as it could be with alternative sources, that Party has the
obligation to notify the other Party under the notice provisions herein.
Upon receiving notice, both parties will meet and try to resolve
competitiveness issues within 30 (thirty) days. If there is no agreement,
then an outside expert firm to be agreed upon by the Parties will review
the competitive issues during the next 30 (thirty) days.
If the outside expert firm confirms that either Party is non-competitive then
the other party has the right to purchase, make or have made the base
module of the non-competitive Party under this license agreement unless the
non-competitive Party chooses to sell their Base Module to the other Party
at competitive terms and conditions (right of first refusal). If the
non-competitive Party does not exercise their right of first refusal, the
other Party is obligated to sell the non-competitive Party upon their
request this base module at those competitive terms and conditions that
could not be offered by the non-competitive Party.
If the outside expert firm confirms that either party is competitive, both
Parties will continue to retain the obligation to buy/sell.
7. Both parties are obligated to provide normal and reasonable warranties on
workmanship and materials and fitness for purpose, but are not obligated to
provide performance warranties on the BASE MODULE; details to be fixed by
mutual terms and conditions of sale.
8. Both Parties are obligated to fully divulge their cost information upon
request by the other Party. Either Party, can request the other Party's
outside audit firm to attest to the cost information, but must pay the
audit cost thereof:
3
<PAGE>
Article IV - Payments
1. ERC shall pay to MTU a royalty of { *** } U. S. Dollars { *** } for each
kilowatt of Rating of any power plant which utilizes the licensed BOP made
by or for ERC, used by, sold by or for ERC or leased by ERC and/or any
sub-licensee to ERC
This payment shall be adjusted by the increase in the United States
Consumer Price Index (CPI) from May, 1998 to the date of each sale, based
on the ratio of the CPI as of May, 1998 compared to the CPI at the month of
the sale. This adjustment shall be subject to a limit of increase per year
of 7%.
2. MTU shall pay to ERC a royalty of { *** } U. S. Dollars { *** } for each
kilowatt of Rating of any power plant which utilizes the licensed BOP made
by or for MTU, used by, sold by or for MTU or leased by MTU and/or any
sub-licensee to MTU.
This payment shall be adjusted by the increase in the United States Consumer
Price Index (CPI) from May, 1998 to the date of each sale, based on the
ratio of the CPI as of May, 1998 compared to the CPI at the month of the
sale. This adjustment shall be subject to a limit of increase per year of
7%.
3. In case ERC resp. MTU does not purchase the other Party's BASE MODULE under
Article III of this Agreement, ERC shall pay to MTU and MTU shall pay to
ERC an increased royalty of { *** } U.S. Dollars { *** } for each kilowatt
of Rating of any power plant which utilizes the other Party's licensed BOP.
This payment shall be adjusted according to the rules set forth in Article IV
clause 1 resp. clause 2.
4. MTU is not committed to pay to ERC a royalty under this Agreement to the
extent MTU is obligated to pay ERC a royalty under the existing CELL
LICENSE AGREEMENT for its BASE MODULE.
Article V - BOP KNOW HOW
1. Each Party shall provide the other Party all information embodying BOP KNOW
HOW during the life of this Agreement upon a time schedule and in
accordance with the other Party's requirements as mutually agreed by the
Parties.
2. Both Parties agree to control and treat as secret and proprietary any BOP
KNOW HOW which is received from the other Party.
Both Parties will develop and implement such procedures as may be required
to prevent the intentional or negligent disclosure to third parties of BOP
KNOW HOW communicated to each other. The following shall not be considered
or treated as secret and proprietary under this provision:
2.1 BOP KNOW HOW that has been or become published or generally known to
the trade or others without breach or fault of one or both of the Parties,
4
<PAGE>
2.2 BOP KNOW HOW received prior to the disclosure of the other Party
legally by a Party from any third party who, to the best of that Party's
knowledge, after reasonable inquiry, did not obtain same by breach of any
obligation owed to the other Party, and who imposes no obligation of
secrecy on the other Party with respect to such BOP KNOW HOW
3. Any rights of a Party related to its BOP KNOW HOW remain with the
respective Party regardless of any contributions of the other Party to
finalizing the commercial design of the compact fuel cell power plant of
the respective Party.
Article VI - Records, Reports and Notices
ERC and MTU shall keep separate records of sales and use of licensed BOP KNOW
HOW and shall report to the other Party on a quarterly basis.
Notices under this Agreement shall go to the respective signers of this
Agreement or their successors.
Article VII - Term, Termination
1. This Agreement shall terminate at the end of 5 (five) years from the
effective date of this Agreement (the "Initial Term").
2. Either Party shall have the right to extend the Initial Term or any
extended term of this Agreement of an additional 5 (five) year period by
giving the other Party advance written notice of extension not less than
180 (one hundred eighty) days prior to expiration of the Initial Term or
any extended term of this Agreement, provided the requesting Party did not
breach the Agreement in the past if such breach has not been remedied to
the satisfaction of the other Party. Any extension after a term of 20 years
needs mutual consent of the Parties. The Parties endeavor to reach such
consent 9 months prior to expiration of the Agreement.
3. Upon termination of this Agreement, the right to use or have used (whether
directly or indirectly) the other Party's BOP KNOW HOW shall cease
immediately except for plants already supplied as far as necessary for the
after sales service and all BOP KNOW HOW shall be held in confidence by the
recipient for 15 (fifteen) years after the date of termination, unless
exempt by Article V, Sections 2.1 and / or 2.2.
Article VIII - Arbitration
1. Should any dispute, controversy or claim arise between ERC and MTU in
connection with, relating to or rising out of this Agreement, efforts to
resolve such an issue shall be made by the respective Parties. If a
resolution is not achieved, either Party may refer the issue to the
5
<PAGE>
executive officers of ERC and MTU, who shall endeavor to reach a mutually
acceptable resolution.
2. In the event an acceptable resolution is not reached within thirty (30)
days of the request to the officers made per Article VIII, Section 1., then
the issue shall be submitted to arbitration of the London Court of
International Arbitration applying their procedural rules then in effect.
The arbitration shall take place in London and the substantive law
applicable to the arbitration shall be British Law. The arbitration award
shall be final and binding upon the Parties. Such award may be confirmed in
any court having jurisdiction and reduced to final judgment.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed
in a manner binding upon them by their duly authorized officers as of the date
shown below.
ENERGY RESEARCH CORPORATION
By: /s/ Jerry D. Leitman
--------------------
Name: Jerry D. Leitman
Title: President and Chief Executive Officer
Date: July 16, 1998
MTU MOTOREN-UND TURBINEN-UNION FRIEDRICHSHAFEN GmbH
By: /s/ Herman J. Amrein /s/ Michael Bode
-------------------- ----------------
Name: Herman J. Amrein Michael Bode
Title: Senior Vice President Director
Date:
6
<PAGE>
Exhibit I of ERC / MTU BOP License Agreement
- --------------------------------------------
Part A Western Europe
- ------
Andorra
Austria
Belgium
Cyprus
Denmark
Federal Republic of Germany
Finland
France
Great Britain and Northern Ireland
Greece
Greenland
Ireland
Island
Italy
Liechtenstein
Luxembourg
Malta
Monaco
Netherlands
Norway
Portugal
San Marino
Spain
Sweden
Switzerland
The Vatican State
Part B Eastern Europe
- ------
Albania
Bulgaria
Czech Republic
Slovakia
Hungaria
Poland
Romania
All states of the former USSR including, but not limited to CIS
(Commonwealth of Independent States)
Yugoslavia
Slovenia
Croatia
7
<PAGE>
Exhibit I of ERC / MTU BOP License Agreement
- --------------------------------------------
Part C Middle East
- ------
Bahrain
Iran
Iraq
Israel
Jordania.
Katar
Kuwait
Lebanon
Oman
Saudi-Arabia
Syria
Turkey
United Arab Emirates (UAE)
Yemen, Arab. Rep.
Yemen, Peoples Rep.
8
<PAGE>
EMPLOYMENT AGREEMENT
--------------------
THIS AGREEMENT is made and entered into as of the 5th day of October,
1998 between ENERGY RESEARCH CORPORATION, a New York corporation (the
"Company"), and JOSEPH G. MAHLER, an individual with a current mailing address
at 2 Queens Peak Road, Canton, Connecticut 06019, (the "the Employee"). Unless
the context otherwise requires, the term "Company", shall include the Company
and each of its subsidiaries.
W I T N E S E T H
WHEREAS, the Company desires to employ the Employee as its Chief
Financial Officer and Corporate Secretary and the Employee desires to be
employed in such capacities in accordance with the terms and conditions set
forth herein;
NOW, THEREFORE, in consideration of the covenants, conditions,
undertakings and premises contained herein, the sufficiency which is hereby
acknowledged, the Company and the Employee agree follows:
ARTICLE 1
---------
EMPLOYMENT AND DUTIES
---------------------
1.1 Employment; Duties
------------------
Subject to the terms and conditions set forth herein, commencing
October 5, 1998 (the "Commencement Date") the Company agrees to employ the
Employee and the Employee agrees to be employed as Chief Financial Officer,
Treasurer and Corporate Secretary of the Company. In such position, the Employee
shall perform such duties as are or may be assigned to the Employee by the Chief
Executive Officer and Board of Directors of the Company (the "Board of
Directors") from time to time. In connection therewith, the Employee shall
report to and be subject to the supervision of the Chief Executive Officer. In
the course of the performance of his duties hereunder, Employee shall comply in
all material respects with the Company's regular employment policies and
procedures as they may be modified from time to time.
1.2. Full Time
---------
The Employee shall devote his full working time, attention, energies,
skills and best efforts exclusively to the performance of his duties hereunder.
The Employee shall not during the term of this Agreement engage in any other
business activity whether or not such activity is pursued for gain, profit or
other pecuniary advantage, except that the Employee, on his own time, (a) may
manage his own investments, and those of his immediate family, and (b) may serve
as a member of the board of directors of other corporations subject to the
restrictions set forth in Section 5.1, so long as such activity (as described in
either clause (a) or (b) above), does not, in the reasonable judgment of the
Company's Board of Directors, adversely affect the performance of his duties
hereunder.
1
<PAGE>
ARTICLE 2
---------
2.1 Term
----
The term of the Employee's employment by the Company hereunder shall
commence on the Commencement Date and, except as otherwise provided in this
Agreement with respect to earlier termination, shall continue until terminated
by either party pursuant to Article 7.
ARTICLE 3
---------
COMPENSATION
------------
3.1 Base Salary
-----------
For all service to be rendered by the Employee under this Agreement,
and such other duties as the Chief Executive Officer and the Board of Directors
may assign to him in accordance with Section 1.1 hereof, the Company agrees to
pay the Employee a base salary of $185,000 per annum. The Employee's base salary
shall be subject to periodic review and adjustment by the Chief Executive
Officer and the Board of Directors in their sole discretion, provided that the
base salary may not be reduced below $185,000 per year. The base salary shall be
payable at such times as is customary for employees of the Company and in
accordance with the normal payroll practices of the Company.
3.2. Incentive Compensation
----------------------
Commencing with the Company's fiscal year beginning November 1, 1998,
the Employee shall be a participant in the Company's incentive compensation plan
generally made available to executive officers as it may be in effect and
revised from time to time. Employee's target bonus under such plan will be
thirty percent (30%) of his base salary with a maximum bonus of 150% of the
target bonus. The Employee understands and agrees that the implementation of an
incentive compensation plan for the Employee and other executive officers will
be subject to the review and approval of the Compensation Committee of the Board
of Directors.
3.3. Expenses
--------
(a) General. In addition to base salary and incentive compensation, the
Company shall reimburse the Employee for all reasonable and necessary business
expenses actually incurred by him in the performance of his duties, including,
without limitation, expenses for travel, meals, entertainment and other
miscellaneous business expenses, in accordance with the Company's policies and
practices as may be in effect from time to time.
(b) Moving Expenses. The Employee agrees to relocate to the vicinity of
the Company's executive offices in Danbury, Connecticut (the "Company Location")
as soon as practicable following his commencement of employment hereunder. In
connection with that relocation, the Company agrees to pay for or reimburse the
Employee for all reasonable out-of-pocket expenses incurred by him in connection
with his relocation from his current residence in Canton, Connecticut to the
2
<PAGE>
Company Location during a two year period following the execution of this
Agreement, including, without limitation, (i) reasonable moving company expenses
and storage fees, (ii) reasonable fees and expenses incurred in connection with
the sale of his current residence, including reasonable brokerage commissions
(iii) reasonable fees and expenses incurred in connection with his purchase of a
home in the vicinity of the Company Location, not including any brokerage
commissions (iv) reasonable expenses associated with commuting to work (for a
maximum period of six months following the execution of this Agreement) and to
search for a new residence.
(c) Documentation. Reimbursement or payment by the Company of the
Employee's expenses as set forth in this Section 3.3 shall be subject to the
Employee's submission of written, itemized expense accounts and such additional
substantiation and justification as the Company may reasonably request
consistent with the Company's reimbursement policies generally applicable for
its salaried employees.
ARTICLE 4
---------
COMPANY BENEFITS
----------------
4.1 Vacation
--------
The Employee shall be entitled to receive four weeks of paid vacation
per calendar year (pro rated for any partial year), which shall be taken at such
time or times as will not unreasonably hinder or interfere with the Company's
business or operations.
4.2. Severance Benefit
-----------------
If during the Employee's employment pursuant to this Agreement, the
Employee ceases to be employed by the Company as a result of the Company's
termination of the Employee without cause pursuant to Section 7.4 (which shall
not include any termination that is otherwise within Article 6) or the
Employee's termination of his employment for good reason pursuant to Section
7.1, the Company shall pay the Employee as a severance benefit, (a) his then
base salary plus (b) an amount equal to the Employee's bonus from the Company,
if any, for the immediately preceding year. This severance benefit shall be
payable by the Company through (i) the continuation of the Employee's base
salary for a period of one year and (ii) the payment of the balance in four
equal quarterly installments, with the first such payment due three months after
the termination and the final payment due one year after the termination. The
severance obligation set forth in this Section 4.2 shall be in lieu of and not
in addition to any other severance benefits made available to other employees of
the Company.
4.3. Stock Options
-------------
(a) Effective on the execution of this Agreement, the Company shall
issue to the Employee an option to purchase 50,000 shares of the Company's
Common Stock with an exercise price equal to the closing price of the Company's
Common Stock on the American Stock Exchange on the date hereof, pursuant to the
Company's standard form of Option Agreement, subject to the following
3
<PAGE>
provisions. The option shall vest over a four year period at 25% per year
(12,500 shares) on each anniversary date of the Commencement Date; provided
however, if the Employee's employment hereunder is terminated without cause by
the Company or for good reason by the Employee prior to the first anniversary
date of the Commencement Date, the options to purchase the first 12,500 shares
of the Company's Common Stock will automatically vest. The options will also
fully vest upon a change of control of the Company.
(b) The Employee understands that the Company is considering a
so-called spin-off of its Battery business. In the event of such spin-off, if it
occurs within the initial one year term of this Agreement, if at all, the
Company will cause the spun-off company (the "Battery Company") to either grant
the Employee an option to purchase 50,000 shares of its Common Stock or provide
the Employee with the right to purchase 50,000 shares of restricted stock. The
exercise or purchase price of such stock will be the fair market value of the
stock, as determined by the Board of Directors on the date of grant. Such
options or stock will vest at 25% per year from the date of their grant or
purchase. The Employee understands and agrees that following the spin-off of the
Battery Company, if it occurs, his employment may include acting as Chief
Financial Officer of the Battery Company during an indefinite period.
4.4. Other Benefit Plans
-------------------
The Employee shall further be entitled to participate in and receive
benefits under any retirement, life insurance, accident, disability, health and
dental insurance, profit sharing, or similar plans generally made available to
its employees.
4.5. Indemnification
---------------
The Company agrees to defend and shall indemnify and hold the Employee
harmless to the fullest extent permitted by law from any and all liability,
costs, and expenses which may be assessed against the Employee by reason of the
performance of his responsibilities and duties under the terms of this
Agreement, provided such liability does not result from willful misconduct or
gross negligence of the Employee.
ARTICLE 5
---------
RESTRICTIONS
------------
5.1 Non-Competition
---------------
(a) So long as the Employee is employed by the Company and for a period
of two years thereafter (the "Noncompetition Period"), the Employee shall not,
directly or indirectly, whether as owner, partner, shareholder, director,
consultant, agent, employee, guarantor, surety or otherwise, or through any
person, consult with or in any way aid or assist any competitor of the Company
or engage or attempt to engage in any employment, consulting or other activity
which directly or indirectly competes with the Business of the Company. For
purposes of this Agreement, the term "employment" shall include the performance
4
<PAGE>
of services by Employee as an employee, consultant, agent, independent
contractor or otherwise and the term "Business" shall mean the research,
development, manufacture, sale or distribution of fuel cells, batteries or
related products and any other business engaged in, planned or under development
by the Company with respect to which the Employee has had access to Company
confidential information during the Noncompetition Period. The Employee
acknowledges that his participation in the conduct of any such Business alone or
with any person other than the Company will materially impair the Business and
prospects of the Company.
(b) In addition to and without limiting the foregoing, during the
Noncompetition Period, Employee shall not knowingly do, attempt to or assist any
other person in doing or attempting to do any of the following: (i) hire any
director, officer, employee, or agent of the Company (a "Company Employee") or
encourage any such person to terminate such relationship with the Company, as
the case may be (for purposes hereof, the Employee shall be deemed to have so
encouraged a Company Employee to terminate such relationship with the Company if
the Employee hires or otherwise assists any person in hiring any such Company
Employee within six months after the Company Employee terminates his or her
relationship with the Company), (ii) encourage any customer, client, supplier or
other business relationship of the Company to terminate or alter such
relationship, whether contractual or otherwise, to the disadvantage of the
Company; (iii) encourage any prospective customer or supplier not to enter into
a business relationship with the Company; (iv) impair or attempt to impair any
relationship, contractual or otherwise, written or oral, between the Company and
any customer, supplier or other business relationship of the Company; or (v)
sell or offer to sell or assist in or in connection with the sale to any
customer or prospective customer of the Company any products of the type sold or
rendered by the Company.
(c) Nothing in this Agreement shall preclude Employee from making
passive investments of not more than 2% of a class of securities of any business
enterprise registered under the Securities Exchange Act of 1934.
5.2. Intellectual Property
---------------------
Upon execution of this Agreement, the Employee shall execute the Energy
Research Corporation Agreement for Assignment, Confidentiality and
Nonsolicitation, which agreement is hereby incorporated herein by reference.
5.3. Injunctive Relief
-----------------
The Employee acknowledges that the restrictions contained in this
Article are reasonable in view of the nature of the business in which the
Company is engaged and his position with the Company which will provide him with
extensive knowledge of the business.
The Company and the Employee mutually agree that the Employee's
obligations under this Article are of a special and unique character which gives
them a peculiar value, and the Company cannot be reasonably or adequately be
compensated in damages in an action at law in the event the Employee breaches
such obligations. The Employee therefore expressly agrees that, in addition to
any other rights or remedies which the Company may possess, the Company shall be
5
<PAGE>
entitled to injunctive and other equitable relief to prevent a breach of this
Article by the Employee, including a temporary restraining order or temporary
injunction from any court of competent jurisdiction restraining any threatened
or actual violation, and each party hereby consents to the entry of such order
and injunctive relief and waives the making of a bond as a condition for
obtaining such relief. Such rights shall be cumulative and in addition to any
other legal or equitable rights and remedies the Company may have.
5.4. Survival Enforceability
-----------------------
It is expressly agreed by the parties hereto that the provisions of
this Article shall survive the termination of this Agreement.
If any one or more of the provisions contained in this Article shall
for any reason in any jurisdiction be held to be excessively broad as to the
time, duration, geographical scope, activity or subject, it shall be construed
with respect to such jurisdiction, by limiting or reducing it, so as to be
enforceable to the extent compatible with the applicable law of such
jurisdiction as it shall then appear.
ARTICLE 6
---------
DEATH; DISABILITY
-----------------
6.1 Death
-----
If the Employee dies while employed under this Agreement, this
Agreement shall terminate immediately. The Company will pay to the Employee's
estate his base salary under Section 3.1 through the last day of the calendar
month in which he dies, plus any incentive compensation awarded to the Employee
under the Incentive Compensation Plan, but not yet paid, and such death benefits
as may be provided pursuant to Section 4.4.
6.2. Disability
----------
If the Employee fails to perform his duties under this Agreement due to
"Disability", as defined below, the Company may terminate this Agreement upon 30
days written notice to him. In that event, the Company shall pay the Employee
his base salary under Section 3.1 through the date of termination; provided,
however, that to the extent the Employee is receiving disability benefits
pursuant to the Company's disability insurance policy, the amount of such
benefits shall be credited against the Employee's base salary during the period
prior to the date of termination. In addition, upon any termination based upon
Disability, the Company shall pay to the Employee any incentive compensation
awarded to the Employee under the Incentive Compensation Plan but not yet paid.
The term "Disability" shall mean the inability of the Employee to perform for
the Company the duties specified in Section 1.1 by reason of any medically
determinable physical or mental impairment for (i) a period of four consecutive
months, (ii) for shorter periods aggregating five months in any 12-month period
or (iii) if the Board of Directors determines that it is probable that the
Disability will continue for a length of time so as to constitute a Disability
under clauses (i) or (ii) above. The determination of whether the Employee is
Disabled shall be made by the Board of Directors on the basis of written medical
evidence reasonably satisfactory to it. Notwithstanding anything to the contrary
6
<PAGE>
in the foregoing, in the event of a termination of the Employee pursuant to
clause (iii), the Company will pay the Employee a minimum of four months base
salary following such termination; provided, however, that to the extent the
Employee is receiving disability benefits pursuant to the Company's disability
insurance policy, the amount of such benefits shall be credited against the
Employee's base salary.
ARTICLE 7
---------
TERMINATION
-----------
7.1 Termination by the Employee for Good Reason
-------------------------------------------
The Employee may terminate this Agreement for good reason upon ninety
(90) days written notice to the Company setting forth with specificity the
grounds for termination upon the occurrence of any of the following: (a) the
failure of the Company to observe or comply with any of its material obligations
under this Agreement, if such failure has not been cured within 30 days after
written notice thereof has been given by the Employee to the Company; (b) the
dissolution of the Company; or (c) any merger in which the Company is not the
surviving corporation and in which the stockholders of the Company own less than
50% of the voting securities of the merged entity upon the effectiveness of the
merger, or any consolidation, sale of substantially all of the assets of the
Company or change of control of the Company, provided the Employee has not
approved the transaction by voting for it either as a director or shareholder.
For purposes of clause (a) a material breach by the Company shall include a
material change in the reporting responsibilities of the Employee such that the
Employee is no longer effectively serving as the Chief Financial Officer of the
Company, a material reduction in benefits or other perquisites of office such
that the Employee is not receiving the benefits set forth herein or the benefits
and other perquisites generally granted for executive positions within the
Company. For purposes of clause (c) above, a "change of control" shall be
presumed to have occurred if within any 12-month period a single person or
entity, or related group of persons or entities, acquires 50% or more of the
outstanding voting stock of the Company. In the event of a termination for good
reason under this Section, the Company shall pay the Employee (i) his base
salary as then in effect under Section 3.1 through the date of termination, (ii)
any incentive compensation awarded to the Employee under the Incentive
Compensation Plan, but not yet paid, and (iii) the severance benefit set forth
in Section 4.2.
7.2. Termination by the Company for Cause
------------------------------------
The Company may terminate this Agreement for cause in the manner set
forth below. For purposes of this Section, "cause" shall mean (a) a material
breach by the Employee of the terms of this Agreement, including without
limitation failure by the Employee to perform a material portion of his duties
hereunder (not otherwise excused by the disability of the Employee) (b) criminal
misconduct or unethical conduct, whether or not in relation to the Company's
affairs or business, which reflects adversely upon Employee's honesty or
integrity in the performance of his duties as an employee of the Company, or
which otherwise is materially detrimental to the interests of the Company; (c)
if the Employee is found guilty or pleads nolo contendere to the commission of a
7
<PAGE>
crime classified as a felony under any Federal, state or local law; and (d)
commission by the Employee of an act of gross incompetence in the course of his
employment hereunder. The term "cause" as used in the preceding sentence does
not include the Employee's erroneous judgment or judgments of a technical,
scientific, financial, legal and/or environmental nature which were, although
erroneous, nevertheless reasonable at the time and under the circumstances in
which they were made. In the event of termination under this Section, the
Company shall pay to the Employee his base salary under Section 3.1 through the
date of termination stated in the notice plus any incentive compensation awarded
to the Employee under the Incentive Compensation Plan but not yet paid, and the
Employee shall, if so requested by the Chief Executive Officer, perform his
duties under Article 1 through the date of termination stated in the notice.
7.3. Termination by the Company for Cause-Procedure
----------------------------------------------
Notwithstanding anything to the contrary set forth herein, the Employee
shall not be deemed to be have been terminated for cause without (i) delivery to
the Employee of written notice setting forth the reasons for the Company's
intention to terminate for cause, and (ii) an opportunity for the Employee to be
heard before the Chief Executive Officer within five business days thereafter.
7.4. Termination by the Company or the Employee Without Cause
--------------------------------------------------------
Either the Company or the Employee may terminate this Agreement for
reasons other than as set forth above in Section 7.1 or Section 7.2 and which
are not otherwise within Article 6 upon 30 days written notice. Upon such
termination, the Company shall pay the Employee his base salary under Section
3.1 through the date of termination (provided, however, that the Employee
continues to be available to perform the services required under Section 1.1
through the date of termination), plus any incentive compensation awarded to the
Employee under the Incentive Compensation Plan, but not yet paid, and any
accrued vacation. In addition, upon the Company's termination of the Employee
without cause, the Company shall be required to pay the Employee the severance
benefit set forth in Section 4.2. Nothing herein shall prohibit the Company from
relieving the Employee of any or all of his duties hereunder pending the
expiration of the 30-day notice period.
7.5. Termination of Duties
---------------------
Notwithstanding anything to the contrary set forth herein, at any time
on or after delivery of written notice to the Employee, the Company may relieve
the Employee of all of his duties and responsibilities hereunder and may relieve
the Employee of authority to act on behalf of, or legally bind, the Company;
provided, however, that any such action by the Company shall not relieve the
Company of its obligation to pay to the Employee all compensation and benefits
otherwise provided for in this Agreement.
8
<PAGE>
ARTICLE 8
---------
MISCELLANEOUS
-------------
8.1 No Conflicting Agreements.
--------------------------
The Employee represents and warrants to the Company, that the Employee
is not under any obligation to any person or entity which is inconsistent with
or in conflict with any of the terms of this Agreement or which would prevent,
limit or impair in any way the Employee's performance of all the terms of this
Agreement and the Employee agrees not to enter into any agreement, either
written or oral, in conflict herewith.
8.2. Entire Agreement
----------------
This Agreement contains the entire understanding and agreement between
the Company and the Employee and cannot be amended, modified, or supplemented in
any respect except by subsequent written agreement entered into by both parties.
8.3. Successors of the Company
-------------------------
This Agreement shall inure to the benefit of and be binding upon the
Company, its successors and assigns, including, without limitation, any person,
firm, corporation or other entity which may acquire all or substantially all of
the Company's assets and business, or with or into which the Company may be
consolidated or merged, and this provision shall apply in the event of any
subsequent merger, consolidation or transfer. In every respect, this Agreement
shall inure to the benefit of and be binding upon the Employee, his heirs,
executors and personal representatives and, being personal in nature, shall not
be assignable by the Employee.
8.4. Effect of Waiver
----------------
The waiver by either party of a breach of any provision of this
Agreement shall not operate as or be construed as a waiver of any subsequent
breach.
8.5. Notices
-------
Any notice, request, demand or other communication in connection with
this Agreement must be in writing and shall be deemed to have been given and
received three days after a certified or registered letter containing such
notice, properly addressed, with postage prepaid, is deposited in the United
States mail; and, if given otherwise than by registered or certified mail, it
shall not be deemed to have been given until actually delivered to and received
by the party to whom it is addressed.
A. Notice to the Company shall be given at its principal
mailing address, which at the time of execution of
this Agreement is 3 Great Pasture Road, Danbury,
Connecticut, 06813, Attention: Chief Executive
Officer, or at such other address as it may
designate.
9
<PAGE>
B. Notice to the Employee shall be given at his home address, which at the time
of execution of this Agreement is the address set forth in the heading of this
Agreement, or at such other address as he may designate.
8.6. Counterparts
------------
This Agreement may be executed in one or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument.
8.7. Severability
------------
If, in any jurisdiction, any provision of this Agreement or its
application to any party or circumstances is restricted, prohibited or
unenforceable, such provision shall, as to such jurisdiction, be ineffective
only to the extent of such restriction, prohibition or unenforceability without
invalidating the remaining provisions hereof and without affecting the validity
or enforceability of such provision in any other jurisdiction or its application
to other parties or circumstances.
8.8. Survival
--------
Each of the terms and provision of this Agreement which are expressly
or impliedly so intended shall survive the termination of this Agreement.
8.9. Applicable Law
--------------
This Agreement shall be governed by and construed according to the laws
of the State of Connecticut.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first stated above.
ENERGY RESEARCH CORPORATION
By: /s/ Jerry D. Leitman
--------------------
Jerry Leitman
Chief Executive Officer
/s/ Joseph G. Mahler
---------------------
Joseph G. Mahler
10
<PAGE>
Consent of Independent Accountants
The Board of Directors
Energy Research Corporation:
We consent to incorporation by reference in the registration statements on Form
S-8 (No. 333-20807; No. 33-77008; No. 33-68866; and 333-63833) of Energy
Research Corporation our report dated January 22, 1999, relating to the
consolidated balance sheets of Energy Research Corporation as of October 31,
1998 and 1997, and the related consolidated statements of income (loss), changes
in common shareholders' equity and cash flows for each of the years in the
three-year period ended October 31, 1998, which report appears in the October
31, 1998 annual report on Form 10-K of Energy Research Corporation.
KPMG LLP
January 28, 1999
Stamford, CT
1
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000886128
<NAME> ENERGY RESEARCH CORPORATION
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-1-1997
<PERIOD-END> OCT-31-1998
<EXCHANGE-RATE> 1
<CASH> 10,304
<SECURITIES> 0
<RECEIVABLES> 3,813
<ALLOWANCES> 0
<INVENTORY> 30
<CURRENT-ASSETS> 15,866
<PP&E> 23,500
<DEPRECIATION> 15,153
<TOTAL-ASSETS> 26,843
<CURRENT-LIABILITIES> 5,632
<BONDS> 0
0
0
<COMMON> 15,270
<OTHER-SE> 600
<TOTAL-LIABILITY-AND-EQUITY> 26,843
<SALES> 24,318
<TOTAL-REVENUES> 24,318
<CGS> 14,590
<TOTAL-COSTS> 25,363
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 269
<INCOME-PRETAX> (369)
<INCOME-TAX> 13
<INCOME-CONTINUING> (382)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (382)
<EPS-PRIMARY> (.09)
<EPS-DILUTED> (.09)
</TABLE>
