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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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 NO. 0-21130
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ENERGY BIOSYSTEMS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3078857
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ENERGY BIOSYSTEMS CORPORATION 77381
4200 RESEARCH FOREST DRIVE (ZIP CODE)
THE WOODLANDS, TEXAS
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(281) 364-6100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Title of Class
Common Stock, par value $.01 per share
Preferred Stock Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $33,008,727 as of March 27, 1998, based on
the closing sales price of the registrant's common stock on the Nasdaq
National Market on such date of $2.4375 per share and assuming full
conversion of the registrant's Series B Convertible Preferred Stock. For
purposes of the preceding sentence only, all directors, executive officers
and beneficial owners of ten percent or more of the common stock are assumed
to be affiliates. As of March 14, 1998, 12,251,434 shares of common stock
were outstanding and 702,100 shares of Series B Convertible Preferred Stock
were outstanding.
Certain sections of the registrant's definitive proxy statement relating
to the registrant's 1998 annual meeting of stockholders, which proxy
statement will be filed under the Securities Exchange Act of 1934 within 120
days of the end of the registrant's fiscal year ended December 31, 1997, are
incorporated by reference into Part III of this Form 10-K.
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WHEN USED IN THIS DOCUMENT, THE WORDS "ANTICIPATE," "BELIEVE," "EXPECT,"
"ESTIMATE," "PROJECT" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS,
UNCERTAINTIES AND ASSUMPTIONS. SHOULD ONE OR MORE OF THESE RISKS OR
UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE INCORRECT,
ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE ANTICIPATED, BELIEVED,
EXPECTED, ESTIMATED OR PROJECTED. FOR ADDITIONAL DISCUSSION OF SUCH RISKS,
UNCERTAINTIES AND ASSUMPTIONS, SEE "ITEM 1. BUSINESS--RISK FACTORS" INCLUDED
ELSEWHERE IN THIS REPORT.
PART I.
ITEM 1. BUSINESS
OVERVIEW
Energy BioSystems Corporation ("EBC" or the "Company") is developing and
commercializing innovative biotechnology-based processes for the petroleum
refining and production industries. The Company's focus to date has been on
developing biocatalytic desulfurization ("BDS"), a proprietary process
involving the use of enzymes to remove sulfur from petroleum. EBC believes
that BDS can be used as a substitute for, or in conjunction with, existing
desulfurization technology and expects BDS to be significantly less expensive
than conventional desulfurization methods. The Company's BDS pilot plant,
which is a fully integrated desulfurization unit capable of processing up to
five barrels of diesel fuel per day, was completed in late 1994 and began
processing diesel feedstock in March 1995. The pilot plant is providing the
basis for the design of commercial-scale BDS units.
Removal of sulfur is one of the most costly issues facing the petroleum
industry and is a growing problem worldwide. Sulfur removal is desirable to
the refining industry because of (i) environmental regulations mandating
decreased sulfur in refined products, (ii) an increasing level of sulfur in
crude oil processed by refiners and (iii) high operating and maintenance
costs associated with the existence of sulfur in petroleum. Desulfurization
is also attractive to the crude oil production market, where low-sulfur crude
oil commands a premium price over high-sulfur crude oil.
The Company has entered into a number of strategic alliances with
recognized industry leaders in support of the Company's BDS development and
commercialization activities, providing an opportunity for the Company to
build on established expertise and resources in critical areas. The Company
has an agreement with The M.W. Kellogg Company ("M.W. Kellogg") for the basic
engineering services necessary for BDS implementation at customer sites, and
an agreement with Baker Petrolite Corporation ("Petrolite") relating to the
development of the Company's BDS technology and the construction and
operation of the Company's pilot plant. The Company also has entered into
collaborations focusing on the application of the BDS technology as follows:
an alliance with TOTAL Raffinage Distribution, S.A. ("TOTAL") to develop a
BDS process for diesel fuel streams; an alliance with Koch Refining Company
("Koch") to develop a BDS process for certain gasoline streams; and an
alliance with the Exploration and Production Technology Division of Texaco
Inc. ("Texaco") to develop a BDS process for crude oil. The Company is
pursuing additional alliances with potential customers, particularly in the
Middle East and Asia, two markets that are expected to make significant
investments in desulfurization technology over the next decade. See
"--Alliances."
To date, the Company has engaged primarily in research and development
related to its BDS process. In March 1998, the Company entered into an
agreement with Petro Star Inc. ("Petro Star") regarding the design and
installation of a BDS unit at Petro Star's Valdez, Alaska refinery. The
Company's BDS process will require additional research, development and testing
in order to determine its commercial viability. See "--Risk
Factors--Technological Uncertainty; Risks Associated with Commercialization of
BDS Technology."
The Company was incorporated in Delaware on December 20, 1989. The
Company's executive offices are located at 4200 Research Forest Drive, The
Woodlands, Texas 77381 and its telephone number is (281) 364-6100.
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THE COMPANY'S TECHNOLOGY
BACKGROUND OF BDS
The first patents covering the use of bacteria to reduce the sulfur
content of petroleum were issued in the United States in 1948. However,
early attempts to utilize bacteria and enzymes to selectively remove sulfur
from hydrocarbons failed primarily because of an inability to control the
action of the bacteria, which resulted in significant degradation of the fuel
value of the hydrocarbon. In 1988, researchers at the Institute of Gas
Technology ("IGT") achieved a breakthrough in microbial desulfurization when
they isolated two unique strains of bacteria. These strains have the ability
to desulfurize coal and selectively remove sulfur from dibenzothiophene, the
industry-recognized model for heterocyclic sulfur molecules found in coal and
petroleum. U.S. patents were issued on these two bacterial strains in 1992.
In 1991, the Company obtained exclusive, worldwide, royalty-free rights
to IGT's desulfurization technology. A critical milestone was achieved in
1992 when the relevant genes from the patented bacteria were cloned and
sequenced. These genes have now been characterized extensively. The cloned
genes now are being manipulated and transferred to alternative microbial
hosts and modified to increase the expression of the desired properties. The
Company has been issued a fundamental patent on these genes, plus numerous
other patents on the BDS process by the U.S. and foreign patent offices.
With bacteria strain isolation and molecular cloning of the genes achieved,
further development of BDS technology involves primarily a new combination of
established biotechnology and chemical engineering processes.
A fully integrated BDS pilot plant capable of processing up to five
barrels of diesel fuel per day was constructed in late 1994 and began
processing diesel feedstock for desulfurization in March 1995. The pilot
plant was designed with the instrumentation and scale necessary to provide
the operating data needed for commercial scale-up. The pilot plant is
utilizing hydrotreated diesel fuel from TOTAL and straight-run diesel fuel
from Petro Star as feedstock, allowing the Company's team of scientists and
engineers to evaluate the performance of the biocatalyst, the reactor and the
separations systems under a wide range of operating conditions. The
information generated from the pilot plant is also being used to guide
further development of the Company's other BDS applications for crude oil and
other petroleum products.
OVERVIEW OF THE COMPANY'S BDS TECHNOLOGY
BDS is a proprietary process based on naturally occurring bacteria that
can remove organically bound sulfur from petroleum without degrading the fuel
value of the hydrocarbon. Enzymes in the bacteria selectively cleave
carbon-sulfur bonds in the presence of oxygen to yield an oxygenated
hydrocarbon product and a sulfate byproduct. Because the chemical reaction
is catalyzed by enzymes associated with the bacteria, the bacteria do not
have to grow in order to desulfurize fossil fuels. Operating at ambient
temperatures and atmospheric pressure, BDS is expected to be significantly
lower in cost than conventional hydrodesulfurization ("HDS") technology in
achieving sulfur levels below those required by current regulatory standards
and flexible enough to desulfurize a wide range of petroleum streams
including crude oil. Since the process is oxidative, the addition of
hydrogen is not required, thus avoiding a significant element of conventional
desulfurization operating costs.
The basic steps of the BDS process are:
- The biocatalyst is combined with water and transferred to the
bioreactor.
- The biocatalyst slurry and high-sulfur petroleum stream are mixed in
the continuous stirred-tank bioreactor and air is sparged in as a
source of oxygen.
- The desulfurized oil is separated from the oil/aqueous/biocatalyst
output stream.
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- The aqueous phase is further treated to separate out the biocatalyst
and water.
- The sulfur byproduct is captured from the aqueous phase as a sulfate
salt or other water-soluble sulfur compound and removed from the
process.
- The biocatalyst and water are recycled to the bioreactor and spent
biocatalyst is drawn off.
CONVENTIONAL DESULFURIZATION TECHNOLOGIES
Hydrotreating is the conventional technology for the removal of sulfur,
nitrogen and other impurities from oil. When this process is used primarily
for the removal of sulfur, it is called hydrodesulfurization ("HDS"). In
this process, petroleum fractions are subjected to high temperatures and
pressure in the presence of an inorganic catalyst and hydrogen. As a result,
organic sulfur molecules are converted to hydrogen sulfide, which is further
processed to yield elemental sulfur. HDS is relatively ineffective against
more complex sulfur molecules found in diesel and heavier fractions.
HDS is a costly process for refiners. A typical HDS unit costs between
$30 million and $80 million to construct, depending on the product stream to
be treated, the level of desulfurization required and the unit size. The
high pressure and temperature required for HDS translate directly into high
capital and maintenance costs because these units require high-pressure
vessels and exotic metals, which are expensive to manufacture and maintain.
Although some refinery units produce hydrogen, the large amount of hydrogen
required for HDS may require refiners to build new hydrogen production
capacity at an additional significant capital expense.
BENEFITS OF BDS
The Company believes that its BDS technology will offer the refining
industry an effective alternative to HDS and will in many cases complement
existing technology. The Company believes that BDS may provide refiners with
the following principal benefits:
- - COST EFFECTIVENESS. BDS is designed to operate at ambient temperatures and
pressures, in contrast to HDS, which requires thick-walled reactors and
other equipment designed to tolerate high temperatures and pressures. As a
result, the Company expects that its BDS units will be significantly less
expensive to build than HDS units. The Company expects that the capital
costs of a BDS unit will be approximately 50 percent less than a comparable
HDS unit. In addition, the BDS process will not require hydrogen, which is
an expensive component of HDS.
- - EASE OF INTEGRATION. The Company believes the BDS process can be
integrated into refinery operations without significant difficulty. Most
of the components of the BDS units are expected to be readily available
equipment. The biocatalyst will be produced off-site and delivered to the
refinery, as is now the case with inorganic catalysts used in conventional
refinery processes. The BDS process is not expected to generate any
unusual byproducts, and byproduct disposition is expected to be
accomplished with existing processes that are familiar to most refiners.
The mild operating conditions of BDS are also expected to contribute to
improved operating safety over HDS in many applications.
- - EFFECTIVENESS AGAINST COMPLEX SULFUR MOLECULES. The Company believes that
BDS will be effective in removing complex sulfur molecules that are
resistant to conventional desulfurization technologies. Diesel fractions,
for example, contain more complex sulfur molecules against which HDS is
relatively ineffective. As a result, HDS becomes increasingly more costly
and less effective in desulfurizing diesel fuel as the lighter-sulfur
compounds are removed and the remaining complex molecules constitute an
increasing proportion of the remaining sulfur. Accordingly, the Company
expects that any reduction in the level of sulfur permitted under
applicable regulations will make BDS increasingly cost-effective as
compared to HDS.
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While EBC believes its BDS process will be economically attractive to
petroleum refiners and to crude oil producers, the BDS process will require
significant capital expenditures by refiners and producers. The refining and
oil production industries historically have been reluctant to accept new
technologies. There is a risk, therefore, that the Company will have
difficulty in obtaining the refining and oil production industries'
acceptance of the BDS process. Also, the rate of purchase of the Company's
BDS process may be affected by economic conditions in the refining and oil
production industries. The refining and oil production industries have been
subject to periods of depressed profitability and are affected substantially
by fluctuations in the price of crude oil and finished products. Oil
production and drilling activity are also largely dependent on the level and
volatility of oil prices.
MARKET OVERVIEW
REFINING INDUSTRY
One of the principal markets for the Company's BDS technology is the
worldwide refining industry, which processes more than 78 million barrels of
crude oil per day or approximately 29 billion barrels per year. A
significant portion of worldwide refining capacity is concentrated among a
small number of large corporations and national oil companies. In the United
States, the top ten companies process approximately 60 percent of the refined
petroleum products, and in Western Europe and Asia, the ten largest refining
companies process more than half of the refined petroleum products.
Refineries purchase crude oil and process it into three principal
products: (i) middle distillates (including diesel fuel), (ii) gasoline and
(iii) residual fuel oil (used primarily by electric utilities and ships). In
the refining process, crude oil is subjected to distillation, resulting in
the separation or fractionation of the hydrocarbons into several intermediate
products. These intermediate products are subjected to additional processing
steps before formulation into finished products. These additional processing
steps include the removal of impurities (such as sulfur, metals and
nitrogen), the "cracking" of large hydrocarbon molecules and the upgrading of
lower-quality intermediate products.
REFINERY DESULFURIZATION
The refining industry is expected to spend more than $37 billion in
capital and up to $10 billion annually in operating expenditures for sulfur
removal through the next decade, assuming the use of conventional
technologies. Asia accounts for approximately 40 percent of this total
expenditure with Western Europe and the United States accounting for
approximately 30 percent each.
Pollution regulations have targeted sulfur in fossil fuels due to its
harmful effects on the environment. The combustion of sulfur results in the
emission of sulfur oxides ("SOx"), which are believed to be a cause of "acid
rain" and smog. Regulations issued under the 1990 amendments to the U.S.
federal Clean Air Act (the "Amendments") required a reduction in the sulfur
content of all on-highway diesel fuels to 500 ppm on October 1, 1993, from a
prior national average of over 2,000 ppm. Similar regulations worldwide will
significantly reduce the level of sulfur allowed in certain petroleum
products, including diesel fuel. In Western Europe, diesel fuel was required
to meet the 500 ppm sulfur specification by October 1996. In Asia, many
countries have adopted or plan to adopt similar sulfur regulations on diesel
fuel, which will be implemented in various stages over the next decade. The
European Union has announced its intention to implement regulations requiring
the further reduction in the sulfur content of diesel fuel, with the
expectation that the diesel sulfur specification will be reduced to 350 ppm
(or possibly 200 ppm) by the year 2000 and to 100 ppm or lower by the year
2005. Historically, the adoption of more stringent environmental standards
in the United States and European Union have often been followed by the
adoption of similarly stringent standards elsewhere in the developed world.
Therefore, it is possible that another series of diesel sulfur regulations,
similar to those now anticipated in Europe, will be forthcoming in the United
States and in Asian countries.
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Sulfur also inactivates catalysts contained in automobile catalytic
converters over time, resulting in a significant increase in the emission of
unburned hydrocarbons and nitrogen oxides ("NOx") from automobile tailpipes,
which in turn contribute to smog. The Amendments required a targeted
reduction in U.S. gasoline emissions of 15 percent by the year 1995 and call
for a targeted reduction of 25 percent by the year 2000. The Environmental
Protection Agency (the "EPA") established a detailed model (the "Complex
Model") for determining the emissions of various gasoline formulations to be
sold in most large cities that have not attained certain prescribed levels of
improvement in air quality ("Nonattainment Areas"). Use of the Complex Model
becomes mandatory starting in 1998 for certifying gasoline sold in
Nonattainment Areas, which currently represents approximately 25 percent of
all gasoline produced in the U.S. The Complex Model explicitly recognizes
the detrimental impact of sulfur on gasoline tailpipe pollution, giving
refiners incentive to decrease the level of sulfur in the gasoline they
produce. Regulations in Europe further limiting sulfur levels permitted in
gasoline are anticipated for the year 2000 and similar regulations may be
adopted in Asia. Industry sources believe that sulfur will play a key role
in refiners' plans to reduce gasoline emissions in the latter part of this
decade.
The Amendments, as well as various state and local regulations,
generally limit the atmospheric emission of SOx by stationary sources, such
as refineries and utilities. For example, permit regulations limit allowable
SOx emissions from fluid catalytic cracking units ("FCCUs") (the refinery
processing unit for upgrading heavier oil molecules to gasoline), which may
cause refiners to constrain the output of a unit that is critical to refining
profitability. New or modified FCCUs are also subject to SOx emissions
limitations. The Amendments and state and local regulations also limit the
amount of high-sulfur fuel that electric utilities may burn, restricting one
of the refining industry's largest end markets for residual fuels.
Consequently, the value of residual fuel is affected significantly by its
sulfur content.
The increasing average level of sulfur in crude oils is also expected to
stimulate demand for new desulfurization technologies. Low-sulfur crude oils
traditionally have been in greater demand and commanded a price premium over
higher-sulfur crude oils. Over the last decade, the average sulfur content
of crude oil processed by U.S. refiners increased by more than 20 percent.
In the future, refiners worldwide are expected to process increased volumes
of high-sulfur crude oil, raising the demand for additional desulfurization
capacity.
Sulfur in crude oil increases refiners' operating costs because of
sulfur's detrimental effect on refinery equipment and catalytic processes.
Many sulfur compounds are corrosive, and the processing of high-sulfur crude
oil necessitates more frequent maintenance of refinery processing units. The
presence of sulfur in the feedstock for FCCUs decreases the effectiveness of
the inorganic catalyst used to crack the fuel, increasing the operating cost
of the FCCU and decreasing product yield. Sulfur has a similar degrading
effect on most catalytic processes in the refinery, increasing operating
costs on a variety of key processing units.
CRUDE OIL DESULFURIZATION
The price of crude oil is affected by its sulfur content. The
difference in price between low-sulfur and high-sulfur crude oils is affected
by increasingly stringent regulation of sulfur content in finished products.
Lower-sulfur crude oils have typically commanded a $1 to $3 per barrel
premium in the market compared to higher-sulfur crude. Over 50 percent of
the crude oil produced worldwide is considered high in sulfur (greater than
one percent). The Company believes the price difference between low-sulfur
crude oil and high-sulfur crude oil will create an incentive for oil
producers to reduce the sulfur levels in their product, resulting in demand
for crude oil desulfurization technologies. The Company believes that by
reducing the sulfur content of crude oil at the production stage, BDS has the
potential to improve the marketability and value of higher-sulfur oil
reserves and improve producers' access to pipelines that limit the sulfur
content of crude oil. To date, conventional desulfurization technologies
have not proven economically viable for the desulfurization of crude oil.
Large reserves of high-sulfur crude oil exist in Venezuela, Canada, the
United States, Mexico, the former Soviet Union, and the Middle East.
Venezuela has proven reserves in excess of one trillion barrels of crude oil
with a sulfur content greater than two percent. Canada has in excess of 50
billion barrels of proven reserves of crude oil
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with a two percent or greater sulfur content, and the United States has
approximately 125 billion barrels of proven reserves of crude oil with a two
percent or greater sulfur content. Cost-effective desulfurization technology
will play a key role in making many of these high-sulfur crude oil reserves
more economically exploitable.
OTHER POTENTIAL APPLICATIONS OF BIOREFINING
The Company believes there are numerous other applications for its
biorefining technology. These potential applications include the following:
NITROGEN REMOVAL. Nitrogen compounds in petroleum present refiners with
many of the same problems associated with sulfur. Refiners currently remove
nitrogen using a hydrotreating process. The Company believes that a system
similar to the BDS system can be developed to remove nitrogen.
METALS REMOVAL. Heavy metals in petroleum damage refinery catalysts and
reduce the value of refined petroleum products. In addition, heavy metals
limit the efficiency of conventional desulfurization technologies.
Bioreactor systems have been developed for the extraction of metals from
wastewater. EBC believes that similar systems can be developed for the
biocatalytic removal of metals from crude oil and residual oil.
VISCOSITY REDUCTION AND CRACKING. Bioprocessing technologies have been
used for many years to depolymerize very viscous solutions of corn starch to
produce high fructose corn syrup. A similar chemical process in refineries,
called "cracking," refers to the thermal degradation of complex hydrocarbon
molecules into simpler, higher-value products. The Company believes that a
biocatalytic liquefaction system could be applied to molecules in some highly
viscous crude oils, which currently have little commercial value. The
Company believes that this process could produce crude oil with significantly
reduced viscosity, a higher proportion of molecules in the gasoline and
diesel fuel boiling range, and increased commercial value.
COAL DESULFURIZATION. Conventional desulfurization technologies cannot
economically remove organic sulfur from coal. Therefore, high-sulfur coal
represents a potential future market for the Company's desulfurization
technology. The Company believes that the BDS technology it develops for
liquid fossil fuels eventually may have application in the desulfurization of
coal and, in particular, coal slurries.
BUSINESS STRATEGY
EBC's goal is to become the leading provider of biorefining solutions
for the petroleum industry. The Company's strategy is to concentrate its
internal resources on the research, development and marketing of its BDS
technology while entering into strategic alliances to assist in the
engineering and construction of BDS units and in the manufacturing of the
biocatalyst employed in the BDS process. To commercialize BDS, the Company
must develop the BDS process to a competitive commercial level, establish the
infrastructure required to deliver, supply and service the BDS units, and
sell the BDS units to refiners and oil producers. The Company believes it
has chosen the most rapid commercialization strategy by working on these
efforts in parallel and leveraging internal resources with strategic
alliances.
EBC believes that its technology has broad potential application in the
processing of petroleum products. Although its technology will first be
directed at biocatalytic desulfurization, the Company's long-term plan is to
expand the capabilities of its technology to address the removal of other
petroleum impurities (e.g., nitrogen and metals), to address other refining
processes (e.g., viscosity reduction and cracking) and to remove sulfur from
coal.
RESEARCH AND DEVELOPMENT
To commercialize BDS, the Company must improve the productivity of the
biocatalyst to a competitive economic level while developing an engineered
bioreactor system that allows the control of several variables to induce
optimal biocatalytic desulfurization. To accomplish these goals, the Company
has conducted extensive
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research, development and testing of the biocatalyst and bioreactor, and has
assembled a team of scientists and engineers with extensive experience in
microbial physiology, molecular biology, biochemistry, fermentation, process
development and scale-up, biochemical engineering, separations technology,
and refinery process engineering and operations.
The focus of EBC's research and development efforts has been to develop
the BDS process for use in treating diesel fuel, gasoline and crude oil.
The Company expects the desulfurization of diesel fuel, where its development
efforts are the most advanced, to be the first commercial application of its
BDS technology. As a result of the specificity of the biocatalyst for each
product application, the Company expects that further development will be
required to commercialize its BDS technology for use in treating gasoline and
crude oil.
In late 1992, EBC initiated operations of a continuous bench-scale unit
capable of desulfurizing up to one-half of a barrel of crude oil per day. A
fully integrated BDS pilot plant capable of processing up to five barrels of
diesel fuel per day was constructed in late 1994 and began processing diesel
feedstock for desulfurization in March 1995. The pilot plant was designed
with the instrumentation and scale necessary to provide the operating data
needed for commercial scale-up. The pilot plant is utilizing hydrotreated
diesel fuel from TOTAL and straight-run diesel fuel from Petro Star as
feedstock, and is undergoing a variety of experiments that will allow the
Company's team of scientists and engineers to evaluate the performance of the
biocatalyst, the reactor and the separations systems under a wide range of
operating conditions. The information derived from operating the pilot plant
is providing the design basis for commercial-scale BDS units and is also
being used to guide further development of the Company's other BDS
applications for crude oil and other petroleum products.
In 1994, the Company was awarded $2 million of federal funding under the
Advanced Technology Program ("ATP") administered by the National Institute of
Standards and Technology. The ATP project is dedicated to the development of
a biotechnology-based method of removing sulfur from crude oil. The
three-year program funded with this award is intended to accelerate the pace
of development in crude oil desulfurization, moving the BDS technology in
this area from the research level toward the pilot plant phase. In 1997, the
Company was awarded funding by the U.S. Department of Energy ("DOE") for a
$2.4 million, three-year program dedicated to the development of a BDS
application for gasoline. The DOE-funded program is intended to accelerate
the advancement of the Company's BDS technology for gasoline desulfurization
from bench-scale research and development to pilot-scale development.
The Company had research and development expenses for the years ended
December 31, 1995, 1996, and 1997 of $7,338,319, $9,210,227, and $9,087,149,
respectively. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations."
BIOCATALYST DEVELOPMENT
The central element of the Company's BDS technology is the
"biocatalyst," a microorganism originally isolated from the soil that has
been genetically engineered to maximize its effectiveness in removing the
sulfur molecules in petroleum. The effectiveness of the biocatalyst, as with
any other catalyst, depends upon the optimization of three important
attributes: (i) the rate of reaction; (ii) the specificity of the catalyst
for the target molecules; and (iii) the stability of the catalyst under
operating conditions. EBC has made significant progress in each of these
areas. See "-- Risk Factors --Technological Uncertainty; Risks Associated
with Commercialization of BDS Technology."
REACTION RATE. The observed reaction rate in the Company's BDS process
is a function both of the intrinsic abilities of the biocatalyst (i.e., its
specific activity) and of the conditions in the particular reactor. The
intrinsic activity of the biocatalyst depends upon several factors at the
cellular level. In 1997, the Company maximized one of these factors by
"overexpressing" the critical enzymes in the biocatalyst's cells so that they
represent about 30 percent of its total cellular protein. The overexpression
of these enzymes was achieved through a combination of
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genetic engineering strategies, the most significant of which were the
amplification of the genes responsible for producing these enzymes (i.e.,
creating multiple copies of such genes in each organism) and the modification
of the DNA sequence of these genes to encourage the cells to make between 100
and 1,000 times more of the key enzymes than they normally would. The
Company also was able to incorporate the earlier discovery of a fourth
component of the system into its current biocatalyst. When appropriately
amplified with the other enzymes, the incorporation of this fourth component
has significantly increased the reaction rate of the biocatalyst.
SPECIFICITY. The Company's BDS process employs enzymes specifically
directed at a certain class of sulfur molecules in petroleum to catalyze the
desulfurization reactions. Although this class of sulfur molecules includes
the predominant types of sulfur molecules found in diesel fuel, anticipated
regulations governing the sulfur content of diesel fuel are expected to
require such low concentrations of sulfur that the Company's BDS process will
also need to address the less predominant, more complex sulfur molecules
found in diesel fuel. In 1997, the Company's scientists identified and
characterized these "desulfurization resistant" molecules and developed a
strategy for the optimization of the biocatalyst to increase the specificity
of the biocatalyst for such molecules. The Company believes that its lab
results support the feasibility of this approach and that it is making rapid
progress in broadening the biocatalyst specificity to address these molecules.
STABILITY. The BDS biocatalyst is a living organism and a dynamic
system in which enzymes within the cell are continually being made and
destroyed. The Company's research and development team has observed a
gradual decay of biocatalyst activity in the reactor system as a result of
these metabolic processes. In 1997, EBC researchers demonstrated that the
cells remained active in the reactor for days after desulfurization activity
had ceased. The Company's research and development team has characterized
the nature of the inactivation of the desulfurization characteristics of
these cells and is working to develop new strains that degrade the
desulfurization enzymes more slowly and are genetically engineered to produce
more desulfurization enzymes while the biocatalyst remains in the reactor
system. In 1997, the Company developed a new strain of the biocatalyst
organism that terminates the desulfurization reaction at a point that allows
removal of the oxidized sulfur molecules (as an organic sulfinate) while
minimizing the metabolic consequences of complete conversion of the molecules
to inorganic sulfate. This change increased the activity of the biocatalyst
significantly and had very positive effects on its stability.
PROCESS ENGINEERING
In addition to efforts in biocatalyst development, EBC has allocated
considerable resources to the development of the process technology for the
first BDS units. The Company believes that scale-up of its BDS process can be
accomplished with conventional process engineering technology. The Company
began pursuing several opportunities in 1997 to accelerate the commercial
viability of its BDS technology through more innovative use of available
process technology. The Company's process development team substantially
improved the efficiency of the BDS reactor system and reduced the cost of the
BDS process in 1997, and is continuing to pursue additional improvements in
efficiency and cost through process engineering efforts in three main areas:
(i) separations technology; (ii) biocatalyst regeneration; and (iii)
byproduct disposition. The Company's objectives in these three areas are to
adapt conventional process technology from other commercially proven
processes in a manner that lowers the activity and stability requirements
placed on the BDS biocatalyst, thereby reducing the cost and improving the
commercial viability of BDS units. Each of the three targeted engineering
innovations represents an attempt to take greater advantage of some
established characteristic or capability of EBC's current biocatalyst
technology, creating a synergy between biocatalyst and process development.
Representatives of the Company meet regularly with representatives of M.W.
Kellogg to ensure that all of the targeted innovations are appropriate and
suitable for scale-up and commercialization within a typical petroleum
refinery. See "-- Risk Factors -- Technological Uncertainty; Risks
Associated with Commercialization of BDS Technology."
BDS PILOT PLANTS. The Company and Petrolite jointly operate the Company's
principal BDS pilot plant at Petrolite's facilities in St. Louis, Missouri. The
St. Louis pilot plant, completed in late 1994, is a fully integrated
desulfurization unit capable of processing up to five barrels of diesel fuel per
day. It began processing diesel
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feedstock in March 1995 and was extensively revamped in 1997 to capitalize on
process engineering improvements. The pilot plant is providing the basis for
the design of commercial-scale BDS units. EBC built a second, smaller pilot
plant during the second quarter of 1997 at its research facility in The
Woodlands, Texas. The new pilot plant, which is capable of processing three
gallons of diesel fuel per day, was built to facilitate the Company's process
engineering initiatives, and was used to develop the reactor improvements
that were implemented at the St. Louis pilot plant in the third quarter of
1997. It is a fully integrated unit, with three staged BDS reactors,
separations equipment, recycle capabilities, and a PC-based process control
system. The Company consulted with its alliance partner, M.W. Kellogg, during
the revamp of the St. Louis pilot plant, and M.W. Kellogg provided the design
for the this smaller pilot unit.
BIOREACTOR TECHNOLOGY. The Company has designed and constructed both
pilot plants to develop the catalytic process with hydrocarbon molecules in
the presence of air, water and various process chemicals. Variables such as
temperature, agitation rate and pH (acidity or alkalinity) can be controlled,
and measured amounts of oxygen and process chemicals can be added to the
mixture of biocatalyst and petroleum, optimizing the desulfurization
environment. EBC implemented a redesigned, staged reactor system at the St.
Louis pilot plant during the third quarter of 1997. Experiments at the pilot
plant confirmed that the redesigned reactor system significantly increased
the level of desulfurization, with no increase in total reactor volume.
Experiments at the Company's smaller pilot plant further indicated that the
Company's biocatalysT can be used more effectively by operating with a higher
concentration of biocatalyst in the reactor. This discovery lead to the
initiation in 1997 of engineering research efforts focused on the development
of a low-cost separation scheme capable of recovering the oil from the
reactor effluent when a much higher cell-loading is used in the reactor
section of the process.
SEPARATIONS. The BDS process produces a mixture of water, desulfurized
hydrocarbons, biocatalyst, and sulfur byproduct. The mixture must be
separated into its components, a process which involves substantial increases
in difficulty and cost as the concentration of biocatalyst increases. The
Company previously has developed technology, demonstrated in the laboratory
and successfully implemented at the Company's St. Louis pilot plant in 1996,
for the efficient separation of these components if the biocatalyst is
present in the reactor at a relatively low concentration. This low
concentration separation process employs a combination of conventional
technologies which the Company believes can be scaled up to commercial levels
without substantial difficulty. In connection with the Company's decision in
1997 to pursue efforts to increase the biocatalyst concentration used within
the process as a complement to its efforts to increase the activity of the
biocatalysT, the Company began working toward developing a low-cost
separation process compatible with higher concentrations of biocatalyst that
could still be scaled up economically to commercial levels. The Company's
engineers are working closely with several equipment vendors and conducting
experiments in the lab and the two pilot plants towards achievement of this
objective.
BIOCATALYST REGENERATION. As the biocatalyst used in the Company's BDS
process circulates and is used to catalyze the BDS reaction, its activity
level decreases with time, a phenomenon common in both biological and
chemical catalysts. Prior to 1997, the Company's BDS process design was
based upon continually feeding fresh biocatalyst into the process, using the
biocatalyst for a period of time, and discarding the spent biocatalyst. In
1997, the Company discovered a biocatalyst formulation and a set of process
operating conditions that allowed the biocatalyst to be regenerated,
permitting the operation of the bioreactor system with a reduced amount of
biocatalyst. The Company is pursuing this new process concept, which it
believes may significantly reduce the operating cost of a BDS unit. In
addition, the Company believes that the byproduct of the biocatalyst
developed for this new mode of operation provides an opportunity to further
improve the economics of the BDS process.
BYPRODUCT DISPOSITION. The principal byproduct of the BDS process, when
using a non-regenerative biocatalyst, is a water-soluble, inorganic sulfur
compound that can be separated from the biorefined petroleum at relatively
low cost. The Company has evaluated alternatives for the disposition of the
sulfur resulting from this process and believes that the best alternative for
most refineries would be conversion of the sulfur byproduct either to
ammonium sulfate, which can be used as a fertilizer, or to sodium sulfate. A
secondary byproduct of this process is the spent biocatalyst stream, which
would be expected to be disposed of at an off-site commercial disposal
facility as either a solid or other refinery waste. The principal byproduct
of the BDS process concept currently being
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developed by the Company, using a regenerative biocatalyst, is an ionic salt
of an organic sulfinic acid, called organic sulfinate, which the Company
believes could have commercial value. The Company currently is exploring the
market potential for this possible byproduct.
MASS TRANSFER ISSUES. The Company's progress on improving the activity
of the biocatalyst prior to 1997 increased the intrinsic reaction rate of the
biocatalyst to a point where it was capable of performing at a rate that
exceeded the rate at which sulfur molecules and the products of
desulfurization could be transported to and from the enzymes. Limitations in
the speed of a catalytic reaction as a result of the rate at which a
substrate transfers to a catalyst (known as "mass transfer limitations") are
commonly encountered in both biological and chemical catalysis and can
frequently be overcome through one or more commonly used biological and
chemical engineering solutions. In 1997, the Company modified both the
biocatalyst and the reactor design to successfully overcome the mass transfer
limitation, such that current biocatalyst is functioning at its maximum
intrinsic activity in the current process design (i.e., the present rate of
biodesulfurization is no longer being limited by mass transfer limitations).
PRODUCTION OF THE BIOCATALYST
Large-scale growth and production, or fermentation, of biocatalysts is
essential to the commercialization of the BDS technology. The Company's
efforts in developing alternative microbial hosts have been intended to
select hosts that can be produced more rapidly and at lower cost. The
Company believes that this fermentation will not be substantially different
from the many antibiotic and enzyme fermentations routinely commercialized by
other biotechnology companies. The Company currently conducts small- and
intermediate-scale (300 liter) fermentations at its laboratory facilities.
These facilities are sufficient to supply laboratory and preliminary pilot
plant needs for the biocatalyst. The Company is pursuing agreements with
leading worldwide biocatalyst manufacturers to ensure a continuous supply of
biocatalyst for the Company's BDS process. See "-- Risk Factors --
Technological Uncertainty; Risks Associated with Commercialization of BDS
Technology" and "-- Risk Factors --Manufacture of Biocatalyst."
SCIENTIFIC ADVISORY BOARD
The Company has retained a group of distinguished research scientists
and engineers to provide advice on matters relating to its research,
development and business activities. The Scientific Advisory Board, composed
of five members, meets with the Company's scientists and management and is
regularly available for consultation. Scientific advisors are compensated
for expenses and certain advisors have been granted options to acquire Common
Stock. The members of the Scientific Advisory Board are as follows:
CHARLES L. COONEY, PH.D., PROFESSOR OF CHEMICAL AND BIOCHEMICAL
ENGINEERING, MASSACHUSETTS INSTITUTE OF TECHNOLOGY. Dr. Cooney is widely
recognized as an expert in the field of bioreactor design and engineering.
He is the author or co-author of more than 200 scientific publications and
patents and has received many academic awards and honors, including being
named Founding Fellow, American Institute for Medical and Biological
Engineering, in 1992. In addition to serving as Professor of Chemical and
Biochemical Engineering, Dr. Cooney also is Executive Officer in the
Department of Chemical Engineering and Co-Director of the Program on the
Pharmaceutical Industry at Massachusetts Institute of Technology. Dr. Cooney
received his B.S. in Chemical Engineering from the University of Pennsylvania
and his M.S. and Ph.D. in Biochemical Engineering from Massachusetts
Institute of Technology.
NORMAN HACKERMAN, PH.D., PRESIDENT EMERITUS AND DISTINGUISHED PROFESSOR
EMERITUS OF CHEMISTRY, RICE UNIVERSITY, AND FORMER PRESIDENT AND PROFESSOR
EMERITUS OF CHEMISTRY, THE UNIVERSITY OF TEXAS AT AUSTIN. Dr. Hackerman is a
member of the National Academy of Sciences and of the American Philosophical
Society, a Fellow of the American Academy of Arts and Sciences, and Chairman of
the Scientific Board of the Robert A. Welch
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Foundation. Dr. Hackerman has been the recipient of many awards, including
the American Institute of Chemists Gold Medal and the Mirabeau B. Lamar Award
of the Association of Texas Colleges and Universities. He received his A.B.
and Ph.D. from Johns Hopkins University.
HERBERT L. HEYNEKER, PH.D., FOUNDER AND CHIEF TECHNICAL OFFICER, EOS
BIOTECHNOLOGY, INC. Dr. Heyneker is an authority in microbial expression of
human proteins, including insulin, growth hormone and tPA; protein
engineering; and expression systems for industrial microorganisms. Dr.
Heyneker serves as a director of Genpharm International, Inc. and Introgene,
B.V., and as chairman of the Scientific Advisory Board of Pharming, B.V. He
also serves as a scientific advisor for Genencor International, Inc., Genomyx
Corp., ProtoGene Laboratories, Inc., and MaxyGen, Inc. He earned his Ph.D.
from the University of Leiden, The Netherlands and completed his
post-doctoral fellowship at the University of California-San Francisco
Medical School.
CHARLES F. KULPA, JR., PH.D., PROFESSOR OF BIOLOGICAL SCIENCES,
UNIVERSITY OF NOTRE DAME. Dr. Kulpa is regarded as an expert in the fields
of microbiology, bioremediation and biochemistry. His laboratory research
work is concentrated in the areas of environmental and applied microbiology.
Dr. Kulpa has authored or co-authored numerous papers detailing his research
in microbiological and biochemistry processes. Active in many scientific
organizations, Dr. Kulpa has served as President of the Indiana Branch of the
American Society for Microbiology and currently is a director of the Southern
Great Lakes Region, Society of Industrial Microbiology. He received his
B.S., M.S. and Ph.D. in Microbiology from the University of Michigan.
W. ARTHUR PORTER, PH.D., PRESIDENT AND CHIEF EXECUTIVE OFFICER OF THE
HOUSTON ADVANCED RESEARCH CENTER. In addition to his responsibilities as
President and Chief Executive Officer of The Houston Advanced Research Center
("HARC"), Dr. Porter is adjunct professor of electrical and computer
engineering at Rice University in Houston. He is a recognized international
authority on technology commercialization and the management of collaborative
projects. Dr. Porter serves on the boards of the Southwest Research
Institute, the Texas Academy of Mathematics and Science, the University of
Houston Center for Public Policy, and HARC. He received his B.S. and M.S.
degrees in Physics from the University of North Texas and his Ph.D. in
Interdisciplinary Engineering from Texas A&M University.
ALLIANCES
The Company has entered into alliances with potential customers and
suppliers in support of its BDS development and commercialization activities.
These alliances give the Company an opportunity to build on established
expertise and resources in areas critical to its success. In the case of
alliances with potential customers, the Company believes that these
relationships may enhance its ability to sell BDS units. Entering into
alliances with recognized industry suppliers is expected to facilitate
commercialization of the BDS technology. However, there can be no assurance
that the Company will be successful in maintaining its existing collaborative
relationships or in establishing new relationships.
ALLIANCES WITH POTENTIAL CUSTOMERS
TOTAL RAFFINAGE DISTRIBUTION S.A. In July 1994, the Company entered
into an agreement with TOTAL Raffinage Distribution S.A. ("TOTAL") to
collaborate on the application of the Company's BDS process to diesel and
other middle distillate fuel streams. The Company and TOTAL will each bear
their own costs and expenses incurred under the collaboration. In addition,
as part of its obligations under the agreement, TOTAL has provided the
Company with the use of analytical equipment valued at approximately
$200,000. The agreement with TOTAL provides that upon commercialization, the
site licenses will be waived on TOTAL's first commercial BDS unit. In
addition, TOTAL will be entitled to receive a 10 percent discount on future
site license and service fees until it has recovered two and one-half times
its research costs and expenses for BDS projects under the agreement. The
Company expects that its alliance with TOTAL will facilitate
commercialization of the BDS technology for diesel fuel and the Company's
entrance into the European market.
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The Company's alliance agreement with TOTAL contemplates an evaluation
of pilot plant operations, commencing after the Company's completion of the
development of a prototype biocatalyst. The Company completed the
development of a prototype biocatalyst in late 1996 and continues to conduct
bench-scale and pilot plant experimentation using improved generations of the
prototype biocatalyst to address the desulfurization targets requested by
TOTAL. The prototype biocatalyst is intended to possess characteristics
sufficiently similar to the commercial biocatalyst to permit the design of a
commercial-scale BDS unit although it is not expected or intended to possess
sufficient specific activity or other characteristics necessary to be
commercially viable. If the results from the pilot plant are satisfactory,
it is expected that TOTAL will build and operate at TOTAL's expense a pilot
BDS unit at TOTAL's European Center for Research and Technology and
simultaneously will build a commercial BDS unit at one of its refineries.
The Company intends to continue the development of the biocatalyst to improve
its specific activity and other characteristics necessary for commercial
viability during the period in which TOTAL is building these BDS units.
TOTAL has indicated that it intends to employ its initial BDS units for the
"ultra deep" (below 500 ppm) desulfurization of diesel, a range of
desulfurization below current regulatory standards in which BDS is expected
to possess greater cost advantages as compared to HDS. The Company is also
continuing to develop its BDS technology for the desulfurization of diesel
fuel in ranges above 500 ppm.
TOTAL is a wholly owned subsidiary of TOTAL S.A., a leading
international oil and gas company based in France. TOTAL S.A. participates
in every phase of the oil and gas industry with operations in more than 80
countries worldwide and revenues of over $46 billion.
KOCH REFINING COMPANY. In December 1993, the Company entered into an
alliance with Koch Refining Company ("Koch") for the development of a
biotechnology-based desulfurization system for refinery oil streams. The
alliance is expected to accelerate the development of BDS for certain
gasoline streams and customize that development for Koch's applications.
Under the terms of the alliance, the Company is primarily responsible for
improving the performance of the biocatalyst used in the BDS process and
developing a commercial BDS system. Koch is primarily responsible for
selecting and providing the target gasoline stream as well as testing
desulfurized product quality. Koch also will provide engineering support as
needed in the development of a BDS unit for Koch's operations. Until
commercialization, the Company and Koch will each bear their own costs and
expenses incurred in connection with the collaboration. Upon
commercialization, Koch will be repaid for direct costs and expenses incurred
in assisting BDS development. Repayment will be in the form of a 10 percent
rebate on desulfurization processing fees charged to Koch until Koch has been
repaid its share of BDS development costs. EBC expects that the development
alliance with Koch will facilitate commercialization of the Company's BDS
technology for target gasoline streams.
Koch is a part of Koch Industries, one of the largest privately held
companies in the United States. Koch Industries, with annual revenues in excess
of $30 billion, is involved in virtually all phases of the oil and gas industry,
as well as chemicals, chemical technology products, agriculture, hard minerals,
real estate, and financial investments.
TEXACO EXPLORATION AND PRODUCTION TECHNOLOGY DIVISION. In July 1993,
the Company signed an agreement with the Exploration and Production
Technology Division of Texaco Inc. ("Texaco") for the development of a BDS
process for crude oil. Under the terms of the alliance, the Company
primarily is responsible for improving the performance of the biocatalyst
used in the BDS process. Texaco primarily is responsible for field
operations, analytical chemistry work, and selecting and providing the target
crude oil stream as well as testing desulfurized product quality. Process
engineering is conducted jointly by the parties. The Company and Texaco each
bear their own costs and expenses incurred in connection with the
collaboration. In the event the Company sub-licenses Texaco's intellectual
property and proprietary information, licensed by Texaco to the Company, the
Company has agreed to pay Texaco an amount equal to 10 percent of the
desulfurization processing fee charged to Texaco until such time as the
Company has paid Texaco an aggregate amount equal to two and one-half times
the aggregate amount of Texaco's direct costs and expenses incurred in
connection with the collaboration. The Company expects that the development
alliance with Texaco will facilitate commercialization of the Company's BDS
technology for crude oil applications.
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Texaco is one of the largest oil companies in the world with operations
in crude oil production, refining and marketing. Texaco has annual revenues
in excess of $46 billion.
PROSPECTIVE ADDITIONAL CUSTOMER ALLIANCES. The Company is pursuing
additional alliances with potential customers, particularly in the Middle
East and Asia, two markets that are expected to make significant investments
in desulfurization technology over the next decade.
ALLIANCES WITH SUPPLIERS
THE M.W. KELLOGG COMPANY. In August 1994, the Company signed an
agreement with The M.W. Kellogg Company ("M.W. Kellogg") to collaborate on
the development and commercialization of BDS technology. Under the terms of
the collaboration, M.W. Kellogg will serve as an engineering consultant to
the Company during completion of the BDS development process and will be the
exclusive provider of the basic engineering design services required for
commercial BDS units. In return for these services, M.W. Kellogg will
receive a portion of the site license fee generated by the sale of BDS units.
The collaboration has a minimum term of at least five years or the
completion of 20 BDS units, whichever is longer, and applies to all
biorefining technologies the Company develops. During the first phase of the
collaboration, M.W. Kellogg provided 500 engineering work hours of service at
no cost to the Company. M.W. Kellogg also agreed to provide an additional
1,500 work hours of service at M.W. Kellogg offices at reduced rates. EBC
expects that the development alliance with M.W. Kellogg will substantially
enhance its refinery engineering capabilities and market access.
M.W. Kellogg is an ISO 9001-certified, international technology-based
engineering and construction contractor, serving primarily the hydrocarbon,
chemical and energy related industries. M.W. Kellogg is a wholly owned
subsidiary of Dresser Industries, Inc., a major supplier of highly engineered
products and services primarily used in hydrocarbon and energy-related
activities throughout the world. Dresser Industries, Inc. has annual
revenues in excess of $7 billion.
BAKER PETROLITE CORPORATION. In March 1992, the Company entered into a
collaboration agreement with Petrolite Corporation, now Baker Petrolite
Corporation ("Petrolite"). The Company and Petrolite agreed to jointly
develop the Company's BDS process and utilize emulsification and separations
technologies and process chemicals developed by Petrolite, if needed. In
connection with this collaboration, Petrolite agreed to provide the
emulsification and separations equipment necessary for the storage, mixing,
injection and delivery of biocatalysts and process chemicals used in the BDS
process and to pay the Company $5.4 million during the first two years of the
agreement for research and development. Petrolite also agreed to design and
finance construction of the pilot plant and to provide service personnel to
operate and service the BDS units on site at customer locations. The Company
agreed to market the BDS process and the Company's biocatalyst, and to fund,
during the third through fifth years of the agreement, research and
development related to BDS at an annual rate of not less than four percent of
the Company's net revenues from BDS projects or $2.5 million, whichever is
greater. Under the collaboration agreement, the Company is obligated to pay
Petrolite 22 percent of all site license fees received by the Company from
BDS customers and 22 percent of adjusted gross profit (as defined in the
agreement) realized from operation of the BDS units. The Company expects
that the development alliance with Petrolite, and now Baker Petrolite, will
facilitate commercialization of the Company's BDS technology through the
development and testing of the pilot plant.
In October 1996, the Company entered into an agreement with Petrolite
providing the Company with the option to amend the terms of its strategic
alliance with Petrolite. Under the agreement, the Company made an initial
payment of $1 million to Petrolite in December 1996 in exchange for the
option and the extension of Petrolite's obligations to provide operational
and technical support for the pilot plant from September 1, 1996 through
December 31, 1998. If the Company exercises its option, the percentage of
site license fees and adjusted gross profit payable to Petrolite will be
reduced to 9.5% from 22%, in exchange for which the Company will (i) assume
responsibility for servicing the BDS units on site at customer locations (ii)
pay Petrolite an additional $9 million in
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cash and (iii) issue to Petrolite a warrant entitling Petrolite to purchase
138,889 shares of Common Stock at an exercise price of $7.20 per share. The
Company may exercise the Petrolite option at any time on or before the
earlier to occur of (i) ten business days following the closing of any equity
financing by the Company in which the gross cash proceeds raised in such
financing (together with the gross cash proceeds raised by the Company in any
other equity financing after the date of the option agreement, if applicable)
equal or exceed $25 million and (ii) December 30, 1998. The Company does not
plan to exercise the option unless and until it has raised substantial
additional funds or received additional capital.
Petrolite was acquired by Baker Hughes Incorporated ("Baker Hughes") in
1997 in connection with which it merged with Baker Hughes subsidiary Baker
Performance Chemicals. Baker Hughes, which serves the worldwide petroleum
and processing industries, has annual revenues in excess of $3 billion.
CUSTOMER AGREEMENT
In March 1998, the Company entered into a site license agreement with
Petro Star Inc. ("Petro Star") regarding the design and installation of a BDS
unit at Petro Star's Valdez, Alaska refinery. The agreement involves several
stages of work, the first of which, involving the completion of scoping
economics, is currently under way. In addition, the agreement provides EBC
with certain rights to conduct development work and demonstrations of its BDS
technology at Petro Star's refinery. The agreement calls for the payment of
staged license fees and royalties to EBC, including a $200,000 initial site
license fee paid upon execution of the agreement and $300,000 additional site
license fees payable at various stages during the term of the agreement. As
is customary in such arrangements in the petroleum refining industry, the
agreement provides certain approval and termination rights to Petro Star at
the completion of each stage prior to commercialization. In connection with
the execution of the agreement, the Company issued a four-year warrant
entitling Petro Star to purchase 200,000 shares of EBC Common Stock at an
exercise price of $3.11 per share. The successful implementation of a
commercial BDS unit will be dependent upon the Company's ability to achieve
additional improvements in the productivity of the biocatalyst (e.g.,
reaction rate, specificity and stability) and process technology (e.g.,
bioreactor and separations technology). See "-- Risk Factors --
Technological Uncertainty; Risks Associated with Commercialization of BDS
Technology."
Petro Star, a wholly owned subsidiary of Arctic Slope Regional
Corporation, refines and distributes petroleum products throughout Alaska.
The Anchorage-based company owns and operates oil refineries in Valdez and
North Pole, Alaska, with distribution facilities in Fairbanks, Kodiak and
Dutch Harbor. The Petro Star Valdez refinery is a major supplier of military
jet fuel, as well as marine diesel and other middle distillate products.
COMPETITION
The primary competition for BDS technology is expected to come from
licensors of HDS technology and the manufacturers of catalysts used in those
units. In most initial diesel fuel applications, BDS will be sold as a
complementary process where expanded capacity is desired or a greater degree
of desulfurization becomes necessary in connection with an existing HDS unit.
Subsequently, BDS will be developed as a stand-alone diesel fuel
desulfurization process, competing directly with HDS. In the case of
gasoline, where HDS units are not typically used, the Company expects BDS to
operate as a stand-alone desulfurization system. The Company intends to
compete on the basis of cost effectiveness, ease of integration,
effectiveness in removing complex sulfur molecules that are resistant to
conventional desulfurization technologies, and the ability to process
petroleum streams that are difficult for HDS to process.
HDS process technologies and catalysts are supplied by a small number of
companies that maintain their market positions through a combination of
recognized expertise, intellectual property rights and established
relationships with refiners. Increasing environmental regulation has caused
these catalyst suppliers to make significant investments in research and
development during the past several years to develop more efficient HDS
technologies. The Company believes that these efforts have been directed at
refinement of the conventional HDS technology rather than development of
entirely new processes. Many of these companies supplying HDS
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technology have substantially greater financial, technical and human
resources than the Company.
BDS may face competition from other biotechnology processes, although
the Company believes it is the leading developer of biorefining in the world.
The most significant competitive effort of which the Company is aware is
based in Japan at the Petroleum Energy Center ("PEC"), a consortium of
Japanese petroleum companies conducting research funded by the Japanese
Ministry of International Trade and Industry. The Company believes, based
upon meetings with PEC personnel and third-party sources, that it has a
substantial lead in developing BDS technology and that its patents provide it
with a substantial competitive advantage over the PEC effort. The Company is
also aware that one or more major oil companies have from time to time
attempted to develop microbial or biocatalytic desulfurization technologies,
although the Company believes that none of these companies has successfully
developed any of these technologies to date. Based upon information
available to the Company, the Company believes that these efforts do not
currently present significant competition for its BDS technology in its
primary markets.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company's ability to compete will depend in part on maintaining the
proprietary nature of its technology. The Company has established an active
program for the protection of its intellectual property. This program
includes, among other things: procedures, notebooks and forms for
documenting, evidencing and disclosing all Company inventions to management;
a Patent Review Committee which meets regularly to discuss all intellectual
property issues; a system for continuously monitoring patents issued to, and
patent applications filed by, relevant third parties; a program of seminars
for employees on intellectual property topics; a recognized intellectual
property law firm on retainer; a patent administrator and other personnel
dedicated to assisting in the preparation and prosecution of the Company's
patents; personnel policies and agreements requiring disclosure by employees
of all inventions and protection of confidential information; and agreements
with all technical and scientific employees providing for the assignment of
inventions made by such employees to the Company.
The Company has an active program in place to maintain and build its
intellectual property position. Seven U.S. patents on BDS technology have
been issued to The Institute of Gas Technology ("IGT") and licensed
exclusively to the Company, subject to the U.S. government's rights to
certain of such patents. Additionally, one U.S. patent has been issued to the
Korean Institute of Science & Technology and licensed on a nonexclusive basis
to the Company. A U.S. patent claiming the use of BDS in combination with
HDS for BDS technology was issued to the Company in 1993. The two-stage
process for deep desulfurization covered by this patent involves the use of
BDS in conjunction with conventional HDS technology, taking advantage of the
significant synergies between the two technologies. The Company was issued
three patents during the year ended December 31, 1994 and three patents
during the year ended December 31, 1995. The most significant of the three
patents issued in 1994 is the "Recombinant DNA Encoding a Desulfurization
Biocatalyst" patent, which is a fundamental recombinant DNA patent on the
genetic sequences for enzymes that desulfurize petroleum. This patent is an
important milestone in the development of the Company's worldwide competitive
position and establishes its technical leadership in biodesulfurization. The
remaining two patents issued in 1994 include "A Process for the
Desulfurization and the Desalting of Fossil Fuels" and "Microemulsion Process
for Direct Biocatalytic Desulfurization of Organosulfur Molecules." The
patents issued in 1995 include "Multistage Process for Deep Desulfurization
of Fossil Fuels," "Method for Separating a Sulfur Compound from Carbonaceous
Materials" and "Continuous Process for Biocatalytic Desulfurization of
Sulfur-Bearing Heterocyclic Molecules." In 1996, an additional five U.S.
patents were issued to the Company, including continuations in part on the
HDS/BDS patent first issued in 1993 and the desalting patent first issued in
1994 as well as two entirely new patents related to oil/water separations
technology and a novel process for the reduction of oil viscosity. The
technologies to which these patents relate are expected to yield long-term
improvement in the economics of biodesulfurization for the Company. In 1997,
an additional U.S. patent was issued to the Company relating to a method for
removing and separating metals from fossil fuels. Patents issued to or
licensed by the Company begin to expire in the year 2010.
15
<PAGE>
The Company has filed patent applications in the U.S. and worldwide
under the Patent Cooperation Treaty as well as in targeted countries not
involved in the treaty such as Venezuela. In total, the Company has rights
to 21 U.S. patents (including cell recombinant DNA and fundamental process
patents) and 32 foreign patents. In addition, the Company has 14
applications pending in the U.S. patent office, and more than 70 foreign
patent applications pending to cover BDS process technology and the molecular
cloning of the biocatalyst gene. See "--Risk Factors--Patents and Proprietary
Technologies."
EMPLOYEES AND CONSULTANTS
The Company believes that its success will be based, among other things,
on achieving and retaining scientific and technological superiority and on
identifying and retaining capable management in order to conduct a fully
integrated program of biorefining technology development. The Company has
assembled a highly qualified team of scientists as well as executives with
extensive experience in the petroleum industry. The Company's product
development program combines basic scientific disciplines, such as molecular
biology, microbial genetics, biochemistry and biochemical engineering, with
applied disciplines such as fermentation, process development, petroleum
product separations and recovery, and byproduct disposition expertise.
As of December 31, 1997, the Company employed 84 people, 26 of whom hold
Ph.D. degrees and 13 of whom hold other advanced degrees. The Company's
employees with doctoral degrees represent collective expertise in molecular
biology, microbiology, biochemistry, chemistry and chemical and process
engineering. The Company believes that its relationship with its employees
is good.
GOVERNMENT REGULATION
Certain of the Company's current and planned operations are, or may be,
subject to regulation under various federal and state laws pertaining to
protection of the environment and employee health and safety. In the course
of its current research and development activities, the Company generates
small quantities of solid and hazardous wastes that are subject to regulation
under the Resource Conservation and Recovery Act ("RCRA") and various other
federal and state regulations. The research and development activities of
the Company are also subject to the Occupational Safety and Health Act
("OSHA") and similar state laws and regulations. Upon commercialization of
the Company's technology, the Company's operations will be subject to the
full scope of environmental and employee health and safety regulations
including not only RCRA and OSHA, but also the Clean Air Act, the Federal
Water Pollution Control Act, the Toxic Substances Control Act ("TSCA") and
other applicable state and federal environmental laws and regulations.
Although current information is not definitive enough to accurately predict
compliance requirements with such laws and regulations, the Company believes
that compliance will not materially affect its operations.
Under TSCA, the U.S. Environmental Protection Agency ("EPA") regulates
the use of chemicals for commercial purposes, and the EPA has asserted that
it has jurisdiction under TSCA to regulate genetically engineered
microorganisms ("GEMs"). Prior to commercialization of the Company's
biocatalyst product, the Company will most likely be subject to the
Premanufacture Notice Requirements under TSCA in marketing its BDS
technology. Under the Premanufacture Notice Requirements, if the EPA finds
that the Company's biocatalyst product poses an unreasonable risk to the
environment, it may establish controls on its manufacture, distribution or
disposal. Based on written communication with the EPA, the Company does not
believe that compliance with TSCA will delay the commercialization of the BDS
process.
Commercialization of the Company's technology outside the U.S. will
require compliance with the regulations of foreign countries. In
anticipation of early commercialization in Europe, the Company has begun
efforts to prepare for compliance with European Union regulations for
genetically modified organisms ("GMOs"). Directive 90/219 of the European
Commission provides a framework for contained use of GMOs. Each of the
member countries has enacted specific regulations consistent with this
directive. Based upon discussions with authorities in France, Belgium and
the United Kingdom regarding their regulations under Directive 90/219, the
Company does not believe that compliance with such regulations will delay
commercialization of the BDS process in Europe.
16
<PAGE>
RISK FACTORS
TECHNOLOGICAL UNCERTAINTY; RISKS ASSOCIATED WITH COMMERCIALIZATION OF BDS
TECHNOLOGY
Since its inception, the Company has engaged primarily in research and
development related to its BDS process. The Company's BDS process will
require substantial additional research, development and testing in order to
determine its commercial viability. The Company has not proven its BDS
technology other than to a limited extent in laboratory, bench-scale and
pilot plant trials. The Company's ability to make its BDS technology
commercially viable will depend in large part on its success in (i) achieving
improvement of its biocatalyst, including the manipulation of the genes
responsible for desulfurization activity to increase the reaction rate,
specificity and stability of the biocatalyst, (ii) improving the rate at
which sulfur molecules transfer from petroleum to the biocatalyst, (iii)
developing the fermentation process, (iv) contracting for the manufacture of,
or manufacturing, sufficient biocatalyst for use in commercial BDS units, (v)
developing a bioreactor for use with the BDS process capable of operating at
commercial levels of throughput and desulfurization, (vi) identifying
economically viable processes for commercial-scale sulfur byproduct
disposition and (vii) marketing its BDS systems effectively. The
accomplishment of some or all of these objectives may take longer than
anticipated or may never occur. If the accomplishment of any of these
objectives takes longer than anticipated, the Company may require additional
capital to continue the development and commercialization of its BDS
technology, and there can be no assurance that such capital will be available
or that the Company will be able to successfully commercialize the BDS
technology.
HISTORY OF OPERATING LOSSES AND UNCERTAINTY OF FUTURE PROFITABILITY
The Company has incurred net losses since its inception and expects its
losses to increase in the foreseeable future as it increases its expenditures
for the continued development and commercialization of its biorefining
technology. The Company has not derived any revenues to date from the use or
sale of its biorefining technology and had an accumulated deficit of
$55,204,265 at December 31, 1997. The time required for the Company to
become profitable is uncertain, and there can be no assurance that the
Company will achieve profitability on a sustained basis, if at all.
MANUFACTURE OF BIOCATALYST
The Company currently intends to manufacture, at its own facility, only
a quantity of biocatalyst sufficient for its in-house research and pilot
plant needs. The Company expects that the biocatalyst to be employed in the
commercial BDS process initially will be manufactured by a third party. The
Company has had discussions regarding non-exclusive biocatalyst supply
arrangements with several parties that it believes are capable of satisfying
the Company's supply requirements. If the Company is unable to enter into
agreements for the supply of commercial quantities of biocatalyst, the
Company may be forced to establish its own fermentation facilities. This
alternative could delay the commercialization of the BDS process and would
require significant capital expenditures.
MARKET ACCEPTANCE
The BDS process will require significant capital expenditures by
refiners and producers. The refining and oil production industries
historically have been reluctant to accept new technologies. There is a
risk, therefore, that the Company will have difficulty in obtaining the
refining and oil production industries' acceptance of the BDS process. Also,
the rate of purchase of the Company's BDS process may be affected by economic
conditions in the refining and oil production industries. The refining and
oil production industries have been subject to periods of depressed
profitability and are substantially affected by fluctuations in the price of
crude oil and finished products. Oil production and drilling activity are
also largely dependent on the level and volatility of oil prices.
17
<PAGE>
RELIANCE ON ENVIRONMENTAL REGULATION
Demand for the BDS units and services being developed by the Company is
based, in large part, on legislation and regulations in the United States,
Europe and Asia that specify stringent environmental quality standards and
that impose penalties for noncompliance. The amendments to the federal Clean
Air Act required the EPA to develop maximum sulfur content standards for
highway diesel fuel and new standards for gasoline content. In response, EPA
promulgated regulations regarding the maximum sulfur content of highway
diesel fuel in 1990 and regulations for a reformulated gasoline program in
1994. Similar regulations regarding the maximum sulfur content of diesel
fuel have been adopted in Western Europe and certain Asian countries. The
Company also expects that European and Asian countries will adopt and enforce
additional standards requiring a reduction in the sulfur content of petroleum
products. Any reduction of severity in current regulations, lax enforcement
of current regulations, delay in implementation and enforcement of planned
regulations, or reduction of severity in planned or anticipated regulations
worldwide may delay or decrease the worldwide demand for the Company's BDS
process.
PATENTS AND PROPRIETARY TECHNOLOGIES
The Company's success is heavily dependent upon its proprietary BDS and
other technologies. In total, the Company has rights to 21 U.S. and 32
foreign patents. In addition, the Company has 14 patent applications pending
in the U.S. patent office and more than 70 foreign patent applications
pending to cover BDS process technology and the molecular cloning of the
biocatalyst genes. There can be no assurance concerning the scope, validity
or value of such patents, patent applications or related intellectual
property rights. Furthermore, there can be no assurance that the steps taken
by the Company to protect its proprietary technologies will be adequate to
prevent misappropriation of these technologies by third parties, particularly
where third parties may independently develop similar technologies, duplicate
any of the Company's technologies or design around any proprietary
technologies owned by the Company. Any such misappropriation could have a
material adverse effect on the Company. Although the Company does not
believe any of its proprietary technologies infringe the patent or other
proprietary rights of third parties, there can be no assurance that
infringement claims will not be asserted against the Company in the future or
that any such claims will not require the Company to enter into license
arrangements or result in litigation. In the event that the Company may be
required to obtain licenses to patents or other proprietary rights of third
parties, there can be no assurance that any required licenses would be made
available to the Company on terms acceptable to the Company, or at all. If
the Company does not obtain such licenses, it could encounter delays in
commercializing its BDS technology while it attempts to design around such
patents or could find that the commercialization of its BDS technology could
be foreclosed. In addition, to the extent that the Company seeks to protect
its proprietary technologies overseas, there can be no assurance that steps
taken by the Company to protect its proprietary technologies will be adequate
under the laws of certain foreign countries, which may not protect the
Company's proprietary rights to the same extent as do the laws of the United
States.
The Company relies on secrecy to protect its proprietary technologies in
addition to patent protection, especially where patent protection is not
believed to be appropriate or obtainable. The Company has entered into
confidentiality agreements with its employees, licensors and certain of its
collaborators and consultants. There can be no assurance that such
obligations of confidentiality will be honored, that other parties will not
otherwise gain access to the Company's trade secrets or that the Company can
effectively protect its rights to its unpatented trade secrets. See " --
Patents and Proprietary Technology."
DEPENDENCE ON COLLABORATORS
The Company has been dependent on collaborative relationships for
development of certain key components of the BDS process, and the Company's
commercialization strategy contemplates continued dependence on collaborative
relationships. The Company has signed an agreement with M. W. Kellogg to
provide the basic engineering designs necessary for BDS implementation at
customer sites and an agreement with Petrolite relating to the development of
the Company's BDS technology and the construction and operation of the
18
<PAGE>
Company's pilot plant. Each alliance partner is currently providing
technical assistance during the development of the BDS process. The Company
also has entered into an alliance with TOTAL relating to the application of
the BDS process to diesel fuel, an alliance with Koch to develop the BDS
process for certain gasoline products, and an alliance with Texaco to develop
a process for desulfurizing high-sulfur crude oil. Collaborative
arrangements involve risks that the participating partners may disagree on
business decisions and strategies, which may result in delays, additional
costs or litigation. The inability of the Company to successfully maintain
existing collaborative relationships or enter into new collaborative
relationships could have a material adverse effect on the Company. See "--
Alliances."
NEED FOR ADDITIONAL FUNDS
EBC's operations to date have consumed substantial amounts of cash. The
negative cash flow from operations is expected to continue over the
foreseeable future. The Company believes that its existing capital resources
will be sufficient to fund its operations through early 1999. The report of
Arthur Andersen LLP, the Company's independent auditors, on EBC's financial
statements for the year ended December 31, 1997 includes an emphasis
paragraph with respect to the Company's need for future financing to develop
and commercialize its technology. Thereafter, the Company will need to raise
additional funds to continue development and commercialization of its
biorefining technology. The Company may seek additional funding through
public or private financings, including equity financings, and through
collaborative arrangements. Adequate funds for these purposes, whether
obtained through financial markets or collaborative or other arrangements
with corporate partners or from other resources, may not be available when
needed or on terms acceptable to the Company. The Company's inability to
raise funds when needed may require the Company to delay, scale back or
eliminate some or all of its research and product development programs. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
LIMITED MARKETING EXPERIENCE
The Company has only limited experience marketing its BDS technology,
and has assembled only a small sales and marketing staff. There can be no
assurance that the Company will be able to successfully implement its sales
and marketing plan.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent on the efforts of its executive officers,
scientists and other key employees, the loss of any one of whom could have a
materially adverse effect on the Company's business. Shortages of qualified
scientists within certain disciplines may occur and competition for the
services of qualified scientists may intensify. The Company may not be
successful in recruiting or retaining such personnel in the future.
GOVERNMENT REGULATION
Certain of the Company's current and planned operations are, or may be,
subject to regulation under various federal and state laws pertaining to
protection of the environment and employee health and safety. In the course
of its current research and development activities, the Company generates
small quantities of solid and hazardous wastes that are subject to regulation
under the Resource Conservation and Recovery Act ("RCRA") and various other
federal and state regulations. The research and development activities of
the Company are also subject to the Occupational Safety and Health Act
("OSHA") and similar state laws and regulations. Upon commercialization of
the Company's technology, the Company's operations will be subject to the
full scope of environmental and employee health and safety regulations
including not only RCRA and OSHA, but also the Clean Air Act, the Federal
Water Pollution Control Act, the Toxic Substances Control Act ("TSCA") and
other applicable state and federal environmental laws and regulations. In
addition, commercialization of the BDS technology outside the United States
will require compliance with the regulations of foreign countries. Failure
to comply with applicable regulations could have an adverse effect on the
Company. See "--Government Regulation."
19
<PAGE>
COMPETITION
The Company expects to encounter competition from suppliers of existing
desulfurization technology in the marketing of the Company's BDS units.
These companies have well-established relationships in the refining industry
and have substantially greater financial, technical and human resources than
the Company. In addition, new desulfurization technologies could be developed
that are competitive with or superior to the Company's BDS technology. See
"--Competition."
ITEM 2. PROPERTIES
FACILITIES
The Company's corporate offices and laboratories are situated in a
28,500 square-foot leased building located at 4200 Research Forest Drive in
The Woodlands, Texas, a suburb of Houston, Texas. Pursuant to the lease,
monthly payments of $30,440 are required for base rent. The lease for this
facility expires in 1998 and the Company has a renewal option extending the
lease to 2003. Approximately 20,500 square feet of this space is devoted to
research and development. The facility includes two laboratories designed
for molecular biology/microbiology/microbial physiology, a process
engineering laboratory, a biochemistry laboratory, a media preparation
laboratory, and an analytical laboratory that provides all the routine sulfur
and hydrocarbon analyses for the operation. In March 1995 the Company
completed construction of a fermentation laboratory, microbiology laboratory
and accelerated development program laboratories.
See "Item 1. Business - Patents and Proprietary Technology" for a
description of the Company's patents.
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending legal proceedings required to be reported
in response to this item.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's security holders
during the last quarter of the fiscal year ended December 31, 1997.
20
<PAGE>
PART II.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's common stock (symbol: ENBC) is traded on the Nasdaq
National Market. The following table sets forth the range of high and low
sales prices for each calendar quarterly period in the two years ended
December 31, 1997 as reported on the Nasdaq National Market:
<TABLE>
YEAR ENDED DECEMBER 31, 1997 HIGH LOW
---------------------------- ------- -------
<S> <C> <C>
First Quarter . . . . . . . . . . . . . . . . . . . . $ 8.25 $ 5.00
Second Quarter . . . . . . . . . . . . . . . . . . . 6.50 4.00
Third Quarter . . . . . . . . . . . . . . . . . . . . 6.63 4.00
Fourth Quarter . . . . . . . . . . . . . . . . . . . 7.81 2.63
YEAR ENDED DECEMBER 31, 1996 HIGH LOW
---------------------------- ------- --------
First Quarter . . . . . . . . . . . . . . . . . . . . $ 8.75 $ 5.25
Second Quarter . . . . . . . . . . . . . . . . . . . 9.50 5.50
Third Quarter . . . . . . . . . . . . . . . . . . . . 8.63 4.38
Fourth Quarter . . . . . . . . . . . . . . . . . . . 7.50 4.88
</TABLE>
As of March 14, 1998, 12,251,434 shares of common stock were outstanding
and the Company had approximately 118 shareholders of record.
DIVIDENDS
EBC has never paid cash dividends on its common stock. The Company
currently intends to retain any earnings to finance the growth and development
of its business and does not anticipate paying cash dividends in the foreseeable
future.
21
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below with respect to the
Company's statements of operations for each of the five years in the period
ended December 31, 1997 and with respect to the Company's balance sheets as
of December 31, 1993, 1994, 1995, 1996 and 1997 are derived from the
audited Financial Statements of the Company. The Company's independent
public accountants, Arthur Andersen LLP, have included an emphasis
paragraph in their report on the Company's Financial Statements as of
December 31, 1997 to the effect that in order to develop and
commercialize its technology, additional financing will be required.
The financial data should be read in conjunction with the "Management's
Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Financial Statements and Notes thereto
included elsewhere in this report.
<TABLE>
YEAR ENDED DECEMBER 31,
-----------------------
1993 1994 1995 1996 1997
---------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Sponsored research revenues . . . . . . .$ 1,134 $ 1,148 $ 1,567 $ 1,778 $ 1,652
Interest and investment income . . . . . . 510 573 1,401 807 650
---------- ---------- ----------- ---------- ------------
Total revenues . . . . . . . . . . . . . 1,644 1,721 2,968 2,585 2,302
Costs and Expenses:
Research and development . . . . . . . . . 4,894 5,723 7,338 9,210 9.087
General and administrative . . . . . . . . 2,037 2,978 2,877 2,608 2,754
---------- ---------- ----------- ---------- ------------
Total costs and expenses . . . . . . . .$ 6,931 $ 8,701 $ 10,215 $ 11,818 $ 11,841
---------- ---------- ----------- ---------- ------------
Net loss . . . . . . . . . . . . . . . . . .$ (5,287) $ (6,980) $ (7,247) $ (9,233) $ (9,539)
---------- ---------- ----------- ---------- ------------
---------- ---------- ----------- ---------- ------------
Net loss per common share - basic and
diluted . . . . . . . . . . . . . . . . . .$ (0.57) $ (0.75)(1) $ (0.95)(1) $ (1.04)(1) $ (1.09)(2)
---------- ---------- ----------- ---------- ------------
---------- ---------- ----------- ---------- ------------
Shares used in computing net loss
per common share - basic and
diluted . . . . . . . . . . . . . . . . . 9,195,517 9,967,645 10,227,595 11,248,029 11,769,458
---------- ---------- ----------- ---------- ------------
---------- ---------- ----------- ---------- ------------
</TABLE>
- --------------
(1) Net loss per common share has been computed by dividing the net loss, which
has been increased for periodic accretion and dividends on the Series A
Preferred Stock issued in October 1994, by the weighted average number of
shares of common stock outstanding during the period.
(2) Net loss per common share has been computed by dividing the net loss, which
has been increased for periodic accretion and dividends on the Series A
Preferred Stock issued in October 1994 and the Series B Preferred Stock
issued in February and March 1997, by the weighted average number of
shares of Common Stock outstanding during the period.
<TABLE>
DECEMBER 31,
------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents . . . . . . . . . . $ 6,135 $ 28,284 $ 6,172 $ 3,106 $ 9,661
Working capital . . . . . . . . . . . . . . . 11,650 26,269 15,084 8,770 10,102
Total assets . . . . . . . . . . . . . . . . 16,055 32,175 23,809 13,711 14,965
Long-term capital lease obligations . . . . . 32 21 11 -- --
Accumulated deficit . . . . . . . . . . . . . (14,501) (21,907) (31,321) (42,713) (55,204)
Total stockholders' equity . . . . . . . . . 12,891 28,444 21,577 12,715 13,698
</TABLE>
22
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Since its inception in December 1989, the Company has devoted
substantially all of its resources to research and development. To date, all
of the Company's revenues have resulted from interest and investment income
and sponsored research payments from collaborative agreements. The Company
has incurred cumulative losses since inception and expects to incur
substantial losses for at least the next several years, due primarily to the
increase in its research and development activities and acceleration of the
development of its biocatalyst, fermentation and bioreactor programs. The
Company expects that losses will fluctuate from quarter to quarter and that
such fluctuations may be substantial. As of December 31, 1997, the Company's
accumulated deficit was $55,204,265.
RESULTS OF OPERATIONS
The Company had total revenues for the years ended December 31, 1995,
1996 and 1997 of $2,967,954, $2,585,419 and $2,302,733, respectively.
Sponsored research revenues increased by $211,354 from 1995 to 1996,
primarily as a result of the Company's grant from the National Institute of
Standards and Technology ("NIST") and a research and development agreement
with The Carbide/Graphite Group, Inc. ("Carbide/Graphite"). Sponsored
research revenues decreased by $126,907 from 1996 to 1997, primarily as a
result of a decrease in deferred revenue recognized under the Petrolite
agreement offset in part by an increase in revenues from the NIST and
Department of Energy ("DOE") grants and Carbide/Graphite research and
development agreement. Payments under the Petrolite agreement were initiated
on April 1, 1992 and totaled $5,400,000 through March 1994. No payments were
received from Petrolite in 1995, 1996 or 1997. In each of the years ended
December 31, 1995 and 1996, $1,134,000 was recognized as revenue and in the
year ended December 31, 1997, $13,500 was recognized as revenue under the
Petrolite agreement; as of December 31, 1995, 1996 and 1997, the Company had
balances of $1,147,500, $13,500 and zero, respectively, of deferred revenues
under the Petrolite agreement. The amount recognized was based on the total
payments received in relation to the total research and development costs to
be incurred under the terms of the agreement. Interest and investment income
decreased by $593,889 and $156,287 in 1996 and 1997, respectively, as a
result of a decrease in cash and cash equivalents and related investments in
marketable securities.
The Company had research and development expenses for the years ended
December 31, 1995, 1996 and 1997 of $7,338,319, $9,210,227 and $9,087,150,
respectively. The increase of $1,871,908 from 1995 to 1996 resulted from the
addition of nine personnel in the research and development department,
additional office space acquired during the first quarter of 1996 for
research personnel and a $1,000,000 option payment to Petrolite. The decrease
of $123,077 from 1996 to 1997 reflects the nonrecurring payment to Petrolite
in 1996 of $1,000,000, offset in part by payment of pilot plant operating
expenses to Baker Petrolite, the hiring of a vice president for process
development and increases in catalyst production. The Company expects its
research and development expenses to decrease during 1998 as a result of the
implementation of certain reductions in costs and expenses to conserve its
resources for the development of the Company's proprietary BDS technology.
The Company's research and development expenses will increase substantially,
however, if the Company makes the $9,000,000 payment to exercise the
Petrolite option in 1998, the entire amount of which will be recorded as a
research and development expense. The Company does not presently intend to
exercise the Petrolite option until it has raised additional funds or
received additional capital.
The Company had general and administrative expenses for the years ended
December 31, 1995, 1996 and 1997 of $2,877,351, $2,607,972 and $2,754,137,
respectively. The $269,379 decrease from 1995 to 1996 resulted primarily from
decreased consulting fees, legal fees and insurance. The $146,165 increase
from 1996 to 1997 resulted primarily from the severance compensation payable
to the Company's former chief executive officer in 1997. The Company expects
to decrease its general and administrative expenses in 1998 as a result of
the implementation of certain reductions in costs and expenses to conserve
its resources for the development of the Company's proprietary BDS technology.
23
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
In February 1997, the Company completed a convertible preferred stock
offering resulting in net cash proceeds of approximately $10.2 million in
exchange for the sale of 224,100 shares of Series B Convertible Preferred
Stock. In October 1994, the Company completed a convertible preferred stock
offering resulting in net cash proceeds of approximately $22.2 million in
exchange for the sale of 480,000 shares of Series A Convertible Preferred
Stock. The Company completed its initial public offering in the first
quarter of 1993, resulting in net cash proceeds of approximately $14.9
million.
For the year ended December 31, 1997, the Company used $8,222,274 of
funds in operating activities, and incurred $682,017 of capital expenditures.
At December 31, 1997, the Company had cash, cash equivalents, and short term
investments totaling $10,354,589 and working capital of $10,101,625.
The Company expects to incur substantial additional research and
development expenses, including expenses associated with biocatalyst,
fermentation and bioreactor development. The Company has commitments through
1998 requiring the Company to spend approximately $25,000 under research and
development agreements. In addition, the Company is subject to cost sharing
arrangements under various collaborative agreements, as discussed below. The
Company also expects its general and administrative expenses to decrease as
it reduces its marketing, sales and other personnel to conserve its resources
for the development of the Company's proprietary BDS technology.
The Company signed an agreement with M.W. Kellogg in August 1994, to
collaborate on the development and commercialization of the Company's
proprietary biocatalytic desulfurization technology for reducing sulfur
levels in petroleum streams. Under the terms of the collaboration, M.W.
Kellogg will serve as an engineering partner to the Company during completion
of the BDS development process and will be the exclusive provider of the
basic engineering design services required for the commercial BDS units. In
return for these services, M.W. Kellogg will receive a portion of the site
license fee generated by the sale of BDS units. The collaboration has a
minimum term of at least five years or the completion of 20 BDS units,
whichever is longer, and has applications to all biorefining technologies the
Company develops. During the first phase of the collaboration, M.W. Kellogg
provided 500 engineering work hours of service at no cost to the Company.
M.W. Kellogg has agreed to provide an additional 1,500 work hours of service
at M.W. Kellogg offices at reduced rates, of which 500 had been utilized by
the Company at December 31, 1997.
In July 1994, the Company entered into an Agreement with TOTAL to
collaborate on the application of the Company's biodesulfurization process to
diesel fuel streams. Following the evaluation of results from Energy
BioSystems' domestic pilot operation, it is anticipated that TOTAL will build
and operate at TOTAL's expense a pilot BDS unit at TOTAL's European Centre for
Research and Technology. Upon successful economic trials of the pilot unit,
TOTAL plans to build the first commercial BDS unit at one of its refineries.
In December 1993, the Company entered into a research collaboration
agreement with Koch, to facilitate the development of BDS technology in
refinery petroleum streams. Under the terms of the alliance, the Company
will be primarily responsible for improving the performance of the
biocatalyst used in the desulfurization process. Koch will be primarily
responsible for selecting and improving the target refinery stream as well as
testing desulfurized product quality. Koch will also provide engineering
support as needed in the development of a BDS unit for Koch's operation. The
Company and Koch will each bear their own costs and expenses incurred in
connection with the collaboration. The Company expects that the development
alliance with Koch will facilitate commercialization of the Company's BDS
technology.
In October 1993, the Company amended its existing Collaboration
Agreement with Petrolite. The Collaboration Agreement, as amended (the
"Agreement"), provides for an expanded territory covered by the Agreement and
permits the use of third party engineering and construction companies to
assist with certain matters. The Agreement expands the territory of
Petrolite's participation from North America, Venezuela and Mexico to the
24
<PAGE>
entire world. In return for the expansion of the territory covered by the
Agreement, the Company's primary participation rate was increased from 70% of
gross profits from biodesulfurization unit sales and fees to 78% of worldwide
gross profits from such sales and fees. Additionally, the Agreement allows
the Company, after obtaining the advice and input of Petrolite, to enter into
an alliance with one or more world-class third party engineering and
construction firms to provide certain equipment and services in connection
with the design and construction of biodesulfurization units.
In October 1996, the Company entered into an agreement with Petrolite
providing the Company with the option to amend the terms of its strategic
alliance with Petrolite. Under the agreement, the Company made an initial
payment of $1 million to Petrolite in December 1996 in exchange for the
option and the extension of Petrolite's obligations to provide operational
and technical support for the pilot plant from September 1, 1996 through
December 31, 1998. If the Company exercises its option, the percentage of
site license fees and adjusted gross profit payable to Petrolite will be
reduced to 9.5% from 22%, in exchange for which the Company will (i) assume
responsibility for servicing the BDS units on site at customer locations,
(ii) pay Petrolite an additional $9 million in cash and (iii) issue to
Petrolite a warrant entitling Petrolite to purchase 138,889 shares of Common
Stock at an exercise price of $7.20 per share. The Company may exercise the
Petrolite option at any time on or before the earlier to occur of (i) ten
business days following the close of any equity financing by the Company in
which the gross cash proceeds raised in such financing (together with cash
proceeds raised by the Company in any other equity financing after the date
of the option agreement, if applicable) equal or exceed $25 million and (ii)
December 30, 1998. The Company does not plan to exercise the option unless
and until it has raised substantial additional funds or received additional
capital.
In July 1993, the Company entered into a research collaboration
agreement with Texaco to facilitate the development of the Company's BDS
technology in crude oil. Under the terms of the alliance, the Company will
be primarily responsible for improving the performance of the biocatalyst
used in the desulfurization process. Texaco will be primarily responsible
for field operations and analytical chemistry work with respect to the
application of the Company's BDS technology to crude oil. The Company and
Texaco will each bear their own costs and expenses incurred in connection
with the collaboration. The Company expects that the development alliance
with Texaco will facilitate commercialization of the Company's BDS technology.
The Company entered into a license agreement with Stanford University in
November 1993 for the use of its patented recombinant DNA technology which
may be employed in the development of the Company's biocatalytic
desulfurization process. The license requires a minimum annual advance on
earned royalties of $10,000. The final payment required under this license
was made in 1997.
The Company has experienced negative cash flow from operations since its
inception and has funded its activities to date primarily from equity
financings and sponsored research revenues. The Company will continue to
require substantial funds to continue its research and development activities
and to market, sell and commercialize its technology. The Company believes
that its available cash, investments and interest income will be adequate to
satisfy its funding operations through early 1999. The Company will need to
raise substantial additional capital to fund its operations thereafter. The
Company's capital requirements will depend on many factors, including the
problems, delays, expenses and complications frequently encountered by
companies developing and commercializing new technologies; the progress of
the Company's research and development activities; timing of environmental
regulations; the rate of technological advances; determinations as to the
commercial potential of the Company's technology under development; the
status of competitive technology; the establishment of biocatalyst
manufacturing capacity or third-party manufacturing arrangements; the
establishment of collaborative relationships; the success of the Company's
sales and marketing programs; the cost of filing, prosecuting and defending
and enforcing patents and intellectual property rights; and other changes in
economic, regulatory or competitive conditions in the Company's planned
business. Estimates about the adequacy of funding for the Company's
activities are based upon certain assumptions, including assumptions that the
research and development programs relating to the Company's technology can be
conducted at projected costs and that progress towards the commercialization
of its technology will be timely and successful. There can be no assurance
that changes in the Company's research and development plans, acquisitions or
other events will not result in accelerated or unexpected
25
<PAGE>
expenditures. To satisfy its capital requirements, the Company may seek
additional funding through public or private financings, including equity
financings, and through collaborative arrangements. There can be no
assurance that any such funding will be available to the Company on favorable
terms or at all. If adequate funds are not available when needed, the
Company may be required to delay, scale back or eliminate some or all of its
research and product development programs. If the Company is successful in
obtaining additional financing, the terms of such financing may have the
effect of diluting or adversely affecting the holdings or the rights of the
holders of the Company's Common Stock.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
None.
ITEM 8. FINANCIAL STATEMENTS.
The financial statements required by this Item are incorporated under
Item 14 in Part IV of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
26
<PAGE>
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item as to the directors and executive
officers of the Company is hereby incorporated by reference from the
information appearing under the captions "Election of Directors" and
"Executive Officers" in the Company's definitive proxy statement which
involves the election of directors and is to be filed with the Securities and
Exchange Commission ("Commission") pursuant to the Securities Exchange Act of
1934 within 120 days of the end of the Company's fiscal year on December 31,
1997.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item as to the management of the
Company is hereby incorporated by reference from the information appearing
under the captions "Executive Compensation" and "Election of Directors -
Director Compensation" in the Company's definitive proxy statement which
involves the election of directors and is to be filed with the Commission
pursuant to the Securities Exchange Act of 1934 within 120 days of the end of
the Company's fiscal year on December 31, 1997. Notwithstanding the
foregoing, in accordance with the instructions to Item 402 of Regulation S-K,
the information contained in the Company's proxy statement under the
sub-heading "Report of the Compensation Committee of the Board of Directors"
and "Performance Graph" shall not be deemed to be filed as part of or
incorporated by reference into this Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item as to the ownership by management
and others of securities of the Company is hereby incorporated by reference
from the information appearing under the caption "Security Ownership of
Certain Beneficial Owners and Management" to the Company's definitive proxy
statement which involves the election of directors and is to be filed with
the Commission pursuant to the Securities Exchange Act of 1934 within 120
days of the end of the Company's fiscal year on December 31, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item as to certain business
relationships and transactions with management and other related parties of
the company is hereby incorporated by reference to such information appearing
under the captions "Certain Transactions" and "Compensation Committee
Interlocks and Insider Participation" in the Company's definitive proxy
statement which involves the election of directors and is to be filed with
the Commission pursuant to the Securities Exchange Act of 1934 within 120
days of the end of the Company's fiscal year on December 31, 1997.
27
<PAGE>
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents Filed as a Part of this Report
1. FINANCIAL STATEMENTS:
PAGE
----
<TABLE>
<S> <C>
Report of Independent Public Accountants . . . . . . . . . . . F-1
Balance Sheets as of December 31, 1996 and 1997 . . . . . . . . F-2
Statements of Operations for the Years Ended December 31,
1995, 1996 and 1997. . . . . . . . . . . . . . . . . . . . . . F-3
Statements of Stockholders' Equity for the Period from
December 31, 1994 to December 31, 1997 . . . . . . . . . . . . F-4
Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . . . F-5
Notes to Financial Statements . . . . . . . . . . . . . . . . . F-6
</TABLE>
All other schedules are omitted because they are not applicable, not
required, or because the required information is included in the financial
statements or notes thereto.
2. EXHIBITS:
Exhibits to the Form 10-K have been included only with the copies of the
Form 10-K filed with the Commission and the Nasdaq Stock Market. Upon
request to the Company and payment of a reasonable fee, copies of the
individual exhibits will be furnished.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1(a) Amended and Restated Certificate of Incorporation of Registrant
(incorporated by reference to Exhibit 2 filed with Post-
Effective Amendment No. 1 to the Registrant's Registration
Statement on Form 8-A as filed with the Commission on March 15,
1993).
3.1(b) Certificate of the Powers, Designations, Preferences and Rights
of the Series A Convertible Preferred Stock (incorporated by
reference to Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1994).
3.1(c) Certificate of Designation of Series One Junior Participating
Preferred Stock of the Company (incorporated by reference to
Exhibit 3.1(c) to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994).
3.1(d) Certificate of the Powers, Designation, Preferences and Rights
of the Series B Convertible Preferred Stock (incorporated by
reference to Exhibit 3.1(d) to the Company's Annual Report on
Form 10-K for the year ended December 31, 1996).
3.2 Bylaws of Registrant (incorporated by reference to Exhibit 3
filed with Post-Effective Amendment No. 1 to the Registrant's
Registration Statement on Form 8-A as filed with the Commission
on March 15, 1993).
4.1 Form of Stock Purchase Agreement, dated as of October 27, 1994,
by and between the Company and the Purchasers of the Series A
Convertible Preferred Stock (incorporated by reference to Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1994).
28
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
4.2 Form of Stock Purchase Agreement, dated as of February 21, 1997,
by and between the Company and the Purchasers of the Series B
Convertible Preferred Stock (incorporated by reference to
Exhibit 4.2 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996).
4.3 Form of Stock Exchange Agreement, dated as of February 21, 1997,
by and between the Company and the Exchanging Holders of Series
A Convertible Preferred Stock (incorporated by reference to
Exhibit 4.3 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996).
4.4 Stockholder Rights Agreement, dated as of March 8, 1995, between
the Company and Society National Bank (incorporated by reference
to Exhibit 4.1 to the Company's Current Report on Form 8-K dated
March 8, 1995).
10.1 License and Technology Assistance Agreement, dated January 15,
1991, between the Company and Institute of Gas Technology
("IGT") (incorporated by reference to Exhibit 10.1 to the
Company's Registration Statement on Form S-1 (No. 33-56718)).
10.2 First Amendment to License and Technology Assistance Agreement,
dated June 25, 1992, between the Company and IGT (incorporated
by reference to Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (No. 33-56718)).
10.3 Second Amendment to License and Technology Assistance Agreement,
dated September 23, 1993, between the Company and IGT
(incorporated by reference to Exhibit 10.21 to the Company's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1993).
10.4 Agreement, dated August 27, 1992, among the Company, IGT, the
University of North Dakota ("UND") and Dr. Kevin Young
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (No. 33-56718)).
10.5 Agreement, dated September 30, 1992, among the Company, UND and
Dr. Kevin Young (incorporated by reference to Exhibit 10.4 to
the Company's Registration Statement on Form S-1 (No. 33-56718)).
10.6 Collaboration Agreement, dated March 5, 1992, between the
Company and Petrolite Corporation (incorporated by reference to
Exhibit 10.5 to the Company's Registration Statement on
Form S-1 (No. 33-56718)).
10.7 First Amendment to Collaboration Agreement, dated July 1, 1992,
between the Company and Petrolite Corporation (incorporated by
reference to Exhibit 10.16 to the Company's Registration
Statement on Form S-1 (No. 33-56718)).
10.8 Second Amendment to Collaboration Agreement, dated October 18,
1993, between the Company and Petrolite Corporation
(incorporated by reference to Exhibit 99.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1993).
10.9 Third Amendment and Addendum to Collaboration Agreement, dated
August 24, 1995, between the Company and Petrolite Corporation
(incorporated by reference to Exhibit 10.36 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1996).
29
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.10 Fourth Amendment and Addendum to Collaboration Agreement, dated
October 25, 1996, between the Company and Petrolite Corporation,
as modified by Letter Agreement dated December 30, 1996
(incorporated by reference to Exhibit 10.37 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1996).
10.11 Lease Agreement, dated January 24, 1994, between The Woodlands
Corporation and the Company (incorporated by reference to
Exhibit 10.6 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993).
10.12 Lease Agreement, dated May 24, 1993, between the Company and The
Woodlands Corporation (incorporated by reference to Exhibit 99.2
to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1993).
10.13 Registration Agreement, dated January 30, 1992, among the
Company, The Travelers Indemnity Company and Gryphon Ventures
II, Limited Partnership (incorporated by reference to Exhibit 10.7
to the Company's Registration Statement on Form S-1 (No. 33-56718)).
10.14 Registration Agreement, dated April 29, 1991, between the
Company and Gryphon Ventures II, Limited Partnership
(incorporated by reference to Exhibit 10.8 to
the Company's Registration Statement on Form S-1 (No. 33-
56718)).
10.15** Energy BioSystems Corporation 1992 Stock Compensation Plan
(incorporated by reference to Exhibit 10.10 to the Company's
Registration Statement on Form S-1 (No. 33-56718)).
10.16** Energy BioSystems Corporation Non-Employee Director Option Plan
(incorporated by reference to Exhibit 10.19 to the Company's
Registration Statement on Form S-1 (No. 33-96096)).
10.17** Energy BioSystems Corporation 1997 Stock Option Plan (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997).
10.18** Simplified Employee Pension Plan Retirement Plan Adoption
Agreement (incorporated by reference to Exhibit 10.15 to the
Company's Registration Statement on Form S-1 (No. 33-56718)).
10.19** Employment Agreement, dated January 31, 1996, between the
Company and Daniel J. Monticello (incorporated by reference to
Exhibit 10.10 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996).
10.20** Consultant Agreement between the Company and John T. Preston
(incorporated by reference to Exhibit 10.12 to the Company's
Registration Statement on Form S-1 (No. 33-56718)).
10.21** Employment Agreement, dated August 21, 1991, between the Company
and John H. Webb (incorporated by reference to Exhibit 10.13 to
the Company's Registration Statement on Form S-1 (No. 33-
56718)).
10.22** Amendment No. 1 to Employment Agreement, dated as of January 15,
1996, between the Company and John H. Webb (incorporated by
reference to Exhibit 10.35 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1995).
30
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
*10.23** Employment Termination and Severence Agreement, dated as of Sepember
30, 1997, between the Company and John H. Webb.
10.24** Employment Agreement, dated July 18, 1995, between the Company
and Paul G. Brown, III (incorporated by reference to Exhibit 10.14
to the Company's Registration Statement on Form S-1 (No. 33-96096)).
10.25** Employment Agreement, dated July 18, 1995, between the Company
and Mark W. John (incorporated by reference to Exhibit 10.15 to
the Company's Registration Statement on Form S-1 (No. 33-96096)).
*10.26 Employment Agreement, dated October 1997, between the Company
and Michael A. Pacheco.
10.27 Research Agreement, dated November 8, 1993, between the Company
and The University of Notre Dame (incorporated by reference to
Exhibit 10.19 to the Company's Registration Statement on Form S-
1 (No. 33-56718)).
10.28 Research Collaboration Agreement, dated July 8, 1993, between
the Company and Texaco, Inc. (incorporated by reference to
Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1993).
10.29 Extension and Assignment of Research Collaboration Agreement,
dated June 23, 1995, between the Company and Texaco Inc.
(incorporated by reference to the similarly numbered exhibits to
the Company's Registration Statement on Form S-1 (No. 3-96096)).
10.30 Extension and Assignment of Research Collaboration Agreement,
dated July 3, 1996, between the Company and Texaco Group, Inc.
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1996).
10.31 Extension and Assignment of Research Collaboration Agreement, dated
June 30, 1997, between the Company and Texaco Group, Inc.
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
10.32 Letter Agreement dated February 10, 1994, between The M. W.
Kellogg Company and the Company (incorporated by reference to
Exhibit 10.22 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1993).
10.33 Letter Agreement for Accelerated Development Program dated
December 8, 1993, between the Company and Koch Refining Company
(incorporated by reference to Exhibit 10.23 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
1993).
31
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.34 License Agreement dated November 1, 1993, between the Company
and Stanford University (incorporated by reference to Exhibit
10.25 to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1993).
10.35 Collaboration Agreement dated July 7, 1994, between the Company
and Total Raffinage Distribution S.A. (incorporated by reference
to Exhibit 99.1 to the Company's Quarterly Report on Form 10-Q
for the second quarter ended June 30, 1994).
10.36 Research Agreement, dated July 1, 1994, between the Company and
Massachusetts Institute of Technology (incorporated by reference
to Exhibit 10.27 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994).
10.37 Research Agreement, dated November 8, 1994, between the Company
and The University of Notre Dame (incorporated by reference to
Exhibit 10.28 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994).
10.38 Research, Option and License Agreement, dated December 15, 1994,
between the Company and the University of Houston (incorporated
by reference to Exhibit 10.29 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1994).
10.39 Cooperative Agreement between the Company and the National
Institute of Standards and Technology (incorporated by reference
to Exhibit 10.30 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994).
*11.1 Computation of earnings per share.
*23.1 Consent of Arthur Andersen LLP.
*27.1 Financial Data Schedule.
- ------------------
* Filed herewith
** Management contract or compensatory plan.
(b) Reports on Form 8-K
None.
32
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
ENERGY BIOSYSTEMS CORPORATION
By: /s/ Ramon Lopez
--------------------------------
Ramon Lopez
CHAIRMAN OF THE BOARD
DATED the 27th day of March, 1998.
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
COMPANY AND IN THE CAPACITIES AND ON THE DATES INDICATED:
NAME TITLE DATE
---- ----- ----
/s/ Ramon Lopez Chairman of the Board March 27, 1998
- --------------------------- (Principal executive
Ramon Lopez officer)
/s/ Paul G. Brown, III Vice President--Finance March 27, 1998
- --------------------------- and Administration
Paul G. Brown, III (Principal financial and
accounting officer)
/s/ Daniel J. Monticello, Ph.D. Vice President--Science March 27, 1998
- --------------------------- and Technology, and
Daniel J. Monticello, Ph.D. Director
/s/ Edward B. Lurier Director March 27, 1998
- ---------------------------
Edward B. Lurier
/s/ Thomas E. Messmore Director March 27, 1998
- ---------------------------
Thomas E. Messmore
/s/ William E. Nasser Director March 27, 1998
- ---------------------------
William E. Nasser
/s/ John S. Patton Director March 27, 1998
- ---------------------------
John S. Patton
/s/ James R. Comeaux Director March 27, 1998
- ---------------------------
James R. Comeaux
/s/ William D. Young Director March 27, 1998
- ---------------------------
William D. Young
33
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Energy BioSystems Corporation:
We have audited the accompanying balance sheets of Energy BioSystems
Corporation (a Delaware corporation) as of December 31, 1996 and 1997, and
the related statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits 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.
As discussed in Note 1 to the Financial Statements, the Company will
require additional capital in order to continue the development and
commercialization of its technology. Management's projections indicate that
the Company can conserve its resources to maintain the Company's operations
through early 1999. Management's plans in regard to these matters are
described in Note 1.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Energy BioSystems
Corporation as of December 31, 1996 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
The Woodlands, Texas
March 9, 1998
F-1
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
BALANCE SHEETS
<TABLE>
DECEMBER 31,
--------------------------------
1996 1997
------------ -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . $ 3,106,004 $ 9,661,310
Short term investments . . . . . . . . . . . . . . . . . . . . . . . . 5,891,584 693,279
Prepaid expenses and other current assets . . . . . . . . . . . . . . . 767,893 1,013,872
------------ -----------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . 9,765,481 11,368,461
------------ -----------
Note receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,683 --
Furniture, equipment and leasehold improvements, net . . . . . . . . . . 3,136,635 2,624,332
Intangible and other assets, net . . . . . . . . . . . . . . . . . . . . 801,832 972,266
------------ -----------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,710,631 $14,965,059
------------ -----------
------------ -----------
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities . . . . . . . . . . . . . . . $ 537,583 $ 864,674
Current portion of deferred revenue . . . . . . . . . . . . . . . . . . 193,500 180,000
Current portion of obligations under capital lease . . . . . . . . . . 11,632 3,556
Note payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252,443 218,606
------------ -----------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . 995,158 1,266,836
------------ -----------
Stockholders' equity:
Series A convertible preferred stock
$0.01 par value (liquidation value $24,000,000,
508,800 shares authorized, 480,000 and zero shares
issued and outstanding, respectively) . . . . . . . . . . . . . . . . . 23,295,585 --
Series B convertible preferred stock
$0.01 par value (liquidation value $35,105,000, zero and
760,000 shares authorized, zero and 702,100 shares
issued and outstanding, respectively) . . . . . . . . . . . . . . . . . -- 33,853,380
Common stock, $0.01 par value (30,000,000 shares
authorized, 11,497,135 and 12,251,434 shares
issued and outstanding, respectively) . . . . . . . . . . . . . . . . . 114,972 122,514
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . . 32,018,218 34,926,594
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . (42,713,302) (55,204,265)
------------ -----------
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . 12,715,473 13,698,223
------------ -----------
Total liabilities and stockholders' equity . . . . . . . . . . . . . $ 13,710,631 $14,965,059
------------ -----------
------------ -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Sponsored research revenues . . . . . . . $ 1,567,329 $ 1,778,683 $ 1,651,776
Interest and investment income . . . . . 1,400,625 806,736 650,449
----------- ----------- -----------
Total revenues . . . . . . . . . . . . 2,967,954 2,585,419 2,302,225
----------- ----------- -----------
COSTS AND EXPENSES:
Research and development . . . . . . . . 7,338,319 9,210,227 9,087,149
General and administrative . . . . . . . 2,877,351 2,607,972 2,754,137
----------- ----------- -----------
Total costs and expenses . . . . . . . 10,215,670 11,818,199 11,841,286
----------- ----------- -----------
NET LOSS . . . . . . . . . . . . . . . . . $(7,247,716) $(9,232,780) $(9,539,061)
----------- ----------- -----------
----------- ----------- -----------
NET LOSS PER COMMON SHARE - BASIC
AND DILUTED . . . . . . . . . . . . . . . $ (0.95) $ (1.04) $ (1.09)
----------- ----------- -----------
----------- ----------- -----------
SHARES USED IN COMPUTING NET LOSS
PER COMMON SHARE . . . . . . . . . . . . . 10,227,595 11,248,029 11,769,458
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM DECEMBER 31, 1994 TO DECEMBER 31, 1997
<TABLE>
PREFERRED STOCK COMMON STOCK ADDITIONAL
--------------------- -------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
------- ----------- --------- -------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994 480,000 $22,694,931 9,988,409 $ 99,884 $27,556,221 $(21,906,806) $28,444,230
Exercise of stock options in
1995 ($0.3036 to $7.25 per
share). . . . . . . . . . . . . . . . -- -- 261,949 2,620 329,392 -- 332,012
Issuance of stock for services
($6.25 per share) . . . . . . . . . . -- -- 10,000 100 62,400 -- 62,500
Additional offering costs for Series
A Preferred Stock . . . . . . . . . . -- (14,132) -- -- -- -- (14,132)
Dividends on Series A Preferred
Stock paid in Common Stock. . . . . . -- (2,178,000) 323,910 3,239 2,174,683 -- (78)
Accretion and dividends on
Series A Preferred Stock. . . . . . . -- 2,465,353 -- -- (299,353) (2,166,000) --
Net loss. . . . . . . . . . . . . . . . -- -- -- -- -- (7,247,716) (7,247,716)
------- ----------- --------- -------- ----------- ------------ -----------
BALANCE AT DECEMBER 31, 1995 480,000 22,968,152 10,584,268 105,843 29,823,343 (31,320,522) 21,576,816
Exercise of stock options in 1996
($0.3036 to $5.50 per share). . . . . -- -- 589,200 5,892 365,620 -- 371,512
Dividends on Series A Preferred
Stock paid in Common Stock. . . . . . -- (2,160,000) 323,667 3,237 2,156,688 -- (75)
Accretion and dividends on
Series A Preferred Stock. . . . . . . -- 2,487,433 -- -- (327,433) (2,160,000) --
Net loss. . . . . . . . . . . . . . . . -- -- -- -- -- (9,232,780) (9,232,780)
------- ----------- --------- -------- ----------- ------------ -----------
BALANCE AT DECEMBER 31, 1996 480,000 23,295,585 11,497,135 114,972 32,018,218 (42,713,302) 12,715,473
------- ----------- --------- -------- ----------- ------------ -----------
Exercise of stock options in 1997
($0.3036 to $6.25 per share). . . . . -- -- 270,740 2,707 348,256 -- 350,963
Issuance of Series B Preferred Stock. . 224,100 10,171,120 -- -- -- -- 10,171,120
Exchange of Series A Preferred
Stock for Series B Preferred
Stock . . . . . . . . . . . . . . . . (478,000) (22,853,138) -- -- -- -- --
Issuance of Series B Preferred Stock
for Series A Preferred Stock. . . . . 478,000 22,853,138 -- -- -- -- --
Issuance of Common Stock in
exchange for Series A Preferred
Stock . . . . . . . . . . . . . . . . (2,000) (99,526) 12,581 125 99,401 -- --
Dividends on Series A Preferred
Stock paid in Common Stock. . . . . . -- (691,575) 98,519 985 690,543 -- (47)
Accretion and dividends on
Series A Preferred Stock. . . . . . . -- 360,604 -- -- (67,904) (292,700) --
Dividends on Series B Preferred
Stock paid in Common Stock. . . . . . -- (2,132,629) 372,559 3,725 2,128,679 -- (225)
Accretion and dividends on
Series B Preferred Stock. . . . . . . -- 2,949,801 -- -- (290,597) (2,659,202) --
Net loss. . . . . . . . . . . . . . . . -- -- -- -- -- (9,539,061) (9,539,061)
------- ----------- --------- -------- ----------- ------------ -----------
BALANCE AT DECEMBER 31, 1997. . . . . . 702,100 $33,853,380 12,251,534 $122,514 $34,926,596 $(55,204,265) $13,698,223
------- ----------- --------- -------- ----------- ------------ -----------
------- ----------- --------- -------- ----------- ------------ -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
------------ ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (7,247,716) $(9,232,780) $(9,539,061)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 998,384 1,160,179 1,255,622
Compensation expense related to stock options
and stock issued for services rendered 62,500 -- --
Changes in assets and liabilities:
Decrease (increase) in trading securities (4,419,020) 4,444,020 --
Decrease (increase) in prepaid expenses and
other current assets 143,061 172,079 (27,373)
Decrease in notes receivable 37,054 38,950 6,683
Increase in intangible and other assets (211,804) (182,196) (231,736)
Increase (decrease) in accounts payable and
accrued liabilities (377,958) (53,951) 327,091
Decrease in deferred revenue (1,134,000) (1,134,000) (13,500)
------------ ----------- -----------
Net cash provided by (used in) operating activities (12,149,499) (4,787,699) (8,222,274)
------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,505,045) (936,877) (682,017)
Net sale (purchase) of investments held to maturity (8,480,298) 2,588,713 5,198,305
------------ ----------- -----------
Net cash provided by (used in) investing activities (9,985,343) 1,651,836 4,516,288
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable, net (281,374) (294,713) (252,443)
Payments on capital lease obligations (12,995) (7,256) (8,076)
Proceeds from Series A Preferred Stock, net (14,132) -- --
Proceeds from Series B Preferred Stock, net -- -- 10,171,120
Proceeds from Common Stock, net 331,934 371,436 350,691
------------ ----------- -----------
Net cash provided by financing activities 23,433 69,467 10,261,292
------------ ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (22,111,409) (3,066,396) 6,555,306
------------ ----------- -----------
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 28,283,809 6,172,400 3,106,004
------------ ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 6,172,400 $ 3,106,004 $ 9,661,310
------------ ----------- -----------
------------ ----------- -----------
SUPPLEMENTAL INFORMATION OF CASH FLOWS:
Cash paid for interest $ 4,010 $ 2,046 $ 1,752
------------ ----------- -----------
------------ ----------- -----------
SUPPLEMENTAL INFORMATION OF NONCASH FINANCING ACTIVITIES:
The Company had an outstanding note payable of $294,713, $252,442 and $218,606 for prepaid insurance for
the years ended December 31, 1995, 1996 and 1997, respectively.
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. DESCRIPTION OF THE COMPANY
Energy BioSystems Corporation (the "Company"), formerly Environmental
BioScience Corporation, was incorporated in the State of Delaware on December
20, 1989, and commenced operations in January 1990. The Company was formed
to develop and commercialize innovative biotechnology-based processes for the
refining of fossil fuels. The Company's focus to date has been on developing
biocatalytic desulfurization ("BDS"), a proprietary process involving the use
of enzymes to remove sulfur from petroleum. The Company's BDS process will
require substantial additional research, development and testing in order to
determine its commercial viability. The Company has not proven its BDS
technology other than to a limited extent in laboratory, bench-scale and
pilot plant trials. If the Company successfully field tests its BDS
technology, the commercialization of the Company's BDS technology will
require significant additional time and expenditures. The commercialization
of the technology will depend on the Company's success in achieving
improvement of its biocatalyst and success in developing fermentation
processes, as well as the Company's ability to manufacture or contract for
the manufacture of sufficient biocatalyst for use in commercial BDS units; to
apply process engineering to design bioreactor systems capable of
accomplishing the BDS process on a commercial scale; and to market its BDS
systems effectively. The accomplishment of some or all of these objectives
may be delayed or may never occur. The Company will require additional
capital to continue the development and commercialization of its BDS
technology, and there can be no assurance that such capital will be available
or that the Company will be able to successfully commercialize its BDS
technology. The Company currently plans to implement certain reductions in
costs and expenses that it believes will enable its available cash and
investments, sponsored research revenues and interest income to satisfy its
funding needs through early 1999. If the Company is unable to raise
sufficient capital, further reductions and, in certain cases, elimination of
operating activities will be required to enable the Company's present levels
of cash and investments to provide sufficient liquidity to fund the Company
through 1999. See "Liquidity and Capital Resources" and "Risk Factors"
included elsewhere herein.
The Company has devoted substantially all of its efforts to research and
development. There have been no revenues from operations other than
sponsored research revenues (see Note 7) and there is no assurance of future
revenues. Prior to the receipt of the sponsored research revenues, the
Company was in the development stage.
2. ACCOUNTING POLICIES
CASH, CASH EQUIVALENTS AND SHORT TERM INVESTMENTS
Debt and equity securities that the Company has the intent and ability
to hold to maturity are classified as "held to maturity" and reported at
amortized cost. Debt and equity securities that are held for current resale
are classified as "trading securities" and reported at fair value with
unrealized gains and losses included in earnings. Debt and equity securities
not classified as either "held to maturity" or "trading securities" are
classified as "securities available for sale" and reported at fair value,
with unrealized gains and losses excluded from earnings and reported as a
separate component of stockholders' equity.
Cash and cash equivalents include corporate debt securities with an
original maturity less than 90 days and are classified as held to maturity.
These securities have an amortized cost and fair market value of $2,675,923.
Included in short-term investments are corporate bonds of $693,279 that are
classified as held to maturity and reported at amortized cost at December 31,
1997.
At December 31, 1996 and 1997, the Company had cash and cash equivalents
of approximately $49,684 and $2,133,786, respectively, in excess of the
federally insured amounts.
F-6
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Furniture and equipment consists of office furniture and equipment,
computers and laboratory equipment and is carried at cost. Depreciation is
calculated on the straight-line method using a five-year estimated useful
life. Leasehold improvements are amortized on the straight-line method over
the term of the lease or the useful life of the assets, whichever is shorter.
Maintenance and repairs that do not improve or extend the life of assets
and expenditures for research and development equipment for which there is no
future alternative use are expensed as incurred. Expenditures which improve
or extend the life of assets are capitalized.
INTANGIBLE AND OTHER ASSETS
Intangible and other assets mainly consist of patent costs, which are
primarily legal fees. These costs are being amortized over 17 years.
Accumulated amortization at December 31, 1996 and 1997 amounted to $235,878
and $297,180, respectively.
RESEARCH AND DEVELOPMENT
Sponsored research revenue is recognized based on the percentage of
total research payments to be received in relation to the total research and
development costs to be incurred under the specific research agreements. All
research and development costs, both generated internally and from research
and development contracts, are expensed as incurred. The Company allocates
certain indirect costs to research and development expenses which consist
primarily of overhead related to the administration of research and
development activities.
NET LOSS PER COMMON SHARE
Net loss per common share has been computed by dividing the net loss,
which has been increased for periodic accretion and accrued dividends on the
Series A Convertible Preferred Stock and Series B Convertible Preferred Stock
issued in October 1994 and February 1997, respectively, by the weighted
average number of shares of Common Stock outstanding during the periods.
In March 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting No. 128, "Earnings Per Share." Statement 128
simplifies the standards for computing earnings per share previously found in
APB Opinion No. 15, EARNINGS PER SHARE, and makes them comparable to
international earnings per share standards. The Statement also retroactively
revises the presentation of earnings per share in the financial statements.
The Company adopted this Standard for the year ended December 31, 1997. In
all applicable years, all Common Stock equivalents were antidilutive and,
accordingly, were not included in the computation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of expenses during
the reporting period. Actual results could differ from those estimates.
F-7
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PRESENTATION
Certain reclassifications have been made to prior year balances to
conform to current year presentation.
3. FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
A summary of furniture, equipment and leasehold improvements is as
follows:
<TABLE>
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
Office furniture and equipment. . . . . . . . . . . . . . $ 395,332 $ 408,356
Laboratory equipment. . . . . . . . . . . . . . . . . . . 3,176,179 3,781,153
Computer equipment. . . . . . . . . . . . . . . . . . . . 805,850 852,506
Leasehold improvements. . . . . . . . . . . . . . . . . . 1,694,489 1,711,852
Equipment under capital lease . . . . . . . . . . . . . . 55,203 55,203
Automobiles . . . . . . . . . . . . . . . . . . . . . . . 23,670 23,670
----------- -----------
6,150,723 6,832,740
Less--Accumulated depreciation and amortization . . . . . (3,014,088) (4,208,408)
----------- -----------
Furniture, equipment and leasehold improvements, net. . . $ 3,136,635 $ 2,624,332
----------- -----------
----------- -----------
</TABLE>
4. STOCKHOLDERS' EQUITY
SERIES B CONVERTIBLE PREFERRED STOCK
In February and March 1997, the Company sold and aggregate of 224,100
shares of Series B Convertible Preferred Stock at $50.00 per share in a
private placement. The net proceeds from the offering were approximately
$10.2 million. The placement agent for the Series B Preferred Stock received
warrants to purchase an aggregate of 20,319 shares of Series B Preferred
Stock at an exercise price of $50.00 per share of Series B Preferred Stock in
addition to customary commissions. The warrants have been recorded at an
estimated fair value of $466,000, which was computed using the Black-Scholes
option pricing model and the following assumptions: risk free interest rate
of 6.51 percent; expected dividend yield of zero; expected life of three
years, and an expected volatility of 68 percent.
Dividends on the Series B Preferred Stock are cumulative from February
27, 1997 and payable semi-annually commencing May 1, 1997, at an annual rate
equal to (i) $4.00 per share of Series B Preferred Stock to the extent the
dividend is paid in cash and (ii) $4.50 per share of Series B Preferred Stock
to the extent the dividend is paid in common stock. Dividends on shares of
Series B Preferred Stock are payable in cash or common stock of the Company,
or a combination thereof, at the Company's option.
F-8
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Shares of Series B Preferred Stock are convertible into shares of common
stock at a conversion price equal to $7.25 per share, subject to certain
adjustments. The Series B Preferred Stock may be redeemed by the Company
under certain circumstances after February 26, 1999 and is required to be
redeemed, subject to certain limitations, on February 26, 2002 at a
redemption price of $50.00 per share, plus accrued and unpaid dividends. It
is the Company's intent, however, to redeem the Series B Stock for common
stock. Accordingly, the Series B Preferred Stock is included in
stockholders' equity.
Concurrently with the private placement, the Company conducted an
exchange offering and consent solicitation with respect to its outstanding
Series A Preferred Stock, pursuant to which the Company offered to exchange
one share of Series B Preferred Stock for each of its 480,000 outstanding
shares of Series A Preferred Stock and requested the holders of its Series A
Preferred Stock consent to the ranking of the Series B Preferred Stock on a
parity with the Series A Preferred Stock with respect to the payment of
dividends and liquidation preference. The Company did not receive any cash
proceeds from the exchange offering. Of the 480,000 shares of Series A
Preferred Stock outstanding, 478,000 shares were exchanged for the same
number of shares of Series B Preferred Stock. In September 1997 the
remaining 2,000 shares of Series A Preferred Stock was exchanged for 12,581
shares of common stock.
The carrying amount of the Series B Preferred Stock is increased for
accrued and unpaid dividends plus periodic accretion, using the effective
interest method, such that the carrying amount will equal the redemption
amount on the Series B Preferred Stock on February 26, 2002.
SERIES A CONVERTIBLE PREFERRED STOCK
In October 1994, the Company sold 480,000 shares of Series A Convertible
Preferred Stock at $50.00 per share in a private placement. The net proceeds
from the offering were approximately $22.2 million. The placement agents for
the Series A Convertible Preferred Stock received warrants to purchase an
aggregate of 28,800 shares of Series A Convertible Preferred Stock at an
exercise price of $50.00 per share of Series A Convertible Preferred Stock,
in addition to customary commissions.
Dividends on the Series A Convertible Preferred Stock are cumulative and
payable semi-annually from October 27, 1994, at an annual rate equal to (i)
$4.00 per share if paid in cash and (ii) $4.50 per share if paid in
F-9
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Common Stock. All but 2,000 shares of the 480,000 shares of Series A
Preferred Stock outstanding were exchanged for shares of Series B Preferred
Stock in an exchange offering.
Shares of Series A Preferred Stock were convertible into shares of the
Company's common stock at the option of the holder at a conversion price
equal to $8.25 per share of common stock, subject to certain adjustments. In
September 1997, the remaining 2,000 shares of Series A Preferred Stock not
exchanged for Series B Preferred Stock were converted into 12,581 shares of
common stock.
COMMON STOCK
In March 1995, the Company adopted a Stockholder Rights Plan (the
"Rights Plan") in which Preferred Stock Purchase Rights (the "Rights") were
distributed for each share of Common Stock held as of the close of business
on March 27, 1995 and are distributed to each share of Common Stock issued
thereafter until the earlier of (i) the Distribution Date (as defined in the
Rights Plan), (ii) the date Rights are redeemed or (iii) March 8, 2005. The
Rights Plan is designed to deter coercive takeover tactics and to prevent an
acquirer from gaining control of the Company without offering a fair price to
all of the Company's stockholders. The Rights will expire on March 8, 2005.
Each Right entitles stockholders to buy one-hundredth of a share of a
new series of Junior Preferred Stock of the Company at an exercise price of
$50.00 per one-hundredth of a share. The Rights are exercisable only if a
person acquires beneficial ownership of 20% or more of the Company's
outstanding Common Stock. The Rights Plan grandfathers certain stockholders
who beneficially owned more than 20% of the outstanding shares of the
Company's Common Stock on the effective date of the Rights Plan from
triggering the exercisability of the Rights.
5. STOCK OPTIONS
In January 1997, the Company's Board of Directors adopted the 1996 Stock
Option Plan (the "1996 Plan"). Under the 1996 Plan, the Company may issue
options for and sell up to 100,000 shares of Common Stock to employees and
consultants of the Company. The options granted under this plan may not have
an exercise price per share less than the fair market value on the date of
grant and are limited to a term not to exceed ten years
The 1992 Stock Compensation Plan (the "1992 Plan") is composed of
non-qualified stock options, incentive stock options, year-end stock bonuses
and restricted and non-restricted stock grants. Under the 1992 Plan,
2,031,030 shares of Common Stock are reserved for issuance upon the exercise
of stock options. Under a 1994 Non-Employee Director Option Plan, composed
of non-qualified stock options, 175,000 shares of Common Stock are reserved
for issuance upon the exercise of stock options.
At December 31, 1997, employees had been granted options to purchase
1,617,199 shares of Common Stock pursuant to the 1992 Plan. Additionally, as
of December 31, 1997 consultants and directors had been granted options to
purchase 345,320 shares of Common Stock that were not issued under the 1992
Plan. Options generally vest over a three-year period and upon the earlier of
the completion of the specified performance milestones or nine years and ten
months from the date of grant. The options expire ten years from the date of
grant. At December 31, 1997, 1,047,306 shares of Common Stock were exercisable
at per share exercise prices ranging from $.296 to $13.00.
The Company accounts for its stock options under APB Opinion No. 25
under which no compensation cost has been recognized. The Company records
deferred compensation for the difference between the exercise price and the
fair market value on the measurement date. During 1995, 1996 and 1997, the
Company issued all options at fair market value. Had compensation cost for
these options been determined consistent with FASB Statement No. 123, the
Company's net loss and loss per share would have been increased to the
following pro forma amounts:
F-10
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<S> <C> <C> <C>
1995 1996 1997
----------- ----------- ------------
Net Loss: As Reported $(7,247,716) $(9,232,780) $ (9,539,061)
----------- ----------- ------------
Pro Forma (7,439,375) (9,627,267) (10,180,316)
----------- ----------- ------------
Net Loss Per Share: As Reported $ (0.95) $ (1.04) $ (1.09)
----------- ----------- ------------
Pro Forma (0.97) (1.08) (1.15)
----------- ----------- ------------
</TABLE>
Because the Statement 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma
compensation cost may not be representative of that expected in future years.
A summary of the status of the Company's stock options at December 31, 1995,
1996 and 1997 and changes during the years then ended is presented in the
table and narrative below:
<TABLE>
1992 PLAN OPTIONS NOT ISSUED UNDER PLAN
---------- -----------------------------
NUMBER WEIGHTED AVG. NUMBER WEIGHTED AVG.
OF OPTIONS EXERCISE PRICE OF OPTIONS EXERCISE PRICE
---------- -------------- ---------- --------------
<S> <C> <C> <C>
Balance at December 31, 1994 . . . . 1,269,064 $ 4.04 1,025,720 $1.34
Granted. . . . . . . . . . . . . . 270,880 5.03 -- --
Exercised. . . . . . . . . . . . . (126,949) 1.86 (145,000) 0.64
Forfeited. . . . . . . . . . . . . (19,550) 10.08 -- --
--------- ------ --------- -----
Balance at December 31, 1995 . . . . 1,393,445 4.35 880,720 1.46
Granted. . . . . . . . . . . . . . 286,170 6.46 -- --
Exercised. . . . . . . . . . . . . (26,645) 1.83 (562,565) 0.57
Forfeited. . . . . . . . . . . . . (15,332) 8.49 -- --
--------- ------ --------- -----
Balance at December 31, 1996 . . . . 1,637,638 4.74 318,155 $3.02
Granted. . . . . . . . . . . . . . 323,360 4.91 -- --
Exercised. . . . . . . . . . . . . (201,805) 1.59 68,835 0.43
Forfeited. . . . . . . . . . . . . (141,994) 5.21 -- --
--------- ------ --------- -----
Balance at December 31, 1997 1,617,199 $ 5.12 249,320 $3.73
--------- ------ --------- -----
--------- ------ --------- -----
Exercisable at December 31, 1995 652,466 $ 3.21 838,220 $1.08
Exercisable at December 31, 1996 727,029 $ 3.77 318,155 $3.02
Exercisable at December 31, 1997 701,986 $ 4.95 345,320 $3.73
</TABLE>
The weighted average fair value of the options issued under the 1992
Plan for the years ended December 31, 1995, 1996 and 1997 was $3.98, $4.92
and $3.95, respectively.
During the years ended December 31, 1995, 1996 and 1997, the Company
granted 24,000, 24,000 and 28,000 options, respectively, under the
Non-Employee Director Option Plan. These options are fully vested upon
issuance. The weighted average exercise price per share on these grants was
$4.00, $7.88 and $4.63, respectively. As of December 31, 1995, 1996 and
1997, the Company had 44,000, 68,000 and 96,000 options exercisable,
respectively, under this plan with weighted average exercise price of $5.82,
$6.54 and $6.22, respectively. The weighted average fair market value of the
options issued under this plan during the years ended December 31, 1995, 1996
and 1997 was $3.04, $5.31 and $ 4.63, respectively.
The fair market value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1995, 1996 and 1997,
respectively: risk-free interest rates of 6.6, 6.5 and 6.5 percent for the
1992 Plan options and 6.6, 6.9 and 6.5 percent for the Non-Employee Director
Plan options; expected dividend yields of zero for both the 1992 Plan and the
Non-Employee Director Plan; expected lives of nine years and ten months for
all options; and expected volatility of 58.3, 65.4 and 69.6 percent for the
1992 Plan and 60.5, 65.1 and 69.6 percent for the Non-Employee Director Plan.
F-11
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. FEDERAL INCOME TAXES
The Company has had losses since inception and, therefore, has not been
subject to federal income taxes. As of December 31, 1997, the Company had
accumulated net operating loss ("NOL") and research and development tax
credit carryforwards for income tax purposes of approximately $45,200,000 and
$1,284,000, respectively. These carryforwards begin to expire in 2005. The
Tax Reform Act of 1986 provided for an annual limitation on the use of NOL
and tax credit carryforwards following certain ownership changes that limit
the Company's ability to utilize these carryforwards. In April 1991 and
October 1994, the Company underwent a "more than 50 percent change in
ownership" as defined by Internal Revenue Code Section 382. Additionally,
because U.S. tax laws limit the time during which NOL and tax credit
carryforwards may be applied against future taxable income and tax
liabilities, the Company may not be able to take full advantage of its NOL
and tax credits for federal income tax purposes.
Significant components of the Company's net deferred tax asset at
December 31, 1996 and 1997 are as follows:
<TABLE>
1996 1997
------------ ------------
<S> <C> <C>
DEFERRED TAX ASSETS RELATINTG TO:
Federal net operating loss carryforwards . . . . . . $ 11,814,351 $ 15,369,029
Research and development credit carryovers . . . . . 989,171 1,284,060
Capital and Texas business loss carryforwards. . . . 357,846 653,720
Book/tax differences on depreciable, amortizable
and other assets and accrued liabilities . . . . . 263,347 26,998
Deferred revenue and unrealized gains 65,790 61,200
------ ------------
Deferred tax valuation reserve . . . . . . . . . . . (13,490,505) $(17,395,007)
Net deferred tax asset . . . . . . . . . . . . . . . $ -- --
------------ ------------
------------ ------------
</TABLE>
Beginning January 1, 1993, the Company adopted SFAS 109 which requires
recognition of deferred tax liabilities and assets for the expected future
tax consequences of events that have been recognized in the financial
statements or tax returns. Since the Company has had a net operating loss
carry forward since inception and there is no assurance of future taxable
income, a valuation allowance has been established to fully offset the
deferred tax assets.
7. LICENSE AND RESEARCH AGREEMENTS
To supplement its research and development budgets, the Company intends
to seek additional collaborative research and development agreements with
corporate partners.
In August 1997, the Company was awarded funding by the U.S. Department
of Energy ("DOE") for a $2.4 million, three-year program dedicated to the
development of a BDS application for gasoline. At December 31, 1997, the
Company had recognized $122,876 in sponsored research revenue from the grant
all of which was receivable at year end.
In this regard, the Company entered into an agreement with The
Carbide/Graphite Group, Inc. ("Carbide/Graphite") in December 1995 to
collaborate on the development of the Company's BDS technology for the
removal of sulfur from decant oil. Under the terms of the agreement, the
Company will be primarily responsible for customizing and commercializing a
biocatalyst and desulfurization system specifically for decant oil.
Carbide/Graphite will be primarily responsible for providing the development
and commercialization funding for this particular BDS process. The Company
recognized $650,000 in sponsored research revenue as of December 31, 1997.
F-12
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company signed an agreement with The M.W. Kellogg Company ("M.W.
Kellogg") in August 1994, to collaborate on the development and
commercialization of the Company's biocatalytic desulfurization ("BDS")
technology. Under the collaboration, M.W. Kellogg will serve as an
engineering partner to the Company during completion of the BDS development
process and will be the exclusive provider of the basic engineering design
services required for the commercial units. In return for these services,
M.W. Kellogg will receive a portion of the site license fee generated by the
sale of BDS units. The collaboration has a minimum term of at least five
years or the completion of 20 BDS units, whichever is longer, and has
applications to all biorefining technologies the Company develops. During
the first phase of the collaboration, M.W. Kellogg provided up to 500
engineering work hours of service at no cost to the Company. M.W. Kellogg
has also agreed to provide an additional 1,500 work hours per year of service
at M.W. Kellogg offices at reduced rates.
In July 1994, the Company entered into an agreement with Total Raffinage
Distribution S.A. ("Total") to collaborate on the application of the
Company's biodesulfurization process to diesel fuel streams. Following the
evaluation of results from the Company's domestic pilot operation, it is
anticipated that Total will build and operate at Total's expense a pilot BDS
unit at Total's European Centre for Research and Technology. Upon successful
economic trials of the pilot unit, Total plans to build the first commercial
BDS unit at one of its refineries. The Company and Total will each bear
their own costs and expenses incurred under the collaboration. In addition,
as part of its obligations under the agreement, Total will provide the
Company with the use of analytical equipment valued at approximately
$200,000. The Total agreement provides that upon commercialization, the site
licenses will be waived on Total's first commercial BDS unit. In addition,
Total will be entitled to receive a ten percent (10%) discount on future site
licenses and service fees until it has recovered two and one-half times its
research cost and expenses for BDS projects under the agreement. The Company
expects that the development alliance with Total will facilitate
commercialization of the BDS technology for middle distillates and facilitate
the Company's entrance into the European market.
In December 1993, the Company entered into an alliance with Koch
Refining Company ("Koch") to facilitate the development of BDS technology in
crude oil. Under the terms of the alliance, the Company will be primarily
responsible for improving the performance of the biocatalyst used in the
desulfurization process. Koch will be primarily responsible for selecting
and improving the target oil stream as well as testing desulfurized product
quality. Koch will also provide engineering support as needed in the
development of a BDS unit for Koch's operation. The Company and Koch will
each bear their own costs and expenses incurred in connection with the
collaboration. Repayment will be in the form of a ten percent (10%) rebate
on desulfurization processing fees charged to Koch until Koch has been repaid
their contribution of BDS development costs. The Company expects that the
development alliance with Koch will facilitate commercialization of the
Company's BDS technology.
The Company entered into a license agreement with Stanford University in
November 1993 for the use of their patented recombinant DNA technology, which
may be employed in the development of the Company's BDS process. The license
requires a minimum annual advance on earned royalties of $10,000. The final
payment under this licensing agreement was paid in 1997.
In July 1993, the Company entered into an agreement with the Exploration
and Development Division of Texaco, Inc. ("Texaco") to facilitate the
development of the Company's BDS technology in crude oil. Under the terms of
the alliance, the Company will be primarily responsible for improving the
performance of the biocatalyst used in the desulfurization process. Texaco
will be primarily responsible for field operations and analytical chemistry
work with respect to the application of the Company's BDS technology to crude
oil. The Company and Texaco will each bear their own costs and expenses
incurred in connection with the collaboration. In the event the Company
sub-licenses Texaco's intellectual and proprietary information, licensed by
agreement to the Company by Texaco, the Company shall pay Texaco an amount
equal to ten percent (10%) of the desulfurization processing fee charged to
Texaco until such time as the Company has paid Texaco an aggregate amount
equal to two and one-half times the aggregate amount of Texaco's direct costs
and expenses incurred in connection with the collaboration.
F-13
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company expects that the development alliance with Texaco will facilitate
commercialization of the Company's BDS technology.
In January 1991, the Company paid $25,000 and issued 730,800 shares of
its Common Stock to the Institute of Gas Technology ("IGT") for the license
to IGT's technology for desulfurizing petroleum which expires at the later of
20 years or when all patents related to the technology expire. As
consideration for future royalties, the Company agreed to pay IGT $400,000,
of which $200,000 was paid and charged to expense as of December 31, 1992 and
the remaining $200,000 was paid and charged to expense as of December 31,
1993. These payments eliminate the royalty to be paid upon future revenues.
Payments to IGT were approximately none, $150,000 and none in 1994, 1995 and
1996, respectively, for research performed under the terms of the research
agreements. As part of the total payments made to IGT in 1993, the Company
had paid $150,000 under the amended agreement which provided an additional
$300,000 financing for research. The remaining payment of $150,000 was made
in June 1995.
The Company has also entered into other contracts with various
institutions for research and development. The amounts paid under these
agreements totaled $211,500, $114,900 and $85,000 for the years ended
December 31, 1995, 1996 and 1997, respectively. The Company is also
committed to pay these institutions approximately $25,000 through December
1998 under various agreements.
In March 1992, the Company entered into a collaborative agreement with
Petrolite Corporation ("Petrolite") to commercialize the Company's BDS
technology. Under the terms of the agreement, both parties are to perform
research and development. Petrolite is to perform research and development
in its own laboratory at its own cost and is to fund research, as agreed
under the terms of the agreement, at the Company beginning April 1, 1992, at
a rate of $225,000 per month for the first two years of the agreement for a
total of $5,400,000. Additionally, Petrolite, under the terms of the
agreement, constructed a pilot plant at its own expense, not to exceed
$1,500,000, to begin testing the effectiveness of the BDS technology. The
Company is committed to fund research and development at its own expense in
the third through fifth years of the agreement at an annual rate equal to the
greater of $2,500,000 per year or 4% of the Company's net revenues, as
defined in the agreement. As of December 31, 1997, the Company has received
$5,400,000 in research payments of which $1,134,000 has been recognized as
revenue in each of the years ended December 31, 1995 and 1996 and $13,500 has
been recognized for the year ended December 31, 1997. The revenue recognized
is based on the percentage of total research payments to be received from
Petrolite in relation to the total research and development costs to be
incurred under the terms of the agreement. The amended collaborative
agreement dated October 18, 1993, provides for an expanded territory covered
by the agreement from North America, Venezuela and Mexico to the entire world
and permits the use of third party engineering and construction companies to
assist with certain matters. In return, the Company's obligation to pay
Petrolite decreased from 30% to 22% of all site licenses fees and adjusted
gross profit from the operation of the desulfurization units. In the event
the collaboration is terminated, the percentage of site license fees and
adjusted gross profit paid to Petrolite will be adjusted as outlined under
the terms of the agreement.
In October 1996, the Company entered into an agreement with Petrolite
providing the Company with the option to amend the terms of its strategic
alliance with Petrolite. Under the agreement, the Company made an initial
payment of $1 million to Petrolite in December 1996, which was expensed by
the Company when made, in exchange for the option and the extension of
Petrolite's obligations to provide operational and technical support for the
pilot plant from September 1, 1996 through December 31, 1998. If the Company
exercises its option, the percentage of site license fees and adjusted gross
profit payable to Petrolite will be reduced to 9.5% from 22%, in exchange for
which the Company will (i) assume responsibility for servicing the BDS units
on site at customer locations, (ii) pay Petrolite an additional $9 million in
cash and (iii) issue to Petrolite a warrant entitling Petrolite to purchase
138,889 shares of Common Stock at an exercise price of $7.20 per share. The
Company may exercise the Petrolite option at any time on or before the
earlier to occur of (i) ten business days following the close of any equity
financing by the Company in which the gross cash proceeds raised in such
financing (together with cash proceeds raised by the Company in any other
equity financing after the date of the option agreement, if applicable) equal
or exceed $25 million and (ii) December 30, 1998. The Company does not plan
to exercise the option unless and until it has raised substantial additional
funds or received additional capital.
F-14
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In December 1994, the Company was awarded a $2 million federal grant
under the Advanced Technology Programs administered by the National Institute
of Standards and Technology ("NIST"). The three-year program funded by this
grant is dedicated to the development of a biotechnology-based method of
removing sulfur from crude oil. As of December 31, 1997, the Company has
recognized $1,943,412 in sponsored research revenue relating to this grant.
Included in this revenue amount is $290,928 of grant receivable from NIST.
8. COMMITMENTS
The Company maintains a Simplified Employee Pension Plan (the "Plan")
for all employees. Under the terms of the Plan, employees are eligible to
participate after completion of six months of service. The Company
contributes an amount equal to 8% of the employees' annual compensation to
the Plan. Employees are vested immediately and there is at present no
employee contribution. Total expenses under the Plan were approximately
$246,000, $302,000 and $316,000 for the years ended December 31, 1995, 1996
and 1997, respectively.
The Company maintains two capital leases for computer and laboratory
equipment. In addition, the Company maintains an operating lease agreement
for its headquarters, which expires in 1998.
Future minimum payments under the non-cancelable operating lease and
capital leases consist of the following at December 31, 1997:
<TABLE>
FISCAL YEAR OPERATING CAPITAL
- ----------- --------- -------
<S> <C> <C>
1998 . . . . . . . . . . . . . . . . . . . $303,959 $3,556
1999 . . . . . . . . . . . . . . . . . . . 1,158 --
-------- ------
Total minimum lease payments . . . . . . $305,117 $3,556
-------- ------
-------- ------
Less interest. . . . . . . . . . . . . . . 95
Present value of future minimum
lease payments . . . . . . . . . . . . . $3,461
------
</TABLE>
The Company incurred rent expense of $320,456, $391,788 and $395,070
during 1995, 1996 and 1997, respectively.
9. RELATED-PARTY TRANSACTIONS
The Company paid consulting fees to certain stockholders and directors
totaling $60,021, $12,155 and $ 13,700 during the years ended December 31,
1995, 1996 and 1997, respectively.
The former Chairman of the Board and Chief Executive Officer of
Petrolite serves as a director for the Company.
10. SUBSEQUENT EVENTS
In March 1998, the Company entered into a site license agreement with
Petro Star Inc. ("Petro Star") regarding the design and installation of a BDS
unit at Petro Star's Valdez, Alaska refinery. The agreement involves several
stages of work, the first of which, involving the completion of scoping
economics, is currently under way. In addition, the agreement provides EBC
with certain rights to conduct development work and demonstrations of its BDS
technology at Petro Star's refinery. The agreement calls for the payment of
staged license fees and royalties to EBC, including a $200,000 initial site
license fee upon execution of the agreement. As is customary in such
F-15
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
arrangements in the petroleum refining industry, the agreement provides
certain approval and termination rights to Petro Star at the completion of
each stage prior to commercialization. In connection with the execution of
the agreement, the Company issued a four-year warrant entitling Petro Star to
purchase 200,000 shares of EBC Common Stock at an exercise price of $3.11 per
share. The successful implementation of a commercial BDS unit will be
dependent upon the Company's ability to achieve additional improvements in
the productivity of the biocatalyst (e.g., reaction rates, specificity and
stability) and process technology (e.g., bioreactor and separations
technology.
Petro Star, a wholly owned subsidiary of Arctic Slope Regional
Corporation, refines and distributes petroleum products throughout Alaska.
The Anchorage-based company owns and operates oil refineries in Valdez and
North Pole, Alaska, with distribution facilities in Fairbanks, Kodiak and
Dutch Harbor. The Petro Star Valdez refinery is a major supplier of military
jet fuel, as well as marine diesel and other middle distillate products.
F-16
<PAGE>
EMPLOYMENT TERMINATION AND SEVERANCE AGREEMENT
THIS EMPLOYMENT TERMINATION AND SEVERANCE AGREEMENT (this "Termination
Agreement") is entered into as of September 30, 1997, by and between Energy
BioSystems Corporation ("EBC"), and John H. Webb, an individual residing at 110
Spring Mist Place, The Woodlands, Texas 77381 ("Employee").
WHEREAS, EBC and Employee have previously entered into an Employment
Agreement dated August 21, 1991, as amended (the "Employment Agreement");
WHEREAS, Employee intends to resign from his employment with EBC
effective October 1, 1997 (the "Effective Date"); and
WHEREAS, EBC and Employee now wish to terminate the Employment
Agreement and release each other from any claims arising thereunder effective
upon the Effective Date;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants contained herein, the parties hereto agree as follows:
1. TERMINATION. The Employment Agreement is terminated effective as
of the Effective Date and none of the parties shall have any further rights or
obligations hereunder after the Effective Date except as expressly specified
herein.
2. SEVERANCE. For and in consideration of Employee's execution
of this Termination Agreement, EBC will, subject to the further provisions of
this Termination Agreement, (i) pay Employee (A) monthly payments of
$18,750.00 for the period beginning as of October 1, 1997 and continuing
through December 31, 1997, payable as and when Employee would otherwise be
paid his salary under Section 2 of the Employment Agreement, and (B) a final
payment of $187,500.00 on January 15, 1998 (collectively, the "Severance
Payments"), (ii) continue to pay through October 31, 1998 the premiums
required for Employee's continued coverage under (A) the Company's group
medical plan, (B) the disability insurance presently maintained by the
Company for the benefit of Employee and (C) the life insurance presently
maintained by the Company for the benefit of Employee, (iii) extend (and
hereby does extend) the period during which options granted to Employee under
EBC's Stock Incentive Plan may vest, to the extent such options vest upon the
completion of a commercial BDS site license, until October 31, 1998, and (iv)
extend (and hereby does extend) the period during which Employee may exercise
options granted to Employee under EBC's Stock Incentive Plan, to the extent
such options are vested as of the Effective Date or become vested pursuant to
the preceding clause of this Termination Agreement, until October 31, 1998.
Notwithstanding the provisions of Section 4.7 of the Employment Agreement,
the Severance Payments shall not be subject to any reduction or right of
offset as a result of Employee's employment by another entity during the term
of this Termination Agreement, provided that Employee has complied with the
terms set forth herein.
3. RELEASE. (a) Employee, on behalf of himself, his heirs,
beneficiaries and personal representatives, hereby releases, acquits and
forever discharges EBC, its officers, employees, former employees,
stockholders, directors, agents and assigns, and all other persons, firms or
corporations in control of, under the direction of, or in any way associated
with EBC (collectively, the "EBC Affiliates"), of and
<PAGE>
from all claims, charges, complaints, liabilities, obligations, promises,
agreements, contracts, damages, actions, causes of action, suits, accrued
benefits or other liabilities of any kind or character, whether known or
hereafter discovered, arising from, growing out of, or in any way connected
with or related to Employee's employment with, and/or termination of
employment from, EBC and the EBC Affiliates, including, but not limited to,
allegations of wrongful termination, discrimination, breach of contract,
intentional infliction of emotional distress, invasion of privacy, promissory
estoppel, whistleblowing, fraud, termination for refusal to perform an
illegal act, defamation, any action in tort or contract, any action for
unpaid wages, attorney's fees, or punitive damages, and any violation of any
federal, state, or local law, including but not limited to, any violation of
Title VII of the Civil Rights Acts of 1964 and 1991, as amended, 42 U.S.C.
Section 2000e ET SEQ., the Civil Rights Act of 1866, 42 U.S.C. Section 1981
ET SEQ., the Equal Pay Act, 29 U.S.C. Section 206, the Employee Retirement
Income Security Act of 1974, as amended (ERISA), 29 U.S.C. Section 1001 ET
SEQ., the Americans with Disabilities Act, 42 U.S.C. Section 12101 ET. SEQ.,
the Fair Labor Standards Act, as amended, 29 U.S.C. Section 621 ET SEQ., the
Family and Medical Leave Act of 1993, 29 U.S.C. Section 2601 ET SEQ., the
Worker Adjustment and Restraining Notification Act (WARN), 29 U.S.C. Section
2101 ET SEQ., the Texas Commission on Human Rights Act, as amended, Texas
Labor Code Section 21.001 ET SEQ., the Texas Payday Act, Texas Labor Code
Section 61.001 ET SEQ., the Texas Workers' Compensation Statute, Texas Labor
Code Section 451.001 ET SEQ., and any other civil rights act, and all
amendments made to any such laws from time to time.
(b) Employee agrees not to commence any legal proceeding or lawsuit
against EBC or any EBC Affiliate arising out of or based upon Employee's
employment with EBC or any EBC Affiliate or because of the termination of
Employee's employment with EBC or any EBC Affiliate.
(c) The consideration cited above and the promises contained herein
are made for the purpose of purchasing the peace of EBC and the EBC Affiliates
and are not to be construed as an admission of liability or as evidence of
unlawful conduct by EBC or any EBC Affiliate, all such liability being herein
expressly denied.
(d) Employee voluntarily accepts the Severance Payments as sufficient
payment for the full, final and complete release stated herein, and agrees that
no other promises or representations have been made to Employee by EBC or an EBC
Affiliate or any other person purporting to act on the behalf of EBC or an EBC
Affiliate, except as expressly stated herein.
(e) Employee understands that this is a full, complete, and final
release of EBC and the EBC Affiliates. As evidenced by the signature below,
Employee expressly promises and represents to EBC and the EBC Affiliates that he
has completely read this Agreement and understands its terms, contents,
conditions, and effects. Employee stipulates and agrees that EBC and EBC
Affiliates do not owe Employee anything in addition to what Employee will be
receiving pursuant to Section 2 of this Termination Agreement.
(f) Employee hereby waives all rights to recall, reinstatement,
reemployment and past or future wages from EBC and the EBC Affiliates and
further, acknowledges that Employee is not entitled to any continued
participation in, or benefits under, any employee benefit plan or compensation
program of EBC or any EBC Affiliate, including, without limitation, any profit,
bonus or commission arrangement, the EBC Stock Incentive Plan, the Employment
Agreement and any other employment agreement (whether written or oral) with the
Company, except as may otherwise be required by ERISA or as otherwise expressly
set forth herein.
-2-
<PAGE>
4. ACKNOWLEDGMENT OF REMAINING OBLIGATIONS UNDER EMPLOYMENT
AGREEMENT. Employee acknowledges that he is subject to valid and enforceable
agreements regarding nondisclosure, inventions and noncompetition pursuant to
the provisions of Sections 5.2, 5.3, 5.4 and 5.5 of the Employment Agreement,
which provisions and obligations remain in full force and effect following this
Termination Agreement.
5. NO ASSIGNMENT OF CLAIMS. Employee hereby warrants that he has
not assigned, transferred or conveyed at any time to any individual or entity
any alleged right, claim or cause of action against EBC or any EBC Affiliate.
Employee agrees to and does hereby indemnify and hold EBC and the EBC Affiliates
harmless from any claims, liabilities, damages, demands, losses, costs, debts
and causes of action whatsoever, including without limitation attorney's fees,
whether known or unknown, which may be asserted by parties for breach of the
foregoing warranty.
6. NO DURESS, ETC. Employee hereby warrants to EBC that he has
completely read this Termination Agreement prior to executing it, and has had a
reasonable period of time within which to consider this Agreement and to
understand its terms, contents, conditions and effects and has entered into this
Termination Agreement knowingly and voluntarily. Employee understands that he
has the right to consult an attorney of his choice and represents that he has
consulted with an attorney or he has knowingly decided not to do so. Employee
states that he is not presently affected by any disability which would prevent
him from knowingly and voluntarily executing this Termination Agreement, and
further states that the promises made herein are not made under duress, coercion
or undue influence.
7. AMENDMENT. This Termination Agreement may not be amended or
modified in any respect except by an agreement in writing executed by the
parties in the same manner as this Agreement.
8. SUCCESSORS. This Termination Agreement shall be binding upon and
shall inure to the benefit of and be enforceable by each of the parties and
their respective successors and assigns.
9. INVALID PROVISIONS. If any provision of this Termination
Agreement is held to be illegal, invalid or unenforceable under present or
future law effective during the term hereof, such provision shall be fully
severable. This Termination Agreement shall be construed and enforced as if
such illegal, invalid or unenforceable provision had never comprised a part
hereof and the remaining portions hereof shall remain in full force and effect
and shall not be effected by the illegal, invalid or unenforceable provision or
by its severance here from. Furthermore, in lieu of such illegal, invalid or
unenforceable provision, there shall be added automatically, as part of this
Termination Agreement, a provision similar in terms to such illegal, invalid or
unenforceable provision as may be possible and be legal, valid and enforceable.
10. DESCRIPTIVE HEADINGS. The descriptive headings of the several
sections of this Termination Agreement are inserted for convenience only and
shall not control or affect the meaning or construction of any of the provisions
hereof.
11. GOVERNING LAW. This Termination Agreement shall be governed by
and construed and enforced in accordance with the laws of the State of Texas.
12. ENTIRE AGREEMENT. This Termination Agreement constitutes the
entire agreement between the parties hereto with respect to the subject matter
of this Termination Agreement and supersedes
-3-
<PAGE>
and is in full substitution for any and all prior agreements and
understandings whether written or oral between said parties relating to the
subject matter of this Termination Agreement.
IN WITNESS WHEREOF, the parties have duly executed this Termination
Agreement effective as of the date first above written.
EMPLOYEE:
--------------------------------
John H. Webb
ENERGY BIOSYSTEMS CORPORATION
By:
-----------------------------
Ramon Lopez
Chairman of the Board
-4-
<PAGE>
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT is made this _____ day of October, 1997 by and
between Energy BioSystems Corporation, a Delaware corporation (the "Company"),
and Michael A. Pacheco ("Employee").
W I T N E S S E T H :
WHEREAS, the Company wishes to employ Employee and Employee wishes to be
employed by the Company on the terms and subject to the conditions set forth
below;
NOW, THEREFORE, in consideration of the foregoing recital and of the mutual
covenants herein set forth, the Company and Employee hereby agree as follows:
1. EMPLOYMENT. Effective as of October ___, 1997 (the "Effective Date"),
the Company hereby employs Employee and Employee accepts such
employment, effective as of the Effective Date, for the compensation
and on the terms and subject to the conditions herein set forth.
2. COMPENSATION. The Company shall pay Employee an initial monthly
salary equivalent to Employee's current monthly salary payable in
accordance with the Company's normal pay practices, which shall be
reviewed no less than annually and from time to time changed (but not
to be decreased to an amount below the initial monthly salary) at the
discretion of the Board of Directors of the Company. Employee shall
also be entitled to all rights and benefits for which he shall be
eligible under group insurance and other fringe benefits which may be
in force from time to time (including any profit-sharing, option or
other incentive compensation plan either Company-wide or specific to
the Employee) and provided to the Company's employees generally.
3. DUTIES. Prior to the termination hereof, Employee agrees to devote
his full time and attention to the service of the Company and, in
furtherance thereof, to use his best efforts and to perform such
duties as may be assigned to him from time to time by or under
authority of the Board of Directors of the Company. Employee agrees
that he will not undertake any other employment, consulting services
or business venture during the period of his employment hereunder,
unless the Company, by action of the Board, shall consent thereto in
writing. The foregoing shall not be construed as preventing Employee
from engaging in such personal and business investment activities as
are essentially passive in nature and do not conflict with or
adversely affect in any material respect the performance or discharge
of Employee's duties and responsibilities hereunder.
<PAGE>
4. TERM AND TERMINATION.
4.1 The term of this Agreement shall commence on the Effective Date and
continue until July 18, 2000 unless earlier terminated as hereinafter
provided.
4.2 This Agreement shall terminate automatically on the death of Employee.
4.3 The Company shall have the right to terminate Employee's employment
for cause by giving notice in writing to Employee. As used herein,
the term "cause" shall mean (i) dishonesty; (ii) conviction of any
crime other than misdemeanors or minor traffic violations; (iii)
material breach of any provision of this Agreement; (iv) commission of
any action or omission to take any action in bad faith and to the
detriment of the Company; (v) willful refusal or failure of Employee
to obey the lawful directions of the Board of Directors of the
Company; or (vi) failure to adequately perform the duties and
responsibilities assigned to Employee pursuant to this Agreement,
which failure shall continue for a period of thirty (30) days after
receipt of written notice from the Board of Directors indicating with
specificity the acts or omissions upon which the Board intends to
terminate his employment.
4.4 The Company shall have the right to terminate Employee's employment in
the event of complete disability by giving notice in writing to
Employee. As used herein, the term "complete disability" shall mean
the inability of Employee, due to illness or injury, to perform his
duties hereunder for a period of 180 consecutive days.
4.5 The foregoing notwithstanding, the Company may terminate Employee's
employment for whatever reason it deems appropriate by one month's
prior notice in writing.
4.6 Employee shall have the right to terminate Employee's employment at
any time following the occurrence of a Change in Control, as defined
below, if Employee's duties or responsibilities are materially reduced
in connection with or following the Change in Control from those in
effect immediately prior to the Change in Control, except in
connection with the termination of Employee's employment pursuant to
Sections 4.2, 4.3, 4.4, 4.5 or 4.7. For purposes of this Agreement, a
"Change in Control" shall be deemed to have occurred if:
(i) any individual, entity or group (within the meaning of
Section 13(d) or 14(d)(2) of the Securities and Exchange Act of
1934) shall become (directly or indirectly) the "beneficial
owner" (within the meaning of Rule 13d-3 promulgated under such
Act) of more than 50% of the combined voting power of the then
outstanding securities of the Company entitled to vote generally
in the election of directors ("Voting Power"); or
-2-
<PAGE>
(ii) the Company's stockholders shall approve a merger or
consolidation, sale or disposition of all or substantially all of
the Company's assets or a plan of liquidation or dissolution of
the Company, other than (A) a merger or consolidation in which
the voting securities of the Company outstanding immediately
prior thereto will become (by operation of law), or are to be
converted into, voting securities of the surviving corporation or
its parent corporation that, immediately after such merger or
consolidation, (x) are owned by the same person or entity or
persons or entities that owned the voting securities of the
Company immediately prior thereto and (y) possess at least 75% of
the Voting Power held by the voting securities of the surviving
corporation or its parent corporation, or (B) a merger or
consolidation effected to implement a recapitalization of the
Company (or similar transaction) in which no person acquires more
than 50% of the Voting Power.
4.7 The foregoing notwithstanding, Employee shall have the right to
terminate Employee's employment for whatever reason Employee deems
appropriate by one month's prior notice in writing.
4.8 In the event of termination of Employee's employment pursuant to
Sections 4.2, 4.3, 4.4 or 4.7 hereof, the Company shall pay Employee
his salary at the then current rate up to the date of such
termination, and Employee shall be entitled to no further
compensation hereunder.
4.9 In the event of termination of Employee's employment pursuant to
Sections 4.5 or 4.6 hereof, the Company shall pay Employee severance
compensation for the lesser of a period of (i) six (6) months from the
date of such termination, (ii) the remaining term of this Agreement,
or (iii) a period ending on the date on which Employee becomes
employed by another entity, payable as and when Employee would
otherwise be paid his salary under Section 2 hereof.
5. NONDISCLOSURE; INVENTIONS; NON-COMPETITION.
5.1 For the purposes of this Agreement the terms set forth below shall
have the following meanings:
5.1.1 CONFIDENTIAL INFORMATION. That secret proprietary information of
the Company of whatever kind or nature disclosed to Employee or
known by Employee (whether or not invented, discovered or
developed by Employee). Such proprietary information shall
include information relating to the design, manufacture and
application of the Company's products, know-how and research and
development relating to the Company's products, sources of supply
and material, operating and other cost data, lists of present,
past or prospective customers, customer proposals, and price
lists and
-3-
<PAGE>
data relating to pricing of the Company's products or
services, any of which information is not generally known in the
industry, and shall specifically include, without limitation, all
information contained in manuals, memoranda, formulae, plans,
drawings and designs, specifications, supply sources, and records
of the Company.
5.1.2 CONCEPTS AND IDEAS. Those concepts and ideas known to Employee
relating to the Company's activities and products.
5.1.3 INVENTIONS. Those discoveries and developments, whether or not
patentable, relating to the Company's activities and products
(whether made by Employee acting alone or in conjunction with
others) made on or after the date on which Employee was first
employed by the Company in any capacity and prior to three years
after the termination of Employee's employment with the Company.
The term "Invention" shall also include any other discovery or
development made by Employee on or after the date on which
Employee was first employed by the Company in any capacity and
prior to the termination of this Agreement, except for any
invention or discovery for which no equipment, supplies,
facility, or trade secret information of the Company was used and
which was developed entirely on the Employee's own time and (i)
which does not relate (a) to the business of the Company, or (b)
to the Company's actual or demonstrably anticipated research or
development, or (ii) which does not result from any work
performed by the Employee for the Company. Such term shall not
be limited to the meaning of "invention" under the United States
patent laws. Listed below by descriptive title for purposes of
identification are all inventions made by Employee prior to the
date on which Employee was first employed by the Company in any
capacity which he considers to be his property and which are
hereby excluded from this Agreement:
NONE
5.2 All Inventions and all Concepts and Ideas shall be the property of and
are hereby assigned to the Company free of any reserved or other
rights of any kind on the part of Employee in respect thereof.
5.3 Employee will promptly make full disclosure of any such Inventions and
Concepts and Ideas to the Company. Further, Employee will, at the
Company's cost and expense, promptly execute formal applications for
patents and also do all other acts and things (including, among
others, the execution and delivery of instruments of further assurance
or confirmation) deemed by the Company to be necessary or desirable at
any time or times in order to effect the full assignment to the
Company of Employee's right and title to such Inventions and Concepts
and Ideas, without, during the term of this Agreement, further
compensation beyond Employee's agreed salary. Employee further
understands that the absence of a request by the Company
-4-
<PAGE>
for information, or for the making of an oath, or for the execution
of any document, shall in no way be construed to constitute a
waiver of the Company's rights under this Agreement.
5.4 Except as required by Employee's duties hereunder, Employee will not,
directly or indirectly, use, publish, disseminate or otherwise
disclose any Confidential Information, Concepts and Ideas or
Inventions relating to the past, present or planned business of the
Company without the prior written consent of the Company, unless any
such items are, prior to such disclosure, part of the written public
knowledge or become part of the written public knowledge through no
fault of Employee or are disclosed to Employee by a third party having
the right to do so.
5.5 All documents, procedural manuals, guides, specifications, plans,
drawings, designs and similar materials, lists of present, past or
prospective customers, customer proposals, invitations to submit
proposals, price lists and data relating to pricing of the Company's
products and services, records, notebooks and similar repositories of
or containing Confidential Information and Inventions, including all
copies thereof, that are or come into Employee's possession or control
by reason of Employee's employment, whether prepared by Employee or
others, are the property of the Company, will not be used by Employee
in any way adverse to the Company, will not be removed from the
Company's premises except as Employee's normal duties require and, at
the termination of Employee's employment with the Company, will be
left with or forthwith returned by Employee to the Company.
5.6 During the term of Employee's employment with the Company and for a
period of five (5) years thereafter, Employee shall not, individually
or on behalf of or in conjunction with any other person or entity,
directly or indirectly, own, manage, operate, control or be employed
by, solicit the Company's past, present or prospective employees or
customers on behalf of, or, otherwise participate in any manner in any
corporation, partnership, proprietorship or other business entity
which is engaged in the development or sale of technology for the
microbial desulfurization of hydrocarbons or in any activity or
development of any product directly competitive with any of the
activities engaged in or products developed by the Company at the time
of Employee's termination; provided, however, that Employee may own
not more than 1% of the outstanding capital stock of a company in a
competitive business whose stock is publicly traded.
6. EXPENSES. Employee shall be entitled to reimbursement for reasonable
expenses incurred in the performance of services hereunder, provided
that the same are accounted for in accordance with the Company's
general requirements.
7. SURVIVAL; REMEDIES. Employee's duties under sections 5.2, 5.3, 5.4,
5.5, and 5.6 of this Agreement shall survive termination of this
Agreement and Employee's
-5-
<PAGE>
employment with the Company. Employee acknowledges that a remedy
at law for any breach or threatened breach by Employee of the
provisions of this Agreement may be inadequate and Employee
therefore agrees that the Company shall be entitled to injunctive
relief in case of any such breach or threatened breach.
8. ASSIGNMENT. This Agreement and the rights and obligations of the
parties hereto shall bind and inure to the benefit of each of the
parties hereto and shall also bind and inure to the benefit of any
successor or successors of the Company by reorganization, merger or
consolidation and any assignee of all or substantially all of its
business and properties, but, except as to any such successor or
assignee of the Company, neither this Agreement nor any rights or
benefits hereunder may be assigned by the Company or by Employee.
9. GOVERNING LAW. This Agreement shall be construed in accordance with
and governed for all purposes by the laws and public policy of the
State of Texas applicable to contracts executed and wholly performed
within such state.
10. SEPARABILITY. In case any one or more of the provisions contained in
this Agreement shall, for any reason, be held to be invalid, illegal
or unenforceable in any respect, such invalidity, illegality or
unenforceability shall not affect any other provisions of this
Agreement, but this Agreement shall be construed as if such invalid,
illegal or unenforceable provision had never been contained herein.
If, moreover, any one or more of the provisions contained in this
Agreement shall for any reason be held to be excessively broad as to
duration, geographical scope, activity or subject, it shall be
construed by limiting and reducing it, so as to be enforceable to the
extent compatible with the applicable law as it shall then appear.
11. WAIVER. If either party should waive any breach of any provision of
this Agreement, he or it shall not thereby be deemed to have waived
any preceding or succeeding breach of the same or any other provision
of this Agreement. No party shall be deemed to waive any rights
hereunder unless such waiver be in writing and signed by such party.
12. ENTIRE AGREEMENT. The foregoing is the entire Agreement of the
parties with respect to the subject matter hereof and may not be
amended, supplemented, cancelled or discharged except by written
instrument executed by both parties hereto.
-6-
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement on the day,
month and year first above stated.
___________________________________
Michael A. Pacheco
ENERGY BIOSYSTEMS CORPORATION
By:___________________________________
Ramon Lopez
Chairman of the Board
-7-
<PAGE>
EXHIBIT 11.1
ENERGY BIOSYSTEMS CORPORATION
BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
YEAR ENDED DECEMBER 31, 1995
WEIGHTED AVERAGE SHARES OUTSTANDING:
<TABLE>
<CAPTION>
TOTAL # DAYS
SHARES OUTSTANDING
- -------------- -------------
<S> <C> <C> <C> <C>
9,988,409 x 2 = 19,976,818
9,988,409 x 28 = 279,955,452
9,999,404 x 4 = 39,997,616
10,000,604 x 4 = 40,002,416
10,040,604 x 16 = 160,649,664
10,041,604 x 1 = 10,041,604
10,046,604 x 62 = 622,889,448
10,228,645 x 21 = 214,801,545
10,233,645 x 89 = 910,794,405
10,235,645 x 2 = 20,471,290
10,237,645 x 7 = 71,663,515
10,242,640 x 18 = 184,367,520
10,249,640 x 13 = 133,245,320
10,258,241 x 7 = 71,807,687
10,270,241 x 1 = 10,270,241
10,293,241 x 4 = 41,172,964
10,368,241 x 3 = 31,104,723
10,370,749 x 23 = 238,527,227
10,512,618 x 1 = 10,512,618
10,513,388 x 8 = 63,080,328
10,514,288 x 1 = 10,514,288
10,514,788 x 2 = 21,029,576
10,516,788 x 2 = 21,033,576
10,524,188 x 30 = 315,725,640
10,524,268 x 18 = 189,436,824
--- -------------
365 3,733,072,305
3,722,072,305 / 385 = 10,227,595
----------
----------
LOSS PER SHARE:
Net Loss plus dividend accrual
plus accretion of offering costs ($9,713,069) = $0.95
- -------------------------------- ------------- ----------
Weighted Avg. Shares 10,227,595 ----------
</TABLE>
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
YEAR ENDED DECEMBER 31, 1996
WEIGHTED AVERAGE SHARES OUTSTANDING:
<TABLE>
<CAPTION>
TOTAL # DAYS
SHARES OUTSTANDING
- -------------- -------------
<S> <C> <C> <C> <C>
10,584,268 x 23 = 243,438,164
11,107,568 x 14 = 155,505,952
11,139,268 x 27 = 300,760,236
11,140,768 x 8 = 89,126,144
11,142,868 x 55 = 612,857,740
11,301,975 x 28 = 616,455,300
11,302,025 x 16 = 180,832,400
11,303,525 x 7 = 79,124,675
11,309,295 x 1 = 11,309,295
11,309,355 x 5 = 56,546,775
11,310,855 x 7 = 79,175,985
11,311,955 x 5 = 56,559,775
11,316,955 x 4 = 45,267,820
44,318,210 x 28 = 316,909,880
11,320,010 x 4 = 45,280,040
11,320,210 x 23 = 260,364,830
11,325,210 x 41 = 464,333,610
11,326,210 x 9 = 101,935,890
11,490,770 x 52 = 597,520,040
11,497,135 x 9 = 103,474,215
--- -------------
386 4,116,778,466
4,116,778,766 / 365 = 11,248,029
----------
----------
LOSS PER SHARE:
Net Loss plus dividend accrual
plus accretion of offering costs ($11,720,213) = ($1.04)
- -------------------------------- ------------- ----------
Weighted Avg. Shares 11,248,029 ----------
</TABLE>
<PAGE>
ENERGY BIOSYSTEMS CORPORATION
BASIC AND DILUTED EARNINGS PER SHARE COMPUTATION
YEAR ENDED DECEMBER 31, 1997
WEIGHTED AVERAGE SHARES OUTSTANDING:
<TABLE>
<CAPTION>
TOTAL # DAYS
SHARES OUTSTANDING
- -------------- -------------
<S> <C> <C> <C> <C>
11,497,135 x 15 = 172,457,025
11,502,135 x 1 = 11,502,135
11,502,235 x 7 = 80,515,645
11,502,395 x 18 = 207,043,110
11,505,395 x 8 = 92,043,160
11,506,053 x 13 = 149,578,689
11,507,163 x 6 = 69,042,978
11,605,377 x 52 = 603,479,604
11,724,758 x 63 = 737,903,754
11,763,593 x 20 = 235,271,860
11,764,343 x 36 = 423,516,348
11,765,343 x 8 = 94,122,744
11,777,924 x 24 = 282,670,175
11,778,204 x 1 = 11,778,204
11,780,704 x 15 = 176,710,560
11,896,470 x 1 = 11,896,470
11,896,670 x 4 = 47,586,680
11,899,670 x 9 = 107,097,030
11,935,951 x 6 = 71,615,706
12,201,434 x 4 = 48,805,736
12,218,434 x 11 = 134,402,774
12,251,434 x 43 = 526,811,662
--- -------------
365 = 4,295,852,050
4,295,852,050 / 365 = 11,769,458
----------
----------
LOSS PER SHARE:
Net Loss plus dividend accrual
plus accretion of offering costs ($12,849,466) = ($1.09)
- ------------------------------- ------------- ----------
Weighted Avg. Shares 11,769,458 ----------
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K, into the Company's previously filed
Registration Statements on Form S-8 dated September 9, 1993 and September 13,
1993 and Form S-3 dated February 13, 1995.
Arthur Andersen LLP
The Woodlands, Texas
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S ANNUAL REPORT
ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 9,661,310
<SECURITIES> 693,279
<RECEIVABLES> 676,384
<ALLOWANCES> 0
<INVENTORY> 13,953
<CURRENT-ASSETS> 11,368,461
<PP&E> 6,832,740
<DEPRECIATION> 4,208,408
<TOTAL-ASSETS> 14,965,059
<CURRENT-LIABILITIES> 1,266,836
<BONDS> 0
0
33,853,380
<COMMON> 122,514
<OTHER-SE> 34,926,594
<TOTAL-LIABILITY-AND-EQUITY> 14,965,059
<SALES> 0
<TOTAL-REVENUES> 2,302,225
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 11,841,286
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (9,539,061)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,539,061)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,539,061)
<EPS-PRIMARY> (1.09)
<EPS-DILUTED> (1.09)
</TABLE>