-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Gd8NdfMgh8g/qWEmrDa/yl0D1Ca6V3nSQ8WZn8liKuTK95jTBj1KdMovd5UJltbK FC9aUQVF5JydMH7exuy8Ng== 0000886128-98-000005.txt : 19980130 0000886128-98-000005.hdr.sgml : 19980130 ACCESSION NUMBER: 0000886128-98-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971031 FILED AS OF DATE: 19980129 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENERGY RESEARCH CORP /NY/ CENTRAL INDEX KEY: 0000886128 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES [3690] IRS NUMBER: 060853042 STATE OF INCORPORATION: NY FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-14204 FILM NUMBER: 98516731 BUSINESS ADDRESS: STREET 1: 3 GREAT PASTURE RD CITY: DANBURY STATE: CT ZIP: 06813 BUSINESS PHONE: 203-825-6047 MAIL ADDRESS: STREET 1: 3 GREAT PASTURE ROAD CITY: DANBURY STATE: CT ZIP: 06813 10-K 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended 10/31/97 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from________ to ________ Commission File Number 0-24852 ENERGY RESEARCH CORPORATION (Exact name of registrant as specified in its charter) New York 06-0853042 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 3 Great Pasture Road, Danbury, CT 06813 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (203) 792-1460 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.0001 par value (Title of class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of 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 voting stock held by non-affiliates of the registrant was approximately $40,019,430, which is based on the closing price of $17.125 on January 21, 1998. On January 22, 1998 there were 4,013,647 shares of Common Stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain information contained in the registrant's definitive proxy statement relating to its forthcoming 1998 Annual Meeting of Stockholders to be filed not later than 120 days after the end of registrant's fiscal year ended October 31, 1997 is incorporated by reference in Part III of this Report on Form 10-K. 1 FORM 10-K ANNUAL REPORT INDEX PAGE PART I Item 1. Business 3 Item 2. Properties 32 Item 3. Legal Proceedings 33 Item 4. Submission of Matters to a Vote of Security 33 Holders PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 33 Item 6. Selected Financial Data 35 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 36 Item 8. Financial Statements and Supplementary Data 44 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 44 PART III Item 10. Directors and Executive Officers of the Registrant 44 Item 11. Executive Compensation 44 Item 12. Security Ownership of Certain Beneficial Owners 44 and Management Item 13. Certain Relationships and Related Transactions 45 PART IV Item 14. Exhibits, Financial Statement Schedules, 46 and Reports on Form 8-K Signatures 52 2 PART 1. ITEM 1. BUSINESS INTRODUCTION ============ ENERGY RESEARCH CORPORATION (ERC or the Company) is a leading developer of electrochemical technologies. At present, the Company is focusing its efforts on the development, demonstration and commercialization of the carbonate fuel cell and the development of an advanced nickel-zinc secondary battery. Fuel Cell - --------- The carbonate fuel cell converts the chemical energy of a fossil fuel into electricity in a one-step galvanic process which is highly efficient, quiet, and causes virtually no pollution from oxides of nitrogen or oxides of sulfur. Unlike most fuel cell power plants, the ERC system feeds a fuel such as natural gas directly into the fuel cell. In most other systems, it is necessary to first produce hydrogen from the fuel in an external device and then feed the hydrogen to the fuel cell for conversion into electricity in the fuel cell. The Company believes its power plant simplification leads to a more efficient and lower cost system than other fuel cell systems. ERC calls its approach the Direct Fuel Cell (DFC). The DFC operates at a temperature of about 1200 degrees fahrenheiht. At this temperature, precious metal electrocatalysts are not required and a high quality waste heat is available for cogeneration. To date, most of the substantial research, development and demonstration costs associated with the DFC have been provided by the Federal Government and the electric utility industry, the latter being potential customers for the final product. The Company is also working together mainly with Mitsubishi Electric Corp. in Japan and Daimler Benz affiliate MTU-Friedrichshafen GmbH in Europe, licensees of the Company, in the product development. (See "License Agreements") 3 The Company believes that markets for the DFC will be the investor owned electric and gas utilities (IOU), municipal owned electric utilities (MOU), rural electric utilities, independent power producers, industrial and commercial cogeneration, and special situations such as landfill gas fueled units. The Company has focused initially on developing power plants in the 1 to 3 megawatt size range,based on 1.25 MW (nominal) modules with single or multiple modules per power plant. For the IOU and large MOU customers, the units or multiples thereof, could serve in a distributed generation mode in their grid systems. For smaller rural electric and MOU customers, the units could be used in an intermediate or base load mode. Non-utility customers, such as hospital or industrial plants may also be attracted by cogeneration applications. At this time, the Company has conducted the first commercial scale demonstration of its DFC at a site in Santa Clara, California. This project demonstrated a nominal 2 megawatt (1.8 MWAC) DFC power plant. The plant startup began in April 1996. This is the largest carbonate fuel cell power plant and largest advanced fuel cell power plant in the world and the largest fuel cell of any type operated in the United States. The project was approximately 60% funded by a group of electric utility companies: the City of Santa Clara, the Los Angeles Department of Water and Power, Southern California Edison Company, Sacramento Municipal Utility District, the City of Vernon, California and the National Rural Electric Cooperative Association, represented by United Power Association, the Salt River Project, Northern California Power Agency and approximately 40% by the U.S. Department of Energy (DOE). The power plant startup was smooth after some minor adjustments to the DC to AC invertor unit. The power plant surpassed its 1.8 MW AC design goal by reaching a peak power of 1.93 MWAC. About 550 hours into the test, peculiar electrical behavior was observed. Voltage spikes were randomly observed and the Company chose to shut down the power plant in order to check out the phenomena and avoid any possible damage to the digital control system. On examining the plant, it was determined that the dielectrics in the piping system used to electrically insulate the fuel cell stacks' high voltage had been damaged. The cause of the problem was the use of 4 a glue to attach thermal insulation to the stacks, pipes and dielectric insulators. This glue, applied during the final stage of manufacturing, was converted to carbon during plant startup. The carbon acted as a conductor, negating the effectiveness of the electrical insulators. The result was damage to dielectrics and other components. The Company replaced the four highest voltage dielectrics and certain piping, cleaned the carbon from the remaining dielectrics and made repairs where there was visible evidence of damage. A decision was made not to remove certain parts for further inspections in the interest of saving time and costs. To a certain extent, the using of the glue has prevented making an unambiguous assessment of the fuel cell performance in the power plant. The power plant was restarted, achieved a level of 1.25 MW but was prevented from higher levels by reduced performance of certain stacks. On this basis, it was decided to reconfigure the power plant into an 8 stack 1 MW unit. The Company believes that the initial event relating to the glue incident might have caused greater damage than originally anticipated. The stacks' reconfiguration was accomplished in the field in a 10 hour period and the power plant was put back on line, after the addition of a new AC to AC transformer. In March, 1997 the Company in conjunction with project sponsors, decided to conclude operational testing on the Santa Clara project. The 4000 hours of grid connected testing and 2500 Mwh AC of electricity generated, were world records for first-of-a-kind large fuel cell power plant demonstrations. The project also achieved records for low SOX and NoX power plant emissions compared with conventional power plants and for efficiency for fossil fueled power plants in this size range as well as a record efficiency for a fossil fuel cell power plant of any type. After the termination of the demonstration, the fuel cells were returned to ERC for final analysis. The design of this demonstration plant did not represent the commercial offering. The design and development of the commercial product are being conducted under a cooperative agreement signed with the Department of Energy's Morgantown Energy Technology Center in the first fiscal quarter of 1995. Currently under this agreement, DOE has agreed to provide $86 million over a five year period to further design, develop and demonstrate a commercial 5 prototype power plant with improved, larger fuel cells and a more compact design (see Principal Development Contracts-Fuel Cells-General sponsors). Major development emphasis under this agreement focuses on fuel cell and total power plant cost reduction and improved operating endurance, although there can be no assurance that required cost reductions and improved endurance will be attained. The design work in 1996 and 1997 continued at a reduced level as funding was limited by the delays in the government's appropriation process, additional expenses associated with these delays and other issues at the Santa Clara Demonstration Project, and a smaller allocation of funds than required by the original cooperative agreement. In fiscal 1997 about $20.1 million was spent under this agreement. This is less than the scheduled amount under the agreement. While fiscal 1997 got off to a reasonable start due to a timely appropriations bill this year, the funding level was below the funds required by the cooperative agreement. The combination of Santa Clara project delays and expense combined with the reduced level of activity in 1996 and 1997 has resulted in the Company extending its planned commercialization into the 2001 time period. There can be no assurance that the Company will not experience further delays. The 1998 DOE fuel cell budget for stationary power plants is about 15% less than 1997. The Company is substantially dependent on government appropriations for funding its development and demonstration efforts. This dependence has advantages for the investor but also introduces an element of risk and schedule uncertainty in the Company's plans. In addition to DOE agreements, the Company essentially completed a Defense Advanced Research Project Agency (DARPA) contract in 1996 for a diesel fuel powered DFC. This project successfully demonstrated the ability of the Company's DFC to operate on a liquid fuel. This is important as a potential emergency fuel for both commercial and military installations in the event natural gas supply is interrupted. This work in 1996 has led to a U.S. Navy contract in 1997. Also a Coast Guard derivative contract from John J. McMullen Assoc. Inc., a ship design firm was received in the first quarter of 1998. In testing to date, the Company has demonstrated the ability to operate on natural gas at sites in Germany, Denmark and California, on coal gas in Louisiana and 6 Germany and on JP-8 and diesel fuels at its facilities in Danbury. Additionally, the Company received 1996 DARPA funds for new work under the Company's cooperative agreement with DOE. These new funds, received in September 1996, the last month of the Federal fiscal year, were used in 1997 to design facilities to support power plant simulations and certain logistical operations in conjunction with a planned megawatt size simulator being built at ERC's Danbury site. In 1997 an additional $2.1 million in DARPA funds was added to the DOE contract. A higher megawatt class power plant, but significantly more compact than Santa Clara is expected to begin to operate in late 1999. In 1997 ERC focused on continuing to produce larger area cells and larger stacks at its manufacturing facility in Torrington, CT and will initiate testing of these new full-size components and stacks in Danbury in the first half of 1998. There can be no assurance that these tests will not be delayed for technical or budgetary reasons. In addition, ERC installed new manufacturing equipment in 1997 to produce the larger cells at higher production rates. A new larger test facility, 400 kW capability, was tested in 1997 and the first of the larger size stacks is expected to be tested in this facility, which management believes is the world's largest, in 1998. All the schedules presented here are forward looking statements subject to uncertainties in funding availability and technological development issues and are subject to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 (PSLRA 95). Battery - ------- In the battery area, the Company continues to focus its efforts on the nickel-zinc rechargeable battery. In the past year, the Company has succeeded in extending cycle life of single cells to 700 cycles. This ongoing improvement should make the nickel-zinc battery an attractive competitor with existing nickel cadmium and nickel metal hydride rechargeable batteries. Because zinc is lighter in weight, less expensive and has about 30% higher voltage output, the resulting nickel-zinc battery delivers more or comparative energy per unit weight at a potentially lower cost than either nickel cadmium or nickel metal hydride batteries. Moreover, zinc is environmentally benign compared with cadmium. Also during 7 the year, the Company built and had tested a full size battery for hybrid electric vehicle operation for several hundred cycles. The Company believes that markets for the nickel-zinc battery would be similar to the existing markets for nickel metal hydride and nickel cadmium, i.e., computers, power tools, high end portable lighting, and medical electronics. In addition, the nickel-zinc battery has the potential to compete in the upper cost segment of the lead acid battery markets where it would enjoy a substantial weight advantage. In the first quarter of 1997, the Company entered into a license agreement with Corning, Incorporated to further develop and commercialize the technology for a broader range of product applications, but excluding electric vehicles ie. Cars & trucks. (See License Agreements) The Company has tested a 4 Ahr size cell suitable for electronic devices and has designed and tested a 2 Ahr cell for use as a power source for a Left Ventricular Assist Device (LVAD) under a National Institute of Health Small Business Innovative Research Phase II award. These small batteries are expected to be tested by the LVAD manufacturer in 1998. The Company held discussions with potentially interested partners for either licensing or joint venture opportunities in the electric vehicle battery area but there can be no assurance that the Company will be successful in this endeavor. While the battery activity at ERC remains small relative to its fuel cell activities, the Company believes that recent developments could result in significant battery business opportunities in the future, but this is contingent on many factors, none of which can be guaranteed; including the success of partners and licensees in commercialization, the continued availability of funds, presently provided by internal research and development allowances under existing contracts and agreements, successful technical results and the ability to reach agreements with outside partners to help in marketing and manufacturing. The Company intends to expand its development activity beyond the nickel-zinc technology into related battery areas. 8 LICENSING AGREEMENTS ==================== General - ------- Fuel Cells - ---------- The Company has entered into international licensing agreements with several major corporations. Generally, the Company has reserved for itself the exclusive rights to manufacture and sell carbonate fuel cells in North America. The licensees pay annual license fees to the Company. These agreements provide that upon termination, the licensee must pay royalties to the Company in order to continue to use the Company's technology and patents during the life of those patents. ERC has benefited from its licenses and has received and generally expects to continue to receive valuable technical and manufacturing information from its licensees. By coordinating its own development program with the extensive effort of its partners, it has leveraged its own efforts substantially. The following table lists (i) the licensees of the Company's fuel cell technology, (ii) the term of each license agreement, (iii) the territory in which the technology is licensed, (iv) the technology licensed and (v) the type of license:
Term of Technology Type of License Agreement Territory Licensed License _______ _________ _________ __________ ________ Sanyo 1998 Japan, Phosphoric Exclusive Australia Acid Fuel and certain Cells Asian countries Sanyo 1998 Japan and Carbonate Non-exclusive certain Fuel Cells Asian countries Mitsubishi Automatically Japan and Carbonate Exclusive Electric extends for certain Fuel Cells (subject to Corporation one year Asian the rights (MELCO) terms unless countries of Sanyo) terminated Daimler Benz 1999, with Europe, Carbonate Exclusive affiliate MTU option to Middle Fuel Cells (subject to Friedrichshafen extend East, Africa, the rights of GmbH South America MELCO and ERC)
9 Although all the above fuel cell licenses are currently in effect, there can be no assurance that the licensees will continue their agreements with the Company. Sanyo Electric Co., Ltd. (Sanyo) - -------------------------------- ERC is a party to two license agreements with Sanyo, a large Japanese electronics manufacturer. The first agreement entered into in June 1980 covers phosphoric acid fuel cell technology and grants to Sanyo an exclusive license to utilize ERC's phosphoric acid fuel cell patents and know-how in Japan, Australia and certain other Asian countries (the "exclusive territory") and a non-exclusive license for the same purposes in all other countries of the world except for the United States. Under this agreement, ERC is to be paid royalties at a rate based on kilowatts of electrical generating capacity of phosphoric acid fuel cell systems made, used or sold by Sanyo. ERC also has been granted a royalty free license to use improvements of Sanyo relating to the phosphoric acid fuel cell subsystems. The second Sanyo Agreement entered into in October, 1986, relates to carbonate fuel cells. In this agreement, Sanyo is granted a non-exclusive license to use ERC's carbonate fuel cell technology and know-how in Japan, South Korea, China and certain other Asian countries (the "non-exclusive territory"). Under this agreement, Sanyo is obligated to pay royalties to ERC at a rate based on kilowatts of electrical generating capacity sold for carbonate fuel cell systems and ERC has been granted a non-exclusive royalty free license to all of Sanyo's carbonate fuel cell improvements. Pursuant to this agreement, Sanyo has built external reforming fuel cell stacks in varying sizes up to thirty kilowatts, and has tested these stacks with liquid fuels such as propane and kerosene. Sanyo is also testing direct fuel cells using natural gas as fuel. Activity at Sanyo decreased in 1996 and the Company does not expect to receive significant new technical information in the future. Under each of the Sanyo licenses, Sanyo has agreed to pay ERC specified yearly license fees for the right to receive further know-how of ERC. In 1988, at ERC's request and to assist ERC in its buy-out from its parent company, Sanyo prepaid the annual fees due to be paid over the lives of the agreements through 1998. This agreement expires in February 1998, unless extended by Sanyo. 10 Through 1997 ERC has received $1.68 million in license payments from Sanyo. Mitsubishi Electric Corporation (MELCO) - --------------------------------------- In November 1981, ERC and MELCO, a Japanese electronics and electric equipment manufacturer entered into a license agreement relating to carbonate fuel cell technology. This agreement is automatically extended yearly unless canceled by either party in advance. Under this agreement, MELCO is granted an exclusive license (subject to the rights of Sanyo) to utilize ERC's patents and know-how for carbonate fuel cells in Japan, South Korea, and certain other Asian countries. It is also granted a non-exclusive license in the other countries of the world, except for certain countries including the United States. ERC is granted a royalty-free license to the improvements of MELCO for carbonate fuel cells in the United States, Canada and Mexico. ERC also receives an annual license fee from MELCO and is to be paid a royalty based on kilowatts of electric generating capacity sold for carbonate fuel cells made or sold by MELCO. Technical collaboration with MELCO is good and they are pursuing the design and construction of a 200 kW power plant incorporating Direct Fuel Cell technology. Through 1997 ERC has received $1.7 million in license payments from MELCO. Daimler Benz affiliate MTU-Friedrichshafen (MTU) GmbH - ----------------------------------------------------- In 1989, the Company entered into a license agreement with DASA, a German aerospace and aircraft equipment manufacturer and a subsidiary of Daimler Benz Corporation, one of the largest industrial companies in Europe. That agreement was transferred to a subsidiary of DASA, MTU Friedrichshafen in 1993 and in 1994, MTU became a subsidiary of AEG Daimler Benz Industrie and now Daimler Benz affiliate MTU-Friedrichshafen GmbH ("MTU Agreement"). Pursuant to the terms of the MTU Agreement, ERC granted to MTU an exclusive license to use, develop and sell carbonate fuel cells in Europe, subject to certain rights of others, and a non-exclusive license in South America, the Middle East and Africa, subject to certain rights of ERC and others. MTU has agreed to conduct research, development, manufacturing and marketing programs in the area of carbonate fuel cell technology and to make available the results to the Company. In addition, MTU has agreed to pay to ERC an annual license fee through at least 1999 and a royalty based on 11 kilowatts of electrical generating capacity using carbonate fuel cells sold by MTU or its permitted licensees. Through 1997 ERC has received $1.98 million in license payments from MTU. During 1996, MTU designed and constructed an innovative balance of plant (BOP) system for cogeneration power plants. ERC's wholly owned subsidiary, Fuel Cell Manufacturing Corporation produced 300 cells for MTU in 1996 and the first quarter of 1997 and MTU conducted a hot fuel cell test in 1997 using their BOP and the ERC supplied components. Electric Power Research Institute (EPRI) - ---------------------------------------- In 1988, ERC entered into a license agreement with EPRI, granting ERC the right to use carbonate fuel cell proprietary data developed under certain EPRI contracts with ERC. ERC has agreed to pay EPRI a one-time fee of approximately $50,000 upon ERC's first commercial sale of a carbonate fuel cell stack of one Megawatt or larger in size, and a royalty upon commercial sales of carbonate fuel cell stacks. Under a recent development contract between EPRI and a subsidiary of the Company dealing with the engineering and design of the balance of plant for a full scale carbonate fuel cell power plant, EPRI has agreed to license to the subsidiary on a worldwide basis the balance of plant equipment technology developed and to provide the subsidiary with worldwide sublicensing rights. The subsidiary has agreed to pay royalties to EPRI for this license based on sales and licensing of carbonate fuel cell power plants, with the total royalties capped at twice the funding provided by EPRI under the contract. EPRI also has been granted certain rights to balance of plant equipment technology of the subsidiary. Total direct funding from EPRI through 1997 is approximately $21 million. Additionally, EPRI provided approximately $5 million to ERC's subsidiary for the Santa Clara project and a similar amount to other contractors for the coal gas testing of an ERC fuel cell in Louisiana. Santa Clara - ----------- In 1993, the Company obtained an exclusive license with rights to sublicense through the year 2005 to use the balance of plant design for the 2 MW demonstration power plant built in Santa Clara, CA. (See "Principal Development Contracts"). The license becomes non-exclusive after 2005 or earlier, at the option of Santa Clara, if the Company does not meet certain due diligence events. In addition, beginning three years after commencement of production of 12 fuel cells at a commercial scale manufacturing plant, the Company is required to make royalty payments of up to $15 per kilowatt (subject to consumer price index and other adjustments) on sales of fuel cell power plant stacks of capacities of 100 kilowatts or more. This royalty is capped at twice the funding provided by the utility participants in the Santa Clara Project. U.S. Department of Energy (DOE) - ------------------------------- In connection with certain contracts and grants from DOE, ERC has agreed to pay DOE 10% of the annual license income received from MTU, up to $500,000. Through 1997, ERC has paid to DOE a total of $200,000 (See "Principal Development Contracts"). Battery - ------- Corning, Incorporated - --------------------- An exclusive worldwide license agreement with Corning, Incorporated (Corning), was signed in the first quarter of 1997. The object of this agreement is to commercialize the Company's nickel-zinc secondary battery technology for a broad range of consumer product applications. The agreement provides that Corning will take the lead in the further development of manufacturing, marketing and sales. The agreement provides estimated expenditures by Corning over a period of time in the multi-phase development, pilot manufacturing and full scale manufacturing program. The agreement may be terminated by Corning any time prior to the commercialization of the battery, in which case the Company would receive benefits and rights to certain Corning developments and activities. The agreement required Corning to pay the Company initial license fees in 1997 and increased license fees in 1998. The agreement also requires Corning to pay royalties on sales including minimum royalties. Through fiscal 1997 ERC received $0.35 million in license payments from Corning. These payments began in April 1997. 13 COMMERCIALIZATION ================= Direct Fuel Cell - ---------------- Markets - ------- The Company believes there are five principal markets for its fuel cell power plants: (i) small municipal electric utilities and rural electric utilities, (ii) large electric utilities, (iii) landfill sites where landfill gases may be used to produce electricity, (iv) independent power producers and cogenerators and (v) gas utilities. Initially, the Company intends to target the needs of the small municipal electric utilities and rural electric cooperatives and the incremental needs of large municipal and investor-owned electric utilities and cogeneration. The vehicle being developed by the Company for approaching these markets is a nominal 2.5 MW unit currently being designed or a multiple thereof. The Company has also begun to consider a single module version (1.25 MW) of its power plant and a three module (3.75MW) in order to capture additional market opportunities. In general, the cost per kilowatt increases as the power plant becomes smaller because of increased cost of balance of plant equipment which, unlike the fuel cell itself, is size dependent. The Company anticipates that a shortage of generating capacity will begin in the 1999-2000 time frame but this view is not shared by many energy experts. The Company believes due to the efficiencies which can be achieved at fuel cell power plants as small as one or two megawatts, that these plants could provide a cost effective means for small municipal utilities to generate their own power. There are approximately 2,000 municipally or cooperatively owned public utilities in the United States representing 90,000 megawatts, or 13% of the United States electric utility market. Large utilities also are potential users of the fuel cell power plant technology. According to the U.S. Department of Energy's (DOE), Energy Information Administration (EIA) Energy Outlook 1996 report, a projected 319 gigawatts of new capacity will be needed by 2015 to meet the growing demand for electricity and to offset retirements. Approximately 81% of this new capacity is projected to be fueled by natural gas. The Company believes most of this nearly $319 billion market, estimated by the Company at approximately $1.0 billion per gigawatt, will develop in the 2002 14 to 2015 time period. According to EIA projections, the fastest growing segment of electric generator capability will be the fuel cell with an annual growth rate of 53.5% in the 1996-2015 time frame beginning in 2005. According to the Electric Power Industry Outlook 1997-2001; 252 gigawatts of new generation capacity will be needed between 1994 and 2015 to satisfy electricity demand growth and to replace retiring units. Electricity prices are projected to remain relatively stable during this period. Large utilities may be interested in the fuel cell both as an efficient, low pollution and cost effective generating system as well as a dispersed generator . Since fuel cells can be located at, or in place of, distribution and transformer stations, they may provide greater flexibility in the transmission and distribution of electricity. The modular aspects of fuel cells may also allow larger utilities to introduce phased capacity construction into their generation system. In this approach, the utilities could expand electricity generation capacity to keep pace with demand by adding blocks of fuel cells on a periodic basis as required, thereby improving cash flow as compared with building a single large plant. With larger fuel cell systems, the utility could substitute coal-derived gas, if available and economically attractive, for natural gas as the operative fuel. This flexibility of the direct fuel cell system, in terms of both its modularity and its adaptability to different fuels, may allow utilities to better control their fuel costs and avoid making a commitment 10 to 12 years in advance to construct a large power station traditionally fueled by coal. The Company is not active in the development of coal gasification facilities and would be dependent on this technology being commercialized in order to use coal as a fuel. The U.S. electric utility industry has been edging toward change for several years triggered in part by the Energy Policy Act of 1992. 1994 saw the beginning of a major upheaval caused by major moves toward direct access and deregulation by the State of California and elsewhere. As a result, a heightened atmosphere of competition exists in the industry. In 1996 and 1997, a number of significant mergers took place within the electric IOU sector and between electric and gas IOUs and between electric IOUs. Olesen, Douglas E., The Electricity Journal, Vol. 8, No. 10, December 1995, p.57 15 This competition, in an industry once secure by territorial monopolies, should result in further major reorganizations. Some utilities have already decided to phase out of the generation side of the business leaving it to independent power producers and non-utility generators. Others have merged with either other electric utilities or gas supply companies. Regardless of these options, substantial generation equipment will always be required but it is becoming more difficult to identify who the purchaser will be and the timing and magnitude of the purchases. Recent delays in the California initiative toward deregulation could cause further confusion. Legislation favorable to large utilities in California relative to stranded investment may cause expected rate reductions to disappear. At present, capacity margins in the U.S. as a whole average about 25%, but are shrinking and vary greatly from region to region. Studies conducted for the Company by outside contractors in 1996 identify the greatest market potential for its fuel cells on the east and west coasts. The Company believes the prospects of wholesale and retail wheeling together with overall uncertainty as to the future will discourage utilities from adding substantial new generation between now and the end of the century. This factor, together with tougher environmental laws already in existence, the need to relicense nuclear plants, which may not be economically feasible in some cases, and the aging of U.S. plants, could result in market opportunities at about the time the Company plans to bring its product to market. Even the wheeling of power over long distances will result in additional energy losses over the transmission lines, thus offsetting some of the gains achieved by balancing power usage and keeping pressure on capacity margins. The vulnerability of both nuclear power plants and power line transmission capacity was demonstrated by the short fall of power in certain northeast states in 1996. The nuclear power plants shut down in the northeast in 1996 did not come back on line in 1997. While the above developments should be favorable to the Company in the long term, in the short term it has become more difficult to coalesce utility groups into joint fuel cell development and demonstration projects. It is also possible that downward pressures on the cost of electricity could develop although the timing and duration of such pricing, if it occurs, is not predictable. Any downward trend in electricity prices would put pressure on all equipment suppliers. In 1997, the Company focused 16 on further defining specific opportunities for its products in this changing utility scenario. As a result of these efforts, the Company identified some attractive IPP and cogeneration market opportunities. The 1997 efforts focused on a site specific basis. Activities - ---------- ERC is continuing the transition from a development company to a commercial manufacturer of fuel cell stacks and a designer of commercial power plants utilizing fuel cells. The Company believes there is still substantial work to be done before it can commercially produce and sell its carbonate fuel cell systems and power plants. Among other things, the Company will need to significantly lower the cost per kilowatt for its carbonate fuel cell power plants to a level competitive with competing power generation systems on a cost of electricity basis and demonstrate the longevity, endurance and reliability of the carbonate fuel cells. The Company believes its commercialization program is dependent upon successful testing and completion of one or more large-scale demonstration projects in addition to the Santa Clara project. While the Santa Clara project has met with certain difficulties as discussed above, the project has been able to achieve many of its goals and new milestones. The following is a list of some of the accomplishments achieved by this project.
TABLE 1: SOME OF SCDP PROJECT ACCOMPLISHMENTS - - World's largest advanced fuel cell power - 3 percent/minute ramping capability plant by an order of magnitude demonstrated so far - - Largest carbonate fuel cell power plant - Instantaneous load shed capability operated in a grid connect utility mode - Virtually flawless balance-of-plant - - Over 4,000 hours of grid connect operation has been proved over power delivery 6,000 hours of operation - - Reached 1.93 MW AC, 7 percent higher - Valuable information on power than related power allocation among fuel cell stacks in - - Achieved 44 percent efficiency level, a the event one stack is under- record for a fossil fuel power plant of performing - the present situation this size - Insight gained into future power - - SOx below detection limits and 2 PPM Nox Plant electrical configuration emissions - - Meets IEEE Specification 519 for less than five percent overall voltage harmonics - - 2,500 Megawatt hours of AC power generated - - Meets Santa Clara 70 decibel noise specifications with no special sound proofing provisions
During 1995 and 1996, the Company, using a consultant (ERI Services, of Hartford, Connecticut), identified cogeneration markets where credits for waste heat usage could be used to reduce the cost of electricity produced. Markets in 11 states were characterized as a function of selling price from $1,000 to $3,000/kW for 2.8 MW size units for applications of less than 20 MW. The study indicated a potential market in these states of $28 billion at $1,500/kW and about $4 billion at $3,000/kW. In 1997, the Company developed and tested a model with ERI to conduct site specific analysis of cost of electricity, inputting actual user demand for heat and electricity. The Company has been working since 1990 with a group of utilities, the Fuel Cell Commercialization Group (FCCG). The purpose of the FCCG is to form a collaborative effort between the Company and a group of prospective buyers to advance the commercialization of the 1-3 MW Direct Fuel Cell power plants. The Company has been working with this group to define power plant requirements, develop system planning models, construct a model contract for power plant purchases and to review power plant designs and other activities. Most of the group's work in these areas, as anticipated and planned in 1990, was essentially finished in 1995. The group remained active in 1997 but with reduced participation. The group worked with ERC in the aforementioned model testing. The initial goal of the Company and the FCCG is to obtain orders for the first 35 power plants from utilities. Any FCCG orders will be based on final negotiations with individual utilities. At this point in time, there can be no assurance that any of the FCCG utilities or others will place any orders for the Company's fuel cell power plants. Factors affecting the utility decision to buy power plants will be based in part on the success of future demonstrations, final contract terms, the individual utility need for additional generation capacity in the 1999-2000 time frame and beyond, the cost of competitive options as well as other factors which are not known to the Company at this time. 18 A number of studies involving the Company's fuel cell power plant were conducted by FCCG members examining site specific market opportunities. These studies were generally quite positive. Studies conducted on behalf of the Los Angeles Dept. of Water and Power, Central and Southwest Services, and Oglethorpe Power Co., a municipal, investor-owned utility and cooperative, are available from EPRI. Manufacturing - ------------- The Company manufactures its fuel cells at its manufacturing facility located in Torrington, CT. It is the Company's goal to develop a fuel cell manufacturing plant able to operate at an annual rated capacity of two megawatts and a single shift. In 1996, ERC installed certain new manufacturing equipment capable of producing higher quality components at much higher rates of production. ERC shipped 300 nine square foot cells to MTU in 1996 using a combination of old and new manufacturing processes. In 1997 the Company added a fully automated cathode production line to manufacture nine square foot electrodes needed for the commercial power plants. The Company also established continuous production of its new low cost anode electrode required for commercial power plants. The Company will need to raise additional funds to expand the capacity of its manufacturing facility. The first stage in this process is to raise the output capability to 50 MW per year. Approximately $16 million has been estimated for this step. There can be no assurance that this funding will be available or if available will result in an output level which will result in a cost competitive fuel cell stack cost. Meanwhile, the Company is EPRI Report TR-100686, "Molten Carbonate Fuel Cells as Distributed-Generation Resources, Case Studies for the Los Angeles Department of Water and Power", May 1992. EPRI Report TR-102163, "Carbonate Fuel Cells and Diesels as Distributed Genaration Resources, Economic Assessment of Application Case Studies at Oglethorpe Power Corporation", October 1993. EPRI Report TR-102468, "Assessment of the Benefits of Distributed Fuel Cell Generators in the Service Areas of Central & South West Services, Inc.", October 1993. 19 using existing funds to expand production capacity incrementally. The Company believes it can raise production capability to 25 MW per year by 1999 funded by its cash flow. There can be no assurances however, that other needs for the cash will not arise. Formation of a Worldwide Network - -------------------------------- ERC, through its licenses and other agreements, is involved with major industrial companies and utilities throughout the world in its overall commercialization plans. In July 1992, ERC's licensee, MTU, formed a European consortium (ARGE) including RWE AG, the largest electric utility in Germany, Ruhrgas AG, the largest natural gas supplier in Germany, Elkraft Power Co. Ltd. (Elkraft), a large Danish utility, and Haldor Topsoe A/S, a Danish industrial company. The stated intent of the consortium is to spend approximately 130 million Deutsche Marks ($90 million), over a nine year period on further development, demonstration and commercialization of the Company's carbonate fuel cell technology. Certain individual members of the consortium, including MTU, Elkraft and Haldor Topsoe A/S, have conducted carbonate fuel cell activities on their own utilizing the Company's technology. The activities of this group complements ERC's efforts to design and manufacture natural gas and coal gas fueled carbonate fuel cell systems based on ERC designs. MTU is an active technical partner and licensee in the European market. For the time being, MTU buys its fuel cells from ERC but is designing its own 300 kW fuel cell base module for the local market. Similarly in Japan, MELCO is working to further develop carbonate fuel cells. MELCO is developing a 200 kW power plant based on the Direct Fuel Cell. Sanyo Electric Company has tested 10 kW and 30 kW systems based on ERC technology but there was no new activity by Sanyo in 1996 or 1997. Batteries - --------- See LICENSE AGREEMENTS - Corning, Incorporated and PRINCIPAL DEVELOPMENT CONTRACTS - Batteries. 20 PRINCIPAL DEVELOPMENT CONTRACTS =============================== Fuel Cells - ---------- General Sponsors - ---------------- The Company has been working on the development of its Direct Fuel Cell technology under contracts since 1977, with various United States Government agencies including, among others, the Department of Energy (DOE), the Department of Defense, the Defense Advanced Research Projects Agency (DARPA), and the National Aeronautics and Space Administration (NASA). There can be no assurance, however, that government funded research and development appropriations will continue or that future contracts will be forthcoming. The Company currently receives its government funding primarily under a long-term Cooperative Agreement with the Department of Energy. This agreement covers a 5 year project which commenced in the first fiscal quarter of 1995 and had an estimated value of $78 million (DOE share). In 1996, the Company received additional funding thru DARPA raising the contract value to $84 million. An additional $2.1 million of DARPA funding was received in 1997, raising the contract value to $86 million. Additional funding is being provided by the Company and its partners. Approximately 60% of the non-DOE portion has been committed or credited to the project in the form of in-kind or direct cost share from non-U.S. government sources. The balance of funding will be sought when needed but there can be no assurance that the final 40% of the private sector funding will be available. The agreement covers the design, scale up, construction and testing of direct carbonate fuel cells operating on natural gas in the 300 kilowatt size range as well as providing funds for megawatt size demonstration of a compact commercial prototype power plant. The award of the above contract was almost one year later than previously anticipated due to extended deliberations with DOE. As a result of this delay and other factors (see INTRODUCTION - Fuel Cells), the Company reassessed its commercialization time table. It is likely that the commercialization will be delayed until 2001 since it is paced to a large extent by the timing and availability of outside funding as well as technical achievements. 21 Santa Clara Demonstration Project - --------------------------------- An important step in the commercialization of new technology for the electric utility industry and others is a demonstration at a utility site. The Company entered into an agreement with the City of Santa Clara and a group of California based and other utilities to design, construct and operate a nominal two megawatt demonstration (1.8 MW) of its direct carbonate fuel cell power plant at a site owned by the City of Santa Clara, California, under the auspices of its municipal electric system (the Santa Clara Demonstration Project [SCDP]). The SCDP consists of a group of utilities (see INTRODUCTION - Fuel Cell), the Department of Energy and EPRI. The Company is required to pay certain license fees relating to the balance of the plant design for the Project as described under "Santa Clara License Agreement". Funding for the Santa Clara Demonstration Project was staged based upon achieving certain milestones, all of which were met. The contract with the utilities was completed as budgeted in 1993. ERC is proud of this achievement since this was the first of a kind demonstration of a new technology on a commercial scale. The Company is seeking to continue operation of the Santa Clara facility by supplying it's commercial fuel cell modules to the city and use the existing balance of plant. Other SCDP participants have agreed to this. The Company is in discussion with the city but there can be no assurance a definitive contract will be reached. Other Activities - ---------------- During fiscal 1995, 1996 and 1997, 100% of the Company's research and development was funded by customers, including approximately $0.94, $1.26 and $1.27 million, respectively, of discretionary independent research and development expense. The Government funding provided approximately 72%, 76% and 94% of revenues in fiscal 1995, 1996 and 1997, respectively. United States Government funding largely was provided by DOE. Because the Company receives a significant portion of its revenues from contracts and subcontracts with the Department of Energy and other government agencies, future revenues and income of the Company could be materially affected by changes in procurement or appropriation policies, a reduction in expenditures for the services provided by 22 the Company, and other risks generally associated with government contracts and cooperative agreements. The Company performs its services under contracts or agreements that usually require performance over a period of one to five years, however congressional budget limits could result in longer terms. In general, the Company's contracts or agreements may be terminated, in whole or in part, at the convenience of the Government. If a termination for convenience occurs involving a cost reimbursement type contract, the Government is generally obligated to pay the cost incurred by the Company under the contract up to the date of termination and the limit of the contract funding plus a pro rata fee based upon the work completed. Virtually all U.S. government contracts are funded annually based on administrative recommendations and congressional appropriations and there can be no assurance that funding beyond the first year of any contract will be available. Funding can also be affected by delays in the passage of Appropriations Bills by Congress, which happened in 1996. ERC has received approximately $18.7 million in 1997 funding from DOE, of which approximately $1.8 million was assigned to the SCDP Cooperative Agreement. There can be no assurance that some of this funding will not be subject to recision. The Congress reduced the DOE Fossil Energy fuel cell budget for 1998 by about 15%. ERC's 1998 allocation to date is $12.9 million and there can be no assurance additional funds will become available. Most of the Company's contracts have been performed under cost reimbursement contracts and, to a lesser extent, time-and-materials contracts and fixed price contracts. Cost reimbursement contracts provide for reimbursement of costs (to the extent allowable under federal regulations up to the funded limit set by the contract) and for payment of a fee. The Company has also entered into cost shared contracts with the Government pursuant to which it receives no fees but does receive a cost of money allowance. Since the Government does not allow interest costs, most of these contracts produce a net loss. At present, most DOE contracts involve cost sharing and no fees are recovered. Substantially, all Government contract revenues for the year ended October 31, 1997 were from cost reimbursement contracts or cost-shared agreements. Since 1981, the Company has received approximately $21 million of funding directly or indirectly from EPRI, a non-profit institute established in 1972 by the nation's utilities to develop and manage technology programs, for its carbonate fuel cell development. EPRI 23 is a major participant funding the SCDP. No new funds are anticipated from EPRI at this time. In addition to the activities listed above, the Company was active in soliciting other business from industry and government organizations. A $4.7 million Defense Advanced Research Projects Agency (DARPA) contract to demonstrate liquid fuels in the Company's fuel cell was awarded to ERC in the first quarter of 1994 and was completed in 1996. This contract was administered by NASA. Additional DARPA funding for fiscal 1994 and 1995 in the amount of $8.2 million was appropriated and earmarked for direct fuel cell work. This funding was directed through DOE and is part of the new Cooperative Agreement with DOE. An additional DARPA $2.1 million funding was available for this project in 1997. Approximately $1.6 million of Navy funds has been provided in the 1997 budget for the study of carbonate fuel cells for naval applications. The Company was awarded a contract for this work on a competitive basis at the end of the fiscal year and work will commence in 1998. During the fiscal year 1996 and first quarter of 1997, the Company produced and shipped approximately $1.5 million of DFC parts to its licensee, MTU and expects to receive further orders in 1998. Also, the Company was active under several Phase I & Phase II Small Business Innovative Research grants in the battery and fuel cell area which are fee bearing contracts. The Company received one new Phase I SBIR in 1997. Batteries - --------- While the Company's battery division currently accounts for only about one percent of the Company's total revenues, the Company believes that its nickel batteries, particularly nickel-zinc currently under development, represent a potential source of future revenue for the Company. ERC has developed a plastic-bonded electrode process technology for use in its nickel-zinc and nickel-cadmium batteries which should permit the construction of batteries that are lighter in weight and lower in cost than conventional batteries currently available. Use of the Company's proprietary process in this construction of nickel-zinc batteries has the additional advantage of having very low environmental impact compared to lead-acid or conventional nickel-cadmium batteries. The prospect of stricter environmental legislation relating to the manufacture, disposal and recycling of batteries containing large amounts of lead or cadmium, both of which are hazardous and toxic, if enacted, could enhance the attractiveness of the Company's 24 nickel-zinc battery. The Company's nickel-zinc batteries can now be recharged up to 600 times. In 1996, the Company successfully duplicated the extended testing in multicell 15 ampere batteries. Also in 1996, the Company began testing of a full size hybrid electric vehicle battery at a potential users site. In 1997, the Company extended testing to 700 cycles in single cells and has designed and ordered tooling for a 30 ampere hour cell for use in electric vehicles. Approximately 69% of the Company's discretionary internal research and development funding, which it receives under its government contracts, was used in further nickel-zinc battery development during the 1997 fiscal year. The Company believes that its batteries represent technological advances over certain existing commercial batteries and is exploring potential worldwide market opportunities for its battery technology. Due to its limited resources and its decision to focus its commercialization efforts in the area of carbonate fuel cell technology, the Company does not presently intend to build a manufacturing facility for the commercial production and sale of its battery products but may take steps to increase production of EV prototype batteries. During 1997, ERC held discussions with several organizations and corporations in China, Europe and the U.S. regarding cooperating on nickel-zinc and related batteries. In the first quarter of 1997, the Company reached an agreement to license its nickel-zinc battery technology to Corning, Inc. for a broad range of applications on an exclusive worldwide basis (see License Agreements). The Company intends to continue to seek nickel-zinc battery business opportunities and partners in the field of electric and hybrid electric vehicles as well as battery opportunities using its technology for non-nickel zinc batteries, but there can be no assurance that it will be successful in these activities. INTELLECTUAL PROPERTY MATTERS ============================= The Company seeks to protect its technology through U.S. patents and trade secrets and other agreements. Many of these patents are also filed in South America, Canada, Europe and Japan. The Company has received 2 new fuel cell and 1 new battery U.S. patents in fiscal year 1997. Also the Company applied for 1 battery patent in fiscal year 1997. 25 Many of the United States patents were the result of government-funded research programs. The Government does not impose significant restrictions on the Company's use of government-sponsored patents, except that military and national security applications of technology remain the property of the United States Government. Patents of ERC that were the result of government-funded research prior to January, 1988 (the date the Company qualified as a small business under applicable government regulations) belong to the Government unless the Government waives its rights to these patents. In most cases, what the Company has obtained is owned by the United States Government. The Company has received a license to use these patents, which is revocable only in the limited circumstances where it has been demonstrated that the Company is not making an effort to commercialize the invention. Patents resulting from government-funded research after January 1988 automatically belong to ERC because of its small business status. In both instances, however, the Government retains a royalty free right to use the patents for government purposes and "march-in" rights with respect to the patents. March-in rights allow the Government to take title to the patents and to license the patented technology to others if the Government believes that the Company is not utilizing the patents. A number of the Company's patents are subject to march-in rights. The Company believes, however, that the likelihood of the Government exercising these rights is very small and would only occur if the Company ceased its commercialization efforts. The Company's patents will expire during the period from 1998 through 2017. The Company does not believe that the expiration of any of its earlier patents will have a material adverse effect on the Company's business. There can be no assurance that the issued patents or the licensing rights of the Company will fully, or even partially, protect the Company's technology from competitors' approaches, or that new patent applications will be allowed. There can be no assurance that the Company would be successful if any challenges are made by the Company to the patents of other parties or that other parties will not be successful in asserting infringement claims against the Company. Further, because of the intense competition in fuel cell and battery technology and the large number of patents filed, or being filed, no assurance can be given that the Company will not 26 need another Company's patent under a license agreement, if such an agreement could be reached or what the terms of that agreement might be. Any determination that the Company's products or manufacturing processes have infringed on the product or process rights held by others could have a material adverse effect on the Company's business and results of operation. Additionally, adverse determinations could result in the Company's loss of proprietary rights, subject the Company to liability to third parties or prevent the Company from manufacturing or selling its products, any of which could have a material negative effect on the Company's business and hinder the Company's commercialization initiatives. The Company has not filed for patent protection in certain potential major markets such as India, China and Southeast Asia. Agreements reached with partners in these areas would have to be based on trade secrets and know-how. In the future, the Company may seek patent protection in those areas. The Company also relies on know-how and trade secrets to establish its fuel cell and battery technologies for commercial applications and there is no assurance it can adequately protect this information in its dealings with other entities. There can be no assurance that other organizations will not develop similar or better information through their own efforts. COMPETITION =========== Fuel Cells - ---------- Although a number of domestic and foreign companies are engaged in the development of fuel cells, the Company knows of no other company that has developed a direct carbonate fuel cell, other than its licensees, although others are probably working to do so. The Company believes that its direct carbonate fuel cell could provide it with a significant competitive advantage. This is a forward looking statement contingent on completing commercialization activities and could be impacted by funding availability and the ability of the Company to reduce fuel cell power plant costs, while increasing power plant life and endurance. The Company knows of four major companies in the United States which are involved in significant fuel cell development and at least one, M-C Power Corporation, of these companies competes directly with ERC in the development of carbonate fuel cells but uses a different technical 27 approach. There is one company in Canada developing a low temperature fuel cell. In Japan there are at least six major companies developing fuel cells (two of which are licensees of the Company) and all are engaged in carbonate fuel cell development. In 1994, two major Japanese companies and potential competitors of ERC demonstrated the extended operation of 100 kW size carbonate fuel cells of the indirect type and continued their efforts in 1996 with the goal to have a 1 MW size plant on test in 1999. This plant is budgeted to cost approximately six times per kilowatt the cost of the Company's power plant in Santa Clara. Some of these companies already produce other types of electric generation equipment and have extensive marketing and sales departments. All of the companies in Japan operating in this field are very large compared to ERC. In Europe, companies in Germany, Holland, Spain and Italy are actively engaged in carbonate fuel cell development and are potential competitors, although these efforts are not as well advanced as the progress of the United States and Japanese companies. The German activity through ERC's licensee MTU and its partners is by far the largest effort. Almost all of these companies are also significantly larger than the Company, possess greater financial resources and have established product lines in electric generation equipment and in other fields. ERC fuel cell products must also compete with more established rotating machinery equipment, including various engines and turbines, which are currently in use and have established operating and cost features. The greatest competition comes from the gas turbine industry which recently has made good progress in improving fuel efficiency and reducing pollution in large size combined cycle natural gas fueled generators. Efforts are underway to extend these advantages to small size machines. The Company believes that in the small size units, under 5 MW, that gas turbines will not be able to match its fuel cell efficiency or environmental characteristics but there can be no assurance that the Company will be able to compete with small gas turbines even if these machines have less desirable operating characteristics. Once the Company has developed commercial products, it expects to encounter competition from various sources, including companies that may have substantially greater technical, marketing and financial resources than the Company. 28 Batteries - --------- The Company does not have much competition in the nickel-zinc area as no competitor is known to have achieved the equivalent cycle life results. In Japan, one major battery company is pursuing nickel-zinc technology and several smaller companies are pursuing the technology in Europe. In Korea, Samsung is pursuing NiZn for electric vehicle applications. Severe competition comes from the entrenched nickel cadmium and nickel metal hydride battery companies who have large volume production capabilities and the associated production cost advantages. Recently some companies have begun marketing a rechargeable zinc manganese oxide battery which is less expensive than the projections for the Company's nickel-zinc battery. At present, cycle life of this battery is limited to about 20 cycles with considerable degradation. There can be no assurance however, that the cycle life of this battery will not be further improved. A barrier to market entry exists because OEM's are reluctant to try new battery technologies in their products that have not been extensively tested or that have different voltage characteristics. SOURCES AND AVAILABILITY OF RAW MATERIALS ========================================= The Company believes that virtually all of the raw materials used in its products are readily available from a variety of vendors in the United States and Canada. However, certain manufacturing processes which are necessary to transform the raw materials into component parts for fuel cells are presently available only through a small number of foreign manufacturers. The Company believes that these manufactured products eventually will be obtainable from the United States suppliers as demand for these items increases. GOVERNMENT REGULATIONS ====================== The Company presently is, and its fuel cell power plants will be, subject to various federal, state and local laws and regulations relating to, among other things, land use, safe working conditions, handling and disposal of hazardous and potentially hazardous 29 substances and emissions of pollutants into the atmosphere. To date, the Company believes that it has obtained all necessary government permits and has been in substantial compliance with all of these applicable laws and regulations. There can be no assurance, however, that the Company will continue to obtain all required permits and will continue to be in compliance with presently applicable regulations and/or will be able to comply with any future regulations. Pursuant to the National Environmental Protection Act (NEPA), since 1991, each local Department of Energy procurement office must file and have approved by the Department of Energy in Washington, DC, appropriate documentation for environmental, safety and health impacts with respect to procurement contracts entered into by that local office. The costs associated with compliance with environmental regulations are generally recoverable under the Company's cost reimbursable contracts. In certain cases, contract work may be delayed until the approval is received. In the first quarter of 1997, DOE's Federal Energy Technology Center (formerly Morgantown Energy Technology Center)received NEPA approval for ERC's east coast demonstration at the Company's site in Danbury. ORGANIZATION ============ ORGANIZATION STRUCTURE - ---------------------- In 1998, the Company, in order to streamline its focus on commercialization of its technologies, split into three core groups under the corporate banner of E R C. These groups are the Advanced Technology Group, the Fuel Cell Group and the Battery Group. While the groups are separate, they are interdependent; all founded on the Company's core competence in electrochemical technology. The Company's subsidiaries, Fuel Cell Manufacturing Corporation and Fuel Cell Engineering Corporation are within the Fuel Cell Group, and are being phased out over time, as the need for these subsidiaries has passed. The Advanced Technology Group concentrates its efforts on research and development of electrochemical technologies, including securing and executing both Government and industry research & development contracts. In effect, the Advanced Technology Group is the 30 historical business of the Company. The Fuel Cell Group is the product group for the Company's Direct Fuel Cell. It consists of product development, engineering, project management, manufacturing and eventually, sales and marketing. The Battery Group is similar to the Fuel Cell Group, although currently not as large. It includes its own research and development, as well as product development and engineering. The business development function reports to the Company and continues to provide support for both Advanced Technology Group and Fuel Cells Group. Corporate staff functions such as finance and accounting, personnel will continue to report to the Company corporate and provide services for the three operating groups. Also in 1998, the Company changed its corporate image with a new signature. EMPLOYEES - --------- As of December 31, 1997, the Company had 149 full-time employees, of which approximately 67 were engineers, scientists, and other degreed professionals and 82 were professional, technical, administrative and manufacturing support personnel. The Company considers relations with its employees to be good. The loss of key employees could cause delays in completing contracted work and development and commercialization activities. EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------ In August, 1997, the Company appointed Jerry D. Leitman as President and Chief Executive Officer, as well as a Director, replacing Dr. Bernard Baker, who was appointed non-executive chairman of the Board and has continued to be employed on a part time basis. The executive officers of the Company are as follows:
NAME AGE POSITION WITH THE COMPANY ---- --- ------------------------- Jerry D. Leitman 55 President and Chief Executive Officer and (After Aug 1, 1997) Director Dr. Hansraj C. Maru 52 Executive Vice President, Chief Operating Officer and Director Christopher R. Bentley 54 Executive Vice President, Director and President of Fuel Cell Manufacturing Corp. Louis P. Barth 53 Senior Vice President, Chief Financial Officer, Treasurer & Corporate Secretary
31 Jerry D. Leitman was previously President of ABB Asea Brown Boveri's global air pollution control businesses from 1992 to 1995. Prior to ABB Mr. Leitman was Group Executive Vice President of FLAKT AB, a Swedish multinational, responsible for FLAKT s worldwide industrial businesses from 1989 to 1992. Mr. Leitman has both a BS & MS in Mechanical Engineering from Georgia Institute of Technology 1965 & 1967 respectively. Dr. Hansraj C. Maru has been Executive Vice President, Chief Operating Officer and director since December, 1992. Prior to that he was Senior Vice President-Research and Development. Dr. Maru joined the Company in 1977. Dr. Maru received a Ph.D. in Chemical Engineering from the Illinois Institute of Technology in 1975. Christopher R. Bentley has been a director since June, 1993. Mr. Bentley has been Executive Vice President of ERC and President of the Company's manufacturing subsidiary since September, 1990. From 1985 through 1989 he was Director of Manufacturing (1985), Vice President and General Manager (1985-1988) and President (1988-1989) of the Turbine Airfoils Division of Chromalloy Gas Turbine Corporation, a major manufacturer of gas turbine hardware. Louis P. Barth has been Senior Vice President since December, 1993, the Chief Financial Officer of ERC since 1981 and the Treasurer and Corporate Secretary since 1988. From 1985 to 1993, Mr. Barth was the Vice President-Finance. He joined ERC in 1976 as Controller. ITEM 2. PROPERTIES The Company currently owns and occupies approximately 72,000 square feet in two interconnected single story buildings on 10.8 acres, of which approximately 5.4 acres are currently used, in Danbury, Connecticut. For specific information with respect to the mortgage on the Danbury, CT facility, see Note 6 to consolidated financial statements long term debt. Additionally, ERC has leased a 63,000 square foot facility in Torrington, Connecticut for its manufacturing operations. The lease expires February 1, 2001. The annual lease cost of the Torrington facility is approximately $300,108. The Company believes that its facilities are adequate for its current operations, with approximately 85-90% utilization of the Danbury and Torrington facilities. 32 ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of securities holders during the fourth quarter of the fiscal year covered in this report. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock (Common Stock), par value $.0001, has been publicly traded since June 25, 1992. From September 21, 1994 - February 25, 1997 the Common Stock traded on The Nasdaq Stock Market (NASDAQ) and since February 26, 1997 the Common Stock has traded on the American Stock Exchange (AMEX). The following table sets forth the range of high and low prices of the Common Stock on the AMEX and NASDAQ for the fiscal quarters indicated, as reported by AMEX and the NASDAQ.
COMMON STOCK - ------------ Year Ended 10/31/97 High Low - ------------------- ------ ------ First Quarter $15.625 $ 9.750 Second Quarter 13.000 9.375 Third Quarter 10.750 8.500 Fourth Quarter 20.500 9.375 Year Ended 10/31/96 HIGH LOW - ------------------- ------ ------ First Quarter $12.250 $10.250 Second Quarter 14.375 9.500 Third Quarter 22.250 11.500 Fourth Quarter 15.750 11.250
The Company has never paid any dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently anticipates retaining all available earnings for the growth and expansion of the Company's business. 33 Under the terms of the Company's Loan Agreement with First Union Bank of Connecticut, the Company may not without the written consent of First Union Bank declare or pay any dividend. On January 22, 1997 there were approximately 1,694 common stockholders of record. Recent Sales of Unregistered Securities - --------------------------------------- On May 3, 1996, the Company issued 22,667 shares of its Common Stock to James Gerson, a Director of the Company, upon the exercise by Mr. Gerson of Warrants issued by the Company to him on July 2, 1992 in connection with the Company's initial public offering. The shares were acquired for an aggregate purchase price of $244,803.60. On December 14, 1995 and on October 31, 1996, the Company issued 24,000 and 73,397 shares, respectively, of its Common Stock to MTU upon the conversion by MTU of certain Promissory Notes of the Company. The principal amount of $216,000 and $450,000 plus $210,573 in accrued interest, were converted in the transactions. 34 With regard to the foregoing transactions, the Company relied upon Section 4(2) of the Act, as an exemption from the registration requirements of the Act. No commissions were paid to any underwriter in connection with the securities issued in any of the foregoing transactions. ITEM 6. SELECTED FINANCIAL DATA The selected financial data presented below as of the end of each of the years in the five-year period ended October 31, 1996 have been derived from the consolidated financial statements of Energy Research Corporation.
STATEMENT OF OPERATIONS DATA (in thousands, except share and per share data) 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- Net Sales $24,830 $29,446 $33,955 $30,084 $22,211 Gross Profit 9,188 8,551 7,696 8,020 7,948 Operating Expenses: Administrative & Selling 6,081 4,858 4,513 4,730 4,657 Depreciation 1,768 1,919 1,801 1,663 1,645 Research & Development 1,270 1,260 944 1,348 1,148 Operating income 69 514 438 279 498 Interest & other income, net 307 442 317 148 174 Interest expense (354) (503) (459) (435) (490) License fee income net 650 357 357 364 356 Income before income taxes 672 810 653 356 538 Income tax expense 247 301 211 136 197 Net Income $ 425 $ 509 $ 442 $ 220 $ 341 Net income per share (primary & fully diluted) $ .10 $ .13 $ .11 $ .06 $ .09 Number of shares used in per share calculation 4,207,144 4,063,061 3,972,281 3,939,925 3,895,667 BALANCE SHEET DATA Working capital 6,366 8,087 8,216 7,619 8,545 Total assets 21,433 23,540 23,847 22,515 20,930 Long-term debt 2,699 4,363 6,487 5,839 6,237 Total shareholders' equity 14,769 14,062 12,238 11,685 10,206
35 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION OVERVIEW - -------- The Company obtains nearly all of its revenues from government and commercially-funded research, development and demonstration contracts or cooperative agreements. United States Government contracts, which represent the bulk of these contracts, are generally multi-year, cost reimbursement type contracts. Their continuation is dependent upon the government's continued allocation of funds. Under a cost-reimbursement contract, the Company is reimbursed for reasonable and allocable costs of the materials, subcontracts, direct labor, overhead, general and administrative expenses, independent research and development costs and bid and proposal preparation costs, provided the total of such costs do not exceed the reimbursement limits set by the contract. In addition, some of these contracts bear a fixed fee or profit. The profitability of these contracts to the Company depends upon limiting nonreimbursable expenses, charging direct costs to contracts, maintaining adequate control of overhead costs and general and administrative expenses so they do not exceed the approved billing rates, and limiting the aggregate reimbursable costs to the allowable amounts set by the contract. In addition to cost reimbursement contracts, the Company enters into firm fixed price contracts and cost sharing type contracts. In performance of a firm fixed price contract, the Company is paid the price that is set in advance without regard to the costs actually incurred in performance, subject to certain excess profit limitations. In a cost sharing type contract, the Company agrees in advance to contribute or cause to be contributed an agreed upon amount of effort or costs toward fulfilling the objective of the contract. Except for the Company's cost contributions, the contract operates in substantially the same manner as a cost reimbursement type contract. At present, most of ERC's contracts and cooperative agreements are cost shared and no fee or profit is allowed. The contracts and agreements do provide for a cost-of-money recovery tied to U.S. Treasury rates. Since 1983, when the Company began to shift its emphasis from fuel cells for military use to commercial applications, the Company's 36 primary development focus has been on carbonate fuel cells and the funding it has received in every year for the fuel cells has represented a substantial portion of the Company's revenues. In 1989, the Company took the first step toward commercialization of the carbonate fuel cell technology by selling Common Stock to, and obtaining financing from MTU. The equity and loan proceeds, together with funds obtained from a commercial loan, were used to establish the carbonate fuel cell stack manufacturing operation, Fuel Cell Manufacturing Corporation, a wholly-owned subsidiary. In 1991, the Company established a wholly-owned engineering and marketing subsidiary, Fuel Cell Engineering Corporation to design, market and build fuel cell power plants. In 1993, the Company entered into the first two-megawatt carbonate fuel cell power plant demonstration contract, which began operating in April 1996 and terminated operations about one year later. The Company will continue to seek research and development contracts for all its product lines. To continue to obtain funding for these contracts, the Company must continue to prove the benefits of its technologies and be successful in its competitive bidding. Failure to obtain these contracts could have an adverse effect upon the Company. Because the Company receives a significant portion of its revenues from contracts and subcontracts with the Department of Energy and other government agencies, future revenues and income of the Company could be materially affected by changes in procurement policies, a reduction in expenditures for the services provided by the Company, and other risks generally associated with government contracts. In general, the Company's government contracts may be terminated, in whole or in part, at the convenience of the government. A reduction or delay in the Company's government funding could have a material adverse effect on the Company's ability to commercialize its fuel cell technology. During 1997, the funding received for its major cooperative agreement was less than the contracted amount due to a DOE budget shortfall. The Company adjusted its expenditures to the lower funding rates as it did in 1996. This caused delays in the work being done under existing contracts which inevitably cause delays in the Company's activities and commercialization schedule. 37 In 1997, the Company was allocated approximately $16,500,000, of which $15,000,000 is for the main Product Improvement Cooperative Agreement and $1,500,000 for the Santa Clara Demonstration Project Cooperative Agreement. The Company was allocated approximately $6,000,000 from the Defense Advanced Research Projects Agency (DARPA) in September 1996 which was added to the U.S. Department of Energy (DOE) Cooperative Agreement, raising its value to $84 million. In 1997, an additional $2 million in DARPA funds were added to the contract. In the 1998 budget $12.8 million has been allocated to the Company's DOE fuel cell cooperative agreement which, together with carryover funds from 1997 and other funding services, are expected to bring 1998 funding to a level similar to 1997. RESULTS OF OPERATIONS - --------------------- 1997 compared to 1996. Revenues decreased 16% to $24,830,000 in the 1997 period from $29,446,000 in the 1996 period. The expected decrease in revenues was due primarily to the completion of the two- megawatt Direct Fuel Cell power plant project in Santa Clara, California. The decrease was partially offset by an increase in billings under the Company's other contracts. Cost of revenues decreased 25% to $15,642,000 in the 1997 period from $20,895,000 in the 1996 period. The decrease was due primarily to the completion of the two- megawatt Direct Fuel Cell power plant project mentioned above. Administrative and selling expense increased 25% to $6,081,000 in the 1997 period from $4,858,000 in the 1996 period. The 1997 period reflects an increase in various expenses including bid and proposal activity, employment costs, amortization and legal and professional fees. Depreciation decreased 8% to $1,768,000 in the 1997 period from $1,919,000 in the 1996 period. The decrease was due substantially to completion of the amortization of costs associated with the manufacturing facility. Research and development expense was relatively unchanged at $1,270,000 in the 1997 period and $1,260,000 in the 1996 period. Income from operations decreased 87% to $69,000 in the 1997 period from $514,000 in the 1996 period. The decrease was due primarily to the recovery of non-recurring costs associated with certain Company contracts in the 1996 period and the incurrence of certain non- 38 recoverable employment related costs due to the hiring of a new chief executive officer in the 1997 period. The remainder of the decrease was due to the decrease in the revenues mentioned above. Income from operations in the 1998 period will be reduced by certain non-recoverable employment costs. License fee income, net, increased 82% to $650,000 in the 1997 period from $357,000 in the 1996 period. The increase was primarily due to the recognition of license income under the Company's battery license with Corning, Inc. Interest expense decreased 30% to $354,000 in the 1997 period from $503,000 in the 1996 period. The decrease was due primarily to the reduction of debt to MTU Friedrichshafen GmbH (MTU) as a result of conversion of $666,000 of principal at $9 per share into common stock of the Company in fiscal 1996 and the repayment of $684,000 of principal during the first quarter of fiscal 1997. The decrease was also due to the Company refinancing its bank debt at more favorable terms during the third quarter of fiscal 1996. Interest and other income, net, decreased 31% to $307,000 in the 1997 period from $442,000 in the 1996 period. The decrease was primarily due to the use of cash for debt repayment during the first quarter of fiscal 1997. 1996 Compared to 1995. Revenues decreased 13% to $29,446,000 in the 1996 period from $33,955,000 in the 1995 period. The decrease in revenues was due primarily to the completion of the manufacture of the fuel cell modules, the completion of construction of the commercial scale two-megawatt direct fuel cell power plant in Santa Clara, California and reduced activity due to the uncertainty of Government funding due to delays in passage of the 1996 Federal budget. The expected decrease in revenues was partially offset by an increase in billing under the Company's other contracts. Cost of revenues decreased 20% to $20,895,000 in the 1996 period from $26,259,000 in the 1995 period. The decrease was due primarily to the completion of the manufacture of the fuel cell modules and the completion of construction of the direct fuel cell power plant mentioned above. 39 Administrative and selling expense increased 8% to $4,858,000 in the 1996 period from $4,513,000 in the 1995 period. The 1996 period reflects an increase in various expenses. Depreciation increased 7% to $1,919,000 in the 1996 period from $1,801,000 in the 1995 period. The increase was due primarily to assets placed in service at the Company's manufacturing facility. Research and development expenses increased 33% to $1,260,000 in the 1996 period from $944,000 in the 1995 period. The increase was due primarily to carbonate fuel cell and battery development activities. Income from operations increased 17% to $514,000 in the 1996 period from $438,000 in the 1995 period. The increase was primarily due to the non-recurring recovery of costs associated with certain foreign patents. License fee income, net, was unchanged at $357,000 in the 1996 period compared to the 1995 period. Interest expense increased 10% to $503,000 in the 1996 period from $459,000 in the 1995 period. The increase was due to the full utilization of the MetLife Capital credit facility. The increase was partially offset by the capitalization of interest for assets under construction and a reduction in the interest rate on existing debt. Interest and other income, net, increased 39% to $442,000 in the 1996 period from $317,000 in the 1995 period. The increase was due primarily to increased interest income. The interest income increased due to the availability of additional cash from working capital resulting from a more favorable payment procedure under the Company's cooperative agreements. Liquidity and Capital Resources - ------------------------------- The Company has funded its operations primarily through cash generated from operations including government contracts and cooperative agreements, borrowings and sales of equity securities. At October 31, 1997, the Company had working capital of $6,366,000 including $6,802,000 of cash and cash equivalents, compared to working capital of $8,087,000 including $7,597,000 of cash and cash equivalents and $1,956,000 of marketable securities at October 31, 1996. The Company decreased its investment in marketable securities 40 by $1,956,000 to acquire machinery and equipment for the manufacturing subsidiary. The Company discontinued its $1,000,000 line of credit during 1996 because it was unnecessary with the favorable payment procedures associated with the cooperative agreements. During fiscal 1997, $2,252,000 of cash was provided by the Company's operating activities. During the 1997 period, accounts receivable was relatively unchanged at $2,828,000. Net cash from operating activities also included the Company's net income of $425,000 and depreciation and amortization of $2,162,000. During the 1997 period, accounts payable decreased $367,000 primarily due to the completion of the two megawatt Direct Fuel Cell power plant project. The Company's capital expenditures are incurred primarily to support ongoing contracts and to replace existing equipment. Capital expenditures for the fiscal 1997 period were $2,801,000. A portion of these expenditures was financed from the recovery of depreciation expense under cost-reimbursement contracts and cooperative agreements. During the 1995 period, the Company entered into a $2,500,000 credit facility with MetLife Capital Corporation, an affiliate of Metropolitan Life Insurance Company. The credit facility bears interest at the 30-day commercial paper rate plus 2.5 percent. The Company used the credit facility during 1995 and 1996 to acquire machinery and equipment for the Company's manufacturing facility in Torrington, Connecticut. Repayment of the credit facility commenced during the 1996 period and provides for repayment over 36-50 months. During the 1996 period, the Company entered into more favorable lending arrangements with First Union Bank of Connecticut, a subsidiary of First Union Corporation, which provide for (i) a $2,250,000 five-year term loan facility, which bears interest at a floating rate equal to 1.75 percent above London Interbank Offered Rates (LIBOR), and (ii) a $600,000 term loan facility to the Company's fuel cell manufacturing subsidiary, which bears interest at a floating rate equal to 1.75 percent above LIBOR. In fiscal year 1990, the Company borrowed $1,980,000 from MTU at a rate of 6% per annum. The payment of principal and interest was deferred until November 30, 1996. The indebtedness, including deferred interest, as of October 31, 1996 was $1,926,000. This 41 loan was secured by the pledge of FCMC stock and certain machinery, equipment and leasehold improvements at the Torrington, CT, facility. The accrued interest on the loan was payable at the Company's option. The principal amount of the loan could be converted at MTU's option, into the Company's common stock at a conversion rate of $9 per share prior to November 30, 1996. During fiscal 1996, $877,000 of this loan was converted into 97,397 shares of common stock of the Company. MTU extended the maturity of $630,000 of the loan to November 30, 1997 with the right to convert to common stock at $9 per share. During December 1996, the Company paid to MTU $1,296,000 of principal and interest. During December, 1997 the Company paid the entire balance of principal and interest due in the amount of $673,000. In December 1994, the Company entered into a $136,000,000 Cooperative Agreement with the U.S. Department of Energy (DOE) that provided that the DOE would provide $78,000,000 to the Company over the next five years to support the continued development and improvement of the Company's commercial product. The balance of the funding is expected to be provided by the Company, the Company's partners or licensees, other private agencies and utilities. Approximately 60% of the non-DOE portion has been committed or credited to the project in the form of in-kind or direct cost share from non-U.S. government sources. There can be no assurance that the final 40% of the private sector funding will be available on favorable terms, if at all. Failure of the Company to obtain the required funding could result in a delay or reduction of DOE funding. The Company will need to raise additional funds to expand its Direct Fuel Cell Manufacturing capability. The first stage in this process is to raise the output capability to 50 MW per year. Approximately $16 million has been estimated for this step. There can be no assurance that this funding will be available or if available will result in an output level which will result in a cost competitive fuel cell stack. Meanwhile, the Company is using existing funds to expand production capacity incrementally. The Company has reviewed the hardware and software of its information systems. The Company believes the year 2000 will not have a material impact on its financial position. 42 The Company anticipates that its existing capital resources together with anticipated revenues will be adequate to satisfy its existing financial requirements and agreements through 1998. However, the Company may require additional capital beginning in 1998 if the aforementioned plan to expand manufacturing capability in its Torrington, CT facility is implemented. 43 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated Financial Statements and Supplementary Data of the Company are listed under Part IV, Item 14, in this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required with respect to directors and executive officers is incorporated by reference from the text appearing under Part I, Item 1 - Business under the caption "Executive Officers OF THE REGISTRANT" in this Report, and by reference from the Section captioned "Election of Directors" to be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders. The information with respect to the compliance of officers and directors with Section 16(a) of the Exchange Act is incorporated by reference from the Section captioned "Compliance with Section 16(a) of the Exchange Act" to be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders. ITEM 11. EXECUTIVE COMPENSATION This information is incorporated by reference from the Sections captioned "Executive Compensation", and "Compensation Pursuant to Plans" to be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT This information is incorporated by reference from the Sections captioned "Security Ownership of Certain Beneficial Owners" and "Security Ownership of Management" to be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders. 44 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS This information is incorporated by reference from the Section captioned "Certain Relationships and Related Transactions" to be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders. 45 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) (1) Financial Statements 1) Independent Auditors' Report KPMG Peat Marwick LLP (See page F-2, hereof.) 2) Consolidated Balance Sheets as of October 31, 1997 and 1996 (See page F-3 hereof.) 3) Consolidated Statements of Income for Years Ended October 31, 1997, 1996 and 1995 (See page F-4, hereof.) 4) Consolidated Statements of Changes in Common Shareholders' Equity for the Years Ended October 31, 1997, 1996 and 1995 (See page F-5, hereof.) 5) Consolidated Statements of Cash Flows for the Years Ended October 31, 1997, 1996 and 1995 (See page F-6, hereof.) 6) Notes to Consolidated Financial Statements (See pages F-7 thru F-22, hereof.) (A) (2) Financial Statement Schedules Supplement schedules are not provided because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto. (A) (3) EXHIBITS EXHIBIT NO. DESCRIPTION - ----------- ----------- 3.1 Certificate of Incorporation of the Company, as amended, March 3, 1994 (Incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1994 dated January 18, 1995) 3.2 Restated By-Laws of the Company, dated December, 1992 (Incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1992 dated January 20, 1993) 4 Specimen of Common Share Certificate (Incorporated by reference to exhibit of the same number contained in the Company's Form 8-A, dated September 20, 1994) 46 (A) (3) EXHIBITS TO THE 10-K EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.2 License Agreement, dated October 24, 1986, between Sanyo Electric and the Company, as amended by Agreement dated February 15, 1988 (confidential treatment requested) (Incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 1 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992) 10.3 License Agreement, dated June 18, 1980 between Sanyo Electric and the Company, as amended by Agreements dated October 7, 1980, June 1, 1981, July 28, 1982 and February 15, 1988 (confidential treatment requested) (Incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 1 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992) 10.4 License Agreement, dated November 24, 1981, between Mitsubishi Electric and the Company, as amended by Agreements dated December 4, 1981, June 3, 1983, January 11, 1984, November 20, 1986, November 23, 1988 and November 23, 1991 (confidential treatment requested) (Incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 1 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992) 10.6 License Agreement, dated February 11, 1988, between EPRI and the Company (confidential treatment requested) (Incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1 (File No. 33-47233) dated April 14, 1992) 10.9 License Agreement, dated November 30, 1989, between Messerschmitt-Daimler Benz and the Company (confidential treatment requested) (Incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1 (File No. 33-47233) dated April 14, 1992) 10.10 Note Purchase Agreement, dated November 30, 1989, between Messerschmitt-Daimler Benz and Fuel Cell Manufacturing Corporation (Incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1 (File No. 33-47233) dated April 14, 1992) 47 (A) (3) EXHIBITS TO THE 10-K EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.11 Subscription Agreement, dated November 30, 1989, between Messerschmitt-Daimler Benz and the Company (Incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1 (File No. 33-47233) dated April 14, 1992) 10.19 Loan Agreement, dated June 15, 1992, between the Company, Fuel Cell Manufacturing Corporation and Fleet Bank, N.A. (Incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1, (File 33-47233) dated April 14, 1992) 10.21 *Energy Research Corporation 1988 Stock Option Plan (Incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 1 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992) 10.26 Addendum to License Agreement, dated as of September 29, 1989, between Messerschmitt- Daimler Benz and the Company (Incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 3 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 24, 1992) 10.27 Agreement, dated September 30, 1992 between the Company and the United States Department of Energy, Contract #DE-FC21-92MC29237 (Incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1992 dated January 20, 1993) 10.29 Agreement dated December 2, 1993 between the Company and NASA-Lewis Research Center, Contract #NAS3-27021 (Incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 19, 1994) 10.30 Supply Agreement dated September 16, 1993, between the Company and the City of Santa Clara, California, for the Design, Construction and Demonstration of a Carbonate Fuel Cell Power Plant (Incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 18, 1994) 49 (A) (3) EXHIBITS TO THE 10-K EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.40 Loan and Security Agreement between the Company and MetLife Capital Corporation. (Incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1995 dated January 17, 1996) 10.41 Amendment No. 2 to the Energy Research Corporation Section 423 Stock Purchase Plan (Incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended April 30, 1996 dated June 13, 1996) 10.42 *Amendments to the Energy Research Corporation 1988 Stock Option Plan (Incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended April 30, 1996 dated June 13, 1996) 10.43 Loan Agreements with First Union Bank of Connecticut, dated June 28, 1996 (Incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996) 10.44 Notes in favor of First Union Bank of Connecticut, dated June 28, 1996 (Incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996) 10.45 Security Agreements with First Union Bank of Connecticut, dated June 28, 1996 (Incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996) 10.46 *Employment Agreement between Energy Research Corporation and Dr. Bernard S. Baker, dated January 1, 1997. 10.47 Amendment of Cooperative Agreement dated September 5, 1996 between the Company and the United States Department of Energy, Cooperative Agreement #DE-FC21-95MC31184 10.48 Technology Transfer and License Agreement between Energy Research Corporation and Corning Inc. dated January 20, 1997.(confidential treatment requested for certain portions of this document) 10.49 *Employment Agreement between Energy Research Corporation and the President and Chief Executive Officer dated August 1, 1997. 50 (A) (3) EXHIBITS TO THE 10-K EXHIBIT NO. DESCRIPTION - ----------- ----------- 11 Computations of Income/(Loss) Per Common Share 21 Subsidiaries of the Company (Incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1, (File No. 33-47233) dated April 14, 1992) 23.1 Consent of KPMG Peat Marwick LLP. 27 Financial data schedule * Management Contract or Compensatory Plan or Arrangement (b) REPORTS ON FORM 8-K. None 51 PART IV SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ENERGY RESEARCH CORPORATION REGISTRANT /s/ Jerry D. Leitman BY: JERRY D. LEITMAN, PRESIDENT DATE: JANUARY 22, 1998 In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the registrant and in the capacities and on the dates indicated. /s/ Jerry D. Leitman /s/ Louis P. Barth BY: JERRY D. LEITMAN BY: LOUIS P. BARTH, SENIOR VICE CHIEF EXECUTIVE OFFICER, DIRECTOR PRESIDENT, CHIEF FINANCIAL OFFICER (PRINCIPAL EXECUTIVE OFFICER) CORP. SECRETARY, TREASURER (PRINCIPAL DATE: JANUARY 22, 1998 ACCOUNTING AND FINANCIAL OFFICER) DATE: JANUARY 22, 1998 /s/ Warren Bagatelle /s/ Christopher R. Bentley BY: WARREN D. BAGATELLE, DIRECTOR BY: CHRISTOPHER R. BENTLEY, DIRECTOR DATE: JANUARY 22, 1998 DATE: JANUARY 22, 1998 /s/ Michael Bode /s/ James D. Gerson BY: MICHAEL BODE, DIRECTOR BY: JAMES D. GERSON, DIRECTOR DATE: JANUARY 22, 1998 DATE: JANUARY 22, 1998 /s/ Thomas L. Kempner /s/ William A. Lawson BY: THOMAS L. KEMPNER, DIRECTOR BY: WILLIAM A. LAWSON, DIRECTOR DATE: JANUARY 22, 1998 DATE: JANUARY 22, 1998 /s/ Hansraj C. Maru /s/ Richard M.H. Thompson BY: HANSRAJ C. MARU, DIRECTOR BY: RICHARD M.H. THOMPSON, DIRECTOR DATE: JANUARY 22, 1998 DATE: JANUARY 22, 1998 /s/ Bernard S. Baker BY: BERNARD S. BAKER, DIRECTOR DATE: JANUARY 22, 1998 52 ENERGY RESEARCH CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 and 1995 INDEX TO FINANCIAL STATEMENTS PAGE ---- Independent Auditors' Report F-2 Consolidated Balance Sheets - October 31, 1997 and 1996 F-3 Consolidated Statements of Income for Years Ended October 31, 1997, 1996 and 1995 F-4 Consolidated Statements of Changes in Common Shareholders' Equity for the Years Ended October 31, 1997, 1996 and 1995 F-5 Consolidated Statements of Cash Flows for the Years Ended October 31, 1997, 1996 and 1995 F-6 Notes to Consolidated Financial Statements F-7 - F-22 1 Independent Auditors' Report The Board of Directors Energy Research Corporation: We have audited the accompanying consolidated balance sheets of Energy Research Corporation and Subsidiaries as of October 31, 1997 and 1996, and the related consolidated statements of income, changes in common shareholders' equity and cash flows for each of the years in the three-year period ended October 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Energy Research Corporation and Subsidiaries as of October 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1997, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP __________________________ January 12, 1998 Stamford, CT 2 ENERGY RESEARCH CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS OCTOBER 31, 1997 AND 1996 (Dollars in thousands, except share and per share amounts)
1997 1996 ---- ---- ASSETS: Current Assets: Cash and cash equivalents $ 6,802 $ 7,597 Marketable securities -- 1,956 Accounts receivable 2,828 2,848 Inventories 47 72 Deferred income taxes 205 209 Other current assets 279 231 ------ ------ Total current assets 10,161 12,913 Property, plant and equipment, net 8,254 7,245 Other assets, net 3,018 3,382 ------ ------ Total Assets $21,433 $23,540 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY: Current Liabilities: Current portion of long-term debt 1,702 $ 2,380 Accounts payable 865 1,232 Accrued liabilities 1,182 1,108 Income taxes payable -- 11 Current portion of deferred license fee income 46 95 ------ ------ Total current liabilities 3,795 4,826 Long-Term Liabilities: Long-term debt 2,699 4,363 Capital lease obligation -- 8 Deferred license fee income -- 17 Deferred income taxes 170 264 ------ ------ Total liabilities 6,664 9,478 ------ ------ Shareholders' Equity: Convertible preferred stock, Series C ($.01 par value); 30,000 shares outstanding in 1997 and 1996 600 600 ------ ------ Common Shareholders' Equity: Common stock, ($.0001 par value); 8,000,000 shares authorized: 4,000,650 and 3,911,787 shares issued and outstanding in 1997 and 1996, respectively -- -- Additional paid-in capital 11,460 11,178 Retained earnings 2,709 2,284 ------ ------ Total common shareholders' equity 14,169 13,462 ------ ------ Total shareholders' equity 14,769 14,062 ------ ------ Total Liabilities and Shareholders' Equity $21,433 $23,540 ====== ====== The accompanying notes are an integral part of the consolidated financial statements.
3 ENERGY RESEARCH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995 (Dollars in thousands, except share and per share amounts)
1997 1996 1995 ---- ---- ---- Revenues $24,830 $29,446 $33,955 Costs and expenses: Cost of revenues 15,642 20,895 26,259 Administrative and selling 6,081 4,858 4,513 Depreciation 1,768 1,919 1,801 Research and development 1,270 1,260 944 ------ ------ ------ Total costs and expenses 24,761 28,932 33,517 ------ ------ ------ Income from operations 69 514 438 License fee income, net 650 357 357 Interest expense (354) (503) (459) Interest and other income, net 307 442 317 ------ ------ ------ Income before provision for income taxes 672 810 653 Provision for income taxes 247 301 211 ------ ------ ------ Net income $ 425 $ 509 $ 442 ====== ====== ====== Primary and fully diluted income per common share $ .10 $ .13 $ .11 ====== ====== ====== Weighted average common and common equivalent shares outstanding 4,207,144 4,063,061 3,972,281 ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 4 ENERGY RESEARCH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS' EQUITY FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995 (Dollars in thousands, except share amounts)
Shares Unrealized Total Of Additional Loss on Common Common Paid-in Retained Marketable Shareholders' Stock Capital Earnings Securities Equity ----- -------- -------- ---------- ------------- Balance at October 31, 1994 3,699,683 $ 9,193 $1,333 $(41) $10,485 Issuance of Common Stock under Benefit Plans 29,231 70 -- -- 70 Value Allowance for Temporary Decline in Market Value of Marketable Securities, Net of Deferred Taxes -- -- -- 41 41 Net Income -- -- 442 -- 442 --------- ------ ------ ---- ------ Balance at October 31, 1995 3,728,914 $ 9,263 $1,775 -- $11,038 Issuance of Common Stock under Benefit Plans 32,809 193 -- -- 193 Conversion of Preferred Stock to Common Stock 30,000 600 -- -- 600 Conversion of Notes Payable to Common Stock 97,397 877 -- -- 877 Warrants Exercised 22,667 245 -- -- 245 Net Income -- -- 509 -- 509 --------- ------ ----- ---- ------ Balance at October 31, 1996 3,911,787 $11,178 $2,284 -- $13,462 Issuance of Common Stock under Benefit Plans 96,621 188 -- -- 188 Common Stock Retired (8,119) -- -- -- -- Conversion of Notes Payable to Common Stock 361 3 -- -- 3 Tax effect of disqualifying disposition of incentive Stock Options -- 91 -- -- 91 Net Income -- -- 425 -- 425 --------- ------ ------ ---- ------ Balance at October 31. 1997 4,000,650 $11,460 $2,709 -- $14,169 ========= ====== ===== ==== ======
The accompanying notes are an integral part of the consolidated financial statements. 5 ENERGY RESEARCH CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995 (Dollars in thousands)
1997 1996 1995 ---- ---- ---- Cash Flows from Operating Activities: Net income $ 425 $ 509 $ 442 Adjustments to reconcile net income to net cash provided by operating activities: Bad debt (recovery) -- -- (27) Depreciation and amortization 2,162 2,156 2,148 Deferred income taxes (90) 46 (15) Conversion of accrued interest to principal on long-term debt 38 109 120 (Gain)loss on disposal of property (1) 3 4 Realized loss on sale of marketable securities -- -- 64 (Increase) decrease in operating assets: Accounts receivable 20 355 4,251 Inventories 25 107 (101) Other current assets (48) (144) 45 Increase (decrease) in operating liabilities: Accounts payable (367) (1,151) (634) Accrued liabilities 74 (416) 589 Income taxes payable 80 (60) 55 Deferred license fee income (66) (66) (65) ----- ----- ----- Net cash provided by operating activities 2,252 1,448 6,876 ----- ------ ----- Cash Flows from Investing Activities: Capital expenditures (2,801) (1,904) (1,520) Proceeds-sale of marketable securities and fixed assets 2,025 2,000 2,341 Payments on other assets (77) (97) (1,161) Purchase of marketable securities -- -- (3,929) ----- ----- ----- Net cash used in investing activities (853) (1) (4,269) ----- ----- ----- Cash Flows from Financing Activities: Repayment on long-term debt (2,382) (3,823) (538) Proceeds from long-term financing -- 4,113 1,245 Common stock issued 188 438 70 ----- ----- ----- Net cash provided by (used in) financing activities (2,194) 728 777 ----- ----- ----- Net Increase (Decrease) in Cash and Cash Equivalents (795) 2,175 3,384 Cash and Cash Equivalents-Beginning of Year 7,597 5,422 2,038 ----- ----- ----- Cash and Cash Equivalents-End of Year $6,802 $7,597 $5,422 ===== ===== ===== Cash paid during the period for: Interest $ 344 $ 404 $ 459 Income taxes 446 508 251 Noncash Items: Unrealized loss on the valuation of marketable securities, net of deferred taxes of $-0-, $-0- and $29, respectively -- -- 41
The accompanying notes are an integral part of the consolidated financial statements. 6 Note 1. Summary of Significant Accounting Policies ------------------------------------------ Nature of Business: ------------------- Energy Research Corporation and its Subsidiaries (the Company or ERC) are engaged in the development of alternate methods of energy generation and storage, primarily through electrochemical processes, the manufacture of fuel cell and battery products, and construction of fuel cell power plants, generally on a contract basis. The Company's revenues are generated from customers located throughout the United States, Europe and Asia. The Company generally does not require collateral in providing credit except for international sales where a deposit may be required with the purchase orders. Principles of Consolidation: ---------------------------- The accompanying financial statements include the accounts of the Company and its wholly-owned subsidiaries, Fuel Cell Manufacturing Corporation (FCMC) and Fuel Cell Engineering Corporation (FCEC). All intercompany transactions have been eliminated in the accompanying financial statements. Cash and Cash Equivalents: -------------------------- Cash equivalents consist primarily of United States Treasury instruments issued directly by the agency with original maturities of three months or less at date of acquisition. The Company places its temporary cash investments with high credit quality financial institutions. Marketable Securities: ---------------------- In fiscal 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which requires that investments in debt securities and marketable equity securities be designated as trading, held-to-maturity or available-for-sale. 7 Securities classified as held-to-maturity are reported at amortized cost and securities classified as available-for-sale are reported at fair value. The unrealized gains or losses on available-for-sale securities are included as a separate component of shareholders' equity. Unrealized losses that are other than temporary are recognized in earnings. Inventories: ------------ Inventories consist principally of raw materials and are stated at the lower of cost or market. Property, Plant and Equipment: ------------------------------ Property, plant and equipment are stated at cost, less accumulated depreciation provided on the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized on the straight-line method over the shorter of the estimated useful lives of the assets or the term of the lease. When property is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations for the period. Intellectual Property: ---------------------- Intellectual property including patents and know-how is carried at no value. Revenue Recognition: -------------------- Revenues and fees on long-term contracts, including government and commercial cost reimbursement contracts, are recognized on the percentage-of-completion method. Percentage-of-completion is measured by costs (including applicable general and administrative) incurred and accrued to date as compared with the estimated total costs for each contract. Contracts typically extend over a period of one or more years. In accordance with industry practice, receivables include amounts relating to contracts and programs having production cycles longer than one 8 year and a portion thereof will not be realized within one year. Provisions for estimated losses, if any, are made in the period in which such losses are determined. The Company recognized approximately $42, $1,131 and $221 of long-term contract revenues from corporate shareholders of the Company during fiscal years ended October 31, 1997, 1996 and 1995, respectively. License fee income arises from license agreements whereby the Company grants the right to use Company patents and know-how. Amounts are deferred and recognized ratably over the respective terms of the agreements. The Company recognized approximately $316 of license fee income during each of the fiscal years ended October 31, 1997, 1996 and 1995, under license agreements with corporate shareholders of the Company. Revenues from the U.S. Government and its agencies directly and through primary contractors were $23,377, $22,410 and $24,303, for the years ended October 31, 1997, 1996 and 1995, respectively. Income Taxes: ------------- Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Stock Option Plan ----------------- Prior to November 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. 9 As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On November 1,1996, the Company adopted SFAS NO. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in fiscal years beginning after December 15, 1994 as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the recognition provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. Net Income Per Common Share: ---------------------------- Primary net income per common share is based upon net income divided by the weighted average number of outstanding common and common share equivalents. Fully diluted net income per common share assumes that dilutive securities had been converted or exercised at the beginning of each period or on the date of issuance. Fully diluted net income per common share is not shown as it is antidilutive for all periods. Use of Estimates: ----------------- Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. Impairment of Long-Lived Assets: -------------------------------- In March 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 121, 10 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of." This statement, effective commencing in fiscal year 1997, establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. The initial adoption of this standard does not have a material impact on the Company's financial position and its operating results. Accounting Changes ------------------ In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 128 - "Earnings Per Share", which is effective for financial statements for both interim and annual periods ending after December 15, 1997. SFAS 128 requires presentation of basic and diluted per-share amounts for income from continuing operations and for net income. The Company does not expect the adoption of SFAS 128 to materially impact earnings per share. Note 2. Marketable Securities: ---------------------- At October 31, 1996, the Company's marketable securities were classified as held-to maturity and related amortized cost amounts to $1,956. Note 3. Accounts Receivable ------------------- Accounts receivable at October 31, 1997, and 1996 consisted of the following:
1997 1996 ---- ---- U.S. Government: Amount billed $ 102 $ 114 Unbilled recoverable costs 2,156 1,057 Retainage 420 338 2,678 1,509 Commercial Customers: Amount billed 88 397 Unbilled recoverable costs 32 929 Retainage 7 8 Other 23 5 150 1,339 $ 2,828 $ 2,848
11 Unbilled receivables represent amounts of revenue recognized on costs incurred on contracts in progress which will be billed within the next 30 days. The balances billed but not paid by customers pursuant to retainage provisions in the contracts will be due upon completion of the contracts and acceptance by the customer. Note 4. Property, Plant and Equipment ----------------------------- Property, plant and equipment at October 31, 1997 and 1996 consisted of the following:
Estimated 1997 1996 Useful Life ---- ---- ----------- Land $ 524 $ 524 -- Building and improvements 3,490 3,115 30 years Machinery and equipment 12,787 11,147 3-8 years Furniture and fixtures 972 984 6-10 years Construction in progress 1,738 1,331 19,511 17,101 Less, accumulated depreciation and amortization 11,257 9,856 $ 8,254 $ 7,245
Note 5. Other Assets ------------ Other assets at October 31, 1997 and 1996 consisted of the following:
1997 1996 ---- ---- Power Plant Contract $ -- $ 41 Power Plant License 2,504 2,788 Other 514 553 Total $ 3,018 $ 3,382
12 The Power Plant Contract and License are being amortized over 4 and 10 years, respectively. Accumulated amortization was $1,091,$767 and $558 at October 31, 1997, 1996 and 1995, respectively. Note 6. Long-Term Debt -------------- Long-term debt at October 31, 1997 and 1996 consisted of the following:
1997 1996 ---- ---- Note payable (a) 668 1,926 Note payable (b) 1,408 2,042 Note payable (c) 250 550 Note payable (d) 2,075 2,225 4,401 6,743 Less, Current portion (1,702) (2,380) Total long-term debt $ 2,699 $ 4,363
(a) On November 30, 1989, Daimler Benz affiliate MTU-Friedrichshafen GmbH (MTU), which was originally Messerschmitt-Bolkow-Blohm GmbH, loaned $500 and $1,480 to FCMC, evidenced by two 6% promissory notes. The notes include $38 and $611 of accrued interest as of October 31, 1997 and 1996, respectively, and are collateralized by a pledge of FCMC stock and a first priority lien on all current and future assets of FCMC, acquired with the proceeds of this loan, until the notes are satisfied in full. Principal and interest were due November 30, 1996. However, pursuant to a separate subscription agreement between the Company and MTU, MTU may convert the promissory notes and the outstanding accrued interest thereon into the Company's common stock at a conversion rate of $9 per share prior to November 1997. During 1996, $877 of principal and deferred interest was converted into 97,397 shares of common stock of the Company. MTU requested the Company extend for one year the repayment of a portion of the loan. Subsequent to the date of the 1997 Consolidated Balance Sheet the Company repaid $630 of principal and accrued interest. 13 (b) During 1995, the Company entered into a $2,500 credit facility with MetLife Capital Corporation, an affiliate of Metropolitan Life Insurance Company. Repayment of this note commenced during 1996 and expires February 2000. The note is payable in monthly installments of $53 plus interest. The interest on this note is payable at the thirty-day commercial paper rate plus 2-1/2%. At October 31, 1997, the commercial paper rate was 5.49%. All borrowings under this credit facility are collateralized by certain assets acquired with the proceeds of this loan. (c) Above was refinanced during 1996 with First Union Bank of Connecticut. The note is payable in monthly installments of $25 plus interest. Interest on this note is payable at the London Interbank Offered Rate (LIBOR) plus 1.75%. At October 31, 1997, the LIBOR was 5.63%. (d) Above was refinanced during 1996 with First Union Bank of Connecticut. The note is payable in monthly installments of $13 plus interest. Interest on this note is payable at the LIBOR plus 1.75%. At October 31, 1997, the LIBOR was 5.63%. The borrowings under the First Union Bank agreement are collateralized by a substantial portion of the Company's equipment and other assets, and a mortgage note in (d) above is collateralized by a first mortgage on the Company's Danbury, Connecticut location. The credit agreement associated with Notes (c) and (d) above require the Company to maintain certain financial covenants, including tangible net worth, debt service coverage and liabilities to tangible net worth. As of October 31, 1997, the above notes payable mature as follows: fiscal 1998, $1,702; fiscal 1999,$755; fiscal 2000, $319; and fiscal 2001, $1,625. Note 7. Commitments and Contingencies ----------------------------- The Company has been notified by the United States Environmental Protection Agency (EPA) that it is a potentially responsible party associated with Gallup's Quarry in Plainfield, Connecticut, which is a National Priorities List site under the Superfund. The alleged disposal at this site took place in 1977. An 14 agreement between the potentially responsible parties (PRP's) and the EPA has been achieved. The PRP's have agreed among themselves as to how to distribute the cost. The Company has been assessed $87 and has paid $83 as its share. The Company does not believe its share of the remediation costs will have a significant impact on the Company's results of operations or financial position. The Company leases certain EDP and office equipment and the Torrington, Connecticut manufacturing facility, and office space in Washington, D.C. under operating leases expiring on various dates through 2000. Rent expense was $463,$460 and $429 for the fiscal years ended October 31, 1997, 1996 and 1995, respectively. Aggregate minimum annual payments under the lease agreements for the five years subsequent to October 31, 1997 are: 1998, $477; 1999, $361; 2000, $356; 2001, $98; and 2002, $13. The Company has an agreement with Electric Power Research Institute (EPRI) pursuant to which ERC has agreed to pay EPRI royalties based upon commercial sales of carbonate fuel cells. In connection with certain contracts and grants from the United States Department of Energy (DOE), ERC has agreed to pay DOE 10% of the annual license income received from MTU, up to $500. Through 1997, ERC has paid to DOE a total of $200. Note 8. Shareholders' Equity -------------------- The Company's common shares are currently traded on The American Stock Exchange. In connection with the Company's public offering of its common stock in 1992, the Company sold to the underwriters, at a nominal price, warrants to purchase from the Company 80,000 shares of common stock at $10.80 per share which were exercisable for a period of four years commencing June 25, 1993. During 1996, 22,667 warrants were exercised. The remaining warrants expired June 25,1997. The Company is authorized to issue a total of 250,000 shares of preferred stock, the character of which is determined by the Board of Directors (the Board). During the year ended October 31, 1994, the Company agreed to exchange 120,000 shares of redeemable, nonconvertible Preferred "B" Shares for 60,000 shares 15 of convertible, nonredeemable Preferred "C". The redemption value of the Preferred "B" was $1,200. The Preferred "C" Shares originally had a liquidation preference of $1,200 and are convertible into shares of common stock on a one-for-one basis. During 1996, 30,000 shares of Preferred "C" were converted to 30,000 shares of the Company's common stock. At October 31, 1997, 738,652 shares of common stock have been reserved for issuance pursuant to the Company's stock option plan and the plan amendment to be approved by the shareholders, FCMC's $630 convertible notes payable, the convertible Preferred "C" Stock and Section 423 Stock Purchase Plan. Note 9. Stock Option Plan ----------------- The Board has adopted a Stock Option Plan (the Plan). Under the terms of the Plan, options to purchase up to 600,000 shares of common stock may be granted to officers, key employees and directors of the Company. Pursuant to the Plan, the Board is authorized to grant incentive stock options or nonqualified options and stock appreciation rights to officers and key employees of the Company and may grant nonqualified options and stock appreciation rights to directors of the Company. Stock options and stock appreciation rights have restrictions as to transferability. The option exercise price shall be fixed by the Board but, in the case of incentive stock options, shall not be granted at an exercise price less than 100% of the fair market value of the shares subject to the option on the date the option is granted. Stock appreciation rights may be granted in conjunction with options granted under the Plan. Stock appreciation rights shall be exercisable during the period and to the extent related stock options are exercisable. Upon exercise, the holder of a stock appreciation right is entitled to receive in cash or stock, the excess fair market value of one share of common stock over the related option price per share multiplied by the number of shares subject to the right. Stock options that have been granted are exercisable commencing one year after grant at the rate of 25% of such shares in each succeeding year. There are no stock appreciation rights outstanding at October 31, 1997. In connection with the hiring of the Company's Chief Executive Officer, options were granted to purchase 149,000 shares of the 16 Company's common stock at the Purchase price of $9.875 per share (the market value at the date of the grant). The company also agreed to grant options to purchase an additional 101,000 shares upon approval by the shareholders at the next annual meeting of the shareholders. The per share weighted-average fair value of stock options granted in 1997 and 1996 was $7.15 and $8.06 on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions:
Risk Free Dividend Interest Rate Expected Volatility Year Rate Range Life Factor ---- -------- ------------ -------- ---------- 1997 0% 6.07-6.66% 10 years .5044 1996 0% 5.63-5.71% 10 years .5044
The Company applies APB Opinion No.25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No.123, the Company's net income would have been reduced to the pro forma amounts indicated below.
1997 1996 ---- ---- Net Income: As reported $425,000 $509,000 Pro forma $ 39,000 $476,000 Earnings Per Share: As reported $ .10 $ .13 Pro forma $ .01 $ .12
Pro forma net income reflects only options granted in 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No.123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period, generally 4 years, and compensation cost for options granted prior to November 1,1995 is not considered. 17 The following table summaries the plan activity for the years ended October 31, 1997 and 1996: 1996 1997 Fixed Weighted Avg. Weighted Avg. Options Shares Exercise Price Shares Exercise Price ------- ------ -------------- ------ -------------- Outstanding beginning or year 281,200 $4.26 289,900 $5.08 Granted 30,000 $12.25 219,000 $10.60 Exercised (21,300) $4.33 (91,292) $1.85 Outstanding at year end 289,900 $5.08 417,668 $8.68 Options Exercisable at year end 240,900 $3.86 176,168 $5.84 Weighted- average fair value of options granted during the year $8.06 $7.15
18 The following tables summarize information about fixed stock options outstanding and exercisable at October 31, 1997 and 1996:
Options Outstanding ----------------------------------- Range Number Weighted-Avg. of Outstanding Remaining Weighted-Avg. Exercise Price at 10/31/97 Contractual Life Exercise Price -------------- ----------- ---------------- -------------- $ 1.67 61,668 0.5 years $ 1.67 $ 4.50 40,000 2.6 years $ 4.50 $9.75-$13.00 316,000 8.5 years $10.58
Options Exercisable ------------------------------------ Range Number Outstanding at Weighted-Avg.Exercise Price at 10/31/97 10/31/96 10/31/97 10/31/96 ----- -------- -------- ------- ------- $ 1.67 61,668 150,900 $ 1.67 $ 1.67 $ 4.50 40,000 40,000 $ 4.50 $ 4.50 $ 9.75-$13.00 74,500 50,000 $10.00 $ 9.75
The share holders of the Company adopted a Section 423 Stock purchase Plan at the April 30, 1993 Annual Meeting. The total shar es allocated to the Plan are 150,000. The shares are offered to employees over a eight-year period commencing January 1, 1993. It allows an employee with one year of service to purchase up to 300 shares per year at 85% of the lower of the average price on the day of grant or issue. An employee may not sell the stock for six months after the date of issue. 19 Plan activity for the years ended October 31, 1997, 1996 and 1995, was as follows:
Number of Shares ---------------- Balance at October 31, 1994 140,313 Issued @$8.08 (3,431) Balance at October 31, 1995 136,882 Issued @$8.50 (1,659) Issued @$8.82 (9,850) Balance at October 31, 1996 125,373 Issued @$10.31 (1,076) Issued @$8.55 (4,313) Balance at October 31, 1997 119,984
Note 10. Employee Benefits ----------------- The Capital Accumulation Plan for Employees of Energy Research Corporation is administered by a three-member pension committee. The plan is a 401(k) plan covering full-time employees of the Company who have completed one year of service. The Company contributes an amount equal to 5% of each participant's W-2 compensation to the plan on a monthly basis. Participants are required to contribute 3% and may make voluntary contributions up to an additional 7% of W-2 compensation out of pretax earnings. The Company charged $412,$395 and $371 to expense during the years ended October 31, 1997, 1996 and 1995, respectively. The Energy Research Corporation Pension Plan,a defined contribution plan, covers full-time employees of the Company who have completed one year of service. The Company contributes an amount equal to 4% effective April 1, 1993 (previously 5%) of each participant's W-2 compensation to the plan on a monthly basis. Participants are not required to contribute to the plan but may make voluntary contributions up to an additional 6% of W-2 compensation out of after-tax earnings. The Company charged $346,$320, and $296 to expense during the years ended October 31, 1997, 1996 and 1995, respectively. 20 Note 11. Income Taxes ------------ The Company's deferred tax assets and liabilities consisted of the following at October 31, 1997 and 1996:
1997 1996 ---- ---- Deferred tax assets: Inventory reserve $ 11 $ 8 Capital loss carryforward 55 55 Vacation accrual 113 135 Self-insurance 49 46 Royalty income 19 46 AMT credit -- 2 Other 26 -- Gross deferred tax assets 273 292 Valuation allowance 55 55 Deferred tax assets after valuation allowance 218 237 Deferred liabilities: Accumulated depreciation (183) (292) Gross deferred tax liabilities (183) (292) Net Deferred Tax Assets/(Liability) $ 35 $ (55)
The components of Federal income tax expense (benefit) were as follows for the years ended October 31, 1997, 1996 and 1995:
1997 1996 1995 ---- ---- ---- Current: Federal $ 327 $ 236 $ 181 Foreign 10 10 10 337 246 191 Deferred: Federal (90) 55 20 Foreign -- -- -- (90) 55 20 Total Income Tax Expense $ 247 $ 301 $ 211
21 The components of state income tax expense which are included in administrative and selling expenses were as follows for the years ended October 31, 1997, 1996 and 1995:
1997 1996 1995 ---- ---- ---- Current $ 234 $ 148 $ 91 Deferred (23) (9) (7) Total State Income Tax Expense $ 211 $ 139 $ 84
The reconciliation of the federal statutory income tax rate to the Company's effective income tax rate for the years ended October 31, 1997, 1996 and 1995 was as follows: 1997 1996 1995 ---- ---- ---- Statutory Federal income tax rate 34.0% 34.0% 34.0% Tax-exempt interest -- -- (5.4) Other, net 2.7 3.2 3.7 Effective Income Tax Rate 36.7% 37.2% 32.3%
22 EX-11 2 COMPUTATION OF EARNINGS EXHIBIT NO. 11 ENERGY RESEARCH CORPORATION COMPUTATION OF INCOME (LOSS) PER COMMON SHARE
Twelve Months Ended October 31, 1997 1996 1995 ---- ---- ---- PRIMARY - ------- Shares outstanding, beginning of period 3,911,787 3,728,914 3,699,683 Weighted average number of shares issued, retired and issuable share equivalents 295,357 334,147 272,598 --------- --------- --------- Weighted average number of common and common equivalent shares outstanding 4,207,144 4,063,061 3,972,281 ========= ========= ========= Net income $ 425,000 $ 509,000 $ 442,000 ========= ========= ========= Net income per common share $ .10 $ .13 $ .11 ========= ========= ========= FULLY DILUTED - ------------- Weighted average number of common and common equivalent shares outstanding as adjusted for full dilution 4,277,144 4,133,061 4,252,281 Adjustment for interest, net of tax, on convertible long-term debt $ 25,000 $ 25,000 $ 80,000 ========= ========= ========= Adjusted net income $ 450,000 $ 534,000 $ 522,000 ========= ========= ========= Net income per common share $ .11 $ .13 $ .12 ========= ========= ========= These calculations are submitted in accordance with SEC requirements, although they are not in accordance with APB Opinion No. 15 because they are anti-dilutive.
EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS LEGEND CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ENERGY RESEARCH CORPORATION'S FORM 10K FOR THE PERIOD ENDED OCTOBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS OCT-31-1997 OCT-31-1997 6,802 0 2,828 0 47 10,161 19,511 11,257 21,433 3,795 0 0 0 14,169 600 21,433 24,830 24,830 15,642 24,761 0 0 354 672 247 425 0 0 0 425 .10 .10
EX-23.1 4 CONSENT OF INDEPENDENT ACCOUNTANTS Consent of Independent Accountants The Board of Directors Energy Research Corporation: We consent to incorporation by reference in the registration statements (No.333-20807, No.33-77008 and No.33-68866) on Form S-8 of Energy Research Corporation and Subsidiaries of our report dated January 12, 1998, relating to the consolidated balance sheets of Energy Research Corporation and Subsidiaries as of October 31, 1997 and 1996, and the related consolidated statements of income, changes in common shareholders' equity and cash flows for each of the years in the three-year period ended October 31, 1997, which report appears in the October 31, 1997 annual report on Form 10-K of Energy Research Corporation. Stamford, CT January 23, 1998 EX-10.49 5 EMPLOYMENT AGREEMENT EXHIBIT 10.49 EMPLOYMENT AGREEMENT THIS AGREEMENT is made and entered into as of the lst day of August, 1997 between ENERGY RESEARCH CORPORATION, a New York corporation (the "Company"), and JERRY LEITMAN, an individual with a current mailing address at 8845 Willowbrae Lane, Roswell, Georgia 30076, (the "the Employee"). Unless the context otherwise requires, the term "Company", shall include the Company and each of its subsidiaries. W I T N E S E T H WHEREAS, the Company desires to employ the Employee as its President and Chief Executive Officer and the Employee desires to be employed in such capacity in accordance with the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the covenants, conditions, undertakings and premises contained herein, the sufficiency which is hereby acknowledged, the Company and the Employee agree follows: ARTICLE 1 EMPLOYMENT AND DUTIES 1.1. Employment; Duties Subject to the terms and conditions set forth herein, commencing August 4, 1997 (the "Commencement Date") the Company agrees to employ the Employee and the Employee agrees to be employed as President and Chief Executive Officer of the Company. In such position, the Employee shall perform such duties as are or may be assigned to the Employee by the Board of Directors of the Company (the "Board of Directors") from time to time. In connection therewith, the Employee shall report to and be subject to the supervision of the Executive Committee of the Board of Directors. 1.2. Full Time The Employee shall devote his full working time, attention, energies, skills and best efforts exclusively to the performance of his duties hereunder The Employee shall not during the term of this Agreement engage in any other business activity whether or not such activity is pursued for gain, profit or other pecuniary advantage, except that the Employee, on his own time, (a) may manage his own investments, and those of his immediate family, and (b) may serve as a member of the board of directors of other corporations subject to the restrictions set forth in Section 5.1, so long as such activity (as described in either clause (a) or (b) above), does not, in the reasonable judgment of the Company's Board of Directors, adversely affect the performance of his duties hereunder. 1 1.3. Board Membership The Employee, effective upon the Commencement Date, shall become a member of the Board of Directors and its Executive Committee. Thereafter, for so long as the Employee is serving as Chief Executive Officer of the Company, the Company will nominate the Employee for re-election as a management nominee of the Board ofDirectors and use its reasonable best efforts to cause the Employee to be so re-elected and, if so elected, to appoint the Employee as a member of the Executive Committee of the Board of Directors. If at any time the Employee ceases to serve as President and Chief Executive Officer of the Company, if the Board of Directors so requests, the Employee shall immediately tender his resignation from Board of Directors and shall automatically be deemed to have so resigned whether or not such resignation is tendered. ARTICLE 2 2.1. Term The term of the Employee's employment by the Company hereunder shall commence on the Commencement Date and, except as otherwise provided in this Agreement with respect to earlier termination, shall continue until terminated by either party pursuant to Article 7. ARTICLE 3 COMPENSATION 3.1. Base Salary For all service to be rendered by the Employee under this Agreement, including services as a officer, director and member of any committee, and such other duties as the Board of Directors or the Executive Committee may assign to him in accordance with Section 1.1 hereof, the Company agrees to pay the Employee a base salary of $320,000 per annum. The Employee's base salary shall be subject to periodic review and adjustment by the Board of Directors in its sole discretion, provided that the base salary may not be reduced below $320,000 per year. The base salary shall be payable at such times as is customary for employees of the Company and in accordance with the normal payroll practices of the Company. 3.2. Incentive Compensation Commencing with the Company's fiscal year beginning November 1, 1997, the Employee shall be a participant in a new Company incentive compensation plan to be developed by the Employee in consultation with the Compensation Committee of the Board of Directors, subject to the approval of the Board of Directors (the "Incentive Compensation Plan"). 3.3. Expenses 2 (a) General. In addition to base salary and incentive compensation, the Company shall reimburse the Employee for all reasonable and necessary business expenses actually incurred by him in the performance of his duties, including, without limitation, expenses for travel, meals, entertainment and other miscellaneous business expenses, in accordance with the Company's policies and practices as may be in effect from time to time. (b) Moving Expenses. The Company agrees to pay for or reimburse the Employee, in an amount not to exceed $75,000 in the aggregate (the "Moving Expense Cap"), for all reasonable out-of-pocket expenses incurred by him in connection with his relocation (including the relocation of his family (spouse and minor children)) from Atlanta, Georgia to the vicinity of the Company headquarters location (the "Company Location"), including, without limitation, (i) reasonable moving company expenses and storage fees, (ii) reasonable fees and expenses incurred in connection with the sale of his home in Georgia, (iii) reasonable fees and expenses incurred in connection with his purchase of a home in the vicinity of the Company Location, (iv) reasonable expenses associated with visits by the Employee's spouse to the Company Location to assist in the purchase of the new residence, and (v) reasonable interim living expenses to maintain an apartment in the vicinity of the Company Location through the earlier to occur of the Employee's purchase of his new residence or March 31, 1998. It is further understood and agreed that the Employee's family may remain located in Georgia until up to March 31, 1998 and that relocation expenses, subject to the Moving Expense Cap, shall also include the Employee's reasonable travel expenses to and from Georgia to visit his family (excluding business travel) during this interim period. The Employee shall coordinate all travel through the Company (c) Documentation. Reimbursement or payment by the Company of the Employee's expenses as set forth in this Section 3.3 shall be subject to the Employee's submission of written, itemized expense accounts and such additional substantiation and justification as the Company may reasonably request consistent with the Company's reimbursement policies generally applicable for its salaried employees. ARTICLE 4 COMPANY BENEFITS 4.1. Vacation The Employee shall be entitled to receive four weeks of paid vacation per calendar year (pro rated for any partial year), which shall be taken at such time or times as will not unreasonably hinder or interfere with the Company's business or operations. 4.2. Death Benefit and Life Insurance (a) The Employee is entitled to participate in any life insurance, accidental death and dismemberment and travel accident plans maintained by the Company for its employees, on terms no less favorable than those extended to any other senior executives of the Company. 3 (b) The Company may, if it so chooses, apply for and procure in its own name, and for its own benefit, additional life insurance and disability insurance on the Employee, and the Employee shall have no right, title or interest therein. (c) The Employee agrees to submit to any reasonable medical or other examination, and to execute any application or other instrument reasonably necessary to obtain any policy of insurance under this Article. 4.3. Liability Insurance The Company will obtain and maintain at all times directors' and officers' liability insurance for the Employee, so long as such insurance can be obtained on terms acceptable to the Company's Board of Directors. 4.4. Indemnification The Company agrees to defend and shall indemnify and hold the Employee harmless to the fullest extent permitted by law from any and all liability, costs, and expenses which may be assessed against the Employee by reason of the performance of his responsibilities and duties under the terms of this Agreement, provided such liability does not result from willful misconduct or gross negligence of the Employee. 4.5. Retirement Plan The Employee is entitled to participate in any retirement plan maintained by the Company for its employees (including, without limitation, pension, annuity, profit-sharing and deferred compensation plans). 4.6. Severance Benefit If at any time prior to the fifth anniversary of the Commencement Date (the "Severance Period"), the Employee ceases to be employed by the Company as a result of the Company's termination of the Employee pursuant to Section 7.4 (which shall not include any termination that is otherwise within Article 6) or the Employee's termination of his employment pursuant to Section 7.1, the Company shall pay the Employee as a severance benefit, (a) two times his then base salary plus (b) an amount equal to the Employee's bonus from the Company, if any, for the immediately preceding year. This severance benefit shall be payable by the Company through (i) the continuation of the Employee's base salary for a period of one year and (ii) the payment of the balance in four equal quarterly installments, with the first such payment due three months after the termination and the final payment due one year after the termination. The severance obligation set forth in this Section 4.6 shall be in lieu of and not in addition to any other severance benefits made available to other employees of the Company. After the termination of the Severance Period, the severance benefit, if any, payable to the Employee upon his termination shall be in accordance with the Company's then existing severance policy, if any, for its salaried employees. 4 4.7. Stock Options (a) Effective on the execution of this Agreement, the Company shall issue to the Employee an option to purchase 250,000 shares of the Company's Common Stock with an exercise price equal to the closing price of the Company's Common Stock on the American Stock Exchange on the date hereof, pursuant to an Option Agreement in the form set forth as Exhibit A to this Agreement. (b) Notwithstanding anything to the contrary in the foregoing, the Employee acknowledges and agrees that there are only 149,000 shares available for issuance under the Company's 1988 Stock Option Plan, as amended, and that, as a result, the option to purchase 101,000 of the 250,000 shares will be subject to stockholder approval in connection with a proposed increase in the number of shares of Common Stock available for issuance under the 1988 Plan or the adoption of a new stock option plan at the Company's next annual meeting of stockholders. The Company hereby undertakes to cause such a proposal to be presented for stockholder approval at such meeting and to use its reasonable best efforts to cause such a proposal to be adopted. The option to purchase shares in excess of that permitted under the 1988 Plan shall be of no force and effect unless and until such additional shares are approved. In the event that such additional shares are not authorized, the Company shall grant the Employee so called phantom stock, stock appreciation rights or such other rights as shall provide the Employee with benefits substantially equivalent to the benefits that the Employee would have received with respect to that portion of the option which has been nullified. 4.8. Other Benefit Plans The Employee shall further be entitled to participate in and receive benefits under any accident, disability, health and dental insurance, profit sharing, or similar plans generally made available to its employees. ARTICLE 5 RESTRICTIONS 5.1. Non-Competition (a) So long as the Employee is employed by the Company, serving as a director of the Company or is receiving payments from the Company hereunder (whether in connection with the Employee's employment hereunder or as a result of the termination of the Employee's employment hereunder) or otherwise in connection with the Employee's employment with the Company after the termination of this Agreement, and for a period of two years thereafter (the "Noncompetition Period"), the Employee shall not, directly or indirectly, whether as owner, partner, shareholder, director, consultant, agent, employee, guarantor, surety or otherwise, or through any person, consult with or in any way aid or assist any competitor of the Company or engage or attempt to engage in any employment, consulting or other activity which directly or indirectly competes with the Business of the Company. For purposes of this Agreement, the term "employment" shall include the performance of services by Employee as an employee, 5 consultant, agent, independent contractor or otherwise and the term "Business" shall mean the research, development, manufacture, sale or distribution of fuel cells, batteries or related products and any other business engaged in, planned or under development by the Company with respect to which the Employee has had access to Company Information or Customer Information (as such terms are defined in Section 5.3) during the Noncompetition Period. The Employee acknowledges that his participation in the conduct of any such Business alone or with any person other than the Company will materially impair the Business and prospects of the Company. (b) In addition to and without limiting the foregoing, during the Noncompetition Period, Employee shall not knowingly do, attempt to or assist any other person in doing or attempting to do any of the following: (i) hire any director, officer, employee, or agent of the Company (a "Company Employee") or encourage any such person to terminate such relationship with the Company, as the case may be (for purposes hereof, the Employee shall be deemed to have so encouraged a Company Employee to terminate such relationship with the Company if the Employee hires or otherwise assists any person in hiring any such Company Employee within six months after the Company Employee terminates his or her relationship with the Company), (ii) encourage any customer, client, supplier or other business relationship of the Company to terminate or alter such relationship, whether contractual or otherwise, to the disadvantage of the Company; (iii) encourage any prospective customer or supplier not to enter into a business relationship with the Company; (iv) impair or attempt to impair any relationship, contractual or otherwise, written or oral, between the Company and any customer, supplier or other business relationship of the Company; or (v) sell or offer to sell or assist in or in connection with the sale to any customer or prospective customer of the Company any products of the type sold or rendered by the Company. (c) Nothing in this Agreement shall preclude Employee from making passive investments of not more than 2% of a class of securities of any business enterprise registered under the Securities Exchange Act of 1934. 5.2. Intellectual Property (a) The Employee agrees to promptly disclose to the Company all ideas and suggestions coming within the scope of the business of the Company, whether now existing or hereafter arising and wherever located, which were conceived or refined by him during his employment with the Company, whether or not conceived or made during regular working hours, and all such ideas and suggestions shall be the sole property of the Company. In the event that any such idea or suggestion is deemed by the Company to be an invention of patentable nature, the Employee, whether or not in the employ of the Company, will assist the Company in obtaining, maintaining and enforcing patents for the invention in the United States of America and in any and all foreign countries. In addition, the Employee will supply evidence, give testimony, sign and execute all papers and do all other legal and proper things which the Company reasonably may deem necessary for obtaining, maintaining, and enforcing patents for said invention and for vesting in the Company full title thereto. The foregoing obligations of the Employee shall be further subject to the Employee being reimbursed for his reasonable out-of- 6 pocket expenses in connection with services rendered by him pursuant to the previous two (2) sentences. (b) The Employee acknowledges that all works of authorship (including, without limitation, works of authorship that contain software program code) relating to the business of the Company and produced during Employee's employment with the Company, whether they are or are not created on the Company's premises or during regular working hours, are works made for hire and are the property of the Company, and that copyrights in those works of authorship are the property of the Company. If for any reason the Company is not the author of any such work of authorship for copyright purposes, the Employee hereby expressly assigns all of his rights in and to that work to the Company and agrees to sign any instrument of specific assignment requested. 5.3. Confidentiality. The Employee recognizes that the Company is engaged in a continuous program of research and development relating to its business opportunities, market forecasting, data processing, operating procedures, products, methods, systems, techniques, machinery, tooling, designs, specifications, processes, plans, "know how" and trade secrets and that the Company has developed information regarding costs, profits, markets, products, customer lists, tooling, designs, plans for present and future development and expansion into new markets and other proprietary information, which is secret and confidential in nature and is not available to the public, which gives the Company a special competence in its various fields of endeavor which are otherwise deemed to be proprietary to the Company, all of which have been acquired or developed at considerable expense to the Company. The Employee acknowledges that a relationship of confidence and trust will be developed between the Employee and the Company with respect to information of a confidential or secret nature made known to Employee during the term of the Employee's employment by the Company. The information referred to in the preceding two sentences is hereafter collectively referred to as the "Company Information." The Employee further recognizes that the Employee will have access to certain information concerning the Company's customers which the Company treats and desires to continue to treat on a confidential basis ("Customer Information") and that the Employee, during the course of his employment with the Company will have access to such Customer Information. Accordingly, the Employee agrees that: A. The Employee shall not disclose, either directly or indirectly, under any circumstances (except as reasonably required in furtherance of the business of the Company), at any time, any of the Company Information or Customer Information to any person, firm, corporation, association or other entity for any reason or purpose whatsoever; provided that the Employee shall not be deemed to be in breach of such covenant if (i) the Employee makes such disclosure pursuant to a subpoena or order of a court of competent jurisdiction, (ii) the Employee shall have promptly given written notice to the Company of the request or demand for such 7 disclosure, (iii) the Company shall have been afforded the right to participate at its own expense in objecting to or limiting the nature and scope of such disclosure and (iv) the disclosure is subject to all judicial protection available for like material, such as protective orders and sealed records of proceedings. The Employee further agrees not to use, directly or indirectly, under any circumstances for his own benefit or for the benefit of any person, firm, corporation or other entity (except as reasonably required in furtherance of the business of the Company), at any time, any of the Company Information or Customer Information. B. Upon termination of the Employee's employment with the Company, the Employee shall deliver to the Company all files and records of any nature which are in the Employee's possession or control and which relate in any manner to his employment or to the activities of the Company. 5.4. Injunctive Relief The Employee acknowledges that the restrictions contained in this Article are reasonable in view of the nature of the business in which the Company is engaged and his position with the Company which will provide him with extensive knowledge of the business. The Company and the Employee mutually agree that the Employee's obligations under this Article are of a special and unique character which gives them a peculiar value, and the Company cannot be reasonably or adequately be compensated in damages in an action at law in the event the Employee breaches such obligations. The Employee therefore expressly agrees that, in addition to any other rights or remedies which the Company may possess, the Company shall be entitled to injunctive and other equitable relief to prevent a breach of this Article by the Employee, including a temporary restraining order or temporary injunction from any court of competent jurisdiction restraining any threatened or actual violation, and each party hereby consents to the entry of such order and injunctive relief and waives the making of a bond as a condition for obtaining such relief. Such rights shall be cumulative and in addition to any other legal or equitable rights and remedies the Company may have. 5.5. Survival Enforceability It is expressly agreed by the parties hereto that the provisions of this Article shall survive the termination of this Agreement. If any one or more of the provisions contained in this Article shall for any reason in any jurisdiction be held to be excessively broad as to the time, duration, geographical scope, activity or subject, it shall be construed with respect to such jurisdiction, by limiting or reducing it, so as to be enforceable to the extent compatible with the applicable law of such jurisdiction as it shall then appear. 8 ARTICLE 6 DEATH; DISABILITY 6.1. Death If the Employee dies while employed under this Agreement, this Agreement shall terminate immediately. The Company will pay to the Employee's estate his base salary under Section 3.1 through the last day of the calendar month in which he dies, plus any incentive compensation awarded to the Employee under the Incentive Compensation Plan, but not yet paid, and such death benefits as may be provided pursuant to Section 4.2. 6.2. Disability If the Employee fails to perform his duties under this Agreement due to "Disability", as defined in Section 6.2 B(i) or (ii), the Company may terminate this Agreement upon 30 days written notice to him. In that event, the Company shall pay the Employee his base salary under Section 3.1 through the date of termination. If the Employee fails to perform his duties under this Agreement due to "Disability," as defined in Section 6.2 B(iii), then the Company may immediately terminate this Agreement upon the payment to the Employee of his base salary for a period of seven (7) months, less such payments previously made by the Company to the Employee on account of such Disability. In addition, upon any termination based upon Disability, the Company shall pay to the Employee any incentive compensation awarded to the Employee under the Incentive Compensation Plan but not yet paid; provided, however, that to the extent the Employee is receiving disability benefits pursuant to the Company's disability insurance policy, the amount of such benefits shall be credited against the Employee's base salary during the period prior to the date of termination. A. If the Company gives notice of termination under this Section and, before the termination date stated in the notice, the Employee's Disability ceases and he takes up and resumes performance of his duties under this Agreement, the notice of termination shall be void and of no effect, and this Agreement shall continue in effect as though such notice had not been given. B. The term "Disability" shall mean the inability of the Employee to perform for the Company the duties specified in Section 1.1 by reason of any medically determinable physical or mental impairment for (i) a period of six consecutive months, (ii) for shorter periods aggregating six months in any 12-month period or (iii) if the Board of Directors determines that it is probable that the Disability will continue for a length of time so as to constitute a Disability under clauses (i) or (ii) above. The determination of whether the Employee is Disabled shall be made by the Board of Directors on the basis of written medical evidence reasonably satisfactory to it. 9 ARTICLE 7 TERMINATION 7.1. Termination by the Employee for Good Reason The Employee may terminate this Agreement for good reason upon thirty (30) days written notice to the Company setting forth with specificity the grounds for termination upon the occurrence of any of the following: (a) the failure of the Company to observe or comply with any of its material obligations under this Agreement, if such failure has not been cured within 30 days after written notice thereof has been given by the Employee to the Company; (b) the failure of the Employee to be elected or reelected to the Board of Directors or its Executive Committee as provided in Section 1.3, (c) the dissolution of the Company; or (d) any merger in which the Company is not the surviving corporation and in which the stockholders of the Company own less than 50% of the voting securities of the merged entity upon the effectiveness of the merger, or any consolidation, sale of substantially all of the assets of the Company or change of control of the Company, provided the Employee has not approved the transaction by voting for it either as a director or shareholder. For purposes of clause (a) a material breach by the Company shall include a material change in the reporting responsibilities of the Employee such that the Employee is no longer effectively serving as the Chief Executive Officer of the Company, a relocation to offices that do not serve as the principle executive offices of the Company, a material reduction in benefits or other perquisites of office such that the Employee is not receiving the benefits set forth herein or the benefits and other perquisites generally granted for executive positions within the Company. For purposes of clause (d) above, a "change of control" shall be presumed to have occurred if within any 12-month period a single person or entity, or related group of persons or entities, acquires 50% or more of the outstanding voting stock of the Company. In the event of a termination for good reason under this Section, the Company shall pay the Employee (i) his base salary as then in effect under Section 3.1 through the date of termination, (ii) any incentive compensation awarded to the Employee under the Incentive Compensation Plan, but not yet paid, and (iii) the severance benefit set forth in Section 4.6. 7.2. Termination by the Company for Cause The Company may terminate this Agreement for cause in the manner set forth below. For purposes of this Section, "cause" shall mean a material breach by the Employee of the terms of this Agreement with results that are materially and demonstrably injurious to the business of the Company. The term "cause" as used in the preceding sentence does not include the Employee's erroneous judgment or judgments of a technical, scientific, financial, legal and/or environmental nature which were, although erroneous, nevertheless reasonable at the time and under the circumstances in which they were made. In the event of termination under this Section, the Company shall pay to the Employee his base salary under Section 3.1 through the date of termination stated in the notice plus any incentive compensation awarded to the Employee under the Incentive Compensation Plan but not yet paid, and the Employee shall, if so 10 requested by the Board of Directors, perform his duties under Article 1 through the date of termination stated in the notice. 7.3. Termination by the Company for Cause-Procedure Notwithstanding anything to the contrary set forth herein, the Employee shall not be deemed to be have been terminated for cause without (i) delivery to the Employee of written notice setting forth the reasons for the Company's intention to terminate for cause, (ii) an opportunity for the Employee, together with his counsel, to be heard before the Board of Directors and (iii) delivery to the Employee of a notice of termination from the Board of Directors stating that a majority of the members of the Board have determined in good faith that the Employee was guilty of conduct that supports the termination for cause, specifying the conduct which gave rise to such termination. 7.4. Termination by the Company or the Employee Without Cause Either the Company or the Employee may terminate this Agreement for reasons other than as set forth above in Section 7.1 or Section 7.2 and which are not otherwise within Article 6 upon 30 days written notice. Upon such termination, the Company shall pay the Employee his base salary under Section 3.1 through the date of termination (provided, however, that the Employee continues to be available to perform the services required under Section 1.1 through the date of termination), plus any incentive compensation awarded to the Employee under the Incentive Compensation Plan, but not yet paid, and any accrued vacation. In addition, upon the Company's termination of the Employee without cause, the Company shall be required to pay the Employee the severance benefit set forth in Section 4.6. Nothing herein shall prohibit the Company from relieving the Employee of any or all of his duties hereunder pending the expiration of the 30-day notice period. 7.5. Termination of Duties Notwithstanding anything to the contrary set forth herein, at any time on or after delivery of written notice to the Employee, the Company may relieve the Employee of all of his duties and responsibilities hereunder and may relieve the Employee of authority to act on behalf of, or legally bind, the Company; provided, however, that any such action by the Company shall not relieve the Company of its obligation to pay to the Employee all compensation and benefits otherwise provided for in this Agreement. ARTICLE 8 MISCELLANEOUS 8.1. No Conflicting Agreements. The Employee represents and warrants to the Company, that the Employee is not under any obligation to any person or entity which is inconsistent with or in conflict with any of the terms of this Agreement or which would prevent, limit or impair in any way the Employee's 11 performance of all the terms of this Agreement and the Employee agrees not to enter into any agreement, either written or oral, in conflict herewith. 8.2. Entire Agreement This Agreement contains the entire understanding and agreement between the Company and the Employee and cannot be amended, modified, or supplemented in any respect except by subsequent written agreement entered into by both parties. 8.3. Successors of the Company This Agreement shall inure to the benefit of and be binding upon the Company, its successors and assigns, including, without limitation, any person, firm, corporation or other entity which may acquire all or substantially all of the Company's assets and business, or with or into which the Company may be consolidated or merged, and this provision shall apply in the event of any subsequent merger, consolidation or transfer. In every respect, this Agreement shall inure to the benefit of and be binding upon the Employee, his heirs, executors and personal representatives and, being personal in nature, shall not be assignable by the Employee. 8.4. Effect of Waiver The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach. 8.5. Notices Any notice, request, demand or other communication in connection with this Agreement must be in writing and shall be deemed to have been given and received three days after a certified or registered letter containing such notice, properly addressed, with postage prepaid, is deposited in the United States mail; and, if given otherwise than by registered or certified mail, it shall not be deemed to have been given until actually delivered to and received by the party to whom it is addressed. A. Notice to the Company shall be given at its principal mailing address, which at the time of execution of this Agreement is 3 Great Pasture Road, Danbury, Connecticut, 06813, Attention: Corporate Secretary, or at such other address as it may designate, with a copy to Mr. Richard M. H. Thompson, 116 East 64th Street, New York, New York, 10021, and Mr. William Lawson, 312 West Main Street, Owosso, Michigan, 48867. B. Notice to the Employee shall be given at his home address, which at the time of execution of this Agreement is the address set forth in the heading of this Agreement, or at such other address as he may designate. 12 8.6. Counterparts This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 8.7. Severability If, in any jurisdiction, any provision of this Agreement or its application to any party or circumstances is restricted, prohibited or unenforceable, such provision shall, as to such jurisdiction, be ineffective only to the extent of such restriction, prohibition or unenforceability without invalidating the remaining provisions hereof and without affecting the validity or enforceability of such provision in any other jurisdiction or its application to other parties or circumstances. 8.8. Survival Each of the terms and provision of this Agreement which are expressly or impliedly so intended shall survive the termination of this Agreement. 8.9. Applicable Law This Agreement shall be governed by and construed according to the laws of the State of Connecticut. 8.10. Attorney's Fees In the event of a dispute between the parties relating to this Agreement, the parties agree that the losing party shall pay the reasonable attorney's fees and expenses of the prevailing party. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first stated above. ENERGY RESEARCH CORPORATION By: /s/ Thomas L. Kempner --------------------- Thomas L. Kempner Chairman of the Board /s/ Jerry Leitman --------------------- Jerry Leitman 13 -----END PRIVACY-ENHANCED MESSAGE-----