-----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, G1qnoevWTZhnG2lZQTGWwXqZJKR70OGZJ99No85Q9t5tfGeKs/Q8kE2wPktyz2It pJYf9cTA2d69eCC+m9UzRg== 0000886128-99-000002.txt : 19990202 0000886128-99-000002.hdr.sgml : 19990202 ACCESSION NUMBER: 0000886128-99-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981031 FILED AS OF DATE: 19990201 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: 99517859 BUSINESS ADDRESS: STREET 1: 3 GREAT PASTURE RD CITY: DANBURY STATE: CT ZIP: 06813 BUSINESS PHONE: 2038256000 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 PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: October 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission File Number: 0-24852 ENERGY RESEARCH CORPORATION (Exact name of registrant as specified in its charter) ---------------------- New York 06-0853042 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 3 Great Pasture Road Danbury, Connecticut 06813 (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code (203) 825-6000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.0001 par value per share (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $34,967,600, which is based on the closing price of $12.50 on January 26, 1999. On January 26, 1999 there were 4,135,873 shares of Common Stock of the registrant issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain information contained in the registrant's definitive proxy statement relating to its forthcoming 1999 Annual Meeting of Stockholders to be filed not later than 120 days after the end of registrant's fiscal year ended October 31, 1998 is incorporated by reference in Part III of this Report on Form 10-K.FORM 10-K ANNUAL REPORT
ENERGY RESEARCH CORPORATION INDEX ----- Description Page Number ----------- ----------- Part I ------ Item 1 Business 3 Item 2 Properties 19 Item 3 Legal Proceedings 20 Item 4 Submission of Matters to a Vote of Security Holders 20 Part II ------- Item 5 Market for the Registrant's Common Equity and Related Stockholder Matters 20 Item 6 Selected Financial Data 21 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 22 Item 8 Financial Statements and Supplementary Data 27 Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 27 Part III -------- Item 10 Directors and Executive Officers of the Registrant 27 Item 11 Executive Compensation 27 Item 12 Security Ownership of Certain Beneficial Owners and Management 27 Item 13 Certain Relationships and Related Transactions 27 Part IV ------- Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 28 Signatures 32
2 Forward-looking Statement Disclaimer When used in this Report, the words "expects", "anticipates", "estimates", "should", "will", "could", "would", "may", and similar expressions are intended to identify forward-looking statements. Such statements include statements relating to the Company's planned spin-off of its battery business, the development and commercialization schedule for its fuel cell technology, future funding under government contracts, the expected cost competitiveness of its technology, and the timing and availability of products under development. These and other forward looking statements contained in this Report are subject to risks and uncertainties, known and unknown, that could cause actual results to differ materially from those forward-looking statements, including, without limitation, general risks associated with product development and introduction, changes in the utility regulatory environment, potential volatility of energy prices, government appropriations, the ability of the government to terminate its development contracts at any time, rapid technological change, and competition, as well as other risks. The Company cannot assure that the spin-off will occur as planned, that the Company will be able to meet any of its development or commercialization schedules, that the government will appropriate the funds anticipated by the Company under its government contracts, that the government will not exercise its right to terminate any or all of the Company's government contracts, that any of the Company's products or technology, once developed, will be commercially successful, or that the Company will be able to achieve any other result anticipated in any other forward-looking statement contained herein. The forward-looking statements contained herein speak only as of the date of this Report. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any such statement to reflect any change in the Company's expectations or any change in events, conditions or circumstances on which any such statement is based. PART I Item 1. Business Introduction Energy Research Corporation (the "Company") is a leading developer of electrochemical technologies for electric power generation and storage. The Company is principally engaged in the development of a carbonate fuel cell power plant for distributed electric power generation. A fuel cell is a device which electrochemically converts the chemical energy of a fossil fuel into electricity without any combustion of fuel. The Company's fuel cell system feeds a fuel, such as natural gas, into the fuel cell where the fuel and air undergo an electrochemical reaction to produce electricity. The Company has also developed a nickel-zinc battery which can be used in a range of rechargeable battery applications. See "Recent Developments". From its founding in 1969 until approximately 1983, the Company focused on developing fuel cells and specialized batteries for the United States military. These efforts resulted in the Company obtaining various patents and expertise in these electrochemical technologies. For the last fifteen years the Company has concentrated on developing products using its technologies for mostly non-military markets, availing itself of substantial funding from the United States Department of Energy ("DOE") and other outside sources such as the MTU division of Daimler Chrysler Corporation. The Company has developed a patented fuel cell technology which allows efficient and environmentally benign generation of electricity without requiring any combustion or mechanical equipment. This technology is known as Direct Fuel Cell because it introduces most of the hydrocarbon fuel such as pipeline natural gas directly into the fuel cell without requiring external reforming for producing hydrogen. This "one-step" operation results in a significantly more efficient, simpler and more cost-effective energy system compared with other external-reforming type fuel cells. The Company currently conducts its operations through two principal operating groups: the Fuel Cell Group and the Battery Group. The Fuel Cell Group concentrates its efforts on the development, demonstration and, commercialization, of the Company's carbonate fuel cell, the Direct Fuel Cell. The Battery Group is engaged in the 3 development and commercialization of an innovative, patented nickel-zinc rechargeable battery, as well as the research and design of other advanced battery technologies. The Company has licensed its fuel cell technology internationally to several major corporations, including MTU-Friedrichshafen GmbH ("MTU"), a subsidiary of DaimlerChrysler and Mitsubishi Electric Corporation. In addition, the Company has licensed its Ni-Zn battery technology to a joint venture between Nan Ya Plastics Corporation of Taiwan, a Formosa Plastics Group company and Xiamen Three Circles Co., Ltd. ("Xiamen") of Xiamen, China and a joint venture formed between the Company and Xiamen. Recent Developments -- Proposed Spin-off of Battery Group On October 1, 1998, the Company announced that its Board of Directors had approved a plan to effect a spin-off to its stockholders of 100% of the shares of Evercel, Inc. ("Evercel"), a newly formed, wholly-owned subsidiary of the Company. In connection with this transaction, which is expected to occur in early 1999, the Company plans to transfer to Evercel the principal assets and liabilities related to the Battery Group. Following the transfer, the Company plans to distribute to its stockholders in a tax-free distribution one share of Evercel Common Stock for every three shares of Common Stock of the Company held. Immediately after the distribution of Evercel's shares to the Company's stockholders, in order to fund its commercialization efforts, Evercel plans to conduct a rights offering to its stockholders. As described more fully in a Registration Statement filed by Evercel with the Securities and Exchange Commission on September 30, 1998, as amended on December 15, 1998, Evercel expects to grant at no cost to holders of its Common Stock, transferable subscription rights ("Rights") to subscribe for and purchase an additional share of Evercel's Common Stock. Each holder of Evercel's Common Stock is expected to receive one Right for each share of Evercel Common Stock held on the record date (which has not yet been determined). Each Right will be exercisable, for a period of approximately 30 days, to purchase one share of Common Stock of Evercel at a purchase price of $6.00 per share. The rights offering will be made only by means of a Prospectus which will be delivered to stockholders concurrently with the distribution. The transaction remains subject to the satisfaction of certain conditions. See "Introductory Statement - Forward-looking Information Disclaimer." The Fuel Cell Group Industry Background According to the U.S. Department of Energy's ("DOE"), "Energy Information Administration Energy Outlook 1999" report, a projected 363 gigawatts of new capacity generation will be needed by 2020 to meet the growing demand for electricity and to offset retirements. Approximately 81% of this new capacity is projected to be fueled by natural gas. The Company believes that most of this $363 billion market, will develop in the 2002 to 2020 time period. At present capacity reserve margins (the difference between installed generating capacity and demand for electricity) in the U.S. as a whole average only 15%. In addition they are shrinking and vary greatly from region to region. The Company believes the prospects of wholesale and retail wheeling of electric power (the sharing of electricity from multiple sources) together with overall uncertainty as to the future will discourage utilities from adding substantial new generation during the next several years. These factors, together with tougher environmental laws already in existence, the need to relicense nuclear plants, which may not be economically feasible in some cases, and the aging of U.S. plants, could result in market opportunities at about the time the Company plans to bring its product to market. Even the wheeling of power over long distances will result in additional energy losses over the transmission lines, thus offsetting some of the gains achieved by balancing power usage and keeping pressure on capacity margins. The U.S. electric utility industry has been edging toward change for several years triggered in part by the Energy Policy Act of 1992, which called for open access for consumers. In 1994, a major upheaval in the industry began as a result of significant moves toward direct access and deregulation of the electric utility industry in various states. As a result, a heightened atmosphere of competition, as well as uncertainty, exists in the industry. Furthermore, some electric utilities have already decided to phase out of the power generation aspect of the business, leaving it to independent power producers and non-utility generators. Others have merged with either other electric utilities or gas supply companies. A number of significant mergers of this type have taken place 4 and further major reorganizations are anticipated. Regardless of the reorganization of the electric utility industry, substantial generation equipment will be required. In their 1997 report on North American Distributed Generation System Markets, Frost and Sullivan predicted that by 2003, up to 20 percent of new installed capacity may be served by distributed generation and that fuel cells will capture an increasing share of this emerging market. In the second phase of Clean Air Act regulations, set to take effect January 1, 2000, emissions reductions will be mandatory. Installation permits for internal combustion engine generators, as anything other than emergency power generation may be severely limited. Furthermore, in a deregulated market, power producers and power marketers are likely to take advantage of "green marketing" to differentiate their electricity to end-users. This general market trend strongly supports a market for emissions-free fuel cell technologies. The Company believes that the restructuring of the utility industry and the growth of the distributed generation market discussed above, greatly enhance its market opportunities. Newly formed entities are working to find the best market solution for the customer. Increasing demands are being put on efficiency, power quality, lifetime, low maintenance and environmental compatibility and cost. The use of highly efficient and flexible heat and power generating systems is being investigated by every potential energy company in the world. Fuel cells with the capability to meet these demands in a wide variety of settings offer an excellent enabling technology to energy services companies. The Company's Fuel Cell The Company's Fuel Cell Group concentrates its efforts on the development, demonstration, and, commercialization of the Company's carbonate fuel cell for generating electricity. Fuel cells are devices for converting the chemical energy of a fossil fuel into electricity electrochemically, that is, without burning fuel or needing any mechanical equipment. Different types of fuel cells are distinguished generally by the electrolyte medium they use. ERC's Direct Fuel Cell system employs metal carbonates as the electrolyte, hence the term "carbonate fuel cell". The Company's fuel cell system feeds a fuel, such as natural gas, into the fuel cell where the fuel and air undergo an electrochemical reaction to produce electricity. A fuel cell power plant can be thought of as having two basic segments: the fuel cell stack module, which is the part that actually produces the electricity, and the "balance of plant", which includes various fuel handling and processing equipment, including requisite pipes and blowers, computer controls, inverters to convert the DC output of the fuel cell to AC, and other related equipment. Conventional non-nuclear power plants burn a hydrocarbon such as coal, oil or natural gas, to create heat. The heat boils water, converting it to steam which rotates a turbine which produces the electricity. Some power plants use a combined cycle approach where the heat is sent to gas turbines, and then to raise steam, which produces additional power in steam turbines. Each step in these processes consumes some of the potential energy in the fuel, and the combustion process typically creates emissions of sulfur and nitrogen oxides, carbon monoxide, soot and other air pollutants. Because of the non-combustion, non-mechanical power generation process, the Company's fuel cell is much more efficient than the conventional power plants. Emissions of sulfur and nitrogen oxides are nearly zero, and other pollutants are minimal or non-existent. With the only moving parts being the air blower, in contrast to large rotating turbines, fuel cells are extremely quiet. In addition, fuel cells achieve high efficiency at extremely small sizes allowing fuel cells to satisfy market needs for distributed generation, such as providing electrical power to a hospital or a retail store. The Company's patented Direct Fuel Cell uses hydrocarbon fuel without the intermediate step (reforming) of creating hydrogen fuel, which is more efficient, simpler and less costly as compared with other external-reforming type fuel cells. The Direct Fuel Cell, is capable of using a variety of fuels, including natural gas, methanol, ethanol, bio-gas and any other hydrocarbon fuels. The Direct Fuel Cell operates at much higher temperatures than most other fuel cells. As a result, less expensive electrocatalysts can be used and high quality heat energy is available for cogeneration. Even though fuel cells are believed to be superior to conventional generators in terms of efficiency, environmental characteristics, and flexibility of size, commercial sales of fuel cells have been minimal to date. The Company, as well as most potential competitors in the field, have not yet completed development and commercial release of their products. In addition, at such an early stage of the technology's development, the selling price of a fuel cell is expected to be high, reflecting the initial low production volume. The Company 5 recognizes that achieving a significant share of the power generation equipment market will require that the Company offer its products at very competitive prices, which can only be accomplished when production costs are cut substantially from current levels. Accomplishing these cost reductions requires a number of interrelated developments and achievements. Some of them include: - Production volume is a significant factor in unit cost. There are numerous fixed costs, such as factory overhead, that would have a lower contribution to unit cost if spread over more units. Likewise, there are numerous components whose costs could decline with volume purchases. - Many components are being purchased from outside vendors at high prices because current volume doesn't yet justify investing in the specialized equipment needed to produce these parts in-house at lower cost. - The Company continues to explore alternative materials, processes, and vendors that it believes could result in savings. For example, by making certain components thinner, material costs could be reduced. - Various processes are being performed manually that the Company believes could be converted to automated operation, producing considerable savings and tightening manufacturing tolerance. Equipment operating at low speeds could be replaced by faster, more efficient equipment. - To the extent that the Company can make improvements in manufacturing and produce its stack components to tighter tolerances, that increased uniformity would increase the electrical output of the stack, in turn lowering its cost per kW. The Company regularly reviews and revises its cost reduction plans. In addition, the DOE has on several occasions assigned an independent outside auditor to examine the Company's present and projected cost figures to determine if the DOE's continued support of the Company through development contracts will achieve its intent of creating commercially viable fuel cell power generation technology in the U.S. The most recent such audit, completed in 1998, projected that the Company's commercial design fuel cell is capable of being manufactured, delivered and installed at a cost per kW of $1140 in 1995, assuming production of 400 MW per year. The Company believes that this cost would be low enough to be competitive in the marketplace. However, achieving these costs savings and the ability of the Company to compete based upon these cost savings, if achieved, are subject to risks and uncertainties. "See Introductory Statement - Forward-looking Information Disclaimer." The Company is transitioning from a development company to a manufacturer of fuel cell power plants. The Company believes there is substantial work to be done before it can commercially produce and sell its fuel cell systems. In addition to achieving cost reductions, the Company will need to demonstrate the endurance and reliability of its fuel cells. The Company believes its commercialization program is dependent upon one or more additional field trials of its power plants. Fuel Cell Development Program During 1996 and 1997, the Company operated its "proof-of-concept" fuel cell plant (the "Santa Clara Plant") at a site in Santa Clara, California. The demonstration involved the largest carbonate fuel cell power plant in the world and the largest fuel cell of any type operated in the United States. The Santa Clara Plant was initially designed to provide 1.8 megawatts. Following its start up, the Santa Clara Plant achieved a peak power output of 1.93 megawatts. Adjusting for supplemental fuel, it achieved an electrical efficiency level of 50%, a record for a single cycle fossil fuel cell power plant, as well as record low emissions of sulfur and nitrogen oxides. The Santa Clara Plant operated at various electrical outputs for almost one year, half of such time being connected to the utility grid. Despite encountering equipment problems unrelated to the basic fuel cell technology, the Santa Clara Plant achieved most of the goals set by the Company for the project and established new milestones. After the end of the operation of the Santa Clara Plant in March 1997, all of the fuel cell stacks were returned to the Company for a comprehensive analysis. The Company used the results of this analysis, along with the results of 6 ongoing development activities, to develop a commercial fuel cell design significantly more compact, reliable and cost-effective than the Santa Clara Plant design. In March 1998, the Company commenced operation of a single stack Direct Fuel Cell power plant demonstration in Danbury, Connecticut (the "Danbury Power Plant"). The single stack power plant produced in excess of 250 kilowatts. The Danbury Power Plant operated for 3000 hours and represented various improvements over the Santa Clara Power Plant. The cells contained 40% less material and produced 50% more power per individual cell. The cells were constructed using an automated process resulting in closer tolerances. The Danbury Power Plant converted pipeline natural gas to DC electricity equivalent to an estimated 50% efficiency in commercial operation. The Company's current fuel cell power plant design is projected to be capable of producing the same output as the Santa Clara Plant with a footprint one ninth as large. This reduction in size and increase in power per stack results in substantial manufacturing cost savings. In the second quarter of 1999, the Company expects to demonstrate its final commercial fuel cell stack design, a 250 kW unit, at its Danbury Power Plant. The Company will provide electrical power for its facility from the fuel cell, and provide excess power to the local utility grid. The Company anticipates a demonstration of a commercial 1 MW fuel cell stack design in 2000, followed by a complete power plant demonstration as well as initiation of commercial sales in 2001. Achieving these time tables are subject to risks and uncertainties. See "Introductory Statement - Forward-looking Information Disclaimer" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Recent market research has indicated that the demand for fuel cell power plants from early commercial adopters of the technology may be greater in the sub-MW size than the larger sizes. To meet that demand, the Company plans to take advantage of its license rights to the "Hot Module" fuel cell developed by MTU. See "Fuel Cell Licenses". This nominal 250kW design, which incorporates the Company's fuel cell stacks, uses an innovative integration of some of the elements of the balance-of-plant into the fuel cell stack module itself, with the expectation of reducing costs to the power plant as a whole. The design is very compact and specially suited for cogeneration applications. During 1999, the Company expects to deliver fuel cell assemblies to MTU for a field demonstration of the Hot Module design at a municipal utility in Germany. In calendar 2000, the Company expects to demonstrate a Hot Module unit in the United States. Principal Development Contracts The Company's revenues have been principally derived from U.S. government and industry research and development contracts and license fee income. Government funding provided approximately 75%, 92% and 97% of revenues in fiscal 1996, 1997 and 1998, respectively, principally by the DOE. Because the Company receives a significant portion of its revenues from contracts and subcontracts with the DOE and other government agencies, future revenues and income of the Company could be materially affected by changes in procurement or appropriation policies, a reduction in expenditures for the services provided by the Company, and other risks generally associated with government contracts and cooperative agreements. The Company performs its services under contracts or agreements that usually require performance over a period of one to five years. However congressional budget limits could prolong the contracts. In general, the Company's contracts or agreements may be terminated, in whole or in part, at the convenience of the Government. Virtually all government contracts are funded annually based on administrative recommendations and annual congressional appropriations. Regardless of the terms of the Company's government contracts, the Company can only receive up to the appropriated funds made available to the Company. The Company has been working on the development of its Direct Fuel Cell technology under contracts since 1977, with various government agencies in addition to the DOE, including the Department of Defense, the Defense Advanced Research Projects Agency ("DARPA"), and the National Aeronautics and Space Administration ("NASA"). 7 The Company currently receives its government funding primarily under a long-term Cooperative Agreement with the DOE. The original agreement covered a 5-year project which commenced in the first fiscal quarter of 1995 and had an estimated value of $78 million, excluding cost-share funding by the Company and other private sector sources. The DOE Cooperative Agreement covers the design, scale up, construction and testing of direct carbonate fuel cells operating on natural gas. Major development emphasis under this agreement focuses on fuel cell and total power plant cost reduction and improved endurance. The present estimated value of the DOE Cooperative Agreement is $86 million, excluding cost share funding, with $20.2 million of work remaining to be performed as of October 31, 1998. The term of this contract has been extended to December 2000. The Company's expected 1999 funding allocation from DOE is $15.7 million subject to government appropriations "See Introductory Statement - Forward-looking Information Disclaimer." The Company has requested additional funds from DOE and an extension of the term of the contract in order to complete the development and conduct planned field trials of its commercial fuel cell stack design products. The Company and its partners have been providing significant cost-share funding for the project covered by this contract. The Company is also seeking additional funding from potential customers and other private sector organizations which will be necessary to complete the project as planned, even if additional funds from DOE are obtained. In addition to the activities listed above, the Company has been active in soliciting other business from industry and government organizations. The Company has been working on Direct Fuel Cell power plants for marine applications under contracts with the U.S. Navy and U.S. Coast Guard. These power plants are required to operate on liquid fuels such as diesel. Initial feasibility of using diesel in Direct Fuel Cell has already been demonstrated. In 1998, the Navy added $3 million to its original $1.6 million contract. Under this contract, the Company has already produced clean fuel-cell compatible fuel from marine diesel in a compact fuel processing system. In 1999, subscale fuel cell stacks will be tested on this clean fuel under conditions simulating marine requirements. The Company also has received several Small Business Innovative Research grants and research contracts from various organizations to explore advanced concepts or new applications of fuel cells. Fuel Cell Licenses The Company has entered into international licensing agreements with several major corporations. Generally, the Company has reserved for itself the exclusive rights to manufacture and sell carbonate fuel cells in North America. The licensees pay annual license fees to the Company and royalties on equipment sales. The Company has benefited from its licenses and has received and generally expects to continue to receive valuable technical and manufacturing information from its licensees. By coordinating its own development program with the extensive effort of its partners, it has leveraged its own efforts substantially. DaimlerChrysler subsidiary MTU-Friedrichshafen GmbH ("MTU"). In 1989, the Company entered into a license agreement (the "MTU Agreement") with DASA, a German aerospace and aircraft equipment manufacturer and a subsidiary of Daimler Benz Corporation, one of the largest industrial companies in Europe. That agreement was transferred to a subsidiary of DASA, MTU Friedrichshafen in 1993, and, in 1994, MTU became a subsidiary of AEG Daimler Benz Industries, now DaimlerChrysler. Pursuant to the terms of the MTU Agreement, the Company has granted to MTU an exclusive license to use, develop and sell carbonate fuel cells in Europe, subject to certain rights of others, and a non-exclusive license in South America, the Middle East and Africa, subject to certain rights of the Company and others. MTU has agreed to conduct research, development, manufacturing and marketing programs in the area of carbonate fuel cell technology and to make the results available to the Company on a royalty-free basis. In addition, MTU has agreed to pay to the Company an annual license fee through at least 1999, with an option for MTU to extend, and a royalty based on kilowatts of electrical generating capacity using carbonate fuel cells made or sold by MTU or its permitted licensees. In July 1992, MTU, formed a European consortium (ARGE) including RWE AG, the largest electric utility in Germany, Ruhrgas AG, the largest natural gas supplier in Germany, Elkraft Power Co. Ltd. (Elkraft), a large Danish utility, and Haldor Topsoe A/S, a Danish industrial company. The intent of the consortium is to spend approximately 130 million Deutsche Marks ($90 million), over a nine year period on further development, 8 demonstration and commercialization of the Company's carbonate fuel cell technology. Certain individual members of the consortium, including MTU, Elkraft and Haldor Topsoe A/S, have conducted carbonate fuel cell activities on their own utilizing the Company's technology. The activities of this group complement the Company's efforts to design and manufacture natural gas and coal gas fueled carbonate fuel cell systems based on the Company's designs. During 1998, MTU designed and built a 250 kW cogeneration fuel cell unit (the "Hot Module"), which incorporates the Company's fuel cell stacks, uses an innovative integration of some of the elements of the balance-of-plant into the fuel cell stack module itself, with the expectation of reducing costs to the power plant as a whole. The design is very compact and especially suitable for cogeneration applications. In July 1998, the Company entered into a Cross-Licensing and Cross-Selling Agreement with MTU pursuant to which MTU and the Company have granted to each other the right to manufacture and sell each other's stationary power fuel cell products in their respective regions. The Company therefore has the right to manufacture and sell fuel cell power plants based on MTU's Hot Module in North America; MTU has the right to sell fuel cell power plants based on the Company's larger 1.25 MW base module in Europe. Each company will pay the other royalties based upon sales. During 1999, the Company expects to deliver a fuel cell stack to MTU for a field demonstration of the Hot Module design at a municipal utility in Bielefeld, Germany. In calendar 2000, the Company expects to demonstrate a Hot Module unit, using a Company-manufactured fuel cell stack, in the United States at a site to be determined in 1999. MTU buys its fuel cell assemblies from the Company and has ordered fuel cell assemblies from the Company for three other power plants to be delivered in 1999 and 2000. The Company anticipates that MTU will continue to purchase fuel cell assemblies from it for the foreseeable future. Mitsubishi Electric Corporation ("MELCO"). In November 1981, the Company and MELCO, a Japanese electronics and electric equipment manufacturer entered into a license agreement relating to carbonate fuel cell technology. This agreement is automatically extended yearly unless canceled by either party in advance. Under this agreement, the Company has granted to MELCO an exclusive license to utilize the Company's patents and know-how for carbonate fuel cells in Japan, South Korea, and certain other Asian countries. The Company has also granted to MELCO a non-exclusive license in the other countries of the world, except for certain countries including the United States. MELCO has granted to the Company a royalty-free license to use the improvements developed by MELCO for carbonate fuel cells in the United States, Canada and Mexico. The Company receives an annual license fee from MELCO and is to be paid a royalty based on kilowatts of electric generating capacity using carbonate fuel cells made or sold by MELCO. MELCO is designing and constructing a 200 kW power plant at a Japanese utility site incorporating Direct Fuel Cell technology, which is planned to be operational in 1999. Electric Power Research Institute ("EPRI"). In 1988, the Company entered into a license agreement with EPRI, granting the Company the right to use carbonate fuel cell proprietary data developed under certain EPRI contracts with the Company. The Company has agreed to pay EPRI a one-time fee of approximately $50,000 upon the Company's first commercial sale of a carbonate fuel cell stack of one megawatt or larger in size, and a royalty of 0.5% to 1% upon commercial sales of carbonate fuel cell stacks. Santa Clara. In 1993, the Company obtained an exclusive license with rights to sublicense through the year 2005 to use the balance of plant design for the Santa Clara Plant. The license becomes non-exclusive after 2005 or earlier, at the option of Santa Clara, if the Company does not meet certain commercialization milestones. In addition, beginning three years after commencement of production of fuel cells at a commercial scale manufacturing plant, the Company is required to make royalty payments of up to $15 per kilowatt subject to consumer price index and other adjustments on sales of fuel cell power plant stacks of capacities of 100 kilowatts or more. U.S. Department of Energy ("DOE"). In connection with certain contracts and grants from DOE, the Company has agreed to pay DOE 10% of the annual license income received from MTU, up to $500,000. 9 Fuel Cell Markets The Company expects to sell its direct fuel cell power plants for distributed generation applications to four principal customer groups. These include: (i) small municipal electric utilities and rural electrical utilities, (ii) large electric utilities, (iii) end users and (iv) retail companies. There are approximately 2000 municipally or cooperatively owned public utilities in the United States representing 90,000 megawatts or more than 10% of the United States Electric Utility market. The Company believes that due to efficiencies, which can be achieved at fuel cell power plants as small as one or two megawatts, its plants could provide a cost-effective means for small municipal utilities to generate their own power. Large utilities are interested in fuel cell power plant technology primarily as an efficient, low pollution and cost-effective dispersed generator. Since fuel cells can be located at, or in place of, distribution and transformer stations, they may provide greater flexibility in the transmission and distribution of electricity. The modular aspects of fuel cells may also allow larger utilities to introduce phased capacity construction into their generation system. In this approach, the utilities could expand electricity generation capacity to keep pace with demand by adding blocks of fuel cells on a periodic basis as required, thereby improving cash flow as compared with building a single large plant. End users such as hospitals, military bases, schools, shopping centers and office buildings have already emerged as early adopters of distributed generation mainly in the form of cogeneration, the combined utilization of heat and electricity generated by the power plant. The high operating temperature of the Company's direct fuel cell provides an advantage in these applications. The Company believes as much as 70% of the early market for distributed generation may come from end users. The Company, using a consultant (ERI Services, of Hartford, Connecticut), has identified cogeneration markets where credits for waste heat could be used to reduce the cost of electricity produced. Markets in 11 states were characterized as a function of selling price from $1,000 to $3,000/kW for units for applications of between 1 and 5 MW. The study indicated a potential market in these states of $15 billion at $1,500/kW and $7 billion at $3,000/kW. Retail companies selling energy services to end-users are expected to emerge as the result of deregulation of the electric utility industry. As markets open and customer's expectations increase, retail companies will offer a comprehensive slate of services. Distributed generation technologies offer a flexible tool for this purpose and industry experts expect that within 10 years energy retailers will purchase up to 60% of all new distributed generation equipment. In 1998, the Company engaged Fletcher Spaght to further define the market for distributed generation. The Company believes, as a result, that the combined available U.S. and European market for distributed generation will reach 8000 MW per year by 2001 and 10,000 MW by 2006. This study also verified the need to broaden the Company's product line to include a submegawatt (250-300kW) power plant. The Company has been working since 1990 with a group of utilities, called the Fuel Cell Commercialization Group (the "FCCG"). The purpose of the FCCG is to form a collaborative effort between the Company and a group of prospective buyers to advance the commercialization of the Direct Fuel Cell power plants. The Company has been working with this group to define power plants requirements, develop system planning models, construct a model contract for power plant purchases and to review power plant designs and other activities. Most of the group's work in these areas, as originally anticipated and planned in 1990, has essentially been completed. The group remained active in 1998 but with reduced participation. The FCCG is modifying its structure in response to the changing utility market by inviting newly emerging prospective buyers such as retail companies, end users and equipment manufacturers to participate. In addition to FCCG, the Company has been active in various trade associations to increase fuel cell awareness among the public, potential customers and legislators. The Company is targeting its initial commercialization efforts for niche stationary power applications. This is because the Company will not yet have gained the cost advantages of mass production. Therefore, the Company expects initial adopters to include those in regions where air pollution requirements are particularly strict, industrial and commercial users who can make use of the high quality waste heat for cogeneration purposes, customers with opportunity fuels such as landfill or digester gas, customers with a requirement for premium power quality, those seeking grid independence or those trying to solve grid transmission shortages and especially those customers who combine several of the above characteristics. The Company also expects to have early purchases 10 from utility and non-utility power producers who will purchase fuel cells to improve their knowledge of the technology with the intention of purchasing or leasing and servicing the equipment in the future. The Company is in active discussions with various utilities, other power producers and equipment suppliers regarding the purchase of its fuel cell products for applications such as those described above, although the Company can give no assurance that any of these discussions will result in equipment sales. Fuel Cell Competition Several companies in the United States are involved in fuel cell development. One of these companies, M-C Power Corporation, competes directly with the Company in the development of carbonate fuel cells but uses a different technical approach, which involves auxiliary equipment to convert fuel to hydrogen. In Japan, at least six manufacturers have demonstrated interest in developing and marketing carbonate fuel cells. One of these, Mitsubishi Electric Company, is a licensee of the Company (see licenses). Some have larger marketing and sales departments than the Company and a history of producing and selling electric generation equipment. Two Japanese companies have demonstrated extended operation of 100kW carbonate fuel cells and are planning to test a 1MW plant in 1999. In Europe, companies in Germany, Holland, Spain and Italy are actively engaged in carbonate fuel cell development and are potential competitors, although these efforts are not as well advanced as the progress of the United States and Japanese companies. The German activity through the Company's licensee MTU and its partners is by far the largest effort. Almost all of these companies are also significantly larger than the Company, possess greater financial resources and have established product lines in electric generation equipment and in other fields. In addition to the carbonate fuel cell, other types of fuel cells are also being developed by different companies worldwide. These fuel cells, generally referred to by the electrolyte medium they use, include phosphoric acid, polymer electrolyte and solid oxide systems. These fuel cells are in various stages of development and aim at different applications including stationary power, transportation and portable power. Only the phosphoric acid fuel cell system, developed by United Technology's ONSI Corporation is in advanced stages of development and has limited commercial sales. This system is significantly less efficient and is expected to be more expensive compared to the Company's Direct Fuel Cell. The Company must also compete with companies manufacturing more established combustion equipment, including various engines and turbines, which are currently in use and have established operating and cost features. The greatest competition comes from the gas turbine industry which recently has made good progress in improving fuel efficiency and reducing pollution in large size combined cycle natural gas fueled generators. Efforts are underway to extend these advantages to small size machines. The Company believes that in the small size units, under 5 MW, gas turbines will not be able to match its fuel cell efficiency or environmental characteristics. However, the Company can give no assurance that the Company will be able to compete with small gas turbines even if these machines have less desirable operating characteristics. See "Introductory Statement - Forward-looking Information Disclaimer." Nuclear power is expected to experience a decline in its share of the electricity market. Social and political hurdles make it virtually impossible to site new nuclear power plants in the U.S. at this time. Further, some of the nuclear plants operating today will not be economical in a competitive market due to high operating and maintenance costs. There are currently 110 nuclear units licensed, providing about 20% of electricity in the United States. DOE projects that, by 2020, 45 nuclear units will remain in service supplying about 8% of electricity in the United States. While hydroelectric power is not forecast to shrink as dramatically as nuclear power as a share of the market, it faces limited growth. The best domestic hydro opportunities have been exploited, and there is growing pressure from conservationists to remove some existing dams that obstruct the up-river journey of spawning salmon. The DOE's forecast projects slightly under 3% growth in hydroelectric capability by 2020. The Company is competing primarily on the basis of fuel cell efficiency, environmental considerations and cost. The Company believes that the carbonate fuel cell enjoys competitive advantages over other fuel cells including 11 higher efficiency, ease of operation, environmental quality and expected low cost. The Company believes it is more advanced in the development of carbonate fuel cells than other manufacturers. The Company can give no assurance that such advantages will continue or that the carbonate fuel cells being developed by the Company will be commercially successful. See "Introductory Statement - Forward-looking Information Disclaimer." Fuel Cell Manufacturing The Company manufactures fuel cells at its facility located in Torrington, CT. At present, the capacity of the plant is approximately 5 MW per year on a single shift basis. The Company is planning to increase the capacity of this plant by, purchasing equipment for certain elements of the manufacturing process which currently restrict the overall output of the facility. The Company will need to raise funds for this purpose. The first stage in this process is to raise the output capability to 50 MW per year. The Company estimates that the cost of this expansion will be approximately $16 million. Meanwhile, the Company is using existing funds to expand production capacity incrementally and to implement cost reduction and process improvement projects. See "Introductory Statement - Forward-looking Information Disclaimer" and Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." The Company believes that virtually all of the raw materials used in its products are readily available from a variety of vendors in the United States and Canada. However, certain manufacturing processes which are necessary to transform the raw materials into component parts for fuel cells are presently available only through a small number of foreign manufacturers. The Company believes that these manufactured products eventually will be obtainable from the United States suppliers as demand for these items increases. The Battery Group Industry Background A battery is an electrochemical apparatus used to store energy and release it in the form of electricity. There are two types of batteries, primary and rechargeable batteries, also known as secondary batteries. A primary, or disposable, battery is used until discharged and then discarded. A rechargeable, or secondary, battery can, after discharge, be recharged and used again. The Company's Ni-Zn batteries are designed to be rechargeable. No one battery system is ideal for all rechargeable applications. There are numerous performance variables which vary in importance by application. Each commercially available battery system is stronger in certain areas and weaker in others. Important variables include: voltage; energy capacity per unit weight (energy density); energy capacity per unit of volume (volumetric energy density); power or discharge rate capability (how rapidly energy can be drawn from the battery or specific power); cycle life and how this varies with discharge rate and depth of discharge; response to ambient temperatures; rate of self-discharge; shelf life in charged and discharged states; size, shape and design flexibility; time and other constraints on recharging; safety, environmental and disposal considerations; and various application-specific considerations. The needs of various battery applications place a different priority on these characteristics, and, thus, require different solutions. In addition, for each anode/cathode combination there are many alternative ways to design a battery, involving choices of electrolyte and electrode materials and how components are shaped and manufactured. Design choices involve trade-offs, and as a result improvement in one element of a battery's performance often comes at a sacrifice of another characteristic. A battery optimized for just one characteristic may not be competitive if its performance in other areas is inferior. The world battery industry totals approximately $33 billion of manufacturers' shipments, growing at 6-8% per year. This total includes primary batteries ($9.8 billion), motive power batteries ($2.1 billion), high performance rechargeable batteries ($6.1 billion) and starting, lighting and ignition batteries ($15 billion). These four major types of batteries are sold into a wide array of different markets, some of which the Company does not intend to enter. These different markets frequently require different battery systems and have different competitors. EVs and Motive: The Company estimates that the total worldwide market for electric vehicles ("Evs") and hybrid electric vehicles ("HEVs") and other motive power that could use the Company's batteries was $700 million in 1997; however, precise statistics are not available. The market for electric vehicles is now in the early stages of development and many of the vehicles on the road are prototypes. The market for EV's is predicted to grow rapidly 12 after the year 2000, and projections for annual growth rates for EV's and motive batteries are expected to accelerate from 7% annually from 1997-2002 to approximately 22% annually, reaching $8 billion of sales in 2007. Successful battery development has been a barrier to the emergence of a large EV market. Lead-acid batteries, while potentially cost effective, are too heavy to give adequate vehicle range. Other higher energy density battery systems including nickel metal-hybrid ("Ni-MH"), nickel cadmium ("Ni-Cd"), lithium-ion ("Li-ion") as well as Ni-Zn are being tested in vehicles. The Company believes that its Ni-Zn battery has adequate energy density to permit acceptable vehicle range and has the potential to be produced at lower cost than the most likely other contenders for the EV market. Recently, HEVs have also received more interest and development efforts. An HEV combines a battery/electric motor drive, which is typically used for acceleration to a predetermined speed, with an alternative drive system, such as a small internal combustion engine, which takes over when the power requirements are lower at steady highway speed. Toyota has reported mileages of greater than 60 mpg for its Prius HEV. HEVs are likely to use similar battery systems to EVs, albeit in smaller capacity battery packs. The other motive power applications for rechargeable batteries include scooters and bicycles; industrial trucks; neighborhood vehicles; golf carts; electric wheelchairs, and marine batteries. These markets are primarily supplied by lead-acid (and some Ni-Cd) batteries today. These markets have been grouped with EV's rather than automotive batteries because of their need for the deeper discharge (deep cycle) capability which is required in the EV/HEV markets. The motive power markets differ in their requirements, however. Target markets for the Company's battery include the electric bicycle market, particularly in China and the electric wheelchair market. The deep-cycle marine market values the benefit Ni-Zn offers in providing a multi-year life; the industrial truck market, in contrast, sees little benefit to weight savings as lead-acid batteries are used as counterweights. The Company believes its Ni-Zn technology is particularly well suited to motive power applications due to its combination of lower weight, higher specific power and acceptable cost compared to presently used batteries. High Performance and Other Rechargeable Batteries: The worldwide market for rechargeable batteries, excluding automotive, motive power and specialty battery systems, including applications such as power tools, emergency power and light, telephones and communications and computers and electronics, among others, is approximately $6.1 billion, growing at 7% to 8% per year. The growth rate of individual application markets varies widely, with the small cell, portable rechargeable markets generally representing the faster-growing sectors, resulting primarily from the continued development and proliferation of new portable electronic products. The market for portable rechargeable batteries consists of three major technologies and is measured on a per unit basis as follows: 1) Ni-Cd, presently approximately 62% of the market, 2) Ni-MH, approximately 31% of the market and 3) lithium-ion ("Li-ion"), approximately 7% of the market. Approximately 75% of all cells are assembled into battery packs for use in a variety of portable devices. Increasingly, these packs contain sophisticated electronics for power management and safety. Ni-Cd is the oldest commercialized rechargeable system in the market. Ni-Cd cells can be employed in battery packs without high-cost electronics and safety devices and enjoy a substantial price advantage over Ni-MH and Li-ion cells. In the last decade, Ni-Cd has increasingly been the subject of tightening environmental and workplace regulations and related pressures for recycling and mandatory collection due to the toxicity of cadmium as a principal component. However, pressures to enforce mandatory collection schemes or even to ban Ni-Cd have partially abated due to industry-wide recycling efforts. Although Ni-Cd will remain attractive in certain applications which do not experience a significant performance benefit from other technologies and are sensitive to their higher cost, industry analysts believe growth in this segment will remain relatively flat. Ni-MH technology, which typically offers a 25% to 40% advantage in energy density relative to Ni-Cd, was commercialized in the early 1990's. Because it employs a metal hydride electrode rather than a cadmium electrode, Ni-MH is considered an environmentally preferred technology and has increased its market penetration in several applications and geographic regions as a result of this attribute. However, Ni-MH cells and batteries typically carry a substantial cost premium relative to Ni-Cd. 13 Li-ion battery technology was also commercialized in the early 1990's. Production of Li-ion cells has increased from 15 million cells in 1994 to an estimated 200 million cells in 1997. Li-ion technology offers the highest energy density of all commercial rechargeable technologies on the market today. On a weight basis, the technology offers 2 to 3 times the energy content of Ni-Cd and offers higher voltage (3.6 volts per cells) than Ni-MH or Ni-Cd (1.2 volt) technologies. Lithium-based technologies are expected to experience high growth rates. Li-ion cells and batteries are expected to continue to be more expensive than the Company's Ni-Zn cells. Ni-Zn technology is in the early stages of commercialization by the Company. Ni-Zn cells can be employed in battery packs without high-cost electronics and safety devices. Ni-Zn cells are considered the safest and most environmentally benign of the rechargeable technologies available today. The Company expects Ni-Zn to enjoy a substantial price advantage over Ni-Cd, Ni-MH and Li-ion battery systems, assuming high volume production levels. Ni-Zn cells offer a 30% volts per cell advantage over Ni-MH and Ni-Cd. The Company believes that Ni-Zn's greatest benefits will be in rechargeable battery markets that require a high specific power (i.e., a high wattage capability per unit of weight), high specific energy (i.e., a high capacity per unit) and a favorable cost, such as EV/HEV, power tools, bicycles and neighborhood transportation. Ni-Zn also offers a weight advantage over current starting, lighting and ignition batteries, due to its higher specific energy, as well as other performance advantages which the Company believes may be of only minor benefit to automotive OEMs. The Company's Ni-Zn batteries are being tested by a European automotive OEM for use in higher voltage electrical systems for vehicles. These benefits may offset the moderately higher cost of Ni-Zn. The success of the Company in capturing a market share in the starting, lighting and ignition market will depend on, among other factors, the timing and degree to which automotive manufacturers adopt these higher voltage electrical systems. The Company's Ni-Zn Batteries The Company's Battery Group is engaged in the development and commercialization of an innovative, patented, nickel-zinc ("Ni-Zn") rechargeable battery. The Company believes that its Ni-Zn battery technology offers high energy density and low material costs, resulting in a low weight, high power battery with a substantial price advantage over other comparable technologies. The Company's Ni-Zn battery has been used on a limited test basis in a range of rechargeable battery applications, including bicycles, scooters, electric vehicles, trolling motors for boats, and lawn mowers. The Company also believes that its Ni-Zn battery may be used in other rechargeable battery applications, including electric wheelchairs, golf carts, power tools, and consumer and electronic products. Use of the Company's proprietary process in the construction of Ni-Zn batteries has the additional advantage of having very low environmental impact compared to lead-acid or Ni-Cd batteries. The Company intends to commercialize its Ni-Zn technology through a combination of direct sales, licensing agreements and joint venture relationships. The Company's Ni-Zn battery combines a low-cost, light-weight nickel electrode with the high-energy of environmentally benign zinc to produce a rechargeable battery having a voltage 30% higher and an energy density per unit weight approximately 30% greater than that of conventional Ni-Cd batteries. In tests conducted by the Company, the Company's batteries have approximately 600 deep discharge cycles and approximately 11,000 shallow discharge cycles. The rechargeable Ni-Zn battery was first patented in 1923. During the early 1980's extensive research and development efforts were made by others to develop a Ni-Zn battery with a satisfactory cycle life; these efforts were not successful. More recently, the Company has solved many of the problems which had been associated with the short cycle life. Patents have been granted to the Company in which the zinc electrode solubility (shape change) has been greatly reduced and construction features provide for a sealed maintenance-free construction. In tests conducted by the Company, the Company's batteries have achieved over 600 charge-discharge cycles with only a 20% loss in capacity. The Ni-Zn cell developed by the Company consists of layers of positive (nickel) electrodes and negative (zinc) electrodes separated by both electrolyte absorptive layers and microporous separator layers. The Company plans to manufacture a range of cells in various energy capacities. These cells can then be arranged in series and packaged 14 to produce convenient voltages, such as typical 12 volt blocks. The Company is supplying demonstration batteries to various potential customers for evaluation and is conducting in-house testing of its batteries for electric vehicles, electric bicycles and scooters. The EV batteries are being evaluated in a European vehicle produced in Germany and are also being supplied for evaluation to another European vehicle produced in Norway. The batteries being evaluated in these vehicles have both recently undergone successful preliminary testing, achieving ranges for these vehicles approximately 2.5 times greater than that produced by lead acid batteries of approximately equivalent weight. Also, batteries are being supplied to an Italian company for electric scooters and to several start-up electric bicycle companies in the United States. The Company is also working with bicycle companies in China through the Company's joint venture partnership in Xiamen, China (Xiamen Three Circles-ERC Battery Corp., Ltd.) to begin manufacture of the Company's batteries which is currently anticipated to begin on a small scale in late fiscal 1999. The Company operates an extensive test facility for evaluation of all the various size cells and modules being manufactured. At any given time there are usually over 300 cells and batteries being life-tested by the Company. To further commercialize its Ni-Zn technology, the Company intends to pursue a range of battery markets, each of which has performance requirements aligned with the benefits Ni-Zn offers. However, since these markets range from moderately-sized, current battery applications to large future markets, such as electric vehicles, the Company intends to pursue a range of business strategies. To capitalize on these opportunities, the Company plans to manufacture and sell directly to OEMs, as well as continue to enter into joint venture agreements, and license its technology to larger organizations with established manufacturing or distribution capabilities in specific markets. Electric vehicles and hybrid electric vehicles and a range of motive power applications are significant potential markets for the Company's Ni-Zn battery. The Company believes that markets for the Ni-Zn battery include the existing markets for Ni-MH and Ni-Cd, such as power tools, high-end portable lighting, and consumer and electronic products. In addition, the Ni-Zn battery has the potential to compete in the upper cost segment of the lead acid battery markets where it would enjoy a substantial weight advantage. Partnerships, Joint Ventures and Licenses Corning, Inc. In January 1997 the Company entered into a license agreement with Corning, Inc. to continue the development of the Ni-Zn battery and to manufacture and market batteries worldwide. This license was exclusive for all applications with the exception of EV/HEVs for which the Company retained all rights. After approximately one and one-half years and having successfully validated the performance of the Company's technology, Corning decided for strategic business reasons to discontinue its development of certain energy related products, including the Company's batteries, and as a result discontinued the license agreement with the Company. This has allowed the Company to seek business opportunities which had previously been reserved exclusively for Corning. Nan Ya Plastics Corporation of Taiwan/ Xiamen Three Circles Co., Ltd.. In February 1998, the Company entered into a license agreement (the "NanYa License Agreement") with a joint venture between NanYa Plastics Corporation of Taiwan, a Formosa Plastics Group company, and Xiamen Three Circles Co., Ltd. of Xiamen, China for the use of the Company's Ni-Zn batteries in EV /HEVs in China, Taiwan, Hong Kong and Macao on an exclusive basis and for certain other Southeast Asian countries on a non-exclusive basis. The license agreement calls for the payment of $5 million in three stages and a royalty for the exclusive and non-exclusive territories. The payments include $1.5 million received by the Company in 1998, a further $2 million to be paid to the Company upon completion of certain conditions which the Company expects will occur in the second fiscal quarter of 1999, and a final payment of $1.5 million to be paid to the Company upon completion of duplication of the battery at its facilities in China. The NanYa License Agreement provides that the Company has the right to invest the final payment in equity in the joint venture manufacturing and sales organization formed between NanYa Plastics and Xiamen Three Circles Co., Ltd. Xiamen Three Circles-ERC Battery Corp., Ltd. In July 1998, the Company also entered into a Technology Transfer and License Contract (the "Three Circles License Agreement") with Xiamen Three Circles-ERC Battery Corp., Ltd. for the use of the Company's Ni-Zn batteries in electric bicycles, scooters, three-wheel vehicles, off-road vehicles, and miner's safety lamps in China on an exclusive basis and in Southeast Asia on a non-exclusive basis. The license included an initial payment to the Company of $3 million. Pursuant to the Three Circles License 15 Agreement, the Joint Venture must also pay the Company certain royalties based upon the net sales of Ni-Zn batteries sold, leased or transferred in the applicable territories. In addition the Joint Venture may sub-license the Company's technology to third parties in China, Hong Kong, Taiwan and Macao on a non-exclusive basis. In connection with the Three Circles License Agreement, the Company entered into a joint venture agreement with Xiamen Three Circles Co., Ltd., used this $3 million as its initial investment in the joint venture, and received a 50.5% share of the joint venture called Xiamen Three Circles-ERC Battery Corp. (the "Joint Venture"). The Company reserves exclusive rights for exporting batteries from the Joint Venture to other territories outside of the exclusive and non-exclusive field territories. The Company expects to use the production capability of this Joint Venture to produce batteries to sell to OEMs and distributors. Battery Sales and Marketing The Company intends to build a sales and marketing organization to focus on the following; - To generate direct sales to OEMs and distributors in selected applications and geographical territories. - To develop joint venture partnerships for manufacturing and distribution in applications and geographical territories for which the Company believes strategic partners can improve its chances of success. - To license its technology and know-how to strategic partners in applications and geographical territories for which the above two business models are not appropriate. The Company will focus its direct marketing efforts on those applications which represent specialty niches where the Ni-Zn battery technology has significant competitive advantages and where the channels of distribution are relatively narrow. An example of such an application is the electric wheelchair market. For those areas where broad distribution is required, the Company believes a joint venture manufacturing and/or sales partnership with companies who have a position in the distribution channels will be a more effective way to exploit the technology in a shorter amount of time. An example of such an application and a geographical area is the Company's license agreement and joint venture with Xiamen Three Circles Co., Ltd. for China and Southeast Asia. The Company intends to license its technology for those applications which require very large capital investment in manufacturing and very broad distribution channels, such as consumer electronics and power tools. Upon establishment of the core joint venture manufacturing and sales agreements, the Company expects to use the manufacturing capability of the joint ventures to sell directly to OEMs in other geographical territories. An example may be to use the China joint venture production capability for batteries for bicycles to satisfy the North American and/or European markets for these products. Battery Competition Competition in the battery industry is, and is expected to remain, intense. Competitors range from development stage companies to major domestic and international companies, most of which have financial, technical, manufacturing, marketing, sales and other resources significantly greater than those of the Company. There are at least two, and possibly more, other battery manufacturers in the world who have demonstrated interest in developing and marketing Ni-Zn rechargeable batteries. The Company does not perceive these competitors, who are significant battery producers, to be its prime competition as their technology development is believed to be less advanced than that of the Company. The Company expects to be competing against suppliers of lead-acid, Ni-Cd, Ni-MH, and lithium rechargeables, as well as other rechargeables and potentially primary battery technologies. The Company is competing on the basis of battery performance, the price and economics of its batteries, as well as usage considerations (stability, safety, environmental). 16 Battery Manufacturing The Company has leased approximately 26,000 square feet of space in Danbury, Connecticut, to be used as a small-scale manufacturing plant for Ni-Zn battery production and for office space. The small-scale Ni-Zn manufacturing plant will be designed to be flexible enough to produce batteries for the different markets which will be pursued. Different size batteries will be produced by combining different numbers of a common cell design into varying combinations of cells in series and parallel arrangements. The intended flexibility precludes investment in a completely automated facility which would have the potential for the lowest direct labor cost per unit. As the markets for higher volume batteries are proven, the Company intends to progressively automate production to reduce production costs. All the materials required to manufacture the Company's Ni-Zn battery are readily available from multiple sources in North America. The Company's principal raw materials for the production of its battery products are nickel and zinc. Prices for both nickel and zinc, as commodities, are subject to market forces beyond the control of the Company. Research and Development Most of the Company's research and development has been funded by the Company's government contracts, therefore, research and development expense has been included in the Company's "cost of revenues" and not in its "research and development expense". In addition, the Company has incurred discretionary research and development expense under its government contracts for both fuel cell and battery development which has been included in "research and development expense" although it, too, has been reimbursed fully under the government contracts. During fiscal 1996, 1997 and 1998, 100% of the Company's research and development was funded by customers, including approximately $1.26 million, $1.27 million and $2.26 million, respectively, of discretionary independent research and development expense. During 1998 the Company also formed a joint venture with the City of Xiamen, China called Xiamen-ERC Technology Company, Limited. This Joint Venture has been formed to fund other entities, such as Xiamen University, to conduct research in advanced electrochemical technologies, which will benefit the Company and Xiamen. The Company has invested $400,000 of capital into this Joint Venture which is two-thirds owned by the Company. Proprietary Rights The Company relies primarily on a combination of copyright and trademark laws, trade secrets, patents, confidentiality procedures (including, in some instances, the encryption of certain technical information) and contractual provisions to protect its proprietary rights. The Company has obtained patents and will continue to make efforts to obtain patents, when available, in connection with its technologies. The Company can give no assurance that any patent obtained will provide protection or be of commercial benefit to the Company, or that its validity will not be challenged. The Company also seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which may afford only limited protection. The Company presently has 73 United States patents (expiring between 1999 and 2017), including 4 obtained in 1998, and 6 pending United States patent applications, including 3 filed in 1998, as well as 117 patents in certain foreign jurisdictions, including 2 obtained in 1998, and 19 pending patent applications, including 1 filed in 1998, in certain other jurisdictions, principally in Europe, South America, and Japan. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's technology or to obtain and use information that the Company regards as proprietary. The laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as do the laws of the United States and, because of the Company's significant international presence, the Company can give no assurance that the Company will be able to protect its proprietary rights in the jurisdictions in which it conducts business or into which it licenses its technology or in which products incorporating its technology are manufactured and sold. The Company can give no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology. 17 In addition, the Company can give no assurance that the Company's pending patent applications or any future applications will be approved, that any patents will provide it with competitive advantages or will not be challenged by third parties. Others may have filed and in the future may file patent applications that are similar or identical to those of the Company. The Company can give no assurance that any such patent application will not have priority over patent applications filed by the Company. Further, any determination that the Company's products or manufacturing processes have infringed on the product or process rights held by others could have a material adverse effect on the Company's business and results of operation. The Company has not filed for patent protection for most of its patents in certain potential major markets such as India, China and Southeast Asia. Agreements reached with partners in these areas would have to be based on trade secrets and know-how. In the future, the Company may seek patent protection in those areas. Many of the Company's United States patents were the result of government-funded research programs. The Government does not impose significant restrictions on the Company's use of government-sponsored patents, except that military and national security applications of technology remain the property of the United States Government. Patents of the Company that were the result of government-funded research prior to January 1988 (the date the Company qualified as a small business under applicable government regulations) belong to the Government unless the Government waives its rights to these patents. In most cases, what the Company has obtained is owned by the United States Government. The Company has received a license to use these patents, which is revocable only in the limited circumstances where it has been demonstrated that the Company is not making an effort to commercialize the invention. Patents resulting from government-funded research after January 1988 automatically belong to the Company because of its small business status. In both instances, however, the Government retains a royalty free right to use the patents for government purposes. In addition, the Government may take title to the patents and may license the patented technology to others if the Government believes that the Company is not utilizing the patents. A number of the Company's patents are subject to such rights. The Company believes, however, that the likelihood of the Government exercising these rights is very small and would only occur if the Company ceased its commercialization efforts. Government Regulation The Company presently is, and its fuel cell power plants will be, subject to various federal, state and local laws and regulations relating to, among other things, land use, safe working conditions, handling and disposal of hazardous and potentially hazardous substances and emissions of pollutants into the atmosphere. To date, the Company believes that it has obtained all necessary government permits and has been in substantial compliance with all of these applicable laws and regulations. Pursuant to the National Environmental Protection Act (NEPA), since 1991, each local Department of Energy procurement office must file and have approved by the Department of Energy in Washington, DC, appropriate documentation for environmental, safety and health impacts with respect to procurement contracts entered into by that local office. The costs associated with compliance with environmental regulations are generally recoverable under the Company's cost reimbursable contracts. In certain cases, contract work may be delayed until the approval is received. Employees As of December 31, 1998, the Company had 165 full-time employees, of which approximately 83 were engineers, scientists, and other degreed professionals and 82 were professional, technical, administrative and manufacturing support personnel. The Company considers relations with its employees to be good. The loss of key employees could cause delays in completing contracted work and development and commercialization activities. 18
Executive Officers of the Registrant The executive officers of the Company and their ages are as follows: NAME AGE POSITION WITH THE COMPANY ---- --- ------------------------- Jerry D. Leitman 56 President and Chief Executive Officer Dr. Hansraj C. Maru 54 Executive Vice President and Director Christopher R. Bentley 56 Executive Vice President and Director Joseph G. Mahler 46 Vice President, Chief Financial Officer, Treasurer & Corporate Secretary
Jerry D. Leitman has been President, Chief Executive Officer and a Director of the Company since August 1997. Mr. Leitman was previously President of ABB Asea Brown Boveri's global air pollution control businesses from 1992 to 1995. Prior to joining ABB Mr. Leitman was Group Executive Vice President of FLAKT AB, a Swedish multinational, responsible for FLAKT`s worldwide industrial businesses from 1989 to 1992. Mr.Leitman is also a Director and a member of the Audit Committee of Esterline Technologies Inc. Mr. Leitman obtained both a BS and MS in Mechanical Engineering from Georgia Institute of Technology in 1965 and 1967 respectively. Dr. Hansraj C. Maru has been Executive Vice President and a director of the Company since December 1992. Dr. Maru was Chief Operating Officer of the Company from December 1992 to December 1997. Prior to that he was Senior Vice President-Research and Development of the Company. Dr. Maru joined the Company in 1977. Prior to joining the Company, Dr. Maru was involved in fuel cell development at the Institute of Gas Technology. Dr. Maru received a Ph.D. in Chemical Engineering from the Illinois Institute of Technology in 1975. Christopher R. Bentley has been a director of the Company since June 1993 and Executive Vice President of the Company since September 1990. Mr. Bentley was President of Fuel Cell Manufacturing Corporation, a subsidiary of the Company, from September 1990 to December 1997. From 1985 through 1989 he was Director of Manufacturing (1985), Vice President and General Manager (1985-1988) and President (1988-1989) of the Turbine Airfoils Division of Chromalloy Gas Turbine Corporation, a major manufacturer of gas turbine hardware. Mr. Bentley received a BSME from Tufts University in 1966. Joseph G. Mahler joined the Company in October 1998 as Vice President, Chief Financial Officer, Corporate Secretary and Treasurer. Prior to joining the Company, Mr. Mahler was Vice President-Chief Financial Officer at Earthgro, Inc. from 1993 to 1998 and prior to that, he was a partner at Ernst & Young. Mr. Mahler received a B.S. in Accounting from Boston College in 1974. Significant Employee Allen Charkey has been Executive Vice President and Chief Operating Officer of Evercel, Inc., the subsidiary of the Company formed to operate the Company's battery group, since October 1988 and a director of Evercel, Inc. since its formation in June 1998. He joined the Company in 1970 and has held various positions of increasing responsibility at the Company since then. Prior to joining the Company, Mr. Charkey was employed by Yardney Electric Corporation from 1963 to 1970 as a battery scientist. Item 2. PROPERTIES The Company currently owns and occupies approximately 72,000 square feet in two interconnected single story buildings on 10.8 acres, of which approximately 5.4 acres are currently used, in Danbury, Connecticut. For specific information with respect to the mortgage on the Danbury, CT facility, see Note 6 to consolidated financial statements. Additionally, ERC has leased a 63,000 square foot facility in Torrington, Connecticut for its manufacturing operations. The lease expires February 1, 2001, however, the Company is currently negotiating to extend the term of this lease. The annual lease cost of the Torrington facility is approximately $325,000. The 19 Company is leasing approximately 28,500 square feet of space in Danbury, Connecticut, to be used as a small-scale manufacturing plant for Ni-Zn battery production and for office space. The annual lease cost in Danbury, Connecticut is approximately $171,000. The Company believes that its facilities are adequate for its current operations. Item 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of securities holders during the fourth quarter of the fiscal year covered in this report. PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock (Common Stock), par value $.0001, has been publicly traded since June 25, 1992. From September 21, 1994 through February 25, 1997 the Common Stock traded on the Nasdaq National Market ("NASDAQ") and since February 26, 1997 the Common Stock has traded on the American Stock Exchange ("AMEX") under the symbol "ERC". On January 26, 1999 there were approximately 1,833 common stockholders of record.
The following table sets forth the range of high and low prices of the Common Stock on the AMEX and NASDAQ for the fiscal quarters indicated, as reported by AMEX and the NASDAQ. Year Ended 10/31/98 High Low - ------------------- ---- --- First Quarter $17.438 $12.750 Second Quarter 29.000 14.875 Third Quarter 24.500 17.250 Fourth Quarter 18.250 9.500 Year Ended 10/31/97 High Low - ------------------- ---- --- First Quarter $15.625 $9.750 Second Quarter 13.000 9.375 Third Quarter 10.750 8.500 Fourth Quarter 20.500 9.375
The Company has never paid any dividends on its Common Stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently anticipates retaining all of its earnings to finance future growth. Under the terms of the Company's Loan Agreement with First Union Bank of Connecticut, the Company may not, without the written consent of First Union Bank, declare or pay any dividend. 20 Item 6. SELECTED FINANCIAL DATA The following selected consolidated financial data presented below as of the end of each of the years in the five-year period ended October 31, 1998 have been derived from the audited consolidated financial statements of the Company together with the notes thereto included elsewhere in this Report (the "Consolidated Financial Statements"). The data set forth below is qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Report.
STATEMENT OF OPERATIONS DATA (in thousands, except share and per share data) 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Net Sales $ 24,318 $ 24,830 $ 29,446 $ 33,955 $ 30,084 Gross Profit 9,728 9,188 8,551 7,696 8,020 Operating Expenses: Administrative & Selling 6,986 6,081 4,858 4,513 4,730 Depreciation 1,529 1,768 1,919 1,801 1,663 Research & Development 2,258 1,270 1,260 944 1,348 Operating income (loss) (1,045) 69 514 438 279 Interest & other income, net 267 307 442 317 148 Interest expense (269) (354) (503) (459) (435) License fee income net 678 650 357 357 364 Income (loss) before income taxes (369) 672 810 653 356 Income tax expense 13 247 301 211 136 Net income (loss) ($ 382) $ 425 $ 509 $ 442 $ 220 --------- --------- --------- --------- --------- Basic earnings (loss) per share $ (0.09) $ 0.11 $ 0.13 $ 0.12 $ 0.06 Basic shares outstanding 4,081,018 3,954,507 3,796,320 3,714,490 3,692,705 Diluted earnings (loss) per share $ (0.09) $ 0.10 $ 0.13 $ 0.11 $ 0.06 Diluted shares outstanding 4,081,018 4,191,830 4,063,061 3,972,281 3,923,925 BALANCE SHEET DATA Working capital $ 10,234 $ 6,366 $ 8,087 $ 8,216 $ 7,619 Total assets 26,843 21,433 23,540 23,847 22,515 Long-term debt 1,944 2,699 4,363 6,487 5,839 Total shareholders' equity 15,870 14,769 14,062 12,238 11,685
21 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company obtains its revenues primarily from government, industry funded research and development contracts and license fees. These contracts are generally multi-year, cost reimbursement type contracts The majority of these are United States Government contracts which are dependent upon the government's continued allocation of funds. Under a cost-reimbursement contract, the Company is reimbursed for reasonable and allocable costs of the materials, subcontracts, direct labor, overhead, general and administrative expenses, independent research and development costs, and bid and proposal preparation costs, provided the total of such costs do not exceed the reimbursement limits set by the contract. In addition, some of these contracts bear a fixed fee or profit. The profitability of these contracts to the Company depends upon charging direct costs to contracts, maintaining adequate control of overhead costs and general and administrative expenses so they do not exceed the approved billing rates, and limiting the aggregate reimbursable costs to the allowable amounts set by the contract. In addition to cost reimbursement contracts, the Company enters into firm fixed-price contracts and cost-sharing type contracts. In performance of a firm fixed price contract, the Company is paid the price that is set in advance without regard to the costs actually incurred in performance, subject to certain excess profit limitations. In a cost sharing type contract, the Company agrees in advance to contribute or cause to be contributed an agreed upon amount of funds, third party services or in-kind services toward fulfilling the objective of the contract. Except for the Company's cost contributions, the contract operates in substantially the same manner as a cost reimbursement type contract. At present, most of the Company's contracts are cost shared and no fee or profit is allowed. The government contracts and agreements provide for a cost-of-money recovery based upon capital investment in facilities employed in contract performance. Since 1983, when the Company began to shift its emphasis from fuel cells for military use to commercial applications, the Company's primary focus has been researching and developing carbonate fuel cells. The funding received for this research has represented a substantial portion of the Company's revenues. The Company will continue to seek research and development contracts for all its product lines. To obtain contracts, the Company must continue to prove the benefits of its technologies and be successful in its competitive bidding. Failure to obtain these contracts could have an adverse effect upon the Company. Because the Company receives a significant portion of its revenues from contracts with the Department of Energy and other government agencies, future revenues and income of the Company could be materially affected by changes in government agency procurement policies, a reduction in expenditures for the services provided by the Company, and other risks generally associated with government contracts. In general, the Company's government contracts may be terminated, in whole or in part, at the convenience of the government. A reduction or delay in the Company's government funding could have a material adverse effect on the Company's ability to commercialize its fuel cell technology. In 1998, the DOE allocated approximately $12,900,000 increasing the total DOE funding to $65,800,000 since inception. For the 1999 budget, $15,700,000 is expected to be allocated to the Company's DOE direct fuel cell cooperative agreement of which $3,500,000 was awarded in November 1998. Separately the Company received approximately $3,000,000 in additional funding on its Navy program for the development of a shipboard direct fuel cell. During 1998, the funding received for its major cooperative agreement was less than the amount anticipated due to a DOE budget shortfall. The Company adjusted its expenditures to the lower funding rates as it had done in prior years. The Company is currently reviewing 1999 expenditure levels based upon expected funding from DOE. The result of adjusting expenditure levels may cause delays on the work being performed under existing contracts, which inevitably cause delays in the Company's activities and commercialization schedule. 22 In 1998, the Company decided to accelerate the commercialization of its proprietary nickel-zinc (Ni-Zi) battery technology. On October 1, 1998, the Company announced that its Board of Directors had approved a plan to effect a spin-off to its stockholders of 100% of the shares of Evercel, Inc. In connection with this transaction, which is expected to occur in early 1999, the Company plans to transfer to Evercel the principal assets and liabilities related to the Battery Group. RESULTS OF OPERATIONS 1998 compared to 1997. Revenues decreased 2% to $24,318,000 in the 1998 period from $24,830,000 in the 1997 period. The decrease in revenues was primarily due to the final completion of all activities related to the Direct Fuel Cell power plant project in Santa Clara, California. The decline was partially offset by an increase in billings, as compared to fiscal year 1997, on the DOE Agreement and the contract with the U.S. Navy for the development of ship service fuel cells. Cost of revenues decreased 7% to $14,590,000 in the 1998 period from $15,642,000 in the 1997 period due to decreased revenues and partially offset by increased spending levels on research and development. Administrative and selling expenses increased 15% to $6,986,000 in the 1998 period from $6,081,000 in the 1997 period. The 1998 period reflects an increase in costs related primarily to the acceleration of the commercialization of the Ni-Zi battery technology. These included salary and fringe benefits, and legal and professional costs related to the creation of joint venture and licensing agreements with the Company's Chinese partner, the unconsummated acquisition of a battery manufacturing company, and the costs associated with the distribution and Rights offering in connection with the spin off of the Battery Group. These costs amounted to $400,000, $280,000, and $240,000, respectively. Depreciation expense decreased 14% to $1,529,000 in the 1998 period from $1,768,000 in the 1997 period. The decrease was substantially due to completion of the depreciation period for assets capitalized in 1992 related to the manufacturing facility in Torrington, which ended February 1, 1998. Research and Development expenses increased 78% to $2,258,000 in the 1998 period from $1,270,000 in the 1997 period. This was a result of increased costs as compared to fiscal 1997 relating to the commercialization of the battery technology amounting to $886,000 and to the development of fuel cell technology of $102,000. License fee income, net, increased 4% to $678,000 in the 1998 period from $650,000 in the 1997 period. Decreased income resulting from the termination of the Company's battery license with Corning in May 1998 was more than offset by increased license fee income from the Nan Ya license. Interest expense decreased 24% to $269,000 in the 1998 period from $354,000 in the 1997 period due to a decrease in the prime rate and the reduction of notes payable to MTU. Interest and other income, net, decreased 13% to $267,000 in the 1998 period from $307,000 in the period. The decrease resulted from lower interest rates on invested funds. The effective tax rate decreased to 3.6% in the 1998 period from 36.7% in the 1997 period. The primary reason for the difference in the rate is attributable to non-deductible expenses for tax purposes relating to the spin off of the Battery Group. 1997 compared to 1996. Revenues decreased 16% to $24,830,000 in the 1997 period from $29,446,000 in the 1996 period. The expected decrease in revenues was due primarily to the completion of the Santa Clara Plant. The decrease was partially offset by an increase in billings under the Company's other contracts. Cost of revenues decreased 25% to $15,642,000 in the 1997 period from $20,895,000 in the 1996 period. The decrease was due primarily to the completion of the Santa Clara Plant. Administrative and selling expense increased 25% to $6,081,000 in the 1997 period from $4,858,000 in the 1996 period. The 1997 period reflects an increase in various expenses including bid and proposal activity, employment costs, amortization and legal and professional fees. Depreciation decreased 8% to $1,768,000 in the 1997 period from $1,919,000 in the 1996 period. The decrease was due substantially to completion of the amortization of costs 23 associated with the Company's manufacturing facility. Research and development expense was relatively unchanged at $1,270,000 in the 1997 period and $1,260,000 in the 1996 period. Income from operations decreased 87% to $69,000 in the 1997 period from $514,000 in the 1996 period. The decrease was due primarily to the recovery of non-recurring costs associated with certain Company contracts in the 1996 period and the incurrence of certain non-recoverable employment related costs due to the hiring of a new chief executive officer in the 1997 period. The remainder of the decrease was due to the decrease in the revenues related to the completion of the Santa Clara Plant. License fee income, net, increased 82% to $650,000 in the 1997 period from $357,000 in the 1996 period. The increase was primarily due to the recognition of license income under the Company's battery license with Corning, Inc. Interest expense decreased 30% to $354,000 in the 1997 period from $503,000 in the 1996 period. The decrease was due primarily to the reduction of debt to MTU as a result of conversion of $666,000 of principal at $9 per share into common stock of the Company in fiscal 1996 and the repayment of $684,000 of principal during the first quarter of fiscal 1997. The decrease was also due to the Company refinancing its bank debt at more favorable terms during the third quarter of fiscal 1996. Interest and other income, net, decreased 31% to $307,000 in the 1997 period from $442,000 in the 1996 period. The decrease was primarily due to the use of cash for debt repayment during the first quarter of fiscal 1997. Liquidity and Capital Resources The Company has funded its operations primarily through cash generated from operations including government contracts and cooperative agreements, borrowings, and sales of equity. In 1998, the Company also received License FeeIncome of $1,500,000 from the Xiamen-Three Circles Co. (formerly Xiamen Daily-Used Chemicals Co.) and Nan Ya Plastics Corp. license agreement and $3,000,000 from the Xiamen-Three Circles Co. (formerly Xiamen Daily-Used Chemicals Co.) Agreement. The $3,000,000 was subsequently invested in the Joint Venture to obtain a 50.5% ownership position in the Joint Venture. At October 31, 1998, the Company had working capital of $10,234,000 including $10,304,000 of cash and cash equivalents, compared to working capital of $6,366,000 including $6,802,000 of cash and cash equivalents at October 31, 1997. The primary increase in cash is the result of investing the license fee of $3,000,000 received as part of the Three Circles License Agreement into the Joint Venture, and the exercise of stock options and purchase of stock under benefit plans of $858,000. During 1998, cash of $2,516,000 was provided from operations primarily from increased deferred income related to the license fees received from the Nan Ya License Agreement of $1,300,000 and depreciation and amortization of $1,942,000. Offsetting these increases was a $2,203,000 increase in current assets (excluding cash) primarily related to increased accounts receivable from the government, legal and professional expenses related to the spin off and Rights offering for Evercel, and an increase in deferred taxes related to the deferred license fee income and accrued incentive costs. Current liabilities increased $1,837,000 which includes deferred income of $1,300,000 from the Nan Ya License Agreement, expenses connected to the commercialization of the battery business, and increased incentive costs. These funds were used to acquire $1,650,000 in property, plant and equipment and retire $1,701,000 in debt. The Company's capital expenditures are incurred primarily to support ongoing contracts and to replace existing equipment. A portion of these expenditures was financed from the recovery of depreciation expense under cost-reimbursement contracts and cooperative agreements. During the 1995 period, the Company entered into a $2,500,000 credit facility with MetLife Capital Corporation, an affiliate of Metropolitan Life Insurance Company. The credit facility bears interest at the 30-day commercial paper rate plus 2.5 percent. The Company used the credit facility during 1995 and 1996 to acquire machinery and equipment for the Company's manufacturing facility in Torrington, Connecticut. Repayment of the credit facility commenced during the 1996 period and provides for repayment over 36-50 months. 24 During the 1996 period, the Company entered lending arrangements with First Union Bank of Connecticut, a subsidiary of First Union Corporation, which provide for (i) a $2,250,000 five-year term loan facility, which bears interest at a floating rate equal to 1.75 percent above London Interbank Offered Rates (LIBOR), and (ii) a $600,000 term loan facility to the Company's fuel cell manufacturing subsidiary, which bears interest at a floating rate equal to 1.75 percent above LIBOR. The term loan facility was fully repaid in 1998. In fiscal year 1990, the Company borrowed $1,980,000 from MTU at a rate of 6% per annum. The pledge of ERC stock and certain machinery, equipment and leasehold improvements at the Torrington, CT, facility, secured this loan. During fiscal 1996, $877,000 of this loan was converted into 97,397 shares of common stock of the Company. MTU extended the maturity of $630,000 of the loan to November 30, 1997 with the right to convert to common stock at $9 per share. During December 1997 the Company paid the entire balance of principal and interest due in the amount of $673,000. In December 1994, the Company entered into a Cooperative Agreement with the U.S. Department of Energy (DOE) pursuant to which the DOE agreed to provide funding to the Company over the next five years to support the continued development and improvement of the Company's commercial product. The current aggregate dollar amount of that contract is $144,000,000 with the DOE providing $86,000,000 in funding. The balance of the funding is expected to be provided by the Company, the Company's partners or licensees, other private agencies and utilities. Approximately 90% of the non-DOE portion has been committed or credited to the project in the form of in-kind or direct cost share from non-U.S. government sources. Failure of the Company to obtain the required final 10% of the funding from non-U.S. government sources on a timely basis, could result in delay or reduction of DOE funding. The Company will need to raise additional funds to expand its Direct Fuel Cell manufacturing capability. The first stage in this process is to raise the output capability of the Company's manufacturing facility to 50 MW per year. Approximately $16 million has been estimated for this step. The Company cannot assure that this funding will be available on favorable terms, if at all, or that such funding if obtained would enable the Company to achieve the desired output level. In the interim, the Company is using existing funds to expand production capacity incrementally. See "Introductory Statement - Forward-looking Information Disclaimer." The Company anticipates that its existing capital resources together with anticipated revenues will be adequate to satisfy its existing financial requirements and agreements through 1999. However, the Company may require additional capital beginning in 1999 if the aforementioned plan to expand manufacturing capability in its Torrington, CT facility is implemented. Proposed Evercel Spin-off On October 1, 1998, the Company announced that its Board of Directors had approved a plan to effect a spin-off to its stockholders of 100% of the shares of Evercel, Inc. ("Evercel"), a newly formed, wholly-owned subsidiary of the Company. In connection with this transaction, which is expected to occur in early 1999, the Company plans to transfer to Evercel the principal assets and liabilities related to the Battery Group. Following the transfer, the Company plans to distribute to its stockholders in a tax-free distribution one share of Evercel Common Stock for every three shares of Common Stock of the Company held. As of October 31, 1998, the Company had $1,175,000 of assets and $753,000 of liabilities attributable to the battery business that it intends to transfer to Evercel. In addition, in fiscal 1998, the Company's revenues and net loss attributable to the battery business were $438,000 and ($2,201,000), respectively. In connection with the proposed spin-off, the Company anticipates that it will also transfer its interest in the Joint Venture and the related Three Circles License Agreement to Evercel. Year 2000 Readiness Disclosure The year 2000 ("Y2K") issue is the potential for system and processing failure of date-related data and the result of computer-controlled systems using two digits rather than four to define the applicable year. For example, computer programs that have date sensitive software may recognize a date using "00" as the year 1900 rather than 25 the year 2000. Systems that do not properly recognize date-sensitive information when the year changes to 2000 could generate system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar ordinary business activities. The Company is evaluating the Y2K issue with respect to its financial and management information systems, its products and its suppliers. At this point in its assessment, the Company is not currently aware of any Y2K problems that are reasonably likely to have a material effect on the Company's business, results of operations or financial condition, without taking into account the Company's efforts to avoid such problems. The Company believes that its accounting and information systems will be compliant as a result of installing new software. The Company anticipates that it will be able to complete, test and implement all upgrades of this software that may be material to its business on a timely basis. The implementation of this software is part of an on-going project to upgrade the information systems at ERC. If this software is not implemented on a timely basis, the cost to upgrade the existing software would be $18,000. There is a risk that notwithstanding is internal review, if the Company has not properly identified all year 2000 compliance issues with respect to its management and information systems, the Company may not be able to implement all necessary changes to these systems on a timely basis and within budget. Such a failure could result in a material disruption to the Company's business, which could have a material adverse effect on its business, results of operations and financial condition. The Company is also exposed to the risk that it could experience material payment or sales delays from its major customers, including the U.S. Government, due to year 2000 issues relating either to their management information or production systems. The Company has inquired of these third parties in an attempt to ascertain their year 2000 readiness. At this time, the Company is unable to estimate the nature or extent of any potential adverse impact resulting from the failure of third parties, such as its suppliers and customers, to achieve year 2000 compliance. Moreover, such third parties, even if year 2000 compliant, could experience difficulties resulting from year 2000 issues that may affect their suppliers, service providers and customers. As a result, although the Company does not currently anticipate that it will experience any material shipment delays from their major product suppliers or any material payment or sales delays from its major customers due to year 2000 issues, these third parties could experience year 2000 problems that could have a material adverse effect on the Company's business, results of operations and financial condition. Apart from its activities described herein, the Company plans to develop a contingency plan to address Y2K issues. As the Company is primarily involved in the research and development of fuel cell technology, it is not subject to major supply issues at this time. The Company believes that alternate sources of material are available to supply Company requirements and the Company will prepare its plans to identify these. To the extent that the Company does not identify any material non-compliant year 2000 issues affecting the Company or third parties, such as the Company's suppliers, service providers and customers, the most reasonably likely worst case year 2000 scenario is a systemic failure beyond the control of the Company, such as a prolonged telecommunications or electrical failure, or a general disruption in United States or global business activities that could result in a significant economic downturn. The Company believes that the primary business risk will be limited to, loss of customers or orders, increased operating costs, inability to obtain materials on a timely basis or other business interruptions of a material nature, as well as claims of mismanagement, misrepresentation, or breach of contract, any of which could have a material adverse effect on the Company's business, results of operations and financial condition. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Exposure The Company's exposure to market risk for changes in interest rates relates primarily to the Company's investment portfolio and long term debt obligations. The investment portfolio includes short term United States Treasury instruments with maturities of three months or less. Cash is invested overnight with high credit quality financial institutions. The Company's notes payable expire in 2000 and 2001. Based on the Company's overall interest exposure at October 31, 1998, including all interest rate sensitive instruments, a near-term change in interest rate movements would not materially affect the consolidated results of operations or financial position of the Company. 26 Currency Rate Exposure The Company's functional currency is the U.S. dollar. During 1998, the Company invested $3,000,000 in a joint venture. This investment is currently being maintained in U.S. dollars. Since the cash deposit with the joint venture is in U.S. dollars, the company's foreign currency risk is limited to the investment in the joint venture. To the extent that the Company expands its international operations, the Company will be exposed to increased risk of currency fluctuation. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated Financial Statements and Supplementary Data of the Company are listed under Part IV, Item 14, in this report. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is contained in part under the caption "Executive Officers of the Company" contained in Part I hereof and the remainder is incorporated herein by reference to "Election of Directors" in the Company's Proxy Statement for the Company's Annual Meeting of Shareholders to be held on March 30, 1999 (the "1999 Proxy Statement") to be filed with the SEC within 120 days from the fiscal year end. Item 11. EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference to the Section captioned "Executive Compensation " to be contained in the 1999 Proxy Statement to be filed with the SEC within 120 days from fiscal year end. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated herein by reference to the Section captioned "Security Ownership of Certain Beneficial Owners and Management" to be contained in the 1999 Proxy Statement to be filed with the SEC within 120 days from fiscal year end. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the Section captioned "Certain Relationships and Related Transactions" to be contained in the 1999 Proxy Statement to be filed with the SEC within 120 days from fiscal year end. 27 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) (1) FINANCIAL STATEMENTS 1) Independent Auditors' Report KPMG LLP (See page F-2, hereof.) 2) Consolidated Balance Sheets as of October 31, 1998 and 1997 (See page F-3 hereof.) 3) Consolidated Statements of Income (Loss) for Years Ended October 31, 1998, 1997 and 1996 (See page F-4, hereof.) 4) Consolidated Statements of Changes in Common Shareholders' Equity for the Years Ended October 31, 1998, 1997 and 1996 (See page F-5, hereof.) 5) Consolidated Statements of Cash Flows for the Years Ended October 31, 1998, 1997 and 1996 (See page F-6, hereof.) 6) Notes to Consolidated Financial Statements (See pages F-7 thru F-22, hereof.) (A) (2) FINANCIAL STATEMENT SCHEDULES Supplement schedules are not provided because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto. 28
(A) (3) EXHIBITS - ---------------- (A) (3) EXHIBITS TO THE 10-K ---------------------------- Method of Exhibit No. Description Filing - ----------------------------------------------------------------------------------------------------------------------- 3.1 Certificate of Incorporation of the Company, as amended, March 3, 1994 (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1994 dated January 18, 1995) 3.2 Restated By-Laws of the Company, dated December, 1992 (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1992 dated January 20, 1993) 4 Specimen of Common Share Certificate (incorporated by reference to exhibit of the same number contained in the Company's Form 8-A, dated September 20, 1994) 10.4 **License Agreement, dated November 24, 1981, between Mitsubishi Electric and the Company, as amended by Agreements dated December 4, 1981, June 3, 1983, January 11, 1984, November 20, 1986, November 23, 1988 and November 23, 1991 (confidential treatment requested) (incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 1 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992) 10.6 **License Agreement, dated February 11, 1988, between EPRI and the Company (confidential treatment requested) (incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1 (File No. 33-47233) dated April 14, 1992) 10.9 **License Agreement, dated November 30, 1989, between Messerschmitt-Daimler Benz and the Company (confidential treatment requested) (incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1 (File No. 33-47233) dated April 14, 1992) 10.21 *Energy Research Corporation 1988 Stock Option Plan (incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 1 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 1, 1992) 10.26 Addendum to License Agreement, dated as of September 29, 1989, between Messerschmitt-Daimler Benz and the Company (incorporated by reference to exhibit of the same number contained in the Company's Amendment No. 3 to its Registration Statement on Form S-1 (File No. 33-47233) dated June 24, 1992) 10.27 Cross-Licensing and Cross-Selling Agreement, dated as of July 16, 1998, between the Company and MTU Friedrichshafen GmbH. 10.31 License Agreement For The Santa Clara Demonstration Project between the Company and the Participants in the Santa Clara Demonstration Project, dated September 16, 1993 (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 18, 1994) 10.32 Security Agreement for the Santa Clara Demonstration Project, dated September 16, 1993 (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 18, 1994) 29 10.33 Guaranty By Energy Research Corporation, dated September 16, 1993 for the Santa Clara Demonstration Project (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 18, 1994) 10.34 Guaranty by Fuel Cell Manufacturing Corporation, dated September 16, 1993 for the Santa Clara Demonstration Project (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1993, dated January 18, 1994) 10.36 *The Energy Research Corporation Section 423 Stock Purchase Plan (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1994 dated January 18, 1995) 10.39 **Cooperative Agreement, dated December 20, 1994, between the Company and the United States Department of Energy, Cooperative Agreement #DE-FC21-95MC31184 (confidential treatment requested) (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1994 dated January 18, 1995) 10.40 Loan and Security Agreement between the Company and MetLife Capital Corporation. (incorporated by reference to exhibit of the same number contained in the Company's 10-KSB for fiscal year ended October 31, 1995 dated January 17, 1996) 10.41 *Amendment No. 2 to the Energy Research Corporation Section 423 Stock Purchase Plan (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended April 30, 1996 dated June 13, 1996 10.42 *Amendments to the Energy Research Corporation 1988 Stock Option Plan (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended April 30, 1996 dated June 13, 1996) 10.43 Loan Agreements with First Union Bank of Connecticut, dated June 28, 1996 (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996) 10.44 Notes in favor of First Union Bank of Connecticut, dated June 28, 1996 (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996) 10.45 Security Agreements with First Union Bank of Connecticut, dated June 28, 1996 (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1996 dated September 12, 1996) 10.47 Amendment of Cooperative Agreement dated September 5, 1996 between the Company and the United States Department of Energy, Cooperative Agreement #DE-FC21-95MC31184 (incorporated by reference to exhibit of the same number contained in the Company's 10-K for the fiscal year ended October 31, 1998) 10.48 *Employment Agreement between Energy Research Corporation and the Chief Financial Officer, Treasurer and Secretary, dated October 5, 1998. 10.49 *Employment Agreement between Energy Research Corporation and the President and Chief Executive Officer, dated August 1, 1997 (incorporated by reference to exhibit of the same number contained in the Company's 10-K for the fiscal year ended October 31, 1997) 30 10.50 Technology Transfer and License Agreement between the Company and the Joint Venture owned jointly by the Xiamen Daily-Used Chemicals Co., Ltd. of China and Nan Ya Plastics Corporation of Taiwan, dated February 21, 1998 (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended April 30, 1998)** 10.51 Technology Transfer and License Contract, dated May 29, 1998 for Ni-Zn Battery Technology among Xiamen ERC Battery Corp., Ltd., and Xiamen Daily-Used Chemicals Co., Ltd. and the Company (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1998)**. 10.52 Cooperative Joint Venture Contract, dated as of July 7, 1998, between Xiamen Three Circles Co., Ltd. and the Company for the establishment of Xiamen Three Circles-ERC Battery Corp., Ltd., a Sino Foreign Manufacturing Joint Venture (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1998)**. 10.53 Amendment to the Energy Research Corporation 1988 Stock Option Plan, as amended (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1998). 10.54 The Energy Research Corporation 1998 Equity Incentive Plan (incorporated by reference to exhibit of the same number contained in the Company's 10-Q for the period ended July 31, 1998). 21 Subsidiaries of the Company (incorporated by reference to exhibit of the same number contained in the Company's Registration Statement on Form S-1, (File No.33-47233) dated April 14, 1992) 23.1 Consent of KPMG LLP 27 Financial data schedule * Management Contract or Compensatory Plan or Arrangement **Confidential Treatment has been granted for portions of this document. (b) REPORTS ON FORM 8-K. None
31 Table of Contents Page Independent Auditors' Report F-2 Consolidated Balance Sheets - October 31, 1998 and 1997 F-3 Consolidated Statements of Income (Loss) for Years ended October 31, 1998, 1997 and 1996 F-4 Consolidated Statements of Changes in Common Shareholders' Equity for the Years ended October 31, 1998, 1997 and 1996 F-5 Consolidated Statements of Cash Flows for the Years ended October 31, 1998, 1997 and 1996 F-6 Notes to Consolidated Financial Statements F-7 F-1 Independent Auditors' Report The Board of Directors Energy Research Corporation: We have audited the accompanying consolidated balance sheets of Energy Research Corporation (the "Company") as of October 31, 1998 and 1997, and the related consolidated statements of income (loss), changes in common shareholders' equity and cash flows for each of the years in the three-year period ended October 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Energy Research Corporation as of October 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 1998, in conformity with generally accepted accounting principles. KPMG LLP January 22, 1999 Stamford, CT F-2 ENERGY RESEARCH CORPORATION Consolidated Balance Sheets October 31, 1998 and 1997 (Dollars in thousands, except share and per share amounts)
1998 1997 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 10,304 6,802 Accounts receivable 3,813 2,828 Inventories 30 47 Deferred income taxes 1,073 205 Other current assets 646 279 ------------- ------------- Total current assets 15,866 10,161 Property, plant and equipment, net 8,347 8,254 Other assets, net 2,630 3,018 ------------- ------------- Total assets $ 26,843 21,433 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 755 1,702 Accounts payable 620 865 Accrued liabilities 2,928 1,182 Current portion of deferred license fee income 1,329 46 ------------- ------------- Total current liabilities 5,632 3,795 Long-term liabilities: Long-term debt 1,944 2,699 Deferred income taxes 177 170 ------------- ------------- Total liabilities 7,753 6,664 ------------- ------------- Minority interest 3,220 -- ------------- ------------- Shareholders' equity: Convertible preferred stock, Series C ($.01 par value); 30,000 shares outstanding in 1998 and 1997 600 600 ------------- ------------- Common shareholders' equity: Common stock, ($.0001 par value); 8,000,000 shares authorized: 4,129,273 and 4,000,650 shares issued and outstanding in 1998 and 1997, respectively Additional paid-in capital 12,943 11,460 Retained earnings 2,327 2,709 ------------- ------------- Total common shareholders' equity 15,270 14,169 ------------- ------------- Total shareholders' equity 15,870 14,769 ------------- ------------- Total liabilities and shareholders' equity $ 26,843 21,433 ============= =============
The accompanying notes are an integral part of the consolidated financial statements. F-3 ENERGY RESEARCH CORPORATION Consolidated Statements of Income (Loss) Years ended October 31, 1998, 1997 and 1996 (Dollars in thousands, except share and per share amounts)
1998 1997 1996 ------------ ------------ ------------ Revenues $ 24,318 24,830 29,446 Costs and expenses: Cost of revenues 14,590 15,642 20,895 Administrative and selling 6,986 6,081 4,858 Depreciation 1,529 1,768 1,919 Research and development 2,258 1,270 1,260 --------- --------- --------- Total costs and expenses 25,363 24,761 28,932 --------- --------- --------- Income (loss) from operations (1,045) 69 514 License fee income, net 678 650 357 Interest expense (269) (354) (503) Interest and other income, net 267 307 442 --------- --------- --------- Income (loss) before provision for income taxes (369) 672 810 Provision for income taxes 13 247 301 --------- --------- --------- Net income (loss) $ (382) 425 509 ========= ========= ========= Basic earnings (loss) per share $ (0.09) 0.11 0.13 ========= ========= ========= Basic shares outstanding 4,081,018 3,954,507 3,796,320 ========= ========= ========= Diluted earnings (loss) per share $ (0.09) 0.10 0.13 ========= ========= ========= Diluted shares outstanding 4,081,018 4,191,830 4,063,061 ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. F-4 ENERGY RESEARCH CORPORATION Statements of Changes in Common Shareholders' Equity Years ended October 31, 1998, 1997 and 1996 (Dollars in thousands, except share amounts)
Shares Total of Additional common common paid-in Retained shareholders' stock capital earnings equity ------------ ------------- ------------- ------------- Balance at October 31, 1995 3,728,914 $ 9,263 1,775 11,038 Issuance of common stock under benefit plans 32,809 193 -- 193 Conversion of preferred stock to common stock 30,000 600 -- 600 Conversion of notes payable to common stock 97,397 877 -- 877 Warrants exercised 22,667 245 -- 245 Net income -- -- 509 509 --------- --------- --------- -------- Balance at October 31, 1996 3,911,787 11,178 2,284 13,462 Issuance of common stock under benefit plans 96,621 188 -- 188 Common stock retired (8,119) -- -- -- Conversion of notes payable to common stock 361 3 -- 3 Tax effect of disposition of stock options -- 91 -- 91 Net income -- -- 425 425 --------- --------- --------- -------- Balance at October 31, 1997 4,000,650 11,460 2,709 14,169 Compensation for options granted -- 239 -- 239 Issuance of common stock under benefit plans 15,226 172 -- 172 Common stock retired (2,022) (31) -- (31) Stock options exercised 115,419 718 -- 718 Tax effect of disposition of stock options -- 385 -- 385 Net loss -- -- (382) (382) --------- --------- --------- -------- Balance at October 31, 1998 4,129,273 $ 12,943 2,327 15,270 ========= ========= ========= =========
The accompanying notes are an integral part of the consolidated financial statements. F-5 ENERGY RESEARCH CORPORATION Consolidated Statements of Cash Flows Years ended October 31, 1998, 1997 and 1996 (Dollars in thousands)
1998 1997 1996 ------------- ------------ ------------ Cash flows from operating activities: Net income (loss) $ (382) 425 509 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Compensation for options granted 239 -- -- Depreciation and amortization 1,942 2,162 2,156 Deferred income taxes (738) (90) 46 Conversion of accrued interest to principal on long-term debt -- 38 109 (Gain) loss on disposal of property 6 (1) 3 (Increase) decrease in operating assets: Accounts receivable (985) 20 355 Inventories 17 25 107 Other current assets (367) (48) (144) Increase (decrease) in operating liabilities: Accounts payable (245) (367) (1,151) Accrued liabilities 1,746 63 (476) Deferred license fee income 1,283 (66) (66) --------- --------- ---------- Net cash provided by operating activities 2,516 2,161 1,448 --------- --------- ---------- Cash flows from investing activities: Capital expenditures (1,650) (2,801) (1,904) Proceeds-sale of marketable securities -- 2,025 2,000 Payments on other assets (3) (77) (97) --------- --------- ---------- Net cash used in investing activities (1,653) (853) (1) --------- --------- ---------- Cash flows from financing activities: Repayment on long-term debt (1,701) (2,382) (3,823) Sale of minority interest in joint venture 3,220 -- -- Proceeds from long-term financing -- -- 4,113 Common stock issued 858 188 438 Tax effect of stock options exercised 262 91 -- --------- --------- ---------- Net cash provided by (used) in financing activities 2,639 (2,103) 728 --------- --------- ---------- Net increase (decrease) in cash and cash equivalents 3,502 (795) 2,175 Cash and cash equivalents-beginning of year 6,802 7,597 5,422 --------- --------- ---------- Cash and cash equivalents-end of year $ 10,304 6,802 7,597 ========= ========= ========= Cash paid during the period for: Interest $ 269 344 404 Income taxes 620 446 508
The accompanying notes are an integral part of the consolidated financial statements. F-6 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) (1) Summary of Significant Accounting Policies Nature of Business Energy Research Corporation (the Company or ERC) is engaged in the development of electrochemical technologies for electric power generation and storage. The Company manufactures fuel cell and battery products, generally on a contract basis. The Company's revenues are generated from customers located throughout the United States, Europe and Asia. The Company generally does not require collateral in providing credit except for international sales where a deposit may be required with the purchase orders. Principles of Consolidation The accompanying financial statements include the accounts of the Company and its three subsidiaries: Xiamen Three Circles - ERC Battery Corp., a 50.5% owned joint venture formed between the Company and Xiamen Three Circle Co., Ltd.; Xiamen-ERC High Technology Joint Venture, Inc. a 66-2/3% owned joint venture formed between the Company and the City of Xiamen, PRC; and Evercel, Inc. a wholly-owned subsidiary. Cash and Cash Equivalents Cash equivalents consist primarily of United States Treasury instruments issued directly by the agency with original maturities of three months or less at date of acquisition. The Company places its temporary cash investments with high credit quality financial institutions. Inventories Inventories consist principally of raw materials and are stated at the lower of cost or market. Property, Plant and Equipment Property, plant and equipment are stated at cost, less accumulated depreciation provided on the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized on the straight-line method over the shorter of the estimated useful lives of the assets or the term of the lease. When property is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations for the period. Intellectual Property Intellectual property including patents and know-how is carried at no value. F-7 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) Revenue Recognition Revenues and fees on long-term contracts, including government and commercial cost reimbursement contracts, are recognized on the percentage-of-completion method. Percentage-of-completion is measured by costs (including applicable general and administrative) incurred and accrued to date as compared with the estimated total costs for each contract. Contracts typically extend over a period of one or more years. In accordance with industry practice, receivables include amounts relating to contracts and programs having production cycles longer than one year and a portion thereof will not be realized within one year. Provisions for estimated losses, if any, are made in the period in which such losses are determined. The Company recognized approximately $74, $42 and $1,131 of long-term contract revenues from corporate shareholders of the Company during fiscal years ended October 31, 1998, 1997 and 1996, respectively. License fee income arises from license agreements whereby the Company grants the right to use Company patents and know-how. Amounts are deferred and recognized ratably over the respective terms of the agreements. The Company recognized approximately $266, $316 and $316 of license fee income during each of the fiscal years ended October 31, 1998, 1997 and 1996, under license agreements with corporate shareholders of the Company. Revenues from the U.S. Government and its agencies directly and through primary contractors were $24,221, $23,377 and $22,410, for the years ended October 31, 1998, 1997 and 1996, respectively. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Stock Option Plan Prior to November 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees, and related interpretations." As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On November 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in fiscal years beginning after December 15, 1994 as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the recognition provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. F-8 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) Earnings Per Share (EPS) Basic earnings per share are based upon the weighted average common shares outstanding during the period. Diluted earnings per share assume exercise of in-the-money stock options outstanding and full conversion of convertible preferred stock into common stock at the beginning of the year or the date of issuance, unless they are antidilutive. Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. Impairment of Long-Lived Assets The Company adopted the provisions of SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of," in fiscal year 1997. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this Statement did not have a material impact on the Companys financial position, results of operations, or liquidity. Accounting Changes FASB Statement No. 128 - Effective the first quarter ending January 31, 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 128 - "Earnings per Share." SFAS No. 128 simplifies the calculation of earnings per share (EPS), replaces primary EPS with basic EPS and replaces fully diluted EPS with diluted EPS. Basic EPS is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that it gives effect to all potentially dilutive instruments that were outstanding during the period. In 1998, the Company has computed EPS without consideration to potentially dilutive instruments due to the loss incurred by the Company. FASB Statement No. 129 - Effective October 1998, the Company adopted No.129, "Disclosure of Information about Capital Structure". The statement lists required disclosures about capital structure. SFAS No. 129 did not require any revisions to the Company's existing disclosures. FASB Statement No. 130 - Effective November 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income". The statement establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. For the Company, comprehensive income is the same as net income (loss). F-9 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) FASB Statement No. 131 - In June 1997, SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" , was issued by the FASB. This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. This standard is effective for fiscal years beginning after December 15, 1997. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The statement address presentation and disclosure matters and will have no impact on the Company's financial position or results of operations. FASB Statement No. 133 - In June 1998, the Financial Accounting Standard Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". It requires that an entity recognize all derivative instruments as either assets or liabilities in the statement of financial position and measure those instruments at fair value. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not expect the adoption of this statement to have a material impact on its financial position or results of operations. During 1998, the American Institute of Certified Public Accountants ("AICPA") released its Statement of Position No. 98-1 ("SOP 98-1") "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" and Statement of Position No. 98-5 ("SOP 98-5") "Reporting on the Costs of Start-Up Activities," both of which are effective for fiscal years beginning after December 15, 1998. SOP 98-1 requires that certain costs related to the development or purchase of internal-use software be capitalized and amortized over the estimated useful life of the software. SOP 98-1 also requires that the costs related to the preliminary project stage and the post-implementation stage of an internal-use computer software development project be expensed as incurred. SOP 98-5 requires that the costs of start-up activities be expensed as incurred. SOP 98-5 requires companies to report the initial application of the standard as a cumulative effect of an accounting change. The Company is not required to adopt these standards until fiscal 2000. Management believes that the adoption of these standards will not have a material effect on the Company's results. (2) Joint Ventures and License Agreements In February 1998, The Company entered into a license agreement (the "NanYa License Agreement") with a joint venture between Nan Ya Plastics Corporation of Taiwan, a Formosa Plastics Group company, and Xiamen Three Circles Co., Ltd. of Xiamen, China for the use of the Company's Ni-Zn batteries in EV/HEVs in China, Taiwan, Hong Kong and Macao on an exclusive basis and for certain other Southeast Asian countries on a non-exclusive basis. The license agreement calls for the payment of $5 million in three stages and a royalty for the exclusive and non-exclusive territories. The payments include $1.5 million received by the Company in 1998, of which amount $1.3 million is recorded as deferred income pending achievement of certain test results, a further $2 million to be paid to the Company upon completion of certain conditions which the Company expects will occur in the second fiscal quarter of 1999, and a final payment of $1.5 million to be paid to the Company upon completion of duplication of the battery at its facilities in China. The NanYa License Agreement provides that the Company has the right to invest the final payment in equity in the joint venture manufacturing and sales organization formed between NanYa Plastics and Xiamen Three Circles Co., Ltd. In July 1998, the Company also entered into a Technology Transfer and License Contract (the "Three Circles License Agreement") with Xiamen Three Circles-ERC Battery Corp., Ltd. for the use of the Company's Ni-Zn batteries in electric bicycles, scooters, three-wheel vehicles, off-road vehicles, and miner's safety lamps in China on an exclusive basis and in Southeast Asia on a non-exclusive basis. The license included an initial payment to the Company of $3 million. Pursuant to the Three Circles License Agreement, the Joint Venture must also pay the Company certain royalties based upon the net sales of Ni-Zn F-10 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) batteries sold, leased or transferred in the applicable territories. In addition the Joint Venture may sub-license the Company's technology to third parties in China, Hong-Kong, Taiwan and Macao on a non-exclusive basis. In connection with the Three Circles License Agreement, the Company entered into a joint venture agreement with Xiamen Three Circles Co., Ltd., used this $3 million as its initial investment in the joint venture, and received a 50.5% share of the joint venture called Xiamen Three Circles-ERC Battery Corp. (the "Joint Venture"). Through October 31, 1998, the results of operations of the Joint Venture are immaterial. During 1998 the Company also formed a joint venture with the City of Xiamen, China, called Xiamen-ERC High Technology Joint Venture, Inc. This joint venture has been formed to fund other entities, such as Xiamen University, to conduct research in advanced electrochemical technologies, which will benefit the Company and Xiamen. The Company has invested $400 of capital into this joint venture. (3) Accounts Receivable Accounts receivable at October 31, 1998 and 1997 consisted of the following:
1998 1997 ------------ ------------ U.S. Government: Amount billed $ 382 102 Unbilled recoverable costs 2,361 2,156 Retainage 724 420 ---------- ---------- 3,467 2,678 ---------- ---------- Commercial Customers: Amount billed 56 88 Unbilled recoverable costs 283 32 Retainage 7 7 Other -- 23 ---------- ---------- 346 150 ---------- ---------- $ 3,813 2,828 ---------- ----------
Unbilled receivables represent amounts of revenue recognized on costs incurred on contracts in progress which will be billed within the next 30 days. The balances billed but not paid by customers pursuant to retainage provisions in the contracts will be due upon completion of the contracts and acceptance by the customer. F-11 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) (4) Property, Plant and Equipment Property, plant and equipment at October 31, 1998 and 1997 consisted of the following:
Estimated 1998 1997 Useful Life ------------ ------------ ----------- Land $ 524 524 -- Building and improvements 4,508 4,362 30 years Machinery and equipment 15,121 13,983 3-8 years Furniture and fixtures 1,409 1,369 6-10 years Construction in progress 1,938 1,738 ---------- ---------- 23,500 21,976 Less, accumulated depreciation and amortization (15,153) (13,722) ---------- ---------- $ 8,347 8,254 ---------- ----------
(5) Other Assets Other assets at October 31, 1998 and 1997 consisted of the following:
1998 1997 ------------ ------------ Power Plant License $ 2,221 2,504 Other 409 514 ---------- ---------- Total $ 2,630 3,018 ---------- ----------
The Power Plant License is being amortized over 10 years. Accumulated amortization was $1,374, $1,091, and $767 at October 31, 1998, 1997 and 1996, respectively. F-12 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) (6) Long-Term Debt Long-term debt at October 31, 1998 and 1997 consisted of the following:
1998 1997 ------------ ------------ Note payable (a) -- 668 Note payable (b) 774 1,408 Note payable (c) -- 250 Note payable (d) 1,925 2,075 ---------- ---------- 2,699 4,401 Less - current portion (755) (1,702) ---------- ---------- Long-term debt, less current portion $ 1,944 2,699 ---------- ----------
(a) On November 30, 1989, Daimler Benz affiliate MTU-Friedrichshafen GmbH (MTU) loaned $500 and $1,480 to ERC, evidenced by two 6% promissory notes. The notes are collateralized by a pledge of stock and a first priority lien on all current and future assets, acquired with the proceeds of this loan, until the notes are satisfied in full. During 1996, $877 of principal and deferred interest was converted into 97,397 shares of common stock of the Company. In 1998, the Company repaid in full $673 of principal and accrued interest. (b) During 1995, the Company entered into a $2,500 credit facility with GE Capital (formerly MetLife Capital Corporation, an affiliate of Metropolitan Life Insurance Company). Repayment of this note commenced during 1996 and expires February 2000. The note is payable in monthly installments of $53 plus interest. The interest on this note is payable at the thirty-day commercial paper rate plus 2-1/2%. At October 31, 1998, the commercial paper rate was 5.09%. All borrowings under this credit facility are collateralized by certain assets acquired with the proceeds of this loan. (c) The note is payable to First Union Bank in monthly installments of $25 plus interest. Interest on this note is payable at the London Interbank Offered Rate (LIBOR) plus 1.75%. During 1998, this loan was paid in full. (d) The note is payable to First Union Bank in monthly installments of $13 plus interest. Interest on this note is payable at LIBOR plus 1.75% or 7.19% at October 31, 1998. The borrowings under the First Union Bank agreement are collateralized by a substantial portion of the Company's equipment and other assets, and a mortgage note in (d) above is collateralized by a first mortgage on the Company's Danbury, Connecticut location. The credit agreement associated with the Notes above require the Company to maintain certain financial covenants, including tangible net worth, debt service coverage and liabilities to tangible net worth. As of October 31, 1998, the above notes payable mature as follows: fiscal 1999, $755; fiscal 2000, $319; fiscal 2001, $1,625. F-13 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) (7) Commitments and Contingencies The Company has been notified by the United States Environmental Protection Agency (EPA) that it is a potentially responsible party associated with Gallup's Quarry in Plainfield, Connecticut, which is a National Priorities List site under the Superfund. The alleged disposal at this site took place in 1977. An agreement between the potentially responsible parties (PRP's) and the EPA has been achieved. The PRP's have agreed among themselves as to how to distribute the cost. The Company has been assessed $87 and has paid $83 as its share. The Company does not believe its share of the remediation costs will have a significant impact on the Company's results of operations or financial position. The Company leases certain EDP and office equipment and the Torrington, Connecticut manufacturing facility, and office space in Washington, D.C. under operating leases expiring on various dates through 2003. Rent expense was $472, $463 and $460 for the fiscal years ended October 31, 1998, 1997 and 1996, respectively. Aggregate minimum annual payments under the lease agreements for the five years subsequent to October 31, 1998 are: 1999, $375; 2000, $375; 2001, $115; 2002, $14; and 2003, $9. The Company has an agreement with Electric Power Research Institute (EPRI) pursuant to which ERC has agreed to pay EPRI royalties based upon commercial sales of carbonate fuel cells. In connection with certain contracts and grants from the United States Department of Energy (DOE), ERC has agreed to pay DOE 10% of the annual license income received from MTU, up to $500. Through 1998, ERC has paid to DOE a total of $225. (8) Shareholders' Equity The Company's common shares are currently traded on the American Stock Exchange. In connection with the Company's public offering of its common stock in 1992, the Company sold to the underwriters, at a nominal price, warrants to purchase from the Company 80,000 shares of common stock at $10.80 per share which were exercisable for a period of four years commencing June 25, 1993. During 1996, 22,667 warrants were exercised. The remaining warrants expired June 25,1997. The Company is authorized to issue a total of 250,000 shares of preferred stock, the character of which is determined by the Board of Directors (the Board). During the year ended October 31, 1994, the Company agreed to exchange 120,000 shares of redeemable, nonconvertible Preferred "B" Shares for 60,000 shares of convertible, nonredeemable Preferred "C". The redemption value of the Preferred "B" was $1,200. The Preferred "C" Shares originally had a liquidation preference of $1,200 and are convertible into shares of common stock on a one-for-one basis. During 1996, 30,000 shares of Preferred "C" were converted to 30,000 shares of the Company's common stock. At October 31, 1998, 858,157 shares of common stock have been reserved for issuance pursuant to the Company's stock option plans, the convertible Preferred "C" Stocks and the Company's Section 423 Stock Purchase Plan. (9) Stock Option Plan The Board has adopted 1988 and 1998 Stock Option Plans (collectively the Plans). Under the terms of the Plans, options to purchase up to 1,201,000 shares of common stock may be granted to officers, key employees and directors of the Company. Pursuant to the Plans, the Board is authorized to grant incentive stock options or nonqualified options and stock appreciation rights to officers and key employees of the Company and may grant nonqualified options and stock appreciation rights to directors of the Company. F-14 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) Stock options and stock appreciation rights have restrictions as to transferability. The option exercise price shall be fixed by the Board but, in the case of incentive stock options, shall not be granted at an exercise price less than 100% of the fair market value of the shares subject to the option on the date the option is granted. Stock appreciation rights may be granted in conjunction with options granted under the Plans. Stock appreciation rights shall be exercisable during the period and to the extent related stock options are exercisable. Upon exercise, the holder of a stock appreciation right is entitled to receive in cash or stock, the excess fair market value of one share of common stock over the related option price per share multiplied by the number of shares subject to the right. Stock options that have been granted are exercisable commencing one year after grant at the rate of 25% of such shares in each succeeding year. There are no stock appreciation rights outstanding at October 31, 1998. In 1997, in connection with the hiring of the Company's Chief Executive Officer, options were granted to purchase 149,000 shares of the Company's common stock at the Purchase price of $9.875 per share (the market value at the date of the grant). The Company also granted options to purchase an additional 101,000 shares at $9.875 per share based upon the approval of the shareholders at the 1998 annual meeting of the shareholders. The per share weighted-average fair value of stock options granted in 1998, 1997 and 1996 was $7.99, $7.15 and $8.06, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions:
Risk free Dividend interest rate Expected Volatility Year rate range life factor ---- -------- ------------- -------- ---------- 1998 0% 4.31-4.43% 10 years .5495 1997 0% 6.07-6.66% 10 years .5044 1996 0% 5.63-5.71% 10 years .5044
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.
1998 1997 1996 --------- --------- --------- Net income: As reported $ (382) 425 509 Pro forma $ (569) 39 476 Earnings per share: As reported - Basic $ (0.09) 0.11 0.13 Pro forma - Basic $ (0.14) 0.01 0.13 As reported - Diluted $ (0.09) 0.10 0.13 Pro forma - Diluted $ (0.14) 0.01 0.12
F-15 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) Pro forma net income reflects only options granted in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No.123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period, generally 4 years, and compensation cost for options granted prior to November 1,1995 is not considered. The following table summarizes the plan activity for the years ended October 31, 1996, 1997 and 1998:
Number Weighted average of shares option price --------- ---------------- Outstanding at October 31, 1995 281,200 $ 4.26 Granted 30,000 $ 12.25 Exercised (21,300) $ 4.33 Outstanding at October 31, 1996 289,900 $ 5.08 Granted 219,000 $ 10.60 Exercised (91,232) $ 1.85 Outstanding at October 31, 1997 417,668 $ 8.68 Granted 151,000 $ 10.91 Exercised (115,269) $ 6.28 Cancelled (3,000) $ 12.25 Outstanding at October 31, 1998 450,399 $ 9.70
The following table summarize information about stock options outstanding and exercisable at October 31, 1998:
Options Outstanding Options exercisable ----------------------------------- --------------------------- Weighted average Weighted Weighted remaining average average Range of exercise Number contractual exercise Number exercise price outstanding life price exercisable price ----------- ----------- -------- ----------- --------- $ 4.50 37,399 1.9 years $ 4.50 37,399 $ 4.50 $ 9.75 - $ 13.00 413,000 7.7 years $ 10.17 192,000 $ 10.39
F-16 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) The shareholders of the Company adopted a Section 423 Stock Purchase Plan at the April 30, 1993 Annual Meeting. The total shares allocated to the Plan are 150,000. The shares are offered to employees over an eight-year period commencing January 1, 1993. It allows an employee with one year of service to purchase up to 300 shares per year at 85% of the lower of the average price on the day of grant or issue. An employee may not sell the stock for six months after the date of issue. Plan activity for the years ended October 31, 1998, 1997 and 1996, was as follows: Number of Shares ---------------- Balance at October 31, 1995 136,882 Issued @ $8.50 (1,659) Issued @ $8.82 (9,850) -------- Balance at October 31, 1996 125,373 Issued @ $10.31 (1,076) Issued @ $8.55 (4,313) -------- Balance at October 31, 1997 119,984 Issued @ $8.55 (6,997) Issued @ $13.65 (8,229) -------- Balance at October 31, 1998 104,758 -------- (10) Employee Benefits The Capital Accumulation Plan for employees of Energy Research Corporation was established by the Company on January 19, 1987 and was last amended on June 1, 1997. The Plan is administered by a three-member pension committee. The plan is a 401(k) plan covering full-time employees of the Company who have completed one year of service. The Company contributes an amount equal to 5% of each participant's W-2 compensation to the plan on a monthly basis. Participants are required to contribute 3% and may make voluntary contributions up to an additional 7% of W-2 compensation out of pretax earnings. Effective June 1, 1997, participants may make voluntary contributions up to an additional 6% of W-2 compensation out of after-tax earnings. The Company charged $435, $412 and $395 to expense during the years ended October 31, 1998, 1997 and 1996, respectively. The Energy Research Corporation Pension Plan, a defined contribution plan was established by the Company on May 10, 1976 and was last amended on June 1, 1997. The Plan covers full-time employees of the Company who have completed one year of service. The Company contributes an amount equal to 4% effective April 1, 1993 (previously 5%) of each participant's W-2 compensation to the plan on a monthly basis. Participants are not required to contribute to the plan but may make voluntary contributions up to an additional 6% of W-2 compensation out of after-tax earnings through May 31, 1997. After May 31, 1997, participants are not permitted to make contributions to the Plan. The Company charged $343, $346 and $320, to expense during the years ended October 31, 1998, 1997 and 1996, respectively. F-17 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) (11) Income Taxes The Company's deferred tax assets and liabilities consisted of the following at October 31, 1998 and 1997:
1998 1997 ------------ ----------- Deferred tax assets: Deferred revenue $ 573 -- Compensation recognized on options 121 26 Incentive bonuses 150 -- Capital loss carryforward 24 55 Vacation accrual 34 113 Self-insurance 53 49 Royalty income -- 19 Tax credit carryforwards 140 -- Other 26 11 --------- --------- Gross deferred tax assets 1,121 273 Valuation allowance 24 55 --------- --------- Deferred tax assets after valuation allowance 1,097 218 --------- --------- Deferred liability - Accumulated depreciation (201) (183) --------- --------- Gross deferred tax liability (201) (183) --------- --------- Net deferred tax assets/(liability) $ 896 35 --------- ---------
Management believes that the result of future operations will generate sufficient taxable income to realize deferred tax assets. The components of Federal income tax expense (benefit) were as follows for the years ended October 31, 1998, 1997 and 1996:
1998 1997 1996 ------------ ------------ ------------ Current: Federal $ 122 327 236 Foreign 460 10 10 -------- ------- ------- 582 337 246 -------- ------- ------- Deferred: Federal (569) (90) 55 Foreign -- -- -- -------- ------- ------- (569) (90) 55 Total income tax expense $ 13 247 301 -------- ------- -------
F-18 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) The components of state income tax expense which are included in administrative and selling expenses were as follows for the years ended October 31, 1998, 1997 and 1996:
1998 1997 1996 ------------ ------------ ------------ Current $ 227 148 91 Deferred (169) (9) (7) ------ ------ ------ Total state income tax expense $ 58 139 84
The reconciliation of the federal statutory income tax rate to the Company's effective income tax rate for the years ended October 31, 1998, 1997 and 1996 was as follows:
1998 1997 1996 ------------ ------------ ------------ Statutory Federal income tax rate (34.0%) 34.0% 34.0% Nondeductible expenditures 34.8 -- -- Other, net 2.8 2.7 3.2 ------ ------ ------ Effective income tax rate 3.6% 36.7% 37.2% ------ ------ ------
(12) Earnings Per Share Basic and diluted earnings per share are calculated based upon the provisions of SFAS No. 128, using the following data:
1998 1997 1996 ------------ ------------ ------------ Weighted average basic Common shares 4,081,018 3,954,507 3,796,320 Effect of dilutive securities Stock options -- 137,323 236,741 Preferred "C" Convertible -- 30,000 30,000 Convertible debt -- 70,000 -- --------- --------- --------- Weighted average basic Common shares adjusted for diluted calculations 4,081,018 4,191,830 4,063,061 --------- --------- ---------
F-19 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) The computation of diluted loss per share for fiscal year 1998 follows the basic calculation since common stock equivalents were antidilutive. The weighted average shares of dilutive securities that would have been used to calculate diluted EPS had their effect not been antidilutive are as follows: Stock options 522,720 Preferred "C" Convertible 30,000 ------- Total 552,720 ------- (13) Proposed Spin Off Of Battery Group On October 1, 1998, the Company announced that its Board of Directors had approved a plan to effect a spin-off to its stockholders of 100% of the shares of Evercel, Inc. ("Evercel"), a newly formed, wholly-owned subsidiary of the Company. In connection with this transaction, which is expected to occur in early 1999, the Company plans to transfer to Evercel the principal assets and liabilities related to its Battery Group. Following the transfer, the Company plans to distribute to its stockholders in a tax-free distribution one share of Evercel Common Stock for every three shares of Common Stock of the Company. Immediately after the distribution of Evercel's shares to the Company's stockholders, in order to fund its commercialization efforts, Evercel plans to conduct a rights offering to its stockholders. Evercel expects to grant at no cost to holders of its Common Stock, transferable subscription rights ("Rights") to subscribe for and purchase an additional share of Evercel's Common Stock. Each holder of Evercel's Common Stock is expected to receive one Right for each share of Evercel Common Stock held on the record date (which has not yet been determined). Each Right will be exercisable, for a period of approximately 30 days, to purchase one share of Common Stock of Evercel at a purchase price of $6.00 per share. The Rights offering will be made only by means of a Prospectus which will be delivered to stockholders concurrently with the distribution. The transaction remains subject to the satisfaction of certain conditions. As part of the separation of Evercel's business from the Company, Evercel will enter into various agreements with the Company including a Distribution Agreement, Tax Sharing Agreement, Service Agreement and License Assistance Agreement. The Distribution Agreement will provide for, among other things, the principal corporate transactions required to effect the Distribution, the transfer to Evercel of the assets of the battery business, the division between the Company and Evercel of certain liabilities and obligations, the distribution by the Company of all outstanding shares of the Evercel Common Stock to the Company stockholders and certain other agreements governing the relationship between the Company and Evercel after the Distribution. Subject to certain exceptions, the Distribution provides for assumptions of obligations and liabilities and cross-indemnities designed to allocate financial responsibility for the obligations and liabilities arising out of or in connection with the battery business to Evercel and financial responsibility for the obligations and liabilities arising out of or in connection with the fuel cell business to the Company. The Tax Sharing Agreement defines the parties' rights and obligations with respect to the filing of returns, payments, etc. relating to the Company business for periods prior to and including the Distribution and with respect to certain tax attributes of the Company after the distribution. F-20 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) The Services Agreement provides that the Company will provide to Evercel certain management and administrative services, as well as the use of certain office, research and development, manufacturing and support facilities and services of the Company. The Services Agreement shall continue until terminated by either party upon 120 days' notice. In addition, Evercel may terminate the Services Agreement as to one or more of the Services upon 60 days' notice to the Company. The types of services to be provided pursuant to the Services Agreement by the Company, through its employees, include financial reporting, accounting, auditing, tax, office services, payroll, human resources, analytical lab, microscopic analysis, machine shop and drafting, as well as the part time management services of the Company Chief Executive Officer and Chief Financial Officer. The Company will also provide office, research and development and manufacturing space for Evercel. The method of calculating the applicable charges to be paid by Evercel for each type of service are set forth in the Services Agreement; such charges are payable quarterly. The Company estimates that the net fees to be paid to the Company for services performed will initially be approximately $208 per quarter, excluding certain services billed on the basis of usage, such as purchasing, analytical lab, microscope analysis, machine shop and drafting, which amount takes into account the Company's additional costs related to providing such services, and will decline as the services performed decrease. Evercel presently expects that most of such services will be provided by the Company for approximately one year. In connection with the proposed spin-off, the Company and Evercel will enter into a License Assistance Agreement pursuant to which Evercel will provide all services and assistance necessary for Evercel to effectively fulfill, on behalf of the Company, all of ERC's obligations under the Joint Venture Contract and the License Contract, until such time as the Company obtains the approval for the assignment of the agreements to Evercel. In return for such assistance, the Company will pay Evercel an amount equal to the sum of all money, dividends, profits, reimbursements, distributions and payments actually paid to the Company in cash or in kind or otherwise accruing to the Company pursuant to the Joint Venture Contract and the License Contract. All expenses and costs incurred by Evercel in meeting the obligations under the License Assistance Agreement shall be solely those of Evercel, and the Company shall not be liable for their payment. Evercel will account for its involvement in the Joint Venture under the License Assistance Agreement in a manner similar to the equity method of accounting. Upon execution of the License Assistance Agreement the Company will relinquish its rights under the Joint Venture Contract and License Contract and, accordingly, will deconsolidate its interest therein. (14) Subsequent Events On December 4, 1998, the Company gave notice, pursuant to Section 2.2 of the Exchange Agreement dated as of April 30, 1994 between Sanyo Electric Co., Ltd a Japanese Corporation and the Company, requiring the exchange of ERC's 30,000 shares of Series C Preferred Stock held by Sanyo into the equivalent number of shares of ERC's Common Stock, $.001 par value. This transaction is expected to complete in February, 1999. F-21 ENERGY RESEARCH CORPORATION Notes to Consolidated Financial Statements October 31, 1998 and 1997 (dollars in thousands except share and per share amounts) On December 22, 1998, Evercel entered into a commitment to borrow up to $1,000 for the purpose of acquiring machinery and equipment. As of January 22, 1999, Evercel had borrowed $500 against this commitment. The notes are due on June 30, 1999. ERC has unconditionally guaranteed the commitment and has pledged $1,000 of cash. The Note is payable from the proceeds of the planned Evercel Rights Offering. On January 15, 1999, Evercel entered into a lease for manufacturing and office space in Danbury, CT. The lease term is five years with a five year option to extend. The annual rent is $171 for the first three years and increases to $178 in year four and $185 in year five. ERC has guaranteed the performance of the lease. In the event of a default by Evercel, ERC's liability is limited to $500 reduced each anniversary date of the lease by $100. Notwithstanding the foregoing, the guaranty terminates after the first anniversary of the lease upon Evercel's Net Worth exceeding $3,000. F-22 PART IV SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ENERGY RESEARCH CORPORATION /s/ Jerry D. Leitman - -------------------- Jerry D. Leitman, President Dated: January 28, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the registrant and in the capacities and on the dates indicated. Signature Capacity Date - --------- -------- ---- /s/ Jerry D. Leitman - ------------------------- Chief Executive Officer, President, Jerry D. Leitman Director (Principal Executive Officer) January 28, 1999 /s/ Joseph G. Mahler - ------------------------ Chief Financial Officer, January 28, 1999 Joseph G. Mahler Vice President,Corporate Secretary, Treasurer(Principal Accounting and Financial Officer) /s/ Warren D. Bagatelle - ------------------------- Director January 28, 1999 Warren D. Bagatelle /s/ Christopher R. Bentley - -------------------------- Director January 28, 1999 Christopher R. Bentley /s/ Michael Bode - -------------------------- Director January 28, 1999 Michael Bode /s/ James D. Gerson - -------------------------- Director January 28, 1999 James D. Gerson /s/ Thomas L. Kempner - -------------------------- Director January 28, 1999 Thomas L. Kempner /s/ William A. Lawson - -------------------------- Director January 28, 1999 William A. Lawson 31 /s/ Hansraj C. Maru - -------------------------- Director January 28, 1999 Hansraj C. Maru /s/ Richard M.H. Thompson - -------------------------- Director January 28, 1999 Richard M.H. Thompson /s/ Bernard S. Baker - -------------------------- Director January 28, 1999 Bernard S. Baker 32 EX-10.27 2 CROSS LICENSING & CROSS SELLING AGREEMENT Confidential Treatment has been Requested for Portions of this document, Deleted portions are marked with an asterisk AGREEMENT by and between ENERGY RESEARCH CORPORATION (ERC) and MTU MOTOREN-UND TURBINEN-UNION FRIEDRICHSHAFEN GmbH (MTU) This Agreement is made and entered into this 16th day of July, 1998 (the Effective Date) by and between ERC and MTU. WHEREAS ERC and MTU presently are parties to the License Agreement of September 29, 1989 (the CELL LICENSE AGREEMENT), which remains in full force and effect, and ERC has developed "Balance of Plant" ("BOP") technologies for its compact Direct Fuel Cell power plant design including 4 (four) vertical stacks in a container, and MTU has developed BOP technologies for its compact fuel cell power plant design including 1 (one) horizontal stack(s) in a container, and ERC and MTU both wish to obtain the mutual benefits and technological advantages of a cross-license between the Parties by sharing their respective BOP technologies, including technical efforts, designs, patents and know how developed or to be developed by each, and ERC and MTU both wish to obtain the mutual benefits and technical advantages, of a cross-selling of BASE MODULES, and ERC and MTU both understand and agree that the BOP technologies which are the subject matter of this BOP license are not included in the existing CELL LICENSE AGREEMENT, and ERC warrants, represents and agrees that it has the capacity and authority to grant the BOP license hereunder and to be bound by the terms of this agreement, and MTU warrants, represents and agrees that it has the capacity and authority to grant the BOP license hereunder and to be bound by the terms of this agreement. 1 THEREFORE In consideration of the mutual covenants contained herein, ERC and MTU agree as follows: Article I - Definitions 1 . The term "BALANCE OF PLANT" or "BOP" shall mean all subsystems necessary for operation and generation of electrical power by Molten Carbonate Fuel Cells (but excluding fuel cell technology included in the CELL LICENSE AGREEMENT) in one or more stacks and including, but not limited to base modules, fuel pre-treatment, boilers, water recovery, fuel exhaust burner, inverter, control system, utility interface and start-up and stand-by equipment, 2. The term "BOP KNOW HOW" shall mean any and all information, whether or not patented or patentable, of ERC and MTU in respect of BOP which presently and/or during the life of this Agreement are or may be useful in the design, development, manufacture and/or use of the BOP and are known to, possessed or acquired by ERC and/or MTU during the life of this Agreement, subject to any third party confidentiality agreements. 3. The term "ERC BASE MODULE" shall mean 4 (four) vertical stacks in a container. 4. The term "MTU BASE MODULE" shall mean 1 (one) horizontal stack(s) in a container, known as the "Hot Module". Article II - BOP Cross License 1. ERC and MTU each grant to the other a non-exclusive BOP license to sell, use, make or have made, use and/or practice their respective BOP KNOW HOW (the "BOP LICENSES") 2. Sub-licenses of ERC's or MTU's BOP KNOW HOW may only be granted upon prior written approval by MTU or ERC respectively. 3. The BOP LICENSE granted herein by MTU to ERC is a non-exclusive license for end use in the territories of USA, Canada and Mexico. 4. The BOP LICENSE granted herein by ERC to MTU is a non-exclusive license for end use in the territories of Western Europe, Eastern Europe, the Middle East, South America and Africa. 5. The BOP LICENSE territories as defined herein are subject to reconsideration upon request of ERC or MTU after the initial term of this agreement. 6. The BOP LICENSES granted herein may not be assigned by either party without prior written approval of the other party. 2 Article III - BOP Cross Selling 1. It is understood by the Parties that the BOP LICENSES are based on and include the cross- selling of ERC's and MTU's BASE MODULES. 2. For the first 10 (ten) units (approximately 2.5 megawatt installed capacity), under the BOP LICENSE, ERC commits to purchase and MTU commits to sell its MTU BASE MODULE at a { *** } basis. 3. For the first unit (approximately 1 megawatt installed capacity) under the BOP LICENSE, MTU commits to purchase and ERC commits to sell its ERC BASE MODULE at { *** } basis. 4. Once the installed capacity defined in Article III, paragraphs 2 and 3 above has been reached or exceeded, both Parties will continue to purchase the other Party's BASE MODULE and retain the obligation to sell their BASE MODULE to the other Party provided the offers will be competitive especially regarding key parameters, including but not limited to price, terms of payment, quality, lead time and overall reliability of the supplier. 5. The Parties always intend to reach cost efficiency to the extent possible and grant each other preferential treatment as licensees. The parties will continuously inform each other regarding the parameters of competitiveness in order to reach the target of cross selling / cross purchasing. 6. In the event either party believes the other Party's base module is not as competitive as it could be with alternative sources, that Party has the obligation to notify the other Party under the notice provisions herein. Upon receiving notice, both parties will meet and try to resolve competitiveness issues within 30 (thirty) days. If there is no agreement, then an outside expert firm to be agreed upon by the Parties will review the competitive issues during the next 30 (thirty) days. If the outside expert firm confirms that either Party is non-competitive then the other party has the right to purchase, make or have made the base module of the non-competitive Party under this license agreement unless the non-competitive Party chooses to sell their Base Module to the other Party at competitive terms and conditions (right of first refusal). If the non-competitive Party does not exercise their right of first refusal, the other Party is obligated to sell the non-competitive Party upon their request this base module at those competitive terms and conditions that could not be offered by the non-competitive Party. If the outside expert firm confirms that either party is competitive, both Parties will continue to retain the obligation to buy/sell. 7. Both parties are obligated to provide normal and reasonable warranties on workmanship and materials and fitness for purpose, but are not obligated to provide performance warranties on the BASE MODULE; details to be fixed by mutual terms and conditions of sale. 8. Both Parties are obligated to fully divulge their cost information upon request by the other Party. Either Party, can request the other Party's outside audit firm to attest to the cost information, but must pay the audit cost thereof: 3 Article IV - Payments 1. ERC shall pay to MTU a royalty of { *** } U. S. Dollars { *** } for each kilowatt of Rating of any power plant which utilizes the licensed BOP made by or for ERC, used by, sold by or for ERC or leased by ERC and/or any sub-licensee to ERC This payment shall be adjusted by the increase in the United States Consumer Price Index (CPI) from May, 1998 to the date of each sale, based on the ratio of the CPI as of May, 1998 compared to the CPI at the month of the sale. This adjustment shall be subject to a limit of increase per year of 7%. 2. MTU shall pay to ERC a royalty of { *** } U. S. Dollars { *** } for each kilowatt of Rating of any power plant which utilizes the licensed BOP made by or for MTU, used by, sold by or for MTU or leased by MTU and/or any sub-licensee to MTU. This payment shall be adjusted by the increase in the United States Consumer Price Index (CPI) from May, 1998 to the date of each sale, based on the ratio of the CPI as of May, 1998 compared to the CPI at the month of the sale. This adjustment shall be subject to a limit of increase per year of 7%. 3. In case ERC resp. MTU does not purchase the other Party's BASE MODULE under Article III of this Agreement, ERC shall pay to MTU and MTU shall pay to ERC an increased royalty of { *** } U.S. Dollars { *** } for each kilowatt of Rating of any power plant which utilizes the other Party's licensed BOP. This payment shall be adjusted according to the rules set forth in Article IV clause 1 resp. clause 2. 4. MTU is not committed to pay to ERC a royalty under this Agreement to the extent MTU is obligated to pay ERC a royalty under the existing CELL LICENSE AGREEMENT for its BASE MODULE. Article V - BOP KNOW HOW 1. Each Party shall provide the other Party all information embodying BOP KNOW HOW during the life of this Agreement upon a time schedule and in accordance with the other Party's requirements as mutually agreed by the Parties. 2. Both Parties agree to control and treat as secret and proprietary any BOP KNOW HOW which is received from the other Party. Both Parties will develop and implement such procedures as may be required to prevent the intentional or negligent disclosure to third parties of BOP KNOW HOW communicated to each other. The following shall not be considered or treated as secret and proprietary under this provision: 2.1 BOP KNOW HOW that has been or become published or generally known to the trade or others without breach or fault of one or both of the Parties, 4 2.2 BOP KNOW HOW received prior to the disclosure of the other Party legally by a Party from any third party who, to the best of that Party's knowledge, after reasonable inquiry, did not obtain same by breach of any obligation owed to the other Party, and who imposes no obligation of secrecy on the other Party with respect to such BOP KNOW HOW 3. Any rights of a Party related to its BOP KNOW HOW remain with the respective Party regardless of any contributions of the other Party to finalizing the commercial design of the compact fuel cell power plant of the respective Party. Article VI - Records, Reports and Notices ERC and MTU shall keep separate records of sales and use of licensed BOP KNOW HOW and shall report to the other Party on a quarterly basis. Notices under this Agreement shall go to the respective signers of this Agreement or their successors. Article VII - Term, Termination 1. This Agreement shall terminate at the end of 5 (five) years from the effective date of this Agreement (the "Initial Term"). 2. Either Party shall have the right to extend the Initial Term or any extended term of this Agreement of an additional 5 (five) year period by giving the other Party advance written notice of extension not less than 180 (one hundred eighty) days prior to expiration of the Initial Term or any extended term of this Agreement, provided the requesting Party did not breach the Agreement in the past if such breach has not been remedied to the satisfaction of the other Party. Any extension after a term of 20 years needs mutual consent of the Parties. The Parties endeavor to reach such consent 9 months prior to expiration of the Agreement. 3. Upon termination of this Agreement, the right to use or have used (whether directly or indirectly) the other Party's BOP KNOW HOW shall cease immediately except for plants already supplied as far as necessary for the after sales service and all BOP KNOW HOW shall be held in confidence by the recipient for 15 (fifteen) years after the date of termination, unless exempt by Article V, Sections 2.1 and / or 2.2. Article VIII - Arbitration 1. Should any dispute, controversy or claim arise between ERC and MTU in connection with, relating to or rising out of this Agreement, efforts to resolve such an issue shall be made by the respective Parties. If a resolution is not achieved, either Party may refer the issue to the 5 executive officers of ERC and MTU, who shall endeavor to reach a mutually acceptable resolution. 2. In the event an acceptable resolution is not reached within thirty (30) days of the request to the officers made per Article VIII, Section 1., then the issue shall be submitted to arbitration of the London Court of International Arbitration applying their procedural rules then in effect. The arbitration shall take place in London and the substantive law applicable to the arbitration shall be British Law. The arbitration award shall be final and binding upon the Parties. Such award may be confirmed in any court having jurisdiction and reduced to final judgment. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed in a manner binding upon them by their duly authorized officers as of the date shown below. ENERGY RESEARCH CORPORATION By: /s/ Jerry D. Leitman -------------------- Name: Jerry D. Leitman Title: President and Chief Executive Officer Date: July 16, 1998 MTU MOTOREN-UND TURBINEN-UNION FRIEDRICHSHAFEN GmbH By: /s/ Herman J. Amrein /s/ Michael Bode -------------------- ---------------- Name: Herman J. Amrein Michael Bode Title: Senior Vice President Director Date: 6 Exhibit I of ERC / MTU BOP License Agreement - -------------------------------------------- Part A Western Europe - ------ Andorra Austria Belgium Cyprus Denmark Federal Republic of Germany Finland France Great Britain and Northern Ireland Greece Greenland Ireland Island Italy Liechtenstein Luxembourg Malta Monaco Netherlands Norway Portugal San Marino Spain Sweden Switzerland The Vatican State Part B Eastern Europe - ------ Albania Bulgaria Czech Republic Slovakia Hungaria Poland Romania All states of the former USSR including, but not limited to CIS (Commonwealth of Independent States) Yugoslavia Slovenia Croatia 7 Exhibit I of ERC / MTU BOP License Agreement - -------------------------------------------- Part C Middle East - ------ Bahrain Iran Iraq Israel Jordania. Katar Kuwait Lebanon Oman Saudi-Arabia Syria Turkey United Arab Emirates (UAE) Yemen, Arab. Rep. Yemen, Peoples Rep. 8 EX-10.48 3 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT is made and entered into as of the 5th day of October, 1998 between ENERGY RESEARCH CORPORATION, a New York corporation (the "Company"), and JOSEPH G. MAHLER, an individual with a current mailing address at 2 Queens Peak Road, Canton, Connecticut 06019, (the "the Employee"). Unless the context otherwise requires, the term "Company", shall include the Company and each of its subsidiaries. W I T N E S E T H WHEREAS, the Company desires to employ the Employee as its Chief Financial Officer and Corporate Secretary and the Employee desires to be employed in such capacities in accordance with the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the covenants, conditions, undertakings and premises contained herein, the sufficiency which is hereby acknowledged, the Company and the Employee agree follows: ARTICLE 1 --------- EMPLOYMENT AND DUTIES --------------------- 1.1 Employment; Duties ------------------ Subject to the terms and conditions set forth herein, commencing October 5, 1998 (the "Commencement Date") the Company agrees to employ the Employee and the Employee agrees to be employed as Chief Financial Officer, Treasurer and Corporate Secretary of the Company. In such position, the Employee shall perform such duties as are or may be assigned to the Employee by the Chief Executive Officer and Board of Directors of the Company (the "Board of Directors") from time to time. In connection therewith, the Employee shall report to and be subject to the supervision of the Chief Executive Officer. In the course of the performance of his duties hereunder, Employee shall comply in all material respects with the Company's regular employment policies and procedures as they may be modified from time to time. 1.2. Full Time --------- The Employee shall devote his full working time, attention, energies, skills and best efforts exclusively to the performance of his duties hereunder. The Employee shall not during the term of this Agreement engage in any other business activity whether or not such activity is pursued for gain, profit or other pecuniary advantage, except that the Employee, on his own time, (a) may manage his own investments, and those of his immediate family, and (b) may serve as a member of the board of directors of other corporations subject to the restrictions set forth in Section 5.1, so long as such activity (as described in either clause (a) or (b) above), does not, in the reasonable judgment of the Company's Board of Directors, adversely affect the performance of his duties hereunder. 1 ARTICLE 2 --------- 2.1 Term ---- The term of the Employee's employment by the Company hereunder shall commence on the Commencement Date and, except as otherwise provided in this Agreement with respect to earlier termination, shall continue until terminated by either party pursuant to Article 7. ARTICLE 3 --------- COMPENSATION ------------ 3.1 Base Salary ----------- For all service to be rendered by the Employee under this Agreement, and such other duties as the Chief Executive Officer and the Board of Directors may assign to him in accordance with Section 1.1 hereof, the Company agrees to pay the Employee a base salary of $185,000 per annum. The Employee's base salary shall be subject to periodic review and adjustment by the Chief Executive Officer and the Board of Directors in their sole discretion, provided that the base salary may not be reduced below $185,000 per year. The base salary shall be payable at such times as is customary for employees of the Company and in accordance with the normal payroll practices of the Company. 3.2. Incentive Compensation ---------------------- Commencing with the Company's fiscal year beginning November 1, 1998, the Employee shall be a participant in the Company's incentive compensation plan generally made available to executive officers as it may be in effect and revised from time to time. Employee's target bonus under such plan will be thirty percent (30%) of his base salary with a maximum bonus of 150% of the target bonus. The Employee understands and agrees that the implementation of an incentive compensation plan for the Employee and other executive officers will be subject to the review and approval of the Compensation Committee of the Board of Directors. 3.3. Expenses -------- (a) General. In addition to base salary and incentive compensation, the Company shall reimburse the Employee for all reasonable and necessary business expenses actually incurred by him in the performance of his duties, including, without limitation, expenses for travel, meals, entertainment and other miscellaneous business expenses, in accordance with the Company's policies and practices as may be in effect from time to time. (b) Moving Expenses. The Employee agrees to relocate to the vicinity of the Company's executive offices in Danbury, Connecticut (the "Company Location") as soon as practicable following his commencement of employment hereunder. In connection with that relocation, the Company agrees to pay for or reimburse the Employee for all reasonable out-of-pocket expenses incurred by him in connection with his relocation from his current residence in Canton, Connecticut to the 2 Company Location during a two year period following the execution of this Agreement, including, without limitation, (i) reasonable moving company expenses and storage fees, (ii) reasonable fees and expenses incurred in connection with the sale of his current residence, including reasonable brokerage commissions (iii) reasonable fees and expenses incurred in connection with his purchase of a home in the vicinity of the Company Location, not including any brokerage commissions (iv) reasonable expenses associated with commuting to work (for a maximum period of six months following the execution of this Agreement) and to search for a new residence. (c) Documentation. Reimbursement or payment by the Company of the Employee's expenses as set forth in this Section 3.3 shall be subject to the Employee's submission of written, itemized expense accounts and such additional substantiation and justification as the Company may reasonably request consistent with the Company's reimbursement policies generally applicable for its salaried employees. ARTICLE 4 --------- COMPANY BENEFITS ---------------- 4.1 Vacation -------- The Employee shall be entitled to receive four weeks of paid vacation per calendar year (pro rated for any partial year), which shall be taken at such time or times as will not unreasonably hinder or interfere with the Company's business or operations. 4.2. Severance Benefit ----------------- If during the Employee's employment pursuant to this Agreement, the Employee ceases to be employed by the Company as a result of the Company's termination of the Employee without cause pursuant to Section 7.4 (which shall not include any termination that is otherwise within Article 6) or the Employee's termination of his employment for good reason pursuant to Section 7.1, the Company shall pay the Employee as a severance benefit, (a) his then base salary plus (b) an amount equal to the Employee's bonus from the Company, if any, for the immediately preceding year. This severance benefit shall be payable by the Company through (i) the continuation of the Employee's base salary for a period of one year and (ii) the payment of the balance in four equal quarterly installments, with the first such payment due three months after the termination and the final payment due one year after the termination. The severance obligation set forth in this Section 4.2 shall be in lieu of and not in addition to any other severance benefits made available to other employees of the Company. 4.3. Stock Options ------------- (a) Effective on the execution of this Agreement, the Company shall issue to the Employee an option to purchase 50,000 shares of the Company's Common Stock with an exercise price equal to the closing price of the Company's Common Stock on the American Stock Exchange on the date hereof, pursuant to the Company's standard form of Option Agreement, subject to the following 3 provisions. The option shall vest over a four year period at 25% per year (12,500 shares) on each anniversary date of the Commencement Date; provided however, if the Employee's employment hereunder is terminated without cause by the Company or for good reason by the Employee prior to the first anniversary date of the Commencement Date, the options to purchase the first 12,500 shares of the Company's Common Stock will automatically vest. The options will also fully vest upon a change of control of the Company. (b) The Employee understands that the Company is considering a so-called spin-off of its Battery business. In the event of such spin-off, if it occurs within the initial one year term of this Agreement, if at all, the Company will cause the spun-off company (the "Battery Company") to either grant the Employee an option to purchase 50,000 shares of its Common Stock or provide the Employee with the right to purchase 50,000 shares of restricted stock. The exercise or purchase price of such stock will be the fair market value of the stock, as determined by the Board of Directors on the date of grant. Such options or stock will vest at 25% per year from the date of their grant or purchase. The Employee understands and agrees that following the spin-off of the Battery Company, if it occurs, his employment may include acting as Chief Financial Officer of the Battery Company during an indefinite period. 4.4. Other Benefit Plans ------------------- The Employee shall further be entitled to participate in and receive benefits under any retirement, life insurance, accident, disability, health and dental insurance, profit sharing, or similar plans generally made available to its employees. 4.5. Indemnification --------------- The Company agrees to defend and shall indemnify and hold the Employee harmless to the fullest extent permitted by law from any and all liability, costs, and expenses which may be assessed against the Employee by reason of the performance of his responsibilities and duties under the terms of this Agreement, provided such liability does not result from willful misconduct or gross negligence of the Employee. ARTICLE 5 --------- RESTRICTIONS ------------ 5.1 Non-Competition --------------- (a) So long as the Employee is employed by the Company and for a period of two years thereafter (the "Noncompetition Period"), the Employee shall not, directly or indirectly, whether as owner, partner, shareholder, director, consultant, agent, employee, guarantor, surety or otherwise, or through any person, consult with or in any way aid or assist any competitor of the Company or engage or attempt to engage in any employment, consulting or other activity which directly or indirectly competes with the Business of the Company. For purposes of this Agreement, the term "employment" shall include the performance 4 of services by Employee as an employee, consultant, agent, independent contractor or otherwise and the term "Business" shall mean the research, development, manufacture, sale or distribution of fuel cells, batteries or related products and any other business engaged in, planned or under development by the Company with respect to which the Employee has had access to Company confidential information during the Noncompetition Period. The Employee acknowledges that his participation in the conduct of any such Business alone or with any person other than the Company will materially impair the Business and prospects of the Company. (b) In addition to and without limiting the foregoing, during the Noncompetition Period, Employee shall not knowingly do, attempt to or assist any other person in doing or attempting to do any of the following: (i) hire any director, officer, employee, or agent of the Company (a "Company Employee") or encourage any such person to terminate such relationship with the Company, as the case may be (for purposes hereof, the Employee shall be deemed to have so encouraged a Company Employee to terminate such relationship with the Company if the Employee hires or otherwise assists any person in hiring any such Company Employee within six months after the Company Employee terminates his or her relationship with the Company), (ii) encourage any customer, client, supplier or other business relationship of the Company to terminate or alter such relationship, whether contractual or otherwise, to the disadvantage of the Company; (iii) encourage any prospective customer or supplier not to enter into a business relationship with the Company; (iv) impair or attempt to impair any relationship, contractual or otherwise, written or oral, between the Company and any customer, supplier or other business relationship of the Company; or (v) sell or offer to sell or assist in or in connection with the sale to any customer or prospective customer of the Company any products of the type sold or rendered by the Company. (c) Nothing in this Agreement shall preclude Employee from making passive investments of not more than 2% of a class of securities of any business enterprise registered under the Securities Exchange Act of 1934. 5.2. Intellectual Property --------------------- Upon execution of this Agreement, the Employee shall execute the Energy Research Corporation Agreement for Assignment, Confidentiality and Nonsolicitation, which agreement is hereby incorporated herein by reference. 5.3. Injunctive Relief ----------------- The Employee acknowledges that the restrictions contained in this Article are reasonable in view of the nature of the business in which the Company is engaged and his position with the Company which will provide him with extensive knowledge of the business. The Company and the Employee mutually agree that the Employee's obligations under this Article are of a special and unique character which gives them a peculiar value, and the Company cannot be reasonably or adequately be compensated in damages in an action at law in the event the Employee breaches such obligations. The Employee therefore expressly agrees that, in addition to any other rights or remedies which the Company may possess, the Company shall be 5 entitled to injunctive and other equitable relief to prevent a breach of this Article by the Employee, including a temporary restraining order or temporary injunction from any court of competent jurisdiction restraining any threatened or actual violation, and each party hereby consents to the entry of such order and injunctive relief and waives the making of a bond as a condition for obtaining such relief. Such rights shall be cumulative and in addition to any other legal or equitable rights and remedies the Company may have. 5.4. Survival Enforceability ----------------------- It is expressly agreed by the parties hereto that the provisions of this Article shall survive the termination of this Agreement. If any one or more of the provisions contained in this Article shall for any reason in any jurisdiction be held to be excessively broad as to the time, duration, geographical scope, activity or subject, it shall be construed with respect to such jurisdiction, by limiting or reducing it, so as to be enforceable to the extent compatible with the applicable law of such jurisdiction as it shall then appear. ARTICLE 6 --------- DEATH; DISABILITY ----------------- 6.1 Death ----- If the Employee dies while employed under this Agreement, this Agreement shall terminate immediately. The Company will pay to the Employee's estate his base salary under Section 3.1 through the last day of the calendar month in which he dies, plus any incentive compensation awarded to the Employee under the Incentive Compensation Plan, but not yet paid, and such death benefits as may be provided pursuant to Section 4.4. 6.2. Disability ---------- If the Employee fails to perform his duties under this Agreement due to "Disability", as defined below, the Company may terminate this Agreement upon 30 days written notice to him. In that event, the Company shall pay the Employee his base salary under Section 3.1 through the date of termination; provided, however, that to the extent the Employee is receiving disability benefits pursuant to the Company's disability insurance policy, the amount of such benefits shall be credited against the Employee's base salary during the period prior to the date of termination. In addition, upon any termination based upon Disability, the Company shall pay to the Employee any incentive compensation awarded to the Employee under the Incentive Compensation Plan but not yet paid. The term "Disability" shall mean the inability of the Employee to perform for the Company the duties specified in Section 1.1 by reason of any medically determinable physical or mental impairment for (i) a period of four consecutive months, (ii) for shorter periods aggregating five months in any 12-month period or (iii) if the Board of Directors determines that it is probable that the Disability will continue for a length of time so as to constitute a Disability under clauses (i) or (ii) above. The determination of whether the Employee is Disabled shall be made by the Board of Directors on the basis of written medical evidence reasonably satisfactory to it. Notwithstanding anything to the contrary 6 in the foregoing, in the event of a termination of the Employee pursuant to clause (iii), the Company will pay the Employee a minimum of four months base salary following such termination; provided, however, that to the extent the Employee is receiving disability benefits pursuant to the Company's disability insurance policy, the amount of such benefits shall be credited against the Employee's base salary. ARTICLE 7 --------- TERMINATION ----------- 7.1 Termination by the Employee for Good Reason ------------------------------------------- The Employee may terminate this Agreement for good reason upon ninety (90) days written notice to the Company setting forth with specificity the grounds for termination upon the occurrence of any of the following: (a) the failure of the Company to observe or comply with any of its material obligations under this Agreement, if such failure has not been cured within 30 days after written notice thereof has been given by the Employee to the Company; (b) the dissolution of the Company; or (c) any merger in which the Company is not the surviving corporation and in which the stockholders of the Company own less than 50% of the voting securities of the merged entity upon the effectiveness of the merger, or any consolidation, sale of substantially all of the assets of the Company or change of control of the Company, provided the Employee has not approved the transaction by voting for it either as a director or shareholder. For purposes of clause (a) a material breach by the Company shall include a material change in the reporting responsibilities of the Employee such that the Employee is no longer effectively serving as the Chief Financial Officer of the Company, a material reduction in benefits or other perquisites of office such that the Employee is not receiving the benefits set forth herein or the benefits and other perquisites generally granted for executive positions within the Company. For purposes of clause (c) above, a "change of control" shall be presumed to have occurred if within any 12-month period a single person or entity, or related group of persons or entities, acquires 50% or more of the outstanding voting stock of the Company. In the event of a termination for good reason under this Section, the Company shall pay the Employee (i) his base salary as then in effect under Section 3.1 through the date of termination, (ii) any incentive compensation awarded to the Employee under the Incentive Compensation Plan, but not yet paid, and (iii) the severance benefit set forth in Section 4.2. 7.2. Termination by the Company for Cause ------------------------------------ The Company may terminate this Agreement for cause in the manner set forth below. For purposes of this Section, "cause" shall mean (a) a material breach by the Employee of the terms of this Agreement, including without limitation failure by the Employee to perform a material portion of his duties hereunder (not otherwise excused by the disability of the Employee) (b) criminal misconduct or unethical conduct, whether or not in relation to the Company's affairs or business, which reflects adversely upon Employee's honesty or integrity in the performance of his duties as an employee of the Company, or which otherwise is materially detrimental to the interests of the Company; (c) if the Employee is found guilty or pleads nolo contendere to the commission of a 7 crime classified as a felony under any Federal, state or local law; and (d) commission by the Employee of an act of gross incompetence in the course of his employment hereunder. The term "cause" as used in the preceding sentence does not include the Employee's erroneous judgment or judgments of a technical, scientific, financial, legal and/or environmental nature which were, although erroneous, nevertheless reasonable at the time and under the circumstances in which they were made. In the event of termination under this Section, the Company shall pay to the Employee his base salary under Section 3.1 through the date of termination stated in the notice plus any incentive compensation awarded to the Employee under the Incentive Compensation Plan but not yet paid, and the Employee shall, if so requested by the Chief Executive Officer, perform his duties under Article 1 through the date of termination stated in the notice. 7.3. Termination by the Company for Cause-Procedure ---------------------------------------------- Notwithstanding anything to the contrary set forth herein, the Employee shall not be deemed to be have been terminated for cause without (i) delivery to the Employee of written notice setting forth the reasons for the Company's intention to terminate for cause, and (ii) an opportunity for the Employee to be heard before the Chief Executive Officer within five business days thereafter. 7.4. Termination by the Company or the Employee Without Cause -------------------------------------------------------- Either the Company or the Employee may terminate this Agreement for reasons other than as set forth above in Section 7.1 or Section 7.2 and which are not otherwise within Article 6 upon 30 days written notice. Upon such termination, the Company shall pay the Employee his base salary under Section 3.1 through the date of termination (provided, however, that the Employee continues to be available to perform the services required under Section 1.1 through the date of termination), plus any incentive compensation awarded to the Employee under the Incentive Compensation Plan, but not yet paid, and any accrued vacation. In addition, upon the Company's termination of the Employee without cause, the Company shall be required to pay the Employee the severance benefit set forth in Section 4.2. Nothing herein shall prohibit the Company from relieving the Employee of any or all of his duties hereunder pending the expiration of the 30-day notice period. 7.5. Termination of Duties --------------------- Notwithstanding anything to the contrary set forth herein, at any time on or after delivery of written notice to the Employee, the Company may relieve the Employee of all of his duties and responsibilities hereunder and may relieve the Employee of authority to act on behalf of, or legally bind, the Company; provided, however, that any such action by the Company shall not relieve the Company of its obligation to pay to the Employee all compensation and benefits otherwise provided for in this Agreement. 8 ARTICLE 8 --------- MISCELLANEOUS ------------- 8.1 No Conflicting Agreements. -------------------------- The Employee represents and warrants to the Company, that the Employee is not under any obligation to any person or entity which is inconsistent with or in conflict with any of the terms of this Agreement or which would prevent, limit or impair in any way the Employee's performance of all the terms of this Agreement and the Employee agrees not to enter into any agreement, either written or oral, in conflict herewith. 8.2. Entire Agreement ---------------- This Agreement contains the entire understanding and agreement between the Company and the Employee and cannot be amended, modified, or supplemented in any respect except by subsequent written agreement entered into by both parties. 8.3. Successors of the Company ------------------------- This Agreement shall inure to the benefit of and be binding upon the Company, its successors and assigns, including, without limitation, any person, firm, corporation or other entity which may acquire all or substantially all of the Company's assets and business, or with or into which the Company may be consolidated or merged, and this provision shall apply in the event of any subsequent merger, consolidation or transfer. In every respect, this Agreement shall inure to the benefit of and be binding upon the Employee, his heirs, executors and personal representatives and, being personal in nature, shall not be assignable by the Employee. 8.4. Effect of Waiver ---------------- The waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach. 8.5. Notices ------- Any notice, request, demand or other communication in connection with this Agreement must be in writing and shall be deemed to have been given and received three days after a certified or registered letter containing such notice, properly addressed, with postage prepaid, is deposited in the United States mail; and, if given otherwise than by registered or certified mail, it shall not be deemed to have been given until actually delivered to and received by the party to whom it is addressed. A. Notice to the Company shall be given at its principal mailing address, which at the time of execution of this Agreement is 3 Great Pasture Road, Danbury, Connecticut, 06813, Attention: Chief Executive Officer, or at such other address as it may designate. 9 B. Notice to the Employee shall be given at his home address, which at the time of execution of this Agreement is the address set forth in the heading of this Agreement, or at such other address as he may designate. 8.6. Counterparts ------------ This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 8.7. Severability ------------ If, in any jurisdiction, any provision of this Agreement or its application to any party or circumstances is restricted, prohibited or unenforceable, such provision shall, as to such jurisdiction, be ineffective only to the extent of such restriction, prohibition or unenforceability without invalidating the remaining provisions hereof and without affecting the validity or enforceability of such provision in any other jurisdiction or its application to other parties or circumstances. 8.8. Survival -------- Each of the terms and provision of this Agreement which are expressly or impliedly so intended shall survive the termination of this Agreement. 8.9. Applicable Law -------------- This Agreement shall be governed by and construed according to the laws of the State of Connecticut. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first stated above. ENERGY RESEARCH CORPORATION By: /s/ Jerry D. Leitman -------------------- Jerry Leitman Chief Executive Officer /s/ Joseph G. Mahler --------------------- Joseph G. Mahler 10 EX-23.1 4 CONSENT OF AUDITORS Consent of Independent Accountants The Board of Directors Energy Research Corporation: We consent to incorporation by reference in the registration statements on Form S-8 (No. 333-20807; No. 33-77008; No. 33-68866; and 333-63833) of Energy Research Corporation our report dated January 22, 1999, relating to the consolidated balance sheets of Energy Research Corporation as of October 31, 1998 and 1997, and the related consolidated statements of income (loss), changes in common shareholders' equity and cash flows for each of the years in the three-year period ended October 31, 1998, which report appears in the October 31, 1998 annual report on Form 10-K of Energy Research Corporation. KPMG LLP January 28, 1999 Stamford, CT 1 EX-27 5 FDS --
5 0000886128 ENERGY RESEARCH CORPORATION 1,000 U.S. DOLLARS 12-MOS OCT-31-1998 NOV-1-1997 OCT-31-1998 1 10,304 0 3,813 0 30 15,866 23,500 15,153 26,843 5,632 0 0 0 15,270 600 26,843 24,318 24,318 14,590 25,363 0 0 269 (369) 13 (382) 0 0 0 (382) (.09) (.09)
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