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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 [NO FEE REQUIRED]
For the fiscal year ended: December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from __________________ to ____________________
Commission File No. 0-27432
CLEAN DIESEL TECHNOLOGIES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-1393453
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(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification Number)
Suite 702, 300 Atlantic Street
Stamford, CT 06901
(203) 327-7050
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(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $0.05 par value per share
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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.
Aggregate market value of the voting stock held by non-affiliates of the
registrant based on the average bid and asked prices of March 23, 1999:
$1,414,978.
Indicate number of shares outstanding of each of the registered classes of
common stock at March 23, 1999: 2,591,125 shares Common Stock, $0.05 par value.
Documents incorporated by reference:
Certain portions of the Proxy Statement for the annual meeting of stockholders
to be held in 1999 described in Parts II, III and IV hereof are incorporated by
reference in this report.
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Part I
Forward-Looking Statements
Statements in this Form 10-K that are not historical facts, so-called
"forward-looking statements," are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Investors are cautioned
that all forward-looking statements involve risks and uncertainties, including
those detailed in the Company's filings with the Securities and Exchange
Commission. See "Risk Factors of the Business" in Item 1, "Business," and also
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
Item 1. Business
General
The Company ("CDT"), a Delaware corporation with a principal place of
business at 300 Atlantic Street, Stamford, Connecticut 06901, is a development
stage specialty chemical company supplying fuel additives and systems that
reduce harmful emissions from internal combustion engines while improving fuel
economy. The Company's two main technology areas are Platinum Fuel Catalysts
("PFCs") for emission control and fuel economy improvement in diesel and
gasoline-fueled engines, and nitrogen oxide ("NOx") reduction systems and
chemicals for control of NOx emissions from diesel engines.
The Company was formed in 1994 as a wholly owned subsidiary of Fuel-Tech
N.V. ("Fuel Tech"), which had conducted fundamental work regarding the Company's
technologies. The Company was spun off by Fuel Tech in a 1995 Rights Offering,
at which time Fuel Tech retained 27.6% of the Company's outstanding stock. In
1998, the Company raised $3.2 million through private placements and the sale of
shares of its Series A Convertible Preferred Stock. Fuel Tech currently owns an
approximate 26.9% interest in the Company on a fully converted basis. The
Company's technologies were acquired by assignment from Fuel Tech or developed
internally.
Global Trends in Diesel Emission Control
Throughout the world, combustion engine development is influenced by two
primary concerns. First is the increasing concern for global warming and second
is the concern over exhaust emissions, especially over particulate ("PM") and
NOx emissions. Each affect the environment and human health because of the
toxicity of particulate particles and the creation of ground-level ozones by
NOx.
Carbon dioxide ("CO2") emissions have been identified as contributing to
the greenhouse effect. The Kyoto Protocol (1997) set out to address the issue.
Since CO2 is the inevitable result of combustion of fossil fuels, the primary
way to reduce CO2 emissions is to reduce fuel consumption. The diesel engine is
the most fuel-efficient power unit. Thus the increasing use of diesel engines,
as opposed to gasoline engines, is considered one way to reduce fuel consumption
and thereby CO2 emissions.
Particulate and NOx emission concerns have been addressed by the US
Environmental Protection Agency ("US EPA") and the European Community, who
continue to set standards prescribing substantial reductions in PM and NOx. The
regulatory process is progressive. New vehicles in the year 1999/2000 have to
meet emission levels some 70-80% lower than ten years ago. Further reductions
have been defined for the years 2002 through 2005 and another tier of reductions
is anticipated in the subsequent five years.
Reducing diesel engine fuel consumption and PM on the one hand, and NOx
on the other, are opposing objectives: When diesel engines are retuned to
minimize fuel consumption or PM, their output of NOx is sharply increased and
vice versa. Moreover, while modern diesel engines have very low PM emissions by
mass, the number of fine particles emitted remains high. Consequently, engine
manufacturers are increasingly looking to "after engine" treatment systems for
the reduction of both fine PM particles and NOx.
Recent events that will have a major impact on the development and use of
aftertreatment systems are:
US EPA and Engine Manufacturers Settlement, October 1998
This has the consequence of bringing forward the emission standards,
previously agreed for 2004, to October 2002 and mandates expenditures by the
engine companies of $109.5 million in projects to reduce NOx emissions,
including research and development to design low-emitting engines and new
emission control technologies. The Company has submitted proposals to the US EPA
and engine companies for four projects totaling approximately $6 million.
2
EURO-4 - European Community Regulations for 2005
New emission levels for particulates are intended to force the fitting of
particulate filters to heavy-duty diesel engines in 2005.
The VERT Program
This program requires the use of filters for mining, tunneling, and urban
construction equipment in Germany, Austria, and Switzerland, for both new and
retrofit applications starting in 1999.
Technologies for Control of NOx Emissions from Diesel Engines
There are two proven technologies that are candidates for adoption in
2002-2005:
Exhaust Gas Recirculation ("EGR")
This technology has been developed by most, if not all, engine
manufacturers. It involves recycling a portion of the exhaust gas to modify the
combustion process in a way that reduces NOx. While the principle is simple, its
application leads to several problems:
- PM emissions increase significantly,
- Fuel consumption increases,
- Heat rejection is increased by 20-40% (requiring more radiator space),
- Durability is reduced.
The problem with increased PM emissions is likely, in the Company's
opinion, to lead to a requirement for an aftertreatment system to reduce PM
emissions. There are currently two proven devices: Diesel Oxidizing Catalysts
("DOCs") and Diesel Particulate Filters ("DPFs"). See "Products and Markets"
below for further information.
In the Company's opinion, the EGR system is the most developed system and
is likely to be adopted, probably accompanied by oxidizers (DOCs) or filters
(DPFs), in 2002 for "on highway" use.
In the longer term, however, the EGR system is likely to be unable to
achieve the reduction in NOx levels anticipated. In that event, Selective
Catalytic Reduction ("SCR") technology is currently the only proven technology
that could be used.
Selective Catalytic Reduction ("SCR")
This technology has been in use for several years for large power
generation boilers and gas turbines and for very large stationary diesel
engines, 5000 HP and above. Its adoption for use with stationary diesels in the
700 to 5000 HP range and for mobile diesels in the 250 to 600 HP range has been
limited primarily by the lack of a cost-effective system.
The process is noninvasive to the engine, allowing the engine
manufacturer to optimize the engine for minimum fuel consumption and minimum
particulates. This configuration is also optimal for engine durability.
The system comprises a tank of urea (a nonhazardous chemical used
primarily as agriculture fertilizer), an injection system for metering and
mixing the urea with the exhaust gas, and a catalyst to react the reactant gases
(from the decomposed urea) with NOx.
The system gives very high NOx reduction performance of up to 90% or
more but requires a separate urea tank and depends on a urea infrastructure
being in place.
SCR will likely be adopted for stationary engines and for many "off road"
applications where fuel economy and durability are priorities. The Company
believes that a near-term market is developing for SCR stationary diesel
engines, particularly for power generation, and that a market will develop for
mobile engines, both "off road" and "on road," after the year 2002.
3
Technologies for Control of Particulates
If SCR is fitted for NOx control, then the engine can be tuned for very
low particulate emissions and no further control technology is needed for PM
control under regulations for 2002 in the US.
Engines fitted with EGR for control of NOx will probably require an
aftertreatment device for control of PM. The two proven devices are:
Diesel Particulate Filters
Several filters are being used or being developed. There are several
different designs. The soot collected on the filter must be oxidized (burned),
otherwise the filter will eventually block. The soot will naturally burn at
temperatures above 560(Degree)C but diesel exhaust temperatures are typically
much lower than this. Metallic combustion catalysts are one way of promoting
oxidation at lower temperatures. Other methods include the use of electrical
heating or diesel fuel burners.
The DPF typically reduces PM by 90-99%.
Diesel Oxidizing Catalysts
These are flow-through devices with a catalytic surface. They are most
effective in reducing gaseous hydrocarbon and carbon monoxide. PM emissions
normally contain absorbed hydrocarbons. The use of DOCs substantially reduces
the absorbed hydrocarbon but, on its own, will not significantly reduce the
carbon content.
On engines without EGR, DOCs will reduce PM by 30-50%. On engines with
EGR, the absorbed hydrocarbons are significantly lower and DOCs alone have
demonstrated less than 10% PM reduction in two test programs conducted for the
Company.
Products and Markets
Platinum Plus(TM) Platinum Fuel Catalysts
The Company has developed a "family" of fuel additives using precious
metals (primarily platinum) that are used in minute concentrations in the fuel.
The Company's test programs have shown that platinum is synergistic with other
metallic additives such as cerium, iron, and copper as a bimetallic additive,
and that the platinum-cerium combination is particularly effective for promoting
oxidation of diesel soot using extremely low levels of total metal (4-8 ppm of
metal in the fuel).
The Company's 1998 research program completed by Delft University of
Technology in the Netherlands helped in establishing the chemical mechanism for
the platinum bimetallics. The platinum-cerium bimetallic was "superior in
performance to any system known yet."
Other programs conducted with engine manufacturers and manufacturers of
emission control equipment have tested the PFCs with aftertreatment devices for
particulate reduction:
Diesel Particulate Filters
Independent testing has demonstrated the ability of the platinum-cerium
additive to reduce particulate emissions by over 90% when used with a diesel
particulate filter.
The platinum-cerium additive oxidizes the soot that collects on the
filter. The challenge is to oxidize the soot at the lowest temperature possible
with the minimum amount of metal additive because excessive metal additive
deposits on the filter reduces its life. The platinum-cerium additive was able
to significantly reduce oxidation temperatures (by 50-80(Degree)C) and was
effective at levels of an order of magnitude lower than cerium alone. The
Company has demonstrated the ability of this system with an EGR-equipped engine
to achieve the NOx/PM standards for 2002.
The Company expects a market to develop for the additives to be supplied
in "onboard reservoirs" on new vehicles to meet regulations in 2002 in the US
and 2005 in Europe. A market is already developing in Europe for additives to be
sold with DPFs for diesel engines in mining, tunneling, and urban construction
equipment. See "The VERT Program" above.
4
The Company's platinum-cerium product is in field testing with DPFs in
Taiwan, where it has already been certified, and in Korea. Both countries have
retrofit programs once the technology is certified.
Diesel Oxidation Catalysts
In tests carried out by an independent laboratory, the platinum-cerium
additive in conjunction with a DOC achieved particulate reductions in excess of
40%, whereas the oxidizer alone achieved only 29%. This shows that the
combination of the platinum-cerium additive and a DOC is, in the Company's
opinion, suitable for a retrofit technology for a broad range of existing diesel
vehicles.
The platinum-cerium additive has also proven in independent tests on
engines fitted with EGR and a DOC to be capable of PM reduction of over 30%,
whereas a DOC alone achieved less than 10% in the same tests. The additive plus
a DOC combination may prove to be a sufficient device to meet US regulations for
2002 and could have benefits in cost, fuel consumption, and durability.
The technology of a platinum-cerium additive with DOCs is new and the
Company will be introducing this technology to engine manufacturers during 1999.
If it is adopted, the additive would be sold to engine manufacturers for use in
"onboard" dosing systems in the same way it is used in oxidizers.
Platinum Plus(R) for Premium Diesel
The Company is field-testing this product and plans to sell it through
additive marketing companies for use in additive packages for premium diesel.
The product's benefits are improved fuel economy and reduced emissions. The
Company is in discussions with additive marketing companies to sell the product
as soon as performance is established in the field tests. The Company has
established supply and blending arrangements for the product.
ARIS(TM) 2000 - Advanced Reagent Injection System for SCR of NOx
Stationary Diesel Engines
The Company identified a market opportunity for urea SCR systems for use
with stationary diesel engines primarily for power generation. The ARIS(TM) 2000
is a single fluid injection and metering system complete with an electronic
control unit that can be integrated with engine electronic and diagnostic
systems. The Company has now completed development of the ARIS 2000 system for
stationary diesels and has sold an initial batch of units for evaluation
purposes. The Company plans to sell the ARIS 2000 stationary system to engine
companies, generator system integrators, and catalyst companies. The Company is
in discussions with engine and catalyst companies concerning developing programs
to demonstrate the urea SCR system in the field. Simultaneously, the Company is
in discussions with specific engine groups concerning developing certification
programs.
Mobile Diesel Engines
The ARIS 2000 was designed to be adaptable to automotive use and to use
automotive components. The Company has made prototypes of the ARIS 2000 mobile
system, one of which is installed on a test vehicle with an engine manufacturer.
The Company is in discussions with catalyst companies and engine
manufacturers for the development, field- testing, and supply of these systems.
The Company has proposed specific programs within the US EPA Engine
Manufacturers Settlement.
The SCR system is being promoted by the German EPA and systems are
expected to be available on some truck models in Europe in the year 2000. As
systems become more cost effective and more experience is gained, the SCR system
could be preferred to EGR for all medium and large diesel engines.
Health Effects and the Use of Metallic Additives
Certain metallic additives have come under scrutiny for their possible
effects on health. While the PFCs are already registered in the US and do not
strictly need to be registered in Europe, where there are no rules for testing
such additives, the Company considered it prudent to take a much more proactive
view. Therefore, in 1996, the Company began discussions with the Ministry of
Transport and the Ministry of Health, regulatory authorities in the United
Kingdom, asking for specific consent to the use of platinum metal additives in
diesel fuel. In December 1996, the following response was received from the
United Kingdom Ministry of Health's Committee on Toxicity: "The Committee is
satisfied that the platinum emissions from vehicles would not be in an
allergenic form and that the concentrations were well below those known to cause
human toxicity." In the US, the Company has completed additional engine testing
to maintain its EPA registration as required of all fuel and fuel additive
manufacturers. Engine test results show that the amount of platinum emitted from
use of the Company's PFCs is roughly equivalent to the platinum attrition from
automotive catalytic converters.
5
Sources of Supply
The Company has outsourcing arrangements with two companies in the
precious metal refining industry and may make arrangements with others. The
Company has made the product itself in the past but considers outsourcing to a
precious metal refinery to be more cost effective. The Company has established a
source of cerium to use in its bimetallic diesel additive.
The Company has made, in the opinion of its management, satisfactory
arrangements for the manufacture of the injectors, which are a key component of
the ARIS 2000 systems.
Research and Development
The Company employs five individuals, including two executive officers,
in engineering and product development as of the date of this report. During the
years ended December 31, 1998, 1997, and 1996, the Company's research and
development expenses exclusive of patent costs totaled approximately $1,009,000,
$1,985,000, and $1,747,000, respectively. The Company expenses all development
costs as incurred.
Protection of Proprietary Information
The Company holds the rights to a number of patents and patent
applications pending. There can be no assurance that pending patent applications
will be approved or that the issued patents or pending applications will not be
challenged or circumvented by competitors. Certain critical technology
incorporated in the Company's products is protected by trademark and trade
secret laws and confidentiality and licensing agreements. There can be no
assurance that such protection will prove adequate or that the Company will have
adequate remedies for disclosure of its trade secrets or violations of its
intellectual property rights.
Insurance
The Company maintains coverage for the customary risks inherent in its
operations. Although the Company believes its insurance policies to be adequate
in the amount and coverage for its current operations, no assurance can be given
that this coverage will, in fact, be or continue to be available in adequate
amounts or at a reasonable cost or that such insurance will be adequate to cover
any future claims against the Company.
Employees
The Company has eight full-time employees. In addition, two executive
officers of Fuel Tech provide management, administrative, financial, and legal
services for the Company pursuant to a Management and Services Agreement between
Fuel Tech and the Company on an as-needed basis. The Company also retains two
outside technical consultants on specific projects related to platinum, engines,
and NOx reduction, and retains three outside marketing agents.
The Company enjoys good relations with its employees and is not a party
to any labor management agreements.
Risk Factors of the Business
Investors in the Company should be mindful of the following risk factors
relative to the Company's business:
Liquidity - Going Concern
At the date of this report, the Company has cash resources estimated to
be sufficient for its needs only through the third quarter of 1999. See the text
below under the captions "Liquidity and Sources of Capital" in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and "Report of Independent Auditors" in Item 8, "Financial
Statements." Accordingly, at December 31, 1998, there is substantial doubt as to
the Company's ability to continue as a going concern.
Competition
Competition in the diesel fuel additive market will come from other large
additive suppliers, supplying other metallic additives. The Company is not
currently in competition with other fuel additive manufacturers. When active
marketing of the Company's PFCs is in progress, the Company anticipates
competing on the basis of price, proprietary technology, effectiveness, and ease
of use of the PFCs.
6
Competition in the NOx control market will come from other suppliers of
reagent-based post-combustion NOx control systems including large,
well-established catalyst and engine manufacturing companies. The Company has
proprietary technology and is forming certain alliances to support its efforts
to commercialize NOx control products.
Need for Additional Research and Development
The Company was incorporated in January 1994. To date, while it has sold
small quantities of its PFCs for the automotive aftermarket and of its ARIS 2000
system for evaluation purposes, it has engaged principally in research and
development related to its PFC process and NOx reduction technologies. The
Company's PFC process and ARIS 2000 system may require substantial field testing
before they are commercially accepted. The commercialization of the technologies
will depend on the Company's success in achieving cost-effective production,
maintaining registration status with the US EPA and other regulatory bodies, and
forming strategic alliances for marketing and distribution of the products. The
accomplishment of some or all of these objectives may be delayed or may never
occur.
Continuing Operating Losses
The Company has had minimal revenues through December 31, 1998. The
Company expects to continue to incur operating losses through at least 1999.
There can be no assurance that the Company will achieve or sustain significant
revenues or profitability in the future. See Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations," elsewhere
herein.
No Assurances of Additional Funding
The Company is seeking additional funding in the form of a private
offering of additional shares of the Company's equity securities. Any offering
of such securities may result in immediate and significant dilution to the
stockholders of the Company. The ability of the Company to consummate a
financing will depend on the status of the Company's research and development
and marketing programs, and field trials, as well as conditions then prevailing
in the relevant capital markets. There can be no assurance that such funding
will be available when needed, or on terms acceptable to the Company. In the
event that the Company is unable to raise additional funds, the Company may be
required to delay, scale back, or severely curtail its development efforts, or
otherwise impede its ongoing field trials, which could have a material adverse
effect on the Company's business, operating results, financial condition, and
long-term prospects. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," elsewhere herein.
Possible Volatility of Stock Price
There has been significant volatility in the market prices of publicly
traded shares of emerging growth technology companies. Factors such as
announcements of technical developments, establishment of strategic alliances,
changes in governmental regulation, and developments in patent or proprietary
rights may have a significant effect on the market price of the Company's Common
Stock.
Relationship with Fuel Tech; Conflicts of Interest
Directors and officers of Fuel Tech and its subsidiaries who are also
directors and officers of the Company, and Fuel Tech as the Company's largest
stockholder, are in positions involving the possibility of conflicts of interest
with respect to transactions concerning the Company. The Company currently has
one independent director. See Item 13, "Certain Relationships and Related
Transactions."
Dependence upon Third-Party Technology
While the PFCs may be used alone for moderate levels of emission control,
it is expected that the product will be integrated into other systems using
third-party technology, such as Diesel Particulate Filters and Diesel Oxidizing
Catalysts, to achieve higher levels of control. The adoption of the use of PFCs
in such systems will depend on the effectiveness of third-party technology, the
ability of third parties to market their products, and the compatibility of the
Company's PFCs and NOx control products with their systems. Failure of these
third-party systems to gain market acceptance or failure of the PFCs and NOx
control products to prove compatible and effective with third-party systems
could have an adverse effect on the Company's business, operating results, and
financial condition. See "Products and Markets" in Item 1, "Business."
7
Uncertainty of Market Acceptance
The commercial success of the Company's products will depend upon
acceptance by the fuel additive, oil, and engine industries, and acceptance by
governmental regulatory bodies. This market acceptance will in turn depend upon
competitive developments and the Company's ability to demonstrate the efficacy,
cost effectiveness, safety, and ease of use of the PFCs and NOx control products
of the Company. The failure by the Company to receive market acceptance for the
PFCs and NOx control products would have an adverse effect on the Company's
business, operating results, and financial condition. See "Products and Markets"
in Item 1, "Business."
No Assurance of Necessary Regulatory Approvals
The Company's products and manufacturing activities are subject to
governmental regulation, principally by the US EPA and corresponding foreign and
state agencies. The US EPA administers the Clean Air Act Amendments of 1990
("CAAA"). The Company is subject to the standards and procedures contained in
such act and the regulations promulgated thereunder, as well as similar
standards, procedures, and regulations of international regulatory authorities,
and is subject to inspection by the US EPA and other regulatory bodies for
compliance with such standards, procedures, and regulations. Failure to receive
appropriate approvals or to comply with the US EPA and similar foreign
regulations could result in civil monetary or criminal sanctions, restrictions
on or injunction against marketing of the Company's products, as well as seizure
or recall of the Company's products, or other regulatory actions. The PFC
received registration from the US EPA to be used as an aftermarket treatment of
individual vehicles and in bulk fuel supplies for diesel. The Company has
received registration status under the US EPA fuel additive regulations for
three additional PFCs with the original PFC. The Company has received consent
from the UK Ministry of Health for use of the PFCs in diesel fuel. See "Health
Effects and the Use of Metallic Additives" in Item 1, "Business."
No Assurance of Protection of Patents and Proprietary Rights
The Company holds licenses to a number of patents, holds certain patents,
and has patent applications pending. There can be no assurance that pending
patent applications will be approved or that the issued patents or pending
applications will not be challenged or circumvented by competitors. Certain
critical technology incorporated in the Company's products is protected by
trademark and trade secret laws and confidentiality and licensing agreements.
There can be no assurance that such protection will prove adequate or that the
Company will have adequate remedies for disclosure of its trade secrets or
violations of its intellectual property rights. See "Protection of Proprietary
Information" in Item 1, "Business."
Platinum Price
The cost of platinum will have a direct impact on the future pricing and
profitability of the PFCs. Although the Company intends to minimize this risk
through various purchasing and hedging strategies, there can be no assurance
that the Company will be able to do so. A significant increase in the price of
platinum could have a material adverse effect on the Company's business,
operating results, and financial condition.
Dependence on Attracting and Retaining Personnel
The success of the Company will depend, in large part, on the Company's
ability (i) to retain current key personnel; (ii) to attract and retain
additional qualified management, scientific, and manufacturing personnel; and
(iii) to develop and maintain relationships with research institutions and other
outside consultants. The loss of key personnel or the inability of the Company
to hire or retain qualified personnel, or the failure to assimilate effectively
such personnel could have a material adverse effect on the Company's business,
operating results, and financial condition. See "Employees" in Item 1,
"Business."
No Dividends
The Company has to date not paid dividends on its Common Stock and does
not intend to pay any dividends to its common stockholders in the foreseeable
future. The Company currently intends to reinvest earnings, if any, in the
development and expansion of its business. Furthermore, while the Company does
not have an intention to pay dividends, its ability to pay any dividends would
be restricted by the dividend requirements of its Series A Convertible Preferred
Stock. See Item 5, "Market for Registrant's Common Equity and Related
Stockholder Matters."
8
Item 2. Properties
Facilities
The Company has leased for administrative purposes 2,900 square feet of
office space at 300 Atlantic Street, Stamford, Connecticut. The original
sublease was effective from February 1, 1996, through February 28, 1999, and had
an annual base rent of $65,250. In January 1999, the Company signed a lease
extension for the period March 1, 1999, through February 28, 2002, with the
possibility of early termination. The annual base rent under the lease extension
is $81,200.
Patents and Technology Assignments
The Company's technology is comprised of patents, patent applications,
trade or service marks, data, and know-how. This technology was acquired by
assignment from Fuel Tech or developed internally. The assignment agreement
provides for running royalties of 2.5% of gross revenues derived from the sale
of the PFCs, commencing in 1998 and terminating in 2008. The Company may at any
time terminate this royalty obligation by payment to Fuel Tech of amounts in
1998 of $12 million and declining annually to $1,090,910 in 2008. The Company as
owner maintains the technology at its expense.
During 1998, the Company filed an additional 5 patent applications and
now has a total of 16 US patents granted and 41 international patents. There are
currently 12 US patent applications pending and 42 international applications.
These patents and patent applications cover the means of controlling the four
principal emissions from diesel engines (NOx, particulates, CO, and HC).
Item 3. Legal Proceedings
The Company is not involved in any legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 1998, no matters were submitted to a vote of
the Company's security holders.
9
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Common Stock
The Company's shares are traded in the US in the over-the-counter market.
Reports of transactions of the Company's shares are available on the OTC
Electronic Bulletin Board (Symbol CDTI).
No dividends have been paid on the Company's Common Stock and the Company
does not intend to pay dividends on these shares in the foreseeable future.
Furthermore, while the Company does not have an intention to pay dividends, its
ability to pay any dividends would be restricted by the dividend requirements of
the Series A Convertible Preferred Stock ("Series A Preferred Stock"). The
Company had approximately 608 beneficial common stockholders at March 24, 1999.
Stock price date: High Low
----------------- ---- ---
4th Quarter 1995, from December 26.......... 7 1/4 6 3/8
1st Quarter 1996............................ 7 3/8 5
2nd Quarter 1996............................ 6 1/8 4 3/8
3rd Quarter 1996............................ 6 3 7/8
4th Quarter 1996............................ 4 1/4 2
1st Quarter 1997............................ 5 1/64 2
2nd Quarter 1997............................ 4 1/2 3 1/4
3rd Quarter 1997............................ 4 1/8 2 1/4
4th Quarter 1997............................ 3 3/4 1 13/16
1st Quarter 1998............................ 3 1/2 1 3/8
2nd Quarter 1998............................ 2 5/8 1 5/16
3rd Quarter 1998............................ 2 9/16
4th Quarter 1998............................ 1 1/2 5/8
Sales of Unregistered Securities During the Period
Pursuant to a Regulation S exemption from registration under the
Securities Act of 1933 with respect to an offshore placement and a ss.4 (2)
private placement exemption under the Securities Act of 1933 with respect to an
exchange of the Company's notes with Platinum Plus, Inc., the Company sold or
exchanged effective November 11, 1998, 7,582 shares of its Series A Convertible
Preferred Stock. The price and liquidation value of the Series A Preferred Stock
was $500 per share. Each share of Series A Preferred Stock is convertible into
333.33 shares of the Company's Common Stock and pays dividends, in cash, of nine
percent or, in kind, of additional shares of Series A Preferred Stock, of eleven
percent of the liquidation value. The directors have elected to pay dividends in
kind. The proceeds of the Series A Preferred Stock issuance of approximately
$1.85 million will be used for general corporate purposes of the Company. There
are, as of the date of this report, 22 beneficial holders of the Series A
Preferred Stock. See also the text under the caption "Liquidity and Sources of
Capital" in Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" below. Additional information relating to the Series
A Preferred Stock is contained in the Company's Form 8-K dated May 26, 1998, and
Form 10-Q for the quarter ending September 30, 1998, which information is
incorporated by reference.
Item 6. Selected Financial Data
The Company was incorporated on January 19, 1994, as a wholly owned
subsidiary of Fuel Tech. Predecessor financial information included below for
the period January 1, 1992, through January 18, 1994, reflects the Company's
operations prior to incorporation, at which time it was accounted for as part of
Fuel Tech. Effective December 12, 1995, Fuel Tech completed a Rights Offering of
the Company's Common Stock, with Fuel Tech retaining a 27.6% ownership interest
in the Company. During 1998, the Company obtained an additional $3.2 million
through private placements and the sale of shares of its Series A Convertible
Preferred Stock ("Series A Preferred Stock"). As a participant in these
financings, Fuel Tech owns 2,029 shares of the Company's Series A Preferred
Stock, and along with its approximately 689,000 shares of the Company's Common
Stock, owns an approximate 26.9% interest in the Company, on a fully converted
basis, at December 31, 1998.
10
The Company is a development stage enterprise, and its efforts from
January 1, 1992, to the present time have been devoted to the research,
development, and commercialization of Platinum Fuel Catalysts and nitrogen oxide
reduction technologies to reduce emissions from diesel engines. There were no
material activities related to the Company's business in 1991.
(in thousands, except share data)
Period from
For the years ended December 31, January 1, 1992,
----------------------------------------------------------- through
1998 1997 1996 1995 1994 December 31, 1998
-------- -------- ---------- ---------- ----------- -----------------------
STATEMENTS OF OPERATIONS DATA
Sales $ 46 $ 199 $ -- $ -- $ -- $ 245
Costs and expenses:
Cost of sales 29 132 -- -- -- 161
General and administrative 1,515 1,730 1,842 963 507 6,557
Research and development 1,009 1,985 1,747 796 441 6,326
Patent filing and maintenance 156 237 223 199 158 1,094
------ ------ ------ ------ ------ --------
Loss from operations 2,663 3,885 3,812 1,958 1,106 13,893
Interest (income) expense, net 57 (121) (323) 66 1 (320)
Cost of withdrawn Rights Offering 264 -- -- -- -- 264
------ ------ ------ ------ ------ --------
Net loss during development stage $2,984 $3,764 $3,489 $2,024 $1,107 $ 13,837
====== ====== ====== ====== ====== ========
Basic and diluted loss per common
share $ 1.20 $1.50 $ 1.40 $ 0.81 $0.44 N/A
Weighted-average shares outstanding 2,517 2,517 2,500 2,500 2,500 N/A
Cash dividends paid $ 0.00 $ 0.00 $ 0.00 $ 0.00 $0.00 N/A
December 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- ---------- ---------- -----------
BALANCE SHEET DATA
Current assets $ 1,940 $1,682 $5,595 $8,882 $513
Total assets 1,985 1,750 5,677 8,882 513
Current liabilities 686 894 1,486 487 1,370
Long-term liabilities -- 395 -- 745 --
Working capital (deficit) 1,254 788 4,109 8,395 (857)
Stockholders' equity (deficiency) 1,299 461 4,191 7,650 (857)
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Company was incorporated on January 19, 1994, as a wholly owned
subsidiary of Fuel-Tech N.V. ("Fuel Tech"). Effective December 12, 1995, Fuel
Tech completed a Rights Offering of the Company's Common Stock, with Fuel Tech
retaining a 27.6% ownership interest in the Company. Net proceeds of the 1995
Rights Offering of $10.5 million were contributed to the Company by Fuel Tech.
During 1998, the Company obtained an additional $3.2 million net of expenses
through private placements and the sale of its Series A Convertible Preferred
Stock (the "Series A Preferred Stock"). As a participant in these financings,
Fuel Tech owns 2,029 shares of the Company's Series A Preferred Stock, and along
with its approximately 689,000 shares of the Company's Common Stock, owns an
approximate 26.9% interest in the Company, on a fully converted basis, at
December 31, 1998.
The Company is a development stage enterprise, and its efforts from
January 1, 1992 (date of inception), to the present time have been devoted to
the research, development, and commercialization of Platinum Fuel Catalysts
("PFCs") and nitrogen oxide ("NOx") reduction technologies for diesel engines.
11
Results of Operations
1998 Versus 1997
Sales and Cost of sales were $46,000 and $29,000, respectively, in 1998
versus $199,000 and $132,000, respectively, in 1997. The 1998 sales related
primarily to sales of the Company's commercial prototype of the ARIS(TM) 2000
diesel NOx reduction system. The units were sold for testing and evaluation
purposes. The 1997 sales related to PFC products purchased by Holt Lloyd
International, Ltd. ("Holts"), pursuant to a September 1996 supply agreement. In
early 1997, Holts launched the Company's PFC products for use with Holts' fuel
additives in the aftertreatment of fuel for both gasoline and diesel engines in
several European countries. The results were disappointing. Additionally, in
December 1997, Holts was acquired by Prestone Products, Inc., a division of
AlliedSignal. There were minimal sales of the PFCs in 1998.
The US EPA and Engine Manufacturers Settlement of October 1998 mandates
the expenditure by engine companies of $109.5 million in projects to reduce NOx
emissions, including research and development to design low-emitting engines and
new emission control technologies. The Company has prepared a demonstration
program of its ARIS 2000 and has submitted proposals to the US EPA and engine
companies for four projects totaling approximately $6 million.
The Company had minimal sales in 1998 of its platinum-cerium bimetallic
additive for use with particulate filters. The 1998 sales were for field trials
and the Company expects retrofit markets to develop in Taiwan and Korea during
1999. The Company believes its platinum-cerium additive has demonstrated better
regeneration performance than other additive systems and has the great benefit
of being effective at much lower dose rates than the other competitive additives
of cerium or iron alone. Dose rates are important because they result in lower
ash buildup and longer filter life.
The Company's platinum-cerium bimetallic additive with diesel flow
through oxidizers has also proven in testing to be effective in reducing the
"carbon fraction" of diesel particulate emissions, whereas oxidizers alone are
effective only on the soluble organic fraction from oil and fuel residues. Many
engine manufacturers plan to meet the new NOx limits by means of Exhaust Gas
Recirculation ("EGR"), which has the disadvantage of increasing particulates and
especially the "carbon fraction" content. Thus, the Company believes it is
extremely well placed to sell either its platinum-cerium additive technology or
its ARIS 2000 urea injection system technology as part of the overall emission
control strategy for a very wide range of diesel engines.
The Company is completing its Tier 1 registration of the platinum-cerium
additive and already has effective registration of its platinum-only additives.
Field trials of the platinum-cerium additive started in the first quarter of
1999. The Company expects to complete sufficient trials in the first half of
1999 and to start commercial sales of the bimetallic additive to fleets as part
of additive packages for premium diesel fuels. The Company expects these sales
to start in midyear 1999.
The Company expects revenues to start in 1999 from sales of its Platinum
Plus(R) additives, initially from sales to fleets and aftermarket products and
later to engine manufacturers for inclusion with an "onboard dosing" system on
new vehicles. The Company also expects revenues from demonstration programs and
joint development agreements (both for its ARIS 2000 system and its Platinum
Plus additives for particulate filters and oxidizers), but will not know whether
its programs are accepted until sometime in 1999.
General and administrative expenses decreased to $1,515,000 in 1998 from
$1,730,000 in 1997. The decrease is primarily the result of measures being taken
by the Company to reduce expenditures in order to conserve cash, pending
securing of additional working capital and the success of its commercialization
efforts.
Research and development expenses decreased to $1,009,000 in 1998 from
$1,985,000 in 1997. The significant reduction in 1998 is due in part to the
completion of a number of fundamental programs in 1997; the deferral of certain
field trials due to the Company's working capital position; and the Company's
expanded participation in collaborative and consortium-based programs with
potential customers and industrial partners for which the Company funds only a
portion of the program cost.
Additionally, as more fully described above, the Company began a shift in
emphasis in 1998 from research and development toward commercialization of its
products. Several units of its ARIS 2000 were sold in 1998 for evaluation
purposes, while field trials of the Company's platinum-cerium additive are
slated to begin in the first quarter of 1999. As a result, research and
development costs were lower in 1998 versus 1997.
Patent filing and maintenance expenses decreased to $156,000 in 1998
versus $237,000 in 1997. The decrease is due in part to the shift in emphasis
toward commercialization as noted above. Additionally, expenses were higher in
1997 due to the costs associated with new patent filings for the Company's NOx
reduction technology.
12
Interest income decreased to $41,000 in 1998 from $165,000 in 1997. The
decrease is the result of the Company's lower cash position. Interest expense
increased to $98,000 in 1998 from $44,000 in 1997 due to interest expenses
associated with the $1.4 million bridge loan notes (the "Bridge Loan") issued
during 1998 and subsequently converted into the Company's Series A Preferred
Stock. See "Liquidity and Sources of Capital" below for further information.
During 1998, the Company incurred approximately $264,000 in expenses
associated with an effort to secure additional funding in the form of a Rights
Offering. The Company submitted a Registration Statement (Form S-1) to the
Securities and Exchange Commission in August 1998. The Registration Statement
was subsequently withdrawn on November 5, 1998, upon the Company receiving a
commitment for approximately $1.85 million, net of expenses, through a private
placement of shares of its Series A Preferred Stock. See "Liquidity and Sources
of Capital" below for further information.
1997 Versus 1996
Sales and Cost of sales were $199,000 and $132,000, respectively, as the
Company started selling small quantities of product in 1997. The Company's
products were purchased by Holts, pursuant to a supply agreement entered into in
September 1996. Holts launched the Company's PFC products for use with Holts'
fuel additives in the aftertreatment of fuel for both gasoline and diesel
engines in several European countries.
Gross margin on PFCs is expected to improve in the future as the PFC
processing costs charged to the Company will be reduced with subsequent
production batches.
General and administrative expenses decreased to $1,730,000 in 1997 from
$1,842,000 in 1996. The decrease was primarily due to a reduction in management
fees charged by Fuel Tech as the Company hired its own personnel and, in August
1996, terminated certain services furnished by Fuel Tech.
Research and development expenses were $1,985,000 in 1997 versus
$1,747,000 in 1996. The increase was primarily due to the costs associated with
significant test programs on light-duty and heavy-duty engines and the addition
of three senior technical employees in midyear 1996. The programs included the
use of the Company's PFCs in gasoline and diesel vehicles, the testing of NOx
control technologies in conjunction with Engelhard Corporation and Nalco Fuel
Tech, and engine testing of the PFCs as required to maintain registration with
the US Environmental Protection Agency. Some of the programs relating to the
PFCs and NOx control were done in collaboration with Cummins Engine Company, a
major US diesel engine manufacturer. The Company announced that the use of the
PFCs in conjunction with advanced heavy-duty engine design techniques and a
diesel particulate filter had achieved US federal emission levels for 2004. The
Company also developed a platinum-cerium bimetallic fuel additive based on a
cerium compound supplied by Rhone-Poulenc. This product achieved emission
reductions of 25-35% on new light-duty diesels. Certification testing of the
bimetallic additive for Taiwan buses equipped with particulate filters began in
late 1997. Based on the extent of the market interest and improved cost and
performance of the bimetallic additive, the Company secured the supply of a
cerium product based on the Company's specifications.
In late 1997, the Company signed a development and marketing agreement
with AMBAC International of Springfield, Massachusetts, for the fabrication of
the ARIS 2000 urea injection equipment suitable for stationary and mobile engine
NOx control. Engine testing began in the second quarter of 1998. AMBAC is a
major supplier of fuel injection equipment for diesel engine manufacturers
worldwide.
Patent filing and maintenance expenses remained relatively flat,
increasing to $237,000 in 1997 from $223,000 in 1996.
Liquidity and Sources of Capital
The Company is a development stage enterprise and has incurred losses
since inception (January 1, 1992) aggregating $13,837,000 and $10,853,000 at
December 31, 1998, and December 31, 1997, respectively. The Company expects to
incur losses through the foreseeable future as it further pursues its research,
development, and commercialization efforts. Although the Company started selling
product in 1997, sales have been minimal and the Company continues to be
dependent upon sources other than operations to finance its working capital
requirements.
In December 1995, the Company raised approximately $10.5 million, net of
offering expenses and broker-dealer commissions of approximately $1.3 million,
through the 1995 Rights Offering of its shares by Fuel Tech. The Company then
repaid Fuel Tech approximately $2.3 million in intercompany loans.
13
On February 17, 1998, Fuel Tech agreed to provide the Company with up to
$500,000 in order to fund its cash requirements until such time as the Company
obtained the long-term financing it was seeking. On May 20, 1998, the $500,000
commitment was converted into a bridge loan (the "Bridge Loan"). The Bridge Loan
stipulated an automatic conversion into shares of the Company's Series A
Preferred Stock upon the conclusion of a public or private financing that
contributed a minimum of $1.75 million of additional net proceeds to the
Company. In mid-1998, the Company also received an additional $900,000 of
financing under the same Bridge Loan (having the same terms and conditions) from
outside investors. As more fully described below, in November 1998, the Bridge
Loan automatically converted into 2,800 shares of the Company's Series A
Preferred Stock.
In 1997, the Company repaid $250,000 of a $745,000 promissory demand note
with Fuel Tech and restructured the remaining amount into a $495,000 promissory
term loan note (the "Term Note") with Platinum Plus, Inc. ("Platinum Plus"), a
wholly owned subsidiary of Fuel Tech. The principal amount of the Term Note was
payable in three annual installments of $100,000 each on July 1 of each of the
years 1998 through 2000 with a final installment of $195,000 on July 1, 2001. On
July 1, 1998, Platinum Plus elected to defer the repayment of the $100,000 of
principal, which was payable on that date. Interest at a rate of eight percent
per annum was payable on the unpaid balance on each principal payment date. The
interest accrued on the note as of July 1, 1998, was paid by the Company. See
below for further information concerning the exchange of the Term Note for
shares of the Company's Series A Preferred Stock.
In November 1998, the Company obtained through a private placement
approximately $1.85 million in net proceeds against the issuance of 3,753 shares
of the Company's Series A Preferred Stock. As the Company received net proceeds
in excess of the $1.75 million minimum, and in accordance with the terms of the
Bridge Loan agreement, the $1.4 million Bridge Loan, mentioned above, converted
into 2,800 shares of the Company's Series A Preferred Stock. Additionally, in an
effort to retain its approximate 27% interest in the Company (assuming
conversion of the Series A Preferred Stock into the Company's Common Shares),
Fuel Tech elected to exchange its $495,000 Term Note, and the associated accrued
interest from its Bridge Loan and Term Note, for 1,029 shares of the Company's
Series A Preferred Stock. As a result, Fuel Tech, owns 2,029 shares of the
Company's Preferred Stock at December 31, 1998. These shares, if converted,
along with its Common Stock ownership would give Fuel Tech an approximate 26.9%
interest in the Company on a fully converted basis.
As a result of the foregoing transactions, the Company has 7,582 shares
of Series A Preferred Stock outstanding at December 31, 1998, which are
convertible into approximately 2.5 million shares of the Company's Common Stock,
$0.05 par (convertible at a rate of 1:333.33). Pursuant to a Registration Rights
Agreement and Consent, these Common Shares will be entitled to registrations
under the Securities Act of 1933, as amended, (a) three on demand, if not less
than $500,000 in value and not more often than once in every twelve months, and
(b) an unlimited number, if incidental or "piggy-back." See "Notes to Financial
Statements -- Stockholders' Equity" in Item 8, "Financial Statements," for
further information on the dividend and conversion features of the Series A
Preferred Stock.
Effective as of October 28, 1994, Fuel Tech granted two licenses to the
Company for all patents and rights associated with its Platinum Fuel Catalyst
technology. Effective November 24, 1997, the licenses were canceled and Fuel
Tech assigned to the Company all such patents and rights on terms substantially
similar to the licenses. In exchange for the assignment, the Company will pay
Fuel Tech a royalty of 2.5% of its annual gross revenue from sales of the PFCs,
commencing in 1998. The royalty obligation expires in 2008. The Company may
terminate the royalty obligation to Fuel Tech by payment of $12 million in 1998
and declining annually to $1,090,910 in 2008. The Company as assignee and owner
will maintain the technology at its own expense. To date, no royalties have been
paid to Fuel Tech.
For the years ended December 31, 1998, 1997, and 1996, and for the period
from January 1, 1992, through December 31, 1998, the Company used cash of
$2,849,000, $3,775,000, $3,520,000, and $13,339,000, respectively, in operating
activities.
At December 31, 1998 and 1997, the Company had cash and cash equivalents
of $1,663,000 and $1,239,000, respectively. The increase in cash and cash
equivalents was the result of the $3.2 million funding in 1998 less the
resources used to fund the Company's operations in 1998. Working capital
increased to $1,254,000 at December 31, 1998, from $788,000, at December 31,
1997. As more fully described above, this is the result of the $3.2 million
funding in 1998 and the conversion of the outstanding debt (the $495,000 Term
Note with Fuel Tech, $100,000 of which was classified as a current liability in
1997) into shares of the Company's Series A Preferred Stock. The Company still
anticipates incurring additional losses through at least 1999 as it further
pursues its commercialization efforts. In light of this, the Company is taking
steps to minimize expenditures until such time as it obtains the additional
capital it is seeking (see below) and is able to generate a positive cash flow.
14
As a result of the Company's recurring operating losses, the Company has
been unable to generate a positive cash flow. The Company's current cash
position (inclusive of the $3.2 million funding mentioned above), coupled with
expected revenues and/or proceeds from joint development agreements, will not be
sufficient to fund the Company's operations until it generates a positive cash
flow. The Company is, however, actively seeking additional financing as it
further pursues its commercialization efforts. Without any further funding or
revenues from sales, demonstration programs, or license fees, the Company
expects to be able to fund its operations through the third quarter of 1999.
Although the Company believes that it will be successful in its capital-raising
efforts, there is no guarantee that it will be able to raise such funds on terms
that will be satisfactory to the Company. The Company has developed contingency
plans in the event its financing efforts are not successful. Such plans include
reducing expenses and selling or licensing the Company's technologies.
Accordingly, at December 31, 1998, there is substantial doubt as to the
Company's ability to continue as a going concern.
Market Risk and Risk Management Policies
In the opinion of management, with the exception of exposure to
fluctuations in the cost of platinum, the Company is not subject to any
significant market risk exposure. See "Risk Factors of the Business -- Platinum
Price" in Item 1, "Business."
Impact of Year 2000
The costs of the planned Year 2000 ("Y2K") modifications and the dates by
which the Company expects to complete its plans are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including continued availability of certain resources, third-party modification
plans, and other factors. Specific factors that might cause differences between
the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas; the ability to locate
and correct all relevant computer codes; changes in consulting fees and costs to
remediate and replace hardware and software; as well as nonincremental costs
resulting from redeployment of internal resources, timely responses to and
corrections by third parties, such as significant customers and suppliers, and
similar uncertainties.
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. The issue
arises if date-sensitive software recognizes a date using "00" as the year 1900
rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
The Company has identified three information technology ("IT") and non-IT
areas for which Y2K compliance is critical to the normal and routine operations
of the Company. These areas are:
1) commercial off-the-shelf software
2) computer hardware and embedded processors
3) facilities-related applications and processes, such as communications
and equipment with embedded chips
The Company uses commercial off-the-shelf software and hardware, which,
based on the representations of the vendors and consultants, are or will be Y2K
compliant. The Company is also evaluating the possible effects of the Y2K issue
on its key suppliers, contractors, and vendors. Although the possible effects of
the Y2K issue on these parties are beyond the control of the Company, the
Company has initiated a process to communicate with these parties to inform them
of the Company's Y2K strategy and to determine their own Y2K strategies and
readiness. The Company estimates that the total cost of its Year 2000 compliance
program will be insignificant, and will primarily require the purchase of new
hardware and/or software (although a portion of the hardware and software would
have been purchased by the Company through the regular and routine upgrading of
systems). Such hardware and software will be capitalized and depreciated over
the estimated useful life of the related asset. All other expenditures will be
charged to expense. As of December 31, 1998, the Company has not expended any
funds specifically for the Y2K problem.
15
Year 2000 Program
As of December 31, 1998, the Company is actively engaged in one or more
compliance phases with respect to each of the three areas described above.
Although there can be no guarantee of complete readiness by the Year 2000, the
Company believes each of the areas described above will be Y2K compliant by
November 30, 1999, or will be substantially compliant by that time, such that
further remediation and testing, if any, will not be significant to its
operations. However, as discussed above, the Company has not completed its Year
2000 compliance program. In the event the Company does not complete its program,
or fails to identify and modify critical business applications, there may be an
interruption to the Company's business that may have a materially adverse impact
on its future financial condition and results of operations. In addition,
Y2K-related disruptions in the economy in general may also have a materially
adverse impact on the Company's future financial condition and results of
operations.
Risks
The failure to identify and correct a Year 2000 problem could result in
an interruption in, or failure of, certain normal business activities or
operations. The Company does not expect such failures to have a materially
adverse impact on its results of operations or financial condition. However,
because of the general uncertainty about Year 2000 readiness throughout the
world economy, which results in uncertainties regarding the readiness of the
Company's vendors, contractors, and potential customers, the Company is
currently unable to determine whether Year 2000 problems may have a materially
adverse impact on its results of operations or financial condition. As the
Company's Year 2000 compliance program progresses, the level of uncertainty
about this matter will reduce, especially as to uncertainties concerning the
Company's own degree of Y2K compliance and the compliance of its suppliers and
contractors.
Worst-Case Scenario
It is not possible to describe a reasonably likely "worst-case Year
2000 scenario" without making numerous assumptions. The Company presently
believes that a most likely worst-case scenario would make it necessary for the
Company to replace some suppliers and contractors, rearrange work plans, or,
perhaps, interrupt some office and field activities. Assuming this assessment is
correct, the Company does not believe that such circumstances would have a
materially adverse impact on its financial condition or results of operations,
even if it is necessary to incur additional costs to correct unanticipated
compliance failures.
Contingency Plans
The Company currently has no contingency plans in place in the event it
does not complete all phases of its Y2K compliance program by December 31, 1999.
However, it expects to have completed enough of its compliance program by July
1999 that it will be able to identify those areas for which contingency plans
will be necessary, and it will develop the required contingency plans at that
time. The Company continues to monitor carefully the progress of its Year 2000
program and its state of readiness. Any future contingency plan will be based on
its best estimate of numerous factors, which, in turn, will be derived by
relying on numerous assumptions of future events. However, there can be no
assurance that these assumptions or estimates will have been made correctly, or
that the Company will have anticipated all relevant factors, or that there will
not be a delay in or increased costs associated with the Company's Y2K program.
Any delay in implementation of the Year 2000 program could affect the Company's
Year 2000 readiness. Specific factors that might cause the actual outcome to
differ from the projected outcome include, without limitation, the continued
availability of personnel and consultants trained in the computer programming
skills necessary for remediation of Year 2000 problems; the ability to locate
and correct all relevant computer codes and embedded software; timely responses
by third parties, including suppliers, contractors, and potential customers; and
the ability to implement interfaces between new systems and systems not being
replaced.
This discussion regarding the Year 2000 Issue is a "Year 2000
Readiness Disclosure" as the term is described in the Year 2000 Information
and Readiness Disclosure Act of 1998.
16
Item 8. Financial Statements
Report of Independent Auditors
The Board of Directors and Stockholders
Clean Diesel Technologies, Inc.
We have audited the accompanying balance sheets of Clean Diesel Technologies,
Inc. (a development stage company) as of December 31, 1998 and 1997, and the
related statements of operations, stockholders' equity (deficiency) and cash
flows for each of the three years in the period ended December 31, 1998, and for
the period from January 1, 1992, through December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Clean Diesel Technologies, Inc.
at December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, and for
the period from January 1, 1992, through December 31, 1998, in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming Clean Diesel
Technologies, Inc. will continue as a going concern. As more fully described in
Note 1, the Company has incurred recurring operating losses and its operations
have not produced a positive cash flow. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
as to these matters are also described in Note 1. The financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classifications
of liabilities that may result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
Stamford, Connecticut
February 26, 1999
17
Clean Diesel Technologies, Inc. (A Development Stage Company)
Balance Sheets
(in thousands except share data)
December 31,
---------------------------------
1998 1997
--------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,663 $ 1,239
Inventories 219 205
Other current assets 58 238
------- -------
Total current assets 1,940 1,682
Other assets 45 68
------- -------
Total assets $1,985 $ 1,750
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 686 $ 794
Loan payable to Fuel-Tech N.V. -- 100
------- -------
Total current liabilities 686 894
Loan payable to Fuel-Tech N.V. -- 395
STOCKHOLDERS' EQUITY:
Preferred Stock, par value $0.05 per share,
authorized 90,000 and 100,000 shares,
no shares issued and outstanding -- --
Series A Convertible Preferred Stock, par value $0.05 per share,
$500 per share liquidation preference, authorized 10,000
shares, issued and outstanding 7,582 shares, involuntary
liquidation value $3,840,000 at December 31, 1998 1 --
Common Stock, par value $0.05 per share,
authorized 15,000,000 and 5,000,000 shares,
issued and outstanding 2,544,443 and 2,516,666 shares 127 126
Additional paid-in capital 15,008 11,188
Deficit accumulated during development stage (13,837) (10,853)
------- -------
Total stockholders' equity 1,299 461
------- -------
Total liabilities and stockholders' equity $ 1,985 $ 1,750
======= =======
See accompanying notes.
18
Clean Diesel Technologies, Inc. (A Development Stage Company)
Statements of Operations
(in thousands except per share data)
Period from
January 1, 1992,
through
For the years ended December 31, December
------------------------------------------ 31,
1998 1997 1996 1998
------- ------ ------- ---------------
Sales $ 46 $ 199 $ -- $ 245
Costs and expenses:
Cost of sales 29 132 -- 161
General and administrative 1,515 1,730 1,842 6,557
Research and development 1,009 1,985 1,747 6,326
Patent filing and maintenance 156 237 223 1,094
------- ------ ------- -------
Loss from operations 2,663 3,885 3,812 13,893
Interest income (41) (165) (383) (622)
Interest expense 98 44 60 302
Cost of withdrawn Rights Offering 264 -- -- 264
------- ------ ------- -------
Net loss during development stage $ 2,984 $3,764 $ 3,489 $13,837
======= ====== ======= =======
Basic and diluted loss per
common share $ 1.20 $ 1.50 $ 1.40 N/A
======= ====== ======= =======
Average number of common
shares outstanding 2,517 2,517 2,500 N/A
======= ====== ======= =======
See accompanying notes.
19
Clean Diesel Technologies, Inc. (A Development Stage Company)
Statements of Changes in Stockholders' Equity (Deficiency)
(in thousands)
Deficit
Series A Convertible Accumulated Total
Preferred Stock Common Stock Additional During Stockholders'
-------------------- -------------------- Paid-In Development Equity
Shares Amount Shares Amount Capital Stage (Deficiency)
---------- --------- ---------- ------- --------- -------------- -------------
Balance at January 1, 1995 -- $ -- 2,500 $ 125 $ 594 $ (1,576) $ (857)
Net loss for year -- -- -- -- -- (2,024) (2,024)
Fuel-Tech N.V. capital contribution -- -- -- -- 10,531 -- 10,531
--- ------ ----- ----- ------- -------- -------
Balance at December 31, 1995 -- -- 2,500 125 11,125 (3,600) 7,650
Net loss for year -- -- -- -- -- (3,489) (3,489)
Issuance of stock purchase warrants -- -- -- -- 30 -- 30
--- ------ ----- ----- ------- -------- -------
Balance at December 31, 1996 -- -- 2,500 125 11,155 (7,089) 4,191
Net loss for year -- -- -- -- -- (3,764) (3,764)
Issuance of stock purchase warrants -- -- -- -- 30 -- 30
Exercise of stock options -- -- 17 1 3 -- 4
--- ------ ----- ----- ------- -------- -------
Balance at December 31, 1997 -- -- 2,517 126 11,188 (10,853) 461
Net loss for year -- -- -- -- -- (2,984) (2,984)
Issuance of Series A Preferred Stock 7.6 1 -- -- 3,790 -- 3,791
Deferred compensation -- -- 27 1 30 -- 31
--- ------ ----- ----- ------- -------- -------
Balance at December 31, 1998 7.6 $ 1 2,544 $ 127 $15,008 $(13,837) $ 1,299
==== ====== ===== ===== ======= ======== =======
See accompanying notes.
20
Clean Diesel Technologies, Inc. (A Development Stage Company)
Statements of Cash Flows
(in thousands)
Period from
For the years ended December 31, January 1, 1992,
------------------------------------------ through
1998 1997 1996 December 31, 1998
------------- ------------- ------------- ------------------------
OPERATING ACTIVITIES
Net loss $ (2,984) $ (3,764) $ (3,489) $(13,837)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation 26 24 12 62
Issuance of stock purchase warrants -- 30 30 60
Deferred compensation 31 -- -- 31
Conversion of bridge loan and term note accrued
interest into preferred stock 20 -- -- 20
Changes in operating assets and liabilities:
Inventories (14) (102) (88) (219)
Other current assets 180 (16) (221) (58)
Accounts payable and accrued expenses (108) 53 320 686
Other assets -- -- (18) (18)
Due to Fuel-Tech N.V. -- -- (66) (66)
-------- ------- ------- -------
Net cash used in operating activities (2,849) (3,775) (3,520) (13,339)
-------- ------- ------- -------
FINANCING ACTIVITIES
Proceeds from 1995 Rights Offering net of
$630 of brokerage commissions -- -- 2,018 11,156
Expenses of 1995 Rights Offering -- -- -- (425)
Repayment of expenses of 1995
Rights Offering paid by Fuel-Tech N.V. -- -- -- (200)
Issuance of common stock to parent -- -- -- 250
Net parent company investment -- -- -- 469
Proceeds of loan from Fuel-Tech N.V. -- -- -- 2,874
Repayment of loan to Fuel-Tech N.V. -- (250) -- (2,313)
Proceeds from exercise of stock options -- 4 -- 4
Proceeds from bridge loan 1,400 -- -- 1,400
Proceeds from issuance of preferred stock 1,876 -- -- 1,876
-------- ------- ------- -------
Net cash provided from (used in) financing
activities 3,276 (246) 2,018 15,091
-------- ------- ------- -------
INVESTING ACTIVITIES
Sale (purchase) of short-term investments -- 2,000 (2,000) --
Purchase of fixed assets (3) (10) (76) (89)
-------- ------- ------- -------
Net cash (used in) provided by investing
activities (3) 1,990 (2,076) (89)
-------- ------- ------- -------
Net increase (decrease) in cash and
cash equivalents 424 (2,031) (3,578) 1,663
Cash and cash equivalents at beginning of period 1,239 3,270 6,848 --
-------- ------- ------- -------
Cash and cash equivalents at end of period $ 1,663 $ 1,239 $ 3,270 $ 1,663
======== ======= ========= =======
Cash payments for interest to Fuel-Tech N.V. $ 41 $ 44 $ 63 $ 148
NON-CASH ACTIVITIES
Contribution of net parent company
investment to capital of the Company $ -- $ -- $ -- $ 469
Stock subscription receivable $ -- $ -- $ -- $2,018
Issuance of stock purchase warrants $ -- $ 30 $ 30 $ 60
Conversion of bridge loan into Series A
Convertible Preferred Stock $ 1,400 $ -- $ -- $1,400
Conversion of loan from Fuel-Tech N.V. into
Series A Convertible Preferred Stock $ 495 $ -- $ -- $ 495
See accompanying notes.
21
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements
1. Basis of Presentation
Clean Diesel Technologies, Inc. (the "Company") was incorporated in the
State of Delaware on January 19, 1994, as a wholly owned subsidiary of Fuel-Tech
N.V. ("Fuel Tech"). Predecessor financial information included in the
accompanying financial statements for the period January 1, 1992, through
January 18, 1994, reflects the Company's operations prior to incorporation, at
which time it was accounted for as part of Fuel Tech. As more fully discussed in
Note 4, effective December 12, 1995, Fuel Tech completed a Rights Offering of
the Company's Common Stock, and reduced its ownership in the Company's Common
Stock to 27.6%.
In the first half of 1998, the Company received $1.4 million, exclusive
of $45,000 of commissions and expenses, from the sale of bridge loan notes (the
"Bridge Loan"), including $500,000 that was received from Fuel Tech. In November
1998, the Company received proceeds of approximately $1.85 million, net of
expenses of $28,000, through a private placement of its shares of Series A
Convertible Preferred Stock (the "Series A Convertible Preferred Stock").
Simultaneously, the Bridge Loan was converted into shares of the Company's
Series A Preferred Stock. Furthermore, Fuel Tech elected to exchange its
$495,000 term loan note (the "Term Note") with the Company, along with the
associated accrued interest of $20,000 from its Bridge Loan and Term Note, for
1,029 shares of the Company's Series A Preferred Stock.
The Company is a development stage enterprise, and its efforts from
January 1, 1992, through December 31, 1998, have been devoted to the research,
development, and commercialization of Platinum Fuel Catalysts ("PFCs"), some of
which are licensed to the Company by Fuel Tech (see Note 6), and nitrogen oxide
("NOx") reduction technologies for diesel engines.
During 1998, the Company began a shift in emphasis from research and
development toward commercialization of its technologies. As more fully
described elsewhere herein, the Company received net proceeds of approximately
$3.2 million in 1998 through private placements to assist in the pursuit of
these commercialization efforts. The commercialization of these technologies
will depend upon the success of field tests and governmental regulations,
principally by the US Environmental Protection Agency, and corresponding foreign
and state agencies. The accomplishment of these objectives by the Company will
require additional capital and there can be no assurance that such capital will
be available.
Going Concern
The financial statements have been prepared assuming that the Company
will continue as a going concern and do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
and the amount and classification of liabilities that may result from the
possible inability of the Company to continue as a going concern.
As a result of the Company's recurring operating losses, the Company has
been unable to generate a positive cash flow. In addition to the $3.2 million
funding mentioned above, the Company will require additional capital in the
future in order to fund its operations. The Company's current cash position,
coupled with expected revenues and/or proceeds from joint development
agreements, will not be sufficient to fund the Company's operations until it
generates a positive cash flow. The Company is, however, actively seeking
additional financing through a private placement or joint development agreements
in order to fund its commercialization efforts. Without any further funding or
revenues from sales, demonstration programs, or license fees, the Company
expects to be able to fund operations through the third quarter of 1999.
Although the Company believes that it will be successful in its capital-raising
efforts, there is no guarantee that it will be able to raise such funds on terms
that will be satisfactory to the Company. The Company has developed contingency
plans in the event its financing efforts are not successful. Such plans include
reducing expenses and selling or licensing the Company's technologies.
Accordingly, at December 31, 1998, there is substantial doubt as to the
Company's ability to continue as a going concern.
2. Significant Accounting Policies
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
22
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements (Continued)
Cash and Cash Equivalents and Financial Instruments
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents. At December 31,
1998, substantially all of the Company's cash and cash equivalents were on
deposit with one financial institution.
All financial instruments are reflected in the accompanying balance
sheets at amounts that approximate fair market value.
Inventories
Inventories are stated at the lower of cost or market and consist of
finished product. Cost is determined using the first-in, first-out (FIFO)
method.
Research and Development Costs
Costs relating to the research, development, and testing of products are
charged to operations as they are incurred. These costs include test program
costs, salaries and related costs, consultancy fees, materials, and certain
testing equipment. The cost of patent filings and maintenance are also charged
to operations as they are incurred. Included in accrued expenses at December 31,
1998, are liabilities for research and development expenses owing to Ricardo
Consulting Engineers Ltd., Southwest Research Institute, and Johnson Matthey of
$57,000, $44,000, and $32,000, respectively. Included in accrued expenses at
December 31, 1997, are liabilities for research and development expenses owing
to Ricardo Consulting Engineers Ltd., Delft University, and Johnson Matthey of
$167,000, $54,000, and $52,000, respectively.
Cost of Withdrawn Rights Offering
As a result of the aforementioned $3.2 million net financings, in
November 1998, the Company canceled its pending $2 million Rights Offering. The
Statement of Operations for the year ended December 31, 1998, includes
approximately $264,000 of costs associated with such Rights Offering.
Stock-Based Compensation
The Company accounts for stock option grants in accordance with
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees. Under the Company's current plan, options may be granted at not less
than the fair market value on the date of grant and therefore no compensation
expense is recognized for the stock options granted. In 1996, the Company
adopted the disclosure provisions of Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation.
Basic and Diluted Loss Per Common Share
Basic and diluted earnings per share is calculated in accordance with
SFAS No. 128, Earnings Per Share. Earnings per share amounts for all periods
presented have been, where appropriate, restated to conform to the
requirements of SFAS No. 128.
3. Taxation
The Company accounts for income taxes in accordance with the "liability
method."
At December 31, 1998 and 1997, the Company had tax losses available for
offset against future years' earnings of approximately $12.5 million and $10
million, respectively. Temporary differences were insignificant as of such
dates. Approximately $0.9 million, $2.0 million, $3.2 million, $3.4 million, and
$3.0 million of the tax loss carryforwards expire in 2009, 2010, 2011, 2012, and
2018 respectively. The Company has not recognized any benefit from the
aforementioned tax loss carryforwards.
The Taxpayer Relief Act of 1997 modified the net operating loss
provisions so that losses arising for tax years beginning after the effective
date of the Act (August 5, 1997) would be eligible for carryforward for twenty
years. Existing losses would still be subject to a fifteen year carryforward
period.
23
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements (Continued)
Under the provisions of the United States Tax Reform Act of 1986,
utilization of the Company's US federal tax loss carryforwards (for the period
prior to December 12, 1995) may be limited as a result of the ownership change
in excess of 50% related to the 1995 Fuel Tech Rights Offering (see Note 4).
4. Stockholders' Equity
On December 12, 1995, Fuel Tech completed a Rights Offering to its
existing shareholders of 72.4% of the Company's Common Stock, retaining 27.6% of
the Common Stock outstanding. Two million of the 2.5 million Company shares held
by Fuel Tech were offered in the 1995 Rights Offering. Approximately 1.8 million
Company shares were purchased in the offering, which raised net proceeds, after
expenses and broker-dealer commissions aggregating $1.3 million, of
approximately $10.5 million, all of which was contributed by Fuel Tech to the
Company. In December 1995, after the offering was completed, the Company paid
Fuel Tech approximately $2.3 million, which represented the repayment of certain
loans made to the Company ($2.1 million), as well as certain expenses of the
1995 Rights Offering paid by Fuel Tech ($200,000). As a result of the 1995
Rights Offering and Fuel Tech's capital contribution of the net offering
proceeds, the Company's additional paid-in capital increased by approximately
$10.5 million.
During 1998, the Company received $1.4 million, exclusive of $45,000 of
commissions and expenses, through the Bridge Loan. In November 1998, the Company
received an additional $1.85 million in net proceeds through a private placement
of 3,753 shares of its Series A Preferred Stock. As the net proceeds exceeded
the $1.75 million minimum stipulated in the terms of the Bridge Loan, the loan
automatically converted into 2,800 shares of the Company's Series A Preferred
Stock. Additionally, in November 1998, Fuel Tech elected to convert its $495,000
Term Note due from the Company, as well as the $20,000 of associated accrued
interest on the Bridge Loan and Term Note, into 1,029 shares of the Company's
Series A Preferred Stock. Accordingly, the Company has 7,582 shares of Series A
Preferred Stock outstanding as of December 31, 1998. The Company's Series A
Preferred Stock has a stated value and liquidation preference of $500 per share
plus accrued and unpaid dividends.
Each share of the Company's Series A Preferred Stock is convertible into
333.33 shares of the Company's Common Stock, which is equivalent to $1.50 per
Common Share. Assuming full conversion of the Series A Preferred Stock, the
Company would have approximately 5.1 million shares of Common Stock outstanding,
of which Fuel Tech would own approximately 1.4 million shares, or a 26.9%
interest in the Company.
The Company can force the holder of Series A Preferred Stock to convert
his shares, in whole or in part, into Common Stock at any time on, or after, the
date that the average Closing Price (as defined in the Certificate of
Designation) of the Common Stock equals or exceeds $4.50 for 20 consecutive
trading days. Such conversion may, at the election of the holders of 60% of the
issued and outstanding shares of the Company's Series A Preferred Stock, be
scheduled to occur on a pro-rata basis quarterly over 18 months. The Series A
Preferred Stock shall be automatically converted into Common Stock should the
Company consummate a public offering of its Common Stock in excess of certain
prescribed amounts. In the event of such mandatory conversion, accrued and
unpaid dividends will also convert into Common Stock, on the same terms as the
underlying shares of Series A Preferred Stock.
Holders of the Company's Series A Preferred Stock are entitled to
receive, when, as, and if declared by the Board of Directors of the Company out
of funds of the Company legally available therefor, cash dividends at the annual
rate of nine percent. However, in lieu of making dividends in cash, the Company
may elect to pay cumulative dividends in kind at the annual rate of eleven
percent. Cash dividends and dividends in kind are each deemed "Preferred
Dividends." Dividends payable to the holders of the Series A Preferred Stock are
payable quarterly in arrears. It is presently anticipated that the Company will
pay dividends on these shares in additional shares of Series A Preferred Stock,
and that any earnings that the Company may realize in the foreseeable future
will be retained to finance the development and expansion of the Company. As of
December 31, 1998, earned but undeclared dividends on the Series A Preferred
Stock approximated $49,000.
On December 31, 1998, the Company issued 27,777 shares of Common Stock to
an executive in lieu of approximately $31,000 of deferred compensation. The
share price used represented the average of the Company's high and low trading
price on December 31, 1998.
24
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements (Continued)
5. Stock Options and Warrants
The Company maintains a stock award plan, the 1994 Incentive Plan (the
"Plan"). Under the Plan, awards may be granted to participants in the form of
non-qualified stock options, stock appreciation rights, restricted stock,
performance awards, bonuses, or other forms of share-based or non-share-based
awards, or combinations thereof. The Company grants awards at fair market value
on the date of grant with expiration dates typically ranging from seven to ten
years. Participants in the Plan may be such of the Company's directors,
officers, employees, consultants, and advisers (except consultants or advisers
in capital-raising transactions) as the directors determine are key to the
success of the Company's business. The Company includes 50%-owned subsidiaries
or affiliates. In 1996, stockholders amended the Plan to increase from 10% to 12
1/2% the percentage of outstanding Common Shares of the Company used to
determine the maximum number of awards to participants. In 1997, the percentage
was further increased from 12 1/2% to 17 1/2%. In general, the policy of the
Board was to grant stock options vesting in three equal portions on the first
through third anniversaries of the grant date for grants prior to 1997, and in
equal portions on the grant date and the first and second anniversaries of the
grant date for grants awarded after 1997.
If compensation expense for the Company's plan had been determined based
on the fair value at the grant dates for awards under its plan, consistent with
the method described in SFAS No. 123, the Company's net loss and basic and
diluted loss per common share would have been increased to the pro forma amounts
indicated below:
1998 1997 1996
----------------------------
Net loss (000's):
As reported $2,984 $3,764 $3,489
Pro forma 3,157 4,040 3,600
Basic and diluted loss per common share:
As reported $ 1.20 $ 1.50 $ 1.40
Pro forma $ 1.25 1.59 1.44
In accordance with the provisions of SFAS No. 123, the pro forma
disclosures include only the effect of stock options granted in 1998, 1997, and
1996. The application of the pro forma disclosures presented above are not
representative of the effects SFAS No. 123 may have on operating results and
earnings (loss) per share in future years due to the timing of stock option
grants and considering that options vest over a period of three years.
The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option pricing models require the input
of highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock options.
The fair value of each option grant, for pro forma disclosure purposes,
was estimated on the date of grant using the modified Black-Scholes option
pricing model with the following weighted-average assumptions:
1998 1997 1996
----------------------------
Expected dividend yield 0.0% 0.0% 0.0%
Risk-free interest rate 4.69% 5.72% 6.8%
Expected volatility 92.4% 61.3% 54.3%
Expected life of option 4 years 4 years 4 years
25
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements (Continued)
The following table presents a summary of the Company's stock option activity
and related information for the years ended December 31:
1998 1997 1996
---------------------------------------------------------------------------------------
Options Weighted-Average Options Weighted-Average Options Weighted-Average
(000's) Exercise Price (000's) Exercise Price (000's) Exercise Price
---------------------------------------------------------------------------------------
Outstanding, beginning
of year 365 $3.77 287 $3.25 222 $2.86
Granted 78 1.75 115 4.61 65 4.59
Exercised -- -- (17) 0.20 -- --
Forfeited (3) 2.00 (20) 4.52 -- --
---------------------------------------------------------------------------------------
Outstanding, end
of year 440 $3.41 365 $3.77 287 $3.25
=======================================================================================
Exercisable, end
of year 340 $3.47 259 $3.41 189 $3.11
Weighted-average
fair value of options
granted during the year $1.02 $2.18 $2.25
The following table summarizes information about stock options
outstanding at December 31, 1998:
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------------------------------------
Weighted-Average
Range of Number of Remaining Weighted-Average Number of Weighted-Average
Exercise Prices Options Contractual Life Exercise Price Options Exercise Price
- ------------------------------------------------------------------------------------------------------------
$ .20 -$2.00 183,334 5.5 years $1.45 133,333 $1.33
2.50 - 4.63 192,500 7.5 4.17 144,162 4.03
5.63 - 6.82 64,450 7.0 6.70 62,784 6.73
- ------------------------------------------------------------------------------------------------------------
$ .20 -$6.82 440,284 6.6 years $3.41 340,279 $3.47
Pursuant to a financial consulting agreement, an investment bank has the
right to purchase warrants covering 50,000 of the Company's Common Stock, with
an exercise price of $6.50 per share (an 18% premium over market price on the
date of issue). The warrants expire on March 1, 2001. Included in the Company's
financial statements is $30,000 of expense in 1996 related to the issuance of
these stock purchase warrants, which represented the fair value of services
received as determined by utilization of the Black-Scholes option pricing model.
In March 1997, in consideration of his undertaking to assist the Company
in obtaining sources of permanent financing, the Company granted a director of
the Company a warrant to purchase 25,000 shares of the Company's Common Stock
for $10.00 per share (a 142% premium over market price on the date of issue).
The warrant expires on March 17, 2004. Included in the Company's 1997 financial
statements is $30,000 of expense, as determined by utilization of the
Black-Scholes option pricing model, related to the issuance of these purchase
warrants, which represented the fair value of the services received.
6. Commitments
The Company is obligated under a sublease agreement for its principal
office. In January, 1999, the Company signed an extension to its original
sublease agreement, which runs from March 1, 1999, through February 28, 2002,
unless it is terminated sooner pursuant to the terms of the sublease. Future
minimum lease payments at December 31, 1998, are $10,875. Upon execution of the
new sublease, the Company's minimum lease payments are as follows:
1999--$78,542, 2000--$81,200, 2001--$81,200, and 2002--$13,533. For the years
ended December 31, 1998, 1997, and 1996, rental expense approximated $81,000,
$93,000, and $90,000, respectively.
26
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements (Continued)
Effective October 28, 1994, Fuel Tech granted two licenses to the Company
for all patents and rights associated with its Platinum Fuel Catalyst
technology. Effective November 24, 1997, the licenses were canceled and Fuel
Tech assigned to the Company all such patents and rights on terms substantially
similar to the licenses. In exchange for the assignment, the Company will pay
Fuel Tech a royalty of 2.5% of its annual gross revenue from sales of the
Platinum Fuel Catalysts commencing in 1998. The royalty obligation expires in
2008. The Company may terminate the royalty obligation to Fuel Tech by payment
of $12 million in 1998 and declining annually to $1,090,910 in 2008. The Company
as assignee and owner will maintain the technology at its own expense. To date,
no royalties have been paid to Fuel Tech, although the Company has recorded an
insignificant accrual for royalties payable to Fuel Tech at December 31, 1998.
7. Related Party Transactions
On July 1, 1995, the Company entered into a $745,000 promissory demand
note (the "Demand Note") with Fuel Tech bearing an interest rate of eight
percent per annum. In the first quarter of 1997, the Company repaid $250,000 of
this note. Throughout the life of the note, the Company made monthly interest
payments on the unpaid balance. On November 5, 1997, the Company entered into a
$495,000 promissory note (the "Term Note") with Platinum Plus, Inc. (a wholly
owned subsidiary of Fuel Tech) representing the unpaid balance of the Demand
Note on that date. The principal amount was payable in three annual installments
of $100,000 each on July 1 of each of the years 1998 through 2000, with a final
installment of $195,000 on July 1, 2001. Interest at a rate of eight percent per
annum was payable on the unpaid balance on each principal payment date. As
discussed in Note 4, in November 1998, Fuel Tech converted such note, along with
the associated accrued interest from such note and its Bridge Loan, into 1,029
shares of the Company's Series A Preferred Stock.
During 1998, Fuel Tech executed a $500,000 Bridge Loan to the Company. On
November 11, 1998, as more fully described in Note 4, and pursuant to the terms
of the Bridge Loan, the entire $1.4 million Bridge Loan, inclusive of Fuel
Tech's portion, was converted into 2,800 shares of the Company's Series A
Preferred Stock.
On August 3, 1995, the Company signed a Management and Services Agreement
with Fuel Tech. According to the agreement, the Company reimburses Fuel Tech for
management, services, and administrative expenses incurred on behalf of the
Company. Additionally, Fuel Tech charged the Company a fee equivalent to an
additional ten percent of such costs. In June 1996, the Company renegotiated
this agreement. Under the new agreement, the Company agreed to pay Fuel Tech a
fee equal to an additional three or ten percent of the costs paid on the
Company's behalf, dependent upon the nature of the costs incurred. Prior to the
August 1995 agreement, the Company paid Fuel Tech a management fee of $150,000
per quarter, which included the direct costs and associated fees. The Company
shares facilities and certain other resources with Fuel Tech and costs are
allocated between the companies based on usage. Certain of Fuel Tech's officers
and directors serve as officers and directors of the Company, and the Company
received management and administrative support from Fuel Tech's staff. The
financial statements include allocations from Fuel Tech of certain management
and administrative costs, which approximate $168,000, $403,000, and $1,232,000
for the years ended December 31, 1998, 1997, and 1996, respectively, and
$3,372,000 for the period from January 1, 1992, through December 31, 1998. Cost
allocations for such periods were based on the amount of management time devoted
to the Company. Certain services furnished by Fuel Tech to the Company were
terminated in midyear 1996. In the opinion of the Company's management, such
cost allocations are fair and reasonable and are on terms no less favorable than
could be obtained from a third party.
Average trade balances due to Fuel Tech for the years ended December 31,
1998 and 1997, approximated $37,000 and $69,000, respectively.
During 1994, Fuel Tech contributed $469,000 to the Company and the
Company issued 2.5 million Common Shares to Fuel Tech for $250,000.
8. Marketing and Joint Development Agreements
In September 1996, the Company entered into a supply agreement with Holt
Lloyd International Ltd. ("Holts") of the United Kingdom to sell the Company's
PFCs under the Company's Platinum Plus trademark for use with Holts' fuel
additives in the aftertreatment of fuel for both new and used diesel engines in
the consumer car care market. The agreement covered territories worldwide except
for North, Central, and South America. The term of this agreement was ten years
with extension options. The exclusivity of the agreement was determined by the
attainment (or reasonable effort toward the attainment) of predetermined minimum
27
Clean Diesel Technologies, Inc. (A Development Stage Company)
Notes to Financial Statements (Continued)
performance levels for each territory on a calendar-year basis. The Company's
PFCs were test-marketed by Holts in Europe in the fourth quarter of 1996, with
commercial sales commencing in the first quarter of 1997. This agreement also
provided for collaborative testing of the Company's PFC product for
gasoline-fueled vehicles, which was to be marketed under similar terms by Holts.
This product was launched by Holts in Europe in late 1997 under the Cat Guard
name. In December 1997, Holts was acquired by Prestone Products, Inc., a
division of AlliedSignal. Based on poor performance by Holts, the Company
elected to terminate this agreement in 1998.
On November 11, 1996, the Company entered into a joint development
agreement with Engelhard Corporation and Fuel Tech. The parties agreed to
collaborate on the commercialization of various diesel engine NOx control
technologies, both in the US and abroad. The companies will demonstrate and
market technologies utilizing urea-based NOx catalyst systems for stationary
diesels.
The Company and AMBAC International reached an agreement in December 1997
under which the parties will jointly share in the cost of development of the
ARIS injector for urea SCR. The Company holds the exclusive marketing rights to
the injector for a period of five years subject to certain minimum purchases of
injectors from AMBAC. The Company has agreed to purchase injectors exclusively
from AMBAC or to pay AMBAC for 50% of AMBAC's development cost and a royalty on
injectors made elsewhere for the Company.
No rights or licenses have been granted by either party to the other on
patents or inventions conceived prior to the agreement. However, the parties
have filed a joint patent on the specific ARIS injector. The Company has
retained all rights to its underlying patents including the fundamental
return-flow injection concept on which the US patent office has issued a "notice
of allowance."
AMBAC is currently assembling complete ARIS 2000 injector systems for the
Company according to the Company's proprietary design. The Company considers its
relationship with AMBAC to be good.
9. Subsequent Events
In January 1999, the Company agreed to an extension of its sublease. The
annual fixed rent amount under the sublease extension, which runs from March 1,
1999, through February 28, 2002 (unless terminated sooner pursuant to the terms
of the agreement), is $81,200. See Note 6 above for additional information.
On February 4, 1999, the Company's Board of Directors declared a dividend
to the holders of the Company's Series A Preferred Stock to be payable in kind
as of January 1, 1999. The eleven percent dividend was paid in shares of the
Company's Series A Preferred Stock. The dividend period was calculated as the
later of November 11, 1998 (the date of execution of the certificates of Series
A Preferred Stock), or the receipt by the Company of payment for the preferred
shares through December 31, 1998.
In February 1999, the Board of Directors of the Company agreed to accept
the Company's Common Stock in consideration of their accrued directors' fees at
December 31, 1998 (totaling $45,000), and for all future fees. A director may
choose to receive either all stock or 20% cash and 80% stock.
28
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
Information regarding directors and executive officers of the Company
will be set forth under the captions "Election of Directors" and "Directors and
Executive Officers of the Company" in the Company's Proxy Statement related to
the 1999 annual meeting of stockholders (the "Proxy Statement") and is
incorporated by reference herein.
Item 11. Executive Compensation
Information required by this item will be set forth under the caption
"Executive Compensation" in the Proxy Statement and is incorporated by reference
herein excluding, however, the information under the captions "Report of the
Board of Directors on Executive Compensation" and "Performance Graph," which is
not incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this item will be set forth under the caption
"Principal Stockholders and Stock Ownership of Management" in the Proxy
Statement and is incorporated by reference herein.
Item 13. Certain Relationships and Related Transactions
Information required by this item will be set forth under the captions
"Compensation Committee Interlocks and Insider Participation" and "Certain
Relationships and Related Transactions" in the Proxy Statement and is
incorporated by reference herein.
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The Financial Statements identified below and required by Part II, Item 8
of this Form 10-K are set forth above.
Report of Independent Auditors
Balance Sheets as of December 31, 1998, and 1997
Statements of Operations for the years ended December 31,
1998, 1997, and 1996, and for the period from January 1,
1992, through December 31, 1998
Statements of Changes in Stockholders' Equity (Deficiency) for
the years ended December 31, 1998, 1997, and 1996
Statements of Cash Flows for the years ended December 31,
1998, 1997, and 1996, and for the period from January 1,
1992, through December 31, 1998
(2) Financial Statement Schedules
Schedules have been omitted because of the absence of the conditions
under which they are required or because the required information where
material is shown in the financial statements or the notes thereto.
29
(3) Exhibits
Exhibit No. Title
----------- -----
* 3(i) Certificate of Incorporation, as amended.
* 3(ii) By-Laws.
++ 3(iii) Certificate of Designation for Series A Convertible Preferred Stock.
**3(iv) Certificate of Amendment of Certificate of Designation for Series A
Convertible Preferred Stock.
* 4a Specimen Stock Certificate, Common Stock.
++4b Specimen Stock Certificate, Series A Convertible Preferred Stock.
+10a Assignment of Intellectual Property Rights Fuel-Tech N.V. to
Platinum Plus, Inc. as of November 5, 1997.
+10b Assignment of Intellectual Property Rights Fuel Tech, Inc. to
Clean Diesel Technologies, Inc. as of November 5, 1997.
+10c Assignment Agreement as of November 5, 1997, among
Platinum Plus, Inc., Fuel-Tech N.V., and Clean Diesel Technologies, Inc.
*****10d 1994 Incentive Plan of Clean Diesel Technologies, Inc., as
amended through August 8, 1996.
****10e Management Services Agreement between Clean Diesel Technologies, Inc., Fuel Tech, Inc.,
and Fuel-Tech N.V. as of June 1, 1996.
***10f Office Premises Lease of January 26, 1996.
+10g Registration Rights Agreement between Clean Diesel Technologies, Inc. and Fuel-Tech N.V.
of November 5, 1997.
+++10h Registration Rights Agreement between Clean Diesel Technologies, Inc. and the holders of
Series A Convertible Preferred Stock as of November 11, 1998.
++10i Bridge Loan Agreement between Clean Diesel Technologies, Inc.
and the several lenders set forth on Schedule A thereto dated May 8, 1998.
+++10j Loan Note Agreement between Clean Diesel Technologies, Inc. and the several lenders set
forth on Schedule A thereto dated November 11, 1998.
*+10m Material Foreign Patents.
**23.1 Consent of Auditors, Ernst & Young LLP.
- ------------------
* Previously filed as Exhibit to Registration Statement on Form S-1 of
August 16, 1995, No. 33-95840 and incorporated by reference herein.
** Filed herewith.
*** Previously filed as Exhibit to Form 10-K for the year ended
December 31, 1995, and incorporated by reference herein.
**** Previously filed as Exhibit to Form 10-Q for the quarter ended
September 30, 1996, and incorporated by reference herein.
***** Previously filed as Exhibit to Form 10-K for the year ended
December 31, 1996, and incorporated by reference herein.
+ Previously filed as Exhibit to Form 10-K for the year ended
December 31, 1997, and incorporated by reference herein.
++ Previously filed as Exhibit to Form 8-K dated May 26, 1998, and
incorporated by reference herein.
+++ Previously filed as Exhibit to Form 10-Q for the quarter ended
September 30, 1998, and incorporated by reference herein.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company for the fourth
quarter of 1998.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Clean Diesel Technologies, Inc. has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
CLEAN DIESEL TECHNOLOGIES, INC.
March 29, 1999 By: /s/ Jeremy D. Peter-Hoblyn
------------------- ------------------------------
Date Jeremy D. Peter-Hoblyn
Chief Executive Officer,
President, and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been duly signed below by the following persons on behalf of Clean
Diesel Technologies, Inc. and in the capacities and on the date indicated.
/s/ Ralph E. Bailey Director and Chairman of the Board of Directors
- ---------------------------
Ralph E. Bailey
/s/ Jeremy D. Peter-Hoblyn Chief Executive Officer, President, and Director
- --------------------------- (principal executive officer)
Jeremy D. Peter-Hoblyn
/s/ Scott M. Schecter Chief Financial Officer, Vice President,
- --------------------------- and Treasurer
Scott M. Schecter (principal financial and accounting officer)
/s/ Douglas G. Bailey Director
- ---------------------------
Douglas G. Bailey
/s/ John A. de Havilland Director
- ---------------------------
John A. de Havilland
/s/ Derek R. Gray Director
- ---------------------------
Derek R. Gray
/s/ Charles W. Grinnell Director, Vice President, and Corporate Secretary
- ---------------------------
Charles W. Grinnell
/s/ James M. Valentine Director, Chief Operating Officer, and
- --------------------------- Executive Vice President
James M. Valentine
Dated: March 29, 1999
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Clean Diesel Technologies, Inc. has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
CLEAN DIESEL TECHNOLOGIES, INC.
By:
- --------------------------- -----------------------------
Date Jeremy D. Peter-Hoblyn
Chief Executive Officer,
President, and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been duly signed below by the following persons on behalf of Clean
Diesel Technologies, Inc. and in the capacities and on the date indicated.
- ----------------------- Director and Chairman of the Board of Directors
Ralph E. Bailey
- ---------------------- Chief Executive Officer, President, and Director
Jeremy D. Peter-Hoblyn (principal executive officer)
- ---------------------- Chief Financial Officer, Vice President, and Treasurer
Scott M. Schecter (principal financial and accounting officer)
- ---------------------- Director
Douglas G. Bailey
- ---------------------- Director
John A. de Havilland
- ---------------------- Director
Derek R. Gray
--------------------- Director, Vice President, and Corporate Secretary
Charles W. Grinnell
- ---------------------- Director, Chief Operating Officer, and
James M. Valentine Executive Vice President
Dated: March 29, 1999