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Form 10KSB for ENER1 INC

31-Mar-2004

Annual Report

The following Management's Discussion and Analysis of Financial Condition and Results of Operations contain" forward-looking statements" within the meaning of Section 27A of the Securities Act, and Section 23E of the Securities Exchange Act of 1934, as amended, including statements about our beliefs and expectations. There are many risks and uncertainties that could cause actual results to differ materially from those discussed in the forward-looking statements. Potential factors that could cause actual results to differ materially from those discussed in any forward-looking statements include, but are not limited to, those stated below under the headings "Cautionary Statement Concerning Forward-Looking Statements" and "Risk Factors" as well as those described from time to time in our filings with the Securities and Exchange Commission.

All forward-looking statements are based on information available to us on the date of this filing, and we assume no obligation to update such statements. The following discussion should be read in conjunction with our filings with the Securities and Exchange Commission and the consolidated financial statements included in this Annual Report.

Overview

                 In 2000, we embarked upon a plan to transition from being
primarily a data communications products manufacturer to a provider of software
and systems solutions-based engineering services. During 2000, we ceased
offering data communications products for sale, and with a part of this
transition, we changed our name from Boca Research, Inc. to Inprimis, Inc.
During 2001 and 2002, we continued to provide software engineering solutions,
and, beginning in 2002, we began to provide engineering and product design
services. During 2002, Ener1 Group acquired a majority interest in us and
through several transactions, including our acquisition of Ener1 Battery from
Ener1 Group, owned over 96% of our outstanding common stock by December 31,
2002. During 2002, we changed our name to Ener1, Inc. and began to focus on
developing high energy lithium batteries and fuel cells instead of providing
software solutions and engineering services.

                 During 2003, we devoted substantially all of our attention to
the continued development of high energy lithium batteries and fuel cells and
have delivered several battery prototypes to prospective future customers.
During 2004, we intend to complete our battery manufacturing plant and the
development of batteries that we will offer for sale, as well as to continue to
develop fuel cell prototypes provided that we have adequate financing available
to fund these activities. We currently expect to begin producing batteries and
battery components in late 2004.

                In the second quarter of 2003, we transferred certain assets of
our Digital Media division to EnerLook Solutions in order to consolidate our set
top box business, which delivers interactive information and entertainment
systems and services to customers in vertical markets such as hospitality and
healthcare. As part of this restructuring, we transferred net assets in the
amount of approximately $1.0 million to EnerLook Solutions, resulting in an
intercompany receivable from EnerLook Solutions in the amount of $1.0 million.
We are winding up the remaining operations of our Digital Media Technologies
Division, which currently consist primarily of inventory liquidation and
warranty/support services.

Critical Accounting Policies

Deferred Tax Assets. We have recorded a deferred tax asset of approximately $29,604,000 at December 31, 2003, which is completely offset by a valuation allowance. Realization of approximately $17,000,000 of the deferred tax asset is limited to the extent we have offsetting income arising from appreciation of assets through January 2002, which we believe is unlikely. Realization of the balance of the deferred tax asset is dependent on generating sufficient taxable income in the future. The amount of the deferred tax asset considered realizable could change in the near term if estimates of future taxable income are modified.

Depreciation and Amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which are as follows:

                                                 Digital Media /  
                              Battery Company       EnerLook       Ener1 Technologies, 
                            ------------------- ----------------- ---------------------
Asset Category                                                                         
Building                       39 years              --                 --             
Building improvements         5-39 years             --                 --             
Software                        3 years              --                 --             
Computer and Office        
equipment                       5 years           5 years               --             
Furniture and Fixtures          7 years             ---               5 years          
                            Not placed into    
                             service as of     
Battery plant equipment       12/31/2003             --                 --             
Machinery & Equipment           5 years           5 years             5 years          

Long-lived Assets: We account for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standard ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." In accordance with SFAS No. 144, long-lived assets to be held are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. An impairment is determined when the sum of the undiscounted cash flows estimated to be generated by those assets is less than their carrying value.

Stock Compensation: Options granted to employees under our stock option plans are accounted for by using the intrinsic method under APB Opinion 25, Accounting for Stock Issued to Employees (APB 25). In October 1995, the Financial Accounting Standards Board issued Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123), which defines a fair value base method of accounting for stock options. Certain aspects of the accounting standards prescribed by SFAS 123 are optional and therefore, we have continued to account for stock options under the intrinsic value method specified in APB 25. We has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation" ("SFAS 123). Accordingly, compensation cost has been recognized for the stock option plans only when the exercise prices of employee stock options are less than the market prices of the underlying stock on the date of grant. If compensation cost had been determined based on the fair value at the grant date for all awards consistent with the provisions of SFAS 123, our net loss and loss per share would have been as indicated below for the years ended December 31, 2002 and 2003:

                                                               2002           2003     
                                                          -------------- --------------
Net loss, as reported                                     $ (7,628,458 ) $ (8,917,848 )
Plus: compensation recorded for stock options issued     
and variable options                                           197,200        397,025  
Less: proforma stock based employee compensation, net    
of related tax                                              (1,280,706 )     (363,031 )
                                                          ------------   ------------ 
                                                          $ (8,711,964 ) $ (8,883,854 )
                                                          ------------   ------------ 
Loss per share                                           
     Basic and diluted as reported                        $       (.03 ) $       (.03 )
     Basic and diluted proforma                           $       (.03 ) $       (.03 )

Results of Operations For Years Ended December 31, 2002 and 2003

Net Sales We had no significant sales from continuing operations in 2002 or 2003.

Gross Profit: We had no significant gross profit from continuing operations in 2002 or 2003.

Research and Development Expenses. In 2002, we incurred no significant research and development expenses for continuing operations. During 2003, we incurred $1,400,000 for research and development expenses related primarily to our battery and fuel cell businesses.

Selling, General and Administrative Expenses ("SG&A"). Selling, general and administrative expenses ("SG&A") related to continuing operations were $6.6 million in 2002, and $5.0 million in 2003. This decrease in SG&A was due to a continuation of the expense-reducing initiatives that we began in early 2001, partially offset by increases in compensation and travel expenses, professional fees and plant startup costs related to our battery business.

We and Ener1 Group have shared some common facilities, personnel, and other resources. Allocation of expenses is made between these companies, utilizing systematic methods. These expenses, which were included in selling, general, and administrative expenses, were as follows for 2002 and 2003.

                   2002        2003    
                ----------- -----------
1st Quarter     $      --   $ 211,580  
2nd quarter       410,207     193,516  
3rd Quarter       307,522      86,062  
4th Quarter       272,112           0  
                ---------   --------- 
Total           $ 989,841   $ 491,158  

Loss from Operations Held for Disposal: The loss from operations held for disposal increased from $.6 million to $1.4 million primarily due to an asset impairment charge taken in December, 2003 for a software license. We incurred this charge when our management determine that we would not allocate the resources necessary to develop the technology required to recognize revenues from this license.

Provision for Income Taxes: The effective tax rate in 2002 and 2003 was zero percent, due to increases in the deferred tax asset valuation allowance.

Liquidity and Capital Resources

As of December 31, 2003, our working capital increased by $4.9 million from December 31, 2002. This increase was primarily the result of the transactions described below. We had a working capital deficit of $7.4 million as of December 21, 2003.

We had negative cash flows from operations of $7.6 million in 2002 and $5.4 million in 2003. Our total net losses were $7.6 million in 2002 and $8.9 million in 2003.

On July 25, 2003, we entered into a Subscription and Investment Agreement with ITOCHU Corporation, under which we issued 14,000,000 shares of our common stock in a private sale to ITOCHU Corporation at a price of $0.25 per share for a total of $3.5 million in cash. In addition, we granted the following options to ITOCHU to increase its ownership of common stock at the following prices: During the six month period from July 25, 2003 through January 24, 2004, ITOCHU had the option to purchase up to 12,461,861 shares of our common stock, for $0.70 per share. During January 2004, ITOCHU exercised a portion of these options and purchased 1,500,000 shares for $1,050,000. All of the remaining $0.70 options expired. Also pursuant to the Subscription and Investment Agreement, during the period from January 25, 2004 through July 24, 2004, ITOCHU had options to purchase up to 9,346,396 shares of our common stock for $2.50 per share. In connection with ITOCHU's exercise of its options in January 2004, we amended our Subscription and Investment Agreement with ITOCHU to extend the exercise expiration date for the 9,346,396 options to January 31, 2005 and increased the exercise price for all of those options to $4.00 per share.

Using a portion of the $3.5 million in cash proceeds from ITOCHU July 2003 investment, in August 2003 we invested $2,000,000 in a new Japanese company called EnerStruct, Inc. ("EnerStruct"), in exchange for a 49% ownership interest in EnerStruct. ITOCHU owns the remaining 51% of EnerStruct, for which it invested $1,100,000 plus equipment totaling approximately $500,000.

In November 2003, we issued to Ener1 Group, Mike Zoi and Peter Novak a total of 17,027,579 shares of our common stock and warrants to purchase up to 18,494,767 shares of our common stock (warrants to purchase 9,247,383 shares were issued with an exercise price of $1.50 per share and warrants to purchase 9,247,384 shares were issued with an exercise price of $2.00 per share) in satisfaction of approximately $13,300,000 in debt including $11,700,000 in debt owed to Ener1 Group (including $4,800,000 in intercompany advances from Ener1 Group), $300,000 in debt owed to Mr. Zoi and $1,300,000 in debt owed to Dr. Novak. These funds were advanced by Ener1 Group, Mr. Zoi and Dr. Novak to the Company over the last two years to fund operations and equipment acquisitions.. The accrued interest on the debt which was exchanged as of the date of the Debt Exchange was converted into two year promissory notes issued to Ener1 Group, Mr. Zoi and Dr. Novak, respectively, with principal amounts equal to the accrued interest on the their notes that were exchanged, totaling $ 1,040,817. As a result of the exchange, Ener1Group received 14,829,288 shares and warrants to purchase up to 16,107,061 shares of common stock, Mr. Zoi received 399,876 shares and warrants to purchase up to 434,330 shares of common stock, and Dr. Novak received 1,798,415 shares and warrants to purchase up to 1,953,376.

Also in November 2003, Ener1 Group purchased 1,388,889 shares of common stock and warrants to purchase up to 1,505,232 shares (warrants to purchase 752,616 shares were issued with an exercise price of $1.50 per share and warrants to purchase 752,616 shares were issued with an exercise price of $2.00 per share), for an aggregate purchase price of $1,000,000.

In January 2004, we raised additional capital through the private placement of $20,000,000 in aggregate principal amount of our 5% senior secured convertible debentures due 2009 and warrants to purchase up to 16,000,000 shares of common stock. We used a portion of the proceeds to pay the expenses of the offering and repay existing debt of $3,600,000, including related party debt and the promissory notes described above issued to Ener1 Group and Peter Novak in November 2003. We expect to use the remaining proceeds for the purchase of manufacturing equipment and to fund general working capital requirements.

We do not expect to receive significant revenue from battery and fuel cell product sales until the beginning of 2005. We expect that the proceeds from the January 2004 private offering will be sufficient to fund our working capital needs throughout the remainder of 2004. We will need to devote substantial additional capital to continue our research and development efforts in high energy lithium batteries and fuel cells after 2004, as well as for general working capital and to carry out our marketing efforts and begin production in our battery manufacturing. We can not assure you that additional funding to meet these needs will be available on terms favorable to us or at all.

We regularly evaluate acquisitions of businesses, technologies, or products complementary to our business. In the event that we decide to pursue one or more acquisitions, our remaining cash balances may be utilized to finance such acquisitions, and additional sources of liquidity, such as debt or equity financing, will in all likelihood be required for such acquisitions or to meet additional resulting working capital needs. There can be no assurance that additional capital beyond the amounts forecasted will not be required or that any such additional required capital will be available on terms acceptable to us, if at all, at such time or times as required by us.

Commitments and Contingencies

We receive communications from time to time alleging various claims. These claims include, but are not limited to, allegations that certain of our products infringe the patent rights of third parties. We cannot predict the outcome of any such claims or the effect of any such claims on the Company's operating results, financial condition, or cash flows.

In 1999, the Company was named a co-defendant in an action brought in the United States District Court for the District of Massachusetts, by NEC Technologies, Inc. ("NEC"). The suit alleged that the Company supplied modem hardware to NEC, which was combined by NEC with software supplied by another co-defendant, Ring Zero Systems, Inc. ("Ring Zero"), causing NEC to be sued for patent infringement by PhoneTel Communications, Inc. ("PhoneTel"), allegedly as a result of NEC's combination of modem hardware and software supplied by the vendors in its personal computer products. NEC alleged that the Company and Ring Zero were obligated to indemnify NEC for NEC's costs of defense and settlement of the PhoneTel suit, in the amount of $327,000. The lawsuit brought against the Company was dismissed without prejudice on April 25, 2000 for procedural reasons, and to date there has been no resolution of the substantive dispute. While NEC has the option of refiling this action in an appropriate jurisdiction, it has not done so in the interim since the dismissal in April 2000, and the Company therefore believes that this claim will not have a material adverse effect on the Company's operating results, financial condition, or cash flows.

We and our Boca Global, Inc. subsidiary were named as co-defendants in an action brought in the United States District Court for the District of South Dakota, by Gateway, Inc. ("Gateway"). Global Village, Inc. had contracted to supply its FaxWorks software to be bundled with Gateway PCs. Gateway's complaint against us and Boca Global, Inc. alleged that either or both us and Boca Global assumed the liabilities of Global Village, Inc. with respect to the FaxWorks product. Gateway sought indemnification for payment in the amount of approximately five million dollars, which it claims to have paid to settle patent infringement litigation brought by PhoneTel. In addition to us and Boca Global, another unrelated co-defendant was named as a party to the action. On January 19, 2001, a motion to dismiss was granted with respect to us. On March 20, 2004, the Court dismissed without prejudice Gateway's remaining action against Boca Global and the other co-defendant based on Gateway's failure to prosecute the action.

Cautionary Statement Concerning Forward-Looking Statements

We have made forward-looking statements in this Annual Report and make forward looking statements in our press releases that are subject to risks and uncertainties. Forward-looking statements include information that is not purely historic fact and include, without limitation, statements concerning our financial outlook for 2004 and beyond, our possible or assumed future results of operations generally, and other statements and information regarding assumptions about our revenues, cash flow from operations, available cash, operating costs, capital and other expenditures, financing plans, capital structure, contractual obligations, legal proceedings and claims, future economic performance, management's plans, goals and objectives for future operations and growth and markets for our stock. The sections of this Annual Report which contain forward-looking statements include "Business", "Properties", "Legal Proceedings", "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and related Notes.

Our forward-looking statements are also identified by words such as "believes," "expects," "thinks," "anticipates," "intends," "estimates" or similar expressions. You should understand that these forward-looking statements are necessarily estimates reflecting our judgment, not guarantees of future performance. They are subject to a number of assumptions, risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. The factors discussed in "Risk Factors" below and in our filings with the Securities and Exchange Commission from time to time, and other unforeseen events or circumstances could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements. Accordingly, you should not place undue reliance on forward-looking statements, which speak only as of the date of this Annual Report. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this Annual Report or to reflect the occurrence of unanticipated events.

Risk Factors

In addition to the other information in this Annual Report, readers should consider carefully the following factors that may affect our future performance.

We have a history of operating losses.

                 We have experienced net operating losses since 1997, incurred
negative cash flows from operations since 1999 and, as of December 31, 2003, had
an accumulated deficit of $60.2 million. Cash used in operations for the years
ended December 31, 1999, 2000, 2001, 2002 and 2003 was $6,100,000, $8,200,000,
$6,200,000, $7,600,000 and $5,400,000, respectively. We expect that we will
continue to incur negative cash flows and require additional cash to fund our
operations and implement our business plan. The continued development of our
energy-related technology and products will require significant additional
capital investment.

The terms of our 5% senior secured convertible debentures restrict our operations.

                 Our 5% senior secured convertible debentures due 2009 contain
restrictive covenants that limit our ability to, among other things:

These covenants may significantly limit our ability to respond to changing business and economic conditions and to secure additional financing, and we may be prevented from engaging in transactions that might be considered important to our business strategy or otherwise beneficial to us.

                 We may never complete the research and development of
commercially viable products.  

                 Although we have conducted other business activities in the
past, we have only recently reorganized our activities to focus on the
development of energy and battery related products. We do not know when or
whether we will successfully complete research and development of commercially
viable energy products. If we are unable to develop commercially viable
products, we will not be able to generate sufficient revenue to become
profitable. The commercialization of our products depends on our ability to
control the costs of manufacturing, and we cannot assure you that we will be
able to sufficiently control these costs. We must complete substantial
additional research and development before we will be able to manufacture a
commercially viable battery products in commercial quantities In addition, while
we are conducting tests to predict the overall life of our products, we may not
have tested our products over their projected useful life prior to large-scale
commercialization. As a result, we cannot be sure that our products will last as
long as predicted, and, if they do not, we may incur liability under warranty
claims.

We acquired our energy products business in September 2002. Accordingly, there is only a limited basis upon which you can evaluate business and prospects. We have an unproven business plan and do not expect to be profitable for the next several years. During the past two years, we have shifted our business from providing engineering services and interactive products to focus primarily on developing technologies and products for the battery and fuel cell industries. Before investing in our securities, you should consider the challenges, expenses and difficulties that we will face as a development stage company seeking to develop and manufacture new products.

Viable markets for our products may never develop, may take longer to develop than we anticipate or may not be sustainable.

                Our energy products and technologies target emerging markets and
we do not know the extent to which our technologies and products will be
accepted. To date we do not have any commercially viable products. We must be
able to develop a commercially viable product for our business to succeed. If a
viable market fails to develop or develops more slowly than we anticipate, we
may be unable to recover the losses we will have incurred to develop our
products and may be unable to achieve profitability. Our target customers for
our battery products include customers in the Department of Defense and military
forces, and in the transportation, medical and other industries. We also plan to
license our technologies for others to use to manufacture battery products for
the consumer product sector. Our target fuel cell customers include automobile
companies and other companies to whom we would license our fuel cell
technologies for use in manufacturing fuel cell products and systems. We will
need to develop or acquire adequate marketing and manufacturing capabilities in
order to develop a commercially successful product. In addition, the development
of a viable market for our products may be impacted by many factors which are
out of our control, including:

We may need additional capital, which may not be accessible on attractive terms or at all.

For the last several years, we have financed our operations through the sale of our securities and by borrowing money. We may need to raise additional funds through public or private financing. Our ability to obtain additional financing will be subject to a number of factors, including market conditions, our operating performance and the terms of our existing indebtedness. The terms of our 5% senior secured convertible debentures due 2009 prevent us from incurring additional debt until the registration statement registering the resale of the common shares underlying the debentures is declared effective; at such time, any additional debt we incur must be contractually subordinated, as to payment and liquidation, to the payment in full of the debentures. We cannot assure you that we will be able to raise additional funds on terms favorable to us or at all. If we raise additional funds through the sale of equity or convertible debt securities, your ownership percentage of our common stock will be reduced. In addition, these transactions may dilute the value of our common stock. We may have to issue securities that have rights, preferences and privileges senior to our common stock. The terms of any additional indebtedness may include restrictive financial and operating covenants that would limit our ability to compete and expand. Our failure to obtain any required future financing could materially and adversely effect our financial condition.

We have no experience manufacturing battery products on a large-scale commercial basis and may be unable to do so.

Since we acquired our energy products business, we have focused primarily on research and development and have no experience manufacturing our battery products on a commercial basis. We do not know whether or when we will be able to develop efficient, low-cost manufacturing capabilities and processes that will enable us to manufacture our battery products in commercial quantities while meeting the quality, price, engineering, design and production standards required to successfully market our battery products. Our failure to develop such manufacturing processes and capabilities could have a material adverse effect on our business, financial condition, results of operations and prospects. Even if we are successful in developing our manufacturing capabilities and processes, we do not know whether we will do so in time to meet our battery product commercialization schedule, which calls for us to begin manufacturing our battery products by the end of 2004 and to produce commercial quantities of such products in 2005, or to satisfy the requirements of potential distributors or customers.

We may not meet our development and commercialization milestones.

We have established product development and commercialization milestones that we use to assess our progress toward developing commercially viable battery and other energy related products, including fuel cell systems. These milestones relate to technology and design improvements as well as to dates for achieving development goals. To gauge our progress, we plan to operate, test and evaluate our battery and energy related products. If our systems or products exhibit technical defects or are unable to meet cost or performance goals, including power output, useful life and reliability, our commercialization schedule could be delayed and potential purchasers of our initial commercial battery and energy products may decline to purchase them. We cannot assure you that we will successfully achieve our milestones in the future or that any failure to achieve these milestones will not result in potential competitors gaining advantages in our target market. Failure to meet our development and commercialization milestones might have a material adverse effect on our operations and our stock price.

We may be unable to establish relationships with third parties for aspects of product development, manufacturing, distribution and servicing and the supply of key components for our products.

We will need to enter into additional strategic relationships in order to complete our current product development and commercialization plans. We will also require partners to assist in the distribution, servicing and supply of components for our anticipated fuel cell products which are in development. If we are unable to identify or enter into satisfactory agreements with potential partners, we may not be able to complete our product development and commercialization plans on schedule or at all. We may also need to scale back these plans in the absence of needed partners, which would adversely affect our future prospects. In addition, any arrangement with a strategic partner may require us to make large cash payments to the partner, issue a significant amount of equity securities to the partner, provide the partner with the opportunity to have representation on our board of directors, agree to exclusive purchase or other arrangements with the partner and/or commit significant financial resources to fund our product development efforts in exchange for their assistance or the contribution to us of intellectual property. Any such issuance of equity securities would reduce the percentage ownership of our then current stockholders. While we have entered into relationships with suppliers of some key components for our products, we do not know when or whether we will secure supply relationships for all required components and subsystems for our products, or whether such relationships will be on terms that will allow us to achieve our objectives. Our business, prospects, results of operations and financial condition could be harmed if we fail to secure relationships with entities which can develop or supply the required components for our products and provide the required distribution and servicing support. Additionally, the agreements governing our current relationships allow for termination by our partners under some circumstances.

We will rely on third parties to develop and provide key components for our battery and energy related products.

We will rely on third party suppliers to develop and supply key components that we will use in our battery and energy related products. If those suppliers fail to develop and supply these components in a timely manner or at all, or fail to develop or supply components that meet our quality, quantity or cost requirements, and we are unable to obtain substitute sources of these components on a timely basis or on terms acceptable to us, we may not be able to manufacture our products. In addition, to the extent that our supply partners use technology or manufacturing processes that are proprietary, we may be unable to obtain comparable components from alternative sources.

We do not know when or whether we will secure long-term supply relationships with any suppliers or whether such relationships will be on terms that will allow us to achieve our objectives. Our business, prospects, results of operations and financial condition could be harmed if we fail to secure long-term relationships with entities that will supply the required components for our battery and energy related products.

We face high levels of competition and may be unable to compete successfully.

The markets in which we intend to compete are highly competitive. There are a number of companies located in the United States, Canada and abroad that are developing battery and fuel cell technologies and energy products that will compete with our technologies and products. Some of our competitors are much larger than we are and may have the manufacturing, marketing and sales capabilities to complete research, development and commercialization of commercially viable products more quickly and effectively than we can.

Not only do we face competition from other companies that are developing battery and fuel cell technologies, but we also face competition from companies that provide energy products based on traditional energy sources, such as oil and natural gas. We also face competition from companies that are developing energy products based on alternative energy sources as a significant amount of public and private funding is currently directed toward development of a number of types of distributed generation technology, including microturbines, solar power, wind power and other types of fuel cell technologies. Technological advances in alternative energy products, improvements in the electric power grid or other fuel cell technologies may make our products less attractive or render them obsolete. There are many companies engaged in all areas of traditional and alternative energy generation in the United States, Canada and abroad, including, among others, major electric, oil, chemical, natural gas, batteries, generators and specialized electronics firms, as well as universities, research institutions and foreign government-sponsored companies. Many of these entities have substantially greater financial, research and development, manufacturing and marketing resources than we do.

Failure of our planned products to pass testing could negatively impact demand for our products.

We may encounter problems and delays during testing of our products for a number of reasons, including the failure of our technology or the technology of third parties, as well as our failure to maintain and service our products properly. Many of these potential problems and delays are beyond our control. Any problem or perceived problem with our product tests could materially harm our reputation and impair market acceptance of, and demand for, our products.

Regulatory and other changes in the energy industry may adversely affect our ability to produce, and reduce demand for, our products.

The market for our technologies and products may be heavily influenced by federal, state, local and foreign government laws, regulations and policies concerning the energy industry. A change in the current regulatory policies could make it more difficult or costly for us to develop, manufacture or market our products. Any such changes could also deter further investment in the research and development of alternative energy sources, including fuel cells, which could significantly reduce demand for our technologies and products. We cannot predict how changes in regulation or other industry changes will affect the market for our products or impact our ability to distribute, install and service our products.

We could be liable for environmental damages resulting from our research, development or manufacturing operations.

Our business exposes us to the risk that harmful substances may escape into the environment, resulting in personal injury or loss of life, damage to or destruction of property, and natural resource damage. Our insurance policies may not adequately reimburse us for costs incurred in defending and settling environmental damage claims, and in some instances, we may not be reimbursed at all. Our business is subject to numerous federal, state and local laws and regulations that govern environmental protection and human health and safety. These laws and regulations have changed frequently in the past and it is reasonable to expect there will be additional changes in the future. If our operations do not comply with current or future environmental laws and regulations, we may be required to make significant unanticipated capital and operating expenditures to bring our operations into compliance. If we fail to comply with applicable environmental laws and regulations, governmental authorities may seek to impose fines and penalties on us or to revoke or deny the issuance or renewal of operating permits and private parties may seek damages from us. Under those circumstances, we might be required to curtail or cease operations, conduct site remediation or other corrective action, or pay substantial damage claims.

Our products may use materials that are inherently dangerous substances which could subject our business to product liability claims.

Our energy technologies and products may use hydrogen or other materials that could leak and combust if ignited by another source. These technologies and products expose us to potential product liability claims that are inherent in hydrogen and products that use hydrogen. Hydrogen is a flammable gas and therefore a potentially dangerous product. Hydrogen is typically generated from gaseous and liquid fuels that are also flammable and dangerous, such as propane, natural gas or methane, in a process known as reforming. Natural gas and propane could leak into a residence or commercial location and combust if ignited by another source. In addition, our products may operate at high temperatures, which could expose us to potential liability claims, in the event of accidents involving combustion or explosion. Accidents involving our products or other hydrogen-based products could materially impede widespread market acceptance and demand for, or heighten regulatory scrutiny of, our products. In addition, we might be held responsible for damages beyond the scope of our insurance coverage. We also cannot predict whether we will be able to maintain our insurance coverage on acceptable terms.

Product liability or defects could negatively impact our results of operations.

Any liability we incur for damages resulting from malfunctions or design defects of our products could be substantial and could materially adversely affect our business, financial condition, results of operations and prospects. In addition, a publicized actual or perceived problem could adversely affect the market's perception of our products resulting in a decline in demand for our products and could divert the attention of our management, which may materially and adversely affect our business, financial condition, results of operations and prospects.

Future acquisitions may disrupt our business, distract our management and reduce the percentage ownership of our stockholders.

As part of our business strategy we may seek to acquire complementary technologies, products, expertise and/or other valuable assets. However, we may not be able to identify suitable acquisition candidates. If we do identify suitable candidates, we may not be able to complete the acquisitions on commercially acceptable terms or at all. We may not be able to successfully integrate the acquired business into our existing business in a timely and non-disruptive manner. We may have to devote a significant amount of time and management and financial resources to do so. Even with this investment of management and financial resources, an acquisition may not produce the desired revenues, earnings or business synergies. In addition, an acquisition may reduce the percentage ownership of our then current stockholders. If we fail to integrate the acquired business effectively or if key employees of that business leave, the anticipated benefits of the acquisition would be jeopardized. The time, capital and management and other resources spent on an acquisition that fails to meet our expectations could cause our business and financial condition to be materially and adversely affected. In addition, as a result of any acquisition, we may incur non-recurring charges and be required to amortize of significant amounts of intangible assets, which could adversely affect our results of operations.

We may not be able to protect the intellectual property upon which we depend and we could incur substantial costs defending against claims that our products infringe on the proprietary rights of others.

Our ability to compete effectively will depend, in part, on our ability to protect our proprietary technologies, systems designs and manufacturing processes. We rely on patents, trademarks, and other policies and procedures related to confidentiality to protect our intellectual property. However, some of our intellectual property is not covered by any patent or patent application. Moreover, we do not know whether any of our pending patent applications will issue or, in the case of patents issued or to be issued, that the claims allowed are or will be sufficiently broad to protect our technology or processes. Even if all of our patent applications are issued and are sufficiently broad, our patents may be challenged or invalidated. We could incur substantial costs in prosecuting or defending patent infringement suits or otherwise protecting our intellectual property rights. While we have attempted to safeguard and maintain our proprietary rights, we do not know whether we have been or will be completely successful in doing so. Moreover, patent applications filed in foreign countries may be subject to laws, rules and procedures that are substantially different from those of the United States, and any resulting foreign patents may be difficult and expensive to enforce. In addition, we do not know whether the U.S. Patent & Trademark Office will grant federal registrations based on our pending trademark applications. Even if federal registrations are granted to us, our trademark rights may be challenged. It is also possible that our competitors or others will adopt trademarks similar to ours, thus impeding our ability to build brand identity and possibly leading to customer confusion. We could incur substantial costs in prosecuting or defending trademark infringement suits.

Further, our competitors may independently develop or patent technologies or processes that are substantially equivalent or superior to ours. If we are found to be infringing third party proprietary rights, we could be required to pay substantial royalties and/or damages, and we do not know whether we will be able to obtain licenses to use the intellectual property at issue on acceptable terms, if at all. Failure to obtain needed licenses could delay or prevent the development, manufacture or sale of our products, and could necessitate the expenditure of significant resources to develop or acquire non-infringing intellectual property.

Asserting, defending and maintaining our intellectual property rights could be difficult and costly and failure to do so may diminish our ability to compete effectively and may harm our operating results. We may need to pursue lawsuits or legal action in the future to enforce our intellectual property rights, to protect our trade secrets and domain names and to determine the validity and scope of the proprietary rights of others. If third parties prepare and file applications for trademarks used or registered by us, we may oppose those applications and be required to participate in proceedings to determine priority of rights to the trademark. Similarly, competitors may have filed applications for patents, may have received patents and may obtain additional patents and proprietary rights relating to products or technology that block or compete with ours. We may have to participate in interference proceedings to determine the priority of invention and the right to a patent for the technology. Litigation and interference proceedings, even if they are successful, are expensive to pursue and time consuming, and we could use a substantial amount of our financial resources in either case.

We rely, in part, on contractual provisions to protect our trade secrets and proprietary knowledge.

Confidentiality agreements to which we are party may be breached, and we may not have adequate remedies for any breach. Our trade secrets may also become known without breach of such agreements or may be independently developed by competitors. Our inability to maintain the proprietary nature of our technology and processes could allow our competitors to limit or eliminate any competitive advantages we may have.

Our business depends on retaining and attracting highly capable management and operating personnel.

Our success depends in large part on our ability to retain and attract management and operating personnel, including our President and Chief Executive Officer, Kevin P. Fitzgerald, our officers and other key employees. Our business requires highly killed specialized workforce, including scientists, engineers, researchers and manufacturing and marketing professionals, who are in high demand and are often subject to competing offers. To retain and attract key personnel, we use various measures, including employment agreements, a stock incentive plan and incentive bonuses for key employees. These measures may not be enough to retain and attract the personnel we need or to offset the impact on our business of the loss of the services of Mr. Fitzgerald or other key officers or employees.

We face risks associated with our plans to market, distribute and service our products internationally.

We intend to market, distribute and service our products internationally. We have limited experience developing and no experience manufacturing our products to comply with the commercial and legal requirements of international markets. Our success in international markets will depend, in part, on our ability and that of our partners to secure relationships with foreign sub-distributors, and our ability to manufacture products that meet foreign regulatory and commercial requirements. Additionally, our planned international operations are subject to other inherent risks, including potential difficulties in enforcing contractual obligations and intellectual property rights in foreign countries and fluctuations in currency exchange rates.

Our government contracts could restrict our ability to effectively commercialize our technology.

Our contracts with government agencies are subject to the risk of termination at the convenience of the contracting agency and potential disclosure of our confidential information to third parties. Under the Freedom of Information Act, any documents that we have submitted to the government or to a contractor under a government funding arrangement may be subject to public disclosure that could compromise our intellectual property rights unless these documents are exempted as trade secrets or as confidential information, appropriately legended by us, and treated accordingly by such government agencies.

As a government contractor, we must comply with and are affected by federal government regulations relating to the formation, administration and performance of government contracts. These regulations will affect how we do business with our customers and may impose added costs on our business. Any failure to comply with applicable laws and regulations could result in contract termination, price or fee reductions or suspension or debarment from contracting with the federal government.

In addition, Federal government agencies routinely audit government contracts. These agencies review a contractor's performance on its contract, pricing practices, cost structure and compliance with applicable laws, regulations and standards. . These audits may occur several years after completion of the audited work. An audit could result in a substantial adjustment to our revenues because any costs found to be improperly allocated to a specific contract will not be reimbursed, while improper costs already reimbursed must be refunded. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with federal government agencies. In addition, our reputation could be harmed if allegations of impropriety were made against us.

We may be unable to manage rapid growth effectively.

We expect to rapidly expand our manufacturing capabilities, accelerate the commercialization of our products and enter a period of rapid growth, which will place a significant strain on our senior management team and our financial and other resources. The proposed expansion will expose us to increased competition, greater overhead, marketing and support costs and other risks associated with the commercialization of a new product. Our ability to manage our rapid growth effectively will require us to continue to improve our operations, to improve our financial and management information systems and to train, motivate and manage our employees. Difficulties in effectively managing the budgeting, forecasting and other process control issues presented by such a rapid expansion could harm our business, prospects, results of operations and financial condition.

Our stock price has been and could remain volatile.

The market price of our common stock has historically experienced and may continue to experience significant volatility. For the 52-week period ended March 23, 2004, our stock closing price has ranged from $0.05 to $1.92. Our progress in developing and commercializing our products, our quarterly operating results, announcements of new products by us or our competitors, our perceived prospects, changes in securities' analysts' recommendations or earnings' estimates, changes in general conditions in the economy or the financial markets, adverse events related to our strategic relationships and other developments affecting us or our competitors could cause the market price of our common stock to fluctuate substantially. In addition, in recent years, the stock market, and in particular the market for technology-related stocks, has experienced significant price and volume fluctuations. This volatility has affected the market prices of securities issued by many companies for reasons unrelated to their operating performance and may adversely affect the price of our common stock. In addition, we may be subject to additional securities class action litigation as a result of volatility in the price of our common stock, which could result in substantial costs and diversion of management's attention and resources and could harm our stock price, business, prospects, results of operations and financial condition.

Our principal stockholder has substantial control over our affairs.

We are controlled by Ener1 Group, which owns approximately 90% of our outstanding common stock. Two of Ener1 Group's board members are also members of our Board of Directors. Ener1 Group has the ability to exert substantial influence over all matters submitted to a vote of the stockholders of Ener1, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, Ener1 Group may dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control or impeding a merger or consolidation, takeover or other business combination which you, as a stockholder, may otherwise view favorably.

Future sales of our common stock may adversely affect our common stock price.

If our stockholders sell a large number of shares of common stock or if we issue a large number of shares in connection with future acquisitions or financings, the market price of our common stock could decline significantly. In addition, the perception in the public market that our stockholders might sell a large number of shares of common stock could cause a decline in the market price of our common stock.

Our certificate of incorporation and Florida law could adversely affect our common stock price.

Provisions of our certificate of incorporation and Florida law could discourage potential acquisition proposals and could delay or prevent a change in control of us. These provisions could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of our common stock. These provisions may also inhibit fluctuations in the market price of our common stock that could result from takeover attempts. In addition, the Board of Directors, without further stockholder approval, may issue additional series of preferred stock that could have the effect of delaying, deterring or preventing a change in control of us. The issuance of additional series of preferred stock could also adversely affect the voting power of the holders of common stock, including the loss of voting control to others

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