10-Q 1 file001.txt QUARTERLY REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------ FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______TO_______ COMMISSION FILE NUMBER: 0-31195 H POWER CORP. (Exact name of Registrant as specified in its charter) DELAWARE 22-3010742 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 60 MONTGOMERY STREET, BELLEVILLE, NEW JERSEY 07109 (Address of principal executive offices) (Zip code) 973-450-4400 (Registrant's telephone number, including area code) ------------------------------------------------------------ (Former name, former address and former fiscal year, if changed since last report.) 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 [ ] APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date 10,776,548 shares of Common Stock, $.001 par value per share, as of January 6, 2003. ================================================================================ 1 H POWER CORP. AND SUBSIDIARY INDEX PART I - FINANCIAL INFORMATION

Page Number Item 1. Financial Statements Consolidated Balance Sheet as of ~~August~~November 3130, 2002 and May 31, 2002 ..........................................3 Consolidated Statement of Operations for the Three and Six Months Ended ~~August~~November 3130, 2002 and ~~August~~November 3130, 2001 ......................................................................4 Consolidated Statement of Cash Flows for the ~~Three~~Six Months Ended ~~August~~November 3130, 2002 and ~~August~~November 3130, 2001 ......................................................................5 Notes to Consolidated Financial Statements ...................................................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview....................................................................................................11 9 Results of Operations.......................................................................................13 10 Liquidity and Capital Resources.............................................................................15 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................................17 13 Item 4. Controls and Procedures.....................................................................................17 13 PART II - OTHER INFORMATION Item 1. Legal Proceedings...........................................................................................18 Item 2. Changes in Securities and Use of Proceeds...................................................................18 14Item 4. Submission of Matters to a Vote of Security Holders.........................................................18 Item 6. Exhibits and Reports on Form 8-K 14............................................................................19

2 PART I FINANCIAL INFORMATION Item 1. Financial Statements H Power Corp. and Subsidiary Consolidated Balance Sheet (Unaudited)

~~August~~November 3130, 2002 May 31, 2002 ------------------- --------------- ASSETS Current assets Cash and cash equivalents $4736,~~626~~745,~~928~~518 $41,678,324 Short-term investments 58,060,~~110~~421 18,079,617 Accounts receivable, net of allowance for doubtful accounts ~~786~~960,~~149~~206 1,316,828 Unbilled receivables 3012,~~157~~287 58,333 Inventories, net 21,~~173~~852,~~778~~326 2,098,421 Tax credit receivable 76,~~923~~433 174,418 Prepaid expenses and other current assets 1951,~~191,359~~932 762,828 ------------ ----------- Total current assets 5648,~~945~~659,~~404~~123 64,168,769 Plant and equipment, net 8,~~765~~184,~~702~~072 8,800,313 Patents, net of accumulated amortization ~~388~~416,~~926~~655 368,370 Restricted cash 50,000 50,000 Other assets ~~276~~248,~~322~~101 364,167 ------------ ----------- Total assets $6657,~~426~~557,~~354~~951 $73,751,619 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current maturities of long-term debt $~~137~~133,~~115~~418 $136,765 Accounts payable 21,~~002~~953,~~035~~196 1,492,720 Accrued expenses 1,~~267~~698,~~190~~052 1,659,251 Deferred revenue ~~313~~406,~~083~~024 601,163 ------------ ----------- Total current liabilities 34,~~719~~190,~~423~~690 3,889,899 Long-term debt ~~119~~118,~~325~~916 124,525 -------~~-----~~ -------~~----~~ Total liabilities 34,~~838~~309,~~748~~606 4,014,424 ------------ ----------- Commitments and contingencies Stockholders' equity Common stock--$.001 par value; ~~150~~30,000,~~0000~~000 shares authorized at ~~August~~November 3130, 2002 and May 31, 2002; 5310,~~882~~776,~~828~~566 shares issued and outstanding at ~~August~~November 3130, 2002 and May 31, 2002 5310,~~883~~777 5310,~~883~~777 Additional paid-in capital 164,~~770~~813,~~005~~111 164,~~770~~813,~~005~~111 Accumulated deficit (~~101~~111,~~804~~179,~~971~~074) (94,813,464) Accumulated other comprehensive loss (~~431~~396,~~311~~469) (273,229) ------------ ----------- Total stockholders' equity 6253,~~587~~248,~~606~~345 69,737,195 ------------ ----------- Total liabilities and stockholders' equity $6657,~~426~~557,~~354~~951 $73,751,619 ============ =========== ~~The accompanying notes are an integral part of these consolidated financial statements.~~

The accompanying notes are an integral part of these consolidated financial statements. 3 H Power Corp. and Subsidiary Consolidated Statement of Operations (Unaudited)

Three ~~Months~~months ~~Ended~~ended Six months ended ------------------- ---------------- ~~August~~November 3130, ~~August~~November 3130, November 30, November 30, 2002 2001 2002 2001 ------------ ------------ ~~Cash~~------------ ~~flows~~------------ ~~from~~Revenues ~~operating~~Products ~~activities~~625,215 ~~Net~~717,749 ~~loss~~1,093,076 945,989 Contracts $ (626,~~991,507)~~631 $ (776,~~356,637)~~778 ~~Adjustments~~$ to501,708 ~~reconcile~~$ ~~net~~219,684 ~~loss~~------------ to------------ ~~net~~------------ ~~cash~~------------ ~~used~~Total byRevenues ~~operating~~651,846 ~~activities:~~794,527 ~~Depreciation and amortization 421~~1,~~372~~594,784 ~~223~~1,~~407~~165,673 ~~Obsolescence~~Operating ~~and~~Expenses ~~lower~~Costs of ~~cost~~revenues or- ~~market~~products ~~inventory~~1,382,063 ~~allowances~~899,374 ~~(12~~2,~~880)~~622,360 ~~113~~1,~~479~~132,299 ~~Loss~~Costs ~~on disposal~~ of ~~equipment~~revenues -- 4contracts 578,~~819~~740 ~~Changes~~19,000 in995,518 ~~assets~~164,348 Research and ~~liabilities:~~development ~~Accounts receivable 530~~4,~~679 110~~677,~~660~~832 ~~Unbilled receivables 28~~4,~~176~~694,183 ~~137~~8,~~869~~451,780 ~~Inventories (62~~10,~~477)~~631,069 ~~329~~Selling,~~733~~ ~~Prepaid~~general ~~expenses~~ and ~~other~~administrative ~~assets (366~~2,~~757)~~442,208 ~~(112~~2,049~~) Tax credit receivable 97~~,~~495~~486 15,~~953 Accounts payable 509~~232,~~316~~077 ~~(807~~4,~~017)~~107,462 ~~Accrued~~Other ~~expenses~~costs ~~(510~~1,~~151) 137~~163,~~362~~849 ~~Deferred revenue (288~~370,~~080)~~366 ~~239~~1,~~645~~163,849 ~~Estimated losses on uncompleted contracts 118~~677,~~090~~230 -- ------------ ------------ ~~Total adjustments 464,783 379,861~~ ------------ ------------ ~~Net~~Total ~~cash~~Operating ~~used~~Expenses by10,244,692 ~~operating~~8,032,409 ~~activities (6~~18,~~526~~465,~~724)~~584 (616,~~976~~712,~~776)~~408 ------------ ------------ ~~Cash flows from investing activities Net sales of short~~-~~term investments 12,999,147 7,592,837 Capital expenditures (381,246) (3,610,538)~~ ------------ ------------ ~~Net~~Loss ~~cash~~from ~~provided~~Operations by(9,592,846) ~~investing~~(7,237,882) ~~activities 12~~(16,~~617~~870,~~901~~800) 3(15,~~982~~546,~~299~~735) ~~------------~~Interest ~~------------~~income ~~Cash~~and ~~flow~~other, ~~from~~net ~~financing~~218,741 ~~activities~~681,549 ~~Repayment~~505,188 ~~of long-term debt (4~~1,~~850)~~633,765 ~~(391)~~ ------------ ------------ ~~Net cash used by financing activities (4,850) (391)~~ ------------ ------------ Net ~~increase~~Loss $ (~~decrease~~9,374,105) in$ ~~cash and cash equivalents~~ (6,~~086~~556,~~327~~333) $(216,~~994~~365,~~868~~612) ~~Effect~~$(13,912,970) of============ ~~exchange~~============ ~~rate~~============ ~~changes~~============ onLoss ~~cash~~per ~~and~~share ~~cash~~attributable ~~equivalents~~to ~~(137,723)~~common 3stockholders,~~472~~ ~~------------~~basic ~~------------~~and ~~Cash~~diluted ~~and~~$ ~~cash~~(0.87) ~~equivalents~~$ at(0.61) ~~beginning~~$ of(1.52) ~~period~~$ ~~41,678,324~~(1.29) ~~49,440,059~~============ ~~------------~~============ ~~------------~~============ ~~Cash~~============ ~~and~~Weighted ~~cash~~average ~~equivalents~~shares atoutstanding, ~~end~~basic ofand ~~period~~diluted $10,776,566 4710,~~626~~770,~~928~~566 $10,776,566 4610,~~448~~770,~~663~~180 ============ ============ ~~The~~============ ~~accompanying~~============ ~~notes~~Comprehensive ~~are~~loss an$ ~~integral~~(9,339,263) ~~part~~$ of(6,515,011) ~~these~~$(16,488,852) ~~consolidated~~$(13,798,074) ~~financial~~============ ~~statements.~~============ ============ ============

The accompanying notes are an integral part of these consolidated financial statements. 4 H Power Corp. and Subsidiary Consolidated Statement of Cash Flows (Unaudited)

Six Months Ended ----------------------------------- November 30, November 30, 2002 2001 -----------------------------------~~-----------------------------------------~~ ~~Contractual~~Cash ~~Less~~flows ~~Than~~from 1operating activities Net loss $(16,365,612) $(13,912,970) Adjustments to 3reconcile 4net loss to 5net ~~After~~cash 5used ~~Obligations~~by ~~Total~~operating 1activities: ~~Year~~Depreciation ~~Years~~and ~~Years~~amortization ~~Years~~963,877 464,776 Obsolescence and lower of cost or market inventory allowances 188,299 371,562 Asset impairment 197,743 -- Loss on disposal of equipment --~~-----------------------------------------------------------------------------------------------------------~~ ~~Obligations~~6,347 toChanges ~~ECO~~in $3assets and liabilities: Accounts receivable 356,~~445~~622 (17,~~334~~164) $2Unbilled receivables 46,~~520~~046 211,~~002~~475 $Inventories ~~925~~57,~~332~~796 $567,755 --Prepaid $expenses and other assets (167,990) 327,391 Tax credit receivable 97,985 7,109 Accounts payable 460,476 (1,090,660) Accrued expenses 196,564 386,474 Deferred revenue (195,139) (196,000) Costs charged to allowance for losses on uncompleted contracts (157.763) -- ------------ ------------ Total adjustments 2,044,516 1,039,065 ------------ ------------ Net cash used by operating activities (14,321,096) (12,873,905) ------------ ------------~~---------------------------------------~~ ~~Long~~Cash flows from investing activities Net proceeds on disposition of short-term ~~debt~~investments ~~139~~9,~~415~~999,304 1417,~~890~~922,736 53Capital expenditures (498,~~954~~710) 70(5,~~571~~334,795) -- ---------- ------------ Net cash provided by investing activities 9,500,594 12,587,941 ------------ ------------ Cash flow from financing activities Proceeds from long-term debt -- 80,968 Repayment of long-term debt (8,956) (1,422) ------------ ------------ Net cash (used) provided by financing activities (8,956) 79,546 ------------ ------------~~-------------~~ ~~Operating~~Net ~~leases~~decrease in cash and cash equivalents (4,~~856~~829,~~168~~458) ~~629~~(206,~~865~~418) ~~1,507,263~~Effect 1of exchange rate changes on cash and cash equivalents (103,~~080,691~~348) 1(54,~~638,349~~196) ---------- --~~--------~~ ---------- --~~--------~~ ~~----------~~Cash and cash equivalents at beginning of period 41,678,324 49,440,059 ------------ ------------~~---------------------------------------------------------------------------------------~~ ~~Total~~Cash ~~$8,440,917~~and ~~$3,164,757~~cash ~~$2,486,549~~equivalents at end of period $1 36,~~151~~745,~~262~~518 $1 49,~~638~~179,~~349~~445 ========== ==~~========~~ ========== ==~~======== ========== ---------------------------------------------------------------------------------------------------------------~~

The accompanying notes are an integral part of these consolidated financial statements. 5 H POWER CORP. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF BUSINESS H Power Corp. (the "Company") was organized on June 6, 1989 under the laws of the State of Delaware. The Company designs, develops, markets and manufactures proton-exchange membrane fuel cells and fuel cell systems designed to provide electricity for a wide range of stationary, portable and mobile applications. 2. BASIS OF PRESENTATION The consolidated balance sheet as of November 30, 2002, the consolidated statement of operations for the three month and six month periods ended November 30, 2002 and 2001 and the consolidated statement of cash flows for the six month periods ended November 30, 2002 and 2001 have been prepared by the Company without audit. In the opinion of management, all adjustments, which consist solely of normal recurring adjustments, necessary to present fairly in accordance with generally accepted accounting principles, the financial position, results of operations and cash flows for all periods presented, have been made. Certain reclassifications have been made with respect to the prior year amounts to provide presentation consistent with the current year. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full year. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statements should be read in conjunction with the Company's audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K filed for the fiscal year ended May 31, 2002. Principles of Consolidation: The accompanying consolidated financial statements include the accounts of the Company and its Canadian subsidiary, H Power Enterprises of Canada, Inc. ("HPEC "). All significant intercompany accounts and transactions are eliminated. Reverse Stock Split: In October 2002, the Company completed a stockholder approved 1:5 reverse common stock split. This reverse stock split decreased the number of common shares outstanding by approximately 43 million shares. Stockholders' equity has been restated to give retroactive recognition to the reverse split for all periods presented by reclassifying the excess par value resulting from the reduced number of shares from common stock to additional paid-in capital. All references in the consolidated financial statements referring to share prices, conversion rates, per share amounts, stock option plans and common stock issued and/or outstanding have been adjusted retroactively for the 1-for-5 reverse stock split. Short-Term Investments: Short-term investments are considered to be available for sale and consist primarily of investments in corporate and government agency debt securities with maturities generally from three to twelve months. Debt securities are typically held until maturity and realized gains and losses on sales of short-term investments for the periods presented are not material. The cost of any investments sold is determined by the specific identification method. The investments are carried at fair market value with the difference between amortized cost and fair market value of these investments reflected in accumulated other comprehensive loss as a separate component of stockholders' equity. The amortized cost and estimated market values of short-term investments at November 30, 2002 and May 31, 2002 are as follows:

6 Other Costs: During the three and six month periods ended November 30, 2002, Other Costs include $966,106 for legal, accounting and investment banking fees incurred in conjunction with our proposed merger with Plug Power, Inc. and $197,743 for restructuring charges related to the closing of our facilities in New Jersey. During the three and six month periods ended November 30, 2001, Other Costs include $370,366 and $677,230, respectively, for pre-production expenses which include personnel costs, recruiting costs, training costs and facility costs as we prepared for production in our North Carolina manufacturing facility. Loss Per Share: The amounts presented for basic and diluted loss per common share in the consolidated statement of operations have been computed by dividing the applicable loss by the weighted average number of common shares outstanding. No options outstanding were included in the calculation of diluted loss per share because their impact would have been anti-dilutive. H Power Japan: During August 2001, the Company and Mitsui & Co., Ltd. formed H Power Japan which is a Japanese corporation headquartered in Tokyo. The Company contributed $84,282 for a 50% ownership interest in the newly created corporation. The Company's investment in H Power Japan is accounted for using the equity method of accounting. The balance of the investment of $65,000 and $71,000 at November 30, 2002 and May 31, 2002, respectively, is included in prepaid expenses and other current assets on the consolidated balance sheet and the equity in the loss on the investment is included in selling, general and administrative expenses as the amounts are diminimus in nature and as the initial activities primarily involve marketing expenditures in the upcoming year. Recent Accounting Pronouncements: In July 2001, the FASB issued SFAS 141, "Business Combinations" (SFAS 141) and SFAS 142, "Goodwill and other Intangible Assets" (SFAS 142). SFAS 141 applies to all business combinations initiated after June 30, 2001, and requires these business combinations be accounted for using the purchase method of accounting. SFAS 142 applies to all goodwill and intangibles acquired in a business combination. Under SFAS 142, all goodwill, including goodwill acquired before initial application of the standard, will not be amortized but will be tested for impairment within six months of adoption of the statement, and at least annually thereafter. Intangible assets other than goodwill will be amortized over their useful lives and reviewed for impairment in accordance with SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS 142 is effective for fiscal years beginning after December 15, 2001, and must be adopted as of the beginning of a fiscal year. The adoption of these standards in fiscal 2002 has not had a material impact on the Company's financial condition or results of operations. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. SFAS No. 144 requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. SFAS No. 144 is effective for all quarters of fiscal years beginning after December 15, 2001. The Company adopted this Statement effective June 1, 2002. The adoption of this Statement has not had a material effect on the Company's financial condition or results of operations. In July 2002, the FASB issued SFAS No.146, Accounting for Costs Associated with Exit or Disposal Activities. The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. Previous accounting guidance was provided by EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 replaces Issue 94-3. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. 3. H POWER-PLUG POWER MERGER On November 11, 2002, H Power and Plug Power, Inc. (Plug Power) entered into an Agreement and Plan of Merger (the "Merger Agreement") providing for a business combination between H Power and Plug Power. If the merger becomes effective, a wholly-owned subsidiary of Plug Power will be merged with and into H Power, and H Power will become a wholly-owned subsidiary of Plug Power. Each issued and outstanding share of common stock of H Power will be converted into the right to receive approximately .89 shares of common stock of Plug Power, subject to, among other things, (1) the 7 number of shares of H Power common stock outstanding immediately prior to the effective time of the merger, (2) the average Plug Power common stock price as defined in the Merger Agreement and (3) the transaction value price, which is determined based on, among other factors, H Power's cash, cash equivalents, and short-term investments, as adjusted by items defined in the Merger Agreement ("Net Cash") at the effective time of the merger. Remaining fractional shares will be paid in cash. The merger requires the approval of both H Power and Plug Power shareholders and is subject to certain closing conditions. The Merger Agreement provides for payment of a $2 million termination fee by H Power under certain circumstances. 4. RESTRUCTURING PLAN Pursuant to the Merger Agreement, the merger consideration to be received by H Power's stockholders will depend in part upon the Net Cash remaining in H Power at the effective date of the merger, as set forth in the Merger Agreement. The Company is therefore restructuring its operations in order to maximize Net Cash while at the same time preserving the operational structure in case the merger is not consummated. As part of the restructuring process, the Company intends to, among other things, reduce its current workforce of 184 personnel by at least 100 employees during the quarter ended February 28, 2003 which will result in severance and other compensation charges in that quarter of approximately $428,000. In the quarter ended November 30, 2002, the Company approved and has commenced the process of restructuring its business operations. This will result in the closing of its New Jersey facilities by July 2003, which coincides with the expiration of these facility leases, and consolidating the operations in North Carolina. A charge of $197,973 has been recorded in the second quarter to reduce the net book value of excess office, computer and manufacturing equipment in New Jersey to its net realizable value as these assets will be disposed of. These actions are anticipated to take place even if the merger is not completed. In addition to anticipated workforce reductions and consolidation of business operations, inventory related to the RCU4500 product line was written down to its net realizable value resulting in a charge of $188,000 in the second quarter. The production of products has been significantly decreased although we are continuing delivery of products that are being produced for customer purchase orders. Some customer purchase orders have been cancelled since the announcement of the execution of merger agreement. Research and development activities have also been substantially reduced. The Company continues to consider whether additional restructuring is necessary and additional charges to operations related to any further restructuring activities may be incurred in future periods. 5. INVENTORIES, NET Inventories, net consist of the following:

During the six months ended November 30, 2002, the Company reduced the allowance by $343,000 of lower of cost or market allowances related to products that were shipped to and accepted by customers. During the same period, the Company directly expensed contract costs of $318,000 that may not be recoverable, which had been capitalized in work in process. In addition, the Company directly expensed $188,000 of inventory related to the discontinued RCU4500 product line by writing down the carrying amount to its net realizable value. 8 6. COMPREHENSIVE INCOME Reconciliation of net loss to comprehensive loss is as follows:

7. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." No benefits for federal or state income taxes have been reported in these consolidated statements of operations as they have been offset by a full valuation allowance because it is more likely than not that the tax benefits of the net operating loss carryforward may not be realized. Section 382 of the Internal Revenue Code limits the ability of a corporation that undergoes an "ownership change" to use its net operating losses to reduce its tax liability. Our initial public offering of common stock (the "IPO") did not trigger such an ownership change, but later transactions may do so. In that event, we would not be able to use net operating losses incurred before our ownership change in excess of the limitation imposed by Section 382. This limitation generally would be calculated by multiplying the value of our stock immediately before the ownership change by the long-term tax-exempt rate as provided in Section 382(f) of the Internal Revenue Code. 8. CAPITAL STRUCTURE The Company's common stockholders are entitled to one vote for each share held of record on all matters submitted to a vote of stockholders. There are 10,000,000 shares of preferred stock authorized and none issued and outstanding as of November 30, 2002 and May 31, 2002. 9. ECO RELATIONSHIP AND AGREEMENTS ECO Fuel Cells, LLC, a subsidiary of Energy Co-Opportunity, Inc. (collectively "ECO") is a stockholder of the Company and has a representative on the Company's Board of Directors. In December 2001, the Company entered into a memorandum of agreement (the "MOA") with ECO that amends, in certain respects, the Amended and Restated Fuel Cell Product Operating Agreement of March 9, 2000 (the "Agreement"). Under the terms of the MOA, the Company re-purchased ECO's exclusive rights to sell and distribute the Company's stationary products in areas of the U.S. served by rural electric cooperatives. The MOA also grants ECO the non-exclusive right to distribute the Company's other fuel cell products. As consideration for the above, the Company paid ECO $2,100,000 (which was the remaining unrecognized revenue related to the initial distribution rights fees) and reduced deferred revenue on the balance sheet by this amount. In April 2002, the Company and ECO amended the Agreement (the "Amended Agreement"). The Amended Agreement continued to provide for ECO to purchase $81 million of the Company's products exclusively from the Company. The Company and ECO amended the products and delivery schedule to include both stationary and portable products, increased the unit prices of the products, extended the period of time for the delivery of the substantial majority of the products to 2005 through 2008, and reduced the number of prototype units to be delivered to 21 at a fixed price of $1,380,500. At November 30, 2002 and May 31, 2002, the Company had $10,000 and $167,763, respectively, accrued for the 9 estimated loss on the prototype phase of this contract obligation as all units have been delivered and are approaching the end of their warranty period. Also in April 2002, the Company and ECO entered into a sales and marketing services agreement, a test reporting, engineering services and field services agreement and a memorandum of agreement for the development of a sustainable fuel cell community. In exchange for ECO's services to be provided under these agreements, the Company will compensate ECO to a maximum amount of $4,400,000 through December 31, 2003. The Company validated the fair value of these services by obtaining independent third party quotations. During the quarter ended and six months ended November 30, 2002 and the fiscal year ended May 31, 2002, the Company recorded $424,000, $1,219,000 and $904,000, respectively, in selling, general and administrative expenses for the value of the services rendered related to these agreements. For the quarter ended and the six months ended November 30, 2002 and the fiscal year ended May 31, 2002, the Company recognized contract revenue for the sale of prototype units of $0, $300,000 and $200,000, respectively, and product revenue for the sale of portable power products of $35,000, $101,000 and $18,000, respectively, under its agreement with ECO. For the fiscal year ended May 31, 2002, the Company recognized $118,278 for the initial distribution rights fees received under the ECO operating agreement. At November 30, 2002 and May 31, 2002, accounts receivable includes $184,100 and $391,166, respectively, which is due from ECO. During the fiscal year ended May 31, 2002, the Company paid $207,512, to an entity in which ECO held a controlling interest, for the development of product documentation, training manuals and courses. No payments were made to the entity during the six months ended November 30, 2002. In connection with our planned merger with Plug Power as discussed in Note 3, the Company entered into a termination agreement with ECO. Pursuant to this termination agreement, all prior agreements with ECO will terminate if and when the closing of the merger occurs, and the Company will pay ECO a termination fee of $2,115,000 in addition to payments due to ECO by the Company pursuant to prior agreements which are anticipated to be $1,600,000 by the effective time of the merger. During the third fiscal quarter of 2003, in light of the pending merger, ECO is continuing to evaluate its activites being performed under certain agreements entered into in April 2002. 10. RELATED PARTY TRANSACTIONS The Company has a customer/vendor relationship with Fuel Cell Components and Integrators, Inc. ("FCCI"), a company controlled by a member of the Rothstein family. The Rothstein family is a principal stockholder of the Company. A member of the Rothstein family served as a director of the Company through April 5, 2000. During the quarter and six months ended November 30, 2002 and the fiscal year ended May 31, 2002, the Company sold products and services to FCCI totaling $8,140, $23,140 and $91,755, respectively, and purchased materials from FCCI totaling $13,849, $96,513 and $281,365, respectively. At November 30, 2002, accounts receivable includes $23,140 due from FCCI and accounts payable includes $4,192 due to FCCI. 11. COMMITMENTS AND CONTINGENCIES H Power has received a complaint and summons, dated December 10, 2002, from havePOWER, LLC, in the U.S. District Court for the District of Maryland. The complaint and summons names both H Power and Plug Power as defendants. havePOWER is alleging breach of a Memorandum of Understanding with H Power dated May 7, 2001, which stated that H Power and havePOWER agreed to work in good faith and use best efforts to enter into a distribution agreement by June 2001. The parties never entered into a distribution agreement. The complaint seeks damages against H Power of not less than $10,000,000, as well as certain injunctive relief. Discovery has not yet commenced in the lawsuit. The Company intends to vigorously defend the claims. The Company does not believe that the outcome of these actions will have a material adverse effect upon its financial position, results of operations or liquidity, however, litigation is inherently uncertain and there can be no assurances as to the ultimate outcome or effect of the actions. If havePOWER were to prevail, such an outcome could have a material adverse effect on our financial condition, results of operation and liquidity. 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Form 10-Q and H Power's audited financial statements and notes thereto included in its Annual Report on Form 10-K filed for the fiscal year ended May 31, 2002. When used in the following discussion, the words "believes", "anticipates", "intends", "expects" and similar expressions are intended to identify forward-looking statements. Forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those projected. These risks include, but are not limited to, those set forth herein and those identified under "Risk Factors" in our Annual Report on Form 10-K filed for the fiscal year ended May 31, 2002. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. OVERVIEW We design, develop, market and manufacture proton-exchange membrane, or PEM fuel cells and fuel cell systems. Fuel cells are devices that produce electrical energy without combustion and its associated environmental contaminants. The fuel cell systems we make and market are designed to complement or replace conventional power sources, such as batteries and electric power generators. The use of alternative electric power systems is desirable in situations where conventional power sources cannot adequately, economically or technologically supply the power required. We were incorporated in June 1989 under the laws of the State of Delaware. A substantial portion of our business activity, from our inception, was development of products subject to various government contracts. The most significant of these contracts were used to develop fuel cell powered vehicles, stationary power systems, communications backup power systems and diesel reformers. Although these contracts have historically accounted for a substantial portion of our revenues, they have diminished in importance as a result of our focus on commercialization of our fuel cell systems. On November 11, 2002, we and Plug Power, Inc. ("Plug Power") entered into an Agreement and Plan of Merger (the "Merger Agreement") providing for a business combination between H Power and Plug Power. If the merger becomes effective, a wholly-owned subsidiary of Plug Power will be merged with and into H Power, and H Power will become a wholly-owned subsidiary of Plug Power. Each issued and outstanding share of common stock of H Power will be converted into the right to receive approximately .89 shares of common stock of Plug Power, subject to, among other things, (1) the number of shares of H Power common stock outstanding immediately prior to the effective time of the merger, (2) the average Plug Power common stock price as defined in the Merger Agreement and (3) the transaction value price, which is determined based on, among other factors, H Power's cash, cash equivalents, and short-term investments, as adjusted by items defined in the Merger Agreement ("Net Cash") at the effective time of the merger with fractional shares paid in cash. The merger requires the approval of both H Power and Plug Power shareholders and is subject to certain closing conditions. We and Plug Power are working to complete the transaction no later than March 31, 2003. The Merger Agreement provides for payment of a $2 million termination fee by H Power under certain circumstances. As discussed above, the merger consideration to be received by H Power's stockholders will depend in part upon our remaining Net Cash at the effective time of the merger, as set forth in the Merger Agreement. In order to maximize Net Cash, we have started the process of restructuring our operations. As required in the Merger Agreement, the Company retained an outside management company to act as the Company's chief restructuring officer (the "CRO"). The role of the CRO is to assist Company management in implementing cost saving measures and take other actions consistent with the objective of maximizing Net Cash. As part of the restructuring process, we intend to, among other things, reduce our current workforce of 184 personnel by at least 100 during the quarter ended February 28, 2003 which will result in severance and other compensation charges in that quarter of approximately $428,000. In the quarter ended November 30, 2002, the Company approved and has commenced the process of consolidating our business operations. This will result in the closing of our New Jersey facilities by July 2003, which coincides with the expiration of the facility leases, and consolidating the operations in North Carolina. A charge of $197,743 has been recorded in the second quarter to reduce the net book value of excess office, computer and manufacturing equipment in New Jersey to its net realizable value as these assets will be disposed of. These actions are anticipated to take place even if the merger is not completed. In addition to anticipated workforce reductions and consolidation of business operations, inventory related to the RCU4500 product line was written down to its net realizable value resulting in a charge of $188,000 in the second quarter. The production of products has been decreased significantly although we are continuing delivery of products pursuant to customer purchase orders. Some customer purchase orders have been cancelled since the announcement of the execution of merger agreement. Research and development activities have been substantially reduced. The Company continues to evaluate whether additional restructuring is necessary and additional charges to operations related to any further restructuring activities may be incurred in future periods. 11 We have also entered into a termination agreement ("Termination Agreement") with ECO Fuel Cells, LLC, a subsidiary of Energy Co-Opportunity, Inc. (collectively "ECO"). Pursuant to this Termination Agreement, all prior agreements with ECO, as described below, will terminate if and when the merger occurs and the Company will pay ECO a termination fee of $2,115,000 in addition to payments due to ECO by the Company pursuant to prior agreements which are anticipated to be $1,600,000 by the effective time of the merger. During the third fiscal quarter of 2003, in light of the pending merger, ECO is continuing to evaluate its activites being performed under prior agreements. In 1997, we began to use our technologies to develop higher power, stationary PEM fuel cell products for use as primary and supplemental on-site electric power systems for residential use. In August 1999, we entered into a ten-year agreement with ECO. ECO is an association of approximately 300 U.S. rural electric cooperatives. The agreement provided for the purchase of $81 million of our fuel cell products which ECO would market, sell, install and service through the rural electric cooperatives. In April 2002, the Company and ECO amended the Agreement (the "Amended Agreement") which continues to provide for the purchase of $81 million of fuel cell products from the Company. The Company and ECO also amended the products and delivery schedule to include both stationary and portable products, increased the unit prices of the products, extended the period of time for the delivery of the substantial majority of the products to 2005 through 2008, and reduced the number of prototype units to be delivered to 21 at a fixed price of $1,380,500. Under the terms of the Amended Agreement, H Power also repurchased ECO's exclusive rights to sell and distribute the Company's stationary products in areas of the U.S. served by rural electric cooperatives and granted ECO the non-exclusive right to distribute our other fuel cell products. As consideration for the above, we paid ECO $2,100,000 (which is the remaining unrecognized revenue related to the initial distribution rights fees) and reduced deferred revenue on the balance sheet by this amount. We also expanded our relationship with ECO in April 2002 by entering into three agreements, a Sales and Marketing Services Agreement, a Test Reporting and Field Services Agreement and a Memorandum of Agreement (the "MOA") for a sustainable fuel cell community project. Under the terms of the Sales and Marketing Agreement, ECO will work with H Power to identify potential new markets, applications and distribution channels for our fuel cell products. Under the terms of the Test Reporting and Field Services Agreement, ECO will support us in the installation, maintenance and the setting up of the field service infrastructure to service our fuel cell products. Under the MOA, ECO will work on the development of a sustainable community that includes the generation, storage, transmission of hydrogen, and distribution of hydrogen based fuel cells. We agreed to pay ECO up to $5.4 million through December 31, 2003, in exchange for the services under these agreements. As a result of ECO receiving funding from an alternative source and consistent with the terms of the MOA, our obligation to ECO has been reduced to $4.4 million. For the quarter and six months ended November 30, 2002 and year ended May 31, 2002, selling, general and administrative expenses include $424,000, $1,219,000 and $904,000, respectively, for services under these agreements. These agreements as well as the Amended Agreement will be terminated pursuant to the Termination Agreement described above if the merger is consummated. We are continuing to make payments under these agreements and are obligated to do so if the merger is not consummated. During August 2001, we and Mitsui & Co., Ltd. ("Mitsui") formed H Power Japan which is a Japanese corporation headquartered in Tokyo. We contributed $84,282 for a 50% ownership interest in the newly created corporation, which is being accounted for using the equity method of accounting. H Power Japan's activities include performing a feasibility study related to the sale and distribution of our fuel cell products in Japan and potentially in other countries. The impact of this venture on our results of operation was not material. Since the announcement of the planned merger with Plug Power, Mitsui has significantly reduced marketing activities of our products in Japan. We have a limited history of generating revenues and our products have only been recently introduced or are still under development. The costs of our products are currently higher than we originally anticipated. Through November 30, 2002, we have incurred accumulated losses of approximately $111 million since our inception in 1989 and we anticipate incurring significant losses in the future. If we are unable to reduce our product costs and achieve our revenue estimates, our net losses in any given quarter could be greater than expected. In addition, to the extent our prototype units do not perform to expectations, our commercialization schedule could be further delayed. You have limited historical financial data and operating results with which to evaluate our business and our prospects. As a result, you should consider our prospects in light of the early stage of our business in a new and rapidly evolving market. We have commenced limited commercial shipments of our portable products. Our products will be priced substantially higher than competing products and will be used primarily for demonstration purposes by early adopters. As a result, revenues from large scale commercial shipments are not expected to begin until calendar year 2005, if then. 12 RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED NOVEMBER 30, 2002 AND NOVEMBER 30, 2001 REVENUES. Revenues were $652,000 for the three months ended November 30, 2002 compared to $795,000 for the three months ended November 30, 2001, a decrease of $143,000 or 18%. Our revenues for the three months ended November 30, 2002 were derived approximately 96% from product revenues and 4% from contract revenues. Product revenues for the three months ended November 30, 2002 were comprised of $494,000 and $131,000 in stationary and portable product revenues, respectively, which represents a decrease of $80,000 and $13,000 for stationary and portable product revenues, respectively, when compared to the three months ended November 30, 2001. The decrease in stationary product revenues is a result of decreased sales of RCU4500 products. Contract revenues for the three months ended November 30, 2002 were $27,000, a decrease of $50,000 from $77,000 for the three months ended November 30, 2001. The decrease in contract revenues is primarily due to the elimination of license revenues related to ECO's exclusive distribution rights recognized during the three months ended November 30, 2001. No additional license revenue will be recognized subsequent to November 30, 2001 as we repurchased ECO's exclusive distribution rights. COSTS OF REVENUES. Costs of revenues were $1,961,000 for the three months ended November 30, 2002 compared to $918,000 for the three months ended November 30, 2001, an increase of $1,043,000 or 114%. The increase in the cost of revenues is a result of $318,000 in costs related to a contract currently in process that may not be recoverable, $247,000 for potential disallowed costs and potential refunds associated with a governmental contract with the remainder of the increase primarily being fixed facility and manufacturing costs. We anticipate that our cost of revenues will exceed our revenues for the foreseeable future due to the current cost of our fuel cell subsystems, limited production volumes and our fixed manufacturing costs. We are pursuing cost reductions of our fuel cell subsystems and components as the cost of our initial beta units must be significantly reduced to be attractive to the markets we intend to serve. RESEARCH AND DEVELOPMENT EXPENSES. Research and development costs were $4,678,000 for the three months ended November 30, 2002 compared to $4,694,000 for the three months ended November 30, 2001, a decrease of $16,000. Our research and development efforts include the continuing development of our stationary power fuel cell systems and the development of our portable and mobile products. The decrease in research and development expenses is primarily due to the material and personnel costs associated with stationary and portable fuel cell prototype systems that were built and tested in the three months ended November 30, 2001 in an effort to accelerate the development of these systems. Similar levels of prototype costs were not incurred in the three months ended November 30, 2002. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative costs were $2,442,000 for the three months ended November 30, 2002 compared to $2,049,000 for the three months ended November 30, 2001, an increase of $393,000. This increase consists of an increase in selling expenses of $498,000 which includes costs of $424,000 for sales and marketing related services provided by ECO. The increase in selling expenses is partially offset by reduced general and administrative expenses associated with our continuing emphasis on cost controls. OTHER COSTS: During the three months ended November 30, 2002, other costs include $966,000 for legal, accounting and investment banking fees incurred in conjunction with our proposed merger with Plug Power, Inc. and $198,000 for asset impairments related to the closing of our facilities in New Jersey. We anticipate that total professional fees related to the merger will be in excess of $2,500,000. During the three months ended November 30, 2001, other costs include $370,000 for costs incurred as we prepared for production in our North Carolina manufacturing facility. These pre-production expenses include personnel, recruiting and training costs of $237,000 and costs for rent, utilities, insurance and other facility related costs totaling $133,000. INTEREST INCOME AND OTHER, NET. Interest income and other, net was $219,000 for the three months ended November 30, 2002 compared to $682,000 for the three months ended November 30, 2001, a decrease of $463,000. The decrease was primarily a result of less interest income earned due to lower interest rates and our reduced short-term investment balances. 13 COMPARISON OF THE SIX MONTHS ENDED NOVEMBER 30, 2002 AND NOVEMBER 30, 2001 REVENUES. Revenues were $1,595,000 for the six months ended November 30, 2002 compared to $1,166,000 for the six months ended November 30, 2001, an increase of $429,000 or 37%. Our revenues for the six months ended November 30, 2002 were derived approximately 69% from product revenues and 31% from contract revenues. Product revenues for the six months ended November 30, 2002 were comprised of $778,000 and $314,000 in stationary and portable product revenues, respectively, which represents an increase of $152,000 for stationary product revenues and a decrease of $5,000 for portable product revenues when compared to the six months ended November 30, 2001. The increase in stationary product revenues is a result of sales of product to Mitsui and Gaz de France. Contract revenues for the six months ended November 30, 2002 were $502,000, an increase of $282,000 from $220,000 for the six months ended November 30, 2001. The increase in contract revenues is primarily due to revenues from the sale of beta units to ECO and revenues associated with our contract with PSA Peugeot Citroen. COSTS OF REVENUES. Costs of revenues were $3,618,000 for the six months ended November 30, 2002 compared to $1,297,000 for the six months ended November, 2001, an increase of $2,321,000 or 179%. The increase in the costs of revenues is a result of product costs associated with increased revenues, $318,000 in costs related to a contract currently in process that may not be recoverable, $247,000 for potential disallowed costs and potential refunds associated with a governmental contract with the remainder of the increase primarily being fixed facility and manufacturing costs. We anticipate that our cost of revenues will exceed our revenues for the foreseeable future due to the current cost of our fuel cell subsystems, limited production volumes and our plans to increase production capacity. We are pursuing cost reductions of our fuel cell subsystem and component costs as the cost of our initial beta units must be significantly reduced to be attractive to the markets we intend to serve. RESEARCH AND DEVELOPMENT EXPENSES. Research and development costs were $8,452,000 for the six months ended November 30, 2002 compared to $10,631,000 for the six months ended November 30, 2001, a decrease of $2,179,000. Our research and development efforts include the continuing development of our stationary power fuel cell systems and the development of our portable and mobile products. The decrease in research and development expenses is primarily due to the substantial material and personnel costs associated with stationary and portable fuel cell prototype systems that were built and tested in the six months ended November 30, 2001 in an effort to accelerate the development of these systems. Similar levels of prototype costs were not incurred in the six months ended November 30, 2002. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative costs were $5,232,000 for the six months ended November 30, 2002 compared to $4,107,000 for the six months ended November 30, 2001, an increase of $1,125,000. This increase consists of an increase in selling expenses of $1,466,000 which includes costs of $1,219,000 for sales and marketing related services provided by ECO. The increase in selling expenses is partially offset by reduced general and administrative expenses associated with our continuing emphasis on cost controls. OTHER COSTS: During the six months ended November 30, 2002, other cost include $966,000 for legal, accounting and investment banking fees incurred in conjunction with our proposed merger with Plug Power, Inc. and $198,000 for restructuring charges related to the closing of our facilities in New Jersey proposed. We anticipate that total professional fees related to the merger will be in excess of $2,500,000. During the six months ended November 30, 2001, other costs include $677,000 for costs incurred as we prepared for production in our North Carolina manufacturing facility. These pre-production expenses include personnel, recruiting and training costs of $397,000 and costs for rent, utilities, insurance and other facility related costs totaling $280,000. INTEREST INCOME AND OTHER, NET. Interest income and other, net was $505,000 for the six months ended November 30, 2002 compared to $1,634,000 for the six months ended November 30, 2001, a decrease of $1,129,000. The decrease was primarily a result of less interest income earned due to lower interest rates and our reduced short-term investment balances. 14 LIQUIDITY AND CAPITAL RESOURCES Pursuant to the merger agreement with Plug Power, the merger consideration to be received by our stockholders will depend in part on the Net Cash in H Power upon the effective date of the merger. In order to maximize Net Cash, we are restructuring our operations by, among other things, reducing our workforce, closing our New Jersey facilities, discontinuing the RCU4500 product line and suspending the development of other product lines. Our capital requirements depend on numerous factors, including, but not limited to, completion of our product development activities that allow us to produce our products in a cost effective manner, and market acceptance of our systems. We will continue to make significant expenditures on the development of our PEM fuel cell systems. We will need to raise additional funds to execute our business plan and achieve commercialization. There can be no assurance that any additional financing will be available on commercially attractive terms, in a timely fashion, in sufficient amounts, or at all. If additional funds are raised through the issuance of equity securities, the percentage ownership of our then current stockholders will be reduced. In addition, we intend to seek strategic partners and suppliers for technical and/or financial assistance in completing the development of our products. In the event we are unsuccessful in entering into such strategic arrangements, we may be unable to complete the development of our products. At November 30, 2002 and May 31, 2002, we had net working capital of approximately $44,468,000 and $60,279,000, respectively. Net working capital included cash, cash equivalents, restricted cash and short-term investments totaling $44,806,000 and $59,758,000 in the respective periods. The decrease in net working capital of $15,811,000 is primarily a result of cash used to fund operations, merger related expenses and the purchase of plant and equipment. Net cash used by operating activities for the six months ended November 30, 2002 was $14,321,000 compared to $12,874,000 for the six months ended November 30, 2001. For the six months ended November 30, 2002 and 2001, cash was used primarily to fund the net loss of $16,366,000 and $13,913,000 respectively. The non-cash portion of the operating losses related primarily to depreciation and amortization of $964,000 and $465,000 for the six months ended November 30, 2002 and 2001 which increased primarily due to the added depreciation for our new facility in North Carolina and changes in the other components of working capital. Accounts payable primarily increased due to the costs incurred in connection with the planned merger. For the six months ended November 30, 2002 and 2001, cash provided by investing activities included the disposition of short-term investments of $9,999,000 and $17,923,000. Cash used for the six months ended November 30, 2002 and 2001 was primarily for capital expenditures of $499,000 and $5,335,000. In January 2001, we signed a ten-year lease for approximately 90,000 square feet of manufacturing and office space in Monroe, North Carolina. This lease has two five-year renewal options exercisable at the end of the 10th year. We occupied the facility in July 2001. The annual base rental rate for this facility is approximately $308,000, subject to annual inflation adjustments. In addition to the base rent, we are responsible for the cost of maintenance, taxes and insurance. We currently occupy space in New Jersey in two adjacent facilities. Leases for these facilities were due to expire in July 2002 and have been extended to July 2003 with an option to renew for an additional year to July 2004. Consistent with our approved restructuring plan which we are implementing, we do not intend to renew either of these leases. The lease for our former facility in Canada was terminated in July 2001, prior to the September 2001 expiration date, for approximately $5,500. We signed a ten-year Offer to Lease for a facility in Canada with approximately 28,000 square feet in January 2001. We commenced our operations in this facility in May 2001. This lease has a five-year renewal option exercisable at the end of the 10th year. The annual base rental rate for this facility for the first and second five year periods is approximately $171,000 and $198,000, respectively. In addition to the base rent, we are responsible for the cost of maintenance, taxes and insurance. We also lease an additional facility in Canada with 2,900 square feet which expires in March 2003. The successful execution of our restructuring plan includes meeting revenue estimates, the continuation of our product development activities, and the continuation of sales and marketing to support the commercialization of our fuel cell systems. We anticipate that we will incur substantial losses over at least the next few years due to expenditures for these activities. The successful commercialization and introduction of our products may be affected by the cost competitiveness of our products, the future costs of fuels used by our products, consumer reluctance to try a new product, the pace of utility deregulation nationwide and the emergence of newer, more competitive technologies and products. These factors may affect our ability to secure additional funding which, in the event the merger is not consummated, we will pursue during fiscal 2003. We believe that the net proceeds of $102 million, which was received in conjunction with our IPO in August 2000, will be adequate to fund our operations at least through May 31, 2004. 15 CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related footnotes. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: Revenue Recognition: We derive our revenue from primarily two sources, product revenue and contract revenue. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Revenues from sales of products are recognized when the product has been shipped and the Company has met its obligations under the sales contract. Revenues from sales of products requiring the Company to perform installation are recognized when installation has been completed. Revenues from sales of products allowing a customer acceptance period are recognized at the conclusion of the acceptance period. Revenues from sales of test and evaluation products which are used by customers primarily for research and development purposes and are sold without a right of return and without a customer acceptance period are recognized when the product has been shipped. Revenues on contracts include reimbursed direct costs and allowable allocated indirect costs incurred, plus recognized profits. Profit is recognized on cost-reimbursable contracts as costs are incurred, and under fixed-price contracts on the cost-to-cost method or the units of delivery method of the percentage-of-completion method. When it is determined that a loss will result from the performance of a contract, the entire amount of the estimated ultimate loss is charged against income. The impact of revisions in contract estimates are recognized on a cumulative catch up basis in the period in which revisions are made. The complexity of the estimation process and all issues related to the percentage-of-completion method of contract accounting affect the amounts reported in our financial statements. A number of internal and external factors affect our cost estimates including labor rates, future materials prices and customer specification and testing requirements changes. The revenues related to contracts which qualify as best-efforts research and development arrangements are treated as an offset to the Company's research and development expenses. Revenues from product distribution rights fees related to our agreement with ECO are deferred and recognized as contract revenue on a straight-line basis over the term of the distribution agreement. As of May 31, 2002, there are no additional product distribution rights fees included in deferred revenue that will be recognized as contract revenue in future periods. Inventories: We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements. In addition, our industry is characterized by technological change, frequent new product development and product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, any significant unanticipated changes in our forecasts or technological developments could have a significant impact on the value of our inventory and our reported operating results. Product Warranty: We offer warranties of various lengths to our customers depending upon the specific product and terms of the customer purchase agreement. We typically negotiate varying terms regarding warranty coverage and length of warranty dependant upon the product involved and the type of customer. Our typical warranties require us to repair or replace defective product during the warranty period at no cost to the customer. As of the balance sheet date, we record an estimate for warranty related costs for products sold based on our historical experience and expectation of future conditions. While we believe that our estimated liability for product warranties is adequate and that the judgment applied is appropriate, the estimated liability for product warranties could differ materially from future actual warranty costs. Long-Lived Assets: Long-lived assets including plant, equipment, intangible and certain other long-lived assets are amortized over their useful lives. We periodically review the useful lives and carrying values of our long-lived assets for continued appropriateness. We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. 16 CONTRACTUAL OBLIGATIONS The following table summarizes our contractual obligations in the fiscal years subsequent to May 31, 2002:

*In the event of the merger, it is expected that the Company will pay ECO a termination fee of $2,115,000 in 2003, in addition to any remaining payments in the table above. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our financial market risk includes risks associated with international operations and related foreign currencies, as we have a significant operation in Canada. Expenses in this operation are incurred in Canadian dollars and therefore are subject to foreign currency exchange risk. Through November 30, 2002, we have not experienced any significant negative impact on our operations as a result of fluctuations in foreign currency exchange rates. In addition, our international business is subject to the risks typical of an international business including, but not limited to, differing economic conditions, changes in political climate, differing tax structures and other legal regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially and adversely affected by changes in these and other factors. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. We maintain our portfolio of cash, cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations and money market funds. We do not utilize any derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. We believe that the investment-grade securities we hold are not subject to any material risks arising from changes in interest rates, however, they may be subject to changes in the financial standing of the issuer of these securities. Item 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. The term "disclosure controls and procedures" is defined in Rules 13a-14 (c) and 15d-14 (c) of the Securities and Exchange Act of 1934 ("Exchange Act"). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Our chief executive officer and our chief financial officer have evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days before the filing of this quarterly report (the "Evaluation Date"), and, they have concluded that, as of the Evaluation Date, such controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act. (b) Changes in internal controls. We maintain a system of internal accounting controls that are designed to provide reasonable assurance that our books and records accurately reflect our transactions and that our established policies and procedures are carefully followed. For the quarter ended November 30, 2002, there were no significant changes to our internal controls or in other factors that could significantly affect our internal controls, and we have not identified any significant deficiencies or material weaknesses in our internal controls. 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS H Power has received a complaint and summons, dated December 10, 2002, from havePOWER, LLC, in the U.S. District Court of Maryland. The complaint and summons names both H Power and Plug Power as defendants. havePOWER is alleging breach of a Memorandum of Understanding with H Power dated May 7, 2001, which stated that H Power and havePOWER agreed to work in good faith and use best efforts to enter into a distribution agreement by June 2001. The parties never entered into a distribution agreement. The complaint seeks damages against H Power of not less than $10,000,000, as well as certain injunctive relief. Discovery has not yet commenced in the lawsuit. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (c) For a description of the one-for-five reverse split of our outstanding common stock, see Part I, Item 1, Note 2 "BASIS OF PRESENTATION - Reverse Stock Split." (d) During the year ended May 31, 2001, net proceeds, after underwriting commissions and additional expenses, of approximately $102 million were received in conjunction with the Company's initial public offering of its securities pursuant to Registration Statement (Registration No. 333-34234) on Form S-1, declared effective by the Securities and Exchange Commission on August 8, 2000. As of November 30, 2002, $58.3 million has been used to fund operating activities and $9.9 million has been used to fund capital expenditures for plant and equipment. The remainder of the net proceeds are invested in a variety of investment grade securities, including money market funds and government and corporate obligations with maturities of less than one year. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On October 15, 2002, we held our Annual Meeting of Stockholders. All share amounts referred to in this section do not account for the one-for-five reverse stock split. The one-for-five reverse split of our outstanding common stock was in effect October 16, 2002. Of the 53,882,828 shares outstanding as of the record date, 41,910,325 shares were present or represented by proxy at the meeting. The matters voted on at the meeting and the results of these votes are as follows: 1. Election of the following directors to a term expiring at the next Annual Meeting of Stockholders: Name ---- H. Frank Gibbard William L. Zang Rachel Lorey Allen Howard L. Clark, Jr. Leonard A. Hadley Robert L. Hance Ivan Roch Gary K. Willis The directors were re-elected as more than a majority of the shares of stock present or represented at the meeting had been cast in favor of each of the candidates nominated. 2. Amendment to our Restated Certificate of Incorporation to effect a reverse split of our outstanding common stock by a ratio of 1-for-5 and to effect a decrease in the number of authorized shares of our common stock from 150,000,000 to 50,000,000. For Against Abstain Withheld Authority --- ------- ------- ------------------ 40,744,835 1,045,279 120,210 0 3. Appointment of PricewaterhouseCoopers LLP as our independent public accountants for the 2003 fiscal year. For Against Abstain Withheld Authority --- ------- ------- ------------------ 41,367,322 466,290 73,321 0 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of this report: 2.1(i) Agreement and Plan of Merger by and among Plug Power Inc., Monmouth Acquisition Corp., and HPower Corp. dated as of November 11, 2002. 4.7 Certificate of Amendment to Restated Certificate of Incorporation, as filed with the Secretary of State of the State of Delaware on October 16, 2002. 10.74* Termination Agreement by and among Plug Power Inc., H Power Corp., H Power Enterprises of Canada, Inc. and Energy Co-Opportunity, Inc. and ECO Fuel Cells, LLC dated November 8, 2002. (b) Reports on Form 8-K On November 12, 2002, we filed a Form 8-K with the Securities and Exchange Commission to report that we entered into the Merger Agreement. ---------------- (i) Incorporated by reference to H Power Corp.'s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on November 12, 2002. * A request for confidential treatment was filed for portions of this document. Confidential portions have been omitted and filed separately with the Commission as required by Rule 24b-2 of the Securities Exchange Act of 1934, as amended. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: January 10, 2003 H POWER CORP. By: /s/ William L. Zang -------------------------------- William L. Zang CHIEF FINANCIAL OFFICER (on behalf of the Registrant and as principal financial officer) CERTIFICATION I, H. Frank Gibbard, certify that: 1. I have reviewed this quarterly report on Form 10-Q of H Power Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; 19 b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: January 10, 2003 /S/ H. FRANK GIBBARD ----------------------------------- H. Frank Gibbard Chief Executive Officer CERTIFICATION I, William L. Zang, certify that: 1. I have reviewed this quarterly report on Form 10-Q of H Power Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 20 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: January 10, 2003 /S/ WILLIAM L. ZANG -------------------------------- William L. Zang Chief Financial Officer 21 EXHIBIT INDEX 2.1(i) Agreement and Plan of Merger by and among Plug Power Inc., Monmouth Acquisition Corp., and H Power Corp. dated as of November 11, 2002. 4.7 Certificate of Amendment to Restated Certificate of Incorporation, as filed with the Secretary of State of the State of Delaware on October 16, 2002. 10.74* Termination Agreement by and among Plug Power Inc., H Power Corp., H Power Enterprises of Canada, Inc. and Energy Co-Opportunity, Inc. and ECO Fuel Cells, LLC dated November 8, 2002. ---------------- (i) Incorporated by reference to H Power Corp.'s Current Report on Form 8-K, as filed with the Securities and Exchange Commission on November 12, 2002. * A request for confidential treatment was filed for portions of this document. Confidential portions have been omitted and filed separately with the Commission as required by Rule 24b-2 of the Securities Exchange Act of 1934, as amended.

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