UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to ___________.
Commission File Number: 000-50542
HYDROGEN ENGINE CENTER, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
NEVADA 000-50542 82-0497807
- ---------------------------- ----------- --------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
602 East Fair Street, Algona, Iowa 50511
(Address of principal executive offices)
Registrant's telephone number, including area code: (515) 295-3178
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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. [X] Yes [ ] No
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
24,494,504 shares of Common Stock, par value $.001
outstanding at November 6, 2005.
Transitional Small Business Disclosure Format (Check one): [ ] Yes [X] No
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets
September 30, 2005 and December 31, 2004............................. 3
Unaudited Condensed Consolidated Statements of Operations Three
Months Ended September 30, 2005 and 2004; Nine Months
Ended September 30, 2005 and 2004; Period from inception
to September 30, 2005................................................. 4
Unaudited Condensed Consolidated Statements of Stockholders' Equity
(Deficit)............................................................. 5
Unaudited Condensed Consolidated Statements of Cash Flows Three
Months Ended September 30, 2005 and 2004; Nine Months
Ended September 30, 2005 and 2004; Period from inception
to September 30, 2005................................................. 6
Notes to Unaudited Condensed Consolidated Financial Statements........ 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 14
Item 3. Controls and Procedures........................................... 25
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use................... 25
of Proceeds
Item 4. Submission of Matters to a Vote of Security Holders............... 25
Item 6. Exhibits.......................................................... 26
Notes About Forward-looking Statements..................................... 26
Signatures................................................................. 26
-2-
ITEM 1. FINANCIAL INFORMATION
Hydrogen Engine Center, Inc. and Subsidiaries
(a corporation in the development stage)
Condensed Consolidated Balance Sheets
September 30, December 31,
2005 2004
----------- -----------
(unaudited)
Assets
- ------
Current Assets:
Cash and cash equivalents $ 3,482,958 $ 19,808
Accounts receivable 2,900 --
Inventories 143,966 102,124
Prepaid expenses 25,160 3,163
----------- -----------
Total current assets 3,654,984 125,095
Property and equipment, at cost:
Land 146,124 --
Building - construction in process 227,950 --
Vehicles 5,000 5,000
Equipment 154,488 64,453
Leasehold improvements 13,772 13,772
----------- -----------
547,334 83,225
Less accumulated depreciation and amortization 37,406 21,882
----------- -----------
509,928 61,343
----------- -----------
Total assets $ 4,164,912 $ 186,438
=========== ===========
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable $ 83,407 $ 1,022
Accrued expenses 30,557 17,130
Current portion of long-term debt (Note 2) 20,000 --
----------- -----------
Total current liabilities 133,964 18,152
Long-term debt:
Note payable - City of Algona (Note 2) 180,000 --
Note payable - AAEDC (Note 2) 146,124 --
Convertible note payable - Stockholder (Note 2) 17,280 17,280
Convertible notes payable - Others (Note 2) 539,771 269,772
----------- -----------
Total long-term debt 883,175 287,052
----------- -----------
Total liabilities 1,017,139 305,204
Commitments and Contingencies (Note 6)
Stockholders' equity (deficit)
Preferred stock, $0.001 par value; 10,000,000 shares
authorized, none issued (Note 4) -- --
Common stock, $0.001 par value; 100,000,000 shares authorized
(10,000,000 at December 31, 2004), 24,494,504
shares issued & outstanding (2,000,000 at December 31, 2004) 24,495 2,000
Additional paid-in capital 4,245,381 137,352
Deficit accumulated during the development stage (825,271) (258,118)
Unearned compensation (296,832) --
----------- -----------
Total stockholders' equity (deficit) 3,147,773 (118,766)
----------- -----------
Total liabilities and stockholders' equity (deficit) $ 4,164,912 $ 186,438
=========== ===========
See accompanying notes.
-3-
Hydrogen Engine Center, Inc. and Subsidiaries
(a corporation in the development stage)
Condensed Consolidated Statements of Operations (unaudited)
Period from May
Three Months Ended September 30 Nine Months Ended September 30 19, 2003
------------------------------- ---------------------------- (inception) to
2005 2004 2005 2004 September 30,
------------ ------------ ------------ ------------ ------------
Sales $ 7,287 $ 3,800 $ 20,887 $ 3,800 $ 40,347
Cost of sales 7,326 3,500 13,521 3,500 17,621
------------ ------------ ------------ ------------ ------------
Gross profit (39) 300 7,366 300 22,726
Sales and marketing 68,354 -- 87,983 7,101 100,084
General and
administrative 256,166 36,454 317,766 91,500 503,344
Research and
development 113,637 6,258 156,342 12,654 217,954
------------ ------------ ------------ ------------ ------------
438,157 42,712 562,091 111,255 821,382
------------ ------------ ------------ ------------ ------------
Operating loss (438,196) (42,412) (554,725) (110,955) (798,656)
Other income (expense):
Interest income 9,492 109 10,589 738 11,332
Interest expense (10,665) (4,341) (23,017) (10,589) (37,947)
------------ ------------ ------------ ------------ ------------
(1,173) (4,232) (12,428) (9,851) (26,615)
------------ ------------ ------------ ------------ ------------
Net loss $ (439,369) $ (46,644) $ (567,153) $ (120,806) $ (825,271)
============ ============ ============ ============ ============
Weighted average shares
outstanding 18,954,208 16,297,200 17,192,602 16,297,200 16,579,795
============ ============ ============ ============ ============
Basic and diluted net loss
per share $ (0.02) $ (0.00) $ (0.03) $ (0.01) $ (0.05)
============ ============ ============ ============ ============
See accompanying notes.
-4-
Hydrogen Engine Center, Inc. and Subsidiaries
(a corporation in the development stage)
Condensed Consolidated Statements of Stockholders' Equity (Deficit) (Unaudited)
Deficit
Accumulated
Common Stock Common Additional During the
Shares Stock Paid-in Development Deferred
Account Capital Stage Compensation Total
------------ ------------ ------------ ------------ ------------ ------------
Issuance of common stock to
founder in exchange for
equipment and expenses
incurred by founder 2,000,000 $ 2,000 $ 98,165 $ -- $ -- $ 100,165
Net loss -- -- -- (65,642) -- (65,642)
------------ ------------ ------------ ------------ ------------ ------------
Balance at 12/31/03 2,000,000 2,000 98,165 (65,642) -- 34,523
Company-related expenses paid
by founder -- -- 39,187 -- -- 39,187
Net loss -- -- -- (192,476) -- (192,476)
------------ ------------ ------------ ------------ ------------ ------------
Balance at 12/31/04 2,000,000 2,000 137,352 (258,118) -- 118,766)
Company-related expenses paid
by founder -- -- 12,135 -- -- 12,135
Exchange of previous shares by
sole shareholder of HECI (2,000,000) -- -- -- -- --
Issuance of common stock to
the sole shareholder of HECI
in connection with the merger 16,297,200 14,297 (14,297) -- -- --
Shares in acquired Company in
reverse merger 1,006,000 1,006 (1,006) -- -- --
Stock split of 3.8 to 1 prior to
the merger 2,816,804 2,817 (2,817) -- -- --
Issuance of restricted common
stock to employees and
directors 426,000 426 425,574 -- (296,832) 129,168
Issuance of common stock in
connection with the private
offering 3,948,500 3,949 3,590,940 -- -- 3,594,889
Consultant compensation
associated with stock options -- -- 97,500 -- -- 97,500
Net loss -- -- -- (567,153) -- (567,153)
------------ ------------ ------------ ------------ ------------ ------------
Balance at 9/30/05 (unaudited) 24,494,504 $ 24,495 $ 4,245,381 $ (825,271) $ (296,832) $ 3,147,773
============ ============ ============ ============ ============ ============
See accompanying notes.
-5-
Hydrogen Engine Center, Inc. and Subsidiaries
(a corporation in the development stage)
Condensed Consolidated Statements of Cash Flows (unaudited)
Three Months Ended Nine Months Ended Period from
September 30 September 30 May 19, 2003
-------------------------- -------------------------- (inception) to
2005 2004 2005 2004 Sept. 30, 2005
----------- ----------- ----------- ----------- -----------
Operating activities:
Net loss $ (439,369) $ (46,644) $ (567,153) $ (120,806) $ (825,271)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 7,132 3,981 15,524 11,942 37,406
Compensation given to directors and
employees in restricted stock 129,168 -- 129,168 -- 129,168
Compensation given to contractors
in stock options 97,500 -- 97,500 -- 97,500
(Increase) decrease in:
Accounts receivable 4,910 (3,819) (2,900) (3,819) (2,900)
Inventories (13,282) (5,800) (41,840) (78,784) (143,964)
Prepaid expenses (21,998) 1,365 (21,998) (8,185) (25,161)
Accrued interest receivable 1,058 -- -- -- --
Increase (decrease) in:
Accounts payable 81,407 (15,026) 94,520 4,760 187,043
Accrued expenses 3,176 4,477 13,427 10,524 30,557
----------- ----------- ----------- ----------- -----------
Net cash used in operating activities (150,298) (61,466) (283,752) (184,368) (515,622)
Investing activities:
Purchases of property and equipment (317,400) -- (317,986) (29,733) (353,360)
----------- ----------- ----------- ----------- -----------
Net cash used in investing activities (317,400) -- (317,986) (29,733) (353,360)
Financing activities:
Proceeds from note payable - bank -- -- 650,000 -- 650,000
Proceeds from long-term debt - stockholder -- -- -- -- 17,280
Proceeds from long-term debt - others 309,999 -- 469,999 201,772 744,771
Payment on note payable - bank (650,000) -- (650,000) -- (650,000)
Payment on long-term debt -- -- -- (5,000) (5,000)
Issuance of common stock in private offering 3,948,500 -- 3,948,500 -- 3,948,500
Payment of expenses in connection with the
merger (353,611) -- (353,611) -- (353,611)
----------- ----------- ----------- ----------- -----------
Net cash provided by financing activities 3,254,888 -- 4,064,888 196,772 4,351,940
----------- ----------- ----------- ----------- -----------
Net increase (decrease) in cash and cash equiv 2,787,190 (61,466) 3,463,150 (17,329) 3,482,958
Cash and cash equivalents at beginning of period 695,768 93,994 19,808 49,857 --
----------- ----------- ----------- ----------- -----------
Cash and cash equivalents at end of period $ 3,482,958 $ 32,528 $ 3,482,958 $ 32,528 $ 3,482,958
=========== =========== =========== =========== ===========
Supplemental disclosures of cash flow activities:
Interest paid $ 7,106 $ -- $ 7,190 $ 200 $ 7,390
Supplemental schedule of non-cash financing
and investing activities:
Additional paid-in capital contribution in
exchange for expenses paid by founder $ -- $ -- $ 12,135 $ -- $ 103,636
Issuance of common stock and paid-in
capital through contribution of equipment $ -- $ -- $ -- $ -- $ 47,851
Acquisition of land through financing $ 146,124 $ -- $ 146,124 $ -- $ 146,124
See accompanying notes.
-6-
HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
(a corporation in the development stage)
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2005
1. Nature of Business and Significant Accounting Policies
Nature of Operations
On August 30, 2005, Hydrogen Engine Center, Inc, an Iowa corporation ("HECI")
merged with our newly formed subsidiary (the "Merger"). The Merger was made
pursuant to an agreement entered into on June 3, 2005, whereby we agreed to
merge our newly created, wholly-owned subsidiary, Green Mt. Acquisitions, Inc.,
with and into HECI, with HECI being the surviving entity. Following the Merger,
we changed our name from Green Mt. Labs, Inc. to Hydrogen Engine Center, Inc.
(the "Company," "HYEG," "us," "we," or "our"). Since its inception on May 19,
2003, HECI has been engaged in designing, developing and planning toward the
manufacturing of internal combustion engines that may be fueled either by
hydrogen or gasoline for the industrial and power generation markets. HECI has
established a process for converting certain Ford internal combustion engines to
run efficiently on hydrogen fuel. Hydrogen as a fuel can be readily extracted
from water, any hydrocarbon fuel or biomass. The Company expects to file core
technology patents covering the use of hydrogen fuel in any internal combustion
engine with zero or near zero emissions.
The Company is in the development stage. This stage is characterized by
significant expenditures for the design and development of the Company's
products and manufacturing processes, and for construction of the Company's new
building. Once the Company's planned principal operations commence, its focus
will be on the manufacturing and marketing of its hydrogen and other fueled
engines and the continued research and development of new products.
In connection with the formation and capitalization of the Company, shares of
common stock were issued for other than cash consideration and have been
assigned amounts equivalent to the fair value of the expense or assets received
in exchange.
Merger
HECI entered into an agreement with Green Mt. Labs, Inc., a Nevada corporation,
("Green Mt.") under which HECI was acquired by Green Mt. and HECI, along with a
newly created subsidiary of Green Mt., entered into an agreement and plan of
merger on June 3, 2005 and executed a revised and amended agreement on July 6,
2005 and an addendum on July 29, 2005. Pursuant to that agreement, the Green Mt.
subsidiary was merged with and into HECI. We issued 16,297,200 shares of our
authorized, but previously unissued common stock, to the sole stockholder of
HECI in exchange for all of the issued and outstanding common stock of HECI.
Upon the closing of the acquisition, all of our existing officers and directors
resigned and four (4) new directors and new management were appointed. The
acquisition closed on August 30, 2005 and became effective upon the filing of
the Articles of Merger with the offices of the Secretaries of the States of
Nevada and Iowa.
At the effective time of the merger, the sole stockholder of the Company owned
81.0% of the outstanding shares of our common stock. We offered a maximum of
4,000,000 of our shares of common stock to certain selected investors in a
private offering at the price of $1.00 per share. 3,948,500 shares in this
private offering have been issued.
-7-
The transaction has been accounted for as a recapitalization, which is accounted
for similar to the issuance of stock by HECI for the net assets of the Company
with no goodwill or other intangibles being recorded. Concurrent with the
closing, Green Mt. changed its name to Hydrogen Engine Center, Inc.
Cash and Cash Equivalents
The Company considers highly-liquid investments with a maturity of six months or
less to be cash equivalents. The Company maintains all of its cash balances in
two institutions. At various times during the three and nine months ended
September 30, 2005, the maintained balances were in excess of the $100,000
balance insured by the Federal Deposit Insurance Corporation. The Company
believes it is not exposed to any significant credit risk on cash and cash
equivalents.
Inventories
Inventories consist mainly of parts, finished engines and gensets that are
stated at the lower of cost (determined by the first-in, first-out method) or
market value.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using the
following straight-line method over the estimated useful lives of the assets as
follows:
Years
-----
Vehicles 5
Equipment 5-7
Depreciation expense was $7,132 and $3,981 for the three months ended September
30, 2005 and 2004, $15,524 and $11,942 for the nine months ended September 30,
2005 and 2004, and $37,406 for the period from May 19, 2003 (inception) to
September 30, 2005, respectively.
Warrants
As described in Note 6, the Company has granted warrants to certain finders in
the private placement, entitling the finders to purchase 69,640 shares at $1.00
per share. Based on Emerging Issues Task Force 00-19, Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settle in, a Company's Own
Stock, the sale of the warrants was reported in permanent equity and
accordingly, there is no impact on the Company's financial position and results
of operation. Subsequent changes in fair value will not be recognized as long as
the warrants continue to be classified as equity instruments.
Income Taxes
The Company accounts for income taxes under Statement of Financial Accounting
Standards ("SFAS") 109, Accounting for Income Taxes, which provides for a
liability approach to accounting for income taxes. Under this method, deferred
tax assets and liabilities are determined based on the differences between the
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates that will be in effect when the differences are
expected to reverse. A valuation allowance is established, when necessary, to
reduce deferred tax assets to the amount expected to be realized.
-8-
The Company recorded a deferred income tax asset for the tax effect of net
operating loss carry forwards and temporary differences aggregating to
approximately $158,000 and $52,000 at September 30, 2005 and December 31, 2004,
respectively. These operating loss carryforwards will begin to expire in 2018.
In recognition of the uncertainty regarding the ultimate amount of income tax
benefits to be derived, the Company has recorded a full valuation allowance at
September 30, 2005 and December 31, 2004.
The effective tax rate differs from the statutory rate of 34% due to the
increase in the valuation allowance.
Advertising Costs
The Company expenses advertising costs as they are incurred.
Research and Development Costs
Research, development and product improvement costs were $113,637 and $6,248 for
the three months ended September 30, 2005 and 2004, $156,342 and $12,654 for the
nine months ended September 30, 2005 and 2004, and $217,954 for the period from
May 19, 2003 (inception) to September 30, 2005, respectively.
Net Loss Per Share
The Company computes net loss per share under the provisions of SFAS No. 128,
"Earnings per Share" (SFAS 128), and SEC Staff Accounting Bulletin No. 98 (SAB
98).
Under the provisions of SFAS 128 and SAB 98, basic loss per share is computed by
dividing the Company's net loss for the period by the weighted-average number of
shares of common stock outstanding during the period. Diluted net loss per share
excludes potential common shares if the effect is anti-dilutive. Diluted loss
per share is determined in the same manner as basic loss per share except that
the number of shares is increased assuming exercise of convertible debt,
dilutive stock options, and warrants using the treasury stock method. As the
Company had a net loss, the impact of the assumed exercise of the convertible
debt, stock options, and warrants is anti-dilutive and as such, these amounts
have been excluded from the calculation of diluted loss per share.
Interim Financial Statements
The financial statements as of September 30, 2005 are unaudited. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair representation in accordance with accounting
principles generally accepted in the United States of America have been
included. Operating results for interim periods are not necessarily indicative
of the results that may be expected for the year ending December 31, 2005.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting periods. Actual results could differ from those estimates.
-9-
Fair Value of Financial Instruments
The carrying amounts reported in the balance sheet for cash and cash
equivalents, accounts receivable, accounts payable and accrued expenses
approximate their fair value due to the short-term nature of these instruments.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries HECI and Hydrogen Engine Center (HEC) Canada, Inc. All
intercompany balances and transactions have been eliminated in consolidation.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123(R), "Share-Based
Payment" (SFAS 123R). The statement requires all entities to recognize
compensation expense in an amount equal to the fair value of share-based
payments granted to employees. The statement eliminates the alternative method
of accounting for employee share-based payments previously available under
Accounting Principles Board (APB) Opinion No. 25 "Accounting for Stock Issued to
Employees" (APB 25) and SFAS 123. In April 2005, the Securities and Exchange
Commission amended the compliance dates to allow small business issuers to
implement SFAS 123(R) at the beginning of 2006. The Company plans to implement
SFAS 123(R) in 2006.
Stock-Based Compensation
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company has elected to follow APB Opinion No. 25, "Accounting for Stock Issued
to Employees," ("APB No. 25") and related interpretations for its employee
stock-based compensation. Under APB No. 25, no compensation expense is
recognized at the time of option grant if the exercise price of the employee
stock option is fixed and equals or exceeds the fair value of the underlying
common stock on the date of grant and the number of shares to be issued pursuant
to the exercise of such option are known and fixed at the date of grant. The
Board of Directors determines the fair value of common stock.
The Company accounts for options issued to non-employees under SFAS No. 123 and
Emerging Issues Task Force Issue ("EITF") No. 96-18, "Accounting for Equity
Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods, or Services". Therefore, the fair value of
options issued to non-employees is recorded as an expense and periodically
remeasured over the vesting terms.
The following table illustrates the effect on net loss as if the Company had
applied the fair value recognition provisions for stock-based employee
compensation of SFAS No. 123, as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure".
-10-
Period From
Three Months Ended Nine Months Ended May 19, 2003
September 30, September 30, (Inception) to
---------------------------- ------------------------------ September 30,
2005 2004 2005 2004 2005
------------ ------------ ------------ -------------- ------------
Net loss, as reported $ (439,369) $ (46,664) $ (567,153) $(120,806) $ (825,271)
Add: stock-based
employee compen-
sation expense included
in reported net income
(loss) 129,168 -- 129,168 -- 129,168
Deduct: stock-based
employee compensation
expense determined under
fair value based method
for all awards (237,001) -- (237,001) -- (237,001)
------------ ------------ ------------ -------------- ------------
Pro forma net loss $ (547,202) $ (46,644) $ (674,986) $ (120,806) $ (933,104)
Net loss per common share:
Basic and diluted,
as reported $ (0.02) $ (0.00) $ (0.03) $ (0.01) $ (0.05)
Basic and diluted,
pro forma $ (0.03) $ (0.00) $ (0.04) $ (0.01) $ (0.06)
Weighted average number of common
shares:
Basic and diluted 18,954,208 16,297,200 17,192,602 16,297,200 16,579,795
For purposes of pro forma disclosures, the estimated fair value of the options
granted is amortized to expense over the option vesting periods.
The Company has an incentive compensation plan under which participants may be
granted options to purchase shares of the Company's common stock or receive
restricted stock. Restricted stock and options may be granted with respect to
2,000,000 shares. On September 1, 2005, grants were made under the plan for a
total of 1,220,000 shares, leaving 780,000 shares available for future grants.
Of the shares which were the subject of these grants, 426,000 were restricted
stock, 464,000 were qualified incentive stock options ("ISOs") and 330,000 were
non qualified stock options. The ISOs that have been granted to employees under
the Company's plan vest ratably over a four-year period and expire ten years
from the date of grant. All options were granted at exercise prices that either
equaled or exceeded fair market value at the respective dates of grant.
A summary of ISOs granted to employees under the Company's incentive
compensation plan is presented below (in thousands, except per share data).
-11-
Weighted
Average Number
Outstanding Exercise Price of Shares
Options Per Share Exercisable
------------- ----------------- -------------
Granted 464 $ 1.00 100
Forfeited -- -- --
Exercised -- -- --
------------- ----------------- -------------
Balance at September 30, 2005 464 $ 1.00 100
============= ================= =============
The weighted-average fair values of ISOs granted to employees during the period
ended September 30, 2005 was $1.00 per share.
The weighted-average exercise prices and weighted-average remaining contractual
lives of the Company's outstanding ISOs granted to employees as of September 30,
2005 are $1.00 and 10 years respectively.
For purposes of pro forma disclosures, the estimated fair value of the ISOs
granted to employees is amortized to expense over the option vesting periods.
The Company has determined, based on the Black-Scholes option pricing formula,
the fair value of ISOs at date of issuance, was $1.00 per share, using a risk
free interest rate of 3.81%, expected life of 10 years, zero expected dividends
and estimated volatility of 190%.
In addition, the option valuation models require input of highly subjective
assumptions. Because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of ISOs. The
pro forma net loss may not be representative of future disclosure since the
estimated fair value of ISOs is amortized to expense over the vesting period and
additional options may be granted in future years.
2. Long - Term Debt
Convertible debt payable to a stockholder and various other parties require
annual payments of interest at 6% and are payable after five (5) years. The
Company had not made any interest payments on these notes as of September 30,
2005. These note holders have the right to convert the initial loan value to
Company stock at a price ranging from 80% to 100% of the share price paid by the
outside investors. The note holders can elect to be paid in full within thirty
(30) days after the closing of the first outside round of equity funding. The
Company has been notified that all of these notes will be converted to stock. As
a result of these conversions, approximately 663,401 shares of common stock will
be issued.
The note payable to the City of Algona requires quarterly payments of $5,000
starting April 1, 2006 and a final payment due October 1, 2015. The interest on
this loan is 0%, subject to certain job creation and retention requirements. If
such requirements are not met, interest on the loan will be payable at 10% per
annum.
The note payable of $146,124 to the Algona Area Economic Development Corporation
is payment for land received to be used for the construction of the new
facility. The loan is a ten (10) year partially forgivable loan with interest at
8%, conditioned upon the Company achieving performance targets as follows:
-12-
- $67,650 of principal and interest will be forgiven if the Company has
certified that it has created fifty (50) new full-time equivalent jobs
by June 1, 2010.
- $67,650 of principal and interest will be forgiven if the Company has
certified that is has created one hundred (100) new full- time
equivalent jobs by June 1, 2015.
- Balance of $10,824 due on June 1, 2015 without interest if paid by that
date.
Future maturities of long-term debt (exclusive of convertible debt) are as
follows:
Years (Period) ending December 31:
2005 (Period) $ --
2006 20,000
2007 20,000
2008 20,000
2009 20,000
Thereafter 266,124
------------
346,124
Less current portion (20,000)
------------
$ 326,124
3. Operating Leases
The Company leases a building which is used for production, storage and office
space. The Company is responsible for insurance and repairs. This lease requires
monthly rental payments of $600 and expires on May 30, 2006. At the option of
the Company, the lease can be extended for two (2) additional terms at $650 per
month for the first year and $700 per month for the second year. Rent expense
under this lease was $1,800 and $1,800 for the three months ended September 30,
2005 and 2004, $6,600 and $4,800 for the nine months ended September 30, 2005
and 2004, and $26,900 for the period from May 19, 2003 (inception) to September
30, 2005, respectively.
The following is a schedule of future non-cancelable lease obligations for the
building:
Year (Period) ending December 31:
2005 (Period) $ 1,800
2006 (Year) 3,000
------------
$ 4,800
The Company also leases storage sheds on a month-to-month lease for various
amounts. Rent expense under this lease was $0 and $420 for the three months and
nine months ended September 30, 2005, respectively.
4. Preferred Stock
The Company is authorized to issue 10,000,000 shares of preferred stock with
such designations, voting and other rights and preferences, as may be determined
from time to time by the Board of Directors.
-13-
5. Common Stock
Prior to the merger of Green Mt. with HECI, Green Mt. amended its Articles of
Incorporation to increase its authorized shares from 10,000,000 to 100,000,000.
It also effected a 3.8 to 1 stock split and, in connection therewith, issued
2,816,804 more shares.
In connection with the merger, Green Mt. issued 16,297,200 shares to the sole
shareholder of HECI in exchange for HECI's stock.
On September 1, 2005, the Company issued 426,000 shares of restricted stock to
directors and employees. Part of the stock is vested immediately and the balance
is vested each year through September 1, 2009. All unvested shares of restricted
stock are subject to a risk of forfeiture upon termination of the participant's
service as a full-time consultant or employee prior to vesting.
During September 2005, the Company issued 3,948,500 shares in connection with a
private offering.
6. Commitments and Contingencies
In August 2005, the Company issued warrants to purchase up to a total of 69,640
shares, for services rendered in connection with the private offering of stock.
These are warrants to purchase Company stock, for $1 per share for the first
three years and $1.50 for years four and five. The warrants expire on the fifth
anniversary date from issuance.
During 2005, the Company acquired a parcel of land located in Algona, Iowa, for
approximately $146,000. In August 2005, the Company began constructing a
manufacturing facility at an approximate cost of $1,200,000 for Phase 1. Phase I
of the project is expected to be completed in December 2005, with the remaining
phases to be completed during 2006, and will be financed through a bank mortgage
agreement and notes from governmental entities. Proceeds from the Private
Offering are also available and could be applied toward construction costs.
7. Subsequent Event
As of November 17, 2005, the convertible note payable - stockholder ($17,280)
and convertible notes payable - others ($539,771) are in the process of being
converted to 663,401 shares of common stock as allowed in their original loan
agreement.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH THE OTHER FINANCIAL INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND
RELATED NOTES APPEARING IN THIS FORM 10-QSB. THIS DISCUSSION CONTAINS FORWARD
LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS WILL
DEPEND UPON A NUMBER OF FACTORS BEYOND OUR CONTROL AND COULD DIFFER MATERIALLY
FROM THOSE ANTICIPATED IN THE FORWARD LOOKING STATEMENTS. SOME OF THESE FACTORS
ARE DISCUSSED UNDER "RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-QSB.
-14-
MERGER
On August 30, 2005, Hydrogen Engine Center, Inc, an Iowa corporation
("HECI") merged with our newly formed subsidiary (the "Merger"). The Merger was
made pursuant to an agreement entered into on June 3, 2005, whereby we agreed to
merge our newly created, wholly-owned subsidiary, Green Mt. Acquisitions, Inc.,
with and into HECI, with HECI being the surviving entity. Following the Merger,
we changed our name from Green Mr. Labs, Inc. to Hydrogen Engine Center, Inc.
(the "Company," "HYEG," "us," "we," or "our").
On July 6, 2005, we revised certain terms of the proposed Merger and,
accordingly, executed a revised and amended agreement and plan of merger. On
July 29, 2005, we added an addendum to the agreement. The revised agreement
provided for effecting a 3.8 shares for 1 share forward stock split of our
issued and outstanding common stock, instead of the previously announced 1.5
shares for 1 share split. The split was payable August 17, 2005 to stockholders
of record on August 16, 2005. As a result of the revised forward stock split,
our outstanding shares of common stock increased from 1,006,000 shares to
approximately 3,822,804 shares, representing 19% of the total outstanding shares
following consummation of the Merger. Under the terms of the merger agreement,
we issued 16,297,200 shares of post-split common stock (representing 81% of our
total outstanding shares (post-split) following the transaction) to Ted
Hollinger, who was prior to the Merger HECI's sole stockholder, in exchange for
100% of HECI's then outstanding capital stock, and HECI has become our
wholly-owned subsidiary. In connection with the Merger, we have changed our name
to Hydrogen Engine Center, Inc.
We also commenced a private placement of up to four million shares of
our common stock at the offering price of $1.00 per share, which offering was
closed as of October 11, 2005 (the "Private Offering"). We sold 3,948,500 shares
of our common stock, $.001 par value, for a total of $3,948,500 to approximately
93 investors, which represents 16.1% of the now 24,494,504 issued and
outstanding shares of common stock of the Company. The shares were sold in
reliance upon an exemption from registration pursuant to Regulation D, Rules
Governing the Limited Offer and Sale of Securities without Registration under
the Securities Act of 1933. Funds relating to the Private Offering had either
been released to the Company, or were being held in escrow on behalf of the
Company, as of September 30, 2005.
The accompanying condensed consolidated balance sheet as of September
30, 2005 and the condensed consolidated statements of operations for the three
and nine months ended September 30, 2005, consolidate the historical financial
statements of the company with HECI after giving effect to the Merger where HECI
is the accounting acquirer and after giving effect to the Private Offering.
OVERVIEW
As a result of the Merger we have assumed all of the operations, assets
and liabilities of HECI. HECI is a development stage company engaged in
designing, developing and manufacturing internal combustion engines that may be
fueled either by hydrogen or gasoline for the industrial and power generation
markets. HECI has established a process for converting certain Ford internal
combustion engines to run efficiently on hydrogen fuel. Hydrogen as a fuel can
be readily extracted from water, any hydrocarbon fuel or biomass. HECI expects
to file core technology patents covering the use of hydrogen fuel in any
internal combustion engine with zero or near zero emissions.
HECI was incorporated on May 19, 2003 by Ted Hollinger, formerly
Director of Engineering at Ford Motor Company and Vice President of the Power
Conversion Group at Ballard Power Systems, responsible for development of
-15-
hydrogen engine gensets. Operations commenced with the lease of the facilities
in Algona, Iowa. Mr. Hollinger, left Ballard with the ultimate intention of
continuing the commercialization of hydrogen engines.
HECI has funded its operations from inception through September 30,
2005 through a series of financing transactions, including an investment of
$151,487 by Ted Hollinger; $3,948,500 in gross proceeds from the Private
Offering, and convertible loans in the amount of $557,051. All holders of the
convertible notes have indicated a desire to convert the notes into shares. Upon
conversion of these notes we will issue an additional 663,401 shares.
Critical Accounting Policies
Our discussion and analysis of our financial position and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these condensed consolidated
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities, and the disclosure of contingent
assets and liabilities at the date of the condensed consolidated financial
statements and the reported revenues and expenses during the period.
We consider certain accounting policies related to the recapitalization
of the Company and stock-based compensation to be critical to our business
operations and the understanding of our results of operations.
Stock-Based Compensation
The Company has granted to employees qualified incentive options under
its incentive compensation plan to purchase 464,000 shares of its common stock
at $1.00 per share. The Company has granted under its incentive compensation
plan nonqualified options to purchase 330,000 shares of its common stock at
$1.00 per share and 426,000 shares of restricted stock.
As permitted by SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company has elected to follow APB Opinion No. 25, "Accounting
for Stock Issued to Employees," ("APB No. 25") and related interpretations for
its employee stock-based compensation. Under APB No. 25, no compensation expense
is recognized at the time of option grant if the exercise price of the employee
stock option is fixed and equals or exceeds the fair value of the underlying
common stock on the date of grant and the number of shares to be issued pursuant
to the exercise of such option are known and fixed at the date of grant. The
Board of Directors determines the fair value of common stock.
The Company accounts for options issued to non-employees under SFAS No.
123 and Emerging Issues Task Force Issue ("EITF") No. 96-18, "Accounting for
Equity Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods, or Services." Therefore, the fair value of
options issued to non-employees is recorded as an expense and periodically
remeasured over the vesting terms.
Results of Operations
Historical information prior to the Merger is that of HECI.
Because HECI is still developing its hydrogen powered internal
combustion engines and related products and has not yet completed construction
of its manufacturing facility, we have not realized significant revenues to
-16-
date. During 2004 we realized $19,460 from the sale of one engine and partial
payments on two gensets. Management believes that we may begin to realize
increased sales revenues by the first quarter of 2006, subject to timely receipt
of parts ordered from suppliers and timely completion of our new facilities.
We are in the process of accelerating our efforts toward full
commencement of operations. Our new building is under construction. We are now
in the process of hiring new personnel and purchasing the inventory of parts we
will need to manufacture engines in our new building. General and administrative
expenses increased $96,965 (153%) from $63,342 for the year ended December 31,
2003 to $160,307 for the year ended December 31, 2004. Management expects
similar or greater increases for the year ending December 31, 2005 and during
2006 in general and administrative expenses due to the anticipated hiring of
additional personnel, purchase of inventory, costs related to the new facility
and other efforts related to the commencement and expansion of our operations.
Costs related to research and development increased from $2,300 in 2003
to $33,342 for 2004, which reflects the beginning of development activities
during 2004. Management believes that with funding provided by the Private
Offering, research and development expenses will increase significantly during
the remainder of 2005 and into 2006.
We recorded a net loss of $192,476 for 2004 compared to a net loss of
$65,642 for 2003. We expect to continue to operate at a net loss until such time
as we can complete construction of our facilities and development of our initial
engines and begin to realize increased sales.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2005 TO THREE MONTHS ENDED
SEPTEMBER 30, 2004
For the quarter ended September 30, 2005 cash and cash equivalents were
$3,482,958 as compared with $32,528 for the quarter ended September 30, 2004.
This increase is mainly attributed to the receipt of gross proceeds of
$3,948,500 from our Private Offering. Net cash used in operating activities and
cash used in investing activities for the three months ended September 30, 2005
were $150,298 and $317,400 respectively, as compared to $61,466 and $0
respectively for the same period in 2004. These increases are the result of the
commencement of our operations, including expenditures for new personnel, our
new facility and the purchase of property and equipment.
For the quarter ended September 30, 2005 total revenues were $7,287 as
compared with $3,800 in the 2004 period. For the quarter ended September 30,
2005 the cost of goods sold was $7,326 as compared with $3,500 in the 2004
period. The increases are attributed to increasing activities related to sales
of engines during the current quarter.
Sales and marketing expenses were $68,354 for the three month period
ended September 30, 2005 compared to $0 for the three month period ended
September 30, 2004.
General and administrative expenses were $256,166 as compared with
$36,454 for the three month period ended September 30, 2004. The increase is
attributed to increasing activities related to commencement of our business
operations.
Research and development expenses were $113,637 for the three month
period ended September 30, 2005 compared to $6,258 for the three month period
ended September 30, 2004. The increase is attributed to increasing activities
related to the continued development of the hydrogen engine in the current
quarter.
-17-
Interest expense was $10,665 for the third quarter of 2005 compared to
$4,341 for the third quarter of 2004, attributed to interest on debt. Management
believes that interest expense will not vary materially during the remainder of
2005.
The net loss for the three month period ended September 30, 2005 was
$439,369 versus $46,644 for the comparable 2004 period.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2005 TO NINE MONTHS ENDED
SEPTEMBER 30, 2004.
For the nine months ended September 30, 2005 cash and cash equivalents
were $3,482,958 as compared with $32,528 for the nine months ended September 30,
2004. This increase is mainly attributed to the receipt of gross proceeds of
$3,948,500 from our Private Offering. Net cash used in operating activities and
cash used in investing activities for the nine months ended September 30, 2005
were $283,752 and $317,986 respectively, as compared to $184,368 and $29,733
respectively for the same period in 2004. These increases are the result of the
commencement of our operations, including expenditures for new personnel, our
new facility and the purchase of property and equipment.
For the nine months ended September 30, 2005 total revenues were
$20,887 as compared with $3,800 in the 2004 period. For the nine months ended
September 30, 2005 the cost of goods sold was $13,521 as compared with $3,500 in
the 2004 period. The increases are attributed to increasing activities related
to sales of engines during the current period.
Sales and marketing expenses were $87,983 for the nine month period
ended September 30, 2005 compared to $7,101 for the nine month period ended
September 30, 2004.
General and administrative expenses were $317,766 for the nine month
period ended September 30, 2005 compared with $91,500 for the nine month period
ended September 30, 2004. The increase is attributed to increasing activities
related to commencement of our business operations.
Research and development expenses were $156,342 for the nine month
period ended September 30, 2005 compared to $12,654 for the nine month period
ended September 30, 2004. The increase is attributed to increasing activities
related to the continued development of the hydrogen engine throughout the
current calendar year.
Interest expense was $23,017 for the third quarter of 2005 compared to
$10,589 for the third quarter of 2004, attributed to interest on debt.
Management believes that interest expense will not vary materially during the
remainder of 2005.
The net loss for the nine month period ended September 30, 2005 was
$567,153 versus $120,806 for the comparable 2004 period.
Management believes that we will continue to operate at a net loss
until such time as we can complete construction of our facilities and
development of our initial engines and begin to realize increased sales.
Liquidity and Capital Resources
From inception through September 30, 2005, we have used $515,622 in
cash in our operating activities. Cash for our operations came from various
financing transactions, including an investment of $151,487 by Ted Hollinger;
$3,948,500 in gross proceeds from the Private Offering and convertible loans in
-18-
the amount of $557,051. Our aggregated net loss from inception, as of September
30, 2005, was $825,271. Our cumulative net loss has resulted principally from
expenditures related to the commencement of operations.
At September 30, 2005, we had cash on hand of $3,482,958, compared to
$32,528 at September 30, 2004; $19,808 at December 31, 2004; and $49,857 as of
December 31, 2003. Inventories increased from $19,452 at December 31, 2003 to
$102,124 at December 31, 2004; and from $98,235 at September 30, 2004 to
$143,966 at September 30, 2005 due to the purchase of engines and parts.
We had accrued expenses of $30,557 at September 30, 2005 compared to
$10,524 at September 30, 2004. We had accrued expenses of $17,130 at December
31, 2004 compared to no accrued expenses at December 31, 2003.
Although we anticipate that our expenses will continue to increase as
we work toward commencement of operations in our new manufacturing facility,
including additional personnel, inventory purchases, and construction costs,
management believes that current cash on hand will be sufficient to satisfy our
cash requirements for the next twelve months. We anticipate that increased sales
of our products could commence the first quarter of 2006, subject to timely
receipt of parts ordered from suppliers and timely completion of our new
facilities, which will likely add to cash reserves. However, if additional cash
is needed during the next twelve months, or if management determines to
accelerate the expansion of our operations, we may seek additional funds through
private or public sources and/or the sale of securities. Presently, there are no
firm plans as to the source of any future funding and there is no assurance that
such funds will be available or, that even if they are available, that they will
be available on terms that will be acceptable to us.
At September 30, 2005, we had total assets of $4,164,912 and a
stockholders' equity of $3,147,773, compared to total assets of $219,582 and a
stockholders' deficit of $86,203 at September 30, 2004. We had total assets of
$186,438 and total stockholders' deficit of $118,766 at December 31, 2004,
compared to total assets $128,934 and total a stockholders' equity of $34,523 at
December 31, 2003.
Net Operating Loss
We have accumulated approximately $755,000 of net operating loss
carryforwards as of September 30, 2005, which may be offset against taxable
income and income taxes in future years. The use of these losses to reduce
future income taxes will depend on the generation of sufficient taxable income
prior to the expiration of the net operating loss carryforwards. The
carry-forwards will begin to expire in the year 2018. In the event of certain
changes in control, there will be an annual limitation on the amount of net
operating loss carryforwards which can be used. No tax benefit has been reported
in the financial statements for the year ended September 30, 2005 because there
is a 50% or greater chance that the carryforward will not be used. Accordingly,
the potential tax benefit of the loss carryforward is offset by a valuation
allowance of the same amount.
Inflation
In the opinion of management, inflation has not and will not have a
material effect on our operations in the immediate future. Management will
continue to monitor inflation and evaluate the possible future effects of
inflation on our business and operations.
-19-
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW TOGETHER WITH ALL OF THE
OTHER INFORMATION INCLUDED IN THIS FORM 10-QSB WHEN EVALUATING THE COMPANY AND
ITS BUSINESS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, OUR BUSINESS,
FINANCIAL CONDITION, OR RESULTS OF OPERATIONS COULD SUFFER. IN THAT CASE, THE
PRICE OF OUR COMMON STOCK COULD DECLINE AND OUR STOCKHOLDERS MAY LOSE ALL OR
PART OF THEIR INVESTMENT.
We have a limited operating history and have not recorded an operating profit
since our inception. Continuing losses may exhaust our capital resources and
force us to discontinue operations.
- --------------------------------------------------------------------------------
HECI was incorporated on May 19, 2003 and has a limited operating
history and has incurred net losses since inception. Prior to the Merger Green
Mt. had been inactive for several years and had a net stockholders' deficit of
$43,617 as of March 31, 2005. The potential for us to generate profits depends
on many factors, including the following:
o the size and timing of future customer orders, milestone achievement,
product delivery and customer acceptance, if required;
o success in maintaining and enhancing existing strategic relationships
and developing new strategic
relationships with potential customers;
o our ability to protect our intellectual property;
o actions taken by competitors, including suppliers of traditional
engines, hydrogen fuel cells and new product introductions and pricing
changes;
o the costs of maintaining and expanding operations; and
o our ability to attract and retain a qualified work force in a small
town.
We cannot assure you we will achieve any of the foregoing factors or
realize profitability in the immediate future or at any time.
If we cannot achieve commercial application of our hydrogen engine and related
technology, we may not achieve profitability.
- --------------------------------------------------------------------------------
The development of a market for our engines is dependent in part upon
the development of a market for hydrogen as a fuel, which may be impacted by
many factors, including:
o the cost competitiveness of hydrogen as a fuel relative to other fuels;
o the future availability of hydrogen as a fuel;
o consumer perception of the safety of hydrogen and willingness to use
engines powered by hydrogen;
o adverse regulatory developments, including the adoption of onerous
regulations regarding hydrogen use or storage;
o barriers to entry created by existing energy providers; and
o the emergence of new competitive technologies and products.
-20-
Financing to proceed with our anticipated business activities may be required
following completion of the acquisition. There can be no assurance that
financing will be available on terms beneficial to us, or at all.
- --------------------------------------------------------------------------------
In order to proceed with our anticipated business activities we may
need to obtain additional financing. If we raise additional capital by selling
equity or equity-linked securities, these securities would dilute the ownership
percentage of our existing stockholders. Also, these securities could also have
rights, preferences or privileges senior to those of our common stock.
Similarly, if we raise additional capital by issuing debt securities, those
securities may contain covenants that restrict us in terms of how we operate our
business, which could also affect the value of our common stock. We also may not
be able to raise capital on reasonable terms, or at all.
We cannot assure you that there will be an active trading market for our common
stock.
- --------------------------------------------------------------------------------
Even though our common stock is quoted on the OTC Bulletin Board, most
shares outstanding, including those issued pursuant to the Merger, are
"restricted securities" within the meaning of Rule 144 promulgated by the SEC
and are therefore subject to certain limitations on the ability of holders to
resell such shares. Restricted shares may not be sold or otherwise transferred
without registration or reliance upon a valid exemption from registration. Thus,
holders of our common stock may be required to retain their shares for a long
period of time.
Certain government regulations concerning electrical and hydrogen generation,
delivery and storage of fuels and other related matters may negatively impact
our business.
- --------------------------------------------------------------------------------
Our business is subject to and effected by federal, state, local and
foreign laws and regulations. These may include state and local ordinances
relating to building codes, public safety, electrical and hydrogen production,
delivery and refueling infrastructure, hydrogen storage and related matters. The
use of hydrogen inside a building will require architectural and engineering
changes in the building to allow the hydrogen to be handled safely. As our
engines and other new products are introduced into the market commercially,
governments may impose new regulations. We do not know the extent to which any
such regulations may impact our business or the businesses of our customers'
businesses. Any new regulation may increase costs and could reduce our potential
to be profitable.
The industry in which we operate is highly competitive and could affect our
results of operations, which would make profitability even more difficult to
achieve and sustain.
- --------------------------------------------------------------------------------
The power generation and alternative fuel industry is highly
competitive and is marked by rapid technological growth. Other competitors and
potential competitors include Ford Power Products, H2Car Co., Cummins, Daimler
Chrysler, General Motors, Koehler and Generac. Many existing and potential
competitors have greater financial resources, larger market share, and larger
production and technology research capability, which may enable them to
establish a stronger competitive position than we have, in part through greater
marketing opportunities. The governments of the United States, Canada, Japan and
certain European countries have provided funding to promote the development and
use of fuel cells. Tax incentives have also been initiated in Japan, and have
been proposed in the United States and other countries, to stimulate the growth
of the fuel cell market by reducing the cost of these fuel cell systems to
consumers. Our business does not currently enjoy any such advantages and, for
that reason, may be at a competitive disadvantage to the fuel cell industry. If
we fail to address competitive developments quickly and effectively, we will not
be able to grow.
-21-
Our business could be adversely affected by any adverse economic developments in
the power generation industry and/or the economy in general.
- --------------------------------------------------------------------------------
We depend on the perceived demand for the application of our technology
and resulting products. These products are focused on reducing gas emissions and
upon the use of alternative fuels for the Ground Support Equipment (GSE)
business and for the power generation business. Therefore, our business is
susceptible to downturns in the airline industry and the genset portion of the
distributed power industry and the economy in general. Any significant downturn
in the market or in general economic conditions would likely hurt our business.
If we fail to keep up with changes affecting our technology and the markets that
we will ultimately service, we will become less competitive and thus adversely
affect future financial performance.
- --------------------------------------------------------------------------------
In order to remain competitive and serve our potential customers
effectively, we must respond on a timely and cost-efficient basis to changes in
technology, industry standards and procedures and customer preferences. We need
to continuously develop new technology, products and services to address new
technological developments. In some cases these changes may be significant and
the cost to comply with these changes may be substantial. We cannot assure you
that we will be able to adapt to any changes in the future or that we will have
the financial resources to keep up with changes in the marketplace. Also, the
cost of adapting our technology, products and services may have a material and
adverse effect on our operating results.
Our business could be adversely affected by local, state, national,
international laws or regulations.
- --------------------------------------------------------------------------------
Our future success depends in part on laws and regulations that exist,
or are expected to be enacted around the world. Should these laws or regulations
take an adverse turn, this could negatively affect our business and anticipated
revenues. We cannot guarantee a positive outcome in direction, timing, or scope
of laws and regulations that may be enacted which will affect the business.
The hydrogen and power generation business may expose us to certain safety risks
and potential liability claims.
- --------------------------------------------------------------------------------
Our business will 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. Any accidents involving our
engines or other hydrogen-using products could materially impede widespread
market acceptance and demand for our hydrogen-fueled engines. 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, or at all.
Our future success depends on retaining our existing key employees and hiring
and assimilating new key employees. The loss of key employees or the inability
to attract new key employees could limit our ability to execute our growth
strategy, resulting in lost sales and a slower rate of growth.
- --------------------------------------------------------------------------------
Our future success depends in part on our ability to retain key
employees including our executive officers and, in particular, our founder Ted
Hollinger. We do not carry, nor do we presently anticipate obtaining, "key man"
insurance on our executives. It would be difficult for us to replace any one of
these individuals. In addition, as we grow we may need to hire additional key
personnel. We may not be able to identify and attract high quality employees or
successfully assimilate new employees into our existing management structure.
We may be unable to protect our intellectual property adequately or cost
effectively, which may cause us to lose market share or reduce prices.
- --------------------------------------------------------------------------------
Our future success depends in part on our ability to protect and
preserve our proprietary rights related to our technology and resulting
products. We cannot assure you that we will be able to prevent third parties
from using our intellectual property rights and technology without our
-22-
authorization. We do not currently own any patents, although one patent is
pending related to our technology. We anticipate making patent applications in
the future. We rely on trade secrets, common law trademark rights and trademark
registrations. We intend to protect our intellectual property via non-disclosure
agreements, contracts, and limited information distribution, as well as
confidentiality and work for hire, development, assignment and license
agreements with our employees, consultants, third party developers, licensees
and customers. However, these measures afford only limited protection and may be
flawed or inadequate. Also, enforcing intellectual property rights could be
costly and time-consuming and could distract management's attention from
operating business matters.
Our intellectual property may infringe on the rights of others, resulting in
costly litigation.
- --------------------------------------------------------------------------------
In recent years, there has been significant litigation in the United
States involving patents and other intellectual property rights. In particular,
there has been an increase in the filing of suits alleging infringement of
intellectual property rights, which pressure defendants into entering settlement
arrangements quickly to dispose of such suits, regardless of their merits. Other
companies or individuals may allege that we infringe on their intellectual
property rights. Litigation, particularly in the area of intellectual property
rights, is costly and the outcome is inherently uncertain. In the event of an
adverse result, we could be liable for substantial damages and we may be forced
to discontinue our use of the subject matter in question or obtain a license to
use those rights or develop non-infringing alternatives. Any of these results
would increase our cash expenditures, adversely affecting our financial
condition.
We may not be able to manage our growth effectively, which could adversely
affect our operations and financial performance.
- --------------------------------------------------------------------------------
The ability to manage and operate our business as we execute our
development and growth strategy will require effective planning. Significant
rapid growth could strain our management and other resources, leading to
increased cost of operations, an inability to ship enough product to meet
customers demand and other problems that could adversely affect our financial
performance. We expect that our efforts to grow will place a significant strain
on personnel, management systems, infrastructure and other resources. Our
ability to manage future growth effectively will also require us to successfully
attract, train, motivate, retain and manage new employees and continue to update
and improve our operational, financial and management controls and procedures.
If we do not manage our growth effectively, our operations could be adversely
affected, resulting in slower growth and a failure to achieve or sustain
profitability.
Being a public company involves increased administrative costs, which could
result in lower net income and make it more difficult for us to attract and
retain key personnel.
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As a public company, we incur significant legal, accounting and other
expenses that HECI did not incur as a private company. In addition, the
Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the
SEC, have required changes in corporate governance practices of public
companies. We expect that these new rules and regulations will increase our
legal and financial compliance costs and make some activities more time
consuming. For example, in connection with being a public company, we may have
to create several board committees, implement additional internal controls and
disclose controls and procedures, retain a transfer agent and financial printer,
adopt an insider trading policy and incur costs relating to preparing and
distributing periodic public reports in compliance with our obligations under
securities laws. These new rules and regulations could also make it more
difficult for us to attract and retain qualified members of our board of
directors, particularly to serve on our audit committee, and qualified executive
officers.
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We do not anticipate paying dividends in the foreseeable future. This could make
our stock less attractive to potential investors.
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We anticipate that we will retain any future earnings and other cash
resources for future operation and development of our business and do not intend
to declare or pay any cash dividends in the foreseeable future. Any future
payment of cash dividends will be at the discretion of our board of directors
after taking into account many factors, including our operating results,
financial condition and capital requirements. Corporations that pay dividends
may be viewed as a better investment than corporations that do not.
Future sales or the potential for sale of a substantial number of shares of our
common stock could cause our market value to decline and could impair our
ability to raise capital through subsequent equity offerings.
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Sales of a substantial number of shares of our common stock in the
public markets, or the perception that these sales may occur, could cause the
market price of our common stock to decline and could materially impair our
ability to raise capital through the sale of additional equity securities. In
addition to the shares of our common stock actually issued and outstanding,
there will be another 2.663 million shares of common stock reserved for future
issuance as follows:
o approximately 663,401 shares which we expect to issue upon conversion
of promissory notes; and
o 2.0 million shares reserved for issuance under our new incentive
compensation plan, subject to shareholder appoval.
The authorization and issuance of blank-check preferred stock may prevent or
discourage a change in our management.
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Our amended certificate of incorporation authorizes the board of
directors to issue up to 10 million shares of preferred stock without
stockholder approval having terms, conditions, rights, preferences and
designations as the board may determine. The rights of the holders of our common
stock will be subject to, and may be adversely affected by, the rights of the
holders of any preferred stock that may be issued in the future. The issuance of
preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
discouraging a person from acquiring a majority of our outstanding common stock.
It may be difficult for a third party to acquire us, and this could depress our
stock price.
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Nevada corporate law includes provisions that could delay, defer or
prevent a change in control of our company or our management. These provisions
could discourage information contests and make it more difficult for you and
other stockholders to elect directors and take other corporate actions. As a
result, these provisions could limit the price that investors are willing to pay
in the future for shares of our common stock. For example:
o Without prior stockholder approval, the board of directors has the
authority to issue one or more classes of preferred stock with rights
senior to those of common stock and to determine the rights, privileges
and inference of that preferred stock;
o There is no cumulative voting in the election of directors, which would
otherwise allow less than a majority of stockholders to elect director
candidates; and
o Stockholders cannot call a special meeting of stockholders.
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ITEM 3. CONTROLS AND PROCEDURES
Our President and our Board of Directors are currently in the process
of designing and developing our disclosure controls and procedures. We are also
in the process of hiring a Chief Financial Officer. We expect to have that
officer, as well as our disclosure controls and procedures in place on or before
the end of the fourth quarter.
PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Information regarding unregistered sales of equity securities and use
of proceeds is included in our Current Report on Form 8-K filed with the
Commission on September 6, 2005 and amended on September 7, 2005 which report is
incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information relating to matters submitted to shareholders is included
in our Current Report on Form 8-K filed with the Commission on September 6, 2005
and amended on September 7, 2005 which report is incorporated herein by
reference.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Description
2.2 Revised and Amended Agreement and Plan of Merger with Hydrogen Engine Center, Inc. and
Green Mt. Acquisitions, Inc. (Incorporated by reference to the preliminary information
statement filed with the SEC on July 12, 2005).
3.1 Certificate of Incorporation (Previously filed as an Exhibit to the Form 10-SB filed
January 8, 2004)
3.2 Bylaws (Previously filed as an Exhibit to the Form 10-SB filed January 8, 2004)
3.3 Certificate of Amendment to Articles of Incorporation
3.4 Amendment to Bylaws
4.1 Instrument defining rights of stockholders (See Exhibits No. 3.1-3.4)
10.1 Iowa Department of Economic Development Enterprise Zone Program Agreement
10.2 Iowa Department of Economic Development PIAP Loan Agreement
10.3 Iowa Department of Economic Development CEBA Loan Agreement
10.4 Construction Agreement
10.5 Lease
10.6 Loan Agreement - City of Algona
10.7 Loan Agreement Algona Area Economic Development Corporation
10.8 Jobs Training Agreement
10.9 Consortium Agreement
10.10 Agreement with Universite Du Quebec a Trois-Rivieres
31.1 Certification pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002, by Theodore G. Hollinger, the Company's Chief
Executive Officer.
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Theodore G. Hollinger, the Company's Chief Executive Officer.
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Notes about Forward-looking Statements
Statements contained in this current report which are not historical
facts, including some statements regarding the effects of the Merger, may be
considered "forward-looking statements" under the Private Securities Litigation
Reform Act of 1995. Forward-looking statements are based on current expectations
and the current economic environment. We caution readers that such
forward-looking statements are not guarantees of future performance. Unknown
risks and uncertainties as well as other uncontrollable or unknown factors could
cause actual results to materially differ from the results, performance or
expectations expressed or implied by such forward-looking statements.
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 hereunto duly authorized.
HYDROGEN ENGINE CENTER., INC.
Date: November 21, 2005 By /s/ THEODORE G. HOLLINGER
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Theodore G. Hollinger
President and Chief Executive Officer
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