UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q/A*
x
|
QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended March 31, 2008
o
|
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
|
82-0497807
|
(State
or other jurisdiction
|
(IRS
Employer
|
of
incorporation)
|
Identification
No.)
|
2502
East Poplar Street, Algona, Iowa 50511
(Address
of principal executive offices)
Registrant's
telephone number, including area code: (515) 295-3178
Indicate
by check mark whether the Registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes
x
No
¨
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer or a smaller reporting company. See definition of "large
accelerated filer” “accelerated filer" and “smaller reporting company” in Rule
12b-2 of the Exchange Act. (Check one):
|
Large
accelerated filer
¨
|
|
Accelerated
filer
¨
|
|
|
Non-accelerated
filer
¨
|
|
Smaller
reporting company
x
|
|
State
the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date
:
Class
|
|
Outstanding
at April 28, 2008
|
Series
B Preferred
|
|
1,932,846
|
Common
|
|
27,590,164
|
*See
explanatory note regarding amendment
EXPLANATORY
NOTE REGARDING AMENDMENT
We
are
amending this Form 10-Q for the three months ended March 31, 2008 in response
to
an SEC comment letter dated July 9, 2008. We have reevaluated our line item
“losses related to inventory” previously included in operating expenses. We have
concluded that portions of these amounts were classified incorrectly and should
be included in cost of goods sold for the quarter ended March 31, 2008 and
2007 and the period from inception (May 19, 2003) to March 31, 2008. The
Condensed Consolidated Statements of Operations and accompanying notes for
these periods have been revised to reflect this reclassification. We are also
revising Item 6, Management’s Discussion and Analysis of Financial Condition and
Results of Operations, in light of the restatement.
Also
in
response to our SEC comment letter, we have concluded that a $1,889,063
beneficial conversion feature accretion was inappropriately recorded as an
increase to the accumulated deficit in our Consolidated Balance Sheet rather
than a decrease to Additional Paid-In Capital in accordance with Emerging Issues
Task Force (“EITF”) Issue No. 98-5, “Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and
Staff Accounting Bulletin (“SAB”) Topic 3 (C), “Senior Securities - Redeemable
Preferred Stock.” The Consolidated Balance Sheets as of March 31, 2008 and
December 31, 2007 have been revised to reflect this change.
We
are
also amending Exhibit 31 in this Form 10-Q to include the introductory language
in paragraph 4 of the certification of internal controls as required by Item
601(b)(31) of Regulation S-K that refers to the certifying officers’
responsibility for establishing and maintaining internal control over financial
reporting for the company and to also include paragraph 4(b) which refers to
the
design of our internal control over financial reporting. Exhibit 31 has been
revised to include the appropriate certification language.
Except
as
described above, no other changes were made to the Form 10-Q as previously
filed.
FORM
10-Q
TABLE
OF CONTENTS
.
|
|
|
Page
|
PART
I
|
|
FINANCIAL
INFORMATION
|
|
|
|
|
|
Item
1.
|
|
Condensed
Consolidated Financial Statements
|
4
|
|
|
|
|
|
|
Condensed
Consolidated Balance Sheets as of March 31, 2008 (unaudited)
and
December 31, 2007
|
4
|
|
|
|
|
|
|
Condensed
Consolidated Statements of Operations for the Three Months
Ended
March 31, 2008 and 2007 and the period from inception
(May
19, 2003) through March 31, 2008 (unaudited)
|
6
|
|
|
|
|
|
|
Condensed
Consolidated Statements of Cash Flows for the Three Months
Ended
March 31, 2008 and 2007 and the period from inception
(May
19, 2003) through March 31, 2008 (unaudited)
|
7
|
|
|
|
|
|
|
Notes
to Consolidated Financial Statements (unaudited)
|
9
|
|
|
|
|
Item
2.
|
|
Management's
Discussion and Analysis of Financial Condition
and
Results of Operations
|
21
|
|
|
|
|
Item
4T.
|
|
Controls
and Procedures
|
29
|
|
|
|
|
PART
II.
|
|
OTHER
INFORMATION
|
|
|
|
|
|
Item
1.
|
|
Legal
Proceedings
|
30
|
|
|
|
|
Item
2.
|
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
30
|
|
|
|
|
Item
6.
|
|
Exhibits
and Reports on Form 8-K
|
31
|
|
|
|
|
|
|
Notes
About Forward-looking Statements
|
31
|
|
|
|
|
SIGNATURES
|
|
|
32
|
ITEM
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
HYDROGEN
ENGINE CENTER, INC. AND SUBSIDIARIES
(a
corporation in the development stage)
Condensed
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
March
31,
|
|
December
31,
|
|
ASSETS
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
|
|
|
|
(Restated)
|
|
(Restated)
|
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
161,578
|
|
$
|
713,289
|
|
Restricted
cash
|
|
|
116,454
|
|
|
115,157
|
|
Accounts
receivable
|
|
|
112,135
|
|
|
134,237
|
|
Inventories
|
|
|
1,578,085
|
|
|
1,655,359
|
|
Prepaid
expenses
|
|
|
78,786
|
|
|
89,901
|
|
Total
current assets
|
|
|
2,047,038
|
|
|
2,707,943
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property,
Plant and Equipment
|
|
|
|
|
|
|
|
Building
|
|
|
2,271,209
|
|
|
2,271,209
|
|
Equipment
|
|
|
899,391
|
|
|
908,999
|
|
Land
and improvements
|
|
|
472,504
|
|
|
472,504
|
|
|
|
|
3,643,104
|
|
|
3,652,712
|
|
Less
accumulated depreciation
|
|
|
431,285
|
|
|
375,178
|
|
Net
property and equipment
|
|
|
3,211,819
|
|
|
3,277,534
|
|
|
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
5,258,857
|
|
$
|
5,985,477
|
|
HYDROGEN
ENGINE CENTER, INC. AND SUBSIDIARIES
(a
corporation in the development stage)
Condensed
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
March
31,
|
|
December
31,
|
|
LIABILITIES
AND EQUITY
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
|
|
|
|
(Restated)
|
|
(Restated)
|
|
|
|
|
|
|
|
Current
Liabilities
|
|
|
|
|
|
Notes
payable, banks
|
|
$
|
580,046
|
|
$
|
594,677
|
|
Current
portion long-term debt
|
|
|
43,337
|
|
|
30,350
|
|
Current
installments of obligation under capital lease
|
|
|
46,637
|
|
|
45,247
|
|
Accounts
payable
|
|
|
156,207
|
|
|
146,585
|
|
Accrued
expenses
|
|
|
221,964
|
|
|
207,328
|
|
Accrued
interest
|
|
|
141,220
|
|
|
129,965
|
|
Unearned
grants
|
|
|
24,184
|
|
|
30,977
|
|
Total
current liabilities
|
|
|
1,213,595
|
|
|
1,185,129
|
|
|
|
|
|
|
|
|
|
Long-term
debt, net of current maturities
|
|
|
1,310,625
|
|
|
1,338,235
|
|
Obligation
under capital lease, excluding current
installments
|
|
|
68,761
|
|
|
80,955
|
|
|
|
|
1,379,386
|
|
|
1,419,190
|
|
Total
liabilities
|
|
|
2,592,981
|
|
|
2,604,319
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
Equity
|
|
|
|
|
|
|
|
Preferred
stock - Series B, $0.001 par value; 5,000,000 shares
authorized,
|
|
|
|
|
|
|
|
1,932,846
shares issued and outstanding
|
|
|
1,933
|
|
|
1,933
|
|
Common
stock, $0.001 par value; 100,000,000 shares authorized,
|
|
|
|
|
|
|
|
27,590,164
shares issued and outstanding
|
|
|
27,590
|
|
|
27,590
|
|
Additional
paid-in capital
|
|
|
16,009,012
|
|
|
15,860,725
|
|
Accumulated
other comprehensive loss - foreign currency
|
|
|
(7,938
|
)
|
|
(3,412
|
)
|
Deficit
accumulated during the development stage
|
|
|
(13,364,721
|
)
|
|
(12,505,678
|
)
|
Total
stockholders' equity
|
|
|
2,665,876
|
|
|
3,381,158
|
|
|
|
|
|
|
|
|
|
Total
Liabilities and Stockholders’ Equity
|
|
$
|
5,258,857
|
|
$
|
5,985,477
|
|
See
accompanying notes
HYDROGEN
ENGINE CENTER, INC. AND SUBSIDIARIES
(a
corporation in the development stage)
Condensed
Consolidated Statements of Operations
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Three
months ended
|
|
From
Inception
|
|
|
|
March
31,
|
|
(May
19, 2003) to
|
|
|
|
2008
|
|
2007
|
|
March
31, 2008
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
|
|
(Restated)
|
|
(Restated)
|
|
(Restated)
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
161,685
|
|
$
|
238,290
|
|
$
|
1,224,388
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Goods Sold
|
|
|
|
|
|
|
|
|
|
|
Material,
labor, and overhead
|
|
|
150,367
|
|
|
202,664
|
|
|
1,072,151
|
|
Inventory
markdown (recovery)
|
|
|
(11,904
|
)
|
|
-
|
|
|
950,119
|
|
|
|
|
138,463
|
|
|
202,664
|
|
|
2,022,270
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit (Loss)
|
|
|
23,222
|
|
|
35,626
|
|
|
(797,882
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
84,065
|
|
|
88,514
|
|
|
1,285,101
|
|
General
and administrative
|
|
|
570,904
|
|
|
823,422
|
|
|
7,042,312
|
|
Research
and development
|
|
|
191,266
|
|
|
407,357
|
|
|
3,441,769
|
|
Vendor
settlement
|
|
|
-
|
|
|
448,011
|
|
|
577,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
846,235
|
|
|
1,767,304
|
|
|
12,346,682
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Loss
|
|
|
(823,013
|
)
|
|
(1,731,678
|
)
|
|
(13,144,564
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other
Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
4,429
|
|
|
11,501
|
|
|
168,481
|
|
Interest
expense
|
|
|
(40,459
|
)
|
|
(41,637
|
)
|
|
(381,904
|
)
|
Loss
on sale of asset
|
|
|
-
|
|
|
-
|
|
|
(6,734
|
)
|
|
|
|
(36,030
|
)
|
|
(30,136
|
)
|
|
(220,157
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(859,043
|
)
|
$
|
(1,761,814
|
)
|
$
|
(13,364,721
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Series
A Preferred stock beneficial conversion
|
|
|
|
|
|
|
|
|
|
|
feature
accreted as a dividend
|
|
$
|
-
|
|
$
|
(1,889,063
|
)
|
$
|
(1,889,063
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss Attributable To Common Stockholders
|
|
$
|
(859,043
|
)
|
$
|
(3,650,877
|
)
|
$
|
(15,253,784
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
-average shares outstanding
|
|
|
27,498,164
|
|
|
25,472,024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diuluted net loss per share
|
|
|
(0.03
|
)
|
|
(0.14
|
)
|
|
|
|
See
accompanying notes
HYDROGEN
ENGINE CENTER, INC. AND SUBSIDIARIES
(a
corporation in the development stage)
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
From
Inception
|
|
|
|
March
31,
|
|
(May
19, 2003) to
|
|
|
|
2008
|
|
2007
|
|
March
31, 2008
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Operating
Activities
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(859,043
|
)
|
$
|
(1,761,814
|
)
|
$
|
(13,364,721
|
)
|
Adjustments
to reconcile net loss to net cash used in operations:
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
65,715
|
|
|
57,213
|
|
|
492,558
|
|
Compensation
to directors and employees of stock options and restricted
stock
|
|
|
138,005
|
|
|
136,089
|
|
|
1,512,424
|
|
Compensation
to consultants of stock options
|
|
|
10,282
|
|
|
2,462
|
|
|
197,092
|
|
Warrants
issued in vendor settlement
|
|
|
-
|
|
|
-
|
|
|
577,500
|
|
Loss
on sale of assets
|
|
|
-
|
|
|
-
|
|
|
6,734
|
|
Change
in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
22,102
|
|
|
(85,175
|
)
|
|
(112,135
|
)
|
Inventories
|
|
|
77,274
|
|
|
(362,217
|
)
|
|
(1,557,020
|
)
|
Prepaid
expenses
|
|
|
11,115
|
|
|
(97,240
|
)
|
|
(100,243
|
)
|
Accounts
payable
|
|
|
9,622
|
|
|
138,135
|
|
|
240,063
|
|
Accrued
expenses
|
|
|
14,636
|
|
|
677,953
|
|
|
268,202
|
|
Accrued
interest
|
|
|
11,255
|
|
|
-
|
|
|
141,220
|
|
Unearned
grants
|
|
|
(6,793
|
)
|
|
(8,484
|
)
|
|
24,184
|
|
Net
cash used in operating activities
|
|
|
(505,830
|
)
|
|
(1,303,078
|
)
|
|
(11,674,142
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Investing
Activities
|
|
|
|
|
|
|
|
|
|
|
Withdrawal/(Deposit)
of restricted cash
|
|
|
(1,297
|
)
|
|
(3,848
|
)
|
|
(116,454
|
)
|
Proceeds
from sale of assets
|
|
|
-
|
|
|
-
|
|
|
36,500
|
|
(Purchases)/Impairment
of property, plant, and equipment
|
|
|
-
|
|
|
(39,277
|
)
|
|
(3,012,679
|
)
|
Net
cash used in investing activities
|
|
|
(1,297
|
)
|
|
(43,125
|
)
|
|
(3,092,633
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Financing
Activities
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from note payable, bank
|
|
|
-
|
|
|
250,000
|
|
|
1,839,420
|
|
Payments
on note payable, bank
|
|
|
(14,630
|
)
|
|
(2,283
|
)
|
|
(927,774
|
)
|
Proceeds
from long-term debt
|
|
|
-
|
|
|
-
|
|
|
1,172,052
|
|
Payments
on long-term debt
|
|
|
(25,428
|
)
|
|
(11,473
|
)
|
|
(169,323
|
)
|
Proceeds
from exercise of stock option
|
|
|
-
|
|
|
-
|
|
|
8,000
|
|
Issuance
of preferred stock (Series A) in private placement, net of
expenses
|
|
|
-
|
|
|
-
|
|
|
2,779,813
|
|
Issuance
of preferred stock (Series B) in private placement, net of
expenses
|
|
|
-
|
|
|
279,000
|
|
|
3,595,095
|
|
Issuance
of common stock in private placements, net of expenses
|
|
|
-
|
|
|
-
|
|
|
6,639,008
|
|
Net
cash provided by (used in) financing activities
|
|
|
(40,058
|
)
|
|
515,244
|
|
|
14,936,291
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of Exchange Rates on Cash and Cash Equivalents
|
|
|
(4,526
|
)
|
|
(1,184
|
)
|
|
(7,938
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Increase (Decrease) in Cash and Cash Equivalents
|
|
|
(551,711
|
)
|
|
(832,143
|
)
|
|
161,578
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and Cash Equivalents – Beginning of Period
|
|
|
713,289
|
|
|
1,149,207
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and Cash Equivalents – End of Period
|
|
$
|
161,578
|
|
$
|
317,064
|
|
$
|
161,578
|
|
-Continued-
See
accompanying notes
HYDROGEN
ENGINE CENTER, INC. AND SUBSIDIARIES
(a
corporation in the development stage)
Condensend
Consolidated Statements of Cash Flows
(Unaudited)
-Continued-
|
|
|
|
|
|
|
|
|
|
Three
months ended
|
|
From
Inception
|
|
|
|
March
31,
|
|
(May
19, 2003) to
|
|
|
|
2008
|
|
2007
|
|
March
31, 2008
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Supplemental
Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
paid
|
|
$
|
29,111
|
|
$
|
13,913
|
|
$
|
240,401
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of Noncash
Investing
and Financing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
paid-in capital contribution for expenses paid by founder
|
|
$
|
-
|
|
$
|
-
|
|
$
|
103,636
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of common stock for equipment
|
|
$
|
-
|
|
$
|
-
|
|
$
|
47,851
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance
of common stock for conversion of debt
|
|
$
|
-
|
|
$
|
-
|
|
$
|
557,051
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquistion
of property, plant, and equipment through
financing
|
|
$
|
-
|
|
$
|
111,450
|
|
$
|
692,081
|
|
|
|
|
|
|
|
|
|
|
|
|
Payables
for construction in progress
|
|
$
|
-
|
|
$
|
-
|
|
$
|
232,208
|
|
|
|
|
|
|
|
|
|
|
|
|
Receivable
for state loan
|
|
$
|
-
|
|
$
|
-
|
|
$
|
100,000
|
|
|
|
|
|
|
|
|
|
|
|
|
Series
A Preferred stock beneficial conversion feature accreted as a
dividend
|
|
$
|
-
|
|
$
|
1,889,063
|
|
$
|
1,889,063
|
|
See
accompanying notes
HYDROGEN
ENGINE CENTER, INC. AND SUBSIDIARIES
(a
corporation in the development stage)
Notes
to Consolidated Financial Statements
(Unaudited)
March
31, 2008
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Overview
of Companies
Hydrogen
Engine Center, Inc. is a Nevada corporation with operations at, Hydrogen Engine
Center, Inc., an Iowa corporation (“HEC Iowa”), and Hydrogen Engine Center (HEC)
Canada Inc. (“HEC Canada”).
HEC
Iowa
was incorporated on May 19, 2003 (“inception date”) for the purpose of
commercializing environmentally friendly internal combustion systems for
industrial engines and generator sets. HEC Iowa’s operations are located in
Algona, Iowa.
HEC
Canada was incorporated as a Canadian corporation on August 25, 2005, for the
purpose of establishing a research and development center to assist in the
development of alternative fuel and hydrogen engines and generator sets. HEC
Canada is located in Quebec, and works with Universite Du Quebec at
Trois-Rivieres.
Description
of Business - A Corporation in the Development Stage
We
develop systems and processes used in the design, manufacture and distribution
of alternative fuel internal combustion engines, engine controls and generator
systems. These technologies are for use by customers and partners in the
industrial and power generation markets. We have filed and continue to file
patents around these next generation systems and processes. These solutions
and
the engines using them are designed to run on alternative fuels including but
not limited to hydrogen, ammonia, ethanol, natural gas, propane and gasoline.
Our engines and engine products are sold under the brand name Oxx
Power
®
.
Through
March 31, 2008, we remain in the development stage. Development stage is
characterized by minimal revenues, with efforts focused on fund raising and
prioritization of expenditures for the design and development of our products,
manufacturing processes, intellectual property and strategic sales and
marketing.
Interim
Financial Statements
The
unaudited interim financial information included in this report reflects normal
recurring adjustments that management believes are necessary for a fair
statement of the results of operations, financial position, and cash flows
for
the periods presented. This interim information should be read in conjunction
with the financial statements and accompanying notes contained in the company’s
Form 10-KSB filed April 15, 2008.
The
results of operations for the quarterly period ended March 31, 2008 are not
necessarily indicative of the results to be expected for other interim periods
or the full year.
Principles
of Consolidation
The
consolidated financial statements include the accounts of our Company and its
wholly owned subsidiaries, HEC Iowa and HEC Canada. All intercompany balances
and transactions have been eliminated in consolidation.
Liquidity
and Going Concern
Our
financial statements have been prepared on the basis of accounting principles
applicable to a going concern. As a result, they do not include adjustments
that
would be necessary if we were unable to continue as a going concern and would
therefore, be obligated to realize assets and discharge its liabilities other
than in the normal course of operations.
Since
inception, we have invested in the resources and technology we believe necessary
to deliver carbon free energy technology. As such, we have incurred substantial
operating losses. We expect to incur operating losses in 2008. We have financed
all development, sales and operations since inception through equity and debt
financings. We continue to take steps to lower our monthly cash expenditures.
On
April 11, 2008, we entered into an agreement to sell up to a maximum of
$4,000,000 in equity securities over twenty-four months to a hedge fund. The
agreement requires that we register stock prior to receiving any funds. The
registration process with the Securities and Exchange Commission could take
60
to 90 days or longer. With our existing capital, projected sales revenue, and
secured financing, we anticipate that we can fund our operations through July,
2008, without additional capital. As of May 13, 2008, we have approximately
$192,303 in cash, $79,195 in trade receivables and $139,833 in trade payables.
We have sales orders of approximately $253,757 (approximately $140,000 of which
are scheduled to be delivered in May 2008) and an expected tax refund of
approximately $30,000. In addition, we have available funds from a line of
credit from a bank in the amount of $165,000. As our funding efforts continue,
we plan to stage our growth by expanding our sales and marketing programs,
and
by proceeding with technology development, patent filings and essential engine
certification. While interest in the alternative energy sector is strong, we
are
prepared to further curtail spending if needed. These timeframes may vary if
events occur which negatively or positively affect our operations.
Our
continuing operations are dependent upon obtaining financing. There can be
no
assurance that we will successfully complete the required stock registration
or
be able to draw funds in a timely manner. These conditions raise substantial
doubt about the ability to continue as a going concern.
Fair
Value of Financial Instruments
Due
to
the short-term nature of cash, cash equivalents, accounts receivable, accounts
payable and accrued expenses, we believe that the carrying amounts reported
in
the balance sheet approximate their fair values at the balance sheet date.
The
fair value of long-term debt is estimated based on anticipated interest rates,
which management believes would currently be available for similar issues of
debt, taking into account our current credit risk and other market factors,
which approximate fair value.
Inventories
Inventories
consist mainly of parts, work-in-process and finished goods that are stated
at
the lower of cost (determined by the first-in, first out method) or market
value
(Note 4). We follow the provisions of SFAS 151, “Inventory Costs” that amends
the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory
Pricing” (ARB No. 43). Under this guidance, we allocate fixed production
overhead to inventory based on the normal capacity of the production facilities,
any expense incurred as a result of idle facility expense, freight and handling
costs are expensed as period costs. For the three months ended March 31, 2008
we
allocated approximately $4,000 of overhead to inventory and approximately
$49,500 of overhead to inventory from inception (May 19, 2003) to March 31,
2008. For the three months ended March 31, 2007 we allocated approximately
$5,000 of overhead to inventory. The balance of fixed production overhead is
recorded in general and administrative costs.
Revenue
Recognition
Revenue
from the sale of our products is recognized at the time title and risk of
ownership transfer to customers. This occurs upon shipment to the customer
or
when the customer picks up the goods.
Business
Agreements
Income
is
also derived through business agreements for the development and/or
commercialization of products based upon our proprietary technology. Some of
the
business agreements have stipulated performance milestones and deliverables
where others require “best efforts” with no performance criteria. The business
agreements require that payments be made to us as certain milestones are reached
prior to delivery of the product to the customer. Accordingly, income related
to
business agreements are recorded as a reduction in research and development
expense, when title and risk of ownership transfers to the customer. Expenses
we
incur are recorded as research and development costs. During the three months
ended March 31, 2008, we did not record a reduction in research and development
expense resulting from business agreements. From inception (May 19, 2003) to
March 31, 2008, we recorded $273,913, as a reduction in research and development
expense.
General
and Administrative Costs
General
and administrative costs include payroll, employee benefits, stock-based
compensation, and other costs associated with general and administrative costs
including administrative personnel, professional fees, consulting fees and
office expense. We allocate overhead and direct production expense to products
manufactured. However, because we have not reached our production capacity,
excess manufacturing costs are expensed as incurred as general and
administrative costs. Expenses related to pre-production include salaries for
production personnel, purchasing costs and the costs associated with production
ramp up. Total pre-production costs included in general and administrative
expenses for the three months ending March 31, 2008 totaled $121,484. For the
period from inception (May 19, 2003) to March 31, 2008 pre-production expense
was $1,464,918.
Research
and Development Costs
Research
and development costs include payroll, employee benefits, stock-based
compensation, and other costs associated with product development and are
expensed as they are incurred. Accordingly, our investments in technology and
patents are recorded at zero in our financial statements, regardless of their
value.
Stock-Based
Compensation
Effective
January 1, 2006, we adopted the fair value recognition provisions of Statement
of Financial Accounting Standards No. 123R
“Share-Based
Payment” (“SFAS 123R”). As prescribed in SFAS 123R, we have elected to use the
modified prospective transition method, and accordingly, prior periods have
not
been restated to reflect the impact of SFAS 123R. Under this method, we are
required to recognize stock-based compensation for all new and unvested
stock-based awards that are ultimately expected to vest as the requisite service
is rendered, beginning January 1, 2006. We record stock-based compensation
expense on a straight-line basis over the requisite period, which is generally
a
four-to five-year vesting period. Historically, we applied the intrinsic method
as provided in Accounting Principles Board (“APB”) Opinion No. 25 (“APB No.
25”), “Accounting for Stock Issued to Employees,” and related interpretations
and accordingly, no compensation cost had been recognized for stock options
issued to employees in years prior to 2006.
In
March
2005, SAB 107 provided supplemental implementation guidance for SFAS 123R.
We
applied the provisions of SAB 107 in our adoption of SFAS 123R. As a result
of
adopting the fair value method for stock compensation, all stock options and
restricted stock awards are expensed over the award vesting period.
These
awards are expensed under the same approach using the fair value measurements
which were used in calculating pro forma stock-based compensation expense under
SFAS 123.
SFAS
123R
requires the use of a valuation model (Note 9), to calculate the fair value
of
stock-based awards. We have elected to utilize the Black-Scholes option pricing
model to estimate the fair value of options.
Prior
to
the adoption of SFAS 123R, we accounted for stock-based awards to employees
and
directors using the intrinsic value method in accordance with APB No. 25 as
allowed under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS
123”). As permitted by SFAS 123, we chose to follow APB No. 25 and related
interpretations for its employee stock-based compensation. Under APB No. 25,
no
compensation expense was 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. We use the fair value of common stock at the close of business
on
the date the option is approved by our Board of Directors.
We
account for options issued to non-employees (other than directors) under SFAS
123R and 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, as
calculated, using the Black Scholes Option pricing formula (Note 9), is recorded
as an expense over the vesting terms. Options issued to non-employees and
employees are issued using the same methodology and assumptions.
The
following table illustrates the effect on net loss as if we had applied, prior
to January 1, 2006, the fair value recognition provisions for stock-based
employee compensation of SFAS 123, as amended by SFAS No. 148, “Accounting for
Stock-Based Compensation -- Transition and Disclosure.”
|
|
Period
from Inception
|
|
|
|
(May
19, 2003) to
|
|
|
|
March
31, 2008
|
|
|
|
|
|
Net
loss attributable to common shareholders, as reported
|
|
$
|
(15,253,784
|
)
|
|
|
|
|
|
Add:
options and restricted stock-based employee compensation
|
|
|
|
|
expense
included in reported net loss attributable to common
shareholders
|
|
|
1,512,424
|
|
Deduct:
options and restricted stock-based employee compensation
|
|
|
|
|
expense
determined under fair value based method
|
|
|
(1,698,226
|
)
|
|
|
|
|
|
Pro
forma net loss attributable to common shareholders
|
|
$
|
(15,439,586
|
)
|
Total
employee non-cash stock compensation expense, net of forfeitures, for the three
months ended March 31, 2008 was $138,005.
For
purposes of pro forma disclosures, the estimated fair value of the options
granted is amortized to expense over the option vesting periods as services
are
performed (Note 9).
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. Our actual results could differ from our
estimates.
Recent
Accounting Pronouncements
In
February 2008, the FASB issued Financial Staff Positions (“FSP”) FAS 157-2,
Effective
Date of FASB Statement No. 157
(“FSP
FAS 157-2”), which delays the effective date of SFAS No. 157,
Fair
Value Measurement
(“SFAS
157”), for all nonfinancial assets and nonfinancial liabilities, except those
that are recognized or disclosed at fair value in the financial statements
on a
recurring basis (at least annually). SFAS 157 establishes a framework for
measuring fair value and expands disclosures about fair value measurements.
FSP
FAS 157-2 partially defers the effective date of SFAS 157 to fiscal years
beginning after November 15, 2008, and interim periods within those fiscal
years for items within the scope of this FSP. FSP FAS 157-2 is effective for
us
beginning January 1, 2009. We are currently evaluating the potential impact
of the adoption of those provisions of SFAS 157, for which effectiveness was
delayed by FSP SFAS 157-2, on our consolidated financial position and results
of
operations.
Reclassifications
Certain
amounts in the Condensed Consolidated Statement of Operations for the three
months ended March 31, 2007 have been reclassified to conform to the current
year presentation. These reclassifications had no effect on net loss as
previously reported.
2.
RESTATEMENT OF FINANCIAL STATEMENTS
Correction
of error related to presentation of inventory write-downs and establishment
of
inventory valuation account.
During
2006, 2007, and 2008 we recorded inventory write-downs, net of recoveries and
inventory write-offs as operating expense. Per EITF 96-9 and note 13 of SAB
100,
inventory markdowns should be classified in the income statement as a component
of cost of goods sold.
We
have
evaluated the financial statement impact in each of the previously filed
reporting periods effected, and concluded that the changes are quantitatively
material to its previously filed financial statements. The amounts previously
recorded in each of the two periods ended March 31, 2007 and March 31, 2008
and
the period from inception to March 31, 2008 have been adjusted for this
reclassification. There were no inventory write-downs or write-offs during
the
three months ended March 31, 2006 and March 31, 2007.
The
effect of the correction of this error on the Consolidated Statement of
Operations for the three months ended March 31, 2008 is summarized as
follows:
Condensed
Consolidated Statement of Operations
|
|
March
31, 2008
As
Previously Reported
|
|
Adjustments
|
|
March
31, 2008
As
Restated
|
|
Sales
|
|
$
|
161,685
|
|
$
|
-
|
|
$
|
161,685
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Goods Sold
|
|
|
|
|
|
|
|
|
|
|
Material,
labor, and overhead
|
|
|
150,367
|
|
|
-
|
|
|
150,367
|
|
Inventory
markdowns (recoveries)
|
|
|
-
|
|
|
(11,904
|
)
|
|
(11,904
|
)
|
|
|
|
150,367
|
|
|
(11,904
|
)
|
|
138,463
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit (Loss)
|
|
|
11,318
|
|
|
11,904
|
|
|
23,222
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses
(recovery) related to inventory
|
|
|
(11,904
|
)
|
|
11,904
|
|
|
-
|
|
Vendor
settlement
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Total
Operating Expenses
|
|
|
834,331
|
|
|
11,904
|
|
|
846,235
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Loss
|
|
|
(823,013
|
)
|
|
-
|
|
|
(823,013
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(859,043
|
)
|
$
|
-
|
|
$
|
(859,043
|
)
|
The
effect of the correction of this error on the Consolidated Statement of
Operations for the three months ended March 31, 2007 is summarized as
follows:
Condensed
Consolidated Statement of Operations
|
|
March
31, 2007
As
Previously Reported
|
|
Adjustments
|
|
March
31, 2007
As
Restated
|
|
Sales
|
|
$
|
238,290
|
|
$
|
-
|
|
$
|
238,290
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Goods Sold
|
|
|
|
|
|
|
|
|
|
|
Material,
labor, and overhead
|
|
|
202,664
|
|
|
-
|
|
|
202,664
|
|
Inventory
markdowns (recoveries)
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
202,664
|
|
|
-
|
|
|
202,664
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit (Loss)
|
|
|
35,626
|
|
|
-
|
|
|
35,626
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses
(recovery) related to inventory
|
|
|
448,011
|
|
|
(448,011
|
)
|
|
-
|
|
Vendor
settlement
|
|
|
-
|
|
|
448,011
|
|
|
448,011
|
|
Total
Operating Expenses
|
|
|
1,767,304
|
|
|
-
|
|
|
1,767,304
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Loss
|
|
|
(1,731,678
|
)
|
|
-
|
|
|
(1,731,678
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(1,761,814
|
)
|
$
|
-
|
|
$
|
(1,761,814
|
)
|
The
effect of the correction of this error on the Consolidated Statement of
Operations for the period from inception to March 31, 2008 is summarized as
follows:
Condensed
Consolidated Statement of Operations
|
|
Inception
to
March
31, 2008
As
Previously Reported
|
|
Adjustments
|
|
Inception
to
March
31, 2008
As
Restated
|
|
Sales
|
|
$
|
1,224,388
|
|
$
|
-
|
|
$
|
1,224,388
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of Goods Sold
|
|
|
|
|
|
|
|
|
|
|
Material,
labor, and overhead
|
|
|
1,072,151
|
|
|
-
|
|
|
1,072,151
|
|
Inventory
markdowns (recoveries)
|
|
|
-
|
|
|
950,119
|
|
|
950,119
|
|
|
|
|
1,072,151
|
|
|
950,119
|
|
|
2,022,270
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit (Loss)
|
|
|
152,237
|
|
|
(950,119
|
)
|
|
(797,882
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Losses
(recovery) related to inventory
|
|
|
1,527,619
|
|
|
(1,539,523
|
)
|
|
-
|
|
Vendor
settlement
|
|
|
-
|
|
|
577,500
|
|
|
577,500
|
|
Total
Operating Expenses
|
|
|
13,296,801
|
|
|
(950,119
|
)
|
|
12,346,682
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Loss
|
|
|
(13,144,564
|
)
|
|
-
|
|
|
(13,144,564
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
|
$
|
(13,364,721
|
)
|
$
|
-
|
|
$
|
(13,364,721
|
)
|
Correction
of error related to presentation of the beneficial conversion feature accretion
for Series A Preferred Stock
The
Series A Convertible Preferred Stock issued in 2006 had certain anti-dilution
rights. As a result of these anti-dilution rights and the sale of the Series
B
Preferred Stock on March 27, 2007, the conversion price of the Series A
Preferred Stock was reduced from $3.25 per share to $2.00 per share. We
concluded that this reduced conversion price resulted in a noncash, quasi
dividend totaling $1,889,063. Our previously filed financial statements
reflected this quasi dividend as an increase to accumulated deficit in the
Consolidated Balance Sheet as of March 31, 2008. Per EITF 98-5 and SAB Topic
3,
when there is an accumulated deficit rather than retained earnings, the quasi
dividend should be recorded as a reduction to additional paid-in
capital.
The
effect of the correction of this error on the Condensed Consolidated Balance
Sheet for the period ended March 31, 2008 is summarized as follows:
Condensed
Consolidated Balance Sheet
|
|
March
31, 2008
As
Previously Reported
|
|
Adjustments
|
|
March
31, 2008
As
Restated
|
|
Additional
paid-in capital
|
|
$
|
17,898,075
|
|
$
|
(1,889,063
|
)
|
$
|
16,009,012
|
|
Deficit
accumulated during the development stage
|
|
|
(15,253,784
|
)
|
|
1,889,063
|
|
|
(13,364,721
|
)
|
Total
Stockholders’ Equity
|
|
$
|
2,665,876
|
|
$
|
-
|
|
$
|
2,665,876
|
|
The
effect of the correction of this error on the Condensed Consolidated Balance
Sheet for the period ended December 31, 2007 is summarized as
follows:
Condensed
Consolidated Balance Sheet
|
|
December
31, 2007
As
Previously Reported
|
|
Adjustments
|
|
December
31, 2007
As
Restated
|
|
Additional
paid-in capital
|
|
$
|
17,749,788
|
|
$
|
(1,889,063
|
)
|
$
|
15,860,725
|
|
Deficit
accumulated during the development stage
|
|
|
(14,394,741
|
)
|
|
1,889,063
|
|
|
(12,505,678
|
)
|
Total
Stockholders’ Equity
|
|
$
|
3,381,158
|
|
$
|
-
|
|
$
|
3,381,158
|
|
3.
FAIR VALUE INSTRUMENTS
Effective
January 1, 2008, we adopted SFAS 157, except as it applies to the
nonfinancial assets and nonfinancial liabilities subject to FSP SFAS 157-2.
SFAS
157 clarifies that fair value is an exit price, representing the amount that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. As such, fair value is a market-based
measurement that should be determined based on assumptions that market
participants would use in pricing an asset or a liability. As a basis for
considering such assumptions, SFAS 157 establishes a three-tier value hierarchy,
which prioritizes the inputs used in the valuation methodologies in measuring
fair value:
Level 1
-
Observable inputs that reflect quoted prices (unadjusted) for identical assets
or liabilities in active markets.
Level 2
-
Include
other inputs that are directly or indirectly observable in the marketplace.
Level 3
-
Unobservable inputs which are supported by little or no market activity.
The
fair
value hierarchy also requires an entity to maximize the use of observable inputs
and minimize the use of unobservable inputs when measuring fair value.
When
determining the fair value measurements for assets or liabilities required
or
permitted to be recorded at and/or marked to fair value, we consider the
principal or most advantageous market in which it would transact and considers
assumptions that market participants would use when pricing the asset or
liability. When possible, we look to active and observable markets to price
identical assets. When identical assets are not traded in active markets, we
look to market observable data for similar assets. Nevertheless, certain assets
are not actively traded in observable markets and we must use alternative
valuation techniques to derive a fair value measurement.
The
following table provides information on those assets and liabilities measured
at
fair value on a recurring basis.
|
|
Carrying
Amount
|
|
|
|
|
|
|
|
In
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet
|
|
Fair
Value
|
|
Fair
Value Measurement Using
|
|
|
|
March
31, 2008
|
|
March
31, 2008
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money
Market Funds
|
|
$
|
61,656
|
|
$
|
61,656
|
|
$
|
61,656
|
|
$
|
-
|
|
$
|
-
|
|
Effective
January 1, 2008, we also adopted SFAS 159,
The
Fair Value Option for Financial Assets and Financial Liabilities - including
an
Amendment of FASB Statement No. 115
,
which
allows an entity to choose to measure certain financial instruments and
liabilities at fair value on a contract-by-contract basis. Subsequent fair
value
measurement for the financial instruments and liabilities an entity chooses
to
measure will be recognized in earnings. As of March 31, 2008, we did not
elect such option for our financial instruments and liabilities.
4.
INVENTORIES
Inventories
are stated at the lower of cost or market value. Cost is determined by the
first-in, first-out method:
|
|
March
31, 2008
|
|
December
31, 2007
|
|
|
|
(unaudited)
|
|
|
|
Component
parts
|
|
$
|
1,216,738
|
|
$
|
1,266,612
|
|
Work
in process
|
|
|
36,444
|
|
|
10,407
|
|
Finished
goods
|
|
|
324,903
|
|
|
378,340
|
|
Totals
|
|
$
|
1,578,085
|
|
$
|
1,655,359
|
|
5.
NOTES PAYABLE, BANK
At
March
31, 2008, we had a letter of credit with a bank in the amount of $108,000.
The
letter of credit bears interest equal to the bank’s prime rate and had a balance
of $0 at March 31, 2007. The letter of credit is secured by a certificate of
deposit in the amount of $116,454. On April 15, 2008, the line of credit was
dissolved and the restriction on the certificate of deposit was lifted.
On
March
24, 2008, we obtained a line of credit from a bank for $250,000. The line of
credit expires August 1, 2008 and is secured by real estate and a business
security agreement. The line of credit carries a variable interest rate equal
to
1.5% above the Wall Street Journal U.S. Prime Rate. At March 31, 2008 the
balance on the line of credit was $0 and carried an interest rate of 6.75%.
As
of May 13, 2008 we had drawn $85,000 from this line of credit for operating
expenses.
6.
LONG-TERM DEBT
Long-term
debt consists of the following:
|
|
March
31,
2008
|
|
December
31, 2007
|
|
|
|
(unaudited)
|
|
|
|
Note
payable to City of Algona. See (a)
|
|
$
|
155,000
|
|
$
|
160,000
|
|
|
|
|
|
|
|
|
|
Note
payable to Algona Area Economic Development Corporation. See (b)
|
|
|
146,124
|
|
|
146,124
|
|
|
|
|
|
|
|
|
|
Note
payable to Algona Area Economic Development Corporation. See
(c)
|
|
|
60,881
|
|
|
64,827
|
|
|
|
|
|
|
|
|
|
Notes
payable to Iowa Department of Economic Development. See (d)
|
|
|
400,000
|
|
|
400,000
|
|
|
|
|
|
|
|
|
|
Note
payable to finance company. See (e)
|
|
|
-
|
|
|
6,388
|
|
|
|
|
|
|
|
|
|
Note
payable to bank. See (f)
|
|
|
591,956
|
|
|
594,246
|
|
|
|
|
|
|
|
|
|
|
|
|
1,353,962
|
|
|
1,368,585
|
|
|
|
|
|
|
|
|
|
Less
amounts due within one year
|
|
|
43,337
|
|
|
30,350
|
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
1,310,625
|
|
$
|
1,338,235
|
|
Future
maturities of long-term debt at March 31, 2008 are as follows:
2009
|
|
$
|
591,011
|
|
2010
|
|
|
169,562
|
|
2011
|
|
|
200,330
|
|
2012
|
|
|
148,800
|
|
Thereafter
|
|
|
200,922
|
|
Total
long-term debt
|
|
$
|
1,310,625
|
|
(a)
In
September 2005, we obtained $200,000 from the City of Algona. The note requires
quarterly payments of $5,000 starting January 1, 2006, with the final payment
due October 1, 2015. There is no interest on this loan provided we create and
retain at least 42 new full-time positions for five years. If such requirements
are not met, interest on the loan will be payable at 10% per annum. At this
time
the requirements have not been met. Therefore, as of March 31, 2008, we have
accrued interest on the note in the amount of $45,974. The loan is
collateralized by real estate.
(b)
On
June 27, 2005, we executed a note payable of $146,124 from the Algona Area
Economic Development Corporation in exchange for land received to be used for
the construction of a new facility. The loan is a ten-year partially forgivable
loan with interest at 8%, conditioned upon us achieving performance targets
as
follows:
|
·
|
$67,650
of principal and interest will be forgiven if we certify that we
have
created 50 new full-time equivalent jobs by June 1, 2010, and continuously
retained those jobs in Algona, Iowa until June 1,
2015.
|
|
·
|
$67,650
of principal and interest will be forgiven if we certify that we
have
created and continuously retained 50 additional 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.
|
|
·
|
Payment
of a wage for the retained jobs that is equal to or greater than
the
average hourly wage for workers in Kossuth County, Iowa, as determined
annually by Iowa Workforce
Development.
|
At
this
time the requirements have not been met. Therefore, as of March 31, 2008, we
have accrued interest in the amount of $32,283. The loan is secured by the
real
estate.
(c)
On
December 16, 2005, we assumed a no-interest note provided by the Algona Area
Economic Development Corporation in the amount of $117,500 in conjunction with
the purchase of land and building. This note was recorded at the fair value
of
future payments using an interest rate of 10% which amounted to $70,401,
resulting in a total purchase price of the land and building of $332,901. This
note is subordinate to a short-term note held by a bank. The note requires
quarterly payments of $2,500 starting January 1, 2006, with the final payment
due July 1, 2017.
(d)
On
June 28, 2005, the Iowa Department of Economic Development (“IDED”) awarded us a
Physical Infrastructure Assistance Program (“PIAP”) grant in the amount of
$150,000. This is a five-year forgivable loan and proceeds are to be used for
the construction and equipping of the 30,000 square foot manufacturing facility.
We received payment of this award in December 2005. Other terms of the loan
include a minimum contribution of $1,543,316 for building construction,
machinery and equipment, and working capital. In addition, we must create 49
full-time equivalent positions, with 38 positions at a starting wage exceeding
$11.76 per hour, and an average wage for all positions of $24.94 per hour.
In
order to qualify for the job count, employees must be Iowa residents. We are
required to maintain the minimum employment level through the thirteenth week
after the project completion date. If requirements are not met, the balance
of
the forgivable loan determined by IDED as due and payable will be amortized
over
three years from the agreement expiration date of July 31, 2010, at 6% interest
per annum with equal quarterly payments. IDED requires end-of-year status
reports to ensure compliance. At this time the requirements have not been met.
Therefore, as of March 31, 2008, the total amount of interest accrued was
$20,984. The note is secured by a security agreement on our assets.
Also
on
June 28, 2005, IDED awarded us a Community Economic Betterment Account (“CEBA”)
forgivable loan in the amount of $250,000. This is a three-year forgivable
loan
and proceeds are to be used for the construction of the plant. We received
$150,000 of this award in December 2005. The balance of the award, $100,000,
was
received in January 2006. The terms of this award are the same as the PIAP
award
explained in the previous paragraph. At the project completion date, if we
have
fulfilled at least 50% of our job creation/retention and wage obligation, $6,579
will be forgiven for each new full-time equivalent job created and retained
and
maintained for at least ninety days past the project completion date. The
project completion date of this award is July 30, 2010. Any balance (shortfall)
will be amortized over a two-year period, beginning at the project completion
date at 6% per annum from the date of the first CEBA disbursement on the
shortfall amount, with that amount accrued as of the project completion date,
being due and payable immediately. If we have a loan balance, the shortfall
balance and existing balance will be combined to reflect a single monthly
payment. We are accruing interest on this note until the terms of the note
have
been met. The total amount of interest accrued at March 31, 2008 was $34,973.
The note is secured by a security agreement on our assets.
At
March
31, 2008 we have created 17 jobs to meet the above job creation
requirement.
(e)
On
March 20, 2006, we acquired manufacturing equipment through an equipment
financing agreement with Wells Fargo Financial Leasing, Inc. The note requires
payments of $2,129 per month for 24 months. The equipment serves as collateral
for the note. At March 31, 2008, the entire remaining balance is due within
one
year and considered current.
(f)
On
March 27, 2008, we renewed a note with a bank for $591,956. The balance
of this
note on December 31, 2007 was $594,246. This note matures on April 1, 2009,
and
carries a variable interest rate equal to the Wall Street Journal U.S.
Prime
Rate. At March 31, 2008, the interest rate on the note was 5.25% and requires
monthly interest and principal payments of $4,340. The loan is secured
by real
estate.
7.
CAPITALIZED LEASES
We
have
entered into three capital lease agreements, to purchase equipment with a net
book value of $126,382 at March 31, 2008. Amortization of assets held under
capital lease is included with depreciation expense.
The
following is a schedule, by years of future minimum payments, required under
the
lease together with their present value as of March 31, 2008:
2008
|
|
$
|
43,086
|
|
2009
|
|
|
57,448
|
|
2010
|
|
|
19,889
|
|
2011
|
|
|
11,586
|
|
2012
|
|
|
635
|
|
Total
minimum lease payments
|
|
|
132,644
|
|
Less
amount representing interest
|
|
|
17,246
|
|
Present
value of minimum lease payments
|
|
|
115,398
|
|
Less
amounts due within one year
|
|
|
46,637
|
|
Totals
|
|
$
|
68,761
|
|
8.
GRANTS AND INCENTIVE PROGRAMS
On
June
28, 2005, we signed an Enterprise Zone (EZ) Agreement with the Iowa Department
of Economic Development (“IDED”). This agreement was later amended, September
26, 2006, to include both properties on our production site. This agreement
provides certain benefits and in order to receive these benefits, we were
required to create 59 new full-time equivalent jobs at our project site within
three years of the date of the agreement. We were also required pay a median
wage of $23.89 per hour and pay 80% of the employees’ medical and dental
insurance. Within three years of the effective date of the agreement, we were
also required to make a capital investment of at least $1,329,716 within the
Enterprise Zone. If we do not meet these requirements, a portion of the
incentives and assistance will have to be repaid, which will be based on the
portion of requirements that we have met.
At
March
31, 2008, we had not met all of our obligations for the EZ agreement and we
have
determined that we will not meet all of the requirements of this agreement
before June 28, 2008. We have recorded the benefits we have received from this
program as liabilities estimated to be $103,000. We have notified IDED of our
inability to meet our job creation obligations and we are in the process of
providing them with essential information so that our liability for this program
can be determined.
9.
STOCK-BASED
COMPENSATION
On
September 1, 2005, we adopted an Incentive Compensation Plan (“Incentive Plan”)
for the purpose of encouraging key officers, directors, employees and
consultants to remain with the company and devote their best efforts to the
business of the company. Under this plan, options may be granted to eligible
participants, at a price not less than the fair market value of the stock at
the
date of grant. Options granted under this plan may be designated as either
incentive or non-qualified options and vest over periods designated by the
Board
of Directors, generally over two to five years, and expire no later than ten
years from the date of grant. Upon exercise, we issue new shares of Common
Stock
to the employee.
We
may
also issue restricted stock under the Incentive Plan. Restricted stock awards
made under this program vest over periods designated by the Board of Directors,
generally two to four years. The aggregate number of shares authorized for
employee stock options, non-employee stock options and restricted stock awards
is 2,000,000. At March 31, 2008, there were 696,084 shares available for grant
and 1,303,916 shares granted. Of the shares granted, 361,000 were granted as
restricted stock, 231,666 were granted as non-employee stock options, and
711,250 were granted as employee and director stock options.
The
following table presents the weighted-average assumptions post repricing, used
to estimate the fair values of the stock options granted to employees and
non-employees in the periods presented, using the Black-Scholes option pricing
formula. The risk-free interest rate for periods within the contractual life
of
the option is based on the U.S. Treasury yield curve in effect at the time
of
grant. The expected life is based on our historical data of option exercise
and
forfeiture. Expected volatility is based on the average reported volatility
and
vesting period of a representative sample of eight comparable companies in
the
alternative fuel technology and services niches with market capitalizations
between $14 million and $1 billion, in addition to our actual history over
a
twenty-eight month period.
|
|
For
the three months ending
|
|
Period
from Inception
|
|
|
|
March
31,
|
|
(May
19, 2003) to
|
|
|
|
2008
|
|
2007
|
|
March
31, 2008
|
|
Risk-free
interest rate
|
|
|
3.6
|
%
|
|
4.7
|
%
|
|
4.2
|
%
|
Expected
volatility
|
|
|
81.0
|
%
|
|
100.8
|
%
|
|
146.5
|
%
|
Expected
life (in years)
|
|
|
4.0
|
|
|
5.5
|
|
|
7.4
|
|
Dividend
yield
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Weighted-average
estimated fair value of options
|
|
|
|
|
|
|
|
|
|
|
granted
during the period
|
|
$
|
0.27
|
|
$
|
2.38
|
|
$
|
0.97
|
|
The
following table summarizes the activity for outstanding employee and
non-employee stock options for the three months ended March 31,
2008:
|
|
Options
Outstanding
|
|
|
|
Number
of Shares
|
|
Weighted-Average
Exercise Price
|
|
Weighted-Average
Remaining Contractual Term
(in
years)
|
|
Aggregate
Intrinsic Value
(1)
|
|
|
|
Balance
at December 31, 2007
|
|
|
884,916
|
|
$
|
1.16
|
|
|
|
|
|
|
|
Granted
|
|
|
50,000
|
|
$
|
.46
|
|
|
|
|
|
|
|
Balance
at March 31, 2008
|
|
|
934,916
|
|
$
|
1.12
|
|
|
5.02
|
|
$
|
0
|
|
Vested
and exercisable as
of
March 31, 2008
|
|
|
629,916
|
|
$
|
1.05
|
|
|
3.38
|
|
$
|
0
|
|
Vested
and expected to vest as
of
March 31, 2008
|
|
|
906,869
|
|
$
|
1.15
|
|
|
5.02
|
|
$
|
0
|
|
|
(1)
|
The
aggregate intrinsic value is calculated as approximately the difference
between the weighted-average exercise price of the underlying awards
and
our closing stock price of $0.40 on March 31, 2008, the last day
of
trading in March.
|
There
were no stock options exercised during the three months ending March 31, 2008.
As
of
March 31, 2008, there was approximately $772,475 of unrecognized compensation
cost related to outstanding stock options, net of forecasted forfeitures. This
amount is expected to be recognized over a weighted-average period of 5.86
years. To the extent the forfeiture rate is different than we have anticipated,
stock-based compensation related to these awards will be different from
expectations.
The
following table summarizes the activity for the unvested restricted stock for
the three months ended March 31, 2008:
|
|
Unvested
Restricted Stock
|
|
|
|
Number
of
Shares
|
|
Weighted-Average
Grant
Date
Fair
Value
|
|
|
|
|
|
Unvested
at December 31, 2007
|
|
|
92,000
|
|
$
|
1.00
|
|
Vested
|
|
|
-
|
|
|
-
|
|
Unvested
at March 31, 2008
|
|
|
92,000
|
|
$
|
1.00
|
|
As
of
March 31, 2008, there was approximately $63,212 of unrecognized compensation
cost related to unvested restricted stock. This amount is expected to be
recognized over a weighted-average period of 2.42 years. To the extent actual
forfeiture rate is different than we have anticipated, the numbers of restricted
stock expected to vest would be different from expectations.
The
following table summarizes additional information about stock options
outstanding and exercisable as of March 31, 2008:
Options
Outstanding
|
|
Options
Exercisable
|
|
Exercise
Price
|
|
Options
Outstanding
|
|
Weighted-Average
Remaining Contractual Life
|
|
Weighted-Average
Exercise Price
|
|
Shares
Exercisable
|
|
Weighted-Average
Exercise Price
|
|
$0.40
|
|
|
20,000
|
|
|
10.00
|
|
$
|
.40
|
|
|
10,000
|
|
$
|
.40
|
|
$0.50
|
|
|
30,000
|
|
|
2.88
|
|
$
|
.50
|
|
|
30,000
|
|
$
|
.50
|
|
$1.00
|
|
|
481,666
|
|
|
2.72
|
|
$
|
1.00
|
|
|
429,666
|
|
$
|
1.00
|
|
$1.34
|
|
|
393,250
|
|
|
7.62
|
|
$
|
1.34
|
|
|
160,250
|
|
$
|
1.34
|
|
$1.40
|
|
|
10,000
|
|
|
9.41
|
|
$
|
1.40
|
|
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
934,916
|
|
|
5.01
|
|
$
|
1.05
|
|
|
629,916
|
|
$
|
1.05
|
|
10.
SUBSEQUENT
EVENT
Standby
Equity Distribution Agreement (SEDA)
In
order
to obtain needed capital, we entered into a Standby Equity Distribution
Agreement (the “SEDA”) with an investor on April 11, 2008. For a two-year period
beginning on
the
date
on which the SEC first declares effective a registration statement registering
the resale of our shares by the Investor, we will have the right
,
at our
discretion, to sell shares of our common stock to the Investor for a total
purchase price of up to $4,000,000. For each share of common stock purchased
under the SEDA, the Investor will pay ninety-three (93%) of the lowest daily
volume weighted average price (“VWAP”) during the five consecutive trading days
after the Advance Notice Date (as such term is defined in the SEDA). Each such
sale (“Advance”) may be for an amount not to exceed $350,000
and each
Advance Notice Date must be no less than five trading days after the prior
Advance Notice Date
.
The
Advance request will be reduced to the extent the price of our common stock
during the
five
consecutive trading days after the Advance Notice Date
is less
that 85% of the VWAP on the trading day
immediately
preceding the Advance Notice Date
.
Under
the
terms of the SEDA, we have paid a structuring fee of $10,000 and a due diligence
fee of $5,000. We are obligated to issue $160,000 worth of stock at the earlier
of the date of effectiveness of the Registration Statement or 60 days from
the
Closing Date as a Commitment Fee under the SEDA. We are also obligated to pay
a
monthly monitoring fee of $3,333 during the term of the agreement. We may
terminate the SEDA upon 15 trading days notice, provided there are no Advances
outstanding and that we have paid all amounts then due to the Investor.
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-Q. 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. READERS SHOULD CAREFULLY READ
OUR
FINANCIAL STATEMENTS AND THE NOTES THERETO, AS WELL AS THE "RISK FACTORS"
DESCRIBED
IN THE DOCUMENTS WE FILE FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE
COMMISSION, INCLUDING OUR ANNUAL REPORT ON FORM 10-KSB FOR THE TWELVE MONTHS
ENDED DECEMBER 31, 2007.
General
Hydrogen
Engine Center, Inc. (“HEC”, “we”, “us”, “our” or the “company”) was organized
for the purpose of developing and commercializing clean solutions for today’s
energy needs. Today, we offer technologies that enable spark-ignited internal
combustion engines and power generation systems to produce clean energy with
near-zero carbon emissions, using our proprietary engine controller and software
to efficiently distribute ignition spark and fuel to injectors. Our business
plan is centered on a growing portfolio of intellectual property that we expect
to play an increasing role in addressing the world’s energy needs as well as its
environmental concerns. Our long-term plans include revenue-generating
opportunities from licensing fees and from the production and marketing, often
in collaboration with others, of our technologies and products to a wider
variety of end-users and manufacturers. As the price of gasoline increases,
and
the price of hydrogen declines, we believe our market position is
improving.
We
expect
future revenue generation from the sale of hydrogen or ammonia-fueled engines
and electrical power generation systems (“
gensets
”)
for
dedicated uses, such as airport ground support and irrigation pumping. We are,
for example, currently working, in collaboration with Air Liquide and a number
of other participants, to finalize an opportunity to sell some of our
hydrogen-fueled engines for use in ground support vehicles at designated
airports. Many airports are seeking clean-energy solutions for operation of
ground support vehicles. We believe we are uniquely situated to meet the needs
of this market. We have constructed the facility and developed the discipline
necessary to enable us to build and sell approximately 700 high-quality engines
over a period of 2.5 years. We have developed our own proprietary controller
that enables our engines to run efficiently on hydrogen. Of the 14
hydrogen-fueled engines we have sold with this controller, none have experienced
controller failure in the field.
The
accompanying condensed consolidated balance sheets as of March 31, 2008 and
December 31, 2007 and the condensed consolidated statements of operations,
and
the condensed consolidated statements of cash flows for the quarters ended
March
31, 2008 and 2007 and for the period from inception (May 19, 2003) to March
31,
2008 respectively, consolidate the historical financial statements of the
company with HEC Iowa after giving effect to the Merger where HEC Iowa is the
accounting acquirer and after giving effect to the Private Offerings.
Overview
As
a
result of the Merger, we own all of the issued and outstanding shares of HEC
Iowa and all of the issued and outstanding shares of Hydrogen Engine Center
(HEC) Canada, Inc. HEC Iowa is a development stage company being built upon
the
vision of carbon-free, energy independence. On a step-by-step basis we are
working to build engines and gensets that provide the ability to generate and
use clean power on demand, where needed.
We
have
funded our operations from inception through March 31, 2008, through a series
of
financing transactions, including convertible loans and Private Offerings.
In
April 2008, we entered into a SEDA which provides us the opportunity to access
additional capital in the maximum amount of Four Million Dollars ($4,000,000),
subject to our obtaining an effective registration statement for shares of
our
Common Stock sold under the SEDA. We expect to access the SEDA in July 2008.
We
view the SEDA as a financial safety net and we do not intend to access the
full
amount that may become available to us unless alternative financing on terms
deemed acceptable to the company is not available. See “Liquidity and Capital
Resources - Terms of the SEDA” below.
Results
of Operations
A
summary
statement of our operations, for the quarters ended March 31, 2008 and 2007
and
for the period from inception through March 31, 2008 follows:
|
|
2008
|
|
2007
|
|
From
Inception
(May
19, 2003) to March 31, 2008
|
|
Revenues
|
|
$
|
161,685
|
|
$
|
238,290
|
|
$
|
1,224,388
|
|
Cost
of Goods Sold
|
|
|
138,463
|
|
|
202,664
|
|
|
2,022,270
|
|
Gross
Profit (Loss)
|
|
|
23,222
|
|
|
35,626
|
|
|
(797,882
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
846,235
|
|
|
1,767,304
|
|
|
12,346,682
|
|
Loss
from Operations
|
|
|
(823,013
|
)
|
|
(1,731,678
|
)
|
|
(13,144,564
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other
Expense
|
|
|
(36,030
|
)
|
|
(30,136
|
)
|
|
(220,157
|
)
|
Net
Loss
|
|
$
|
(859,043
|
)
|
$
|
(1,761,814
|
)
|
$
|
(13,364,721
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Series
A Preferred Stock Beneficial Conversion Feature Accreted as a
Dividend
|
|
|
-
|
|
$
|
(1,889,063
|
)
|
$
|
(1,889,063
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss Available to Common Stockholders
|
|
$
|
(859,043
|
)
|
$
|
(3,650,877
|
)
|
$
|
(15,253,784
|
)
|
Historical
information for periods prior to the merger is that of HEC Iowa.
We
continue to operate as a development stage company. We are still developing
our
alternative-fueled internal combustion engines and related products and have
not
realized significant revenues to date. As a development stage company we are
engaging in the research and development of our products, we continue to foster
relationships with vendors and customers and we are in the process of raising
additional capital to support our business plan.
Revenues
Revenues
in the period ended March 31, 2008 totaled $161,685, a decrease of 32.15%
compared to revenues of $238,290 in 2007. However we believe sales for the
second quarter 2008 will show an increase compared to the second quarter of
2007. For the period ended March 31, 2008 we realized $112, 013 from the sale
of
87 of our 4.9L remanufactured engines, $29,821 from the sale of three new 4.9L
Oxx Power® engines and five new Oxx Power® power units and $19,851 from the sale
of parts. For the period ended March 31, 2007 we realized $
238,290
from the
sale of eight Oxx Power® engines, thirty-three open power units and eighteen
remanufactured engines. From inception to date we have realized revenues of
$1,224,388.
We
also
derive income through business agreements for the development and/or
commercialization of our hydrogen and ammonia products, which are not reflected
in our revenue. We record income related to business agreements as a reduction
in research and development expense. The expenses we incur are recorded as
research and development costs. During the period ended March 31, 2008, we
did
not record a reduction in research and development expense resulting from
business agreements. During the period ended March 31, 2007 we realized project
reimbursements in the amount of $30,000 from delivery of one 50kW hydrogen
genset.
Cost
of Sales and Gross Profit
We
realized gross profit on our revenues of approximately 14.0% in 2008 and
approximately 15.0% in 2007. We expect to continue to realize gross profit
margins in this range as long as our primary sales are composed of traditional
fueled engines. We expect our gross profit margins to increase as we increase
our alternative fuel sales.
We
recovered $11,904 during the period ended March 31, 2008 from previously
recorded inventory write downs.
Operating
Expenses
Our
sales
and marketing expenses for the periods ended March 31, 2008 and 2007 were
$84,065 and $88,514, respectively and the total expense from inception to date
(May 19, 2003) is $1,285,101. We continue our search for technically qualified
sales personnel, who we feel are key to the success of our company. We expect
to
be more involved in the distributed generation market because of the tightening
of governmentally imposed emission standards and the growing clean-energy
solutions offered by our intellectual property. We also plan to aggressively
market our carbon-reduced and carbon-freed products in 2008 and expect that
our
sales and marketing expense may increase as we pursue national and international
sales opportunities for these products.
General
and administrative expenses decreased from $823,422 for the three months ended
March 31, 2007 to $
570,904
for the three months ended March 31, 2008. General and administrative expenses
from inception (May 19, 2003) through March 31, 2008 were $7,042,312. Our
general and administrative costs include payroll, employee benefits, stock-based
compensation, and other costs associated with general and administrative costs
such as investor relations, accounting and legal fees.
Our
general and administrative expenses also include overhead and direct production
expense related to pre-production costs, which costs, if we had reached
production capacity, would be allocated to products manufactured. Expenses
related to pre-production include salaries for production, personnel, purchasing
costs and costs associated with production ramp up. Total pre-production
expenses included in general and administrative expense for the periods ended
March 31, 2008 and 2007 respectively, were $121,484 and $203,134. Pre-production
expense from inception (May 19, 2003) through March 31, 2008 totaled $1,464,918.
We
view
our stock based compensation as a key tool that allows us to attract talented,
experienced employees and directors without having to increase cash
compensation. Although we have been able to preserve cash with this tool, we
have recognized $138,005 in stock option and restricted stock expense for
employees and directors in the three months ended March 31, 2008 and $136,089
in
stock option and restricted stock expense for the three months ended March
31,
2007. Total stock option compensation for employees and directors from inception
(May 19, 2003) through March 31, 2008 was $1,512,424. Stock option expense
is
allocated among sales and marketing expense, general and administrative expense
and research and development expense.
Since
inception (May 19, 2003), we have accrued approximately $38,500 in accrued
property taxes and approximately $40,678 in accrued program costs related to
forgivable loans and grants from state and local government sponsored programs.
These expenses have also been recorded as general and administrative expenses.
Expenses related to forgivable loans and grants will continue to accrue until
we
meet certain criteria for job creation. If we can comply with the job creation
criteria, these expenses would be recorded, at the time of forgiveness, as
other
income.
Costs
related to research and development were $191,266 and $407,357 for the periods
ended March 31, 2008 and 2007, respectively. Total expense for research and
development expense from inception (May 19, 2003) to March 31, 2008 is
$3,441,769. Management believes that, assuming receipt of additional capital,
research and development expenses will increase during 2008. Research and
development costs for 2008 are expected to include the cost of engine
certification along with the cost of additional engine and generator
development.
During
the period ended March 31, 2007 we recorded an expense of $448,011 to settle
a
dispute with a vendor. The settlement payment was made by issuing 375,000
warrants with a three year term and an exercise price of $2.00. The fair value
of the warrants was calculated using the Black Scholes Option pricing formula.
Loss
from Operations
We
recorded a net loss of $859,043 for the three months ended March 31, 2008
compared to a net loss
of
$1,761,814
for the
three months ended March 31, 2007.
We
recorded net losses totaling $13,364,721 from inception (May 19, 2003) through
March 31, 2008. We expect to continue to operate at a net loss during
2008.
During
the three months ended March 31, 2008 we did not recognize any stock dividends
attributable to stockholders. During the three months ended March 31, 2007,
we
accreted a beneficial conversion dividend to the holders of Series A Preferred
Stock of $1,889,063. The stock dividend, resulted in a net loss to common
stockholders of $3,650,877 for the three months ended March 31, 2007 and did
not
have an affect on the net loss to common stockholders at March 31, 2008. We
recorded net losses attributable to common stockholders totaling $15,253,784
from inception (May 19, 2003) through March 31, 2008.
Other
Income (Expense)
We
had
total interest income for the three months ended March 31, 2008 of $4,429 as
compared to interest income received for the three months ended March 31, 2007
of $11,501. We realized interest income from inception (May 19, 2003) to March
31, 2008 of $168,481.
Interest
expense for the three months ended March 31, 2008 was $40,459 and $41,637 for
the three months ended March 31, 2007. Our interest expense from inception
(May
19, 2003) to March 31, 2008 totaled $381,904. We accrue interest expense related
to forgivable loans and grants from state and local government sponsored
programs. From inception (May 19, 2003) through March 31, 2008 we have accrued
approximately $136,000 in accrued interest expense related to our forgivable
loans and grants and will continue to accrue these expenses until we meet
certain criteria for job creation. If we can comply with the job creation
criteria, these amounts would be recorded, at the time of forgiveness, as other
income.
Critical
Accounting Policies
Our
discussion and analysis of our financial position and results of operations
are
based upon our consolidated financial statements, which have been prepared
in
accordance with accounting principles generally accepted in the United States
of
America. The preparation of these 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 consolidated financial statements and the reported revenues and expenses
during the period.
Inventories
Our
inventories consist mainly of parts, work-in-process and finished goods that
are
stated at the lower of cost or market. Certain inventory items have been written
down to the estimated sales price.
Warranty
Reserve
We
record
a warranty reserve at the time products are sold or at the time revenue is
recognized. We estimate the liability for product warranty costs based upon
industry standards and best estimate of future warranty claims. Due to a lack
of
actual warranty history to use as a basis for our reserve estimate, it is
possible that actual claims may vary significantly from the estimated
amounts.
Revenue
Recognition
Revenue
from the sale of our products is recognized at the time title and risk of
ownership transfer to customers. This occurs upon shipment to the customer
or
when the customer picks up the goods.
Stock-based
Compensation
We
consider certain accounting policies related to stock-based compensation to
be
critical to our business operations and the understanding of our results of
operations. See Note 1 of Notes to Consolidated Financial Statements for
additional information about stock-based compensation.
Stock-based
Compensation
We
consider certain accounting policies related to stock-based compensation to
be
critical to our business operations and the understanding of our results of
operations. See Note 1 of Notes to Condensed Consolidated Financial
Statements.
Liquidity
and Capital Resources
Operating
Budget and Financing of Operations
With
current cash and cash flow generated from operations we believe that we will
have sufficient cash to cover operations through July, 2008. On March 24, 2008
we secured a line of credit from a local bank in the amount of $250,000. On
April 11, 2008, we entered into a Standby Equity Distribution Agreement with
YA
Global, which provides us the opportunity to access additional capital in the
maximum amount of Four Million Dollars ($4,000,000) in increments not to exceed
$350,000 each. We will have access to these funds over a two-year period
beginning on the date on which the SEC first declares effective the registration
statement to which this Prospectus is made a part, registering the resale of
our
shares by the YA Global. We plan to access the SEDA funds in August and will
only access the SEDA funds thereafter to the extent necessary.
In
addition to the above, we expect to secure an agreement to provide
hydrogen-fueled engines for ground support vehicles at designated airports
during the first half of 2008 and we continue to engage in discussions to secure
a strategic banking relationship. We believe that the combination of these
opportunities and potentials can provide needed cash flow to the company
throughout 2008.
Going
Concern
Our
accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates our continuation of operations, realization
of
assets, and liquidation of liabilities in the ordinary course of business.
Since
inception, we have incurred substantial operating losses and expect to incur
additional operating losses over the next several months. As of March 31, 2008,
we had an accumulated deficit of approximately $13.36 million. Our accompanying
financial statements do not include any adjustments that might result from
the
outcome of this uncertainty.
We
have
financed our operations since inception primarily through equity and debt
financings and loans from our officers, directors, and stockholders. Continuing
our operations is dependent upon obtaining further financing. Although we expect
to access necessary funds through the SEDA, there can be no assurance that
we
will successfully complete the registration required under the agreement, or
that amounts accessed would be sufficient to satisfy our capital requirements.
These conditions raise substantial doubt about our ability to continue as a
going concern.
Since
inception, we have incurred substantial operating losses and expect to incur
additional operating losses in the foreseeable future. We have financed
operations since inception primarily through equity and debt financings. We
anticipate our expenses will increase as we continue to expand our operations.
We had approximately $192,303 in cash, $79,195 in trade receivables and $139,833
in trade payables at May 13, 2008. As of May 13, 2008, we had sales orders
of
approximately $250,000 (approximately $140,000 of which are scheduled to be
delivered in May 2008) and an expected tax refund of approximately $30,000.
We
have a balance of $165,000 remaining on our bank line of credit. If we are
unable to raise additional funds through the SEDA, we anticipate that our
existing capital will fund operations through July 2008. These timeframes will
vary either positively or negatively based on subsequent events.
Terms
of the SEDA
On
April
11, 2008, we entered into a Standby Equity Distribution Agreement with YA
Global. The SEDA provides us the opportunity, for a two-year period beginning
on
the date on which the SEC first declares effective the registration statement
to
which this Prospectus is made a part registering the resale of our shares by
YA
Global, to sell shares of our Common Stock to YA Global for a total purchase
price of up to Four Million Dollars ($4,000,000). For each share of Common
Stock
purchased under the SEDA, YA Global will pay 93% of the lowest daily VWAP during
the five (5) consecutive trading days after the Advance notice date. Each
Advance may be for an amount not to exceed $350,000 and each Advance notice
date
must be no less than five (5) trading days after the prior Advance notice date.
The Advance request will be reduced to the extent the price of our Common Stock
during the five (5) consecutive trading days after the Advance notice date
is
less that 85% of the VWAP on the trading day immediately preceding the Advance
notice date.
We
have
paid $15,000 to YA Global as a structuring and due diligence fee and are
obligated to issue $160,000 worth of stock at the earlier of the date of
effectiveness of the registration statement to which this Prospectus is made
a
part or sixty (60) days from April 11, 2008 as a commitment fee under the SEDA.
We are obligated to pay a monthly monitoring fee of $3,333 during the term
of
the SEDA. We may terminate the SEDA upon fifteen (15) trading days of prior
notice to YA Global, as long as there are no Advances outstanding and we have
paid to YA Global all amount then due. A copy of the SEDA is attached as Exhibit
10.3 to the company’s Annual Report on Form 10-K as filed with the SEC on April
15, 2008.
We
have
engaged Growth Energy Capital Advisors (GenCap) of Dallas, TX, an unaffiliated
registered broker-dealer, to act as placement agent in connection with the
SEDA.
GenCap is entitled to receive a fee equal to seven percent (7%) of the gross
proceeds of the SEDA and warrants to purchase a number of shares of Common
Stock
equal to five percent (5%) of the total number of shares issued under the SEDA
(neither the warrants or shares of Common Stock issuable upon exercise of the
warrants are being registered hereunder). If the company drew down on the entire
Four Million Dollars ($4,000,000) available under the SEDA, GenCap would receive
an aggregate placement fee equal to $280,000 plus warrants to purchase common
stock.
We
claim
an exemption from the registration requirements of the Securities Act for the
private placement of our shares in the SEDA pursuant to Section 4(2) of the
Securities Act and/or Rule 506 of Regulation D promulgated thereunder. The
transaction does not involve a public offering, YA Global is an “accredited
investor” and/or qualified institutional buyer and YA Global has access to
information about the company and its investment.
Cash
Flow From Operations
The
following table depicts cash flow information for the periods ended March 31,
2008 and 2007 and from inception (May 19, 2003) to March 31, 2008:
|
|
|
|
From
Inception
|
|
|
|
Three
months ended March 31,
|
|
(May
19, 2003) to
|
|
|
|
2008
|
|
2007
|
|
March
31, 2008
|
|
Net
cash used in operating activities
|
|
$
|
(505,830
|
)
|
$
|
(1,303,078
|
)
|
$
|
(11,674,142
|
)
|
Net
cash used in investing activities
|
|
|
(1,297
|
)
|
|
(43,125
|
)
|
|
(3,092,633
|
)
|
Net
cash provided by (used in) financing activities
|
|
|
(40,058
|
)
|
|
515,244
|
|
|
14,936,291
|
|
Net
cash
used in operating activities were $505,830 during the three months ended March
31, 2008 compared to $1,303,078 during the same period in 2007, which
constitutes a decrease of $797,248. The decrease is primarily the result of
a
decrease in inventory purchasing activity and efforts to reduce our operating
expenses. From inception (May 19, 2003) through March 31, 2008 we have used
$11,674,142 to fund our operating activities.
At
March
31, 2008 we had cash on hand of $161,578 compared to cash on hand of $317,064
at
March 31, 2007, compared to $713,289 at December 31, 2007.
Cash
Flow Used in Investing Activities
Net
cash
used in investing activities for the three months ended March 31, 2008 was
approximately $1,297 compared to $43,125 for the three months ended March 31,
2007. The decrease is a result of a decrease in purchases of property and
equipment. We have used $3,092,633 for the purchase of property and equipment
from inception (May 19, 2003) through March 31, 2008.
Cash
Flow From Financing Activities
Net
cash
used to pay short term and long term debt during the three months ended March
31, 2008 and 2007, respectively was $40,058 and $13,756. We did not receive
any
proceeds from borrowings or private placements during the three months ended
March 31, 2008. During the period ended March 31, 2007, we borrowed $250,000
and
raised $279,000 from private placements.
During
the three months ended March 31, 2008, we renewed our note with Farmers State
Bank in the principal amount of $591,956. In addition, on March 24, 2008, we
obtained a line of credit with Iowa State Bank in the amount of $250,000. As
of
May 13, 2008, we have drawn $85,000 from this line of credit.
At
March
31, 2008 we had total assets of $5,258,857 and stockholders equity of $2,665,876
compared to total assets of $5,985,477 and stockholders’ equity of $3,381,158 at
December 31, 2007.
Plan
of Operation
Since
inception, we have incurred substantial operating losses and expect to incur
additional operating losses in the foreseeable future. We have financed
operations since inception primarily through equity and debt financings. We
anticipate our expenses will increase significantly only if we obtain sufficient
capital to expand our operations. Until such time, we intend to curtail our
operations and decrease our monthly expenditures.
We
expect
to continue our efforts to raise additional capital resources during 2008.
We
anticipate that increased sales of our products could commence for calendar
year
2008, subject to timely receipt of quality parts from suppliers and receipt
of
anticipated purchase orders, which may add to cash reserves. We are currently
exploring a variety of opportunities to obtain additional capital. There is
no
assurance that we will be able to raise the necessary capital or that the
capital, if available, will be available on terms that will be acceptable to
us.
We
are a
development stage enterprise and, as such, our continued existence is dependent
upon our ability to resolve our liquidity problems, principally by obtaining
additional debt or equity financing. We have yet to generate a positive internal
cash flow, and until meaningful sales of our products begin, we are dependent
upon debt and equity funding.
In
the
event that we are unable to obtain debt or equity financing or we are unable
to
obtain financing on terms and conditions that are acceptable to us, we may
have
to cease or severely curtail our operations. These factors raise substantial
doubt about our ability to continue as a going concern. So far, we have been
able to raise the capital necessary to reach this stage of product development
and have been able to obtain funding for operating requirements, but there
can
be no assurance that we will be able to continue to do so.
We
believe that the manufacture and sale of our current Oxx Power® engines, open
power units and gensets are merely the first steps toward our vision of a
carbon-free, energy independent future. We have not received the amount of
capital we anticipated receiving from investors to date. We have also
experienced delays in the receipt of quality parts for our engines and we have
experienced delays in initiating the certification process of our engines.
Our
long-term vision has been focused around three market segments: fuel delivery
and controls, by-product gas, and renewables. Capital constraints have delayed
our efforts to commercialize our intellectual property. However, we anticipate
that revenue from these sources will continue to help support our continuing
operations and assist with funding for our research and development
efforts.
Our
basic
business plan is based upon the development of our intellectual property and
the
commercialization of our technologies. We currently have nine patents pending
and expect to file several more during the next several months. In May 2008
we
were notified that our application for a patent on a
Precision
Hi-speed Generator Alignment Fixture
has been
allowed.
In
the
event that we are unable to obtain debt or equity financing or we are unable
to
obtain financing on terms and conditions that are acceptable to us, we will
not
be able to attain our goals and we may have to cease or severely curtail our
operations. These factors raise substantial doubt about our ability to continue
as a going concern. So far, we have been able to raise the capital necessary
to
reach this stage of product development and have been able to obtain funding
for
operating requirements and for construction of our manufacturing facilities,
but
there can be no assurance that we will be able to continue to do
so.
We
do not
anticipate expanding our manufacturing facilities in 2008. We anticipate our
capital expenditures for 2008 will be approximately $500,000, subject to
sufficient capital from anticipated financing.
We
believe we will have expenditures of up to $500,000 in 2008 to certify the
4.9L
engine. This testing procedure will be an expense of research and development.
We anticipate that our research and development costs could be approximately
$1
million (including this certification process) in 2008, subject to sufficient
capital from anticipated financing.
Grants
and Government Programs
The
Iowa
Department of Economic Development has provided the following funding assistance
to us:
·
Community
Economic Betterment Account Forgivable Loan (“CEBA”)
|
|
$
|
250,000
|
|
·
Physical
Infrastructure Assistance Program Forgivable Loan (“PIAP”)
|
|
$
|
150,000
|
|
·
Enterprise
Zone (estimated value)
|
|
$
|
142,715
|
|
The
CEBA
and PIAP programs provide that the loan amounts will be forgiven if we meet
certain requirements, including the creation of 49 jobs in Iowa by July 2010.
As
of March 31, 2008, we had 17 employees in Iowa. We are accruing interest on
these loans until we meet the terms.
Under
the
Enterprise Zone program, we are eligible for the following benefits provided
we
continue to meet certain Program requirements:
|
§
|
Funding
for training new employees through a supplemental new jobs withholding
credit equal to 3% of gross wages of the new jobs created;
|
|
§
|
A
refund of 100% of the sales, service and use taxes paid to contractors
and
subcontractors during the construction phase of the plant (excluding
local
option taxes);
|
|
§
|
A
6.5% research activities tax credit based on increasing research
activities within the State of Iowa;
|
|
§
|
An
investment tax credit equal to 10% of our capital investment. This
Iowa
tax credit may be carried forward for up to seven
years.
|
|
§
|
A
value-added property tax exemption. Our community has approved an
exemption from taxation on a portion of the property in which our
business
is located.
|
In
order
to receive these benefits, we must meet a number of requirements, including
the
creation of 59 new full-time equivalent jobs at the company’s headquarters by
June 28, 2008. We will not meet this requirement and are in discussions with
the
department about possible alternatives. We estimate that the amount due to
the
department if we are unable to negotiate more favorable terms would be
approximately $103,000.
We
received a partially forgivable loan in the amount of $146,124 from the Algona
Area Economic Development Corporation (“
AAEDC
”),
used
for purchase of land and construction of our manufacturing facility. If we
create 50 new jobs in Algona, Iowa by June 1, 2010 and retain those jobs through
June 1, 2015, $67,650 of this loan will be forgiven. If we create and retain
50
additional new jobs in Algona, Iowa (total of 100 jobs) by June 1, 2015 another
$67,650 of this loan will be forgiven. The balance of $10,824 will be the only
amount we repay to AAEDC, if we are successful in creating 100 new jobs. A
wage
must be paid equal to or greater than the average hourly wage for workers in
Kossuth County, Iowa, as determined annually by Iowa Workforce Development.
If
we are unsuccessful we must repay the loan with 8% interest. We are accruing
interest on this loan until we meet the terms.
Employees
We
currently have 20 employees, 17 of whom are in Algona, Iowa and 3 of whom are
in
Canada. We plan to maintain lean staffing and will only add key skill sets
as
required - mainly in the technical and sales disciplines.
Inflation
In
our
opinion, 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.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements.
ITEM
4T. CONTROLS AND PROCEDURES
EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES.
Under
the
supervision and with the participation of our management, including our Acting
Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as such term is defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934 (the "Exchange Act")). Disclosure controls and procedures
are the controls and other procedures that we designed to ensure that we record,
process, summarize and report in a timely manner the information we must
disclose in reports that we file with or submit to the Securities and Exchange
Commission under the Exchange Act. Based on this evaluation, we have concluded
that our disclosure controls and procedures were effective as of the end of
the
period covered by this report.
CHANGES
IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
As
of the
date of this report, management has initiated efforts to define, publish and
implement policies and procedures in key areas related to its internal controls
and financial reporting. Management has enhanced its review and approval
procedures in the first quarter of 2008 to include accounting reviews as it
pertains to stock conversions. Management will provide education in this area
and will have future conversions reviewed by an external subject matter
expert.
Except
as
described above, there has been no change in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the exchange act) that occurred
in
the first quarter ended March 31, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS.
We
are
not a party to any pending legal proceeding. We are not aware of any pending
legal proceeding to which any of our officers, directors, or any beneficial
holders of 5% or more of our voting securities are adverse to us or have a
material interest adverse to us.
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
During
the quarter ended March 31, 2008, we granted options to purchase 20,000 shares
to a director and options to purchase 30,000 shares to a consultant under the
company’s 2005 Incentive Compensation Plan, with exercise prices of $0.40 -
$0.50 per share. Further information about awards under the 2005 Incentive
Compensation Plan is included in our Annual Report on Form 10-KSB filed with
the
Commission on April 15, 2008, which report is incorporated herein by reference.
ITEM
6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit
No.
|
Description
|
|
|
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 Acting President and Chief Executive
Officer.
|
|
|
31.2
|
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 Sandra Batt,
the
company's Chief Financial 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
Acting President and Chief Executive Officer.
|
|
|
32.2
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002, by Sandra Batt, the company's Chief
Financial Officer.
|
−−−−−−−−−−−−−−−−
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.
Readers
should carefully review the our financial statements and the notes thereto,
as
well as the "
risk
factors
"
described in the documents we file from time to time with the Securities and
Exchange Commission, including our annual report on Form 10-KSB for the year
ended December 31, 2007.
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:
July 22, 2008
|
By
|
/s/
Theodore
G. Hollinger
|
|
|
|
Theodore
G. Hollinger
|
|
|
|
Acting
President and Chief Executive Officer
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
|
|
Date:
July 22, 2008
|
By
|
/s/
Sandra
Batt
|
|
|
|
Sandra
Batt
|
|
|
|
Chief
Financial Officer
|
|
|
|
(Principal Financial
Officer)
|
|
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